-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, TqelY4ZLw129yd8bfS4XbXXXfmBVJQtpQZYCDaqYqKX/8dyk7HUz+pLFKkFKUz+4 o//e3fkujc0h++p3bgwhZQ== 0000950153-98-000291.txt : 19980401 0000950153-98-000291.hdr.sgml : 19980401 ACCESSION NUMBER: 0000950153-98-000291 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 13 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: UGLY DUCKLING CORP CENTRAL INDEX KEY: 0001012704 STANDARD INDUSTRIAL CLASSIFICATION: PERSONAL CREDIT INSTITUTIONS [6141] IRS NUMBER: 860721358 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-20841 FILM NUMBER: 98580535 BUSINESS ADDRESS: STREET 1: 2525 E. CAMELBACK #1150 STREET 2: STE 1150 CITY: PHOENIX STATE: AZ ZIP: 85016 BUSINESS PHONE: 6028526600 MAIL ADDRESS: STREET 1: 2525 E CAMELBACK RD STREET 2: STE 1150 CITY: PHOENIX STATE: AZ ZIP: 85016 10-K 1 10-K 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ 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, 1997. 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 1150, PHOENIX, ARIZONA 85016 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) (602) 852-6600 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
TITLE OF CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED -------------- ----------------------------------------- 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 26, 1998, the aggregate market value of common stock held by non-affiliates of the registrant was approximately $138,250,000. 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 30, 1998: 18,584,977. DOCUMENTS INCORPORATED BY REFERENCE None. ================================================================================ 2 TABLE OF CONTENTS
PAGE ---- PART I Item 1 Business.................................................... 2 Item 2 Properties.................................................. 12 Item 3 Legal Proceedings........................................... 12 Item 4 Submission Of Matters To A Vote Of Security Holders......... 12 PART II Item 5 Market For The Registrant's Common Equity Securities And Related Stockholder Matters................................. 13 Item 6 Selected Consolidated Financial Data........................ 16 Item 7 Management's Discussion And Analysis Of Financial Condition And Results Of Operations................................... 17 Item 8 Consolidated Financial Statements And Supplementary Data.... 47 Item 9 Changes In And Disagreements With Accountants On Accounting And Financial Disclosures................................... 76 PART III Item 10 Directors And Executive Officers Of The Registrant.......... 76 Item 11 Executive Compensation...................................... 80 Item 12 Security Ownership Of Certain Beneficial Owners And Management.................................................. 85 Item 13 Certain Relationships And Related Transactions.............. 88 PART IV Item 14 Exhibits, Consolidated Financial Statement Schedules, And Reports On Form 8-K......................................... 89 Signatures................................................................... 93
1 3 PART I ITEM 1 -- BUSINESS GENERAL The Company operates the largest publicly-held chain of Buy Here-Pay Here used car dealerships in the United States and underwrites, finances and services retail installment contracts generated from the sale of used cars by its wholly-owned used car dealerships ("Company Dealerships") and by third party independent used car dealers ("Third Party Dealers") located in selected markets throughout the country. As part of its financing activities, the Company has initiated a collateralized dealer financing program ("Cygnet Dealer Program"), pursuant to which the Company provides qualified independent used car dealers with warehouse purchase facilities and operating credit lines primarily secured by the dealers' retail installment contract portfolio. The Company began its used car sales and financing operations in 1992 and has pursued an aggressive growth strategy since that time. The Company targets its products and services to the sub-prime segment of the automobile financing industry, which focuses on selling and financing the sale of used cars to persons who have limited credit histories, low incomes, or past credit problems. As of the date of this Form 10-K Report, the Company is operating 46 Company Dealerships located in ten metropolitan areas in seven states. The Company originated 16,001 contracts through its Company Dealerships with an aggregate principal balance of $116.8 million and purchased 37,645 contracts from Third Party Dealers with an aggregate principal balance of $209.8 million during 1997. The principal balance of the Company's total contract portfolio serviced as of December 31, 1997, was $451.3 million, including $238.0 million in contracts serviced under the Company's securitization program ("Securitization Program") and $127.3 million in contracts serviced on behalf of third parties. From 1996 to 1997, total revenues increased by 152.7% from $75.6 million to $191.1 million. The Company's net earnings grew to $9.5 million in 1997 from $5.9 million in 1996, while earnings per diluted share decreased to $0.52 from $.60 in 1996. See Part II. Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations--Introduction." For operating results and other financial data by business segment, see Note 22 to the Consolidated Financial Statements. The Company was formed in Arizona in 1992 for the purpose of purchasing Duck Ventures, Inc. and other subsidiaries and was reincorporated in Delaware in 1996. Except as otherwise specified, all references in this Form 10-K Report to the "Company" refer to Ugly Duckling Corporation and its subsidiaries. OVERVIEW OF USED CAR SALES AND FINANCE INDUSTRY Used Car Sales. The Company participates in the sub-prime segment of the independent used car sales and finance market. This segment is serviced primarily by small independent used car dealerships ("Buy Here--Pay Here dealers") that sell and finance the sale of used cars to persons who have limited credit histories, low incomes, or past credit problems ("Sub-Prime Borrowers"). Buy Here--Pay Here dealers typically offer their customers certain advantages over more traditional financing sources, such as expanded credit opportunities, flexible payment terms (including prorating customer payments due within one month into several smaller payments and scheduling payments to coincide with a customer's pay days), and the ability to make payments in person, an important feature to many Sub-Prime Borrowers who may not have checking accounts or are otherwise unable to make payments by the due date through use of the mail because of the timing of paychecks. Recently, the growth of the used car sales and finance market has attracted significant attention from a number of large companies, including AutoNation, U.S.A. and Driver's Mart, which have entered the used car sales business or announced plans to develop large used car sales operations. The Company believes that these companies are attracted by the relatively high gross margins that can be earned in this business and the lack of consolidation in this market. None of these companies have indicated an intention to focus on the Buy Here--Pay Here segment. 2 4 Used Car Financing. The automobile financing industry is the third-largest consumer finance market in the country, after mortgage debt and credit card revolving debt. The industry is served by such traditional lending sources as banks, savings and loans, and captive finance subsidiaries of automobile manufacturers, as well as by independent finance companies and Buy Here--Pay Here dealers. In general, the industry is categorized according to the type of car sold (new versus used) and the credit characteristics of the borrower. With respect to the borrowers, finance companies classify such individuals according to the following generalized criteria: - An "A" credit or "prime" borrower is a person who has a long credit history with no defaults, has been employed in the same job for a period of at least 18 months, and can easily finance a new car purchase through a bank, a captive finance subsidiary of an automobile manufacturer, or an independent finance company. - A "B" credit or "non-prime" borrower is a person who has a substantial credit history that includes late payments, an inconsistent employment history, or significant or unresolved problems with credit in the past. To finance a used car purchase, this borrower will generally not be able to obtain a loan from a captive finance subsidiary or a bank, and will have to obtain financing from an independent finance company that lends into this market category. - A "C" credit or "sub-prime" borrower generally has little or no credit history or a credit history characterized by consistently late payments and sporadic employment. Like "B" credit borrowers, "C" credit borrowers generally are not able to obtain a loan from a captive finance subsidiary or a bank, and have to obtain financing from an independent finance company that lends into this market category. - A "D" credit borrower is also referred to as a "sub-prime" borrower. These persons, however, in addition to having an unfavorable employment history, have also experienced debt charge offs, foreclosures, or personal bankruptcy. In purchasing a car, this borrower's only choice is to obtain financing from an independent finance company or through a Buy Here--Pay Here dealer. As with its used car sales operations, the Company's finance operations are directed to the sub-prime segment of the market. In particular, the finance operations of Company Dealerships are directed toward Sub-Prime Borrowers classified in the "C" and "D" categories, while its Third Party Dealer finance operations are generally directed to "C" credit borrowers. Many of the traditional lending sources do not consistently provide financing to the sub-prime consumer finance market. The Company believes traditional lenders avoid this market because of its high credit risk and the associated collection efforts. Similarly, many independent used car dealers are not able to obtain debt financing from traditional lending sources such as banks, credit unions, or major finance companies. These dealers typically finance their operations through the sale of contract receivables at a substantial discount. The Company believes that independent dealers prefer to finance their operations through credit facilities that enable them to retain their receivables, thereby increasing their finance income. Accordingly, the Company believes that there is a substantial opportunity for a company capable of serving the needs of such dealers to make significant penetration into this underdeveloped segment of the sub-prime market. The Company's Cygnet Dealer Program is intended to fill this niche. See Part I. Item 1. "Business -- Third Party Dealer Operations." RECENT ACQUISITIONS AND AGREEMENTS Acquisitions. 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 and related companies ("Kars"), including six dealerships in the Los Angeles market, two in the Miami market, two in the Atlanta 3 5 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 Company's statements of operations from the respective acquisition dates. Transactions involving First Merchants Acceptance Corporation. In recent periods, the Company has been actively involved in the reorganization proceeding of First Merchants Acceptance Corporation ("FMAC"). FMAC was in the business of purchasing and securitizing loans made primarily to Sub-Prime Borrowers by various third party used car dealers. On July 11, 1997 (the "FMAC Petition Date"), FMAC filed for reorganization under Title 11 of the United States Code (the "Bankruptcy Code") in the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court"). Concurrent with the filing of the Chapter 11 petition, the Company, which owned approximately 2.5% of FMAC's common stock, agreed to provide debtor-in-possession financing to FMAC, of which $10.9 million was outstanding at December 31, 1997. During the pendency of the proceeding, the Company acquired FMAC's senior bank debt (the "Senior Bank Debt") aggregating $103.0 million in principal amount as of the FMAC Petition Date. In connection with the acquisition of the Senior Bank Debt, the Company issued the selling bank group 389,800 warrants ("Bank Group Warrants") to purchase common stock, $.001 par value, of the Company ("Common Stock") at any time through February 20, 2000. On December 15, 1997, the Bankruptcy Court entered an order approving a transfer whereby the agent for the holders of the Senior Bank Debt credit bid this debt and purchased the contracts which secured the debt (the "Owned Contracts"), and sold the Owned Contracts to a third party purchaser (the "Contract Purchaser") for approximately $78.9 million. The Company recorded a gain of approximately $8.1 million ($5.0 million after income taxes) from this transaction. The Company has guaranteed to the Contract Purchaser a 10.35% return on the transaction subject to a maximum guarantee of $10.0 million. In connection with FMAC's proposed Plan of Reorganization (the "FMAC Plan of Reorganization"), the Company has agreed to increase its debtor-in-possession financing to up to $21.5 million if certain conditions are satisfied, to issue warrants to FMAC to purchase up to 325,000 shares of Common Stock (the "FMAC Warrants") at any time prior to February 27, 2001, and to provide FMAC an interest in any returns in respect of the Owned Contracts in excess of a formularized amount. FMAC has guaranteed such formularized amount and granted a lien on certain of its assets to secure the same. In addition, the FMAC Plan of Reorganization contemplates that on the effective date (the "Effective Date") of such Plan, the Company would acquire certain servicing rights and FMAC's servicing platform with respect to such rights, and an interest in distributions to be made under the residual interests held by FMAC in various securitization transactions. Under the FMAC Plan of Reorganization, the Company may increase its interest in the cash distributions to be made in connection with the residual interests by issuing to FMAC Common Stock in lieu of cash distributions. On March 16, 1998, the Bankruptcy Court executed a formal order confirming the FMAC Plan of Reorganization. The Effective Date of FMAC's Plan of Reorganization, however, is subject to a number of conditions precedent, which as of March 29, 1998 had not yet been satisfied. The Company cannot predict whether all of the conditions precedent to the Effective Date can be satisfied and, if so, when such Effective Date will occur. See Part II. Item 5. "Market For The Registrant's Common Equity Securities And Related Stockholder Matters" and Part II. Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources- Transactions Regarding First Merchants Acceptance Corporation." Transactions involving Reliance Acceptance Group. On February 9, 1998, the Company announced that it had agreed to enter into servicing and transition servicing arrangements with Reliance Acceptance Group, Inc. ("Reliance"). Reliance filed for reorganization under the Bankruptcy Code on February 9, 1998 (the "Reliance Petition Date"). Reliance is a national specialty finance company, primarily engaged in the business of purchasing and servicing contracts ("receivables") for the purchase of new or used automobiles, trucks, vans and sport utility vehicles by Sub-Prime Borrowers. 4 6 Pursuant to a servicing agreement entered into between Company and Reliance (the "Servicing Agreement"), the Company will service certain receivables in exchange for (i) a monthly servicing fee of the greater of four percent (4%) per annum of the aggregate outstanding principal balance of all non-defaulted receivables computed monthly on the basis of the declining balance of the receivables portfolio (consisting of Reliance's portfolio of (A) prime receivables and (B) sub-prime receivables), or fifteen dollars ($15.00) per receivable per month plus reimbursement of certain costs and expenses; (ii) $1.3 million in proceeds realized from the sale of a pool of charged off receivables existing as of the Reliance Petition Date ("Charged-Off Proceeds"); (iii) a total of (A) four percent (4%) of the outstanding principal balance of each receivable (exclusive of defaulted and certain other receivables) sold in any bulk sale to a person other than the Company or an affiliate of the Company, and (B) $4.7 million in net collections, recovery and sale proceeds from the receivables portfolio and certain other cash receipts of Reliance reduced by any amount previously paid under clause (A) above, following payment of Reliance's primary bank debt and, if applicable, repayment to Reliance of any proceeds of litigation, the Reliance Warrants (as defined below) and equity proceeds used by Reliance to pay its primary bank debt ("Post-Bank Debt Proceeds"); and (iv) following the Company's receipt of the Post-Bank Debt Proceeds, twenty-five percent (25%) of the net collections, recovery and sale proceeds from the receivables portfolio and certain other cash receipts of Reliance (the "Incentive Fee"). Reliance, in consideration for entering into the Servicing Agreement will receive privately issued warrants ("Reliance Warrants") to purchase shares of Common Stock of the Company as follows: Fifty thousand (50,000) Reliance Warrants will be granted to Reliance upon the Company's receipt of the Charged-Off proceeds; up to one hundred thousand (100,000) Reliance Warrants will be granted to Reliance based upon the Company's receipt of up to $4.7 million of Post-Bank Debt Proceeds; and Reliance will be granted an additional seventy-five thousand (75,000) Reliance Warrants for every $1 million actually received by the Company through the Incentive Fee. The Reliance Warrants are to be non-exercisable for thirty (30) months and will have a strike price of twelve dollars and 50/100 ($12.50) for the first one hundred fifty thousand (150,000) Reliance Warrants and a strike price for all other Reliance Warrants of the greater of twelve dollars and 50/100 ($12.50) or one hundred twenty percent (120%) of the market price of the Common Stock on the date of issuance of the Reliance Warrants. The Reliance Warrants will be subject to vesting and a right of redemption of the Company on terms still to be negotiated. The Servicing Agreement has not yet been approved by the Bankruptcy Court. In addition to the Servicing Agreement and granting of Reliance Warrants, the Company and Reliance have entered into a transition services agreement (the "Transition Agreement"), up and until the Servicing Agreement is approved by the Bankruptcy Court. The Bankruptcy Court has entered an order approving the Transition Agreement. Pursuant to the Transition Agreement, the Company will provide transition services to Reliance, at Reliance's request, relating to the current and future servicing of receivables, for an hourly fee of $175.00 and reimbursement of costs and expenses. In addition, the Bankruptcy Court also has approved a mutual $2.0 million breakup fee in the event the Servicing Agreement, the Transition Agreement or related agreements are terminated or materially breached by Reliance or a person other than the Company is selected as the servicer for the receivables. Similarly, if the Company breaches the Transition Agreement or elects in the future not to service the receivables pursuant to the Servicing Agreement, the Company will be required to pay a $2.0 million breakup fee to Reliance. Reliance has filed a proposed plan of reorganization, and a tentative hearing for confirmation of Reliance's proposed plan of reorganization is currently scheduled for May 22, 1998. A motion has also been filed by Reliance seeking authority to sell its charged off receivables portfolio to the highest bidder. The Company has committed to an opening credit bid amount of $1.3 million in any such sale. There can be no assurance that the Reliance transaction will be concluded on the terms and conditions outlined above or at all, or if concluded, will prove profitable. STRATEGIC EVALUATION OF THIRD PARTY DEALER OPERATIONS. In the fourth quarter of 1997, the Company announced a strategic evaluation of its Third Party Dealer operations. In connection with this strategic evaluation, the Company recently determined to close its network of Third Party Dealer contract buying offices ("Branch Offices"), exit this line of business, and record a pre- 5 7 tax charge of $6.0 million to $10.0 million in 1998. The restructuring is expected to be complete by the end of the first quarter of 1998 and includes the termination of approximately 400 to 450 employees, substantially all of whom were employed at the Company's 76 Branches Offices that were in place on the date of the announcement. The Company intends to continue to move its focus from Branch Offices to the bulk purchasing and/or servicing of large contract portfolios and other Third Party Dealer operations. The Company believes bulk purchase and large servicing transactions are more efficient methods of purchasing or obtaining servicing rights to sub-prime automobile contracts. See "Third Party Dealer Operations-Contract Purchasing and Servicing" below in this Item 1. The Company continues to evaluate strategic alternatives for its remaining Third Party Dealer operations including the potential sale or spin-off to third parties or shareholders of its third party bulk purchasing and servicing operations, Cygnet Dealer Program, insurance operations, and related portfolios. During this evaluation process, the Company plans to continue to expand its Cygnet Dealer Program. The Company believes that providing warehouse purchase facilities and operating credit lines to qualified Third Party Dealers will give such dealers a unique opportunity to obtain the debt financing necessary to expand their businesses while enabling the Company to earn additional finance income and diversify its earning asset base. The Company began full-scale marketing of the Cygnet Dealer Program during the first quarter of 1997. COMPANY DEALERSHIP OPERATIONS Company Dealership operations include the retail sale of used cars and the underwriting, financing, and servicing of contracts originated from such sales. The Company's total revenues from its Company Dealership operations were $125.3 million, $53.9 million, and $47.8 million ($46.6 million excluding sales at the Company Dealership in Gilbert, Arizona (the "Gilbert Dealership") which was closed at the end of 1995) for the years ended December 31, 1997, 1996, and 1995, respectively. See Note 22 to the Consolidated Financial Statements and Part II. Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations." Retail Car Sales. The Company distinguishes its Company Dealership operations from those of typical Buy Here--Pay Here dealers through its network of multiple locations, upgraded facilities, large inventories of used cars, centralized purchasing, value-added marketing programs, and dedication to customer service. Company Dealerships are generally located in high visibility, high traffic commercial areas, and generally are newer and cleaner in appearance than other Buy Here--Pay Here dealers, which helps promote the Company's image as a friendly and reputable business. The Company believes that these factors, coupled with its widespread brand name recognition (achieved through extensive promotion of its duck mascot and logo), enable it to attract customers who might otherwise visit another Buy Here--Pay Here dealer. Company Dealerships generally maintain an average inventory of 100 to 300 used cars and feature a wide selection of makes and models (with ages generally ranging from 5 to 10 years) and a range of sale prices, all of which enables the Company to meet the tastes and budgets of a broad range of potential customers. The Company acquires its inventory from new or late-model used car dealers, used car wholesalers, used car auctions, and customer trade-ins, as well as from repossessions. In making its purchases, the Company takes into account each car's retail value and the costs of buying, reconditioning, and delivering the car for resale. After purchase, cars are delivered to the individual dealerships or reconditioning centers, where they are inspected and reconditioned for sale. The average sales price per car at Company Dealerships was $7,443, $7,107, and $6,065 for the years ended December 31, 1997, 1996, and 1995 (exclusive of sales at the Company's Gilbert Dealership), respectively. Company Dealerships use a standardized sales contract that typically provides for down payments of approximately 10.0% to 15.0% of the purchase price with the balance of the purchase price financed at fixed interest rates generally ranging from 21.0% to 29.9% over periods generally ranging from 12 to 48 months. Except for vehicles sold under the Golden Wing Program, the Company sells cars on an "as is" basis, and requires its customers to sign an agreement at the date of sale releasing the Company from any obligation with respect to vehicle-related problems that subsequently occur. The Golden Wing Program was a marketing program which the Company tested in the Arizona market from July 1997 through December 1997 when the program was terminated. Under the Golden Wing Program, 6 8 customers were provided certain insurance including a limited drive train warranty, limited unemployment and disability insurance and a road side assistance program. See Part I. Item 3. "Legal Proceedings." Used Car Financing. The Company finances approximately 95.0% of the used cars sold at its Company Dealerships through retail installment contracts that the Company services. Subject to the discretion of its sales managers, potential customers must meet the Company's underwriting guidelines, referred to as minimum deal standards, before the Company will agree to finance the purchase of a car. The Company created these minimum deal standards to control its exposure to credit risk while providing its sales managers with sufficient flexibility to consummate sales when appropriate. In connection with each sale, customers are required to complete a credit application. Company personnel analyze and verify customer application information, which contains employment and residence histories, income information, and references, as well as the customer's personal cash flow statement (taking into account the completion of the sale), credit bureau reports, and other information regarding the customer's credit history. The Company's credit underwriting process takes into account the ability of its managers and other sales employees, who typically have extensive experience, to make sound judgments regarding the extension of credit to Sub-Prime Borrowers and to personalize financing terms to meet the needs of individual customers. For example, contract payments may be scheduled to coincide with the customer's pay days, whether weekly, biweekly, semi-monthly, or monthly. In addition, each manager makes credit approvals only after a "face-to-face" interview with the potential customer in which the manager gains firsthand information regarding the customer's financial situation, sources of income, and past credit problems. The Company believes that its customers value the expanded credit opportunities that such flexibility provides and, consequently, will pay a higher price for their cars. The Company believes that the higher prices it charges are necessary to fund the high rate of credit losses incurred as a result of financing Sub-Prime Borrowers. To the extent the Company is unable to charge such higher prices or otherwise obtain acceptable margins, its results of operations will be adversely affected. See Part II. Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Risk Factors -- Highly Competitive Industry" and "Impact of Usury Laws." Subsequent to each sale, all finance transactions are reviewed by the Company's portfolio manager for compliance with the Company's underwriting standards. To the extent such reviews reveal non-compliance, such non-compliance is discussed with dealership management and, where appropriate, remedial action is taken against the responsible manager. The Company's use of wide area and local area networks enables it to service large volumes of contracts from its centralized servicing facilities while allowing the customer the flexibility to make payments at and otherwise deal with the individual dealerships. In addition, the Company has developed comprehensive databases and sophisticated management tools, including static pool analysis, to analyze customer payment history and contract performance and to monitor underwriting effectiveness. See Part II. Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations." For a discussion of certain issues relating to the Company's loan servicing and collection systems, see Part II. Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Allowance for Doubtful Accounts and -- Risk Factors -- Data Processing and Technology and Year 2000." Advertising and Marketing. The Company's advertising campaigns generally emphasize its multiple locations, wide selection of quality used cars, and ability to provide financing to most Sub-Prime Borrowers. The Company's advertising campaign revolves around a series of radio and television commercials that feature the Company's animated duck mascot, as well as complementary billboard and print advertisements. The Company believes that its marketing approach creates brand name recognition and promotes its image as a professional, yet approachable, business, in contrast to the lack of name recognition and generally unfavorable public image of many Buy Here--Pay Here dealers. A primary focus of the Company's marketing strategy is its ability to finance consumers with poor credit histories. Consequently, the Company has initiated marketing programs designed to attract Sub-Prime 7 9 Borrowers, assist such customers in reestablishing their credit, reward those customers who pay on time, develop customer loyalty, and increase referral and repeat business. Among these programs are: - The Down Payment Back Program. This program encourages customers to make timely payments on their contracts by enabling them to receive a refund of their initial down payment (typically representing 10.0% - 15.0% of the initial purchase price of the car) at the end of the contract term if all payments have been made by the scheduled due date. - The Income Tax Refund Program. During the first quarter of each year, the Company offers assistance to customers in the preparation of their income tax returns, including forwarding customers' tax information to a designated preparer, paying the preparation fee, and, if there is a forthcoming tax refund, crediting such refund toward the required down payment. This program enables customers to purchase cars without having to wait to receive their income tax refund. - Secured Visa Card Program. Pursuant to this program, the Company arranges for qualified applicants to obtain a Visa credit card secured by a partially refundable payment of approximately $175 or $275 made by the Company to the credit card company. This program offers otherwise unqualified customers the chance to obtain the convenience of a credit card and rebuild their credit records. The Company also utilizes various telemarketing programs. For example, potential customers are contacted within several days of their visit to a Company Dealership to follow up on leads and obtain information regarding their experience while at a Company Dealership. In addition, customers with satisfactory payment histories are contacted several months before contract maturity and are offered an opportunity to purchase another vehicle with a nominal down payment requirement. The Company also maintains a loan-by-phone program utilizing its toll-free telephone number of 1-800-THE-DUCK. General Manager -- Responsibilities and Compensation. Each Company Dealership is run by a general manager who has complete responsibility for the operations of the dealership facility, including final approval of sales and contract originations, inventory maintenance, the appearance and condition of the facility, and the hiring, training, and performance of Company Dealership employees. The Company trains its managers to be contract underwriters. The Company pays its managers a base salary and allows them to earn bonuses based upon a variety of factors, including the overall performance of the contract portfolio originated. Although sales persons are paid on commission, each sale must be underwritten and approved by a manager. THIRD PARTY DEALER OPERATIONS Collateralized Dealer Financing. The Company believes that many Third Party Dealers have difficulty obtaining traditional debt financing and, as a result, are forced to sell the contracts that they originate through used car sales at deep discounts in order to obtain the working capital necessary to operate their businesses. To capitalize on this opportunity, the Company initiated the Cygnet Dealer Program, pursuant to which it provides qualified Third Party Dealers (generally, dealers that meet certain minimum net worth and operating history criteria) with warehouse purchase facilities and operating credit lines primarily secured by the dealers' retail installment contract portfolios. These credit facilities are for a specified amount 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 contracts originated. As a condition to providing such financing, the Company requires each dealer to provide its portfolio activity to the Company on a weekly basis, and provide the Company with periodic financial statements. In addition, the Company has initiated an internal audit program whereby dealers with loan balances that exceed certain amounts will be audited by the Company's internal audit department at least semi-annually. The goal of these controls is to allow Company account officers, who oversee the operations of each dealer participating in the program, to better ensure dealer compliance with financial covenants and determine the appropriateness of continued credit extensions. The Company believes that the Cygnet Dealer Program fulfills the need of Third Party Dealers for debt financing to expand their businesses while enabling the Company to earn finance income at favorable rates and diversify its earning asset base. The Company began full-scale marketing of the program during the first 8 10 quarter of 1997. As of December 31, 1997, the Company had lending relationships with a total of 42 Third Party Dealers. Contract Purchasing and Servicing. In 1994, the Company acquired Champion Financial Services, Inc., an independent automobile finance company ("Champion"), primarily for its management expertise and contract servicing software and systems. Champion had a portfolio of approximately $1.9 million in sub-prime contracts averaging approximately $2,000 in principal amount. Through its acquisition of Champion, the Company entered the Third Party Dealer financing market and, at December 31, 1997, the Company maintained 83 Third Party Dealer contract Branch Offices and had entered into contract purchasing agreements terminable at will by either party with approximately 4,000 Third Party Dealers. The Company's total revenues from its Branch Office network operations were $21.2 million, $7.8 million and $1.8 million in the years ended December 31 1997, 1996 and 1995, respectively. In February 1998, the Company announced its intention to close its Branch Office network and exit this line of business, focusing instead on the bulk purchasing and/or servicing of large contract portfolios and other Third Party Dealer operations in connection with the Cygnet Dealer Program. See Part I. Item 1. "Business -- Strategic Evaluation of Third Party Dealer Operations." In recent periods the Company has entered into several large servicing or bulk purchasing transactions involving Third Party Dealer contract portfolios and, in some cases, has sold or securitized these portfolios, with servicing retained. For example, in the Seminole and EZ Plan acquisitions described above in this Item 1, the Company acquired contract portfolios of approximately $31.1 million and $24.3 million, respectively. In the Kars transaction described above in this Item 1, the Company did not acquire the contract portfolio of Kars, but acquired its loan servicing assets and began servicing Kars retained portfolio and portfolios previously securitized by Kars, which aggregated approximately $127.3 million at December 31, 1997. In the FMAC transaction described above in this Item 1, on the Effective Date of FMAC's Plan of Reorganization, the Company will acquire the servicing platform of FMAC and rights to service receivables with a face amount as of February 28, 1998 of approximately $438.9 million, including approximately $355.5 million of receivables previously securitized by FMAC and held in certain securitized pools (the "Securitized Pools") of FMAC. For further details concerning the Company's involvement in the FMAC bankruptcy case, see Part II. Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources -- Transactions Regarding First Merchants Acceptance Corporation." Similarly, in the Reliance transaction described above in this Item 1, the Servicing Agreement entered into between the Company and Reliance, subject to Bankruptcy Court approval, would allow the Company to service certain receivables of Reliance aggregating approximately $213.9 million as of December 31, 1997. The Company plans to continue to seek out new opportunities for large servicing and/or bulk purchasing transactions. Insurance Services. The retail installment contracts that the Company purchases from Third Party Dealers generally require the customers to obtain casualty insurance within 30 days of their vehicle purchase. While all customers are free to obtain such coverage from an insurer of their choice, if a customer fails to obtain the required coverage, the Company may purchase a policy on the customer's behalf and charge back to the customer the cost of the premiums and fees associated with such policy. The Company's ability to force place such insurance has significantly increased the number of customers who have obtained their own casualty insurance. To facilitate its ability to force place mandated insurance coverage, the Company has contracted with American Bankers Insurance Group ("ABIG"), a licensed property, casualty, and life insurance company. Through its subsidiary, Drake Insurance Agency, Inc., which acts as agent for ABIG, the Company places casualty insurance policies issued by ABIG with Third Party Dealer Branch Office customers. These policies provide for a maximum payment on a claim equal to the current contract principal balance. ABIG, in turn, reinsures the policies it issues with Drake Property & Casualty Insurance Company, one of the Company's Turks and Caicos Islands-chartered and licensed reinsurance subsidiaries. Under the terms of its relationship with ABIG, the Company earns commissions on each policy issued by ABIG (which may mitigate any credit loss the Company suffers in the event of an otherwise uninsured casualty), while ABIG administers all accounts and claims and is responsible for regulatory compliance. As of December 31, 1997, the Company had placed casualty insurance policies with approximately 1,000 customers. 9 11 MONITORING AND COLLECTIONS One of the Company's goals is to minimize credit losses through close monitoring of contracts in its portfolio. Relating to this, upon the origination or purchase of a contract, Company personnel enter all terms of the contract into the Company's computer systems. The Company's monitoring and collections staff then utilize the Company's collections software to monitor the performance of the contracts. The Company currently services its loan portfolios on loan servicing and collection data processing systems on various platforms. See Part II. Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Risk Factors -- Data Processing and Technology and Year 2000." The collections software provides the Company with, among other things, up-to-date activity reports, allowing immediate identification of customers whose accounts have become past due. In accordance with Company policy, collections personnel contact a customer with a past due account within three days of delinquency (or in the case of first payment delinquencies, within one day) to inquire as to the reasons for such delinquency and to suggest ways in which the customer can resolve the underlying problem, thereby enabling the customer to continue making payments and retain the car. The Company's early detection of a customer's delinquent status, as well as its commitment to working with its customers, allows it to identify and address payment problems quickly, thereby reducing the amount of its credit loss. See Part II. Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Allowance for Credit Losses." If the Company's efforts to work with a customer are unsuccessful and the customer becomes seriously delinquent, the Company will take the necessary steps to protect its collateral. Frequently, delinquent customers will recognize their inability to honor their contractual obligations and will work with the Company to coordinate "voluntary repossessions" of their cars. For cases involving uncooperative customers, the Company retains independent firms to repossess the cars pursuant to prescribed legal procedures. Upon repossession and after a statutorily-mandated waiting period, the Company will recondition the car, if necessary, and sell it in the wholesale market or at retail through its Company Dealerships. The Company estimates that it recovers over 90.0% of the cars that it attempts to repossess, approximately 90.0% of which are sold on a wholesale basis and the remainder of which are sold through Company Dealerships. Unlike most other used car dealerships with multiple locations or automobile finance companies, the Company permits its customers to make cash payments on their contracts in person at Company Dealerships or at the Company's collection facilities. Cash payments account for a significant portion of monthly contract receipts on the Company Dealership portfolio. The Company's computer technology enables it to process these payments on-line in real time and its internal procedures enable it to verify that such cash receipts are deposited and credited to the appropriate accounts. COMPETITION Although the used car industry has historically been highly fragmented, it has attracted significant attention recently from a number of large companies, including AutoNation, U.S.A. and Driver's Mart, which 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. The Company believes that these companies are attracted by the relatively high gross margins that can be achieved in this market as well as the industry's lack of consolidation. Many of these companies and franchised dealers have significantly greater financial, marketing, and other resources than the Company. However, none of these companies have indicated an intention to focus on the Buy Here-Pay Here segment of the market. The Company's primary competition for its Company Dealerships are the numerous independent Buy Here-Pay Here dealers that sell and finance sales of used cars to Sub-Prime Borrowers. The Company distinguishes its direct sales and financing operations from those of typical Buy Here-Pay Here dealers by providing multiple locations, upgraded facilities, large inventories of used automobiles, centralized purchasing on a regional basis, value-added marketing programs, and dedication to customer service. In addition, the Company has developed flexible underwriting guidelines and techniques to facilitate rapid credit decisions, as 10 12 well as an integrated, technology-based corporate infrastructure that enables the Company to monitor and service large volumes of contracts. The sub-prime segment of the used car financing business is also highly fragmented and very competitive. In recent years, several consumer finance companies have completed public offerings in order to raise the capital necessary to fund expansion and support increased purchases of used car retail installment contracts. These companies have increased the competition for the purchase of contracts, in many cases purchasing contracts at prices which the Company believes are not commensurate with the associated risk. In addition, there are numerous financial services companies serving, or capable of serving, this market. While traditional financial institutions, such as commercial banks, savings and loans, credit unions, and captive finance companies of major automobile manufacturers, have not consistently serviced Sub-Prime Borrowers, the high rates of return earned by companies involved in sub-prime financing have encouraged certain of these traditional institutions to enter, or contemplate entering, this market. Increased competition may cause downward pressure on the interest rate the Company charges on contracts originated by its Company Dealerships or cause the Company to reduce or eliminate the nonrefundable acquisition discount on bulk purchases of contracts it purchases. Such events would have a material adverse affect on the Company. Similarly, increased competition may be a possible reason for a Company sale or spin-off of certain of its business segments, including its Third Party Dealer operations. See Part I. Item 1. "Business- Strategic Evaluation of Third Party Dealer Operations." REGULATION, SUPERVISION, AND LICENSING The Company's operations are subject to ongoing regulation, supervision, and licensing under various federal, state, and local statutes, ordinances, and regulations. Among other things, these laws require that the Company obtain and maintain certain licenses and qualifications, limit or prescribe terms of the contracts that the Company originates and/or purchases, require specified disclosures to customers, limit the Company's right to repossess and sell collateral, and prohibit the Company from discriminating against certain customers. The Company is also subject to federal and state franchising and insurance laws. The Company typically charges fixed interest rates significantly in excess of traditional finance companies on the contracts originated at its Company Dealerships and on the Third Party Dealer contracts it purchases. Historically, a significant portion of the Company's used car sales activities were conducted in, and a significant portion of the contracts the Company services were originated in Arizona, which does not impose limits on the interest rate that a lender may charge. However, the Company has expanded, and will continue to expand, its operations into states that impose usury limits, such as Florida and Texas. The Company attempts to mitigate these rate restrictions by attempting to obtain higher sales prices on the cars it sells, and by purchasing contracts originated in these states at a higher discount. The Company believes that it is currently in substantial compliance with all applicable federal, state, and local laws and regulations. There can be no assurance, however, that the Company will be able to remain in compliance with such laws, and such failure could have a material adverse effect on the operations of the Company. In addition, the adoption of additional statutes and regulations, changes in the interpretation of existing statutes and regulations, or the Company's entrance into jurisdictions with more stringent regulatory requirements could have a material adverse effect on the Company's business. TRADEMARKS AND PROPRIETARY RIGHTS The Company has obtained federal trademark registrations on its duck mascot and logo, as well as for the trade names "Ugly Duckling Car Sales," "Ugly Duckling Rent-A-Car," and "America's Second Car." These registrations are effective through 2002 and are renewable for additional terms of ten years. The Company grants its Ugly Duckling Rent-a-Car franchisees the limited right to use its duck mascot and logo in their used car rental operations. The Company has also obtained a federal trademark registration for the slogan "Putting You On the Road to Good Credit." The Company licenses software from various third parties. It has also developed and copyrighted customized software to facilitate its sales and financing activities. Although the Company believes it takes 11 13 appropriate measures to protect its proprietary rights and technology, there can be no assurance that such efforts will be successful. The Company believes it is in material compliance with all third party licensing requirements. EMPLOYEES At December 31, 1997, the Company employed approximately 2,300 persons. None of the Company's employees are covered by a collective bargaining agreement. SEASONALITY Historically, the Company has experienced higher same store revenues in the first two quarters of the year than in the latter half of the year. The Company believes that these results are due to seasonal buying patterns resulting in part from the fact that many of its customers receive income tax refunds during the first half of the year, which are a primary source of down payments on used car purchases. ITEM 2 -- PROPERTIES As of December 31, 1997, the Company owned the property on which eight of its dealerships, two of its collection facilities, and three of its reconditioning facilities are located. In addition, the Company leased 126 other facilities, of which 83 were Branch Office locations that the Company closed in 1997 or plans on closing in 1998. The Company's corporate headquarters is located in approximately 30,000 square feet of leased space in Phoenix, Arizona. ITEM 3 -- LEGAL PROCEEDINGS Except for vehicles sold under the Golden Wing Program, the Company sells its cars on an "as is" basis, and requires all customers to sign an agreement on the date of sale pursuant to which the Company disclaims any obligation for vehicle-related problems that subsequently occur. Although the Company believes that such disclaimers are enforceable under applicable law, there can be no assurance that they will be upheld in every instance. Despite obtaining these disclaimers, the Company, in the ordinary course of business, receives complaints from customers relating to such vehicle-related problems as well as alleged violations of federal and state consumer lending or other similar laws and regulations. While most of these complaints are made directly to the Company or to various consumer protection organizations and are subsequently resolved, the Company is named occasionally as a defendant in civil suits filed by customers in state, local, or small claims courts. There can be no assurance that the Company will not be a target of similar claims in the future. Although the amount of the ultimate exposure of the above, if any, cannot be determined at this time, the Company, based on the advice of counsel, does not expect the final outcome to have a material adverse effect on its financial position. ITEM 4 -- SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 12 14 PART II ITEM 5 -- MARKET FOR THE REGISTRANT'S COMMON EQUITY SECURITIES AND RELATED STOCKHOLDER MATTERS The Company's Common Stock trades on the Nasdaq Stock Market under the symbol "UGLY." The Company's initial public offering was effected on June 17, 1996. The high and low closing sales prices of the Common Stock, as reported by Nasdaq since that date are reported below.
MARKET PRICE ---------------- HIGH LOW ------ ------ FISCAL YEAR 1996: Second Quarter (from June 18, 1996)......................... $10.00 $ 8.50 Third Quarter............................................... $15.50 $ 8.13 Fourth Quarter.............................................. $21.63 $13.00 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 (through March 22, 1998)...................... $10.88 $ 6.31
On March 26, 1998 there were approximately 200 record owners of the Company's Common Stock. The Company estimates that as of such date there were approximately 3,200 beneficial owners of the Company's Common Stock. Dividend Policy. The Company has never paid cash dividends on its Common Stock and does not anticipate doing so in the foreseeable future. It is the current policy of the Company's Board of Directors to retain any earnings to finance the operation and expansion of the Company's business. In addition, the terms of certain of the Company's credit agreements from time to time may restrict the Company's ability to pay dividends. In this regard, the revolving facility agreement (the "Revolving Facility") with General Electric Capital Corporation ("GE Capital") prevents the Company from declaring or paying dividends in excess of 15.0% of each year's net earnings available for distribution. See Part II. Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources -- Revolving Facility." Reincorporation. On April 24, 1996, the Company reincorporated from Arizona to Delaware by way of a merger in which the Company, an Arizona corporation, merged with and into a newly created Delaware subsidiary of the Company. In the merger, each share of the Arizona corporation's issued and outstanding common stock was exchanged for 1.16 shares of the Delaware corporation's common stock and each option to purchase shares of the Arizona corporation's common stock was exchanged for 1.16 options to purchase shares of the Delaware corporation's common stock. All share figures set forth herein give effect to this exchange ratio. Warrant Issuances. In connection with the Company's initial public offering, the Company issued warrants to Cruttenden Roth Incorporated to purchase 170,000 shares of Common Stock at an exercise price per share of $9.45 at any time through June 21, 2001. The warrants were issued in exchange for $1,700 pursuant to an Underwriting Agreement between the Company and Cruttenden Roth, as the representative of the several underwriters in the initial public offering, and pursuant to a Representative's Warrant Agreement between the Company and Cruttenden Roth. In connection with the FMAC transaction, in August 1997, the Company issued Bank Group Warrants to members of the FMAC bank group to purchase 389,800 shares of Common Stock at an exercise price per share of $20.00, and on the Effective Date of FMAC's Plan of Reorganization, the Company will issue FMAC Warrants to FMAC to purchase 325,000 shares of Common Stock at an exercise price per share of $20.00. 13 15 See Part II. Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources -- Transactions Regarding First Merchants Acceptance Corporation." In February 1998, in connection with the Company's execution of a senior subordinated debt agreement, the Company issued warrants to the lenders to purchase 500,000 shares of Common Stock at an exercise price per share of $10.00. See Part II. Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." Subordinated Debt Conversion. In connection with the Company's initial public offering, on June 21, 1996, SunAmerica Life Insurance Company ("SunAmerica") converted $3,000,000 of subordinated debt into Common Stock (444,444 shares at the initial public offering price of $6.75 per share) in accordance with the terms of a Convertible Note, dated as of August 31, 1995. In addition, in partial consideration for SunAmerica's agreement to convert the Convertible Note, the Company issued warrants to SunAmerica on June 21, 1996, to purchase 121,023, as adjusted, shares of Common Stock at an exercise price per share of $6.75 at any time through June 21, 2006. Private Placement. On February 13, 1997, the Company sold 5,075,500 shares of Common Stock to approximately 115 institutional purchasers for an aggregate purchase price of approximately $94.5 million. Friedman, Billings, Ramsey & Co., Inc. acted as placement agent in the transaction. The total proceeds to the Company, net of discounts and commissions, was approximately $89.8 million before deducting offering expenses. Potential Issuance of Dilutive Securities. In connection with the confirmed FMAC Plan of Reorganization, and assuming that the Effective Date has occurred, the Company has the right to issue up to 5,000,000 shares of its Common Stock ("Stock Option Shares") to FMAC in lieu of making cash distributions otherwise payable to FMAC from proceeds of certain residual interests in securities held by FMAC or its subsidiaries. Should the Company make such an election, it would issue all or a portion of the Stock Option Shares for 98% of the average of the closing prices of the Company's Common Stock for the ten trading days prior to the date of issuance and would thereafter retain the cash distributions collected from such residual interests. See Part II. Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources -- Transactions Regarding First Merchants Acceptance Corporation." Such an issuance could prove to be dilutive for the Company's then existing stockholders. For a description of certain debt issuances during the first quarter of 1998, see Part II. Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." Securities Act Compliance. Exemption from registration for the reincorporation, the warrant issuances, the subordinated debt conversions, the first quarter debt issuances, and the private placement was claimed pursuant to Section 4(2) of the Securities Act of 1933, as amended (the "Securities Act"), regarding transactions by an issuer not involving any public offering and/or pursuant to Rule 145 under the Securities Act regarding transactions the sole purpose of which is to change an issuer's domicile solely within the United States. The issuance of the FMAC Warrants and underlying Common Stock or the distribution or resale thereof by FMAC and the issuance of Stock Option Shares or the distribution or resale thereof by FMAC have been registered by the Company under the Securities Act. FACTORS THAT MAY AFFECT FUTURE STOCK PERFORMANCE The performance of the Company's Common Stock is dependent upon numerous factors including those set forth below and in Part II. Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Risk Factors." Control by Principal Stockholder. Mr. Ernest C. Garcia, II, the Company's Chairman, Chief Executive Officer, and principal stockholder, holds 25.1% of the outstanding Common Stock. As a result, Mr. Garcia will have a significant influence upon the activities of the Company, as well as on all matters requiring approval of the stockholders, including electing or removing members of the Company's Board of Directors, causing the 14 16 Company to engage in transactions with affiliated entities, causing or restricting the sale or merger of the Company, and changing the Company's dividend policy. Potential Anti-Takeover Effect of Preferred Stock. The Company's Certificate of Incorporation authorizes the Company to issue "blank check" Preferred Stock, the designation, number, voting powers, preferences, and rights of which may be fixed or altered from time to time by the Board of Directors. Accordingly, the Board of Directors has the authority, without stockholder approval, to issue Preferred Stock with dividend, conversion, redemption, liquidation, sinking fund, voting, and other rights that could adversely affect the voting power or other rights of the holders of the Common Stock. The Preferred Stock could be utilized, under certain circumstances, to discourage, delay, or prevent a merger, tender offer, or change in control of the Company that a stockholder might consider to be in its best interests. Although the Company has no present intention of issuing any shares of its authorized Preferred Stock, there can be no assurance that the Company will not do so in the future. Shares Eligible for Future Sale. Approximately 5,432,000 shares of Common Stock outstanding as of March 26, 1998 were "restricted securities," as that term is defined under Rule 144 promulgated under the Securities Act. In general, under Rule 144 as currently in effect, subject to the satisfaction of certain other conditions, if one year has elapsed since the later of the date of acquisition of restricted shares from an issuer or an affiliate of an issuer, the acquiror or subsequent holder is entitled to sell in the open market, within any three-month period, a number of shares that does not exceed the greater of one percent of the outstanding shares of the same class or the average weekly trading volume during the four calendar weeks preceding the filing of the required notice of sale. (A person who has not been an affiliate of the Company for at least the three months immediately preceding the sale and who has beneficially owned shares of Common Stock as described above for at least two years is entitled to sell such shares under Rule 144 without regard to any of the limitations described above.) Of the "restricted securities" outstanding at March 26, 1998, substantially all of these shares have either been held for the one-year holding period required under Rule 144 or were subsequently registered for resale under the Securities Act. No predictions can be made with respect to the effect, if any, that sales of Common Stock in the market or the availability of shares of Common Stock for sale under Rule 144 will have on the market price of Common Stock prevailing from time to time. Nevertheless, the possibility that substantial amounts of Common Stock may be sold in the public market may adversely affect prevailing market prices for the Common Stock. In addition, the Company has issued a substantial number of warrants as discussed above in this Item 5, which warrants and/or Common Stock underlying such warrants have or may be registered by the Company under the Securities Act for resale by the holders thereof, and may issue the FMAC Warrants, Reliance Warrants and the Stock Option Shares and/or other warrants and shares of Common Stock in the future, all of which may further dilute the Company's equity and could adversely affect the market and price for the Common Stock. Possible Volatility of Stock Price. The market price of the Common Stock could be subject to significant fluctuations in response to such factors as, among others, variations in the anticipated or actual results of operations of the Company or other companies in the used car sales and finance industry, general trends in the industry, changes in conditions affecting the economy generally, analyst reports, and other factors. 15 17 ITEM 6 -- SELECTED CONSOLIDATED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE AND OPERATING DATA) The following table sets forth selected historical consolidated financial data of the Company for each of the years in the five-year period ended December 31, 1997. The selected annual historical consolidated financial data for 1997, 1996, 1995, 1994, and 1993 are derived from the Company's Consolidated Financial Statements audited by KPMG Peat Marwick LLP, independent certified public accountants. For additional information, see the Consolidated Financial Statements of the Company included elsewhere in this report. The following table should be read in conjunction with Part II. Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations."
YEARS ENDED DECEMBER 31, ------------------------------------------------------- 1997 1996 1995 1994 1993 -------- -------- -------- -------- ------- STATEMENT OF OPERATIONS DATA: Sales of Used Cars................... $123,814 $ 53,768 $ 47,824 $ 27,768 $13,969 Less: Cost of Used Cars Sold............. 66,509 29,890 27,964 12,577 6,089 Provision for Credit Losses........ 24,075 9,811 8,359 8,140 3,292 -------- -------- -------- -------- ------- 33,230 14,067 11,501 7,051 4,588 -------- -------- -------- -------- ------- Interest Income...................... 34,384 15,856 10,071 5,449 1,629 Gain on Sale of Loans................ 21,713 4,434 -- -- -- Servicing Income..................... 7,230 921 -- -- -- Other Income......................... 3,977 650 308 556 879 -------- -------- -------- -------- ------- 67,304 21,861 10,379 6,005 2,508 -------- -------- -------- -------- ------- Income before Operating Expenses..... 100,534 35,928 21,880 13,056 7,096 Operating Expenses: Selling and Marketing.............. 10,567 3,585 3,856 2,402 1,293 General and Administrative......... 65,000 19,538 14,726 9,141 3,625 Depreciation and Amortization...... 3,683 1,577 1,314 777 557 -------- -------- -------- -------- ------- 79,250 24,700 19,896 12,320 5,475 -------- -------- -------- -------- ------- Income before Interest Expense....... 21,284 11,228 1,984 736 1,621 Interest Expense..................... 5,260 5,262 5,956 3,037 893 -------- -------- -------- -------- ------- Earnings (Loss) before Income Taxes.............................. 16,024 5,966 (3,972) (2,301) 728 Income Taxes (Benefit)............... 6,579 100 -- (334) 30 -------- -------- -------- -------- ------- Net Earnings (Loss).................. $ 9,445 $ 5,866 $ (3,972) $ (1,967) $ 698 ======== ======== ======== ======== ======= Basic Earnings (Loss) per Share...... $ 0.53 $ 0.63 $ (0.72) $ (0.35) $ 0.14 ======== ======== ======== ======== ======= Diluted Earnings (Loss) per Share.... $ 0.52 $ 0.60 $ (0.72) $ (0.35) $ 0.14 ======== ======== ======== ======== ======= Basic Shares......................... 17,832 7,887 5,522 5,584 5,011 ======== ======== ======== ======== ======= Diluted Shares....................... 18,234 8,298 5,522 5,584 5,011 ======== ======== ======== ======== ======= BALANCE SHEET DATA: Cash and Cash Equivalents............ $ 3,537 $ 18,455 $ 1,419 $ 168 $ 79 Finance Receivables, Net............. 123,093 60,952 40,726 15,858 7,089 Total Assets......................... 279,054 118,083 60,790 29,711 11,936 Subordinated Notes Payable........... 12,000 14,000 14,553 18,291 8,941 Total Debt........................... 77,171 26,904 49,754 28,233 9,380 Preferred Stock...................... -- -- 10,000 -- -- Common Stock......................... 172,622 82,612 127 77 1 Total Stockholders' Equity (Deficit).......................... 181,774 82,319 4,884 (1,194) 697 Principal Balances Serviced: Dealership Sales Portfolio......... 55,965 7,068 34,226 19,881 9,588 Third Party Dealer Portfolio....... 29,965 51,213 13,805 1,620 -- Portfolio Securitized with Servicing Retained.............. 238,025 51,663 -- -- -- Servicing on Behalf of Others........ 127,322 -- -- -- -- -------- -------- -------- -------- ------- Total Serviced Portfolios............... $451,277 $109,944 $ 48,031 $ 21,501 $ 9,588 ======== ======== ======== ======== =======
16 18
YEARS ENDED DECEMBER 31, ------------------------------------------------------- 1997 1996 1995 1994 1993 -------- -------- -------- -------- ------- DEALERSHIP OPERATING DATA (UNAUDITED): Average Sales Price per Car.......... $ 7,443 $ 7,107 $ 6,478 $ 5,269 $ 4,159 Number of Used Cars Sold............. 16,636 7,565 7,383 5,270 3,359 Company Dealerships.................. 41 8 8 8 5 Number of Contracts Originated....... 16,001 6,929 6,129 4,731 3,093 Principal Balances Originated (000 Omitted)...................... $116,830 $ 48,996 $ 36,568 $ 23,589 $12,984 Retained Portfolio: Number of Contracts Outstanding...... 7,993 1,045 8,049 5,515 2,929 Allowance as % of Outstanding Principal.......................... 18.5% 23.0% 21.9% 30.4% 30.0% Average Principal Balance Outstanding........................ $ 7,002 $ 6,764 $ 4,252 $ 3,605 $ 3,273 Average Yield on Contracts........... 26.7% 29.2% 28.0% 28.2% 26.4% Delinquencies -- Retained Portfolio: Principal Balances 31 to 60 Days..... 2.2% 2.3% 4.2% 5.1% 10.5% Principal Balances over 60 Days...... 0.6% 0.6% 1.1% 1.3% 15.0% THIRD PARTY OPERATING DATA (UNAUDITED)(1): Number of Contracts Purchased........ 37,645 9,825 3,012 1,423 -- Principal Balances Purchased (000 Omitted)...................... $209,773 $ 56,770 $ 16,455 $ 3,607 $ -- Number of Branch Offices............. 83 35 8 1 -- Number of Third Party Dealers........ 4,000 1,400 118 20 -- Retained Portfolio: Number of Contracts Outstanding...... 5,845 10,900 2,733 726 -- Allowance as % of Outstanding Principal.......................... 12.0% 12.7% 7.2% 9.8% -- Average Principal Balance Outstanding........................ $ 5,127 $ 5,252 $ 5,051 $ 2,232 $ -- Average Yield on Contracts........... 23.5% 25.8% 26.7% 30.9% -- Delinquencies -- Retained Portfolio: Principal Balances 31 to 60 days..... 1.5% 3.1% 1.2% 6.0% -- Principal Balances over 60 days...... 2.3% 1.1% 0.4% 2.6% -- Per Branch Office Contract Purchased: Average Discount..................... $ 706 $ 660 $ 551 $ 504 $ -- Average Percent Discount............. 12.3% 11.4% 10.1% 12.5% --
- --------------- (1) The Company recently determined to close its network of Branch Offices and exit this line of business. The Company will continue to focus on the bulk purchasing and/or servicing of large contract portfolios and other Third Party Dealer operations. See Part I. Item 1. "Business -- Strategic Evaluation of Third Party Dealer Operations." ITEM 7 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD LOOKING STATEMENTS This report contains forward looking statements. Additional written or oral forward looking statements may be made by the Company from time to time in filings with the Securities and Exchange Commission or otherwise. Such forward looking statements are within the meaning of that term in Section 27A of the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Such statements may include, but not be limited to, projections of revenues, income, or loss, estimates of capital expenditures, plans for future operations, products or services, and financing needs or plans, as well as assumptions relating to the foregoing. The words "believe," "expect," "anticipate," "estimate," "project," and similar expressions identify forward looking statements, which speak only as of the date the statement was made. Forward looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified. Future events and actual results could differ materially from those set forth in, contemplated by, or underlying the forward looking statements. The Company undertakes no obligation to 17 19 publicly update or revise any forward looking statements, whether as a result of new information, future events, or otherwise. The following disclosures, as well as other statements in this Report on Form 10-K, including those contained below in Part II. Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations," and Part II. Item 5. "Market for the Registrant's Common Equity Securities and Related Stockholders Matters," and in the Notes to the Company's Consolidated Financial Statements, describe factors, among others, that could contribute to or cause such differences, or that could affect the Company's stock price. INTRODUCTION General. The Company operates the largest publicly-held chain of Buy Here-Pay Here used car dealerships in the United States and underwrites, finances and services retail installment contracts generated from the sale of used cars by its Company Dealerships and by Third Party Dealers located in selected markets throughout the country. As part of its financing activities, the Company has initiated its Cygnet Dealer Program, pursuant to which the Company provides qualified independent used car dealers with warehouse purchase facilities and operating credit lines primarily secured by the dealers' retail installment contract portfolio. In addition, the Company purchases loan portfolios in bulk and services loan portfolios on behalf of third parties. The Company targets its products and services to the sub-prime segment of the automobile financing industry, which focuses on selling and financing the sale of used cars to Sub-Prime Borrowers. The Company commenced its used car sales and finance operations with the acquisition of two Company Dealerships in 1992. During 1993, the Company acquired three additional Company Dealerships. In 1994, the Company constructed and opened four new Company Dealerships that were built specifically to meet the Company's new standards of appearance, reconditioning capabilities, size, and location. During 1994, the Company closed one Company Dealership because the facility failed to satisfy these new standards and, at the end of 1995, closed its Gilbert Dealership. In July 1996, the Company opened an additional dealership in Arizona. In January 1997, the Company acquired selected assets of a group of companies engaged in the business of selling and financing used motor vehicles, including four dealerships located in the Tampa Bay/St. Petersburg market (Seminole). In March 1997, the Company opened its first used car dealership in the Las Vegas market. In April 1997, the Company acquired selected assets of a company in the business of selling and financing used motor vehicles, including seven dealerships located in the San Antonio market (EZ Plan). In August 1997, the Company closed a dealership in Prescott, Arizona which was opened in July 1996. In September 1997, the Company acquired selected assets of a company in the business of selling used motor vehicles, including six dealerships in the Los Angeles market, two in the Miami market, two in the Atlanta market and two in the Dallas market (Kars). In addition, the Company opened two additional dealerships in the Albuquerque market and three additional dealerships in the Phoenix market, one additional dealership in the Tampa/St. Petersburg market, and four additional dealerships in the Atlanta market during 1997. The Company operated 41 and 8 dealerships at December 31, 1997 and 1996, respectively. For substantially all of 1995, the Gilbert Dealership was used by the Company to evaluate the sale of later model used cars. These cars had an average age of approximately three years, which is two to seven years newer than the cars typically sold at Company Dealerships, and cost more than twice that of typical Company Dealership cars. The Company determined that its standard financing program could not be implemented on these higher cost cars. Furthermore, operation of this dealership required additional corporate infrastructure to support its market niche, such as distinct advertising and marketing programs, which the Company was unable to leverage across its other operations. Accordingly, the Company terminated this program, and sold the land, dealership building, and other improvements to a third party for $1.7 million. Pursuant to this sale and the disposition of other assets, the Company recognized a loss of approximately $221,000. During fiscal year 1995, the Gilbert Dealership produced sales of $9.5 million (average of $8,946 per car sold) and gross profits (Sales of Used Cars less Cost of Used Cars Sold) of $2.2 million (average of $2,060 per car sold), and the Company incurred selling and marketing expenses of $627,000 (average of $593 per car sold). The results of operations discussed below have been adjusted as if the Gilbert Dealership had been terminated as of December 31, 1994, as management believes these pro forma results are more indicative of ongoing operations. Accordingly, 1995 amounts followed by "(pro forma)" have been adjusted to eliminate Gilbert Dealership operations. For 18 20 the Company's actual 1995 results, including the Gilbert Dealership, see Part II. Item 6. "Selected Consolidated Financial Data" and Part II. Item 8. "Consolidated Financial Statements and Supplementary Data." In 1996 the Company completed an initial public offering and a secondary offering in which it sold common stock for a total of $82.3 million. In February 1997, the Company completed a private placement of common stock for a total of $88.7 million, net of expenses. The registration of the resale of the shares sold in the private placement became effective in April 1997. Restructuring of Third Party Dealer Operations. In 1994, the Company acquired Champion Financial Services, Inc., an independent automobile finance company. In April 1995, the Company initiated an aggressive plan to expand the number of contracts purchased from its Third Party Dealer Branch Office network. The Company operated 83 and 22 Branch Offices at December 31, 1997 and 1996, respectively. In February 1998, the Company announced its intention to close its Branch Office network, exit this line of business, and record a pre-tax restructuring charge of $6.0 million to $10.0 million in the first quarter of 1998. The restructuring is expected to be complete by the end of the first quarter of 1998 and include the termination of approximately 400 to 450 employees, substantially all of whom are employed at the Company's 76 Branch Offices that were in place on the date of the announcement. Following the Branch Office closures, the Company will focus instead on the bulk purchasing and/or servicing of large contract portfolios and other Third Party Dealer operations. The Company believes bulk purchase and large servicing transactions are more efficient methods of purchasing or obtaining servicing rights to sub-prime automobile contracts. In this regard, the Company has effected certain transactions with FMAC and may also acquire significant servicing and other rights from FMAC on the Effective Date of FMAC's Plan of Reorganization, and has entered into a Servicing Agreement in the Reliance bankruptcy case that, subject to Bankruptcy Court approval, will allow the Company to obtain additional servicing rights. See Part I. Item 1. "Business -- Third Party Dealer Operations -- Contract Purchasing and Servicing," and "Transactions Regarding First Merchants Acceptance Corporation" below in this Item 7. The Company is in the process of expanding its Cygnet Dealer Program pursuant to which the Company provides Third Party Dealers with warehouse purchase facilities and operating credit lines primarily secured by the dealers' retail installment contract portfolios and inventory. The Company is currently evaluating strategic alternatives for its remaining Third Party Dealer operations including the potential sale or spin-off to third parties or shareholders of its third party bulk purchasing and servicing operations, Cygnet Dealer Program, insurance operations, and related portfolios. The following discussion and analysis provides information regarding the Company's consolidated financial position as of December 31, 1997 and 1996, and its results of operations for the years ended December 31, 1997, 1996, and 1995. Growth in Finance Receivables. As a result of the Company's rapid expansion, contract receivables serviced increased by 310.6% to $451.3 million at December 31, 1997 (including $238.0 million in contracts serviced under the Company's Securitization Program and $127.3 million serviced on behalf of others) from $109.9 million at December 31, 1996 (including $51.7 million in contracts serviced under the Company's Securitization Program). 19 21 The following tables reflect the growth in period end balances measured in terms of the principal amount and the number of contracts. TOTAL CONTRACTS OUTSTANDING: (IN THOUSANDS, EXCEPT NUMBER OF CONTRACTS)
DECEMBER 31, ------------------------------------------------ 1997 1996 ---------------------- ---------------------- PRINCIPAL NO. OF PRINCIPAL NO. OF AMOUNT CONTRACTS AMOUNT CONTRACTS --------- --------- --------- --------- Company Dealerships.............................. $139,814 26,667 $ 49,066 9,615 Third Party Dealers.............................. 184,141 37,747 60,878 12,942 -------- ------ -------- ------ Total Portfolio Managed.......................... 323,955 64,414 109,944 22,557 -------- ------ -------- ------ Less Portfolios Securitized and Sold: Company Dealerships............................ 83,849 18,674 41,998 8,570 Third Party Dealers............................ 154,176 31,902 9,665 2,042 -------- ------ -------- ------ Total Portfolios Securitized and Sold................................. 238,025 50,576 51,663 10,612 -------- ------ -------- ------ Company Total.................................... $ 85,930 13,838 $ 58,281 11,945 ======== ====== ======== ======
In addition to the Company Dealership and Third Party Dealer loan portfolios summarized above, the Company also serviced loan portfolios totaling approximately $127.3 million on behalf of third parties as of December 31, 1997. The following tables reflect the growth in contract originations by Company Dealerships and contract purchases from Third Party Dealers measured in terms of the principal amount and the number of contracts. TOTAL CONTRACTS ORIGINATED/PURCHASED (IN THOUSANDS, EXCEPT NUMBER OF CONTRACTS AND AVERAGE PRINCIPAL)
YEARS ENDED DECEMBER 31, --------------------------------------------------------------------- 1997 1996 --------------------------------- --------------------------------- PRINCIPAL NO. OF AVERAGE PRINCIPAL NO. OF AVERAGE AMOUNT CONTRACTS PRINCIPAL AMOUNT CONTRACTS PRINCIPAL --------- --------- --------- --------- --------- --------- Company Dealerships.................... $172,230 29,251 $5,888 $ 48,996 6,929 $7,071 Third Party Dealers.................... 209,773 37,645 5,572 56,770 9,825 5,778 -------- ------ ------ -------- ------ ------ Total........................ $382,003 66,896 $5,710 $105,766 16,754 $6,313 ======== ====== ====== ======== ====== ======
For the year ended December 31, 1997, Finance Receivable Principal Balances originated/purchased increased by 261.1% to $382.0 million, including $55.4 million from the Seminole and EZ Plan acquisitions (approximately 13,250 contracts), from $105.8 million in the year ended December 31, 1996. RESULTS OF OPERATIONS The prices at which the Company sells its cars and the interest rates that it charges to finance these sales take into consideration that the Company's primary customers are high-risk borrowers, many of whom ultimately default. The Provision for Credit Losses reflects these factors and is treated by the Company as a cost of both the future interest income derived on the contract receivables originated at Company Dealerships as well as a cost of the sale of the cars themselves. Accordingly, unlike traditional car dealerships, the Company does not present gross profits in its Statements of Operations calculated as Sales of Used Cars less Cost of Used Cars Sold. 20 22 YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995 Sales of Used Cars. Sales of Used Cars increased by 130.3% to $123.8 million for the year ended December 31, 1997 from $53.8 million for the year ended December 31, 1996 which was a 40.1% increase from $38.4 million (pro forma) for the year ended December 31, 1995. This growth reflects increases in the number of used car dealerships in operation and the average unit sales price. Units sold increased by 119.9% to 16,636 units in the year ended December 31, 1997 from 7,565 units in the year ended December 31, 1996 compared to an increase of 8.8% from 1995 units sold of 6,956 (pro forma). Net same store unit sales declined by 11.6% in the year ended December 31, 1997 compared to the year ended December 31, 1996. The Company believes that this is due to the increased emphasis on underwriting at the Company Dealerships, particularly at one dealership where unit sales decreased by 742 units, which represents 85.0% of the net decrease for the year ended December 31, 1997. Net same store unit sales increased by 4.6% (pro forma) in the year ended December 31, 1996 compared to the year ended December 31, 1995. The average sales price per car increased by 4.7% to $7,443 for the year ended December 31, 1997 from $7,107 for the year ended December 31, 1996 compared to a 17.2% increase in the year ended December 31, 1996 from $6,065 (pro forma) in 1995. Cost of Used Cars Sold and Gross Margin. The Cost of Used Cars Sold increased by 122.5% to $66.5 million for the year ended December 31, 1997 from $29.9 million for the year ended December 31, 1996, which was an increase of 44.4% from $20.7 million (pro forma) for the year ended December 31, 1995. On a per unit basis, the Cost of Used Cars Sold increased by 1.2% to $3,998 for the year ended December 31, 1997 from $3,951 for the year ended December 31, 1996, which was an increase of 20.8% from $3,270 (pro forma) for the year ended December 31, 1995. The gross margin on used car sales (Sales of Used Cars less Cost of Used Cars Sold excluding Provision for Credit Losses) increased by 140.0% to $57.3 million for the year ended December 31, 1997 from $23.9 million for the year ended December 31, 1996, which was an increase of 35.0% from $17.7 million (pro forma) for the year ended December 31, 1995. As a percentage of sales, the gross margin was 46.3%, 44.4% , and 46.1% (pro forma) for the years ended December 31, 1997, 1996, and 1995, respectively. On a per unit basis, the gross margin per car sold was $3,445, $3,156, and $2,795 (pro forma) for the years ended December 31, 1997, 1996, and 1995, respectively. The Company believes that the increase in gross margin per unit sold is consistent with the Company's strategy of attempting to obtain higher retail sales prices in markets with interest rate limitations. Provision for Credit Losses. The Provision for Credit Losses increased by 145.4% to $24.1 million in the year ended December 31, 1997 from $9.8 million for the year ended December 31,1996 compared to 25.6% from $7.8 million (pro forma) in 1995. This includes an increase of $877,000 in the Provision for Credit Losses in the year ended December 31, 1997 for Branch Office third party receivables and $691,000 in Provision for Credit Losses for the Cygnet Dealer Program over the year ended December 31,1996. For 1996, the Company recorded $153,000 in Provision for Credit losses for Branch Office third party receivables. The Company recorded no Provision for Credit Losses for the third party receivables in 1995. On a percentage basis, the Provision for Credit Losses per unit originated at Company Dealerships increased by 6.3% to $1,505 per unit in the year ended December 31, 1997 from $1,416 per unit in the year ended December 31, 1996 compared to an increase of 3.1% from $1,239 (pro forma) per unit in 1995. This increase is primarily due to an increase in the average amount financed in the years ended December 31, 1997, 1996, and 1995, respectively, to $7,301 per unit in the year ended December 31, 1997 from $7,071 per unit in the year ended December 31, 1996 and $5,966 per unit in the year ended December 31, 1995. As a percentage of Company Dealership contract balances originated, the Provision for Credit Losses averaged 19.1%, 19.7%, and 22.8% (pro forma), for the years ended December 31, 1997, 1996, and 1995, respectively. Interest Income. Interest Income consists primarily of interest on finance receivables from Company Dealership sales, interest on Third Party Dealer finance receivables, income from Residuals in Finance Receivables Sold, income from the Cygnet Dealer Program, and other interest income from the FMAC Senior Bank Debt and Debtor In Possession Loans. Company Dealership Sales -- Interest Income from this category increased by 49.7% to $12.6 million for the year ended December 31, 1997 from $8.4 million for the year ended December 31, 1996, which increased 21 23 by 2.4% from $8.2 million in the year ended December 31, 1995. Interest Income during the years ended December 31, 1997 and 1996 was adversely affected by the sale of finance receivables pursuant to the Securitization Program, and will continue to be affected in future periods by additional securitizations. A primary element of the Company's sales strategy is to provide financing to customers with poor credit histories who are unable to obtain automobile financing through traditional sources. The Company financed 94.4% of sales revenue and 96.2% of the used cars sold at Company Dealerships for the year ended December 31, 1997 compared to 91.1% of sales revenue and 91.6% of the used cars sold at Company Dealerships for the year ended December 31, 1996, and 89.7% (pro forma) of sales revenue and 91.2% (pro forma) of the used cars sold for the year ended December 31, 1995. The average amount financed increased to $7,301 for the year ended December 31, 1997 from $7,071 for the year ended December 31, 1996, which had increased from $5,966 for the year ended December 31, 1995. As a result of its expansion into markets with interest rate limits, the Company's yield on its Company Dealership receivable contract portfolio has trended downward. The average effective yield on finance receivables from Company Dealerships was approximately 26.7%, 29.2%, and 28.0% for the years ended December 31, 1997, 1996, and 1995, respectively. The Company's policy is to charge 29.9% per annum on its Company Dealership contracts. However, in those states that impose usury limits the Company charges the maximum interest rate permitted. Third Party Dealers -- Interest Income from this category increased by 97.7% to $14.4 million for the year ended December 31, 1997 from $7.3 million in 1996, which was an increase of 305.6% from $1.8 million in 1995. Interest Income during the years ended December 31, 1997 and 1996 was adversely affected by the sale of finance receivables pursuant to the Securitization Program, and will continue to be affected in future periods by additional securitizations. Interest Income has increased in conjunction with the increases in Third Party Dealer contracts purchased and outstanding. However, as a result of expansion into markets with interest rate limits, the Company's yield on its Third Party Dealer contract portfolio has trended downward. The average effective yield was approximately 23.5%, 25.8%, and 26.7% for the years ended December 31, 1997, 1996, and 1995, respectively. The Company operated 83, 35 and 8 branch office(s) at December 31, 1997, 1996, and 1995, respectively. In February 1998, the Company announced its intention to close its Branch Office network and exit this line of business. See Part I. Item 1. "Business -- Strategic Evaluation of Third Party Dealer Operations." Cygnet Dealer Program and Other Interest Income. Interest Income from this category increased by 100.0% to $7.4 million for the year ended December 31, 1997. This income consisted of $3.7 million in Interest Income from the Cygnet Dealer Program and $3.8 million in Interest Income from the aforementioned FMAC Senior Bank Debt transaction and related DIP loans which occurred during the last half of 1997. There were no material Cygnet Dealer Program operations prior to 1997. Gain on Sale of Finance Receivables. Champion Receivables Corporation ("CRC") and Champion Receivables Corporation II ("CRC II") (collectively referred to as the "Securitization Subsidiaries"), are the Company's wholly owned special purpose "bankruptcy remote" entities. During the first quarter of 1996, the Company initiated a Securitization Program under which CRC sold securities backed by contracts to SunAmerica. Beginning with the third fiscal quarter of 1997, the Company expanded the Securitization Program to include CRC II and sales of CRC II securities through private placement of securities to investors other than SunAmerica. Under the Securitization Program, the Securitization Subsidiaries assign and transfer the contracts to separate trusts ("Trusts") pursuant to Pooling and Servicing Agreements (the "Pooling Agreements"). Pursuant to the Pooling Agreements, Class A Certificates and subordinated Class B Certificates are issued to the Securitization Subsidiaries. The Securitization Subsidiaries then sell the Class A Certificates to unrelated investors. The transferred contracts are serviced by Champion Acceptance Corporation ("CAC"), another subsidiary of the Company. For the Company's securitizations that took place prior to July 1, 1997, the Company's Class A Certificates received ratings from Standard & Poors ranging from "BBB" to "A". To obtain these ratings from Standard & Poors, CRC was required to provide a credit enhancement by establishing and maintaining a cash spread account for the benefit of the certificate holders. For the securitization transactions that were consummated after July 1, 1997, the Company's Class A Certificates received a "AAA" rating from Standard & Poors, and a "Aaa" rating from Moody's Investors Service. To obtain these ratings, CRC II (1) obtained an insurance policy from MBIA Insurance Corporation 22 24 which unconditionally and irrevocably guaranteed full and complete payment of the Class A guaranteed distribution (as defined), and (2) provided a credit enhancement by establishing and maintaining a cash spread account for the benefit of the certificate holders. The Securitization Subsidiaries make an initial cash deposit into the spread account, ranging from 3% to 4% of the initial underlying finance receivables principal balance and pledge this cash to the Trusts. The Securitization Subsidiaries are also required to then make additional deposits to the spread account from the residual cash flow (through the trustees) as necessary to attain and maintain the spread account at a specified percentage, ranging from 6.0% to 8.0%, of the underlying finance receivables principal balance. Distributions are not made to the Securitization Subsidiaries on the Class B Certificates unless the spread account has the required balance, the required periodic payments to the Class A Certificate holders are current, and the trustee, servicer and other administrative costs are current. The Company recognizes a Gain on Sale of Loans equal to the difference between the sales proceeds for the finance receivables sold and the Company's recorded investment in the finance receivables sold. The Company allocates the recorded investment in the finance receivables between the portion of the finance receivables sold and the portion retained based on the relative fair values on the date of sale. To the extent that actual cash flows on a securitization are below original estimates, and differ materially from the original securitization assumptions and, in the opinion of management, those differences appear to be other than temporary in nature, the Company would be required to revalue the Residuals in Finance Receivables Sold and record a charge to earnings based upon the reduction. For a discussion of how the Company values the Residuals in Finance Receivables Sold, see "-- Residuals in Finance Receivables Sold" below in this Item 7. During the year ended December 31,1997, the Company recorded a $10.0 million charge (approximately $6.0 million, net of income taxes) to write down the Residuals in Finance Receivables Sold. During the year ended December 31, 1997, the Securitization Subsidiaries made initial spread account deposits totaling $11.5 million. Additional net deposits to the spread accounts during the year ended December 31,1997 totaled $3.3 million. Based upon securitizations in effect as of December 31, 1997, the Company's targeted balance in all spread accounts was approximately $18.8 million, a portion of which may be funded over time. As of December 31, 1997, the Company maintained a total spread account balance of $17.6 million. Accordingly, an additional $1.2 million will need to be funded from future cash flows. The additional funding requirements will decline as the trustees deposit additional cash flows into the spread account and as the principal balance of the underlying finance receivables declines. In addition to the spread account balance of $17.6 million, the Company had deposited a total of $1.3 million in trust accounts in conjunction with certain other agreements. During the years ended December 31, 1997 and 1996, the Company securitized an aggregate of $298.2 and $68.2 million in contracts, issuing $245.5 million and $53.5 million in securities, respectively. Pursuant to these transactions, the Company reduced its Allowance for Credit Losses by $46.1 million and $10.0 million during 1997 and 1996, respectively, and retained Residuals in Finance Receivables Sold of $29.4 million and $9.9 million at December 31, 1997 and 1996, respectively. The Company also recorded Gain on Sale of Loans of $13.6 million and $4.4 million, net of expenses (and a $10.0 million charge recorded by the Company during 1997), related to securitization transactions during the years ended December 31, 1997 and 1996, respectively. In addition, the Company recorded a gain of $8.1 million in 1997 related to the aforementioned FMAC transaction. During 1997, the Trusts issued certificates at a weighted average yield of 6.99%, with the yields ranging from 6.27% to 8.16%, resulting in net spreads, after servicing and trustee fees, ranging from 12.49% to 17.84% and averaging 14.32%. During 1996, the Trusts issued certificates at a weighted average yield of 8.38%, with the yields ranging from 8.15% to 8.62%, resulting in net spreads, after servicing and trustee fees, ranging from 12.56% to 17.40% and averaging 16.36%. The decrease in net spreads from 1996 to 1997, despite lower certificate yields, is primarily the result of the decrease in the average contract yield of the finance receivable contracts securitized due to the Company's expansion into markets with interest rate limits. Other Income. Other Income which consists primarily of servicing income, insurance premiums earned on force placed insurance policies, earnings on investments from the Company's cash and cash equivalents, and franchise fees from the Company's rent-a-car franchisees increased by 613.4% to $11.2 million for the 23 25 year ended December 31, 1997 from $1.6 million for the year ended December 31, 1996, compared to an increase of 410.1% from $308,000 in the year ended December 31, 1995. The Company services the $238.0 million in securitized contract principal balances for monthly fees ranging from .25% to .33% of the beginning of month principal balances (3.0% to 4.0% annualized). In addition, in conjunction with the Kars acquisition in September 1997, the Company recognizes income from servicing the Kars portfolio at a rate of approximately .33% (4.0% annualized) of beginning of month principal balances. Servicing income for the year ended December 31, 1997 increased to $7.2 million from $921,000 in the year ended December 31, 1996. The significant increase is due to the increase in the principal balance of contracts being serviced pursuant to the Securitization Program and the addition of servicing of the Kars portfolio. The increase in Other Income is also due to an increase in insurance premium income to $788,000 in the year ended December 31, 1997 from $607,000 in the year ended December 31,1996, compared to the year ended December 31, 1995 when the Company recognized no insurance premium income, and an increase in earnings on investments of $1.2 million compared to no investment earnings in the years ended December 31, 1996 and 1995. The Company no longer actively engages in the rent-a-car franchise business. Income before Operating Expenses. As a result of the Company's continued expansion, Income before Operating Expenses grew by 179.8% to $100.5 million for the year ended December 31, 1997 from $35.9 million for the year ended December 31, 1996 compared to an increase of 64.2% in 1996 from $21.9 million in 1995. Growth of Sales of Used Cars, Interest Income, Gain on Sale of Loans, and Other Income were the primary contributors to the increase. Operating Expenses. Operating Expenses consist of Selling and Marketing Expenses, General and Administrative Expenses, and Depreciation and Amortization. The Company has five distinct business segments. These consist of retail car sales operations (Company Dealerships), operations attributable to the administration and collection of finance receivables generated at the Company Dealerships (Company Dealership Receivables), activities associated with the origination, administration, and collection of finance receivables purchased from Third Party Dealers (Third Party Dealers), financing activities related to the Cygnet Dealer Program (Cygnet), and corporate and other operations. A summary of Operating Expenses by business segment for the years ended December 31, 1997, 1996, and 1995, respectively, follows:
COMPANY THIRD COMPANY DEALERSHIP PARTY CORPORATE DEALERSHIPS RECEIVABLES RECEIVABLES CYGNET & OTHER TOTAL ----------- ----------- ----------- ------ --------- ------- 1997: Selling and Marketing.............. $10,499 $ -- $ -- $ 18 $ 50 $10,567 General and Administrative......... 23,064 12,523 15,729 2,194 11,490 65,000 Depreciation and Amortization...... 1,536 1,108 383 28 628 3,683 ------- ------- ------- ------ ------- ------- $35,099 $13,631 $16,112 $2,240 $12,168 $79,250 ======= ======= ======= ====== ======= =======
COMPANY THIRD COMPANY DEALERSHIP PARTY CORPORATE DEALERSHIPS RECEIVABLES RECEIVABLES CYGNET & OTHER TOTAL ----------- ----------- ----------- ------ --------- ------- 1996: Selling and Marketing.............. 3,$568.... $ -- $ -- $ -- $ 17 $ 3,585 General and Administrative......... 8,295 3,042 3,955 -- 4,246 19,538 Depreciation and Amortization...... 318 769 195 -- 295 1,577 ------- ------- ------- ------ ------- ------- $12,181 $ 3,811 $ 4,150 $ -- $ 4,558 $24,700 ======= ======= ======= ====== ======= =======
24 26
COMPANY THIRD COMPANY DEALERSHIP PARTY CORPORATE DEALERSHIPS RECEIVABLES RECEIVABLES CYGNET & OTHER TOTAL ----------- ----------- ----------- ------ --------- ------- 1995: Selling and Marketing.............. $ 3,856 $ -- $ -- $ -- $ -- $ 3,856 General and Administrative......... 8,210 2,681 1,163 -- 2,672 14,726 Depreciation and Amortization...... 279 479 89 -- 467 1,314 ------- ------- ------- ------ ------- ------- $12,345 $ 3,160 $ 1,252 $ -- $ 3,139 $19,896 ======= ======= ======= ====== ======= =======
Selling and Marketing Expenses. For the years ended December 31, 1997, 1996, and 1995, Selling and Marketing Expenses were comprised almost entirely of advertising costs and commissions relating to Company Dealership operations. Selling and Marketing Expenses increased by 194.8% to $10.6 million for the year ended December 31, 1997 from $3.6 million for the year ended December 31, 1996, which was an increase of 12.5% from $3.2 million (pro forma) in 1995. As a percentage of Sales of Used Cars, these expenses averaged 8.5%, 6.7%, and 8.3% (pro forma) for the years ended December 31, 1997, 1996, and 1995, respectively. On a per unit sold basis, Selling and Marketing expenses increased by 34.0% to $635 per unit for the year ended December 31, 1997 from $474 per unit for the year ended December 31, 1996, which was a decrease of 7.1% from $510 (pro forma) per unit in 1995. The significant increase in per unit marketing in 1997 is primarily due to the Company's expansion into several new markets. The Company operated dealerships in ten markets during 1997, compared to operating in two markets in 1996 and 1995. As a result of this expansion, the Company incurred significant marketing costs in new markets in an effort to establish brand name recognition. General and Administrative Expenses. General and Administrative Expenses increased by 232.7% to $65.0 million for the year ended December 31, 1997 from $19.5 million for the year ended December 31, 1996, which was an increase of 45.5% from $13.4 million (pro forma) for the year ended December 31, 1995. These expenses represented 34.0%, 25.8%, and 27.5% of total revenues for the years ended December 31, 1997, 1996, and 1995, respectively. For the year ended December 31, 1997, 35.5% of General and Administrative Expenses were attributable to Company Dealership activities, 19.3% to the Company Dealership Receivables' financing activities, 24.2% to Third Party Dealer activities, 3.4% to the Cygnet Dealer Program, and 17.6% to Corporate activities. For the year ended December 31, 1996, 42.5% of General and Administrative Expenses were attributable to Company Dealership activities, 15.6% to the Company Dealership Receivables' financing activities, 20.2% to Third Party Dealer activities, and 21.7% to Corporate activities. For the year ended December 31, 1995, 55.8% of General and Administrative Expenses were attributable to Company Dealership activities, 18.2% to the Company Dealership Receivables' financing activities, 7.9% to Third Party Dealer activities, and 18.1% to Corporate activities. The increase in General and Administrative Expenses is primarily a result of the Company's increased number of used car dealerships and significant expansion of its Third Party Dealer financing operations, as well as continued expansion of infrastructure to administer growth. Depreciation and Amortization. Depreciation and Amortization consists of depreciation and amortization on the Company's property and equipment and amortization of the Company's goodwill and trademarks. Depreciation and amortization increased by 133.5% to $3.7 million for the year ended December 31, 1997 from $1.6 million for the year ended December 31, 1996, which was an increase of 23.1% from $1.3 million for the year ended December 31, 1995. The increase was due primarily to the increase in amortization of goodwill associated with the Company's recent acquisitions, and increased depreciation expense from the addition of used car dealerships and Third Party Dealer Branch Offices. For the year ended December 31, 1997, 41.7% of these expenses were attributable to Company Dealership activities, 30.1% to the Company Dealership Receivables' financing activities, 10.4% to Third Party Dealer activities, 0.8% to the Cygnet Dealer Program, and 17.0% to Corporate activities. For the year ended December 31, 1996, 20.2% of these expenses were attributable to Company Dealership activities, 48.7% to the Company Dealership Receivables' financing activities, 12.4% to Third Party Dealer activities, and 18.7% to Corporate activities. For the year ended December 31, 1995, 21.2% of these expenses were attributable to Company Dealership activities, 36.5% to the 25 27 Company Dealership Receivables' financing activities, 6.8% to Third Party Dealer activities, and 35.5% to Corporate activities. Interest Expense. Interest Expense was $5.3 million in 1997 and 1996, compared to a decrease of 11.7% from $6.0 million in 1995. The lack of an increase in interest expense in 1997 and the decrease in 1996, despite significant growth in Company assets during this two year period, is primarily the result of the private placement of Common Stock in February 1997, which generated $89.2 million in cash, the two public offerings that were completed in 1996, which generated $79.4 million in cash, and the Company's Securitization Program, which generated cash from the sale of Finance Receivables which the Company utilized to pay down debt. Income Taxes. Income taxes increased to $6.6 million in 1997 which is an effective tax rate of approximately 41.1%, compared to $100,000 in 1996, up from zero in 1995. In 1996, the Company utilized all of the Valuation Allowance that existed against its deferred income tax assets as of December 31, 1995. No income tax benefit was recognized in 1995 as a result of an increase in the Valuation Allowance for deferred tax assets. ALLOWANCE FOR CREDIT LOSSES The Company has established an Allowance for Credit Losses ("Allowance") to cover anticipated credit losses on the contracts currently in its portfolio. The Allowance has been established through the Provision for Credit Losses on contracts originated at Company Dealerships and through nonrefundable acquisition discounts and Provision for Credit Losses on contracts purchased from Third Party Dealers and originated under the Cygnet Dealer Program. The Allowance on contracts originated at Company Dealerships decreased to 18.5% of outstanding principal balances as of December 31, 1997 compared to 23.0% as of December 31, 1996. The Allowance as a percentage of Third Party Dealer contracts decreased to 12.0% from 12.7% over the same period. The Allowance as a percentage of Cygnet Dealer Program contracts was 29.8% at December 31, 1997. However, the Allowance as a percentage of the Company's combined contract portfolio increased to 19.5% at December 31, 1997 from 13.9% at December 31, 1996, reflecting the fact that a greater portion of the Company's overall contract portfolio is represented by contracts generated at the Company Dealerships and acquired through the Cygnet Dealer Program, for which higher levels of Allowance are maintained. The following table reflects activity in the Allowance, as well as information regarding charge off activity, for the years ended December 31, 1997 and 1996, in thousands.
YEARS ENDED DECEMBER 31, -------------------------------------------------------------------- COMPANY DEALERSHIPS THIRD PARTY DEALERS CYGNET DEALER PROGRAM ------------------- ------------------- ---------------------- 1997 1996 1997 1996 1997 1996 -------- ------- -------- ------- --------- --------- Allowance Activity: Balance, Beginning of Year... $ 1,625 $ 7,500 $ 6,500 $ 1,000 $ -- $ -- Provision for Credit Losses..................... 22,354 9,658 1,030 153 491 -- Allowance on Acquired Loans...................... 15,309 -- 25,571 8,963 7,705 -- Accretion of Discount to Interest Income............ -- -- (642) -- -- -- Reduction Attributable to Loans Sold.............. (21,408) (9,331) (24,662) (650) -- -- Net Charge Offs.............. (7,524) (6,202) (4,197) (2,966) (6) -- -------- ------- -------- ------- ------- ------- Balance, End of Year......... $ 10,356 $ 1,625 $ 3,600 $ 6,500 $ 8,190 $ -- ======== ======= ======== ======= ======= ======= Allowance as % of Year Ended Principal Balance.......... 18.5% 23.0% 12.0% 12.7% 29.8% -- ======== ======= ======== ======= ======= =======
26 28
YEARS ENDED DECEMBER 31, -------------------------------------------------------------------- COMPANY DEALERSHIPS THIRD PARTY DEALERS CYGNET DEALER PROGRAM ------------------- ------------------- ---------------------- 1997 1996 1997 1996 1997 1996 -------- ------- -------- ------- --------- --------- Charge off Activity: Principal Balances: Collateral Recovered....... $ 8,795 $ 6,256 $ 5,091 $ 3,618 $ -- $ -- Collateral Not Recovered... 1,490 1,859 858 717 6 -- -------- ------- -------- ------- ------- ------- Total Principal Balances... 10,285 8,115 5,949 4,335 6 $ -- Accrued Interest........... -- 487 -- 123 -- -- Recoveries, Net............ (2,761) (2,400) (1,752) (1,492) -- -- -------- ------- -------- ------- ------- ------- Net Charge Offs.............. $ 7,524 $ 6,202 $ 4,197 $ 2,966 $ 6 $ -- ======== ======= ======== ======= ======= ======= Net Charge Offs as % of Average Principal Outstanding................ 17.6% 23.0% 8.4% 10.7% 0.0% -- ======== ======= ======== ======= ======= =======
The Company's policy is to charge off contracts when they are deemed uncollectible, but in any event at such time as a contract is delinquent for 90 days. During the year ended December 31, 1997, the Company experienced rapid growth in the number of states in which it operated Company Dealerships and Third Party Dealer branches. As a result, the Company's loan base was more geographically diversified throughout the country, which in turn led to the Company repossessing significantly more vehicles throughout the country than it historically had, in markets where it did not operate reconditioning centers or repossession lots. The Company, therefore, relied extensively on third parties to dispose of its repossessed collateral. This led to the Company not realizing its expected recovery amount upon liquidation of these repossessions. The Company has taken several actions to reverse this trend including consolidation of auction locations through which repossessed vehicles are liquidated, expansion of its repossession administration department, development of an enhanced repossession tracking and monitoring system, hiring of staff whose primary responsibility is to represent the Company at auctions, and expansion of efforts to better recondition repossessions prior to liquidation. For loans originated at Company Dealerships, recoveries as a percentage of principal balances charged off where collateral has been recovered averaged 31.4% for the year ended December 31, 1997 compared to 38.4% for the year ended December 31, 1996. Company Dealership loan recoveries in Arizona are positively effected by the Company's ability to receive a sales tax benefit for charged off loans that it does not receive in other markets. As a result of the Company's expansion outside of the Arizona market in 1997, recovery rates for the Company Dealership loan portfolio were negatively effected. For Third Party Dealer loans, recoveries as a percentage of principal balances charged off where collateral has been recovered averaged 34.4% for the year ended December 31, 1997 compared to 41.2% for the year ended December 31, 1996. The Company's Net Charge Offs on its Third Party Dealer contract portfolio are lower than those incurred on its Company Dealership contract portfolio. This is attributable to the relationship of the average amount financed to the underlying collateral's wholesale value and to a lesser degree the generally more creditworthy customers served by Third Party Dealers. In its Third Party Dealer portfolio, the Company generally limits the amount financed to not more than 120.0% of the wholesale value of the underlying car, although the Company does make exceptions on a case-by-case basis. Static Pool Analysis. To monitor contract performance, beginning in June 1995, the Company implemented "static pool" analysis for contracts originated since January 1, 1993. Static pool analysis is a monitoring methodology by which each month's originations and subsequent charge offs are assigned to a unique pool and the pool performance is monitored separately. Improving or deteriorating performance is measured based on cumulative gross and net charge offs as a percentage of original principal balances, based on the number of complete payments made by the customer before charge off. The table below sets forth the cumulative net charge offs as a percentage of original contract cumulative balances, based on the quarter of origination and segmented by the number of payments made prior to charge off. For periods denoted by "x", 27 29 the pools have not seasoned sufficiently to allow for computation of cumulative losses. For periods denoted by " -- ", the pools have not yet attained the indicated cumulative age. While the Company monitors its static pools on a monthly basis, for presentation purposes the information in the tables is presented on a quarterly basis. Effective January 1, 1997, the Company modified its methodology to reflect additional historical experience in computing "Monthly Payments Completed by Customer Before Charge Off" as it relates to loan balances charged off after final insurance settlements and on loans modified from their original terms. Resulting adjustments affect the timing of previously reported interim cumulative losses, but do not impact ending cumulative losses. For loan balances charged off after insurance settlement principal reductions, the revised calculation method only gives credit for payments actually made by the customer and excludes credit for reductions arising from insurance proceeds. For modified loans, completed payments now reflect customer payments made both before and after the loan was modified. The numbers presented below reflect the adoption of the revised calculation method. Currently reported cumulative losses may also vary from those previously reported due to ongoing collection efforts on charged off accounts and the difference between final proceeds on the liquidation of repossessed collateral versus original accounting estimates. Management believes that such variation will not be material. 28 30 CONTRACTS ORIGINATED AT COMPANY DEALERSHIPS The following table sets forth the cumulative net charge offs as a percentage of original contract cumulative (pool) balances, based on the quarter of origination and segmented by the number of monthly payments completed by customer before charge off. Additionally, set forth is the percent of principal reduction for each pool since inception and cumulative total net losses incurred (TLI). POOL'S CUMULATIVE NET LOSSES AS PERCENTAGE OF POOL'S ORIGINAL AGGREGATE PRINCIPAL BALANCE
MONTHLY PAYMENTS COMPLETED BY CUSTOMER BEFORE CHARGE OFF --------------------------------------------------------------- ORIG. 0 3 6 12 18 24 TLI REDUCED ------- ---- ----- ----- ----- ----- ----- ----- -------- 1993: 1st Quarter................... $ 2,326 6.9% 18.7% 26.5% 31.8% 33.9% 35.1% 35.4% 100.0% 2nd Quarter................... $ 2,942 7.2% 18.9% 25.1% 29.4% 31.7% 32.1% 32.4% 100.0% 3rd Quarter................... $ 3,455 8.6% 19.5% 23.7% 28.5% 30.7% 31.6% 31.9% 100.0% 4th Quarter................... $ 4,261 6.3% 16.1% 21.6% 27.0% 28.9% 29.5% 29.6% 100.0% 1994: 1st Quarter................... $ 6,305 3.4% 9.9% 13.3% 17.9% 20.3% 20.9% 21.0% 100.0% 2nd Quarter................... $ 5,664 2.8% 10.5% 14.1% 19.6% 21.5% 22.1% 22.2% 100.0% 3rd Quarter................... $ 6,130 2.8% 8.1% 12.0% 16.2% 18.2% 19.1% 19.2% 100.0% 4th Quarter................... $ 5,490 2.4% 7.6% 11.2% 16.6% 19.5% 20.4% 20.5% 100.0% 1995: 1st Quarter................... $ 8,191 1.1% 7.3% 12.3% 17.5% 20.0% 20.8% 21.0% 99.3% 2nd Quarter................... $ 9,846 1.7% 7.0% 11.9% 16.3% 19.1% 20.6% 20.8% 97.5% 3rd Quarter................... $10,106 1.9% 6.9% 10.8% 17.7% 21.2% 22.8% 22.9% 93.2% 4th Quarter................... $ 8,426 1.2% 5.6% 10.8% 17.3% 22.0% x 23.4% 90.0% 1996: 1st Quarter................... $13,635 1.3% 7.5% 13.1% 20.2% 24.1% -- 24.8% 83.9% 2nd Quarter................... $13,462 2.2% 9.1% 13.4% 22.2% x -- 25.8% 76.3% 3rd Quarter................... $11,082 1.6% 6.7% 12.4% 21.1% -- -- 23.4% 68.1% 4th Quarter................... $10,817 1.6% 8.5% 16.0% x -- -- 24.4% 62.1% 1997: 1st Quarter................... $16,279 2.1% 10.4% 17.3% -- -- -- 20.6% 53.0% 2nd Quarter................... $25,875 1.4% 8.2% x -- -- -- 12.2% 37.8% 3rd Quarter................... $32,147 1.2% x -- -- -- -- 5.5% 20.9% 4th Quarter................... $42,529 -- -- -- -- -- -- 0.9% 10.0%
Trends set forth in the table above indicate a deterioration in the performance of the associated loan portfolio. Management believes the deterioration is primarily attributable to less effective collection procedures resulting from a loan servicing and collection data processing system conversion in the first and second quarters of 1997 rather than from any fundamental change in loan quality or underwriting. As a result of this trend, the Company recorded a $10.0 million charge against its Residuals in Finance Receivables Sold during 1997. The charge was determined based upon revised estimates of cumulative net charge offs of finance receivables and assumed an improvement in the future performance of the underlying loan portfolio. Although the Company believes that the charge is sufficient to absorb anticipated future credit losses, there can be no assurance in that regard. Should future cumulative net charge offs exceed the revised estimates or the underlying portfolio performance not improve, the Company may record additional charges in the future in order to write down the Residuals in Finance Receivables Sold or increase its Allowance. 29 31 The following table sets forth the principal balances 31 to 60 days delinquent, and 61 to 90 days delinquent as a percentage of total outstanding Company Dealership contract principal balances.
RETAINED SECURITIZED MANAGED -------- ----------- ------- December 31,1997: 31 to 60 days............................... 2.2% 4.5% 3.6% 61 to 90 days............................... 0.6% 2.2% 1.5% December 31,1996: 31 to 60 days............................... 2.3% 5.4% 5.0% 61 to 90 days............................... 0.6% 1.9% 1.7%
In accordance with the Company's charge off policy, there are no accounts more than 90 days delinquent as of December 31, 1997 and 1996. During 1996 and continuing throughout 1997, the Company elected to extend the time period before repossession is ordered with respect to those customers who exhibit a willingness and capacity to bring their contracts current. As a result of this revised repossession policy, delinquencies increased as expected. CONTRACTS PURCHASED FROM THIRD PARTY DEALERS Non-refundable acquisition discount ("Discount") acquired totaled $25.6 million and $9.0 million for the years ended December 31, 1997 and 1996, respectively. The Discount, attributable to Third Party Dealer branch purchases, averaged 12.3% as a percentage of principal balances purchased in 1997, compared to 11.4% in 1996. Beginning in 1996, the Company expanded into markets with interest rate limits. While contractual interest rates on these contracts are limited by law, the Company has attempted to purchase contracts in markets with interest rate limits at Discounts in excess of those in markets where no such limits exist. Therefore, Discounts have trended upward. The Company credited the Allowance for Credit Losses for all Discount acquired with the purchase of contracts from Third Party Dealers. The following table sets forth as of February 28, 1998, the cumulative net charge offs as a percentage of original contract cumulative (pool) balances, based on the quarter of origination and segmented by the number of monthly payments completed by customer before charge off. Additionally, set forth is the percent of principal reduction for each pool since inception and cumulative total net losses incurred (TLI). POOL'S CUMULATIVE NET LOSSES AS PERCENTAGE OF POOL'S ORIGINAL AGGREGATE PRINCIPAL BALANCE
MONTHLY PAYMENTS COMPLETED BY CUSTOMER BEFORE CHARGE OFF PRINCIPAL --------------------------------------------------------- PERCENT PURCHASED 0 3 6 12 18 24 TLI REDUCED --------- ---- ---- ----- ----- ----- ----- ----- ------- 1995: 2nd Quarter........... $ 3,883 0.9% 4.1% 5.7% 7.7% 9.1% 10.5% 10.9% 95.9% 3rd Quarter........... $ 5,368 1.2% 3.7% 4.6% 6.3% 7.5% 8.7% 9.1% 89.5% 4th Quarter........... $ 5,537 1.0% 4.3% 6.7% 9.3% 11.0% x 12.8% 91.0% 1996: 1st Quarter........... $ 7,186 0.8% 3.7% 6.9% 10.2% 12.7% -- 13.1% 85.8% 2nd Quarter........... $10,017 1.6% 6.2% 9.7% 13.4% x -- 15.0% 80.4% 3rd Quarter........... $15,716 1.3% 6.0% 9.2% 13.3% -- -- 14.8% 72.2% 4th Quarter........... $23,851 1.4% 7.4% 12.3% x -- -- 16.8% 62.6% 1997: 1st Quarter........... $41,510 1.4% 7.6% 12.0% -- -- -- 14.4% 51.9% 2nd Quarter........... $50,139 1.5% 7.1% x -- -- -- 10.3% 37.6% 3rd Quarter........... $52,588 1.3% x -- -- -- -- 5.5% 22.7% 4th Quarter........... $65,536 x -- -- -- -- -- 0.7% 7.0%
30 32 Trends set forth in the table above indicate a deterioration in the performance of the associated loan portfolio. For further information concerning management's analysis of the cause and effects of this deterioration, see "-- Contracts Originated at Company Dealerships" above in this Item 7. Beginning April 1, 1995, the Company initiated a new purchasing program for Third Party Dealer contracts which included an emphasis on higher quality contracts. As of March 31, 1995, the Third Party Dealer portfolio originated under the prior program had a principal balance of $2.0 million which are paid in full. Therefore, contract performance under this prior program has been excluded from the table above. While the static pool information is developing, management augments its evaluation of the adequacy of the Allowance for Third Party Dealers through comparisons in the characteristics of collateral ratios and borrowers on Third Party Dealer contracts versus those of the Company Dealership contracts, as well as through comparisons of portfolio delinquency, actual contract performance and, to the extent information is available, industry statistics. The following table sets forth the principal balances 31 to 60 days delinquent, and 61 to 90 days delinquent as a percentage of total outstanding Third Party Dealer contract principal balances.
RETAINED SECURITIZED MANAGED -------- ----------- ------- December 31, 1997: 31 to 60 days............................... 1.5% 5.1% 4.5% 61 to 90 days............................... 2.3% 1.6% 1.7% December 31, 1996: 31 to 60 days............................... 3.1% 4.3% 3.3% 61 to 90 days............................... 1.1% 1.0% 1.1%
In accordance with the Company's charge off policy there are no Third Party Dealer contracts more than 90 days delinquent as of December 31, 1997 and 1996. During 1996 and continuing throughout 1997, the Company elected to extend the time period before repossession is ordered with respect to those customers who exhibit a willingness and capacity to bring their contracts current. As a result of this revised repossession policy, delinquencies increased as expected. RESIDUALS IN FINANCE RECEIVABLES SOLD Residuals in Finance Receivables Sold represent the Company's retained portion of the securitization assets. The Company utilizes a number of estimates in arriving at the initial valuation of the Residuals in Finance Receivables Sold, which represent the expected present value of net cash flows into the Trust in excess of those required to pay principal and interest on the Class A Certificates. The present value of expected cash flows is a function of a number of items including, but not limited to, charge off rates, repossession recovery rates, portfolio delinquency, prepayment rates, and Trust expenses. Subsequent to the initial recording of the Residuals in Finance Receivables Sold, the carrying value is adjusted for the actual cash flows into the respective Trusts in order to maintain a carrying value which approximates the present value of the expected net cash flows into the Trust in excess of those required to pay all obligations of the respective Trust other than the obligations to the Class B Certificates. To the extent that actual cash flows on a securitization are below original estimates, and differ materially from the original securitization assumptions, and in the opinion of management, those differences appear to be other than temporary in nature, the Company would be required to revalue the residual portion of the securitization which it retains, and record a charge to earnings based upon the reduction. During the year ended December 31, 1997, the Company recorded a $10.0 million charge (approximately $6.0 million, net of income taxes) to write down the Residuals in Finance Receivables Sold. The Company determined a write down in the Residuals in Finance Receivables Sold was necessary due to an increase in net losses in the securitized loan portfolio, particularly the Third Party Dealer portfolio. With the exception of the Company's first two securitization transactions which took place during the first six months of 1996, the estimated cash flows into the Trusts were discounted with a rate of 16%. The two 31 33 securitization transactions that took place during the first six months of 1996 were discounted with a rate of 25%. For securitization transactions between June 30, 1996 and June 30, 1997, for contracts originated at Company Dealerships, net losses were originally estimated using total expected cumulative net losses at loan origination of approximately 26.0%, adjusted for actual cumulative net losses prior to securitization. For contracts purchased from Third Party Dealers, net losses were originally estimated using total expected cumulative net losses at loan origination of approximately 13.5%, adjusted for actual cumulative net losses prior to securitization. Prepayment rates were estimated to be 1.5% per month of the beginning of month balance. The $10.0 million charge (approximately $6.0 million, net of income taxes) in the year ended December 31, 1997 which resulted in a reduction in the carrying value of the Company's Residuals in Finance Receivables Sold had the effect of increasing the cumulative net loss assumption for contracts originated at Company Dealerships to approximately 27.5%, and for contracts purchased from Third Party Dealers to approximately 17.5% for the securitization transactions that took place prior to July 1, 1997. As a result of this charge, the remaining allowance for credit losses inherent in the securitization assumptions as a percentage of the remaining principal balances of securitized contracts was approximately 15.3% as of December 31, 1997, compared to 15.2% as of December 31, 1996. There can be no assurance that the charge taken by the Company is sufficient and that the Company will not record additional charges in the future in order to write down the Residuals in Finance Receivables Sold. For the securitization transactions that took place after July 1, 1997, for contracts originated at Company Dealerships, net losses were estimated using total expected cumulative net losses at loan origination of approximately 27.5%, adjusted for actual cumulative net losses prior to securitization, and for contracts purchased from Third Party Dealers, net losses were estimated using total expected cumulative net losses at loan origination of approximately 17.5%, adjusted for actual cumulative net losses prior to securitization. The estimated cash flows into the trust were discounted with a rate of 16%. Prepayment rates were estimated to be 1.5% per month of the beginning of month balance. The assumptions utilized in prior securitizations may not necessarily be the same as those utilized in future securitizations. The Company classifies the residuals as "held-to-maturity" securities in accordance with SFAS No. 115. LIQUIDITY AND CAPITAL RESOURCES The Company requires capital to support increases in its contract portfolio, expansion of Company Dealerships, the Cygnet Dealer Program, the purchase of inventories, the purchase of property and equipment, and for working capital and general corporate purposes. The Company funds its capital requirements through equity offerings, operating cash flow, the sale of finance receivables, and supplemental borrowings. The Company's Net Cash Provided by (Used in) Operating Activities decreased by 111.3% to ($792,000) for 1997 from $7.0 in 1996, compared to an increase of 10.1% from $6.3 million in 1995. The decrease in 1997 was primarily due to increases in Gain on Sale of Finance Receivables, Increases in Inventory and Other Assets offset by increases in Net Earnings, Provision for Credit Losses and an increase in Accounts Payable, Accrued Expenses, and Other Liabilities. The increase in 1996 was primarily due to increases in Net Earnings and the Provision for Credit Losses, offset by an increase in Other Assets and the Gain on Sale of Loans. Net Cash Used in Investing Activities increased by 312.4% to $123.7 million in the year ended December 31, 1997 from $30.0 million in the year ended December 31, 1996. The increase was due primarily to the $12.0 million used for the net increase in Investments Held in Trust, $46.3 million for the purchase of the assets of Seminole, EZ Plan, and Kars, the $13.6 million for the increase in Notes Receivable, and the $13.3 million increase used for the purchases of Property and Equipment. Net Cash Used in Investing Activities decreased by 17.6% from $36.4 million in the year ended December 31, 1995 to $30.0 million in the year ended December 31, 1996. The decrease was due primarily to a net increase in Finance Receivables of $14.6 million and the $2.8 million used for the net increase in the securitization spread account (Investments Held in Trust), the deposit of $636,000 into a trust account, and the $2.9 million increase used for the purchases of Property and Equipment. 32 34 The Company's Net Cash Provided by Financing Activities increased by 173.6% to $109.6 million in the year ended December 31, 1997 from $40.1 million in the year ended December 31, 1996. This increase was the result of the $89.4 million in proceeds from the Company's private placement of Common Stock, plus the addition of Notes Payable of $22.5 million. Net Cash Provided by Financing Activities increased by 27.8% to $40.1 million in the year ended December 31, 1996 from $31.3 million in the year ended December 31, 1995. This increase was the result of the $79.4 million in proceeds from the Company's public offerings of Common Stock, net of the $28.6 million of repayment of Notes Payable and the redemption of $10.0 million of Preferred Stock. Revolving Facility. The Company maintains a Revolving Facility with GE Capital that has a maximum commitment of up to $100.0 million. Under the Revolving Facility, the Company may borrow up to 65.0% of the principal balance of eligible Company Dealership contracts and up to 86.0% of the principal balance of eligible Third Party Dealer contracts. However, an amount up to ten million dollars (such amount being reduced as collections on certain contracts are received by the Contract Purchaser) of the borrowing capacity under the Revolving Facility is not available at any time when the guarantee of the Company to the Contract Purchaser (as described below in this Item 7 under "- Transactions Regarding First Merchants Acceptance Corporation") is in effect. The Revolving Facility expires in December 1998. The facility is secured by substantially all of the Company's assets. As of December 31, 1997, the Company's borrowing capacity under the Revolving Facility was $55.1 million, the aggregate principal amount outstanding under the Revolving Facility was approximately $57.0 million, and the amount available to be borrowed under the facility was $3.1 million. The Revolving Facility bears interest at the 30-day LIBOR plus 3.15%, payable daily (total rate of 8.9% as of December 31, 1997). The Revolving Facility contains covenants that, among other things, limit the Company's ability to, without GE Capital's consent: (i) incur additional indebtedness; (ii) make unsecured loans or other advances of money to officers, directors, employees, stockholders or affiliates in excess of $25,000 in total; (iii) engage in securitization transactions (other than the Securitization Program, for which GE Capital has consented); (iv) merge with, consolidate with, acquire or otherwise combine with any other person or entity, transfer any division or segment of its operations to another person or entity, or form new subsidiaries; (v) make any change in its capital structure; (vi) declare or pay dividends except in accordance with all applicable laws and not in excess of fifteen percent (15%) of each year's net earnings available for distribution; (vii) make certain investments and capital expenditures; and (viii) engage in certain transactions with affiliates. These covenants also require the Company to maintain specified financial ratios, including a debt ratio of 2.1 to 1 and a net worth of at least $75,000,000, and to comply with all laws relating to the Company's business. The Revolving Facility also provides that a transfer of ownership of the Company that results in less than 15.0% of the Company's voting stock being owned by Mr. Ernest C. Garcia II, will result in an event of default under the Revolving Facility. Subordinated Indebtedness and Preferred Stock. Prior to its public offering in June 1996, the Company historically borrowed substantial amounts from Verde Investments Inc. ("Verde"), an affiliate of the Company. The Subordinated Note Payable balances outstanding to Verde totaled $12.0 million and $14.0 million as of December 31, 1997 and December 31, 1996, respectively. Prior to June 21, 1996, these borrowings accrued interest at an annual rate of 18.0%. Effective June 21, 1996, the annual interest rate on these borrowings was reduced to 10.0%. The Company is required to make monthly payments of interest and annual payments of principal in the amount of $2.0 million. This debt is junior to all of the Company's other indebtedness and the Company may suspend interest and principal payments in the event it is in default on obligations to any other creditors. In July 1997, the Company's Board of Directors approved the prepayment of the $12.0 million in subordinated debt after the earlier of (1) the Company's completion of a debt offering; or (2) at such time as (a) the FMAC transactions described under the heading "Transactions Regarding First Merchants Acceptance Corporation" herein have been completed or the cash requirements for completion of said transaction are known, and (b) the company either has cash in excess of its current needs or has funds available under its financing sources in excess of its current needs. No such prepayment has been made as of the date of filing of this Form 10-K. Any such prepayment would require the consent of the lenders in the Company's subordinated debt offering effected in February 1998 as described below. 33 35 On December 31, 1995, Verde converted $10.0 million of subordinated debt to Preferred Stock of the Company. Prior to June 21, 1996, the Preferred Stock accrued a dividend of 12.0% annually, increasing one percent per year up to a maximum of 18.0%. Effective June 21, 1996, the dividend on the Preferred Stock was decreased from 12.0% to 10.0%. During the year ended December 31, 1996, the Company paid a total of $916,000 in dividends to Verde on the Preferred Stock which was redeemed in November 1996. As the Preferred Stock was redeemed in 1996, there were no dividends paid in 1997. Subsequent to December 31, 1997, the Company executed senior subordinated notes payable agreements with unrelated third parties for a total of $15.0 million in subordinated debt. The unsecured three year notes call for interest at 12.0% per annum payable quarterly and are senior to the Verde subordinated note payable. In connection with the issuance of these notes, the Company issued the lenders warrants 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 latter of (1) February 2001, or (2) such time as the notes have been paid in full. The Company has certain redemption rights should the closing price of the Company's Common Stock meet certain criteria. The lenders were also granted certain registration rights with respect to the Common Stock underlying the warrants. Additional Financing. Subsequent to December 31, 1997, the Company executed two additional short term notes payable totaling $37.0 million. On January 28, 1998, the Company executed a $7.0 million note payable which accrues interest at 9.5% per annum and is due in full on April 28, 1998. In addition, on February 19, 1998, the Company and certain of its affiliates executed a second short term $30.0 million standby repurchase credit facility. Pursuant to the terms of this facility, the lender agreed to purchase, subject to repurchase rights of the Company and its subsidiaries, certain eligible sub-prime automobile finance receivables originated and or purchased by the Company's affiliates for a purchase price (and corresponding repurchase obligation) of no more than $30.0 million. On February 19, 1998, the lender purchased approximately $16.9 million in contracts pursuant to the facility. On March 3, 1998, the lender purchased approximately $13.1 million in contracts pursuant to the facility. The amounts due and owing the lender under this facility will accrue interest at 9.5%, with the repurchase obligations being exercised no later than March 31, 1998. The obligations of the Company and its affiliates under the facility are secured by a pledge of (a) all of the Company's rights in and to the receivables being acquired by the lender; (b) a pledge by the Company of all of the issued and outstanding common stock of CRC II, a bankruptcy remote subsidiary; and (c) all of the Company's rights and interests (including all collateral) under that certain Loan and Credit Agreement, dated July 17, 1997, between the Company and FMAC pursuant to which the Company is to provide, subject to certain conditions, debtor-in-possession financing to FMAC. See "-- Transactions Regarding First Merchants Acceptance Corporation" below in this Item 7. The Company has executed a commitment letter with a finance company to obtain a $150.0 million surety-enhanced revolving credit facility to supplement the GE Capital Revolving Facility. The execution of definitive agreements is subject to a number of factors, including final negotiation of loan terms and approval of the Company's Board of Directors. The Company believes that it will require additional financing in the near future should it be unsuccessful in consummating the $150.0 million credit facility. Securitizations. The Company's Securitization Program is a primary source of funding for the Company. Under this program, the Company sold approximately $170.4 million in certificates secured by contracts to SunAmerica through securitizations effected prior to June 30, 1997. Since June 30, 1997, the Company has consummated additional securitizations under the Securitization Program with private investors through Greenwich Capital Markets, Inc. ("Greenwich Capital"). Subsequent to December 31, 1997, the Company executed a commitment letter with Greenwich Capital under which, among other things, Greenwich Capital will become the exclusive securitization agent for the Company for up to $1.0 billion of AAA-rated surety wrapped securities as part of the Company's ongoing Securitization Program. At the closing of each securitization, the Securitization Subsidiaries receive payment for the certificates sold (net of Investments Held in Trust). The Company also generates cash flow under this program from ongoing servicing fees and excess cash flow distributions resulting primarily from the difference between the payments received from customers on the contracts and the payments paid on the Class A Certificates. In 34 36 addition, securitization allows the Company to fix its cost of funds for a given contract portfolio, and broadens the Company's capital source alternatives. Failure to periodically engage in securitization transactions will adversely affect the Company. In connection with its securitization transactions, the Securitization Subsidiaries are required to make an initial cash deposit into an account held by the trustee (spread account) and to pledge this cash to the Trust to which the finance receivables were sold. The Trust in turn invests the cash in high quality liquid investment securities. In addition, the cash flows due to the B Certificates first are deposited into the spread account as necessary to attain and maintain the spread account at a specified percentage of the underlying finance receivables principal balance. In the event that the cash flows generated by the finance receivables sold to the Trust are insufficient to pay obligations of the Trust, including principal or interest due to certificate holders or expenses of the Trust, the trustee will draw funds from the spread account as necessary to pay the obligations of the Trust. The spread account must be maintained at a specified percentage of the principal balances of the finance receivables held by the Trust, which can be increased in the event delinquencies or losses exceed specified levels. If the spread account exceeds the specified percentage, the trustee will release the excess cash to the Securitization Subsidiaries from the pledged spread account. Debt Shelf Registration. On July 18, 1997, the Company filed a Form S-3 registration statement for the purpose of registering up to $200 million of its debt securities in one or more series at prices and on terms to be determined at the time of sale. The registration statement has been declared effective by the Securities and Exchange Commission and is available for future debt offerings. Transactions Regarding First Merchants Acceptance Corporation. On August 21, 1997, the Company purchased approximately 78% of the Senior Bank Debt of FMAC held by seven members (the "Selling Banks") of FMAC's original nine member bank group for approximately $69 million, which represented a discount of 10% of the outstanding principal amount of such debt (the "Purchased Claims"). The Company paid 20% of the purchase price at the closing of the purchase and the remainder of the purchase price was financed through a loan to the Company by the Selling Banks (the "Selling Bank Loan") for a term of six months, with interest accruing at LIBOR plus 2%. The Selling Bank Loan was secured by the Company's interest in the Collateral described below that also secured the Purchased Claims. In connection with the purchase, the Company also issued to the Selling Banks the Selling Bank Warrants to purchase up to 389,800 shares of the Company's Common Stock at an exercise price of $20.00 per share at any time through February 20, 2000, and subject to a call feature by the Company if the closing market price of the Company's Common Stock equals or exceeds $27.00 per share for a period of five consecutive trading days. In November of 1997, the Company entered into an agreement allowing the Company to purchase the remaining 22% of FMAC's Senior Bank Debt (the "Remaining Interest"). Pursuant to such agreement, on December 18, 1997, the Company purchased the Remaining Interest at 95% of the outstanding principal balance of the Remaining Interest, plus interest at approximately 8% per annum on such purchase price from November 12, 1997, less all payments received by the sellers with respect to the Remaining Interest through the date of closing (an aggregate amount of approximately $16,974,000 -- excluding an amount equal to approximately $749,000 (the "Disputed Amount") which was in dispute between the parties). On that same day, the Company issued warrants to the sellers to purchase up to 110,200 shares of the Company's Common Stock, which warrants were subsequently returned to the Company and canceled pursuant to a negotiated settlement of the dispute between the parties described above. The Company also received approximately one half of the Disputed Amount as part of such settlement. The Senior Bank Debt was originally secured by (1) the Owned Contracts, (2) all personal property of FMAC, (3) accounts, accounts receivable, including tax refunds, contract rights and other general intangibles, and (4) the common stock of FMARC (defined below) (collectively, the "Collateral"). On December 15, 1997, LaSalle National Bank, as Agent (the "Agent") for the holders of the Senior Bank Debt (the "Bank Group"), credit bid the entire amount of the Senior Bank Debt plus certain interest and fees, costs and expenses relating to the Owned Contracts (collectively, the "Credit Bid Purchase Price"), and the Bankruptcy Court approved the proposed purchase subject to execution by FMAC of appropriate transfer documents. On December 18, 1997, FMAC executed the necessary transfer documents assigning the Owned Contracts to the 35 37 Agent (the "Transfer"), and the Agent then sold the Owned Contracts to the Contract Purchaser for 86% of the principal balance of certain eligible Owned Contracts (approximately $78.9 million) (the "Base Price") plus a residual interest in the Owned Contracts. The Company has guaranteed to the Contract Purchaser a return on the Owned Contracts equal to the Base Price plus interest at the rate of 10.35% per annum, subject to a maximum guarantee amount of $10 million. The Company has the option to purchase the Owned Contracts from the Contract Purchaser at certain times upon certain events, including at any time after three years and if the principal balance on the remaining contracts is less than 10% of the balance of the Owned Contracts on the date of purchase, for a price to yield the Contact Purchaser 10.35%. The cash proceeds from the sale of the Owned Contracts to the Contract Purchaser were distributed by the Agent at the direction of the Company to (i) pay the purchase price of the Remaining Interest as described above, and (ii) pay in full the Selling Bank Loan described above, with proceeds of approximately $15.5 million being distributed to the Company. The Company recorded a gain of approximately $8.1 million (approximately $5.0 million after income taxes) from the Senior Bank Debt transaction in the fourth quarter of 1997. Concurrently with the Transfer, the Agent released the lien of the Bank Group on the Collateral, allowing FMAC to retain all assets constituting any part of the Collateral other than the Owned Contracts (the "Retained Assets"), including but not limited to uncollected state and federal income tax refunds for 1996 and prior years (the "Tax Refunds"), certain receivables and related vehicles pledged to Greenwich Capital (the "Greenwich Collateral"), and FMAC's furniture, fixtures, equipment, general intangibles and causes of action. In consideration for the Bank Group's release of its liens on the Retained Assets, FMAC subsequently (A) guaranteed on a non-recourse basis full and timely payment to the Agent and the Company of any shortfall between (i) the Credit Bid Purchase Price of the Owned Contracts plus interest thereon at the rate of 11% per annum from December 15, 1997, plus an additional charge for servicing the Owned Contracts (the "Owned Contracts Servicing Fee"), calculated on a monthly basis, of the greater of 1/12 of 3 1/4% of the outstanding principal balance of the Owned Contracts or $15.00 per Owned Contract, applied only to Owned Contracts that are less than 120 days past due and for which the related vehicle has not been repossessed and (ii) collections and proceeds of the Owned Contracts (collectively, the "Secured Claim Recovery Amount"), and (B) granted a lien (the "Replacement Lien") on the stock of First Merchants Auto Receivables Corporation ("FMARC") and First Merchants Auto Receivables Corporation II ("FMARC II"), the holders of the residual interests and certain equity certificates (collectively, the "B Pieces") of the various Securitized Pools of FMAC, to secure the Secured Claim Recovery Amount and the Modified UDC Fee (defined below). In the event that the Owned Contracts are not being serviced by the Company, a wholly-owned subsidiary of the Company, or another affiliate or assignee of the Company that meets certain conditions (an "Authorized Servicer"), without the prior written consent of FMAC (an "Owned Loan Servicing Change"), which consent will not be unreasonably withheld, the Secured Claim Recovery Amount will be limited to $10 million. Assuming that the Effective Date of the Plan has occurred, any recovery on the Owned Contracts in excess of the Secured Claim Recovery Amount will be shared with FMAC on the basis of 82 1/2% for the benefit of FMAC and 17 1/2% for the benefit of the Company (the "Excess Collections Split"). After payment in full of the Secured Claim Recovery Amount, the DIP Facility (defined below), the Modified UDC Fee (defined below), and certain other amounts, any further distributions from the B Pieces will be shared between the Company and FMAC on the same basis as the Excess Collections Split. In the event that an Owned Loan Servicing Change occurs, the Excess Collections Split will change to 85% for the benefit of FMAC and 15% to the Company with respect to the B Pieces and, subject to certain adjustments, 100% for the benefit of FMAC and 0% to the Company with respect to the Owned Contracts. The Company will not be entitled to receive any share of the Excess Collections Split relating to a Securitized Pool for any period during which it is not acting as servicer for such Securitized Pool. Assuming that the Effective Date of the Plan has occurred, the confirmed FMAC Plan of Reorganization states that, at the option of the Company, the Company may distribute the Stock Option Shares to FMAC or at the request of FMAC and pursuant to its instructions directly to the unsecured creditors of FMAC, in lieu of FMAC's right to receive all or a portion of distributions under the Excess Collections Split (including both recoveries under the Excess Collections Split from the Owned Contracts and the B Pieces) in cash (the 36 38 "Stock Option"). If the Company decides to exercise the Stock Option, the Company must give FMAC at least 15 days advance written notice (the "Option Notice") (and make a public announcement on the same date as the giving of the notice) of the date on which the Company will exercise the Stock Option (the "Exercise Date") and the number of Stock Option Shares that the Company will issue on the Exercise Date. The Company may exercise the Stock Option one time only, with exercise being the actual delivery of the Stock Option Shares. Revocation of the Option Notice shall not be deemed to be an exercise of the Stock Option by the Company. On the Exercise Date, the aggregate value of the distribution shall be determined by multiplying the Stock Option Shares by 98% of the average of the closing prices for the previous 10 trading days of Company Common Stock on Nasdaq or such other market on which such stock may be traded (the "Stock Option Value"). After issuance and delivery of the Stock Option Shares, the Company will be entitled to receive FMAC's share of cash distributions under the Excess Collections Split (including both recoveries under the Excess Collections Split from the Owned Contracts and the B Pieces) from and after the Exercise Date until the Company has received cash distributions equal to the Stock Option Value. This would be in addition to the Company's right to receive its share under the Excess Collections Split. Once the Company has received cash distributions equal to the Stock Option Value, FMAC will retain the remaining portion of its share of cash distributions under the Excess Collections Split, if any, in excess of the Stock Option Value. The Company will not be entitled to exercise the Stock Option unless (i) the value of its Common Stock on the Exercise Date and the closing price for its Common Stock on each day during the previous ten trading days shall be at least $8.00 per share, (ii) the Company shall have caused (at its sole cost and expense) the Stock Option Shares to be registered under the Securities Act, and be unrestricted and fully transferable, and shall have taken all steps necessary to allow FMAC to distribute the Stock Option Shares to its unsecured creditors, and (iii) the Company shall not have purchased any of its Common Stock (except upon the exercise of previously issued and outstanding options, warrants, stock appreciation rights or other rights) or announced any stock repurchase programs from and after the delivery of the Option Notice through the Exercise Date. At the commencement of the Bankruptcy Case, the Company agreed to provide up to $10 million of "debtor-in-possession" financing (the "DIP Facility"). Borrowings under the DIP Facility originally were to mature on February 28, 1998 and accrue interest at the rate of 12% per annum. The DIP Facility was originally secured by super priority liens on all of FMAC's assets then existing or thereafter acquired. The DIP Facility was subsequently amended (i) to provide for additional advances to pay administrative and post-plan confirmation operating expenses of FMAC, provided that total advances under the DIP Facility may not exceed $21.5 million, (ii) to be secured by the Retained Assets, including the Tax Refunds, (iii) to reduce the interest rate on borrowings outstanding under the DIP Facility (effective on the date of confirmation of the Plan of Reorganization) to 10% per annum; and (iv) to waive the maturity date of the DIP Facility. The first $10 million of Tax Refunds will be used to pay down the DIP Facility and will permanently reduce the amount of the DIP Facility. Thereafter, the DIP Facility will be permanently paid down from distributions on the B Pieces, after payment of the Secured Claim Recovery Amount. Payments made from other sources on the DIP Facility will not permanently reduce the amount thereof and FMAC will be allowed to reborrow such amounts under the facility. The Company's increase in the DIP Facility to $21.5 million was agreed to in exchange for an agreement by the parties involved to assign the receivables in the Securitized Pools that were charged off prior to February 28, 1998 to the Company. The Company would be entitled to retain 30% of every dollar collected on the charged off receivables. The remaining 70% out of every dollar collected would be accumulated in an interest bearing account ("Charged Off Receivable Funds"). When the spread account in an applicable Securitized Pool reaches a certain coverage (the "Coverage Point"), the Charged Off Receivable Funds relating to that Pool would be released. One percent of the face amount of all receivables charged off prior to or on November 30, 1997 and 2% of the face amount of all receivables charged off from December 1, 1997 to and including February 28, 1998 would be released back to the applicable Pool and would be available for distribution in accordance with the Excess Collections Split. Any additional collections with respect to charged-off receivables relating to a Securitized Pool that has reached the Coverage Point would be retained by the Company. The increase in the DIP Facility to $21.5 million is contingent on the occurrence of the Effective Date of FMAC's Plan of Reorganization. FMAC will pay the Company on a non-recourse basis a fee of $450,000 payable prior to any payments pursuant to the Excess Collections Split solely from collections on the B Pieces and secured by a pledge of the 37 39 stock of FMARC and FMARC II, subordinate only to the DIP Facility, the Secured Claim Recovery Amount and prior pledges of the FMARC II stock (the "Modified UDC Fee"). The Company also will receive reimbursement of out-of-pocket expenses related to the DIP Facility of $100,000 on the Effective Date of the FMAC Plan of Reorganization. The Company entered into a Servicing Agreement dated December 18, 1997 (the "Owned Contracts Servicing Agreement") between the Company and the Contract Purchaser, pursuant to which the Owned Contracts would be serviced by the Company in the event that FMAC ceases to service the Owned Contracts. The Company anticipates that it will begin servicing the Owned Contracts on the Effective Date. The Company will receive a servicing fee under the Owned Contracts Servicing Agreement. On the Effective Date, it is anticipated that the Company will also enter into amendments, with FMAC and other parties thereto, to the existing Pooling and Servicing Agreements and Sale and Servicing Agreements that currently govern servicing of the receivables in the Securitized Pools of FMAC, which amendments would provide for the Company to service such Securitized Pools. The Company would begin servicing these receivables on the Effective Date. Under these agreements, the Company would receive a servicing fee for servicing the receivables in the Securitized Pools of the greater of (i) 3.25% per annum of the aggregate outstanding principal balance of substantially all of the non-defaulted receivables computed monthly on the basis of the declining balance of the receivables portfolio or (ii) $15 per receivable per month, plus reimbursement of certain costs and expenses. On the Effective Date, the Company will contribute to FMAC all of its shares of FMAC common. On that date, the Company will also issue the FMAC Warrants to FMAC for its benefit or the benefit of its secured creditors and equity holders. The Effective Date of FMAC's Plan of Reorganization is subject to a number of conditions precedent, which as of March 29, 1998 had not yet been satisfied. The Company cannot predict whether such conditions precedent will be satisfied or when or if the Effective Date will occur. Industry Considerations. In recent periods, several major used car finance companies have announced major downward adjustments to their financial statements, violations of loan covenants, related litigation, and other events. In addition, certain of these companies have filed for bankruptcy protection. These announcements have had a disruptive effect on the market for securities of sub-prime automobile finance companies, have resulted in a tightening of credit to the sub-prime markets, and could lead to enhanced regulatory oversight. A reduction in access to the capital markets or to credit sources could have an adverse affect on the Company. Capital Expenditures and Commitments. The Company is pursuing an aggressive growth strategy. In January 1997, the Company acquired selected assets of a group of companies engaged in the business of selling and financing used motor vehicles, including four dealerships located in the Tampa Bay/St. Petersburg market (Seminole). In March 1997, the Company opened its first used car dealership in the Las Vegas market. In April 1997, the Company acquired selected assets of a company in the business of selling and financing used motor vehicles, including seven dealerships located in the San Antonio market (EZ Plan). In September 1997, the Company acquired selected assets of a company in the business of selling used motor vehicles, including six dealerships in the Los Angeles market, two in the Miami market, two in the Atlanta market and two in the Dallas market (Kars). In addition, the Company has one dealership in Phoenix, two in San Antonio, two in Dallas, two in Atlanta, one in Albuquerque and three in Tampa currently under development. In addition, the Company opened two additional dealerships in the Albuquerque market and three additional dealerships in the Phoenix market, one additional dealership in the Tampa/St. Petersburg market, and four additional dealerships in the Atlanta market during 1997. On July 11, 1997, the Company entered into an agreement to provide "debtor-in-possession" financing to First Merchants Acceptance Corporation in an amount up to $10.0 million. Assuming that the Effective Date of the Plan has occurred, the agreement has been amended to increase the maximum commitment to $21.5 million. The Company had advanced $10.9 million against this commitment as of December 31, 1997. The Company intends to finance these expenditures through operating cash flows and supplemental borrowings, including amounts available under the Revolving Facility and the Securitization Program, if any. 38 40 Sale-Leaseback of Real Property. In March 1998, the Company executed a commitment letter with an investment company for the sale-leaseback of up to $37.0 million in real property. Pursuant to the terms of the commitment letter, which is subject to final negotiation, approval of the Company's Board of Directors, and execution of definitive agreements, the Company would sell certain real property to the investment company for its original cost and leaseback the properties for an initial term of twenty years. The Company would retain certain extension options, and pay monthly rents of approximately one-twelfth of 10.75% of the purchase price plus all occupancy costs and taxes. The commitment letter calls for annual increases in the monthly rents of not less than 2%. The ultimate terms of the agreement may differ from those described herein. Common Stock Repurchase Program. In October 1997, the Company's Board of Directors authorized a stock repurchase program by which the Company may acquire up to one million shares of its Common Stock from time to time on the open market. Under the program, purchases may be made depending on market conditions, share price, and other factors. The stock repurchase program will terminate on December 31, 1998, unless extended by the Company's Board of Directors, and may be discontinued at any time. As of the date of filing of this Form 10-K, the Company had not repurchased any shares of its Common Stock. Year 2000. The Company has commenced a study of its computer systems in order to assess its exposure to year 2000 issues. The Company expects to make the necessary modifications or changes to its computer information systems to enable proper processing of transactions relating to the year 2000 and beyond. The Company estimates that it will cost from $500,000 to $1.0 million to modify its existing systems, should it choose to do so. 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. Resolution of all year 2000 issues is critical to the Company's business. There can be no assurance that the Company will be able to completely resolve all year 2000 issues in a timely fashion or that the ultimate cost to identify and implement solutions to all year 2000 problems will not be material to the Company. See Part II. Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Risk Factors -- Data Processing and Technology and Year 2000." INFLATION Increases in inflation generally result in higher interest rates. Higher interest rates on the Company's borrowings would decrease the profitability of the Company's existing portfolio. The Company will seek to limit this risk through its Securitization Program and, to the extent market conditions permit, for contracts originated at Company Dealerships, either by increasing the interest rate charged, or the profit margin on, the cars sold, and for bulk purchases, by increasing the purchase discount at which the Company purchases the contract portfolio. To date, inflation has not had a significant impact on the Company's operations. ACCOUNTING MATTERS In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS No. 130) which became effective for the Company January 1, 1998. SFAS No. 130 establishes standards for reporting and displaying comprehensive income and its components in a full set of general-purpose financial statements. Management does not expect the adoption of SFAS No. 130 to have a material impact on the Company. In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" (SFAS No. 131) which became effective for the Company January 1, 1998. SFAS No. 131 establishes standards for the way that public enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim reports issued to stockholders. Management does not expect the adoption of SFAS No. 131 to have a material impact on the Company. 39 41 RISK FACTORS No Assurance of Profitability The Company began operations in 1992 and incurred significant operating losses in 1994 and 1995. The Company recorded net earnings of $5.9 million in 1996 and net earnings in 1997 of $9.5 million. However, the Company incurred a net loss for the three month period ended September 30, 1997 due in large part to a charge of $10.0 million (approximately $6.0 million, net of income taxes) against Residuals in Finance Receivables Sold. Although the Company regained profitability in the three month period ended December 31, 1997, the Company also announced that it intends to close its Branch Office network and take a charge to earnings with respect to such closure in 1998 (see Part I. Item 1. "Business -- Strategic Evaluation of Third Party Dealer Operations"). There can be no assurance that the Company will maintain profitability in future periods. The Company's ability to sustain profitability will depend primarily upon its ability to: (i) expand its revenue generating operations while not proportionately increasing its administrative overhead; (ii) originate and purchase contracts with an acceptable level of credit risk; (iii) effectively collect payments due on the contracts in its portfolio; (iv) locate sufficient financing, with acceptable terms, to fund the expansion of used car sales and the origination and purchase of additional contracts; and (v) adapt to the increasingly competitive market in which it operates. Outside factors, such as the economic, regulatory, and judicial environments in which it operates, will also have an effect on the Company's business. The Company's inability to achieve or maintain any or all of these objectives could have a material adverse effect on the Company. Dependence on Securitizations In recent periods, the Company's earnings (loss) from operations have been significantly impacted by the sales of contract receivables and the earnings (loss) recorded by the Company on the Residuals in Finance Receivables Sold. The Company's ability to successfully complete securitizations in the future may be affected by several factors, including the condition of securities markets generally, conditions in the asset-backed securities markets specifically, and the credit quality of the Company's portfolio. The amount of any gain on sale in connection with securitizations is based upon certain estimates and assumptions, which may not subsequently be realized. To the extent that actual cash flows on a securitization differ materially from the original securitization assumptions, and in the opinion of management those differences appear to be other than temporary in nature, the Company is required to revalue the Residuals in Finance Receivables Sold, and record a charge to earnings based upon the reduction. In addition, the Company records ongoing income based upon the cash flows on Residuals in Finance Receivables Sold. The income recorded on the Residuals in Finance Receivables Sold will vary from quarter to quarter based upon cash flows received in a given period. To the extent that cash flows are deficient, charge offs of finance receivables exceed estimates, or assumptions that were applied to the underlying portfolio are not realized, and in the opinion of management those differences appear to be other than temporary in nature, the Company is required to revalue the Residuals in Finance Receivables Sold, and record a charge to earnings. During the year ended December 31, 1997, the Company recorded a charge of $10.0 million ($6.0 million after taxes) against the Residuals in Finance Receivables Sold. The charge resulted from an upward revision in the Company's net charge off assumptions related to the underlying contract portfolios supporting the Company's Residuals in Finance Receivables Sold. Although the Company believes the charge is adequate to adjust the assumptions to a level which will more closely approximate future net losses in the underlying contract portfolio, there can be no assurance in that regard. CRC and CRC II (the Securitization Subsidiaries), are the Company's wholly-owned special purpose "bankruptcy remote" entities. Their assets include Residuals in Finance Receivables Sold and Investments Held in Trust, in the amounts of $29.4 million and $17.6 million, respectively, at December 31, 1997, which amounts would not be available to satisfy claims of creditors of the Company 40 42 Dependence on External Financing; Cash Position The Company has borrowed, and will continue to borrow, substantial amounts to fund its operations. In this regard, the Company's operations, including its recently initiated Cygnet Dealer Program, are highly capital intensive. Currently, the Company receives financing pursuant to the Revolving Facility with GE Capital, which has a maximum commitment of $100.0 million. Under the Revolving Facility, the Company may borrow up to 65.0% of the principal balance of eligible Company Dealership contracts and up to 86.0% of the principal balance of eligible Third Party Dealer contracts. However, an amount up to ten million dollars (such amount being reduced as collections on certain contracts are received by the Contract Purchaser) of the borrowing capacity under the Revolving Facility is not available at any time when the guarantee of the Company to the Contract Purchaser (as described above under "-- Transactions Regarding First Merchants Acceptance Corporation") is in effect. The Revolving Facility is secured by substantially all of the Company's assets. In addition, the Revolving Facility and/or other credit facilities of the Company contain various restrictive covenants that limit, among other things, the Company's ability to engage in mergers and acquisitions, incur additional indebtedness, and pay dividends or make other distributions, and also requires the Company to meet certain financial tests. Although the Company believes it is currently in compliance with the terms and conditions of the Revolving Facility and such other facilities, there can be no assurance that the Company will be able to continue to satisfy such terms and conditions or that the Revolving Facility will be extended beyond its current expiration date. In addition, the Company has established a Securitization Program pursuant to which the Company is subject to numerous terms and conditions. See "-- Liquidity and Capital Resources" above in this Item 7. Failure of the Company to engage in securitization transactions could have a material adverse effect on the Company. The Company's cash and cash equivalents decreased from $18.5 million at December 31, 1996 to $3.5 million at December 31, 1997. This decrease is due in large part to the growth of the Cygnet Dealer Program loan portfolio and the making of debtor-in-possession loans in connection with the reorganization of FMAC (see "- Transactions Regarding First Merchants Acceptance Corporation" above in this Item 7), as well as the growth in vehicle inventory and property and equipment. The Company is currently evaluating its alternatives for the future financing of the Cygnet Dealer Program. On January 28, 1998, the Company borrowed $7 million from Greenwich Capital (the "Greenwich Loan"), the proceeds of which were utilized to reduce the Revolving Facility. The Greenwich Loan is repayable on April 28, 1998. In addition, on February 19, 1998, the Company entered into the $30.0 million standby repurchase credit facility discussed above, the repurchase obligations under which are due on March 31, 1998. There can be no assurance that the Company will have the liquidity to repay the Greenwich Loan or fulfill its repurchase obligations when due. The Company is currently evaluating other longer term financing options, including certain additional financing transactions that may be entered into with Greenwich Capital. There can be no assurance that any further securitizations will be completed or that the Company will be able to secure additional financing when and as needed in the future, or on terms acceptable to the Company. Poor Creditworthiness of Borrowers; High Risk of Credit Losses Substantially all of the contracts that the Company services are with Sub-Prime Borrowers. Due to their poor credit histories and/or low incomes, Sub-Prime Borrowers are generally unable to obtain credit from traditional financial institutions, such as banks, savings and loans, credit unions, or captive finance companies owned by automobile manufacturers. The Company has established an Allowance for Credit Losses, which approximated 19.5% and 13.9% of contract principal balances as of December 31, 1997 and 1996, respectively, to cover anticipated credit losses on the contracts currently in its portfolio. At December 31, 1997 and 1996, the principal balance of the retained and securitized loan portfolios of delinquent contracts in excess of thirty days past due as a percentage of total outstanding contract principal balances was 5.7% and 5.2%, respectively. The Company's net charge offs on its retained portfolio as a percentage of average principal outstanding for the years ended December 31, 1997 and 1996 were 12% and 16.7%, respectively. The Company believes its current Allowance for Credit Losses is adequate to absorb anticipated credit losses. However, there is no assurance that the Company has adequately provided for, or will adequately provide for, such credit risks or that credit losses in excess of its Allowance for Credit Losses will not occur in the future. A significant 41 43 variation in the timing of or increase in credit losses on the Company's portfolio would have a material adverse effect on the Company. The Company has initiated its Cygnet Dealer Program, pursuant to which the Company provides qualified Third Party Dealers with warehouse purchase facilities and operating lines of credit primarily secured by such dealers' retail installment contract portfolios and/or inventory. While the Company requires Third Party Dealers to meet certain minimum net worth and operating history criteria to be considered for inclusion in the Cygnet Dealer Program, the Company will, nevertheless, be extending credit to dealers who may not otherwise be able to obtain debt financing from traditional lending institutions such as banks, credit unions, and major finance companies. Consequently, similar to its other financing activities, the Company will be subject to a high risk of credit losses that could have a material adverse effect on the Company and on the Company's ability to meet its own financing obligations. Potential Change in Business Strategy The Company is evaluating strategic alternatives for certain of its business segments. Specifically, the Company is reviewing the potential sale or spin-off to third parties or shareholders of the Company's Third Party Dealer operations, including its third party purchasing and servicing operations, Cygnet Dealer Program, insurance operations, and related portfolios. Any sale or spin-off would be subject to a number of factors, including satisfactory resolution of relevant business, accounting, regulatory, legal, and tax issues. No change in the Company's primary business of selling and financing used cars through its dealership network is being considered. There can be no assurance that the Company will effect a sale or spin-off of any business operation; what form that such a transaction would take if implemented, including whether stockholders will receive or be able to acquire equity interests in any operation sold or spun-off; or that any sale or spin-off would prove successful or economically beneficial to the Company or its stockholders. Further, failure to implement a sale or spin-off could adversely affect the Company's operations and financial condition, as well as the market for its Common Stock and warrants. In addition, under the Company's most recent securitizations, a sale or spin-off of its servicing operations would constitute a "termination event," under which the insurer in respect of the securitization could terminate the Company's servicing rights. Further, upon a termination event, distributions in connection with the Company's residual interest in such securitization effectively would be suspended until the interest of third party holders is paid in full. In connection with its strategic evaluation, the Company determined to close its Branch Office network but to continue to pursue its Cygnet Dealer Program and the bulk purchase and/or servicing of contracts originated by other subprime lenders, which it believes is a more efficient method of purchasing or obtaining servicing rights to sub-prime automobile contracts. There can be no assurance that the restructuring of the Company's Third Party Dealer operations and focus on the purchase and/or servicing of large contract portfolios will prove successful, will enhance the Company's profitability or, if pursued, will facilitate a sale, spin-off, or other disposition of these operations. There can also be no assurance that the Company will be able to maintain sufficient liquidity to fund additional bulk contract purchases. Data Processing and Technology and Year 2000 The success of any participant in the sub-prime industry, including the Company, depends in part on its ability to continue to adapt its technology, on a timely and cost-effective basis, to meet changing customer and industry standards and requirements. The Company recently converted to a new loan servicing and collection data processing system at its Gilbert, Arizona facility which services the Company's Arizona, Nevada, and New Mexico Company Dealership loan portfolios as well as substantially all of the Third Party Dealer Branch Office loan portfolio. In connection with the conversion, the Company confronted various implementation and integration issues, which management believes have resulted in increases in both contract delinquencies and charge offs. Although many of these issues have been resolved, failure to promptly and fully resolve all issues could have a material adverse effect on the Company. The Company services its loan portfolios on loan servicing and collection data processing systems on various platforms. In the future, the Company may migrate and convert all of its Company Dealership loan 42 44 servicing and collection data processing to a single loan servicing and collection data processing system. Failure to successfully migrate and convert to a single loan servicing and data processing system could have a material adverse affect on the Company. The Company has commenced a study of its computer systems in order to assess its exposure to year 2000 issues. The Company expects to make the necessary modifications or changes to its computer information systems to enable proper processing of transactions relating to the year 2000 and beyond. The Company estimates that it will cost from $500,000 to $1.0 million to modify its existing systems, should it choose to do so. 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. However, failure of the Company to fully address and resolve its year 2000 issues, including modification of its existing systems, replacement of such systems, or other matters could have a material adverse effect on the Company. The Company is dependent on its loan servicing and collection facilities as well as long-distance and local telecommunications access in order to transmit and process information among its various facilities. The Company maintains a standard program whereby it prepares and stores off site back ups of its main system applications and data files on a routine basis. Due primarily to the Company's recent acquisitions and significant growth, the Company believes that its current disaster response plan will need to be revised. Although management intends to update the disaster response plan during 1998, there can be no assurance a failure will not occur in the interim or that the plan as revised will prevent or enable timely resolution of any systems failure. Further, a natural disaster, calamity, or other significant event that causes long-term damage to any of these facilities or that interrupts its telecommunications networks could have a material adverse effect on the Company. Risks Relating to FMAC Transaction In recent periods, the Company has been actively involved in the reorganization proceeding of FMAC. See Part I. Item 1. "Business -- Recent Acquisitions and Agreements -- Transactions involving First Merchants Acceptance Corporation" and Part II. Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." There can be no assurance that the servicing rights and interests in the residual interests in securitizations obtained or to be obtained on the Effective Date by the Company will prove valuable or profitable. Neither the issuance of the FMAC Warrants nor any other consideration to be given by the Company is conditioned upon the profit ultimately achieved by the Company. Further, the FMAC Warrants, Bank Group Warrants, and Stock Option Shares will further dilute the Company's equity and could adversely affect the market and price for the Common Stock. The Company has guaranteed a 10.35% return on certain Owned Contracts acquired from FMAC and sold to the Contract Purchaser, subject to a maximum guarantee of $10.0 million. Although FMAC has provided a similar guarantee to the Company payable out of certain distributions from residual interests held by FMAC in securitization transactions, there can be no assurance that there will be sufficient distributions from the residual interests to support the guarantee. The Company's debtor-in-possession loans to FMAC and certain fees payable to the Company would also be payable out of certain expected tax refunds of FMAC and/or distributions from residual interests in FMAC's securitization transactions. Although the Company anticipates collecting such items, there can be no assurance that these loans or fees will be paid. Payments pursuant to the residual interests may not be made until the senior certificates in the securitization transactions are paid in full. Certain benefits to the Company in the transaction would be contingent on the Company, a wholly-owned subsidiary of the Company, or an Authorized Servicer servicing the Owned Contracts and/or certain other receivables currently serviced by FMAC. In the event that the Company, its subsidiary, or an Authorized Servicer does not obtain or retain such servicing rights, the Company could be materially adversely affected. 43 45 No Assurance of Successful Acquisitions In 1997, the Company completed three significant acquisitions (Seminole, EZ Plan, and Kars) and intends to consider additional acquisitions, alliances, and transactions involving other companies that could complement the Company's existing business. There can be no assurance that suitable acquisition parties, joint venture candidates, or transaction counterparties can be identified, or that, if identified, any such transactions will be consummated on terms favorable to the Company, or at all. Furthermore, there can be no assurance that the Company will be able to integrate successfully such acquired businesses, including those recently acquired, into its existing operations, which could increase the Company's operating expenses in the short-term and adversely affect the Company. Moreover, these types of transactions by the Company may result in potentially dilutive issuances of equity securities, the incurrence of additional debt, and amortization of expenses related to goodwill and intangible assets, all of which could adversely affect the Company's profitability. As of December 31, 1997, the Company had goodwill totaling approximately $17.9 million, the components of which will be amortized over a period of 15 to 20 years. These transactions involve numerous risks, such as the diversion of the attention of the Company's management from other business concerns, the entrance of the Company into markets in which it has had no or only limited experience, and the potential loss of key employees of the acquired company, all of which could have a material adverse effect on the Company. Highly Competitive Industry Although the used car sales industry has historically been highly fragmented, it has attracted significant attention from a number of large companies, including AutoNation, U.S.A. and Driver's Mart, which have 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. The Company believes 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 the Company. 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 in order 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 prices that the Company believes are not commensurate with the associated risk. There are numerous financial services companies serving, or capable of serving, this market, including traditional financial institutions such as banks, savings and loans, credit unions, and captive finance companies owned by automobile manufacturers, and other non-traditional consumer finance companies, many of which have significantly greater financial and other resources than the Company. Increased competition may cause downward pressure on the interest rates the Company charges on contracts originated by its Company Dealerships or cause the Company to reduce or eliminate the nonrefundable acquisition discount on the contracts it purchases from Third Party Dealers, which could have a material adverse effect on the Company. Similarly, increased competition may be a reason for a potential Company sale or spin-off to third parties or shareholders of Third Party Dealer operations, including its third party purchasing and servicing operations, Cygnet Dealer Program, insurance operations, and related portfolios. General Economic Conditions The Company's business is directly related to sales of used cars, which are affected by employment rates, prevailing interest rates, and other general economic conditions. While the Company believes that current economic conditions favor continued growth in the markets it serves and those in which it seeks to expand, a future economic slowdown or recession could lead to decreased sales of used cars and increased delinquencies, repossessions, and credit losses that could hinder the Company's business. Because of the Company's focus on the sub-prime segment of the automobile financing industry, its actual rate of delinquencies, repossessions, 44 46 and credit losses could be higher under adverse conditions than those experienced in the used car sales and finance industry in general. Industry Considerations and Legal Contingencies In recent periods, several major used car finance companies have announced major downward adjustments to their financial statements, violations of loan covenants, related litigation, and other events. In addition, certain of these companies have filed for bankruptcy protection. These announcements have had a disruptive effect on the market for securities of sub-prime automobile finance companies, have resulted in a tightening of credit to the sub-prime markets, and could lead to enhanced regulatory oversight. Furthermore, companies in the used vehicle financing market have been named as defendants in an increasing number of class action lawsuits brought by customers alleging violations of various federal and state consumer credit and similar laws and regulations. Although the Company is not currently a named defendant in any such lawsuits, no assurance can be given that such claims will not be asserted against the Company in the future or that the Company's operations will not be subject to enhanced regulatory oversight. Need to Establish and Maintain Relationships with Third Party Dealers Pursuant to the Cygnet Dealer Program, the Company enters into financing agreements with qualified Third Party Dealers. The Company's Third Party Dealer financing activities depend in large part upon its ability to establish and maintain relationships with such dealers. While the Company believes that it has been successful in developing and maintaining relationships with Third Party Dealers in the markets that it currently serves, there can be no assurance that the Company will be successful in maintaining or increasing its existing Third Party Dealer base, or that a sufficient number of qualified dealers will become involved in the Cygnet Dealer Program. Geographic Concentration Company Dealership operations are currently located in Arizona, Georgia, California, Texas, Florida, Nevada, and New Mexico. Because of this concentration, the Company's business may be adversely affected in the event of a downturn in the general economic conditions existing in the Company's primary markets. Sensitivity to Interest Rates A substantial portion of the Company's financing income results from the difference between the rate of interest it pays on the funds it borrows and the rate of interest it earns on the contracts in its portfolio. While the contracts the Company owns bear interest at a fixed rate, the indebtedness that the Company incurs under its Revolving Facility bears interest at a floating rate. In the event the Company's interest expense increases, it would seek to compensate for such increases by raising the interest rates on its Company Dealership contracts, increasing the acquisition discount at which it purchases Third Party Dealer contracts, or raising the retail sales prices of its used cars. To the extent the Company were unable to do so, the Company's net interest margins would decrease, thereby adversely affecting the Company's profitability. Impact of Usury Laws Historically, a significant portion of the Company's used car sales activities were conducted in, and a significant portion of the contracts the Company services were originated in, Arizona, which does not impose limits on the interest rate that a lender may charge. However, the Company has expanded, and will continue to expand, its operations into states that impose usury limits, such as Florida and Texas. The Company attempts to mitigate these rate restrictions by raising the retail prices of its used cars or purchasing contracts originated in these states at a higher discount. The Company's inability to mitigate rate restrictions in states imposing usury limits would adversely affect the Company's planned expansion and its results of operations. There can be no assurance that the usury limitations to which the Company is or may become subject or that additional laws, rules, and regulations that may be adopted in the future will not adversely affect the Company's business. 45 47 Dependence Upon Key Personnel The Company's future success will depend upon the continued services of the Company's senior management as well as the Company's ability to attract additional members to its management team with experience in the used car sales and financing industry. The unexpected loss of the services of any of the Company's key management personnel, or its inability to attract new management when necessary, could have a material adverse effect upon the Company. The Company has entered into employment agreements (which include non-competition provisions) with certain of its officers. The Company does not currently maintain any key person life insurance on any of its executive officers. Control by Principal Stockholder Mr. Ernest C. Garcia, II, the Company's Chairman, Chief Executive Officer, and principal stockholder, holds approximately 25.1% of the outstanding Common Stock, including 136,500 shares held by The Garcia Family Foundation, Inc., an Arizona non-profit corporation, and 20,000 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 the activities of the Company, as well as on all matters requiring approval of the stockholders, including electing or removing members of the Company's Board of Directors, causing the Company to engage in transactions with affiliated entities, causing or restricting the sale or merger of the Company, and changing the Company's dividend policy. Potential Anti-Takeover Effect of Preferred Stock The Company's Certificate of Incorporation authorizes the Company to issue "blank check" Preferred Stock, the designation, number, voting powers, preferences, and rights of which may be fixed or altered from time to time by the Board of Directors. Accordingly, the Board of Directors has the authority, without stockholder approval, to issue Preferred Stock with dividend, conversion, redemption, liquidation, sinking fund, voting, and other rights that could adversely affect the voting power or other rights of the holders of the Common Stock. The Preferred Stock could be utilized, under certain circumstances, to discourage, delay, or prevent a merger, tender offer, or change in control of the Company that a stockholder might consider to be in its best interests. Although the Company has no present intention of issuing any shares of its authorized Preferred Stock, there can be no assurance that the Company will not do so in the future. Regulation, Supervision, and Licensing The Company's operations are subject to ongoing regulation, supervision, and licensing under various federal, state, and local statutes, ordinances, and regulations. Among other things, these laws require that the Company obtain and maintain certain licenses and qualifications, limit or prescribe terms of the contracts that the Company originates and/or purchases, require specified disclosures to customers, limit the Company's right to repossess and sell collateral, and prohibit the Company from discriminating against certain customers. The Company is also subject to federal and state franchising and insurance laws. The Company believes that it is currently in substantial compliance with all applicable material federal, state, and local laws and regulations. There can be no assurance, however, that the Company will be able to remain in compliance with such laws, and such failure could result in fines or interruption or cessation of certain of the business activities of the Company and could have a material adverse effect on the operations of the Company. In addition, the adoption of additional statutes and regulations, changes in the interpretation of existing statutes and regulations, or the Company's entrance into jurisdictions with more stringent regulatory requirements could have a material adverse effect on the Company. Possible Volatility of Stock Price The market price of the Common Stock has been and may continue to be volatile in response to such factors as, among others, variations in the anticipated or actual results of operations of the Company or other companies in the used car sales and finance industry, changes in conditions affecting the economy generally, analyst reports, or general trends in the industry. 46 48 ITEM 8 -- CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders Ugly Duckling Corporation: We have audited the accompanying consolidated balance sheets of Ugly Duckling Corporation and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1997. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Ugly Duckling Corporation and subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1997 in conformity with generally accepted accounting principles. /s/ KPMG Peat Marwick LLP Phoenix, Arizona February 10, 1998 47 49 UGLY DUCKLING CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
DECEMBER 31, -------------------- 1997 1996 -------- -------- (IN THOUSANDS) ASSETS Cash and Cash Equivalents................................... $ 3,537 $ 18,455 Finance Receivables, Net.................................... 123,093 60,952 Investments Held in Trust................................... 18,914 3,479 Notes Receivable, Net....................................... 22,773 1,063 Inventory................................................... 33,888 5,752 Property and Equipment, Net................................. 41,252 20,652 Intangible Assets, Net...................................... 17,543 2,150 Other Assets................................................ 18,054 5,580 -------- -------- $279,054 $118,083 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Accounts Payable.......................................... $ 3,004 $ 2,132 Accrued Expenses and Other Liabilities.................... 17,105 6,728 Notes Payable............................................. 65,171 12,904 Subordinated Note Payable................................. 12,000 14,000 -------- -------- Total Liabilities................................. 97,280 35,764 -------- -------- Stockholders' Equity Preferred Stock........................................... -- -- Common Stock.............................................. 172,622 82,612 Retained Earnings (Accumulated Deficit)................... 9,152 (293) -------- -------- Total Stockholders' Equity........................ 181,774 82,319 Commitments, Contingencies and Subsequent Events -------- -------- $279,054 $118,083 ======== ========
See accompanying notes to Consolidated Financial Statements. 48 50 UGLY DUCKLING CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, -------------------------------------------------- 1997 1996 1995 ------------ ----------- ----------- (IN THOUSANDS, EXCEPT EARNINGS PER SHARE AMOUNTS) Sales of Used Cars................................. $123,814 $53,768 $47,824 Less: Cost of Used Cars Sold........................... 66,509 29,890 27,964 Provision for Credit Losses...................... 24,075 9,811 8,359 -------- ------- ------- 33,230 14,067 11,501 -------- ------- ------- Other Income: Interest Income.................................. 34,384 15,856 10,071 Gain on Sale of Loans............................ 21,713 4,434 -- Servicing Income................................. 7,230 921 -- Other Income..................................... 3,977 650 308 -------- ------- ------- 67,304 21,861 10,379 -------- ------- ------- Income before Operating Expenses................... 100,534 35,928 21,880 Operating Expenses: Selling and Marketing............................ 10,567 3,585 3,856 General and Administrative....................... 65,000 19,538 14,726 Depreciation and Amortization.................... 3,683 1,577 1,314 -------- ------- ------- 79,250 24,700 19,896 -------- ------- ------- Income before Interest Expense..................... 21,284 11,228 1,984 Interest Expense................................... 5,260 5,262 5,956 -------- ------- ------- Earnings (Loss) before Income Taxes................ 16,024 5,966 (3,972) Income Taxes....................................... 6,579 100 -- -------- ------- ------- Net Earnings (Loss)................................ $ 9,445 $ 5,866 $(3,972) ======== ======= ======= Basic Earnings (Loss) per Share.................... $ 0.53 $ 0.63 $ (0.72) ======== ======= ======= Diluted Earnings (Loss) per Share.................. $ 0.52 $ 0.60 $ (0.72) ======== ======= =======
See accompanying notes to Consolidated Financial Statements. 49 51 UGLY DUCKLING CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995 (IN THOUSANDS)
RETAINED TOTAL SHARES AMOUNT EARNINGS STOCKHOLDERS' ------------------ -------------------- (ACCUMULATED EQUITY PREFERRED COMMON PREFERRED COMMON DEFICIT) (DEFICIT) --------- ------ --------- -------- ------------ ------------- Balances at December 31, 1994......................... -- 5,522 $ -- $ 77 $(1,271) $ (1,194) Issuance of Common Stock....... -- 58 -- 50 -- 50 Conversion of Subordinated Notes Payable to Preferred Stock........................ 1,000 -- 10,000 -- -- 10,000 Net Loss for the Year.......... -- -- -- -- (3,972) (3,972) ------ ------ -------- -------- ------- -------- Balances at December 31, 1995......................... 1,000 5,580 10,000 127 (5,243) 4,884 Issuance of Common Stock for Cash......................... -- 7,281 -- 79,335 -- 79,335 Conversion of Debt to Common Stock........................ -- 444 -- 3,000 -- 3,000 Issuance of Common Stock to Board of Director's.......... -- 22 -- 150 -- 150 Redemption of Preferred Stock........................ (1,000) -- (10,000) -- -- (10,000) Preferred Stock Dividends...... -- -- -- -- (916) (916) Net Earnings for the Year...... -- -- -- -- 5,866 5,866 ------ ------ -------- -------- ------- -------- Balances at December 31, 1996......................... -- 13,327 -- 82,612 (293) 82,319 Issuance of Common Stock for Cash......................... -- 5,194 -- 89,398 -- 89,398 Issuance of Common Stock Warrants..................... -- -- -- 612 -- 612 Net Earnings for the Year...... -- -- -- -- 9,445 9,445 ------ ------ -------- -------- ------- -------- Balances at December 31, 1997......................... -- 18,521 $ -- $172,622 $ 9,152 $181,774 ====== ====== ======== ======== ======= ========
See accompanying notes to Consolidated Financial Statements. 50 52 UGLY DUCKLING CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, --------------------------------- 1997 1996 1995 --------- -------- -------- (IN THOUSANDS) Cash Flows from Operating Activities: Net Earnings (Loss)..................................... $ 9,445 $ 5,866 $ (3,972) Adjustments to Reconcile Net Earnings (Loss) to Net Cash Provided by (Used in) Operating Activities: Provision for Credit Losses.......................... 24,075 9,811 8,359 Gain on Sale of Loans................................ (13,581) (4,434) -- Issuance of Warrants for Notes Receivable............ 612 -- -- Decrease (Increase) in Deferred Income Taxes......... 1,394 249 449 Depreciation and Amortization........................ 3,683 1,577 1,314 Decrease (Increase) in Inventory..................... (21,821) 577 (1,500) Purchase of Finance Receivables for Sale............. (301,116) (45,989) -- Proceeds from Sale of Finance Receivables............ 237,173 38,989 -- Collections of Finance Receivables................... 62,454 -- -- Increase in Other Assets............................. (10,459) (3,150) (529) Increase in Accounts Payable, Accrued Expenses, and Other Liabilities.................................. 8,726 2,949 3,035 Increase (Decrease) in Income Taxes Receivable/Payable................................. (1,377) 534 (984) Other, Net........................................... -- -- 169 --------- -------- -------- Net Cash Provided by (Used in) Operating Activities.................................... (792) 6,979 6,341 --------- -------- -------- Cash Flows from Investing Activities: Increase in Finance Receivables......................... (29,100) (67,803) (53,023) Collections of Finance Receivables...................... -- 49,201 19,795 Increase in Investments Held in Trust................... (15,436) (3,479) -- Net (Increase) Decrease in Notes Receivable............. (13,487) 100 -- Purchase of Property and Equipment...................... (19,373) (6,111) (3,195) Payment for Acquisition of Assets....................... (46,316) -- -- Other, Net.............................................. -- (1,909) -- --------- -------- -------- Net Cash Used in Investing Activities........... (123,712) (30,001) (36,423) --------- -------- -------- Cash Flows from Financing Activities: Additions to Notes Payable.............................. 22,448 1,000 22,259 Repayments of Notes Payable............................. (81) (28,610) -- Net Issuance (Repayment) of Subordinated Notes Payable.............................................. (2,000) (553) 6,262 Redemption of Preferred Stock........................... -- (10,000) -- Proceeds from Issuance of Common Stock.................. 89,398 79,435 5 Other, Net.............................................. (179) (1,214) 2,807 --------- -------- -------- Net Cash Provided by Financing Activities....... 109,586 40,058 31,333 --------- -------- -------- Net Increase (Decrease) in Cash and Cash Equivalents...... (14,918) 17,036 1,251 Cash and Cash Equivalents at Beginning of Year............ 18,455 1,419 168 --------- -------- -------- Cash and Cash Equivalents at End of Year.................. $ 3,537 $ 18,455 $ 1,419 ========= ======== ========
51 53 UGLY DUCKLING CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
YEARS ENDED DECEMBER 31, ---------------------------- 1997 1996 1995 ------- ------ ------- (IN THOUSANDS) Supplemental Statement of Cash Flows Information: Interest Paid............................................. $ 5,382 $5,144 $ 5,890 ======= ====== ======= Income Taxes Paid......................................... $ 6,570 $ 450 $ 535 ======= ====== ======= Assumption of Debt in Connection with Acquisition of Assets................................................. $29,900 $ -- $ -- ======= ====== ======= Conversion of Note Payable to Common Stock................ $ -- $3,000 $ -- ======= ====== ======= Conversion of Subordinated Debt to Preferred Stock........ $ -- $ -- $10,000 ======= ====== ======= Purchase of Property and Equipment with Notes Payable..... $ -- $8,313 $ -- ======= ====== ======= Purchase of Property and Equipment with Capital Leases.... $ 357 $ 57 $ 792 ======= ====== =======
See accompanying notes to Consolidated Financial Statements. 52 54 UGLY DUCKLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) ORGANIZATION AND ACQUISITIONS Ugly Duckling Corporation, a Delaware corporation (the Company), was incorporated in April 1996 as the successor to Ugly Duckling Holdings, Inc. (UDH), an Arizona corporation, formed in 1992. Contemporaneous with the formation of the Company, UDH was merged into the Company with each share of UDH's common stock exchanged for 1.16 shares of common stock in the Company and each share of UDH's preferred stock exchanged for one share of preferred stock in the Company under identical terms and conditions. UDH was effectively dissolved in the merger. The resulting effect of the merger was a recapitalization increasing the number of authorized shares of common stock to 20,000,000 and a 1.16-to-1 common stock split effective April 24, 1996. The stockholders' equity section of the Consolidated Balance Sheets and the Statements of Stockholders' Equity reflect the number of authorized shares after giving effect to the merger and common stock split. The Company's principal stockholder is also the sole stockholder of Verde Investments, Inc. (Verde). The Company's subordinated debt is held by, and the land for certain of its car dealerships and loan servicing facilities was leased from, Verde until December 31, 1996, see Note 14. During 1997, the Company completed several acquisitions. In January 1997, the Company acquired substantially all of the assets of Seminole Finance Corporation and related companies (Seminole) including four dealerships in Tampa/St. Petersburg and a contract portfolio of approximately $31.1 million in exchange for approximately $2.5 million in cash and assumption of $29.9 million in debt. In April 1997, the Company purchased substantially all of the assets of E-Z Plan, Inc. (EZ Plan), including seven dealerships in San Antonio and a contract portfolio of approximately $24.3 million in exchange for approximately $26.3 million in cash. In September 1997, the Company acquired substantially all of the dealership and loan servicing assets (but not the loan portfolio) of Kars Yes Holdings 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. The following summary, prepared on a pro forma basis, combines the consolidated results of operations (unaudited) as if the acquisitions had taken place on January 1, 1996. Such pro forma amounts are not necessarily indicative of what the actual results of operations might have been if the acquisitions had been effective on January 1, 1996, (in thousands, except per share amounts):
YEARS ENDED DECEMBER 31, ------------------------ 1997 1996 ---------- ---------- Sales of Used Cars................................... $225,882 $244,074 ======== ======== Interest Income...................................... $ 47,857 $ 32,467 ======== ======== Other Income......................................... $ 31,978 $ 12,244 ======== ======== Total Revenues....................................... $305,717 $285,785 ======== ======== Net Loss............................................. $(34,777) $ (7,508) ======== ======== Basic Loss Per Share................................. $ (1.95) $ (0.95) ======== ======== Diluted Loss Per Share............................... $ (1.95) $ (0.95) ======== ========
53 55 UGLY DUCKLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Operations The Company, through its subsidiaries, owns and operates sales finance companies, used car sales dealerships, a property and casualty insurance company, and is a franchiser of rental car operations. Additionally, Champion Receivables Corporation and Champion Receivables Corporation II, "bankruptcy remote entities" are the Company's wholly-owned special purpose securitization subsidiaries. Their assets include residuals in finance receivables sold, and investments held in trust, in the amounts of $29,376,000 and $17,600,000 respectively, at December 31, 1997, and in the amounts of $9,889,000 and $2,843,000, respectively, at December 31, 1996, which amounts would not be available to satisfy claims of creditors of the Company. Principles of Consolidation The Consolidated Financial Statements include the accounts of the Company and its subsidiaries. Significant intercompany accounts and transactions have been eliminated in consolidation. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Concentration of Credit Risk The Company provides sales finance services in connection with the sales of used cars to individuals residing primarily in several metropolitan areas. The Company operated a total of forty-one, eight, and eight used car dealerships (company dealerships) in ten, two and two metropolitan markets in 1997, 1996 and 1995, respectively. CFS operated eighty-three, thirty-five and eight branch offices in twenty-one, twelve and one states in 1997, 1996, and 1995, respectively. Periodically during the year, the Company maintains cash in financial institutions in excess of the amounts insured by the federal government. Cash Equivalents The Company considers all highly liquid debt instruments purchased with maturities of three months or less to be cash equivalents. Cash equivalents generally consist of interest bearing money market accounts. Revenue Recognition Interest income is recognized using the interest method. Direct loan origination costs related to contracts originated at company dealerships are deferred and charged against finance income over the life of the related installment sales contract as an adjustment of yield. Pre-opening and start-up costs incurred on third party dealer branch offices are deferred and charged to expense over a twelve-month period. 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. 54 56 UGLY DUCKLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Residuals in Finance Receivables Sold, Investments Held in Trust, and Gain on Sale of Loans In 1996, the Company initiated a Securitization Program under which it sells (securitizes), on a non-recourse basis, finance receivables to a trust which uses the finance receivables to create asset backed securities (A certificates) which are remitted to the Company in consideration for the sale. The Company then sells senior certificates to third party investors and retains subordinated certificates (B certificates). In consideration of such sale, the Company receives cash proceeds from the sale of certificates collateralized by the finance receivables and the right to future cash flows under the subordinated certificates (residual in finance receivables sold, or residual) arising from those receivables to the extent not required to make payments on the A certificates sold to a third party or to pay associated costs. Gains or losses are determined based upon the difference between the sales proceeds for the portion of finance receivables sold and the Company's recorded investment in the finance receivables sold. The Company allocates the recorded investment in the finance receivables between the portion of the finance receivables sold and the portion retained based on the relative fair values on the date of sale. The Company is required to make an initial deposit into an account held by the trustee (spread account) and to pledge this cash to the trust to which the finance receivables were sold. The trustee in turn invests the cash in highly liquid investment securities. In addition, the Company (through the trustee) deposits additional cash flows from the residual to the spread account as necessary to attain and maintain the spread account at a specified percentage of the underlying finance receivable principal balances. These deposits are classified as Investments Held in Trust. To the extent that actual cash flows on a securitization are below original estimates and differ materially from the original securitization assumptions, and in the opinion of management if those differences appear to be other than temporary in nature, the Company's residual will be adjusted, with corresponding charges against income in the period in which the adjustment is made. Such evaluations are performed on a security by security basis, for each certificate or spread account retained by the Company. Residuals in finance receivables sold are classified as "held-to-maturity" securities in accordance with SFAS No. 115. Servicing Income Servicing Income is recognized when earned. Servicing costs are charged to expense as incurred. In the event delinquencies and/or losses on the portfolio serviced exceed specified levels, the Company may be required to transfer the servicing of the portfolio to another servicer. Finance Receivables and Allowance for Credit Losses The Company originates installment sales contracts from its company dealerships and purchases contracts from third party dealers. Finance receivables consist of contractually scheduled payments from installment sales contracts net of unearned finance charges, accrued interest receivable, direct loan origination costs, and an allowance for credit losses, including acquired allowances. Finance receivables held for investment represent finance receivables that the Company expects to hold until they have matured. Finance receivables held for sale represent finance receivables that the Company expects to securitize. The Company follows the provisions of Statement of Financial Accounting Standards No. 91, "Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases" for contracts originated at its company dealerships. Direct loan origination costs represent the unamortized balance of costs incurred in the origination of contracts at the Company's dealerships. 55 57 UGLY DUCKLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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 a nonrefundable 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 discount available for credit losses 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 losses on the third party dealer portfolio, additions to the allowance are established through a charge to the provision for credit losses. The evaluation of the discount and allowance considers such factors as the performance of each third party dealer's 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 all amounts due according to the contractual terms of the note agreement. When a loan is considered to be impaired, the amount of impairment is measured based on the present value of expected future cash flows discounted at the note's effective interest rate. Impairment losses are included in the allowance for credit losses through a charge to provision for credit losses. Cash receipts on impaired notes receivable are applied to reduce the principal amount of such notes until the principal has been received and are recognized as interest income, thereafter. Inventory Inventory consists of used vehicles held for sale which is valued at the lower of cost or market, and repossessed vehicles which are valued at market value. Vehicle reconditioning costs are capitalized as a component of inventory cost. The cost of used vehicles sold is determined on a specific identification basis. 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. 56 58 UGLY DUCKLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Goodwill Goodwill, which represents the excess of purchase price over fair value of net assets acquired, is amortized on a straight-line basis over the expected periods to be benefited, generally fifteen to twenty years. The Company assesses the recoverability of this intangible asset by determining whether the amortization of the goodwill balance over its remaining life can be recovered through undiscounted future operating cash flows of the acquired operation. The amount of goodwill impairment, if any, is measured based on projected discounted future operating cash flows using a discount rate reflecting the Company's average cost of funds. The assessment of the recoverability of goodwill will be impacted if estimated future operating cash flows are not achieved. Trademarks, Trade Names, Logos, and Contract Rights The registered trade names, "Ugly Duckling Car Sales," "Ugly Duckling Rent-A-Car," "America's Second Car," "Putting You on the Road to Good Credit" and related trademarks, logos, and contract rights are stated at cost. The cost of trademarks, trade names, logos, and contract rights is amortized on a straight-line basis over their estimated economic lives of ten years. Post Sale Customer Support Programs A liability for the estimated cost of post sale customer support, including car repairs and the Company's down payment back and credit card programs, is established at the time the used car is sold by charging Cost of Used Cars Sold. The liability is evaluated for adequacy through a separate analysis of the various programs' historical performance. Income Taxes The Company utilizes the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Advertising All costs related to production and advertising are expensed in the period incurred or ratably over the year in relation to revenues or certain other performance measures. Advertising costs capitalized as of December 31, 1997 were immaterial. The Company had no advertising costs capitalized as of December 31, 1996. Stock Option Plan The Company accounts for its stock option plan in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. As such, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. On January 1, 1996, the Company adopted the 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. 57 59 UGLY DUCKLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The Company uses one of the most widely used option pricing models, the Black-Scholes model (the Model), for purposes of valuing its stock option grants. The Model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, it requires the input of highly subjective assumptions, including the expected stock price volatility, expected dividend yields, the risk free interest rate, and the expected life. Because the Company's stock options have characteristics significantly different from those of traded options, and because changes in subjective input assumptions can materially affect the fair value estimate, in management's opinion, the value determined by the Model is not necessarily indicative of the ultimate value of the granted options. Earnings Per Share Basic earnings per share is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of The Company adopted the provisions of SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of, on January 1, 1996. The Statement requires that long-lived assets and certain identifiable intangibles be 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. Adoption of this Statement did not have a materiel impact on the Company. Transfers and Servicing of Financial Assets and Extinguishments of Liabilities The Company adopted the provisions of SFAS No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (SFAS No. 125) on January 1, 1997. This Statement provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities based on consistent application of a financial-components approach that focuses on control. It distinguishes transfers of financial assets that are sales from transfers that are secured borrowings. Adoption of SFAS No. 125 did not have a material impact on the Company. Reclassifications Certain reclassifications have been made to the prior years' consolidated financial statement amounts to conform to the current year presentation. 58 60 UGLY DUCKLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (3) FINANCE RECEIVABLES AND ALLOWANCE FOR CREDIT LOSSES A summary of finance receivables as of December 31, 1997 and 1996 follows (in thousands):
THIRD COMPANY PARTY CYGNET DEALERSHIPS DEALERS PROGRAM TOTAL ----------- ------- ------- -------- December 31, 1997: Installment Sales Contract Principal Balances............................... $55,965 $29,965 $27,481 $113,411 Add: Accrued Interest Receivable......... 461 414 147 1,022 Loan Origination Costs, Net........ 1,430 -- -- 1,430 ------- ------- ------- -------- Principal Balances, Net.................. 57,856 30,379 27,628 115,863 Residuals in Finance Receivables Sold.... 11,216 18,160 -- 29,376 ------- ------- ------- -------- 69,072 48,539 27,628 145,239 Allowance for Credit Losses.............. (10,356) (3,600) (1,035) (14,991) Discount on Finance Receivables.......... -- -- (7,155) (7,155) ------- ------- ------- -------- Finance Receivables, net................. $58,716 $44,939 $19,438 $123,093 ======= ======= ======= ========
THIRD COMPANY PARTY CYGNET DEALERSHIPS DEALERS PROGRAM TOTAL ----------- ------- ------- -------- December 31, 1996: Installment Sales Contract Principal Balances............................... $ 7,068 $51,213 $ -- $ 58,281 Add: Accrued Interest Receivable......... 42 676 -- 718 Loan Origination Costs, Net........ 189 -- -- 189 ------- ------- ------- -------- Principal Balances, Net.................. 7,299 51,889 -- 59,188 Residuals in Finance Receivables Sold.... 8,512 1,377 -- 9,889 ------- ------- ------- -------- 15,811 53,266 -- 69,077 Allowance for Credit Losses.............. (1,625) (6,500) -- (8,125) ------- ------- ------- -------- Finance Receivables, net................. $14,186 $46,766 $ -- $ 60,952 ======= ======= ======= ========
The finance receivables are classified as follows:
DECEMBER 31, ------------------- 1997 1996 -------- ------- Finance Receivables Held for Sale....................... $ 79,763 $52,188 Finance Receivables Held for Investment................. 36,100 7,000 -------- ------- $115,863 $59,188 ======== =======
59 61 UGLY DUCKLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) A summary of allowance for credit losses on finance receivables for the years ended December 31, 1997, 1996 and 1995 follows (in thousands):
THIRD COMPANY PARTY CYGNET DEALERSHIPS DEALERS PROGRAM TOTAL December 31, 1997: ----------- -------- ------- -------- Balances, Beginning of Year.............. $ 1,625 $ 6,500 $ -- $ 8,125 Provision for Credit Losses............ 22,354 1,030 491 23,875 Allowance on Acquired Loans............ 15,309 25,571 550 41,430 Accretion of Discount to Interest Income.............................. -- (642) -- (642) Net Charge Offs........................ (7,524) (4,197) (6) (11,727) Sale of Finance Receivables............ (21,408) (24,662) -- (46,070) -------- -------- ------ -------- Balances, End of Year.................... $ 10,356 $ 3,600 $1,035 $ 14,991 ======== ======== ====== ========
THIRD COMPANY PARTY CYGNET DEALERSHIPS DEALERS PROGRAM TOTAL December 31, 1996: ----------- -------- ------- -------- Balances, Beginning of Year.............. $ 7,500 $ 1,000 $ -- $ 8,500 Provision for Credit Losses............ 9,658 153 -- 9,811 Allowance on Acquired Loans............ -- 8,963 -- 8,963 Net Charge Offs........................ (6,202) (2,966) -- (9,168) Sale of Finance Receivables............ (9,331) (650) -- (9,981) -------- -------- ------ -------- Balances, End of Year.................... $ 1,625 $ 6,500 $ -- $ 8,125 ======== ======== ====== ========
THIRD COMPANY PARTY CYGNET DEALERSHIPS DEALERS PROGRAM TOTAL December 31, 1995: ----------- -------- ------- -------- Balances, Beginning of Year.............. $ 6,050 $ 159 $ -- $ 6,209 Provision for Credit Losses............ 8,359 -- -- 8,359 Allowance on Acquired Loans............ -- 1,660 -- 1,660 Net Charge Offs........................ (6,909) (819) -- (7,728) -------- -------- ------ -------- Balances, End of Year.................... $ 7,500 $ 1,000 $ -- $ 8,500 ======== ======== ====== ========
The valuation of the Residual in Finance Receivables Sold as of December 31, 1997 totaled $29,376,000 which represents the present value of the Company's interest in the anticipated future cash flows of the underlying portfolio. With the exception of the Company's first two securitization transactions which took place during the first six months of 1996, the estimated cash flows into the Trusts were discounted with a rate of 16%. The two securitization transactions that took place during the first six months of 1996 were discounted with a rate of 25%. For securitization transactions involving contracts originated at Company Dealerships 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. For contracts purchased from Third Party Dealers, net losses were originally estimated using total expected cumulative net losses at loan origination of approximately 13.5%, adjusted for actual cumulative net losses prior to securitization. Prepayment rates were estimated to be 1.5% per month of the beginning of month balances. During the year ended December 31, 1997, the Company recorded a $10.0 million charge to write-down the residuals in finance receivables sold. The charge had the effect of increasing the cumulative net loss assumption for contracts originated at Company Dealerships to approximately 27.5%, and for contracts purchased from Third Party Dealers to approximately 17.5% for the securitization transactions that took place 60 62 UGLY DUCKLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) prior to June 30, 1997. For the securitization transactions involving contracts originated at Company Dealerships that took place subsequent to June 30, 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, and for contracts purchased from Third Party Dealers, net losses were estimated using total expected cumulative net losses at loan origination of approximately 17.5%, adjusted for actual cumulative net losses prior to securitization. Prepayment rates were estimated to be 1.5% per month of the beginning of month balance. As of December 31, 1997 and 1996, the Residuals in Finance Receivables Sold were comprised of the following (in thousands):
1997 1996 -------- ------- Retained interest in subordinated securities (B certificates)............................................. $ 42,765 $10,900 Net interest spreads, less present value discount........... 22,935 6,839 Reduction for estimated credit losses....................... (36,324) (7,850) -------- ------- Residuals in finance receivables sold....................... $ 29,376 $ 9,889 ======== ======= Securitized principal balances outstanding.................. $238,025 $51,663 ======== ======= Estimated credit losses and allowances as a % of securitized principal balances outstanding............................ 15.3% 15.2% ======== =======
The following table reflects a summary of activity for the Residuals in Finance Receivables Sold for the years ended December 31, 1997 and 1996, respectively (in thousands):
1997 1996 -------- ------- Balance, Beginning of Year............................ $ 9,889 $ -- Additions............................................. 37,320 10,704 Amortization.......................................... (7,833) (815) Write-down of Residual in Finance Receivables Sold.... (10,000) -- -------- ------- Balance, End of Year.................................. $ 29,376 $ 9,889 ======== =======
(4) INVESTMENTS HELD IN TRUST In connection with its securitization transactions, the Company is required to provide a credit enhancement to the investor. The Company makes an initial cash deposit, ranging from 3% to 4% of the initial underlying finance receivables principal balance, of cash into an account held by the trustee (spread account) and pledges this cash to the trust to which the finance receivables were sold and then makes additional deposits from the residual cash flow (through the trustee) to the spread account as necessary to attain and maintain the spread account at a specified percentage, ranging from 6.0% to 8.0%, of the underlying finance receivables principal balance. In the event that the cash flows generated by the Finance Receivables sold to the trust are insufficient to pay obligations of the trust, including principal or interest due to certificate holders or expenses of the trust, the trustee will draw funds from the spread account as necessary to pay the obligations of the trust. The spread account must be maintained at a specified percentage of the principal balances of the finance receivables held by the trust, which can be increased in the event delinquencies or losses exceed specified levels. If the spread account exceeds the specified percentage, the trustee will release the excess cash to the Company from the pledged spread account. Except for releases in this manner, the cash in the spread account is restricted from use by the Company. 61 63 UGLY DUCKLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) During 1997, the Company made initial spread account deposits totaling $11,470,000. Additional net deposits through the trustee during 1997 totaled $3,321,000 resulting in a total balance in the spread accounts of $17,634,000 as of December 31, 1997. In connection therewith, the specified spread account balance based upon the aforementioned specified percentages of the balances of the underlying portfolios as of December 31, 1997 was $18,780,000, resulting in additional funding requirements from future cash flows as of December 31, 1997 of $1,146,000. The additional funding requirement will decline as the trustee deposits additional cash flows into the spread account and as the principal balance of the underlying finance receivables declines. During 1996, the Company made initial spread account deposits totaling $2,630,000. Additional net deposits through the trustee during 1996 totaled $213,000 resulting in a total balance in the spread accounts of $2,843,000 as of December 31, 1996. In connection therewith, the specified spread account balance based upon the aforementioned specified percentages of the balances of the underlying portfolios as of December 31, 1996 was $3,941,000. In connection with certain other agreements, the Company has deposited a total of $1,280,000, and $636,000 in an interest bearing trust account as of December 31, 1997 and 1996, respectively. (5) NOTES RECEIVABLE In July 1997, First Merchants Acceptance Corporation (FMAC) filed for bankruptcy. Immediately subsequent to the bankruptcy filing, the Company executed a loan agreement with FMAC to provide FMAC with up to $10.0 million in debtor in possession (the DIP facility) financing. The DIP facility accrues interest at 12.0%, is scheduled to mature on February 28, 1998, and is secured by substantially all of FMAC's assets. The Company and FMAC subsequently amended the DIP facility to increase the maximum commitment to $16.5 million and decrease the interest rate to 10.0% per annum. In connection with the amendment, FMAC pledged the first $10.0 million of income tax refunds receivable, which FMAC anticipates collecting in 1998, to the Company. Once the proceeds from the income tax refunds are remitted to the Company, such amounts permanently reduce the maximum commitment under the DIP facility. Thereafter, the Company anticipates collecting the balance of the DIP facility from distributions to FMAC from FMAC's residual interests in certain securitization transactions. The outstanding balance on the DIP facility totaled $10,868,000 at December 31, 1997. 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 third party purchased the owned loans for 86% of the principal balance of the loan portfolio, and the Company retained a 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 as of December 31, 1997 totaled $5,399,000. Various revolving notes receivable from used car dealers with a total commitment of $8,750,000 expiring through September 1999 with interest rates ranging from prime plus 5.50% to prime plus 9.75% per annum (14.0% to 18.25% at December 31, 1997), interest payable monthly. The respective revolving notes subject the borrower to borrowing base requirements with advances on eligible collateral ranging from sixty to sixty-five percent of the value of the underlying collateral. The balance outstanding on these revolving notes receivable totaled $4,802,000, net of an allowance for credit losses of $200,000 at December 31, 1997. The Company had other notes receivable totaling $1,704,000 and $1,063,000 as of December 31, 1997 and 1996, respectively. 62 64 UGLY DUCKLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) A summary of the allowance for credit losses for notes receivable for the year ended December 31, 1997 follows (in thousands):
1997 ---- Balance, Beginning of Year.................................. $ -- Provision for Credit Losses................................. 200 Net Charge Offs............................................. -- ---- Balance, End of Year........................................ $200 ====
(6) PROPERTY AND EQUIPMENT A summary of Property and Equipment as of December 31, 1997 and 1996 follows (in thousands):
DECEMBER 31, ------------------ 1997 1996 ------- ------- Land..................................................... $13,813 $ 7,811 Buildings and Leasehold Improvements..................... 16,245 5,699 Furniture and Equipment.................................. 13,785 6,389 Vehicles................................................. 232 156 Construction in Process.................................. 2,816 3,536 ------- ------- 46,891 23,591 Less Accumulated Depreciation and Amortization........... (5,639) (2,939) ------- ------- Property and Equipment, Net.............................. $41,252 $20,652 ======= =======
Interest Expense capitalized in 1997, 1996 and 1995 totaled $229,000, zero, and $54,000, respectively. (7) INTANGIBLE ASSETS A summary of intangible assets as of December 31, 1997 and 1996 follows (in thousands):
DECEMBER 31, ------------------ 1997 1996 ------- ------- Original Cost: Goodwill............................................... $17,944 $ 1,944 Trademarks............................................. 581 581 Covenants not to Compete............................... 250 -- ------- ------- 18,775 2,525 Accumulated Amortization................................. (1,232) (375) ------- ------- Intangibles, Net......................................... $17,543 $ 2,150 ======= =======
Amortization expense relating to intangible assets totaled $857,000, $63,000, and $63,000 for the years ended December 31 1997, 1996, and 1995, respectively. 63 65 UGLY DUCKLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (8) OTHER ASSETS A summary of Other Assets as of December 31, 1997 and 1996 follows (in thousands):
DECEMBER 31, ----------------- 1997 1996 ------- ------ Due from GE Capital Corporation........................... $ 3,000 $ -- Pre-opening and Startup Costs............................. 2,453 1,242 Prepaid Expenses.......................................... 2,193 796 Income Taxes Receivable................................... 1,693 316 Investment in Marketable Securities....................... 1,451 -- Servicing Receivables..................................... 1,389 -- Deposits.................................................. 956 753 Forced Place Insurance Receivables, net................... 931 -- Employee Advances......................................... 821 42 Escrow Deposits........................................... -- 900 Deferred Income Taxes..................................... -- 676 Other Assets.............................................. 3,167 855 ------- ------ $18,054 $5,580 ======= ======
(9) ACCRUED EXPENSES AND OTHER LIABILITIES A summary of Accrued Expenses and Other Liabilities as of December 31, 1997 and 1996 follows (in thousands):
DECEMBER 31, ----------------- 1997 1996 ------- ------ Sales Taxes............................................... $ 3,909 $2,904 Accrued Payroll, Benefits & Taxes......................... 2,806 637 Servicing Liability....................................... 2,380 695 Deferred Revenue.......................................... 1,136 601 Accrued Advertising....................................... 850 50 Obligations under Capital Leases.......................... 775 742 Accrued Post Sale Support................................. 771 250 Deferred Income Taxes..................................... 718 -- Others.................................................... 3,760 849 ------- ------ $17,105 $6,728 ======= ======
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. 64 66 UGLY DUCKLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (10) NOTES PAYABLE A summary of Notes Payable at December 31, 1997 and 1996 follows:
DECEMBER 31, ------------------ 1997 1996 ------- ------- (IN THOUSANDS) $100,000,000 revolving loan with a finance company, interest payable daily at 30 day LIBOR (5.70% at December 31, 1997) plus 3.15% through December 1998, secured by substantially all assets of the Company................................. $56,950 $ 4,602 Two notes payable to a finance company totaling $7,450,000, monthly interest payable at the prime rate (8.50% at December 31, 1997) plus 1.50% through January 1998; thereafter, monthly payments of $89,000 plus interest through January 2002 when balloon payments totaling $3,282,000 are due, secured by first deeds of trust and assignments of rents on certain real property............. 7,450 7,450 Others bearing interest at rates ranging from 9% to 11% due through April 2007, secured by certain real property and certain property and equipment............................ 771 852 ------- ------- Total............................................. $65,171 $12,904 ======= =======
The aforementioned revolving loan agreement contains various reporting and performance covenants including the maintenance of certain ratios, limitations on additional borrowings from other sources, restrictions on certain operating activities, and a restriction on the payment of dividends under certain circumstances. The Company was in compliance with the covenants at December 31, 1997 and 1996. A summary of future minimum principal payments required under the aforementioned notes payable after December 31, 1997 follows (in thousands):
DECEMBER 31, AMOUNT ------------ ------ 1998....................................................... $58,021 1999....................................................... 1,169 2000....................................................... 1,179 2001....................................................... 1,191 2002....................................................... 3,296 Thereafter................................................. 315 ------- $65,171 =======
(11) SUBORDINATED NOTE PAYABLE During 1996, the Company amended its previous subordinated notes payable with Verde and executed a single $14,000,000 unsecured note payable with Verde. The note bears interest at an annual rate of 10%, with interest payable monthly and is subordinate to all other Company indebtedness. The note also calls for annual principal payments of $2,000,000 through June 2003 when the loan will be paid in full. The Company had $12,000,000 and $14,000,000 outstanding under this note payable at December 31, 1997 and 1996, respectively. Interest expense related to the subordinated note payable with Verde totaled $1,232,000, $1,933,000, and $3,492,000 during the years ended December 31, 1997, 1996 and 1995, respectively. 65 67 UGLY DUCKLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (12) INCOME TAXES Income taxes amounted to $6,579,000, $100,000, and zero for the years ended December 31, 1997, 1996 and 1995, respectively (an effective tax rate of 41.1%, 1.7% and 0.0%, respectively). A reconciliation between taxes computed at the federal statutory rate of 35% in 1997 and 34% in 1996 and 1995 at the effective tax rate on earnings (loss) before income taxes follows (in thousands):
DECEMBER 31, ---------------------------- 1997 1996 1995 ------ ------- ------- Computed "Expected" Income Taxes (Benefit)............. $5,608 $ 2,028 $(1,350) State Income Taxes, Net of Federal Effect.............. 906 41 -- Change in Valuation Allowance.......................... -- (2,315) 1,418 Other, Net............................................. 65 346 (68) ------ ------- ------- $6,579 $ 100 $ -- ====== ======= =======
Components of income taxes (benefit) for the years ended December 31, 1997, 1996 and 1995 follow (in thousands):
CURRENT DEFERRED TOTAL ------- -------- ------ 1997: Federal........................................ $3,920 $1,265 $5,185 State.......................................... 980 414 1,394 ------ ------ ------ $4,900 $1,679 $6,579 ====== ====== ====== 1996: Federal........................................ $ (149) $ 187 $ 38 State.......................................... -- 62 62 ------ ------ ------ $ (149) $ 249 $ 100 ====== ====== ====== 1995: Federal........................................ $ (449) $ 449 $ -- State.......................................... -- -- -- ------ ------ ------ $ (449) $ 449 $ -- ====== ====== ======
66 68 UGLY DUCKLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities as of December 31, 1997 and 1996 are presented below (in thousands):
DECEMBER 31, ----------------- 1997 1996 ------- ------ Deferred Tax Assets: Finance Receivables, Principally Due to the Allowance for Credit Losses.......................................... $ 473 $ 131 Inventory................................................. 246 -- Federal and State Income Tax Net Operating Loss Carryforwards.......................................... 28 995 Residual in Finance Receivables........................... -- 140 Accrued Post Sale Support................................. 357 179 Other..................................................... 395 100 ------- ------ Total Gross Deferred Tax Assets........................... 1,499 1,545 Less: Valuation Allowance................................. -- -- ------- ------ Net Deferred Tax Assets........................... 1,499 1,545 ------- ------ Deferred Tax Liabilities: Acquisition Discount...................................... -- (112) Software Development Costs................................ (237) (192) Pre-opening and Startup Costs............................. (1,236) (490) Loan Origination Fees..................................... (586) (75) Other..................................................... (158) -- ------- ------ Total Gross Deferred Tax Liabilities................... (2,217) (869) ------- ------ Net Deferred Tax Asset (Liability)................ $ (718) $ 676 ======= ======
The valuation allowance for deferred tax assets as of December 31, 1997 and 1996 was zero. There was no change in the Valuation Allowance for the year ended December 31, 1997. The net change in the total Valuation Allowance for the year ended December 31, 1996 was a decrease of $2,315,000. In assessing the realizability of Deferred Tax Assets, management considers whether it is more likely than not that some portion or all of the Deferred Tax Assets will not be realized. The ultimate realization of Deferred Tax Assets is dependent upon generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the reversal of Deferred Tax Liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods in which the Deferred Tax Assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these deductible differences. At December 31, 1997, the Company had net operating loss carryforwards for federal income tax purposes of approximately $91,000, which, subject to annual limitations, are available to offset future taxable income, if any, through 2110. (13) SERVICING Pursuant to the Company's securitization program which began in 1996, the Company securitizes loan portfolios with servicing retained. The Company services the securitized portfolios for a monthly fee ranging from .25% to .33% (3.00% to 4.0% per annum) of the beginning of month principal balance of the serviced portfolios. During 1997, the Company began servicing a loan portfolio for an unaffiliated party and recognizes servicing fee income of approximately .33% (4.0% annualized) of beginning of month balances, generally 67 69 UGLY DUCKLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) subject to a minimum fee of $15 per contract per month. The Company recognized servicing income of $7,230,000 and $921,000 in the years ended December 31, 1997 and 1996, respectively. A summary of portfolios serviced by the Company as of December 31, 1997 and 1996 follows:
1997 1996 -------- -------- Finance receivables.................................. $ 85,930 $ 58,281 Securitized with servicing retained.................. 238,025 51,663 -------- -------- Amounts originated by the Company.................... 323,955 109,944 Servicing on behalf of others........................ 127,322 -- -------- -------- Total serviced portfolios.................. $451,277 $109,944 ======== ========
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. The Company has executed agreements with FMAC and other interested parties whereby the Company has agreed to replace FMAC as servicer on loan portfolios which totaled approximately $525 million at December 31, 1997. The agreements are subject to bankruptcy court approval, which the Company anticipates will be received during the first fiscal quarter of 1998. (14) LEASE COMMITMENTS The Company leases used car sales facilities, offices, and certain office equipment from unrelated entities under various operating leases which expire through March 2007. The leases require monthly rental payments aggregating approximately $580,000 and contain various renewal options from one to ten years. In certain instances, the Company is also responsible for occupancy and maintenance costs, including real estate taxes, insurance, and utility costs. Rent expense for the year ended December 31, 1997 totaled $5,345,000. During 1996, the Company purchased six car lots, a vehicle reconditioning center, and two office buildings from Verde. These properties had previously been rented from Verde pursuant to various leases which called for base monthly rents aggregating approximately $123,000 plus contingent rents as well as all occupancy and maintenance costs, including real estate taxes, insurance, and utilities. In connection with the purchase, Verde returned security deposits which totaled $364,000. Rent expense for the year ended December 31, 1996 totaled $2,394,000 which included rents paid to Verde totaling $1,498,000 including contingent rents of $440,000. There was no accrued rent payable to Verde at December 31, 1996. Rent expense for the year ended December 31, 1995 totaled $2,377,000. Rents paid to Verde totaled $1,889,000, including contingent rents of $465,000, and $113,000 of rent capitalized during the construction period of a facility. Accrued rent payable to Verde totaled $101,000 at December 31, 1995. 68 70 UGLY DUCKLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) A summary of future minimum lease payments required under noncancelable operating leases with remaining lease terms in excess of one year as of December 31, 1997 follows (in thousands):
DECEMBER 31, AMOUNT ------------ ------- 1998..................................................... $ 7,635 1999..................................................... 6,895 2000..................................................... 4,884 2001..................................................... 2,810 2002..................................................... 1,342 Thereafter............................................... 1,233 ------- Total.......................................... $24,799 =======
(15) STOCKHOLDERS' EQUITY On April 24, 1996, the Company effectuated a 1.16-to-1 stock split. The effect of this stock split has been reflected for all periods presented in the Consolidated Financial Statements. The Company has authorized 100,000,000 shares of $.001 par value common stock. There were approximately 18,521,000 and 13,327,000 shares issued and outstanding at December 31, 1997 and 1996, respectively. The common stock consists of $18,000 of common stock and $172,604,000 of additional paid-in capital at December 31, 1997. The common stock consists of $13,000 of common stock and $82,599,000 of additional paid-in capital as of December 31, 1996. During 1997, the Company completed a private placement of 5,075,500 shares of common stock for a total of approximately $89,156,000 cash, net of stock issuance costs. The registration of the shares sold in the private placement was effective in April 1997. During 1996, the Company completed two public offerings in which it issued a total of 7,245,000 shares of common stock for approximately $79,435,000 cash, net of stock issuance costs. During 1997, the Company issued warrants for the right to purchase 389,800 shares of the Company's common stock for $20.00 per share. The warrants were valued at approximately $612,000. These warrants remained outstanding at December 31, 1997. In addition, warrants to acquire 116,000 shares of the Company's common stock at $6.75 per share and 170,000 shares of the Company's common stock at $9.45 per share were outstanding at December 31, 1997. The Company has authorized 10,000,000 shares of $.001 par value preferred stock. There were zero shares issued and outstanding at December 31, 1997 and 1996, respectively. On December 31, 1995, the Company exchanged 1,000,000 shares of Series A preferred stock for $10,000,000 of subordinated notes payable with Verde. Cumulative dividends were payable at a rate of 12% per annum through June 21, 1996, at which time the Series A preferred stock was exchanged on a share-for- share basis for 1,000,000 shares of Series B preferred stock. The dividends were payable quarterly upon declaration by the Company's Board of Directors. In November 1996, the Company redeemed the 1,000,000 shares of Series B preferred stock. The Company's Board of Directors declared quarterly dividends on preferred stock totaling approximately $916,000 during the year ended December 31, 1996. There were no cumulative unpaid dividends at December 31, 1996. 69 71 UGLY DUCKLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (16) EARNINGS (LOSS) PER SHARE A summary of the reconciliation from basic earnings (loss) per share to diluted earnings (loss) per share for the years ended December 31, 1997, 1996, and 1995 follows (in thousands, except for per share amounts):
1997 1996 1995 ------- ------ ------- Net Earnings (Loss).................................. $ 9,445 $5,866 $(3,972) Less: Preferred Stock Dividends...................... -- (916) -- ------- ------ ------- Income (Loss) available to Common Stockholders....... $ 9,445 $4,950 $(3,972) ======= ====== ======= Basic EPS-Weighted Average Shares Outstanding........ 17,832 7,887 5,522 ======= ====== ======= Basic Earnings (Loss) Per Share...................... $ 0.53 $ 0.63 $ (0.72) ======= ====== ======= Basic EPS-Weighted Average Shares Outstanding........ 17,832 7,887 5,522 Effect of Diluted Securities: Warrants........................................... 98 71 -- Stock Options...................................... 304 340 -- ------- ------ ------- Dilutive EPS-Weighted Average Shares Outstanding..... 18,234 8,298 5,522 ======= ====== ======= Diluted Earnings (Loss) Per Share.................... $ 0.52 $ 0.60 $ (0.72) ======= ====== ======= Warrants Not Included in Diluted EPS Since Antidilutive....................................... 390 -- -- ======= ====== ======= Stock Options Not Included in Diluted EPS Since Antidilutive....................................... 828 -- -- ======= ====== =======
(17) STOCK OPTION PLAN In June, 1995, the Company adopted a long-term incentive plan (stock option plan). The stock option plan, as amended, sets aside 1,800,000 shares of common stock to be granted to employees at a price of not less than fair market value of the stock at the date of grant. Options are to vest over a period to be determined by the Board of Directors upon grant and will generally expire six years after the date of grant. The options generally vest over a period of five years. At December 31, 1997, there were 344,000 additional shares available for grant under the Plan. The per share weighted-average fair value of stock options granted during 1997 and 1996 was $6.54 and $8.39, respectively on the date of grant using the Black-Scholes option-pricing model with the following weighted- average assumptions: 1997 -- expected dividend yield 0%, risk-free interest rate of 5.53%, expected volatility of 40.0%, and an expected life of 5 years; 1996 -- expected dividend yield 0%, risk-free interest rate of 6.4%, expected volatility of 56.5% and an expected life of 7 years. The Company applies APB Opinion 25 in accounting for its Plan, and accordingly, no compensation cost has been recognized for its stock options in the consolidated financial statements. Had the Company determined compensation cost based on the fair value at the grant date for its stock options under 70 72 UGLY DUCKLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) SFAS No. 123, the Company's net earnings and earnings per share would have been reduced to the pro forma amounts indicated below:
DECEMBER 31, ------------------------ 1997 1996 ---------- ---------- Net Earnings As reported....................................... $9,445,000 $4,950,000 Pro forma......................................... $8,567,000 $4,832,000 Earnings per Share -- Basic As reported....................................... $ 0.53 $ 0.63 Pro forma......................................... $ 0.48 $ 0.61 Earnings per Share -- Diluted As Reported....................................... $ 0.52 $ 0.60 Pro forma......................................... $ 0.48 $ 0.58
The full impact of calculating compensation cost for stock options under SFAS No. 123 is not reflected in the pro forma net earnings amounts presented above because compensation cost is reflected over the options' vesting period of five years. A summary of the aforementioned stock plan activity follows:
WEIGHTED AVERAGE NUMBER PRICE PER SHARE --------- ---------------- Balance, December 31, 1995....................... 442,000 $ 1.70 Granted........................................ 539,000 13.41 Forfeited...................................... (30,000) 3.26 Exercised...................................... (39,000) 1.00 --------- ------ Balance, December 31, 1996....................... 912,000 8.60 --------- ------ Granted........................................ 582,000 15.07 Forfeited...................................... (78,000) 14.00 Exercised...................................... (118,000) 2.04 --------- ------ Balance, December 31, 1997....................... 1,298,000 $11.76 ========= ======
A summary of stock options granted at December 31, 1997 follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------------------------------------ ---------------------------- NUMBER WEIGHTED-AVG. WEIGHTED-AVG. NUMBER WEIGHTED-AVG. RANGE OF OUTSTANDING REMAINING EXERCISE EXERCISABLE EXERCISE EXERCISE PRICES AT 12/31/97 CONTRACTUAL LIFE PRICE AT 12/31/97 PRICE - --------------------- ----------- ---------------- ------------- ----------- ------------- $ .50 to $ 1.00..... 97,000 6.4 years $ 0.86 -- $ -- $ 1.50 to $ 2.60..... 169,000 3.7 years 2.36 58,000 2.45 $ 3.45 to $ 9.40..... 162,000 4.4 years 6.80 24,000 6.86 $11.88 to $20.75..... 870,000 5.3 years 15.73 75,000 17.28 --------- ------ ------- ------ 1,298,000 $11.76 157,000 $10.21 ========= ====== ======= ======
(18) COMMITMENTS AND CONTINGENCIES During 1997, the Company acquired certain notes receivable collateralized by a loan portfolio. Thereafter, the Company exchanged the notes receivable for the underlying collateral (the acquired collateral) and received a guarantee from the borrower of an 11.0% return on the acquired collateral. An unrelated third party 71 73 UGLY DUCKLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) purchased the collateral and the Company guaranteed the purchaser, a return of 10.35%, not to exceed $10,000,000. No accruals have been made by the Company related to this guarantee. The Company has commenced a study of its computer systems in order to assess its exposure to year 2000 issues. The Company expects to make the necessary modifications or changes to its computer information systems to enable proper processing of transactions relating to the year 2000 and beyond. The Company will evaluate appropriate courses of action, including replacement of certain systems whose associated costs would be recorded as assets and subsequently amortized or modification of its existing systems which costs would be expensed as incurred. In October 1997 the Company's Board of Directors authorized a stock repurchase program by which the Company may acquire up to one million shares of its common stock from time to time on the open market. Under the program, purchases may be made depending on market conditions, share price and other factors. The stock repurchase program will terminate on December 31, 1998, unless extended by the Company's Board of Directors, and may be discontinued at any time. The Company had not repurchased any shares of common stock related to this program as of December 31, 1997. On July 18, 1997, the Company filed a Form S-3 registration statement for the purpose of registering up to $200 million of its debt securities in one or more series at prices and on terms to be determined at the time of sale. The registration statement has been declared effective by the Securities and Exchange Commission and is available for future debt offerings. During 1997, the Company acquired approximately 2.5% of the outstanding common stock of FMAC with a cost of approximately $1,450,000. In connection with FMAC's proposed plan of reorganization, and subject to bankruptcy court approval, the Company and FMAC have agreed to exchange the Company's common stock in FMAC for the property and equipment that constitute FMAC's loan servicing platform. The Company anticipates receiving bankruptcy court approval for the plan of reorganization during the first fiscal quarter of 1998. The Company is involved in various claims and actions arising in the ordinary course of business. In the opinion of management, based on consultation with legal counsel, the ultimate disposition of these matters will not have a material adverse effect on the Company. No provision has been made in the accompanying consolidated financial statements for losses, if any, that might result from the ultimate disposition of these matters. Subsequent to year end, the Company executed a commitment letter with a finance company for the Company to obtain a short term $30.0 million standby repurchase credit facility and a $150.0 million surety-enhanced revolving credit facility. The commitment letter also provides for the finance company to be the exclusive securitization agent of the Company for $1.0 billion of AAA-rated surety wrapped securities as part of the Company's ongoing securitization program. (19) RETIREMENT PLAN During 1995, the Company established a qualified 401(k) retirement plan (defined contribution plan) which became effective on October 1, 1995. The plan, as amended, covers substantially all employees having no less than three months of service, have attained the age of 21, and work at least 1,000 hours per year. Participants may voluntarily contribute to the plan up to the maximum limits established by Internal Revenue Service regulations. The Company will match 10% of the participants' contributions. Participants are immediately vested in the amount of their direct contributions and vest over a five-year period, as defined by the plan, with respect to the Company's contribution. Pension expense totaled $49,000, $23,000 and $5,000 during the years ended December 31, 1997, 1996, and 1995, respectively. 72 74 UGLY DUCKLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (20) DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS Statement of Financial Accounting Standards No. 107, "Disclosures about Fair Value of Financial Instruments," requires that the Company disclose estimated fair values for its financial instruments. The following summary presents a description of the methodologies and assumptions used to determine such amounts. Limitations Fair value estimates are made at a specific point in time and are based on relevant market information and information about the financial instrument; they are subjective in nature and involve uncertainties, matters of judgment and, therefore, cannot be determined with precision. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular instrument. Changes in assumptions could significantly affect these estimates. Since the fair value is estimated as of December 31, 1997 and 1996, the amounts that will actually be realized or paid in settlement of the instruments could be significantly different. Cash and Cash Equivalents and Investments Held in Trust The carrying amount is estimated to be the fair value because of the liquidity of these instruments. Finance Receivables, Residuals in Finance Receivables Sold, and Notes Receivable The carrying amount is estimated to be the fair value because of the relative short maturity and repayment terms of the portfolio as compared to similar instruments. Accounts Payable, Accrued Expenses, and Notes Payable The carrying amount approximates fair value because of the short maturity of these instruments. The terms of the Company's notes payable approximate the terms in the market place at which they could be replaced. Therefore, the fair market value approximates the carrying value of these financial instruments. Subordinated Notes Payable The terms of the Company's subordinated notes payable approximate the terms in the market place at which they could be replaced. Therefore, the fair value approximates the carrying value of these financial instruments. (21) SUBSEQUENT EVENTS Subsequent to December 31, 1997, the Company announced that it intended to terminate its third party dealer branch network and record a pre-tax restructuring charge of $6.0 million to $10.0 million in 1998. The restructuring is expected to be complete by the end of the first quarter of 1998 and include the termination of approximately 400 employees, substantially all of whom are employed at the Company's 76 branches that were in place on the date of the announcement. Approximately $1.0 million of the restructuring charge is for termination benefits, $2.5 million for writeoff 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. (22) BUSINESS SEGMENTS Operating results and other financial data are presented for the principal business segments of the Company for the years ended December 31, 1997, 1996, and 1995, respectively. The Company has five distinct business segments. These consist of retail car sales operations (Company dealerships), the income 73 75 UGLY DUCKLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) generated from the finance receivables generated at the Company dealerships, finance income generated from third party finance receivables, the Cygnet program 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.
COMPANY THIRD COMPANY DEALERSHIP PARTY CYGNET CORPORATE DEALERSHIPS RECEIVABLES RECEIVABLES PROGRAM AND OTHER TOTAL ----------- ----------- ----------- ------- --------- -------- (IN THOUSANDS) December 31, 1997: Sales of Used Cars..................... $123,814 $ -- $ -- $ -- $ -- $123,814 Less: Cost of Cars Sold................ 66,509 -- -- -- -- 66,509 Provision for Credit Losses........ 22,355 -- 1,030 690 -- 24,075 -------- ------- ------- ------- ------- -------- 34,950 -- (1,030) (690) -- 33,230 -------- ------- ------- ------- ------- -------- Interest Income........................ -- 12,613 14,352 3,655 3,764 34,384 Gain on Sale of Loans.................. -- 6,721 6,861 -- 8,131 21,713 Other Income........................... 1,498 7,305 33 355 2,016 11,207 -------- ------- ------- ------- ------- -------- Income before Operating Expenses... 36,448 26,639 20,216 3,320 13,911 100,534 -------- ------- ------- ------- ------- -------- Operating Expenses: Selling and Marketing................ 10,499 -- -- 18 50 10,567 General and Administrative........... 23,064 12,523 15,729 2,194 11,490 65,000 Depreciation and Amortization........ 1,536 1,108 383 28 628 3,683 -------- ------- ------- ------- ------- -------- 35,099 13,631 16,112 2,240 12,168 79,250 -------- ------- ------- ------- ------- -------- Income before Interest Expense......... $ 1,349 $13,008 $ 4,104 $ 1,080 $ 1,743 $ 21,284 ======== ======= ======= ======= ======= ======== Capital Expenditures................... $ 13,571 $ 3,791 $ 1,090 $ 19 $ 902 $ 19,373 ======== ======= ======= ======= ======= ======== Identifiable Assets.................... $ 74,287 $78,514 $61,540 $27,539 $37,174 $279,054 ======== ======= ======= ======= ======= ======== December 31, 1996: Sales of Used Cars..................... $ 53,768 $ -- $ -- $ -- $ -- $ 53,768 Less: Cost of Cars Sold................ 29,890 -- -- -- -- 29,890 Provision for Credit Losses........ 9,658 -- 153 -- -- 9,811 -------- ------- ------- ------- ------- -------- 14,220 -- (153) -- -- 14,067 -------- ------- ------- ------- ------- -------- Interest Income........................ -- 8,426 7,259 -- 171 15,856 Gain on Sale of Loans.................. -- 3,925 509 -- -- 4,434 Other Income........................... 195 921 -- -- 455 1,571 -------- ------- ------- ------- ------- -------- Income before Operating Expenses... 14,415 13,272 7,615 -- 626 35,928 -------- ------- ------- ------- ------- -------- Operating Expenses: Selling and Marketing................ 3,568 -- -- -- 17 3,585 General and Administrative........... 8,295 3,042 3,955 -- 4,246 19,538 Depreciation and Amortization........ 318 769 195 -- 295 1,577 -------- ------- ------- ------- ------- -------- 12,181 3,811 4,150 -- 4,558 24,700 -------- ------- ------- ------- ------- -------- Income (loss) before Interest Expense.............................. $ 2,234 $ 9,461 $ 3,465 $ -- $(3,932) $ 11,228 ======== ======= ======= ======= ======= ======== Capital Expenditures................... $ 4,530 $ 455 $ 621 $ -- $ 505 $ 6,111 ======== ======= ======= ======= ======= ======== Identifiable Assets.................... $ 20,698 $12,775 $45,558 $ -- $39,052 $118,083 ======== ======= ======= ======= ======= ========
74 76 UGLY DUCKLING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
COMPANY THIRD COMPANY DEALERSHIP PARTY CYGNET CORPORATE DEALERSHIPS RECEIVABLES RECEIVABLES PROGRAM AND OTHER TOTAL ----------- ----------- ----------- ------- --------- -------- (IN THOUSANDS) December 31, 1995: Sales of Used Cars..................... $ 47,824 $ -- $ -- $ -- $ -- $ 47,824 Less: Cost of Cars Sold................ 27,964 -- -- -- -- 27,964 Provision for Credit Losses........ 8,359 -- -- -- -- 8,359 -------- ------- ------- ------- ------- -------- 11,501 -- -- -- -- 11,501 -------- ------- ------- ------- ------- -------- Interest Income........................ -- 8,227 1,844 -- -- 10,071 Other Income........................... -- -- -- -- 308 308 -------- ------- ------- ------- ------- -------- Income before Operating Expenses... 11,501 8,227 1,844 -- 308 21,880 -------- ------- ------- ------- ------- -------- Operating Expenses: Selling and Marketing................ 3,856 -- -- -- -- 3,856 General and Administrative........... 8,210 2,681 1,163 -- 2,672 14,726 Depreciation and Amortization........ 279 479 89 -- 467 1,314 -------- ------- ------- ------- ------- -------- 12,345 3,160 1,252 -- 3,139 19,896 -------- ------- ------- ------- ------- -------- Income (loss) before Interest Expense.............................. $ (844) $ 5,067 $ 592 $ -- $(2,831) $ 1,984 ======== ======= ======= ======= ======= ======== Capital Expenditures................... $ 1,195 $ 1,561 $ 216 $ -- $ 223 $ 3,195 ======== ======= ======= ======= ======= ======== Identifiable Assets.................... $ 11,452 $32,187 $13,419 $ -- $ 3,732 $ 60,790 ======== ======= ======= ======= ======= ========
(23) QUARTERLY FINANCIAL DATA -- UNAUDITED A summary of the quarterly data for the years ended December 31, 1997 and 1996 follows:
FIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER TOTAL ------- ------- ------- ------- -------- (IN THOUSANDS) 1997: Total Revenue..................... $30,734 $44,271 $45,204 $70,909 $191,118 ======= ======= ======= ======= ======== Income before Operating Expenses....................... 17,589 24,587 20,129 38,229 100,534 ======= ======= ======= ======= ======== Operating Expenses................ 11,406 16,705 21,517 29,622 79,250 ======= ======= ======= ======= ======== Income (Loss) before Interest Expense........................ 6,183 7,882 (1,388) 8,607 21,284 ======= ======= ======= ======= ======== Net Earnings (Loss)............... $ 3,262 $ 4,311 $(1,828) $ 3,700 $ 9,445 ======= ======= ======= ======= ======== Basic Earnings (Loss) Per Share... $ 0.21 $ 0.23 $ (0.10) $ 0.20 $ 0.53 ======= ======= ======= ======= ======== Diluted Earnings (Loss) Per Share.......................... $ 0.20 $ 0.23 $ (0.10) $ 0.20 $ 0.52 ======= ======= ======= ======= ======== 1996: Total Revenues.................... $19,396 $20,081 $18,259 $17,893 $ 75,629 ======= ======= ======= ======= ======== Income before Operating Expenses....................... 8,442 9,005 8,741 9,740 35,928 ======= ======= ======= ======= ======== Operating Expenses................ 5,694 6,296 5,522 7,188 24,700 ======= ======= ======= ======= ======== Income before Interest Expense.... 2,716 2,721 3,157 2,634 11,228 ======= ======= ======= ======= ======== Net Earnings...................... $ 1,065 $ 1,083 $ 1,967 $ 1,751 $ 5,866 ======= ======= ======= ======= ======== Basic Earnings Per Share.......... $ 0.13 $ 0.14 $ 0.20 $ 0.15 $ 0.63 ======= ======= ======= ======= ======== Diluted Earnings Per Share........ $ 0.13 $ 0.13 $ 0.19 $ 0.14 $ 0.60 ======= ======= ======= ======= ========
75 77 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 CONCERNING DIRECTORS AND EXECUTIVE OFFICERS Information concerning the names, ages, terms, positions with the Company and business experience of the Company's current directors and executive officers is set forth below as of March 30, 1998.
TERM AS DIRECTOR DIRECTOR NAME AGE POSITION EXPIRES SINCE - ---- --- -------- -------- ---------- Ernest C. Garcia II.................. 40 Chairman of the Board and Chief 1998 1992(3) Executive Officer Robert J. Abrahams(1)................ 71 Director 1998 June 1996(4) Christopher D. Jennings(2)........... 44 Director 1998 June 1996(4) John N. MacDonough................... 53 Director 1998 June 1996(4) Arturo R. Moreno(1).................. 51 Director 1998 June 1996(4) Frank P. Willey(2)................... 44 Director 1998 June 1996(4) Gregory B. Sullivan.................. 39 President and Chief Operating Officer Steven P. Johnson.................... 38 Senior Vice President and General Counsel Russell J. Grisanti.................. 51 Executive Vice President -- Operations Steven T. Darak...................... 50 Senior Vice President and Chief Financial Officer Steven A. Tesdahl.................... 38 Senior Vice President and Chief Information Officer Donald L. Addink..................... 48 Vice President -- Senior Analyst Peter R. Fratt....................... 40 Vice President -- Real Estate Eric J. Splaver...................... 35 Corporate Controller Robert V. Sicina..................... 53 Executive Officer of the Company, as Chairman and Chief Executive Officer of Champion Financial Services, Inc.
- --------------- (1) Member of the Audit Committee. (2) Member of the Compensation Committee. (3) Elected upon the Company's founding in 1992. (4) Elected on or around the date the Company made an initial public offering of its Common Stock. Ernest C. Garcia II has served as the Chairman of the Board and Chief Executive Officer of the Company since its founding in 1992, and served as President from 1992 to 1996. Since 1991, Mr. Garcia has served as President of Verde Investments, Inc., a real estate investment corporation that is also an affiliate of the Company. Prior to 1992, when he founded the Company, Mr. Garcia was involved in various real estate, securities, and banking ventures. Mr. Garcia's sister is married to Mr. Johnson. See below, Part III. Item 10. "Directors and Executive Officers of the Registrant -- Involvement in Certain Legal Proceedings," Part III. Item 12. "Security Ownership of Certain Beneficial Owners and Management," and Part III. Item 13. "Certain Relationships and Related Transactions." 76 78 Robert J. Abrahams has served as a director of the Company since June 1996. Mr. Abrahams has served since 1988 as a consultant to the financing industry, including service as a consultant to the Company from 1994 to 1995. From 1960 to 1988, Mr. Abrahams was an executive officer of Heller Financial, Inc., a finance company. Prior to joining Heller Financial, Inc., Mr. Abrahams co-founded Financial Acceptance Company in 1948. Mr. Abrahams is also a director of Smart Choice Automotive Group, Inc., a retail automotive and finance company, and HMI Industries, Inc., a manufacturing and direct selling company. Mr. Abrahams serves as a member of the Audit Committee of the Board of Directors. Christopher D. Jennings has served as a director of the Company since June 1996. Mr. Jennings has served as a managing director of Cruttenden Roth Incorporated ("Cruttenden Roth"), an investment banking firm, since 1995. From 1992 to 1994, Mr. Jennings served as a Managing Director of investment banking at Sutro & Co., an investment banking firm. From 1989 to 1992, Mr. Jennings served as a Senior Managing Director at Maiden Lane Associates, Ltd., a private equity fund. Prior to 1989, Mr. Jennings served in various positions with, among others, Dean Witter Reynolds, Inc. and Warburg Paribas Becker, Inc., both of which are investment banking firms. Mr. Jennings serves as a member of the Compensation Committee of the Board of Directors. See Part III. Item 12. "Security Ownership of Certain Beneficial Owners and Management" and Part III. Item 13. "Certain Relationships and Related Transactions." John N. MacDonough has served as a director of the Company since June 1996. Mr. MacDonough has served as Chairman and Chief Executive Officer of Miller Brewing Company, a brewer and marketer of beer, since 1993, having previously served from 1992 to 1993 as President and Chief Operating Officer of that company. Prior to 1992, Mr. MacDonough was employed in various positions at Anheuser Busch, Inc. also a brewer and marketer of beer. Mr. MacDonough is also a director of Marshall & Ilsley Bank. Mr. MacDonough is married to the sister of Mr. Sullivan. Arturo R. Moreno has served as a director of the Company since June 1996. Mr. Moreno has served as the President and Chief Executive Officer of Outdoor Systems, Inc., one of the largest outdoor media companies in the United States, since 1984. Prior to 1984, Mr. Moreno held various executive positions in the outdoor advertising industry. Mr. Moreno serves as a member of the Audit Committee of the Board of Directors. Frank P. Willey has served as a director of the Company since June 1996. Mr. Willey has served as the President of Fidelity National Financial, Inc., one of the nation's largest title insurance underwriters, since January 1995. From 1984 to 1995, Mr. Willey served as the Executive Vice President and General Counsel of Fidelity National Title. Mr. Willey is also a director of Fidelity National Financial, Inc., CKE Restaurants, Inc., an operator of various quick-service restaurant chains, and Southern Pacific Funding Corporation, a specialty finance company that originates, purchases, and sells high-yield, non-conforming mortgage loans. Mr. Willey serves as a member of the Compensation Committee of the Board of Directors. Gregory B. Sullivan has served as President of the Company since December 1996 and Chief Operating Officer of the Company since March 1996. From 1995 through February 1996, Mr. Sullivan was a consultant to the Company. Mr. Sullivan formerly served as President and principal stockholder of National Sports Games, Inc., an amusement game manufacturing company that he co-founded in 1989 and sold in 1994. Prior to 1989, Mr. Sullivan was involved in the securities industry and practiced law with a large Arizona firm. He is a member of the State Bar of Arizona. Mr. Sullivan's sister is married to Mr. MacDonough. Russell J. Grisanti has served as the Executive Vice President -- Operations of the Company and President of Champion Acceptance Corporation since June of 1997. From 1989 to 1991, Mr. Grisanti served as the President of Brookland Financial; from 1991 to 1994, Mr. Grisanti served as the President of Kars-Yes Financial, Inc.; and from 1995 to 1996, Mr. Grisanti served as President of Central Auto Sales. From 1996 to June 1997, Mr. Grisanti provided consulting services to various companies in the automobile sales and financing industry. Mr. Grisanti has also held positions as Chief Financial Officer of various savings and loan associations and real estate firms and was an Audit Manager with Coopers & Lybrand LLP. Mr. Grisanti is a CPA and has an MBA. Steven P. Johnson has served as Senior Vice President, Secretary, and General Counsel of the Company since its founding in 1992. Since 1991, Mr. Johnson has also served as the General Counsel of Verde 77 79 Investments, an affiliate of the Company. Prior to 1991, Mr. Johnson practiced law in Tucson, Arizona. Mr. Johnson is licensed to practice law in Arizona and Colorado and is married to the sister of Mr. Garcia. Steven T. Darak has served as the Senior Vice President and Chief Financial Officer of the Company since February 1994, having joined the Company in 1994 as Vice President and Chief Financial Officer. From 1989 to 1994, Mr. Darak owned and operated Champion Financial Services, Inc., a used car finance company that the Company acquired in early 1994. Prior to 1989, Mr. Darak served in various positions in the banking industry and in public accounting. Steven A. Tesdahl has served as Senior Vice President and Chief Information Officer since September 1997. From 1993 to 1997, Mr. Tesdahl was a Partner with Andersen Consulting, a leading global provider of business integration consulting services. Prior to 1993, Mr. Tesdahl was an Associate Partner with Andersen Consulting. Donald L. Addink has served as the Vice President -- Senior Analyst of the Company since 1995 and also serves as the Vice President of Verde Investments. From 1988 to 1995, Mr. Addink served as Executive Vice President of Pima Capital Co., a life insurance holding company. Prior to 1988, Mr. Addink served in various capacities with a variety of insurance companies. Mr. Addink is a Fellow of the Society of Actuaries and a Member of the American Academy of Actuaries. Peter R. Fratt has served as Vice President -- Real Estate of the Company since October 1993. From 1989 to 1993, Mr. Fratt was an associate of CB Commercial Real Estate Services. Prior to that time, Mr. Fratt was involved in commercial real estate brokerage and investment. Eric J. Splaver has served as Corporate Controller of the Company since May 1994. From 1985 to 1994, Mr. Splaver worked as a certified public accountant with KPMG Peat Marwick LLP. Robert V. Sicina has served as Chairman and Chief Executive Officer of Champion Financial Services, Inc. since January of 1998. During 1997, Mr. Sicina was the Chief Financial Officer and Executive Vice President for National Insurance Premium Finance, a financial services provider to the non-standard insurance products market. Mr. Sicina was employed at various positions at American Express Company from 1992 through 1996 including President of the Latin American and Caribbean Division of Travel Related Services and President of American Express Bank, Ltd. Previously, Mr. Sicina served in various positions with Citibank both domestically and internationally in its retail financial services activities including Chief Financial Officer of its U.S. Credit Card Product Group. Directors of the Company are elected for one year terms. Each director of the Company serves until the following annual meeting of the Company, until his successor is duly elected and qualified, or until retirement, resignation, or removal. Executive officers of the Company serve at the discretion of the Board of Directors. INVOLVEMENT IN CERTAIN LEGAL PROCEEDINGS In March 1987, Mr. Ernest C. Garcia II, the Company's Chairman, Chief Executive Officer, and principal stockholder, obtained $20 million in financing from Lincoln Savings and Loan Association ("Lincoln") to repurchase stock in his real estate development company held by a corporate investor. Mr. Garcia also agreed to facilitate the purchase of certain land from a Lincoln subsidiary. The two transactions closed simultaneously. Soon thereafter, Lincoln was placed into receivership and federal regulators from the RTC and other government agencies began investigating numerous transactions involving Lincoln and a variety of third parties, including Mr. Garcia. Upon being notified of the RTC's investigation, Mr. Garcia met voluntarily with RTC investigators, without counsel, for several months and provided full disclosure concerning the details of his dealings with Lincoln. Nearly one year later, the RTC asserted that the financing transaction and the land transaction, though documented separately, were linked and that, as a result of the transaction, Lincoln improperly recorded a gain in violation of certain accounting rules applicable to Lincoln. As a result, in October 1990, the United States, on behalf of the RTC, informed Mr. Garcia that it intended to charge him with bank fraud. 78 80 Mr. Garcia was never indicted for his role in the transaction, but, facing severe financial pressures, agreed to plead guilty to one count of bank fraud. Prior to his sentencing in 1993, the RTC submitted a letter to the United States District Court for the Central District of California urging that the court take favorable account of Mr. Garcia's relative responsibility and culpability, as well as his timely and honest cooperation, in determining an appropriate sentence. In this letter, the RTC stated its belief that the chief executive officer of Lincoln's parent company, Charles H. Keating, Jr., not Mr. Garcia, devised the transaction and that Mr. Garcia was not even aware of the existence of Mr. Keating's illegal schemes and had no reason to believe that the transaction would enable Mr. Keating to defraud Lincoln. The RTC letter also noted Mr. Garcia's extensive cooperation with federal investigators, which began prior to the time he was charged and continued until his sentencing. In December 1993, the court, following the RTC's recommendation, sentenced Mr. Garcia to three years of probation and fined him $50 (the minimum fine that the court could assess). Under the terms of the probation, Mr. Garcia was barred from affiliating in any way with a federally insured banking institution without prior approval. In December 1996, Mr. Garcia completed his probation. In connection with the criminal action, the RTC filed a civil suit against Mr. Garcia, which the parties settled after Mr. Garcia agreed to cooperate fully with the RTC in its investigation and prosecution of Lincoln-related matters. Pursuant to the terms of his settlement agreement, and in light of Mr. Garcia's cooperation, the RTC released Mr. Garcia from civil liability. Also in connection with this action, the Securities and Exchange Commission ("Commission") commenced civil and administrative actions against Mr. Garcia. Without admitting or denying any of the Commission's allegations, Mr. Garcia consented to a court order permanently enjoining him and his affiliates from violating the federal securities laws and to a Commission order barring him (with a right to reapply upon the cessation of his probation) from associating in any capacity with any broker, dealer, municipal securities dealer, investment adviser, or investment company. As a result of a decline in the Arizona real estate market in the late 1980s, changes in the tax laws affecting real estate, and the 1987 stock market crash, in April 1990 a real estate investment company controlled by Mr. Garcia, as well as several limited partnerships organized by that company, filed petitions for reorganization under Chapter 11 of the Bankruptcy Code. All of these reorganization proceedings were successfully concluded by 1993. Many of the obligations of these entities were personally guaranteed by Mr. Garcia and his wife. As a result, Mr. Garcia and his wife filed a petition under Chapter 7 of the Bankruptcy Code in 1990, which was discharged in October 1991. SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Exchange Act requires the Company's executive officers, directors, and persons who own more than 10% of a registered class of the Company's equity securities, to file reports of ownership and changes in ownership with the Commission. Officers, directors, and greater than 10% stockholders are required by Commission regulations to furnish the Company with copies of all Section 16(a) forms they file. Based upon a review of the filings of such forms, or written representations that no other forms were required, the Company believes that all of the Company's executive officers, directors, and greater than 10% stockholders complied during the fiscal year ended December 31, 1997 with the reporting requirements of Section 16(a), with the exception of one Form 3 filing with respect to Mr. Russell J. Grisanti, which was made after the applicable deadline. The delay in filing the Form 3 (initial statement of beneficial ownership of securities) was the result of an administrative error on the Company's part in recognizing Mr. Grisanti as an executive officer of the Company when he was hired by the Company, and the Company's processing of the filing on behalf of Mr. Grisanti. 79 81 ITEM 11 -- EXECUTIVE COMPENSATION COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS, AND RELATED MATTERS COMPENSATION OF DIRECTORS AND THE DIRECTOR INCENTIVE PLAN The Company's independent directors are compensated $1,000 for physical attendance at meetings of the Board of Directors and at meetings of committees of the Board of Directors of which they are members, and are reimbursed for reasonable travel expenses incurred in connection with attendance at each Board and committee meeting. Board and committee members are not compensated for their telephonic attendance at meetings. If a Board and committee meeting are held on the same day, a member who attends both meetings will received combined total compensation of only $1,000. In addition, pursuant to the Company's Director Incentive Plan, upon initial appointment or initial election to the Board of Directors, each independent director of the Company receives Common Stock of the Company valued at $30,000, which is subject to vesting in equal annual increments over a three-year period as provided for under the plan. Directors who are also officers of the Company are not compensated for their service as directors and are not entitled to participate in the Director Incentive Plan. SUMMARY COMPENSATION TABLE FOR NAMED EXECUTIVE OFFICERS The table below sets forth information concerning the annual and long-term compensation for services rendered in all capacities to the Company during the three fiscal years ended December 31, 1997, of those persons who were, at December 31, 1997: (i) the chief executive officer of the Company and (ii) the four other most highly compensated executive officers of the Company ("Named Executive Officers"):
LONG-TERM COMPENSATION --------------------------------- SECURITIES ANNUAL COMPENSATION UNDERLYING ---------------------- OPTIONS -- ALL OTHER NAME AND PRINCIPAL POSITION YEAR SALARY ($) BONUS($) AWARDS(#)(1) COMPENSATION($)(2) - --------------------------- ---- ---------- -------- ------------ ------------------ Ernest C. Garcia II................. 1997 $131,677 -- -- $ 3,935(3) Chairman of the Board and 1996 121,538 -- -- 3,873(3) Chief Executive Officer 1995 100,000 -- -- 3,151(3) Gregory B. Sullivan................. 1997 197,846 -- -- 554 President and Chief 1996 97,385 -- 125,000 -- Operating Officer 1995 --(4) -- 116,000(4) -- Steven T. Darak..................... 1997 148,654 $ 25,000 -- 1,750(5) Senior Vice President and 1996 100,000 100,000 40,000 9,250(5) Chief Financial Officer 1995 100,000 100,000 -- 12,250(5) Walter T. Vonsh(7).................. 1997 150,000 -- -- 3,439(6) Senior Vice President -- Credit 1996 126,923 30,000 50,000 5,277(6) 1995 97,692 -- -- 3,704(6) Donald L. Addink.................... 1997 139,671 10,000 -- 950 Vice President -- Senior Analyst 1996 122,142 10,000 42,000 485 1995 71,026 10,000 58,000 984
- --------------- (1) The amounts shown in this column represent stock options granted pursuant to the Ugly Duckling Corporation Long-Term Incentive Plan ("Incentive Plan"). Generally, options are subject to vesting over a five-year period, with 20.0% of the options becoming exercisable on each successive anniversary of the date of grant. See below, Part III. Item 11. "Executive Compensation -- Compensation of Directors and Executive Officers, and Related Matters -- Long-Term Incentive Plan" for a discussion of the Incentive Plan. (2) The amounts shown includes the dollar value of 401(k) plan contributions made by the Company for the benefit of the Named Executive Officers. 80 82 (3) This amount includes a $2,985 car allowance during 1997, and a $2,950 car allowance during both 1996 and 1995, respectively, for Mr. Garcia. (4) Mr. Sullivan became an executive officer of the Company during March 1996. For all of 1995 and a portion of 1996, Mr. Sullivan was employed as an independent contractor by the Company and was not an employee. Therefore, the above table does not reflect the compensation paid to Mr. Sullivan while he was an independent contractor for the Company in 1995 and 1996, respectively. The table does, however, reflect stock options granted to Mr. Sullivan under the Incentive Plan during both 1995 and 1996. (5) This amount includes $7,500 and $10,500 paid by the Company for a Phoenix apartment for Mr. Darak during 1996 and 1995, respectively, while his full time residence was in Tucson, Arizona and a $1,750 car allowance during 1997, 1996, and 1995. (6) This amount includes a $2,550, $5,000, and $2,850 car allowance for Mr. Vonsh during 1997, 1996, and 1995, respectively. (7) Effective as of March 16, 1998, Mr. Vonsh resigned his officer position of Senior Vice President -- Credit for the Company. Mr. Vonsh continues to be employed by the Company in other capacities and positions. OPTION GRANTS IN LAST FISCAL YEAR TO NAMED EXECUTIVE OFFICERS There were no stock options granted pursuant to the Company's Incentive Plan or otherwise during the fiscal year ended December 31, 1997, to the Named Executive Officers. AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND OPTION VALUES AS OF DECEMBER 31, 1997 OF NAMED EXECUTIVE OFFICERS The table below sets forth information with respect to option exercises and the number and value of options outstanding at December 31, 1997 held by the Named Executive Officers. The Company has never issued any other forms of stock based awards.
NUMBER OF SECURITIES VALUE OF UNEXERCISED IN- UNDERLYING OPTIONS AT THE-MONEY OPTIONS AT SHARES FISCAL YEAR END(#)(1) FISCAL YEAR END($)(2) ACQUIRED ON VALUE --------------------------- --------------------------- NAME AND PRINCIPAL POSITION EXERCISE(#) REALIZED($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - --------------------------- ----------- ----------- ----------- ------------- ----------- ------------- Ernest C. Garcia II......... -- -- -- -- -- -- Gregory B. Sullivan......... -- -- 71,400 169,000 $282,974 $446,336 Steven T. Darak............. -- -- 8,000 32,000 3,500 14,000 Walter T. Vonsh............. -- -- 10,000 40,000 8,750 35,000 Donald L. Addink(3)......... 63,000 $622,490(4) 17,000 20,000 -- 35,000
- --------------- (1) Generally, options are subject to vesting over a five-year period, with 20% of the options becoming exercisable on each successive anniversary of the date of grant. (2) In-the-money options are options for which the option exercise price (the fair market value on the date of grant) was lower than the market price of the Company's Common Stock on December 31, 1997, which market price of $8.50 per share was based on the closing price of the Common Stock on that date as reported by Nasdaq. The values in the last two columns have not been, and may never be, received by the Named Executive Officers. Actual gains, if any, on option exercises will depend on the value of the Common Stock on the exercise dates. Accordingly, there can be no assurance that the values shown in the last two columns will be realized. The closing price of the Company's Common Stock on March 26, 1998 was $10.50 per share. (3) Subsequent to December 31, 1997 and during January 1998, Mr. Addink exercised 20,000 stock options at an exercise price of approximately $6.75 per share. As discussed herein, these options were subject to accelerated vesting pursuant to Mr. Addink's restated employment agreement with the Company. (4) The value realized represents the value of stock options exercised by Mr. Addink during the last fiscal year. During this period, he exercised options to acquire 63,000 shares of the Company's Common Stock. 81 83 The value realized was calculated by subtracting the exercise price of Mr. Addink's options from the fair market value of the Common Stock underlying the options as of the exercise date. The fair market value of the Company's Common Stock was based on the closing price of the stock on the date of exercise as reported by Nasdaq. Pursuant to Incentive Plan documents, the exercise date was the date Mr. Addink provided notice of his exercise to the Company and method of payment. LONG-TERM INCENTIVE PLAN In June 1995, the Company's stockholders approved the Ugly Duckling Corporation Long-Term Incentive Plan ("Incentive Plan"). Under the Incentive Plan, the Company may grant incentive stock options ("ISOs"), non-qualified stock options ("NQSOs"), stock appreciation rights ("SARs"), performance shares, restricted stock, dividend equivalents, and other Common Stock-based awards to employees, consultants, and advisors of the Company. The Company believes that the Incentive Plan promotes the success and enhances the value of the Company by linking the personal interests of participants to those of the Company's stockholders and providing participants with an incentive for outstanding performance. The total number of shares of Common Stock originally available for awards under the Incentive Plan, as amended, is 1,800,000, subject to a proportionate increase or decrease in the event of a stock split, reverse stock split, stock dividend, or other adjustment to the Company's total number of issued and outstanding shares of Common Stock. As of March 1, 1998, the Company had granted options under the Incentive Plan to purchase approximately 1,445,700 (net of cancelled and lapsed grants) shares of Common Stock to various of its employees of which 1,265,444 were outstanding. Also as of March 1, 1998, there were 354,300 shares that remained available for grant under the Incentive Plan. During the first quarter of 1998, the Compensation Committee granted, subject to certain conditions, approximately 775,000 options to purchase Common Stock of the Company to several of its officers, which grant is not reflected in the preceding option and grant information as of March 1, 1998 for the Incentive Plan. See below, Part III. Item 11. "Executive Compensation -- Compensation of Directors and Executive Officers, and Related Matters -- Contracts with Directors and Executive Officers." The Incentive Plan is administered by the Compensation Committee of the Board of Directors, which has the exclusive authority to administer the Incentive Plan, including the power to determine eligibility, the type and number of awards to be granted, and the terms and conditions of any award granted, including the price and timing of awards, vesting, and acceleration of such awards. The Incentive Plan does provide an award limit to a single participant equal to no more than 250,000 shares of Common Stock during any single calendar year. To date, the exercise price of all options granted under the Incentive Plan has been equal to the fair market value of the Common Stock on the date of grant. The Compensation Committee may terminate, amend or modify the Incentive Plan at any time but such termination, amendment or modification shall not affect any stock options, SARs or restricted stock awards then outstanding under the Incentive Plan. Also, the Compensation Committee may not terminate, amend or modify the Incentive Plan as it deems advisable, but subject to any stockholder approval required under applicable law or by any national securities exchange or system on which the Common Stock is then listed or reported. Unless terminated by action of the Compensation Committee, the Incentive Plan will continue in effect until June 30, 2005, but awards granted prior to such date shall continue in effect until they expire in accordance with their terms. The Compensation Committee may amend the term of any award or option theretofore granted, retroactively or prospectively, but no such amendment shall adversely affect any such award or option without the holder's consent. Generally, the Incentive Plan's stock options have been subject to vesting over a five-year period, with 20.0% of the options becoming exercisable by the holder thereof on each successive anniversary date of the grant, and presently expire 10 years after grant date. However, during 1997, the Compensation Committee exercised its discretion and accelerated the vesting of certain stock option awards previously granted to Mr. Addink under the Incentive Plan. See below, Part III. Item 11. "Executive Compensation -- Compensation of Directors and Executive Officers, and Related Matters -- Contracts with Directors and Executive Officers" herein. Also, the Incentive Plan has a "Change of Control" provision which is summarized herein under this Part III. Item 11. "Executive Compensation -- Compensation of Directors and Executive Officers, and Related Matters -- Change of Control Arrangements." 82 84 401(K) PLAN Under the Company's 401(k) plan, adopted in October 1995, eligible employees may direct that a portion of their compensation, up to a legally established maximum, be withheld by the Company and contributed to their account. All 401(k) plan contributions are placed in a trust fund to be invested by the 401(k) plan's trustee, except that the 401(k) plan may permit participants to direct the investment of their account balances among mutual or investment funds available under the plan. The 401(k) plan provides a matching contribution of 10.0% of a participant's contributions, and discretionary additional matching, if authorized by the Company. Amounts contributed to participant accounts under the 401(k) plan and any earnings or interest accrued on the participant accounts are generally not subject to federal income tax until distributed to the participant and may not be withdrawn until death, retirement, or termination of employment. CHANGE OF CONTROL ARRANGEMENTS The Incentive Plan provides that the Board of Director or the Compensation Committee (whichever entity is administering the Incentive Plan at the time) may, in its sole and absolute discretion, provide participants with certain rights and benefits in the event of a "Change of Control" (as defined in the Incentive Plan), including, without limitation (1) allowing all grants to become exercisable and all restrictions on outstanding grants to lapse and allowing each participant the right to exercise the grants prior to the occurrence of the Change of Control event; or (2) providing that every grant outstanding under the Incentive Plan terminates, provided that the surviving or resulting entity tenders grants to participants that substantially preserve the rights and benefits of any grant then outstanding under the Incentive Plan. A "Change of Control" under the Incentive Plan may be any consolidation or merger of the Company in which the Company is not the continuing or surviving entity, or pursuant to which stock would be converted into cash, securities, or other property; any sale, lease, exchange, or other transfer of more than 40% of the assets or earning power of the Company; the approval by stockholders of any plan or proposal for liquidation or dissolution of the Company; or any person, other than any current stockholder of the Company or affiliate thereof or any employee benefit plan of the Company or any subsidiary of the Company, becomes the beneficial owner of 20% or more of the Company's outstanding stock. See below, Part III. Item 11. "Executive Compensation -- Compensation of Directors and Executive Officers, and Related Matters -- Contracts with Directors and Executive Officers." CONTRACTS WITH DIRECTORS AND EXECUTIVE OFFICERS During the first quarter of 1998, the Compensation Committee granted, subject to certain conditions, approximately 775,000 options to purchase Common Stock of the Company to several of its officers. Included in this grant is a stock option award to acquire 500,000 shares of the Company's stock to Gregory B. Sullivan, President and Chief Operating Officer of the Company. On January 1, 1996, the Company entered into a three-year employment agreement with Mr. Ernest C. Garcia II, the Company's Chairman and Chief Executive Officer. The agreement establishes Mr. Garcia's base salary for 1997 at $132,000 per year and provides a minimum 10.0% increase in the base salary each year throughout the term of the agreement. In addition, the agreement provides for the continuation of Mr. Garcia's base salary and certain benefits for a period of one year in the event Mr. Garcia is terminated by the Company without cause prior to that time. The agreement also contains confidentiality and non-compete covenants. On April 1, 1995, the Company entered into a three-year employment agreement with Mr. Walter T. Vonsh, the Company's former Senior Vice President -- Credit that was modified on or about August 6, 1997. As stated above, Mr. Vonsh is no longer the Senior Vice President -- Credit for the Company, but continues to be employed by the Company in other capacities and positions. The modified agreement provides for a base salary of $150,000 per year for 1997 and certain other compensation and benefits. Subject to certain conditions, the modified agreement also provides for an extension of Mr. Vonsh's employment agreement to April 2002. The modified agreement also provides for the continuation of Mr. Vonsh's base salary and certain 83 85 benefits for the term of the agreement in the event Mr. Vonsh is terminated by the Company without cause prior to that time. The modified agreement contains confidentiality and non-compete covenants. On June 1, 1995, the Company entered into a five-year employment agreement with Mr. Donald L. Addink, the Company's Vice President -- Senior Analyst, that was amended and restated effective August 1, 1997. The restated agreement establishes Mr. Addink's base salary at $165,000 per year beginning on or around the effective date of the restated employment agreement, a $10,000 bonus payment upon execution of the restated employment agreement, certain benefits, and the continuation of Mr. Addink's base salary and certain benefits for a period of one year in the event Mr. Addink is terminated by the Company without cause prior to expiration of the restated employment agreement. The restated employment agreement also contains confidentiality and non-compete covenants. Further, the restated employment agreement accelerated the vesting of Mr. Addink's 100,000 stock options previously granted under the Incentive Plan, as described below. Originally, the 100,000 stock options were granted: (1) pursuant to the Incentive Plan's general five-year vesting schedule with 20% vesting each year, and (2) on the following dates, in the following number and for the following exercise prices.
NUMBER EXERCISE PRICE DATE OF SHARES(#) PER SHARE($) - ---- ------------ ----------------- June 1995....................................... 58,000 $ 1.72 June 1996....................................... 25,000 6.75 December 1996................................... 17,000 17.69
In recognition of Mr. Addink's performance for the Company, the Board of Directors of the Company and the Board's Compensation Committee, approved the acceleration of the above options, such that they became fully vested on the following dates: (1) the June 1995 and December 1996 options vested on August 1, 1997 (the date of the restated employment agreement), and (2) the June 1996 options vested on January 15, 1998. The accelerated vesting does not affect any other options of Mr. Addink presently held or thereafter acquired by him. On June 12, 1997, the Company entered into a two-year employment agreement with Russell J. Grisanti, the Company's Executive Vice President -- Operations. The agreement establishes Mr. Grisanti's base salary at $170,000 per year beginning on or around the effective date of the agreement, reimbursement of certain costs and other assistance in connection with Mr. Grisanti (at the request of the Company) relocating his household from California to Arizona, an initial stock option grant to acquire 100,000 shares of the Company's Common Stock, and certain other benefits. The initial option grant consisted of a NQSO under the Incentive Plan, with terms and conditions consistent with the plan's general terms. The agreement also provides for the continuation of Mr. Grisanti's base salary for a period of one year in the event Mr. Grisanti is terminated by the Company without cause prior to the expiration of the agreement. On August 16, 1997, the Company entered into an employment agreement with Steven A. Tesdahl, the Company's Senior Vice President and Chief Financial Officer. The agreement provides for no minimum or maximum term of employment. It does, however, establish Mr. Tesdahl's annual base salary at $175,000 per year beginning on or around the effective date of the agreement (subject to a minimum ten percent increase on each anniversary hire date), an initial stock option grant to acquire 100,000 shares of the Company's Common Stock, a grant of restricted stock of the Company valued at $100,000 at the approximate effective date of Mr. Tesdahl's employment with the Company, and certain other benefits. The initial option grant consisted of a NQSO under the Incentive Plan, with terms and conditions consistent with the plan's general terms. The restricted stock award consisted of Common Stock of the Company, which vested on or around January 15, 1998. The agreement provides for the continuation of Mr. Tesdahl's base salary for a maximum period of one year in the event Mr. Tesdahl is terminated by the Company without cause prior to his one year anniversary date with the Company (i.e., prior to September 1, 1998). The potential severance benefit decreases over the period of Mr. Tesdahl's employment with the Company and goes to zero after September 1, 2000. The agreement contains a "Change of Control" provision that provides that upon such an event occurring and either (a) Mr. Tesdahl himself terminates his employment with the Company within 12 months after the change of control; or (b) the Company terminates Mr. Tesdahl without cause within 90 days prior to 84 86 the change of control or within 12 months after the change of control, then in either event Mr. Tesdahl will receive a termination fee equal to 200% of his then current salary. In addition, at the time of a change of control Mr. Tesdahl's initial NQSO award will automatically fully vest without any further action or authority of the Board of Directors or the Compensation Committee. The agreement adopts the Incentive Plan's definition of a "Change of Control" and adds the removal and/or resignation of Ernest C. Garcia II as the Chairman of the Board and Chief Executive Officer of the Company as an additional change of control event. See above, Part III. Item 11. "Executive Compensation -- Compensation of Directors and Executive Officers, and Related Matters -- Change of Control Arrangements." COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION There are no compensation committee interlocks and no Company officer or former officer was a member of the Company's Compensation Committee. However, Mr. Jennings was, during 1997, and continues to be a member of the Compensation Committee of the Board of Directors. As discussed herein, Mr. Jennings is also a managing director of Cruttenden Roth. Cruttenden Roth served as the sole representative in the Company's initial public offering. In its capacity as representative, Cruttenden Roth participated in the underwriting discount and received a non-accountable expense allowance and warrants to purchase Common Stock. See Part II. Item 5. "Market For The Registrant's Common Equity Securities and Related Stockholder Matters -- Warrant Issuances" and Part III. Item 12. "Security Ownership of Certain Beneficial Owners and Management." ITEM 12 -- SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth certain information regarding the beneficial ownership of the Company's Common Stock as of March 1, 1998, for: (1) each director of the Company; (2) the Named Executive Officers of the Company; (3) all directors and executive officers of the Company as a group; and (4) each beneficial owner of more than 5% of the outstanding Common Stock as of March 1, 1998, unless otherwise indicated. To the knowledge of the Company, each person listed below or their family members have sole voting and investment power with respect to their shares, except to the extent that (a) authority is shared by their respective spouses under applicable law, or (b) as otherwise indicated below.
SHARES BENEFICIALLY OWNED(1) ------------------------------------ NUMBER ---------------------- NAME OF BENEFICIAL OWNER(2) COMMON STOCK OPTIONS TOTAL(#) PERCENT - --------------------------- ------------ ------- ---------- ------- Ernest C. Garcia II(3)(12)......................... 4,656,500 4,656,500 25.1% Robert J. Abrahams(4).............................. 6,744 6,744 * Christopher D. Jennings(4)(5)...................... 36,194 36,194 * John N. MacDonough(4).............................. 4,444 4,444 * Arturo R. Moreno(4)................................ 24,444 24,444 * Frank P. Willey(4)................................. 9,444 9,444 * Gregory B. Sullivan(6)............................. 20,000 71,400 91,400 * Steven T. Darak(6)................................. 140,000 8,000 148,000 * Walter T. Vonsh(6)................................. 72,000 10,000 82,000 * Donald L. Addink(7)................................ 98,000 67,000 165,000 *
85 87
SHARES BENEFICIALLY OWNED(1) ------------------------------------ NUMBER ---------------------- NAME OF BENEFICIAL OWNER(2) COMMON STOCK OPTIONS TOTAL(#) PERCENT - --------------------------- ------------ ------- ---------- ------- Steven P. Johnson(6)............................... 310,000 5,000 315,000 1.7% Harris Associates L.P.(8)(12)...................... 1,825,000 1,825,000 9.9% Wellington Management Company, LLP(9)(12).......... 1,664,500 1,664,500 9.0% Merrill Lynch & Co., Inc.(10)(12).................. 1,615,000 1,615,000 8.8% FMR Corp.(11)(12).................................. 1,284,000 1,284,000 6.9% All directors and executive officers as a group (16 persons)......................................... 5,581,875 30.1
- --------------- * Represents less than one percent of the outstanding Common Stock. (1) A person is deemed to be the beneficial owner of securities that can be acquired within 60 days from March 1, 1998 through the exercise of any option, warrant, or right. Shares of Common Stock subject to options, warrants, or rights which are currently exercisable or exercisable within 60 days are deemed outstanding for computing the percentage of the person holding such options, warrants, or rights, but are not deemed outstanding for computing the percentage of any other person. The amounts and percentages are based upon 18,550,869 shares of Common Stock outstanding as of March 1, 1998. (2) Unless otherwise noted, the address of each of the listed stockholders is 2525 East Camelback Road, Suite 1150, Phoenix, Arizona 85016. (3) Includes 136,500 shares and 20,000 shares held by The Garcia Family Foundation, Inc., an Arizona nonprofit corporation, and Verde, an affiliate of the Company and Mr. Garcia, respectively. Also, includes 50,000 shares of Common Stock that Mr. Garcia presently owns, but to which he has provided an option to purchase to Donald L. Addink. The Option Agreement was entered into on August 18, 1997 and allows Mr. Addink to exercise the option at any time through May 31, 2000 at an exercise price of $15.00 per share. As of March 1, 1998, Mr. Addink had not exercised his option right to purchase any of these shares of Common Stock from Mr. Garcia. Until the option is exercised by Mr. Addink, Mr. Garcia retains voting and investment power with respect to the 50,000 shares of Common Stock. (4) The total for each independent Board of Director member includes 4,444 shares of Common Stock of the Company granted under the Company's Director Incentive Plan. Shares having a value of $30,000 on or about the date of grant (i.e., 4,444 shares of Common Stock) were granted and issued to each independent Board member upon their appointment or election to the Board of Directors in June 1996. Pursuant to the Director Incentive Plan, these shares vest over a three-year period at an annual rate of 33%, beginning on the first anniversary date after the date of grant (June 1996). (5) The total for Mr. Jennings includes 6,444 shares of Common Stock of the Company. The total also includes 29,750 warrants to purchase Common Stock held of record by Cruttenden Roth, investment banking firm of which Mr. Jennings is managing director. The warrants are convertible into Common Stock at an exercise price of $9.45 per share and vest over a three-year period at an annual rate of 33%, beginning in June 1996. (6) The options listed for Messrs. Sullivan, Darak, Vonsh and Johnson include their respective options granted under the Incentive Plan that are exercisable pursuant to the plan on March 1, 1998 or within 60 days thereafter. The options are exercisable at various prices, established in accordance with the provisions of the Incentive Plan. (7) The total for Mr. Addink includes options granted under the Incentive Plan. Generally options issued pursuant to the Incentive Plan vest over a five-year period, with 20% of the options becoming exercisable by a holder on each successive anniversary date of the grant. During 1997, the Compensation Committee of the Board of Directors of the Company and the Board approved an accelerated vesting schedule for Mr. Addink's existing options under the Incentive Plan. The total also includes an option to acquire 50,000 shares of Common Stock directly from Mr. Garcia, pursuant to their Option Agreement dated August 18, 1997. As of March 1, 1998, Mr. Addink had not exercised any of his option rights 86 88 under this agreement. However, the Option Agreement does provide Mr. Addink the right to exercise his option at any time through May 31, 2000 at an exercise price of $15.00 per share. Until the option is exercised by Mr. Addink, Mr. Garcia retains voting and investment power with respect to these 50,000 shares of Common Stock. (8) Based on two (2) Schedule 13G filings as of December 31, 1997, by Harris Associates L.P. ("Harris") and an affiliate of Harris, Harris Associates Investment Trust and related funds ("Harris Trust"), all located, at Two North LaSalle Street, Suite 500, Chicago, Illinois 60602. According to these Schedule 13Gs, Harris has shared voting and dispositive power over 1,825,000 of the shares (including 1,750,000 share of Harris Trust) and Harris Trust has shared voting and dispositive power over 1,750,000 of the shares of the Company's Common Stock. The Company makes no representation as to the accuracy or completeness of the information provided in this footnote or the above beneficial ownership table related to the same, which is based solely on the Harris and Harris Trust Schedule 13G filings. (9) Based on a Schedule 13G (Amendment No. 1) ("Amendment") filing as of December 31, 1997, by Wellington Management Company, LLP, at 75 State Street, Boston, Massachusetts 02109. According to the Amendment, Wellington Management Company, LLP has shared voting power over 767,100 of the shares and shared dispositive power over 1,664,500 of the shares of the Company's Common Stock. The Company makes no representation as to the accuracy or completeness of the information provided in this footnote or the above beneficial ownership table related to the same, which is based solely on Wellington Management Company LLP's Amendment filing. (10) Based on a Schedule 13G filing as of December 31, 1997, by Merrill Lynch & Co., Inc. ("Merrill Parent") and four (4) of its subsidiaries and/or affiliates, including Merrill Lynch Global Allocation Fund, Inc. ("Merrill Global"). Merrill Parent and one of its subsidiary/affiliates that is included within this Merrill Schedule 13G filing are located, at 250 Vesey Street, New York, New York 10281. Merrill Global and the other two (2) subsidiaries/affiliates that are included within this Merrill Schedule 13G filing are located at 800 Scudders Mill Rd., Plainsboro, New Jersey 08536. According to the Schedule 13G, Merrill Global has shared voting and dispositive power over 1,530,000 of the shares and Merrill Parent along with each of its other three subsidiaries and/or affiliates have shared voting and dispositive power over 1,615,000 of the shares of the Company's Common Stock. The Company makes no representation as to the accuracy or completeness of the information provided in this footnote or the above beneficial ownership table related to the same, which is based solely on Merrill's Schedule 13G filing. (11) Based on a Schedule 13G filing as of December 31, 1997, by FMR Corp., along with certain of its affiliates ("FMR"), at 82 Devonshire Street, Boston, Massachusetts 02019. According to the Schedule 13G, FMR has no voting power over the shares but has sole dispositive power over 1,284,000 shares of the Company's Common Stock. The Company makes no representation as to the accuracy or completeness of the information provided in this footnote or the above beneficial ownership table related to the same, which is based solely on FMR's Schedule 13G filing. (12) The Company knows of no other person who beneficially owned more than five percent of Company's Common Stock as of March 1, 1998. 87 89 ITEM 13 -- CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Since its inception, the Company has maintained business relationships and engaged in certain transactions with the affiliated companies and parties described below. Any future transactions between the Company and its affiliated entities, executive officers, directors, or significant stockholders will require the approval of a majority of the independent directors of the Company and will be on terms no less favorable to the Company than the Company could obtain from non-affiliated parties. Pursuant to an agreement ("Modification Agreement") between the Company and Verde, effective June 21, 1996, Verde agreed to sell to the Company at any time prior to June 21, 1997, subject to financing, six car lots, a vehicle reconditioning center, and two office buildings owned by Verde and leased to the Company at the lower of $7.45 million or the appraised value of the properties (as determined by an independent third party), and to lower the rents on such properties to an aggregate of $745,000 per year subject to cost of living adjustments if the sale did not take place. These properties had previously been rented from Verde pursuant to various leases which called for base monthly rents aggregating approximately $123,000 plus contingent rents as well as all occupancy and maintenance costs, including real estate taxes, insurance, and utilities. Rents paid to Verde pursuant to these leases totaled $1.5 million in 1996. The Company believes the reduced rental rates approximate the financing costs to be incurred in connection with the purchase of such properties. In addition, Verde assigned to the Company its leasehold interest in two properties it sub-leased to the Company. These transactions (the reduction in rental rates and/or the purchase of property) would have resulted in savings to the Company of approximately $626,000 for 1996. Also pursuant to the Modification Agreement, Verde lowered the interest rate on $14.0 million of the Company's subordinated debt payable to Verde from 18.0% to 10.0% per annum and lowered from 12.0% to 10.0% the dividend rate on $10.0 million of the Company's Preferred Stock held by Verde. For the years ended December 31, 1997 and 1996, the Company paid Verde $2.0 million and $553,000 of principal, and approximately $1.2 million and $1.9 million of interest, respectively, in connection with the Verde subordinated debt. In July 1997, the Company's Board of Directors approved the prepayment of the $12.0 million in subordinated debt subject to certain conditions. See Part II. Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operation -- Liquidity and Capital Resources -- Subordinated Indebtedness and Preferred Stock." On December 31, 1996, the Company purchased the properties listed above from Verde pursuant to the Modification Agreement. Mr. Garcia is the President and sole stockholder of Verde. In connection with the purchase, Verde returned security deposits which totaled $364,000. In January 1996, in connection with the sale of the Gilbert Dealership, the Company purchased the land for the Gilbert Dealership from Verde for a total price of $750,000, which the Company believes approximated fair market value. Simultaneous with such purchase, the Company sold the land purchased from Verde together with the dealership building and other improvements (which had been constructed by the Company) to a third party for $512,500 in cash and a promissory note in the principal amount of $1.2 million. The Company recognized a loss on the sale of $120,000, for which an allowance was established as of December 31, 1995. Mr. Christopher D. Jennings, a managing director of Cruttenden Roth, is a director of the Company. Cruttenden Roth served as the sole representative in the Company's initial public offering. In its capacity as representative, Cruttenden Roth participated in the underwriting discount and received a non-accountable expense allowance and warrants to purchase Common Stock. See Part II. Item 5. "Market For The Registrant's Common Equity Securities and Related Stockholder Matters -- Warrant Issuances" and Part III. Item 12. "Security Ownership of Certain Beneficial Owners and Management." In September 1997, the Company's Board of Directors approved the Ugly Duckling Director and Officer Stock Purchase Program. The Director and Officer Stock Purchase Program includes the providing of loans of up to $1.0 million in total to the directors and senior officers under the program to assist Directors' and officers' purchases of Company Common Stock on the open market. The program provides for loans, which are unsecured by the related Common Stock, at arms-length terms and conditions. During November 1997, senior officers purchased 50,000 shares of Common Stock under the Director and Officer Stock Purchase Program and the Company advanced $500,000 to the senior officers for these purchases. 88 90 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................................ 47 Consolidated Financial Statements and Notes thereto of Ugly Duckling Corporation: Consolidated Balance Sheets -- December 31, 1997 and 1996................................................... 48 Consolidated Statements of Operations -- for the years ended December 31, 1997, 1996 and 1995................. 49 Consolidated Statements of Stockholders' Equity -- for the years ended December 31, 1997, 1996 and 1995........... 50 Consolidated Statements of Cash Flows -- for the years ended December 31, 1997, 1996 and 1995................. 51 Notes to Consolidated Financial Statements................ 53 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 1997, the Company filed three reports on Form 8-K, including one Form 8-K/A. The first report on Form 8-K, dated September 19, 1997 and filed October 5, 1997, pursuant to Items 2, 5 and 7, reported (1) the completion of the acquisition by the Company of certain assets of Kars, and (2) the completion of the securitization of approximately $104 million of vehicle receivables by CRC II. The second report on Form 8-K, dated November 14, 1997 and filed November 20, 1997, pursuant to Items 2 and 7 (1) reported the execution by the Company of a letter agreement, and related terms, entitled Binding Agreement to Propose and Support Modified Plan Agreement regarding the FMAC Plan of Reorganization and other matters ("Plan Letter Agreement"), and (2) filed a copy of the Plan Letter Agreement. The third report on Form 8-K/A, dated September 19, 1997 and filed October 28, 1997, pursuant to Item 7 amended the Form 8-K dated September 19, 1997 to add the financial statements of the Kars business acquired by the Company and related pro forma financial information. After the fourth quarter 1997, the Company filed four reports on Form 8-K. The first report on Form 8-K, dated December 15, 1997 and filed January 2, 1998, pursuant to Items 5 and 7 (1) reported the execution by the Company of a modified letter agreement, and related terms, which superseded and replaced the Plan Letter Agreement regarding the FMAC Plan of Reorganization and other matters ("Final Plan Letter Agreement"), (2) reported the Company's expected gain of $6.0 to $7.0 million (before income taxes) during the fourth quarter of 1997 from the sale of certain contracts in connection with the FMAC transaction, (3) reported certain arrangements for the servicing of contracts in connection with FMAC, (4) disclosed the Company's Directors and Officers Stock Purchase Program, and (5) filed related agreements such as the Final Plan Letter Agreement, a purchase agreement, and servicing agreement. The second report on Form 8-K, dated February 6, 1998 and filed February 9, 1998, pursuant to Item 5, reported (1) the Company's earnings for its year and quarter ended December 31, 1997, and (2) the closure of the Company's third party dealer Branch Office network and a related restructuring charge to be recorded in the first quarter of 1998. The third report on Form 8-K, dated January 28, 1998 and filed February 10, 1998, pursuant to Item 5, reported (1) the Reliance transaction, including the entering into of a servicing agreement and transition services agreement whereby the Company would service certain Reliance contracts and provide other services to Reliance, and (2) the Company's borrowing of $7 million from Greenwich Capital. The fourth report on Form 8-K, dated February 10, 1998 and filed February 20, 1998, pursuant to Items 5 and 7 (1) filed a copy of the Company's audited consolidated financial statements 89 91 as of December 31, 1997 and 1996 and for each of the years in the three-year period ended December 31, 1997, (2) reported the Company's issuance of $15 million of 12% senior subordinated notes and warrants to acquire 500,000 shares of the Company's Common Stock at an exercise price of $10 per share, (3) reported the Company and certain of its subsidiaries and affiliates entering into a master repurchase agreement with Greenwich Capital for Greenwich Capital to purchase eligible contracts from the Company for a purchase price of no more than $30 million, and (4) filed agreements relating to the preceding, including the form of senior subordinated note, form of warrant, loan agreement, and the Company's audited consolidated financial statements. (C) EXHIBITS. DESCRIPTION OF EXHIBIT
EXHIBIT NUMBER - ------- 3.1 Certificate of Incorporation of the Registrant Amended and Restated as of May 15, 1997(5) 3.2 Bylaws of the Registrant (5) 4.1 Certificate of Incorporation of the Registrant (filed as Exhibit 3.1) 4.2 Form of Warrant Agreement between the Registrant and Harris Trust Company of California, as warrant agent, with respect to the FMAC Warrants 4.3 Form of Certificate representing Common Stock (1) 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) 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) 10.2 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)
90 92
EXHIBIT NUMBER - ------- 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) 10.6* Employment Agreement between the Registrant and Ernest C. Garcia II (1) 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) 10.9* 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) 10.12 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, 1996 (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(a) Portfolio Servicing Agreement among Registrant, Kars-Yes Financial, Inc., and certain other parties, dated as of September 15, 1997 (7) 10.26(b) Subservicing Agreement among Registrant, Kars-Yes Financial, Inc., and certain other parties, dated as of September 15, 1997 (7)
91 93
EXHIBIT NUMBER - ------- 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 18, 1997 between Registrant and Contract Purchaser (11) 10.31 FMAC Guaranty and Stock Pledge Agreement among FMAC, Registrant and certain banks 10.32 Contribution Agreement between Registrant and FMAC (13) 10.33 Indemnification Agreement between the Company and FMAC 10.34 Loan Agreement dated as of February 12, 1998 between the Registrant and each of the Kayne Anderson related Lenders named therein (12) 11 Earnings (Loss) per Share Computation (see Note 16 to Notes to Consolidated Financial Statements) 12 Statement on Computation of Ratios 21 List of Subsidiaries 23.1 Consent of KPMG Peat Marwick 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 A. Moreno 24.5 Special Power of Attorney for F. Willey 27 Financial Data Schedule
- --------------- * Management contract or compensatory plan, contract or arrangement. (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. 92 94 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/ GREGORY B. SULLIVAN ------------------------------------ Gregory B. Sullivan President and Chief Operating Officer Date: March 30, 1998 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 Director March 30, 1998 - ------------------------------------------ (Principal Executive Officer and Ernest C. Garcia II Director) /s/ STEVEN T. DARAK Senior Vice President and Chief March 30, 1998 - ------------------------------------------ Financial Officer (Principal financial Steven T. Darak and accounting officer) * Director March 30, 1998 - ------------------------------------------ Robert J. Abrahams * Director March 30, 1998 - ------------------------------------------ Christopher D. Jennings * Director March 30, 1998 - ------------------------------------------ John N. MacDonough * Director March 30, 1998 - ------------------------------------------ Arturo R. Moreno * Director March 30, 1998 - ------------------------------------------ Frank P. Willey *By: /s/ GREGORY B. SULLIVAN - ------------------------------------------ Gregory B. Sullivan Attorney-in-Fact
93 95 EXHIBIT INDEX
EXHIBIT NUMBER - ------- 3.1 Certificate of Incorporation of the Registrant Amended and Restated as of May 15, 1997(5) 3.2 Bylaws of the Registrant (5) 4.1 Certificate of Incorporation of the Registrant (filed as Exhibit 3.1) 4.2 Form of Warrant Agreement between the Registrant and Harris Trust Company of California, as warrant agent, with respect to the FMAC Warrants 4.3 Form of Certificate representing Common Stock (1) 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) 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) 10.2 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)
96
EXHIBIT NUMBER - ------- 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) 10.6* Employment Agreement between the Registrant and Ernest C. Garcia II (1) 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) 10.9* 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) 10.12 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, 1996 (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(a) Portfolio Servicing Agreement among Registrant, Kars-Yes Financial, Inc., and certain other parties, dated as of September 15, 1997 (7) 10.26(b) Subservicing Agreement among Registrant, Kars-Yes Financial, Inc., and certain other parties, dated as of September 15, 1997 (7)
97
EXHIBIT NUMBER - ------- 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 18, 1997 between Registrant and Contract Purchaser (11) 10.31 FMAC Guaranty and Stock Pledge Agreement among FMAC, Registrant and certain banks 10.32 Contribution Agreement between Registrant and FMAC (13) 10.33 Indemnification Agreement between the Company and FMAC 10.34 Loan Agreement dated as of February 12, 1998 between the Registrant and each of the Kayne Anderson related Lenders named therein (12) 11 Earnings (Loss) per Share Computation (see Note 16 to Notes to Consolidated Financial Statements) 12 Statement on Computation of Ratios 21 List of Subsidiaries 23.1 Consent of KPMG Peat Marwick 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 A. Moreno 24.5 Special Power of Attorney for F. Willey 27 Financial Data Schedule
- ---------- * Management contract or compensatory plan, contract or arrangement. (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. EX-4.2 2 EX-4.2 1 Exhibit 4.2 UGLY DUCKLING CORPORATION WARRANT AGREEMENT THIS WARRANT AGREEMENT (the "Agreement"), dated as of , 1998, is between UGLY DUCKLING CORPORATION, a Delaware corporation (the "Company"), and HARRIS TRUST COMPANY OF CALIFORNIA, as warrant agent (the "Warrant Agent"). WHEREAS, on July 11, 1997, First Merchants Acceptance Corporation, a Delaware corporation ("FMAC"), filed a Chapter 11 petition under the provisions of Title 11, United States Code, as amended, in the United States District Court for the District of Delaware and such petition is currently pending as Case No. 97-1500 (JJF) (the "Bankruptcy Case"); WHEREAS, the Company has entered into a Binding Agreement to Propose and Support Modified Plan Agreement dated as of December 15, 1997 (the "Letter Agreement"), by and among the Company, FMAC, and The Official Committee of Unsecured Creditors of First Merchants Acceptance Corporation, in connection with the Bankruptcy Case, pursuant to which the parties agreed to jointly support a plan of reorganization of FMAC in compliance with the Letter Agreement (the "Plan"); WHEREAS, pursuant to the Letter Agreement, the Company has agreed to issue to FMAC warrants (the "Warrants") to purchase up to an aggregate of 325,000 shares of common stock, $.001 par value per share ("Common Stock"), of the Company, subject to the terms and conditions of this Agreement; WHEREAS, FMAC may, but is under no obligation to, redistribute the Warrants, to its creditors or interest holders in the manner provided for in the Plan; and WHEREAS, the Company desires the Warrant Agent to act on behalf of the Company, and the Warrant Agent is willing so to act, in connection with the issuance, registration, transfer, exchange, exercise, and redemption of the Warrants. NOW, THEREFORE, in consideration of the promises and the mutual agreements herein set forth, the parties agree as follows: Section 1. APPOINTMENT OF WARRANT AGENT. The Company hereby appoints the Warrant Agent to act as agent of the Company in accordance with the terms and conditions set forth in this Agreement, and the Warrant Agent hereby accepts such appointment. 2 Section 2. ISSUANCE OF WARRANTS AND FORM OF WARRANTS. (a) Subject to the terms and conditions hereof, the Company shall issue to FMAC and FMAC shall accept from the Company, 325,000 Warrants substantially in the form attached hereto as Exhibit A. (b) Each Warrant shall entitle the registered holder of the certificate representing such Warrant to purchase upon the exercise thereof one share of Common Stock, subject to the adjustments provided for in Section 9 hereof, at any time until 5:00 p.m., New York City time, on , 200 , unless earlier redeemed pursuant to Section 11 hereof. (c) The Warrant certificates shall be in registered form only. Each Warrant certificate shall be dated by the Warrant Agent as of the date of issuance thereof (whether upon initial issuance or upon transfer or exchange), and shall be executed on behalf of the Company by the manual or facsimile signature of its President or a Vice President, and attested to by the manual or facsimile signature of its Secretary or an Assistant Secretary. In case any officer of the Company who shall have signed any Warrant certificate shall cease to be such officer of the Company before such Warrant Certificate has been countersigned by the Warrant Agent or prior to the issuance thereof, such Warrant certificate may nevertheless be issued and delivered with the same force and effect as though the person who signed the same had not ceased to be such officer of the Company. Section 3. EXERCISE OF WARRANTS, DURATION AND WARRANT PRICE. Subject to the provisions of this Agreement, each registered holder of one or more Warrant certificates shall have the right, which may be exercised as provided in such Warrant certificates, to purchase from the Company (and the Company shall issue and sell to such registered holder) the number of shares of Common Stock or other securities to which the Warrants represented by such certificates are at the time entitled hereunder. (a) Each Warrant not exercised by its expiration date shall become void, and all rights thereunder and all rights in respect thereof under this Agreement shall cease on such date. (b) A Warrant may be exercised by the surrender of the certificate representing such Warrant to the Company, at the office of the Warrant Agent, or at the office of a successor to the Warrant Agent, with the subscription form set forth on the reverse thereof duly executed and properly endorsed with the signatures properly guaranteed, and upon payment in full to the Warrant Agent for the account of the Company of the Warrant Price (as hereinafter defined) for the number of shares of Common Stock or other securities as to which the Warrant is exercised. Such Warrant Price shall be paid in full in cash, or by certified check or bank draft payable in United States currency to the order of the Warrant Agent. 2 3 (c) The price per share of Common Stock at which each Warrant may be exercised (the "Warrant Price") shall be Twenty Dollars ($20.00) (subject to adjustment in accordance with Section 9 hereof). (d) Subject to the further provisions of this Section 3 and of Section 6 hereof, upon surrender of Warrant certificates and payment of the Warrant Price, the Company shall issue and cause to be delivered, as promptly as practicable to or upon the written order of the registered holder of such Warrants and in such name or names as such registered holder may designate, subject to applicable securities laws, a certificate or certificates for the number of securities so purchased upon the exercise of such Warrants, together with a current Prospectus meeting the requirements of Section 10 of the Securities Act of 1933 and cash, as provided in Section 10 of this Agreement, in respect of any fraction of a share or security otherwise issuable upon such surrender. All shares of Common Stock or other such securities issued upon the exercise of a Warrant shall be duly authorized, validly issued, fully paid and nonassessable and free and clear of all liens and other encumbrances. (e) Certificates representing such securities shall be deemed to have been issued and any person so designated to be named therein shall be deemed to have become a holder of record of such securities as of the date of the surrender of such Warrants and payment of the Warrant Price; provided, however, that if, at the date of surrender of such Warrants and payment of such Warrant Price, the transfer books for the Common Stock or other securities purchasable upon the exercise of such Warrants shall be closed, the certificates for the securities in respect of which such Warrants are then exercised shall be issuable as of the date on which such books shall next be opened and until such date the Company shall be under no duty to deliver any certificate for such securities and the person to whom such securities are issuable shall not be deemed to have became a holder of record of such securities. The rights of purchase represented by each Warrant certificate shall be exercisable, at the election of the registered holder thereof, either as an entirety or from time to time for part of the number of securities specified therein and, in the event that any Warrant certificate is exercised in respect of less than all of the securities specified therein at any time prior to the expiration date of the Warrant certificate, a new Warrant certificate or certificates will be issued to such registered holder for the remaining number of securities specified in the Warrant certificate so surrendered. Section 4. COUNTERSIGNATURE AND REGISTRATION. (a) The Warrant Agent shall maintain books (the "Warrant Register") for the registration and the registration of transfer of the Warrants. Upon the initial issuance of the Warrants, the Warrant Agent shall issue and register the Warrants in the name of FMAC in accordance with Section 2 hereof. The Warrant certificates shall be countersigned manually or by facsimile by the Warrant Agent (or by any successor to the Warrant Agent then acting as such under this Agreement) and shall not be valid for any purpose unless so countersigned. Warrant certificates may be so countersigned, however, by the Warrant Agent and delivered by the Warrant Agent, notwithstanding 3 4 that the persons whose manual or facsimile signatures appear thereon as proper officers of the Company shall have ceased to be such officers at the time of such countersignature or delivery. (b) Prior to due presentment for registration of transfer of any Warrant certificate, the Company and the Warrant Agent may deem and treat the person in whose name such Warrant certificate shall be registered upon the Warrant Register (the "registered holder") as the absolute owner of such Warrant certificate and of each Warrant represented thereby (notwithstanding any notation of ownership or other writing on the Warrant certificate made by anyone other than the Company or the Warrant Agent), for the purpose of any exercise thereof, of any distribution or notice to the holder thereof, and for all other purposes, and neither the Company nor the Warrant Agent shall be affected by any notice to the contrary. Section 5. TRANSFER AND EXCHANGE OF WARRANTS. (a) The Warrant Agent shall register the transfer, from time to time, of any outstanding Warrant or portion thereof upon the Warrant Register, upon surrender of the certificate evidencing such Warrant for transfer, properly endorsed with signatures properly guaranteed and accompanied by appropriate instructions for transfer. Upon any such transfer, a new Warrant certificate representing an equal aggregate number of Warrants so transferred shall be issued to the transferee and the surrendered Warrant certificate shall be canceled by the Warrant Agent. In the event that only a portion of a Warrant is transferred at any time, a new Warrant certificate representing the remaining portion of the Warrant will also be issued to the transferring holder. The Warrant certificates so canceled shall be delivered by the Warrant Agent to the Company from time to time upon written request. Notwithstanding the foregoing, no transfer or exchange may be made except in compliance with applicable securities laws and Section 14 hereof. (b) Warrant certificates may be surrendered to the Warrant Agent, together with a written request for exchange, and thereupon the Warrant Agent shall issue in exchange therefor one or more new Warrant certificates as requested by the registered holder of the Warrant certificate or certificates so surrendered, representing an equal aggregate number of Warrants. (c) The Warrant Agent shall not be required to effect any registration of transfer or exchange which will result in the issuance of a Warrant certificate for a fraction of a Warrant. (d) No service charge shall be made for any exchange or registration of transfer of Warrant certificates. (e) The Warrant Agent is hereby authorized to countersign and to deliver, in accordance with the terms of this Agreement, the new Warrant certificates required to be issued pursuant to the provisions hereof, and the Company, whenever required by the Warrant Agent, will supply the Warrant Agent with certificates duly executed on behalf of the Company for such purpose. 4 5 Section 6. PAYMENT OF TAXES. The Company will pay any documentary stamp taxes attributable to the initial issuance or delivery of the shares of Common Stock or other securities issuable upon the exercise of Warrants; provided, however, the Company shall not be required to pay any tax or taxes which may be payable in respect of any transfer of the Warrants or involved in the issuance or delivery of any Warrant certificate or certificates for shares of Common Stock in a name other than registered holder of Warrants in respect of which such shares are issued, and in such case neither the Company nor the Warrant Agent shall be required to issue or deliver any certificate for shares of Common Stock or any Warrant certificate until the person requesting the same has paid to the Company the amount of such tax or has established to the Company's satisfaction that such tax has been paid. Section 7. MUTILATED OR MISSING WARRANTS. In case any of the Warrant certificates shall be mutilated, lost, stolen or destroyed, the Company may issue, and the Warrant Agent shall countersign and deliver in exchange and substitution for and upon cancellation of the mutilated Warrant certificate, or in lieu of and substitution for the Warrant certificate lost, stolen or destroyed, a new Warrant certificate representing an equal aggregate number of Warrants, but only upon receipt of evidence satisfactory to the Company and the Warrant Agent of such loss, theft or destruction of such Warrant certificate and reasonable indemnity, if requested, also satisfactory to them. Applicants for such substitute Warrant certificates shall also comply with such other reasonable conditions and pay such reasonable charges as the Company or the Warrant Agent may prescribe. Section 8. RESERVATION OF COMMON STOCK. (a) There have been reserved, and the Company shall at all times keep reserved, out of its authorized and unissued shares of Common Stock, a number of shares sufficient to provide for the exercise of the rights of purchase represented by the Warrants then outstanding or issuable upon exercise, and the transfer agent for the Common Stock and every subsequent transfer agent for any shares of the Company's capital stock issuable upon the exercise of any of the rights of purchase aforesaid are hereby irrevocably authorized and directed at all times to reserve such number of authorized and unissued shares as shall be requisite for such purpose. The Company will keep a copy of this Agreement on file with the transfer agent for the Common Stock and with every subsequent transfer agent for any shares of the Company's capital stock issuable upon the exercise of the rights of purchase represented by the Warrants. (b) The Warrant Agent is hereby irrevocably authorized to requisition from time to time from such transfer agent stock certificates required to honor outstanding Warrants. The Company will supply such transfer agent with duly executed certificates for such purpose and will itself provide or otherwise make available any cash as provided in Section 10 of this Agreement. All Warrant certificates surrendered in the exercise of the rights thereby evidenced shall be canceled by the Warrant Agent and shall thereafter be delivered to the Company. Promptly after the expiration date of the Warrants, the Warrant Agent shall certify to the Company the aggregate number of such 5 6 Warrants which expired unexercised, and after the expiration date of the Warrants, no shares of Common Stock shall be subject to reservation in respect of such Warrants. Section 9. ADJUSTMENT OF WARRANT PRICE AND NUMBER OF SHARES OF COMMON STOCK. The number and kind of securities purchasable upon the exercise of the Warrants and the Warrant Price shall be subject to adjustment from time to time upon the happening of certain events, as follows: 9.1 ADJUSTMENTS. The number of shares of Common Stock or other securities purchasable upon the exercise of each Warrant and the Warrant Price shall be subject to adjustment as follows: (a) If the Company (i) pays a dividend in Common Stock or makes a distribution in Common Stock, (ii) subdivides its outstanding Common Stock into a greater number of shares, (iii) combines its outstanding Common Stock into a smaller number of shares, or (iv) issues, by reclassification of its Common Stock, other securities of the Company, then the number and kind of shares of Common Stock or other securities purchasable upon exercise of a Warrant immediately prior thereto will be adjusted so that the holder of a Warrant will be entitled to receive the kind and number of shares of Common Stock or other securities of the Company that such holder would have owned and would have been entitled to receive immediately after the happening of any of the events described above, had the Warrant been exercised immediately prior to the happening of such event or any record date with respect thereto. Any adjustment made pursuant to this subsection 9.1(a) will become effective immediately after the effective date of such event retroactive to the record date, if any, for such event. (b) No adjustment in the number of shares or securities purchasable pursuant to the Warrants shall be required unless such adjustment would require an increase or decrease of at least one percent in the number of shares or securities then purchasable upon the exercise of the Warrants. (c) Whenever the number of shares or securities purchasable upon the exercise of the Warrants is adjusted, as herein provided, the Warrant Price for shares payable upon exercise of the Warrants shall be adjusted by multiplying such Warrant Price immediately prior to such adjustment by a fraction, the numerator of which shall be the number of shares purchasable upon the exercise of the Warrant immediately prior to such adjustment, and the denominator of which shall be the number of shares so purchasable immediately thereafter. (d) Whenever the number of shares or securities purchasable upon the exercise of the Warrants and/or the Warrant Price is adjusted as herein provided, the Company shall cause to be promptly mailed to the Warrant Agent and each registered holder of a Warrant by first class mail, postage prepaid, notice of such adjustment and a certificate of the chief financial officer of the 6 7 Company setting forth the number of shares or securities purchasable upon the exercise of the Warrants after such adjustment, the Warrant Price as adjusted, a brief statement of the facts requiring such adjustment and the computation by which such adjustment was made. The Warrant Agent shall be fully protected in relying on any such certificate and any adjustment therein contained, and shall not be obligated or responsible for calculating any adjustment nor shall it be deemed to have knowledge of such an adjustment unless and until it shall have received such certificate. (e) For the purpose of this subsection 9.1, the term "Common Stock" shall mean (i) the class of stock designated as the voting Common Stock of the Company at the date of this Agreement, or (ii) any other class of stock or securities resulting from successive changes or reclassifications of such Common Stock consisting solely of changes in par value, or from par value to no par value, or from no par value to par value. In the event that at any time, as a result of an adjustment made pursuant to this Section 9, a registered holder shall become entitled to purchase any securities of the Company other than shares of Common Stock, thereafter the number of such other securities so purchasable upon exercise of the Warrants shall be subject to adjustment from time to time in a manner and on terms as nearly equivalent as practicable to the provisions with respect to the shares contained in this Section 9. 9.2 NO ADJUSTMENT FOR DIVIDENDS. Except as provided in subsection 9.1, no adjustment in respect of any dividends or distributions shall be made during the term of the Warrants or upon the exercise of the Warrants. 9.3 NO ADJUSTMENT IN CERTAIN CASES. No adjustments are required to be made pursuant to Section 9 hereof in connection with the issuance of shares of Common Stock or the Warrants (or the underlying shares of Common Stock) in the transactions contemplated by this Agreement. 9.4 PRESERVATION OF PURCHASE RIGHTS UPON RECLASSIFICATION, CONSOLIDATION, ETC. In case of any consolidation of the Company with or merger of the Company into another corporation or in case of any sale or conveyance to another corporation of the property, assets or business of the Company as an entirety or substantially as an entirety, the Company or such successor or purchasing corporation, as the case may be, shall execute with the Warrant Agent an agreement that the registered holders of the Warrants shall have the right thereafter, upon payment of the Warrant Price in effect immediately prior to such action, to purchase, upon exercise of each Warrant, the kind and amount of shares and other securities and property which it would have owned or have been entitled to receive after the happening of such consolidation, merger, sale or conveyance had each Warrant been exercised immediately prior to such action. Any such agreements referred to in this subsection 9.4 shall provide for adjustments, which shall be as nearly equivalent as may be practicable to the adjustments provided for in Section 9 hereof. The provisions of this subsection 9.4 shall similarly apply to successive consolidations, mergers, sales, or conveyances. 7 8 9.5 PAR VALUE OF SHARES OF COMMON STOCK. Before taking any action that would cause an adjustment reducing the Warrant Price below the then par value of the Common Stock issuable upon exercise of the Warrants, the Company will take any corporate action which may, in the opinion of its counsel, be necessary in order that the Company may validly and legally issue fully paid and nonassessable Common Stock at such adjusted Warrant Price. 9.6 INDEPENDENT PUBLIC ACCOUNTANTS. The Company may but shall not be required to retain a firm of independent public accountants of recognized regional or national standing (which may be any such firm regularly employed by the Company) to make any computation required under this Section 9, and a certificate signed by such firm shall be conclusive evidence of the correctness of any computation made under this Section 9 and the Company shall cause to be promptly mailed to the Warrant Agent and each registered holder of a Warrant by first class mail, postage prepaid, a copy of such certificate. 9.7 STATEMENT ON WARRANT CERTIFICATES. Irrespective of any adjustments in the Warrant Price or the number of securities issuable upon exercise of Warrants, Warrant certificates theretofore or thereafter issued may continue to express the same price and number of securities as are stated in the similar Warrant certificates initially issuable pursuant to this Agreement. However, the Company may, at any time in its sole discretion (which shall be conclusive), make any change in the form of Warrant certificate that it may deem appropriate and that does not affect the substance thereof; and any Warrant certificate thereafter issued, whether upon registration of, transfer of, or in exchange or substitution for, an outstanding Warrant certificate, may be in the form so changed. 9.8 NO RIGHTS AS STOCKHOLDER; NOTICES TO HOLDERS OF WARRANTS. If, at any time prior to the expiration of a Warrant and prior to its exercise, any one or more of the following events shall occur: (a) any action that would require an adjustment pursuant to subsection 9.1 or 9.4 hereof; or (b) a dissolution, liquidation or winding up of the Company (other than in connection with a consolidation, merger or sale of its property, assets and business as an entirety or substantially as an entirety) shall be proposed; then the Company must give notice in writing of such event to the registered holders of the Warrants, as provided in Section 21 hereof, at least 20 days to the extent practicable, prior to the date fixed as a record date or the date of closing the transfer books for the determination of the stockholders entitled to any relevant dividend, distribution, subscription rights or other rights or for the determination of stockholders entitled to vote on such proposed dissolution, liquidation or winding up. Such notice must specify such record date or the date of closing the transfer books, as the case may be. Failure to mail or receive such notice or any defect therein will not affect the validity of any action taken with respect thereto. 8 9 Section 10. FRACTIONAL INTERESTS. The Company is not required to issue fractional shares of Common Stock on the exercise of a Warrant. If any fraction of a share of Common Stock would, except for the provisions of this Section 10, be issuable on the exercise of a Warrant (or specified portion thereof), the Company will in lieu thereof pay an amount in cash equal to the then Current Market Price multiplied by such fraction. For purposes of this Agreement, the term "Current Market Price" means (i) if the Common Stock is listed for quotation on the Nasdaq National Market or the Nasdaq SmallCap Market or on a national securities exchange, the average for the 10 consecutive trading days immediately preceding the date in question of the daily per share closing prices of the Common Stock as quoted by the Nasdaq National Market or the Nasdaq SmallCap Market or on the principal stock exchange on which it is listed, as the case may be, whichever is the higher, or (ii) if the Common Stock is traded in the over-the-counter market and is not listed for quotation on the Nasdaq National Market or the Nasdaq SmallCap Market nor on any national securities exchange, the average of the per share closing bid prices of the Common Stock on the 10 consecutive trading days immediately preceding the date in question, as reported by Nasdaq or an equivalent generally accepted reporting service. The closing price referred to in clause (i) above shall be the last reported sale price or, in case no such reported sale takes place on such day, the average of the reported closing bid and asked prices, in either case as quoted by the Nasdaq National Market or the Nasdaq SmallCap Market or on the national securities exchange on which the Common Stock is then listed. For purposes of clause (ii) above, if trading in the Common Stock is not reported by Nasdaq, the bid price referred to in said clause shall be the lowest bid price as reported on the OTC Bulletin Board or in the "pink sheets" published by National Quotation Bureau, Incorporated. Section 11. REDEMPTION. (a) The then outstanding Warrants may be redeemed, at the option of the Company, at $.10 per share of Common Stock purchasable upon exercise of such Warrants, at any time after the average Daily Market Price per share of the Common Stock for a period of at least 10 consecutive trading days ending not more than fifteen days prior to the date of the notice given pursuant to Section 11(b) hereof has equaled or exceeded $28.50, and prior to expiration of the Warrants. The Daily Market Price of the Common Stock will be determined by the Company in the manner set forth in Section 11(e) as of the end of each trading day (or, if no trading in the Common Stock occurred on such day, as of the end of the immediately preceding trading day in which trading occurred) and verified to the Warrant Agent before the Company may give notice of redemption. All outstanding Warrants must be redeemed if any are redeemed, and any right to exercise an outstanding Warrant shall terminate at 5:00 p.m. (New York City time) on the date fixed for redemption. Trading day means a day in which trading of securities occurred on the Nasdaq National Market. (b) The Company may exercise its right to redeem the Warrants only by giving the notice set forth in the following sentence. If the Company exercises its right to redeem, it shall give notice to the Warrant Agent and the registered holders of the outstanding Warrants by mailing or causing 9 10 the Warrant Agent to mail to such registered holders a notice of redemption, first class, postage prepaid, at their addresses as they shall appear on the records of the Warrant Agent. Any notice mailed in the manner provided herein will be conclusively presumed to have been duly given whether or not the registered holder actually receives such notice. (c) The notice of redemption must specify the redemption price, the date fixed for redemption (which must be at least 30 days after the date such notice is mailed), the place where the Warrant certificates must be delivered and the redemption price paid, and that the right to exercise the Warrant will terminate at 5:00 P.M. (New York City time) on the date fixed for redemption. (d) Appropriate adjustment shall be made to the redemption price and to the minimum Daily Market Price prerequisite to redemption set forth in Section 11(a) hereof, in each case on the same basis as provided in Section 9 hereof with respect to adjustment of the Warrant Price. (e) For purposes of this Agreement, the term "Daily Market Price" means (i) if the Common Stock is quoted on the Nasdaq National Market or the Nasdaq SmallCap Market or on a national securities exchange, the daily per share closing price of the Common Stock as quoted on the Nasdaq National Market or the Nasdaq SmallCap Market or on the principal stock exchange on which it is listed on the trading day in question, as the case may be, whichever is the higher, or (ii) if the Common Stock is traded in the over-the-counter market and not quoted on the Nasdaq National Market or the Nasdaq SmallCap Market nor on any national securities exchange, the closing bid price of the Common Stock on the trading day in question, as reported by Nasdaq or an equivalent generally accepted reporting service. The closing price referred to in clause (i) above shall be the last reported sale price or, in case no such reported sale takes place on such day, the average of the reported closing bid and asked prices, in either case on the Nasdaq National Market or the Nasdaq SmallCap Market or on the national securities exchange on which the Common Stock is then listed. For purposes of clause (ii) above, if trading in the Common Stock is not reported by Nasdaq, the bid price referred to in said clause shall be the lowest bid price as quoted on the OTC Bulletin Board or reported in the "pink sheets" published by National Quotation Bureau, Incorporated. (f) On the redemption date, each Warrant will be automatically converted into the right to receive the redemption price and the Warrant Agent will no longer honor any purported exercise of a Warrant. On or before the redemption date, the Company will deposit with the Warrant Agent sufficient funds for the purpose of redeeming all of the outstanding unexercised Warrants. All such funds shall be maintained by the Warrant Agent in an interest-bearing, segregated account for payment to holders of Warrants upon surrender of Warrant Certificates in exchange for the redemption price therefor. Funds remaining in such account on the date three years from the redemption date will be returned to the Company. Any Warrants thereafter submitted to the Warrant Agent for redemption will be forwarded for redemption by the Warrant Agent to the Company, and the Warrant Agent will have no further responsibility with respect thereto. 10 11 Section 12. RIGHTS AS WARRANTHOLDERS. Nothing contained in this Agreement or in any of the Warrants shall be construed as conferring upon the holders thereof, as such, any of the rights of stockholders of the Company, including, without limitation, the right to receive dividends or other distributions, to exercise any preemptive rights, to vote or to consent or to receive notice as stockholders in respect of the meetings of stockholders or the election of directors of the Company or any other matter. Section 13. DISPOSITION OF PROCEEDS ON EXERCISE OF WARRANTS. The Warrant Agent must account promptly to the Company with respect to Warrants exercised, and must promptly pay to the Company all monies received by it upon the exercise of such Warrants, and agrees to keep copies of this Agreement available for inspection by holders of Warrants during normal business hours. Section 14. REGISTRATION OF WARRANTS. (a) The Company has registered the Warrants and the Common Stock issuable upon exercise of the Warrants under the Securities Act of 1933, as amended (the "Securities Act"). The Company agrees to use its best efforts to maintain such registration for the period during which the Warrants are exercisable. If at any time during the continuance of such registration, the Company shall determine that the applicable registration statement contains an untrue statement of a material fact or omits to state a material fact required to be stated therein or necessary to make the statements therein not misleading in light of the circumstances then existing, or if for any other reason as required by law it is necessary to amend or supplement the registration statement or to discontinue trading in or exercise of the Warrants, the Company may request the Warrant Agent in writing to discontinue effecting the registration of transfer and/or exercise of the Warrants, as appropriate, until such time as the Company subsequently advises the Warrant Agent in writing that trading and/or exercises, as applicable, of the Warrants may be continued. The Company will use best efforts to promptly amend or supplement its registration statement to permit trading and exercise. (b) All fees, disbursements, and out-of-pocket expenses incurred in connection with the filing of any registration statement under Section 14(a) hereof and in complying with applicable securities and Blue Sky laws shall be borne by the Company, provided, however, that any expenses of the holders of the Warrants or the Shares, including but not limited to their attorneys' fees, shall be borne by such holders. (c) Until sold by FMAC pursuant to the applicable prospectus included within the registration statement filed by the Company and in effect from time to time as contemplated in Section 14(a) above, the certificates evidencing the Warrants and shares issuable upon exercise of the Warrants will bear a legend in substantially the following form: THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 OR ANY STATE SECURITIES LAWS AND MAY NOT BE SOLD, EXCHANGED, HYPOTHECATED OR OTHERWISE TRANSFERRED IN ANY MANNER EXCEPT IN COMPLIANCE WITH SECTION 14 OF THE WARRANT AGREEMENT DATED AS OF , 1998, BETWEEN UGLY DUCKLING CORPORATION AND HARRIS TRUST COMPANY OF CALIFORNIA, AS WARRANT AGENT, AS THE SAME MAY BE AMENDED FROM TIME TO TIME. Section 15. [Intentionally Left Blank] 11 12 Section 16. MERGER OR CONSOLIDATION OR CHANGE OF NAME OF WARRANT AGENT. (a) Any corporation into which the Warrant Agent may be merged or with which it may be consolidated, or any corporation resulting from any merger or consolidation to which the Warrant Agent shall be a party, or any corporation succeeding to the corporate trust business of the Warrant Agent, shall be the successor to the Warrant Agent hereunder without the execution or filing of any paper or any further act on the part of any of the parties hereto, provided that such corporation would be eligible for appointment as a successor Warrant Agent under the provisions of Section 19 of this Agreement. In case at the time such successor to the Warrant Agent shall succeed to the agency created by this Agreement and any of the Warrant certificates shall have been countersigned but not delivered, any such successor to the Warrant Agent may adopt the countersignature of the original Warrant Agent and deliver such Warrant certificates so countersigned; and in case at that time any of the Warrant certificates shall not have been countersigned, any successor to the Warrant Agent may countersign such Warrant certificates either in the name of the predecessor Warrant Agent or in the name of the successor Warrant Agent, and in all such cases the Warrants represented by such Warrant certificates shall have the full force provided in the Warrant certificates and in this Agreement. Any such successor Warrant Agent shall promptly give notice of its succession as Warrant Agent to the Company and to the registered holder of each Warrant certificate. (b) If at any time the name of the Warrant Agent is changed and at such time any of the Warrant certificates have been countersigned but not delivered, the Warrant Agent may adopt the countersignature under its prior name and deliver Warrant certificates so countersigned; and if at that time any of the Warrant certificates have not been countersigned, the Warrant Agent may countersign such Warrant certificates either in its prior name or in its changed name; and in all such cases the Warrants represented by such Warrant certificates will have the full force provided in the Warrant certificates and in this Agreement. Section 17. CONCERNING THE WARRANT AGENT. The Company agrees to pay to the Warrant Agent reasonable compensation for all services rendered by it hereunder and, from time to time, on demand of the Warrant Agent, its reasonable expenses and counsel fees and other disbursements incurred in the administration and execution of this Agreement and the exercise and performance of its duties hereunder. The Company also agrees to indemnify the Warrant Agent, and its officers, agents and directors for, and to hold each of them harmless against, any loss, liability, or expense incurred without negligence or willful misconduct on the part of the Warrant Agent, for anything done or omitted by the Warrant Agent or such indemnified party in connection with the acceptance or administration of this Agreement or the exercise or performance of its duties hereunder, including the costs and expenses of defending against any claim of liability in the premises. The indemnification provided for hereunder shall survive the expiration of the Warrant, the termination of this Agreement and the resignation or removal of the Warrant Agent. The costs and expenses of enforcing this right of indemnification shall also be paid by the Company. 12 13 The Warrant Agent may conclusively rely upon and shall be protected by the Company and shall incur no liability for, or in respect of any action taken, suffered or omitted by it in connection with, its administration of this Agreement or the exercise or performance of its duties hereunder in reliance upon any Warrant certificate or certificate for the Common Stock or for other securities of the Company, instrument of assignment or transfer, power of attorney, endorsement, affidavit, letter, notice, direction, consent, certificate, statement, or other paper or document believed by it to be genuine and to be signed, executed and, where necessary, verified or acknowledged, by the proper person or persons, or otherwise upon the advice of counsel as set forth herein. Notwithstanding anything in this Agreement to the contrary, in no event shall the Warrant Agent be liable for special, indirect or consequential loss or damage of any kind whatsoever (including but not limited to lost profits), even if the Warrant Agent has been advised of the likelihood of such loss or damage and regardless of the form of the action. Section 18. DUTIES OF WARRANT AGENT. The Warrant Agent undertakes the duties and obligations expressly imposed by this Agreement, and no implied duties or obligations shall be read into this Agreement against the Warrant Agent, upon the following terms and conditions, by all of which the Company and the holders of Warrant certificates, by their acceptance thereof, shall be bound: (a) Before the Warrant Agent acts or refrains from acting, the Warrant Agent may consult with legal counsel (who may be legal counsel for the Company) and the opinion of such counsel shall be full and complete authorization and protection to the Warrant Agent as to any action taken or omitted by it in good faith and in accordance with such opinion. (b) Whenever in the performance of its duties under this Agreement the Warrant Agent shall deem it necessary or desirable that any fact or factual matter be proved or established by the Company prior to taking or suffering any action hereunder, such fact or matter (unless other evidence in respect thereof be herein specifically prescribed) may be deemed to be conclusively proved and established by a certificate signed by any person believed in good faith by the Warrant Agent to be one of the Chairman of the Board, the Chief Executive Officer, the President, any Vice President, the Treasurer or the Secretary of the Company and delivered to the Warrant Agent; and such certificate shall be full authorization to the Warrant Agent for any action taken or suffered in good faith by it under the provisions of this Agreement in reliance upon such certificate. (c) The Warrant Agent shall be liable hereunder to the Company and any other Person only for its own negligence, bad faith or wilful misconduct. (d) The Warrant Agent shall not be liable for or by reason of any of the statements of fact or recitals contained in this Agreement or in the Warrant certificates (except its countersignature 13 14 thereof) or be required to verify the same, but all such statements and recitals are and shall be deemed to have been made by the Company only. (e) The Warrant Agent is serving as an administrative agent and, accordingly, shall not be under any responsibility in respect of the validity of any provision of this Agreement or the execution and delivery hereof (except the due execution hereof by the Warrant Agent) or in respect of the validity or execution of any Warrant certificate (except its countersignature thereof); nor shall it be responsible for any breach by the Company of any covenant or condition contained in this Agreement or in any Warrant certificate; nor shall it be responsible for any change in the exercisability of the Warrant (including the Warrant becoming void) or any adjustment in the terms of the Warrant (including the manner, method or amount thereof) provided for herein, or the ascertaining of the existence of facts that would require any such change or adjustment (except with respect to the exercise of any Warrant evidenced by a Warrant certificate after actual notice to the Warrant Agent that such change or adjustment is required); nor shall it by any act hereunder be deemed to make any representation or warranty as to the authorization or reservation of any shares of Common stock to be issued pursuant to this Agreement or any Warrant certificate or as to whether any shares of Common stock will, when issued, be validly authorized and issued, fully paid and nonassessable. (f) The Company agrees that it will perform, execute, acknowledge and deliver or cause to be performed, executed, acknowledged and delivered all such further and other acts, instruments and assurances as may reasonably be required by the Warrant Agent for the carrying out or performing by the Warrant Agent of the provisions of this Agreement. (g) The Warrant Agent is hereby authorized and directed to accept instructions with respect to the performance of its duties hereunder from any person believed in good faith by the Warrant Agent to be one of the Chairman of the Board, the Chief Executive Officer, the President, any Vice President, the Treasurer, or the Secretary of the Company, and to apply to such officers for advice or instructions in connection with its duties, and it shall not be liable for any action taken or suffered by it in good faith in accordance with instructions of any such officer of for any delay in acting while waiting for those instructions. Any application by the Warrant Agent for written instructions from the Company may, at the option of the Warrant Agent, set forth in writing any action proposed to be taken or omitted by the Warrant Agent under this Agreement and the date on or after which such action shall be taken or such omission shall be effective. The Warrant Agent shall not be liable for any action taken by, or omission of, the Warrant Agent in accordance with a proposal included in any such application on or after the date specified in such application (which date shall not be less than ten Business Days after the date any officer of the Company actually receives such application, unless any such officer shall have consented in writing to an earlier date) unless, prior to taking any such action (or the effective date in the case of an omission), the Warrant Agent shall have received 14 15 written instructions in response to such application subject to the proposed action or omission and/or specifying the action to be taken or omitted. (h) Subject to applicable law, the Warrant Agent and any stockholder, director, officer or employee of the Warrant Agent may buy, sell or deal in any of the Warrants or other securities of the Company or become pecuniarily interested in any transaction in which the Company may be interested, or contract with or lend money to the Company or otherwise act as fully and freely as though it were not Warrant Agent under this Agreement. Nothing herein shall preclude the Warrant Agent from acting in any other capacity for the Company or for any other legal entity. (i) The Warrant Agent may execute and exercise any of the rights or powers hereby vested in it or perform any duty hereunder either itself or by or through its attorneys or agents, and the Warrant Agent shall not be answerable or accountable for any act, default, neglect or misconduct of any such attorneys or agents or for any loss to the Company resulting from any such act, default, neglect or misconduct, provided that reasonable care was exercised in the selection and continued employment thereof. (j) No provision of this Agreement shall require the Warrant Agent to expend or risk its own funds or otherwise incur any financial liability in the performance of any of its duties hereunder or in the exercise of its rights if there shall be reasonable grounds for believing that repayment of such funds or adequate indemnification against such risk or liability is not reasonably assured to it. (k) The Warrant Agent shall not be required to take notice or be deemed to have notice of any fact, event or determination (including, without limitation, any dates or events defined in this Agreement) under this Agreement unless and until the Warrant Agent shall be specifically notified in writing by the Company of such fact, event or determination. Section 19. CHANGE OF WARRANT AGENT. The Warrant Agent may resign and be discharged from its duties under this Agreement by giving the Company at least 30 days prior notice in writing, and by mailing notice in writing to the registered holders at the expense of the Company at their addresses appearing on the Warrant Register, of such resignation, at least 15 days prior to the date such resignation shall take effect and specifying a date when such resignation shall take effect. The Warrant Agent may be removed by like notice to the Warrant Agent from the Company and by like mailing of notice to the registered holders of the Warrants. If the Warrant Agent resigns or is removed or otherwise becomes incapable of acting, the Company shall appoint a successor to the Warrant Agent. If the Company fails to make such appointment within 30 days after such removal or after it has been notified in writing of such resignation or incapacity by the resigning or incapacitated Warrant Agent or by the registered holder of a Warrant (who shall, with such notice, submit his Warrant certificate for inspection by the Company), then the Warrant Agent or the registered holder of any Warrant may, at the expense of the Company, apply to any court of competent jurisdiction for the appointment of a successor to the Warrant Agent. Pending appointment of a successor to the Warrant Agent, either by the Company 15 16 or such a court, the Company shall carry out the duties of the Warrant Agent. Any successor Warrant Agent, whether appointed by the Company or by such a court, must be registered and otherwise authorized to serve as a transfer agent pursuant to the Securities Exchange Act of 1934, as amended. If at any time the Warrant Agent ceases to be eligible in accordance with the provisions of this Section 19, it will resign immediately in the manner and with the effect specified in this Section 19. After acceptance in writing of the appointment, the successor Warrant Agent will be vested with the same powers, rights, duties and responsibilities as if it had been originally named as Warrant Agent without further act or deed; but the former Warrant Agent will deliver and transfer to the successor Warrant Agent any property at the time held by it hereunder, and execute and deliver any further assurance, conveyance, act or deed necessary for this purpose. Upon request of any successor Warrant Agent, the Company will make, execute, acknowledge and deliver any and all instruments in writing for more fully and effectually vesting in and confirming to such successor Warrant Agent all such powers, rights, duties and responsibilities. Failure to file or mail any notice provided in this Section 19, however, or any defect therein, will not affect the legality or validity of the resignation or removal of the Warrant Agent or the appointment of the successor Warrant Agent, as the case may be. Section 20. IDENTITY OF TRANSFER AGENT. Following the appointment of any transfer agent for the Common Stock or of any subsequent transfer agent for shares of the Common Stock or other shares of the Company's capital stock issuable upon the exercise of the rights of purchase represented by the Warrants, the Company will file with the Warrant Agent a statement setting forth the name and address of such transfer agent. Section 21. NOTICES. Notices or demands authorized by this Agreement to be given or made by the Warrant Agent or by the holder of any Warrant certificate to or on the Company shall be sufficiently given or made if sent by registered or certified mail, addressed (until another address is filed in writing with the Warrant Agent) as follows (and shall be deemed given upon receipt): Ugly Duckling Corporation 2525 East Camelback Road Suite 1150 Phoenix, Arizona 85016 Attention: Steven P. Johnson, Senior Vice President, General Counsel and Secretary With a copy to: Steven D. Pidgeon Snell & Wilmer L.L.P. One Arizona Center Phoenix, Arizona 85004-0001 16 17 Notices or demands authorized by this Agreement to be given or made by the Company or by the holder of any Warrant certificate to or on the Warrant Agent shall be sent by registered or certified mail, addressed (until another address is filed in writing with the Company) as follows (and shall be deemed given upon receipt): Harris Trust Company of California 601 South Figueroa 49th Floor Los Angeles, CA 90017 Attention: Neil Rosso, Corporate Trust Notices or demands authorized by this Agreement to be given or made by the Company or the Warrant Agent to the holder of any Warrant certificate shall be sufficiently given or made if sent by first class mail, postage prepaid, addressed to such holder at the address of such holder as shown in the Warrant Register. The Company shall deliver a copy of any notice or demand it delivers to the holder of any Warrant certificate to the Warrant Agent. Section 22. SUPPLEMENTS AND AMENDMENTS. The Company and the Warrant Agent may from time to time supplement or amend this Agreement without the approval of any holders of Warrants in order to cure any ambiguity or to correct or supplement any provision contained herein which may be defective or inconsistent with any other provision herein, or to make any other provisions in regard to matters or questions arising hereunder which the Company and the Warrant Agent may deem necessary or desirable and which shall not be inconsistent with the provisions of the Warrants, or which shall not adversely affect the interests of the holders of Warrants (including reducing the Warrant Price or extending the redemption or expiration date). In any situation in which this Agreement cannot be amended pursuant to the next sentence above, this Agreement may be amended by the Company, the Warrant Agent and the holder or holders of a majority of the outstanding Warrants representing a majority of the shares of Common Stock underlying such Warrants; provided, however, that without the consent of each holder of a Warrant, except as otherwise provided in Section 9, there can be no increase of the Warrant Price, reduction of the number of shares of Common Stock purchasable or reduction of the exercise period for such holder's Warrants and provided, further, that no such supplement or amendment may affect the rights or duties of the Warrant Agent under this Agreement without the written consent of the Warrant Agent. Notwithstanding anything in this Agreement to the contrary, no supplement or amendment that changes the rights and duties of the Warrant Agent under this Agreement shall be effective against the Warrant Agent without the execution of such supplement or amendment by the Warrant Agent. Section 23. SUCCESSORS. All the covenants and provisions of this Agreement by or for the benefit of the Company, or the Warrant Agent or the registered holders of the Warrants will bind and inure to the benefit of their respective successors and assigns hereunder. 17 18 Section 24. GOVERNING LAW. This Agreement will be deemed to be a contract made under the laws of the State of Arizona and for all purposes will be construed in accordance with the laws of said State, except as to Sections 17, 18 and 22, which shall be governed by and construed in accordance with the laws of the State of Illinois. Each holder of a Warrant by its acceptance thereof agrees to submit to the jurisdiction of a court of competent jurisdiction in the State of Arizona, but to the State of Illinois as to Sections 17, 18 and 22, for the purpose of resolving any disputes arising with respect to the rights and obligations of the Warrant Agent. Section 25. BENEFITS OF THIS AGREEMENT. Nothing in this Agreement will be construed to give to any person or corporation other than the Company, the Warrant Agent and the registered holders of the Warrants any legal or equitable right, remedy or claim under this Agreement. This Agreement is for the sole and exclusive benefit of the Company, the Warrant Agent and the registered holders of the Warrants. Section 26. COUNTERPARTS. This Agreement may be executed in counterparts and each of such counterparts will for all purposes be deemed to be an original, and all such counterparts will together constitute but one and the same instrument. Section 27. DESCRIPTIVE HEADINGS. The descriptive headings of the several Sections of this Agreement are inserted for convenience only and do not control or affect the meaning or construction of any of the provisions hereof. IN WITNESS WHEREOF, the parties have caused this Agreement to be duly executed, as of the day and year first above written. UGLY DUCKLING CORPORATION By:_________________________ Name:_______________________ Its:________________________ HARRIS TRUST COMPANY OF CALIFORNIA, as Warrant Agent By:_________________________ Name:_______________________ Its:________________________ 18 19 Warrant No. ____ EXHIBIT A WARRANT TO PURCHASE ________ SHARES OF COMMON STOCK VOID AFTER 5:00 P.M., NEW YORK CITY TIME, ON _______ __, 200_ UGLY DUCKLING CORPORATION This certifies that, for value received ________________________, the registered holder hereof or assigns (the "Holder"), is entitled to purchase from UGLY DUCKLING CORPORATION, a Delaware corporation (the "Company"), at any time before 5:00 p.m., New York City time, on _______ __, 200_, at the purchase price per share of $20 (the "Warrant Price"), the number of shares of Common Stock, par value $0.001 per share, of the Company set forth above (the "Shares"). The number of shares of Common Stock purchasable upon exercise of the Warrant evidenced hereby and the Warrant Price is subject to adjustment from time to time as set forth in the Warrant Agreement referred to below. This Warrant may be redeemed, at the option of the Company and as more specifically provided in the Warrant Agreement, at $.10 per share of Common Stock purchasable upon exercise hereof, at any time after the average Daily Market Price (as defined in Section 11 of the Warrant Agreement) per share of the Common Stock for a period of at least 10 consecutive trading days ending not more than fifteen days prior to the date of the notice given pursuant to Section 11(b) thereof has equaled or exceeded $28.50, and prior to expiration of this Warrant. The Holder's right to exercise this Warrant terminates at 5:00 p.m. (New York City time) on the date fixed for redemption in the notice of redemption delivered by the Company in accordance with the Warrant Agreement. The Warrants evidenced hereby may be exercised in whole or in part by presentation of this Warrant certificate with the Purchase Form attached hereto duly executed and guaranteed and simultaneous payment of the Warrant Price (as defined in the Warrant Agreement and subject to adjustment as provided therein) at the principal office in Los Angeles, California, of Harris Trust Company of California (the "Warrant Agent"). Payment of such price may be made at the option of the Holder in cash or by certified check or bank draft, all as provided in the Warrant Agreement. The Warrants evidenced hereby are part of a duly authorized issue of Warrants and are issued under and in accordance with the Warrant Agreement dated as of _____ __, 1998, between the Company and the Warrant Agent, and are subject to the terms and provisions contained in such 19 20 Warrant Agreement, which Warrant Agreement is hereby incorporated by reference herein and made a part hereof and is hereby referred to for a description of the rights, limitations, duties and indemnities thereunder of the Company and the Holder of the Warrants, and to all of which the Holder of this Warrant certificate by acceptance hereof consents. A copy of the Warrant Agreement may be obtained for inspection by the Holder hereof upon written request to the Warrant Agent. Upon any partial exercise of the Warrants evidenced hereby, there will be issued to the Holder a new Warrant certificate in respect of the Shares evidenced hereby that have not been exercised. This Warrant certificate may be exchanged at the office of the Warrant Agent by surrender of this Warrant certificate properly endorsed either separately or in combination with one or more other Warrants for one or more new Warrants to purchase the same aggregate number of Shares as evidenced by the Warrant or Warrants exchanged. No fractional Shares will be issued upon the exercise of rights to purchase hereunder, but the Company will pay the cash value of any fraction upon the exercise of one or more Warrants, as provided in the Warrant Agreement. The Warrant Price and the number of shares of Common Stock issuable upon exercise of this Warrant is subject to adjustment as provided in Section 9 of the Warrant Agreement. The Warrant Agreement may be amended by the holder or holders of a majority of the outstanding Warrants representing a majority of the shares of Common Stock underlying such Warrants; provided that without the consent of each holder of a Warrant certain specified changes cannot be made to such holder's Warrants and no amendment may affect the rights and duties of the Warrant Agent without the consent of the Warrant Agent. Pursuant to the Warrant Agreement, by acceptance of a Warrant, each holder consents to the jurisdiction of a court of competent jurisdiction in the State of Arizona for the purpose of resolving any disputes arising with respect to the Warrants or the Warrant Agreement. The Holder hereof may be treated by the Company, the Warrant Agent and all other persons dealing with this Warrant certificate as the absolute owner hereof for all purposes and as the person entitled to exercise the rights represented hereby, any notice to the contrary notwithstanding, and until any transfer is entered on such books, the Company may treat the Holder hereof as the owner for all purposes. Notices and demands to be given to the Company or the Warrant Agent must be given by certified or registered mail at the addresses provided in the Warrant Agreement. All terms used in the Warrant Certificate that are defined in the Warrant Agreement shall have the respective meanings ascribed to such terms in the Warrant Agreement. Dated:______________ UGLY DUCKLING CORPORATION By:_____________________________ President 20 21 ATTEST: ____________________________ Secretary This is one of the Warrants referred to in the within mentioned Warrant Agreement. HARRIS TRUST COMPANY OF CALIFORNIA By: __________________________________________ Authorized Representative 21 22 UGLY DUCKLING CORPORATION PURCHASE FORM Mailing Address: HARRIS TRUST COMPANY OF CALIFORNIA 601 South Figueroa 49th Floor Los Angeles, CA 90017 Attention: Corporate Trust The undersigned hereby irrevocably elects to exercise the right of purchase represented by the within Warrant certificate for, and to purchase thereunder, _____________Shares of Common Stock provided for therein, and requests that certificates for such Shares be issued in the name of: (Please Print or Type Name, Address and Social Security Number) and that such certificates be delivered to _____________________________________ whose address is _______________________________________________________________ and, if said number of Shares shall not be all the Shares purchasable hereunder, that a new Warrant certificate for the balance of the Shares purchasable under the within Warrant certificate be registered in the name of the undersigned Holder or his or her Assignee as below indicated and delivered to the address stated below. Dated:_____________________ Name of Holder or Assignee: ________________________________________________________________________________ (Please Print) Address:________________________________________________________________________ ________________________________________________________________________________ Signature: __________________________ NOTE: The above signature must correspond with the name as it appears upon the face of the within Warrant certificate in every particular, without alteration or enlargement or any change whatever, unless these Warrants have been assigned. Signature Guaranteed: __________________________ THE SIGNATURE(S) SHOULD BE GUARANTEED BY AN ELIGIBLE GUARANTOR INSTITUTION (Banks, Stock Brokers, Savings and Loan Association, and Credit Unions) WITH 22 23 MEMBERSHIP IN AN APPROVED SIGNATURE GUARANTEE MEDALLION PROGRAM PURSUANT TO S.E.C. RULE 17Ad-15. ASSIGNMENT (To be signed only upon assignment of Warrants) FOR VALUE RECEIVED, the undersigned hereby sells, assigns and transfers unto ________________________________________________________________________________ (Name and Address of Assignee Must Be Printed or Typewritten) _________ Warrants, hereby irrevocably constituting and appointing_____________ _______ Attorney to transfer said Warrants on the books of the Company, with full power of substitution in the premises. Dated: ______________________________ Signature of Registered Holder Note: The signature on this assignment must correspond with the name as it appears upon the face of the within Warrant certificate in every particular, without alteration or enlargement or any change whatever. Signature Guaranteed: _______________________ THE SIGNATURE(S) SHOULD BE GUARANTEED BY AN ELIGIBLE GUARANTOR INSTITUTION (Banks, Stock Brokers, Savings and Loan Association, and Credit Unions) WITH MEMBERSHIP IN AN APPROVED SIGNATURE GUARANTEE MEDALLION PROGRAM PURSUANT TO S.E.C. RULE 17Ad-15. 23 EX-10.31 3 EX-10.31 1 Exhibit 10.31 GUARANTY AND PLEDGE AGREEMENT (STOCK) THIS GUARANTY AND PLEDGE AGREEMENT dated as of December 15, 1997 (the "Pledge Agreement") is made by and among First Merchants Acceptance Corporation, a Delaware corporation (the "Pledgor") (as owner of all of the outstanding capital stock in First Merchants Auto Receivables Corporation, a Delaware corporation ("FMARC") and First Merchants Auto Receivables Corporation II, a Delaware corporation ("FMARC II")), LaSalle National Bank, as Agent under the Warehouse Facility, Ugly Duckling Corporation ("UDC") and Harris Trust and Savings Bank, an Illinois banking corporation, as collateral agent (the "Collateral Agent") on behalf of the Agent. Capitalized terms not otherwise defined herein are used as defined in Schedule I attached hereto. INTRODUCTORY STATEMENTS A. The Pledgor is the sole shareholder of FMARC and FMARC II. B. Pursuant to a Stock Pledge Agreement dated as of March 1, 1996, among the Pledgor, FSA and the Collateral Agent (as the same may be amended, supplemented or otherwise modified from time to time, the "FSA Pledge Agreement"), the Pledgor has pledged all of its interest as sole shareholder of FMARC II to the Collateral Agent on behalf of FSA. All such interest is represented by a single stock certificate (the "FMARC II Certificate"). The FMARC II Certificate has been delivered to the Collateral Agent by the Pledgor pursuant to the FSA Pledge Agreement. C. Pursuant to a Stock Pledge Agreement dated as of June 9, 1997, among the Pledgor, Greenwich and the Collateral Agent (as the same may be amended, supplemented or otherwise modified from time to time, the "Greenwich Pledge Agreement"), the Pledgor has further pledged its interest as sole shareholder of FMARC II to the Collateral Agent on behalf of Greenwich, subject to the rights of FSA under the FSA Pledge Agreement and pursuant to an Intercreditor Agreement dated as of June 9, 1997 by and between FSA and Greenwich (the "Intercreditor Agreement"). D. Pursuant to that certain Pledge Agreement (Stock) dated as of July 17, 1997, among Pledgor, UDC, and the Collateral Agent (the "DIP Pledge"), the Pledgor has pledged all of its interest as sole shareholder of FMARC II to the Collateral Agent to secure its obligations to UDC under the DIP Facility and Overadvance Cap subject to the limitations set forth in the DIP Pledge. UDC has elected to subordinate the DIP Pledge to the liens granted hereunder. 2 E. The Pledgor has entered into the Modified Plan Agreement. Pursuant to the Modified Plan Agreement, the Pledgor has agreed to sell the Owned Loans to the Agent. F. In order to acquire the Owned Loans free and clear of any interests, liens or encumbrances, the Agent, at the direction of UDC, has agreed to credit bid the Purchase Price for the Owned Loans. The Pledgor, UDC and the Committee have recognized that a cash sale of the Owned Loans would not provide sufficient proceeds to satisfy, in full, all amounts due the Bank Group under the Warehouse Facility. Moreover, the Pledgor and the Committee have requested that the Agent release its lien on the Retained Property. As consideration for the Agent's (1) credit bid of the Purchase Price for the Owned Loans and (2) release of its lien on the Retained Property, the Pledgor has agreed to execute a non-recourse guaranty guaranteeing to the Agent on behalf of the Current Bank Group satisfaction in full of the Secured Claim Recovery Amount and to secure the guaranty with a pledge of the FMARC Certificate and the FMARC II Certificate (collectively the "Pledged Shares"). AGREEMENTS In consideration of the premises and of the agreements herein contained, the Pledgor, the Agent and the Collateral Agent agree as follows: Section 1. Definitions. As used herein, the term "Final Date" shall mean the earlier of (i) the date upon which the Agent has fully recovered and received the Secured Claim Recovery Amount and, if the Chapter 11 Plan is confirmed, UDC has received the Modified UDC Fee or (ii) the date on which all of Pledgor's obligations under the Contribution Agreement have been satisfied. The term "Senior Creditors" shall mean with respect to FMARC II individually and/or collectively FSA and Greenwich. The term "Senior Pledge Agreements" shall mean individually and/or collectively the FSA Pledge Agreement and the Greenwich Pledge Agreement. The term "Senior Obligations" shall mean individually and/or collectively the obligations of Pledgor to the Senior Creditors secured by the Senior Pledge Agreements. The term "Senior Security Interests" shall mean any and all properly perfected, valid and enforceable liens existing as of July 11, 1997, of Pledgor to the Senior Creditors securing the Senior Obligations. The term "Responsible Officer" shall mean when used with respect to the Collateral Agent any officer within its principal corporate trust office located at 311 West Monroe Street, Chicago, Illinois 60606, including any Vice President, Managing Director, Assistant Vice President, Secretary, Assistant Secretary or Assistant Treasurer or any other officer of the Collateral Agent customarily performing functions similar to those performed by any of the above designated officers and also, with respect to a particular matter, any other officer to whom such matter is referred because of such officer's knowledge and familiarity with 3 the particular subject. Section 2. Guaranty. Pledgor guarantees, absolutely and irrevocably, the full and timely receipt and recovery by the Agent (and the successors or assigns of Agent) and/or UDC (collectively, the "Secured Party"), in the aggregate of the Secured Claim Recovery Amount and, if the Chapter 11 Plan is confirmed, the Modified UDC Fee. Pledgor's guaranty obligations hereunder (collectively, the "Obligations") shall be non-recourse to the Pledgor or any assets of the Pledgor other than the FMARC Collateral (as defined below). The Secured Party agrees to satisfy any claim arising hereunder against Pledgor only from the proceeds of the FMARC Collateral. Section 3. Pledge of Stock and Grant of Security Interest. As security for the full and complete performance of all of the Obligations, the Pledgor hereby delivers, pledges and assigns to the Collateral Agent for the benefit of the Secured Party, and grants in favor of the Collateral Agent for the benefit of the Secured Party, a security interest in all of the Pledgor's right, title and interest in and to the Pledged Shares, together with all of the Pledgor's rights and privileges with respect thereto, all proceeds, dividends, distributions (including specifically, without limitation, all distributions or dividends in any way related to Pledgor's interest in FMARC and FMARC II), income and profits therefrom and all property received in exchange or in substitution therefor (the "FMARC Collateral"); provided, however, that such security interest of the Secured Party shall be subordinate to the Senior Security Interests of the Senior Creditors in and to such FMARC Collateral granted pursuant to the Senior Pledge Agreements for so long as any Senior Obligations shall be outstanding and for so long as such Senior Security Interests shall continue. Section 4. Stock Dividends, Options, or Other Adjustments. Until the Final Date, the Pledgor shall deliver to the Collateral Agent, as FMARC Collateral, any and all additional shares of stock or any other property of any kind distributable on or by reason of the FMARC Collateral, whether in the form of or by way of stock dividends, warrants, total or partial liquidation, conversion, prepayments, redemptions or otherwise, with the sole exception of cash dividends or cash interest payments, as the case may be. If any additional shares of capital stock, instruments, or other property, a security interest in which can only be perfected by possession, which are distributable on or by reason of the FMARC Collateral pledged hereunder, shall come into the possession or control of the Pledgor, the Pledgor shall forthwith transfer and deliver such property to the Collateral Agent, as FMARC Collateral hereunder. The security interest of the Secured Party in and to such additional FMARC Collateral shall be subordinate to the Senior Security Interests for so long as any Senior Obligation shall be outstanding, and for as long as such Senior Security Interests 4 shall continue. Section 5. Delivery of Share Certificates; Stock Powers. Pursuant to the FSA Pledge Agreement and the pledge of the FMARC stock herein, the Pledgor has previously delivered to the Collateral Agent all instruments and stock certificates representing the FMARC Collateral, together with stock powers duly executed in blank by the Pledgor. The Pledgor shall promptly deliver to the Collateral Agent, or cause FMARC and FMARC II (collectively, the "FMARC Entities") or any other entity issuing the FMARC Collateral, to deliver directly to the Collateral Agent share certificates or other instruments representing any FMARC Collateral issued to, acquired or received by the Pledgor after the date of this Pledge Agreement with a stock or bond power duly executed by the Pledgor. Subject to the rights of the Senior Creditors for so long as the Senior Security Interests shall continue, if, at any time, either the Collateral Agent acting on behalf of the Secured Party or the Secured Party notifies the Pledgor that it requires additional stock powers endorsed in blank, the Pledgor shall promptly execute in blank and deliver the requested power to the requesting party. Section 6. Power of Attorney. Subject to the rights of the Senior Creditors for so long as any Senior Obligations shall be outstanding and the Senior Security Interests shall continue, and subject further to the provisions of Title 11 of the United States Code (the "Bankruptcy Code"), the Pledgor hereby constitutes and irrevocably appoints the Collateral Agent on behalf of the Secured Party and the Secured Party, or either one acting alone, exercisable at any time after the Senior Obligations shall have been paid in full, with full power of substitution and revocation, as the Pledgor's true and lawful attorney-in-fact, with the power, upon the failure of Pledgor to satisfy its obligations under Section 2 hereof, and a failure to cure as provided in Section 12(a) hereof, to the full extent permitted by law, to affix to any certificates and documents representing the FMARC Collateral, the stock or bond powers delivered with respect thereto, and to transfer or cause the transfer of the FMARC Collateral, or any part thereof, on the books of the FMARC Entities or any other entity issuing such FMARC Collateral, to the name of the Collateral Agent or the Secured Party or any nominee thereof, and thereafter to exercise with respect to such FMARC Collateral all the rights, powers and remedies of an owner. Subject to the rights of the Senior Creditors for so long as the Senior Security Interests shall continue, the power of attorney granted pursuant to this Pledge Agreement and all authority hereby conferred are granted and conferred solely to protect the Secured Party's interest in the FMARC Collateral and shall not impose any duty upon the Collateral Agent or the Secured Party to exercise any power. This power of attorney shall be irrevocable as one coupled with an interest until the Final Date. 5 Section 7. Inducing Representations of the Pledgor. The Pledgor represents and warrants to UDC that: (a) The Pledged Shares are validly issued, fully paid for and nonassessable. (b) The Pledged Shares represent all of the issued and outstanding capital stock of FMARC and FMARC II. (c) The Pledgor is the sole legal and beneficial owner of, and has good and marketable title to, the Pledged Shares, free and clear of all pledges, liens, security interests and other encumbrances, except the security interests created by this Pledge Agreement, the Senior Security Interests and the DIP Pledge, and the Pledgor has the unqualified right and authority to execute and perform this Pledge Agreement, subject to (e) below. (d) No options, warrants or other agreements with respect to the FMARC Collateral are outstanding, except with respect to the Senior Security Interests and the DIP Pledge. (e) Any necessary consent, approval or authorization of or designation or filing with any authority on the part of the Pledgor which is required in connection with the Pledge and security interest granted under this Pledge Agreement has been obtained or effected by Court approval of this Pledge Agreement in the Bankruptcy Case after notice and an opportunity to be heard. (f) Once approved by the Court in the Bankruptcy Case, neither the execution and delivery of this Pledge Agreement by the Pledgor, the consummation of the transaction contemplated hereby nor the satisfaction of the terms and conditions of this Pledge Agreement: (i) conflicts with or results in any breach or violation of any provision of the articles of incorporation or bylaws of the Pledgor or any law, rule, regulation, order, writ, judgment, injunction, decree, determination or award currently in effect having applicability to the Pledgor or any of its properties, including regulations issued by an administrative agency or other governmental authority having supervisory powers over the Pledgor; (ii) conflicts with, constitutes a default (or an event which with the giving of notice or the passage of time, or both, would constitute a default) by the Pledgor under, or a breach of or contravenes any provision of, any agreement to which the Pledgor or any of its subsidiaries is a party or by which it or any of their properties is or may be bound or affected, including without limitation any loan agreement, mortgage, indenture or other agreement or instrument except where such consent has been obtained or is effected by entry of an order approving this Pledge 6 Agreement; or (iii) results in or requires the creation of any lien upon or in respect of any of the Pledgor's assets except the lien created by this Pledge Agreement. (g) With respect to all Pledged Shares heretofore delivered to and currently held by the Collateral Agent, and upon delivery to the Collateral Agent of any Pledged Shares hereafter issued to, acquired or received by the Pledgor, the Secured Party will have a valid, perfected security interest in and to the FMARC Collateral, enforceable as such against all other creditors of the Pledgor and against all persons purporting to purchase any of the FMARC Collateral from the Pledgor, except that such security interest of the Secured Party in the FMARC Collateral is subordinate to the Senior Security Interests for so long as such Senior Security Interests shall continue and the right of the Secured Party to enforce such security interest is limited by the rights of the Senior Creditors under the Senior Pledge Agreements and the Intercreditor Agreement for so long as the Senior Security Interests shall continue. Section 8. Obligations of the Pledgor. The Pledgor further represents, warrants and covenants to the Secured Party that: (a) The Pledgor will not sell, transfer or convey any interest in, or suffer or permit any lien or encumbrance to be created upon or with respect to, any of the FMARC Collateral (other than the Senior Security Interests or the security interests created under this Pledge Agreement and the DIP Pledge) during the term of this Pledge Agreement, without the prior written consent of the Secured Party. (b) On and after the date hereof, the Pledgor will not, and will not cause or permit the FMARC Entities or any affiliate of the Pledgor or of the FMARC Entities to, enter into any new agreement or arrangement with FSA for the insurance of any securitization by FSA or the cross-collateralization of any such securitization with the presently existing securitizations, without the prior written consent of the Secured Party. (c) The Pledgor will, at its own expense, at any time and from time to time at the request of the Collateral Agent on behalf of the Secured Party or the Secured Party, at such time as the Senior Obligations shall have been paid in full, do, make, procure, execute and deliver all acts, things, writings, assurances and other documents as may be reasonably proposed by the Collateral Agent or the Secured Party to preserve, establish, demonstrate or enforce the rights, interests and remedies of the Collateral Agent or the Secured Party as created by, provided in, or emanating from this Pledge Agreement, in each case subject to the rights of the 7 Senior Creditors for so long as the Senior Security Interests shall continue. (d) The Pledgor will not take any action which would cause the FMARC Entities to issue any other capital stock without the prior written consent of the Secured Party, subject to the rights of the Senior Creditors for so long as the Senior Security Interests shall continue. Any such issuance shall be subject to the rights of the Secured Party under this Pledge Agreement and the Senior Creditors under the Senior Pledge Agreements for so long as the Senior Security Interests shall continue. (e) The Pledgor will not consent to any amendment to the articles of incorporation of the FMARC Entities without the prior written consent of the Secured Party, which consent shall not be unreasonably withheld or delayed. Section 9. Dividends. Pledgor agrees that, until the Final Date, it shall not cause the FMARC Entities to declare or make payment of (i) any dividend or other distribution on any shares of its capital stock, or (ii) any payment on account of the purchase, redemption, retirement or acquisition of any option, warrant or other right to acquire shares of its capital stock, unless such dividends, distribution or proceeds are paid to Agent or UDC hereunder to be applied to reduce the Secured Claim Recovery Amount and, if a Chapter 11 Plan is confirmed, the Modified UDC Fee, or to the Senior Creditors. Section 10. Voting Proxy. Subject to the rights of the Senior Creditors for so long as the Senior Security Interests shall continue, the Pledgor hereby grants to the Collateral Agent on behalf of the Secured Party an irrevocable proxy, exercisable at such time as the Senior Obligations shall have been paid in full, to vote, upon the occurrence of an Event of Default (as hereinafter defined), the Pledged Shares with respect to the matters contained in Article XII of the Articles of Incorporation of the FMARC Entities, which proxy shall continue until the Final Date, subject to the rights of the Senior Creditors for so long as the Senior Security Interests shall continue. UDC will provide written notice to the Collateral Agent and the Pledgor in the event that (i) the Senior Obligations are paid in full, (ii) the Final Date has occurred or (iii) an Event of Default has occurred. The Pledgor represents and warrants that it has directed the FMARC Entities, in accordance with Section 217 of the Delaware General Corporation Law, to reflect on their respective books the right of the Collateral Agent to vote the FMARC Collateral, as applicable, on behalf of the Secured Party, exercisable at such time as the Senior Obligations shall have been paid in full, and only on the occurrence of an Event of Default (as defined below). Upon the request of the Collateral Agent or the Secured Party, the Pledgor shall deliver to the Collateral Agent such further evidence of such irrevocable proxy or such further irrevocable proxy exercisable at 8 such time as the Senior Obligations shall have been paid in full, and only on the occurrence of an Event of Default (as defined below), to vote the FMARC Collateral as the Collateral Agent or the Secured Party may request pursuant hereto. The Collateral Agent shall exercise all such rights to vote the FMARC Collateral granted hereunder in accordance with the written directions given by the Secured Party. Section 11. Rights of the Collateral Agent and the Secured Party. Subject to the rights of the Senior Creditors for so long as the Senior Security Interests shall continue, the Secured Party may, at any time and without notice, upon providing the Collateral Agent with the full amount necessary to carry out such direction, direct the Collateral Agent in writing to discharge any taxes, liens, security interests or other encumbrances levied or placed on the FMARC Collateral, pay for the maintenance and preservation of the FMARC Collateral, or pay for insurance on the FMARC Collateral; the amount of such payments, plus any and all reasonable fees, costs and expenses of the Collateral Agent and the Secured Party (including reasonable attorneys' fees and disbursements) in connection therewith, shall, at the option of the Collateral Agent or the Secured Party, as appropriate, be reimbursed by the Pledgor on demand, with interest thereon from the date paid at a rate of ten (10) percent per annum. The Collateral Agent shall have no duty or obligation to follow any direction provided in this Section 11 unless the Secured Party has provided the Collateral Agent with the full amount necessary to carry out such direction. Section 12. Remedies Upon Event of Default under this Pledge Agreement. Subject to the rights of the Senior Creditors for so long as the Senior Security Interests shall continue, at such time as the Senior Obligations shall have been paid in full and/or the Senior Creditors rights under the Senior Pledge Agreements have been released or discharged, and subject further to the provisions of the Bankruptcy Code, the Collateral Agent, on behalf of the Secured Party, or the Secured Party may exercise any one or more of the following remedies upon an Event of Default under this Pledge Agreement: (a) Upon the failure by Pledgor to satisfy its obligations under Section 2 hereof, the Secured Party may, directly or through the Collateral Agent, with at least five (5) business days prior written notice to the Pledgor (during which period Pledgor may cure such default) (such failure to satisfy and failure to cure, collectively, an "Event of Default"), (i) cause the FMARC Collateral to be transferred to the Collateral Agent's name or the Secured Party's name, or to the name of a nominee of either, and thereafter exercise as to such FMARC Collateral all of the rights, powers and remedies of an owner; 9 (ii) collect by legal proceedings or otherwise all dividends, interest, principal payments, capital distributions and other sums now or hereafter payable on account of the FMARC Collateral, and hold all such sums as part of the FMARC Collateral, or apply such sums to the payment of the Obligations in such manner and order as the Secured Party may decide, in its sole discretion; or (iii) enter into any extension, subordination, reorganization, deposit, merger, or consolidation agreement, or any other agreement relating to or affecting the FMARC Collateral, and in connection therewith deposit or surrender control of the FMARC Collateral thereunder, and accept other property in exchange therefor and hold and apply such property or money so received in accordance with the provisions hereof; or (b) In addition to all the rights and remedies of a secured party under the Uniform Commercial Code as in effect in any applicable jurisdiction, upon the occurrence of an Event of Default, the Secured Party shall have the right, without demand of performance or other demand, advertisement or notice of any kind, except as specified below and subject to the rights of the Senior Creditors for so long as the Senior Security Interests shall continue, to or upon the Pledgor or any other person (all and each of which demands, advertisements and/or notices are hereby expressly waived to the extent permitted by law), to proceed forthwith or direct the Collateral Agent in writing to proceed forthwith, to collect, receive, appropriate and realize upon the FMARC Collateral, or any part thereof and to proceed forthwith to sell, assign, give an option or options to purchase, contract to sell, or otherwise dispose of and deliver the FMARC Collateral or any part thereof in one or more parcels in accordance with applicable securities laws and in a manner designed to ensure that such sale will not result in a distribution of the Pledged Shares in violation of Section 5 of the Securities Act of 1933, as amended (the "Securities Act") (it being understood and agreed that the Collateral Agent will have no liability with respect thereto) and on such terms (including, without limitation, a requirement that any purchaser of all or any part of the FMARC Collateral shall be required to purchase any securities constituting the FMARC Collateral solely for investment and without any intention to make a distribution thereof) as the Secured Party, in its sole and absolute discretion, deems appropriate without any liability for any loss due to a decrease in the market value of the FMARC Collateral during the period held. If any notification to the Pledgor of intended disposition of the FMARC Collateral is required by law, such notification shall be deemed reasonable and properly given if hand delivered or express mailed to the Pledgor at least ten (10) days before any such disposition at the address in Section 22 hereof. Any disposition of the FMARC Collateral or any part thereof may be for cash or on credit or for future delivery without assumption of any credit risk, with the right of the Secured Party 10 to purchase all or any part of the FMARC Collateral so sold at any such sale or sales, public or private, free of any equity or right of redemption in the Pledgor, which right of equity is, to the extent permitted by applicable law, hereby expressly waived or released by the Pledgor; or (c) The Agent, in its sole and absolute discretion, may elect to obtain or cause the Collateral Agent to obtain the advice of any independent nationally known investment banking firm, which is a member firm of the New York Stock Exchange, with respect to the method and manner of sale or other disposition of any of the FMARC Collateral, the best price reasonably obtainable therefor, the consideration of cash and/or credit terms, or any other details concerning such sale or disposition; costs and expenses of obtaining such advice shall be for the account of the Secured Party. Subject to the rights of the Senior Creditors, for so long as the Senior Security Interests shall continue, the Secured Party, with the prior written consent of the Senior Creditors, or, at such time as the Senior Obligations shall have been paid in full, in its sole and absolute discretion, may elect to sell or cause the Collateral Agent to sell, the FMARC Collateral on any credit terms which it deems reasonable. The out-of-pocket costs and expenses of such sale shall be for the account of the Secured Party, except that, where such sale is effected with the prior written consent of the Senior Creditors, such costs and expenses shall be allocated pro rata between the Senior Creditors and the Secured Party to the extent, if any, that the proceeds of such sale are paid to each of the Senior Creditors and the Secured Party. The sale of any of the FMARC Collateral on credit terms shall not relieve the Pledgor of its liability with respect to the Obligations. All payments received in respect of any sale of the FMARC Collateral by the Collateral Agent or the Secured Party shall be applied to the Obligations as and when such payments are received, subject to the rights of the Senior Creditors for so long as the Senior Security Interests shall continue and any price received by the Collateral Agent in respect of such sale shall be conclusive and binding upon the Secured Party; or (d) The Pledgor recognizes that it may not be feasible to effect a public sale of all or a part of the FMARC Collateral by reason of certain prohibitions contained in the Securities Act, and that it may be necessary to sell privately to a restricted group of purchasers who will be obliged to agree, among other things, to acquire the FMARC Collateral for their own account, for investment and not with a view for the distribution or resale thereof. The Pledgor agrees that private sales may be at prices and other terms less favorable to the seller than if the FMARC Collateral were sold at public sale, and that neither the Collateral Agent nor the Secured Party has any obligation to delay the sale of any FMARC Collateral for the period of time necessary to permit the registration of the FMARC Collateral for public sale under the Securities Act. The Pledgor agrees that a private sale or sales 11 made under the foregoing circumstances shall be deemed to have been made in a commercially reasonable manner; or (e) If any consent, approval or authorization of any state, municipal or other governmental department, agency or authority shall be necessary to effectuate any sale or other disposition of the FMARC Collateral, or any partial disposition of the FMARC Collateral, the Pledgor will execute all such applications and other instruments as may be reasonably required in connection with securing any such consent, approval or authorization, and will otherwise use reasonable efforts to secure the same; or (f) Subject to the rights of the Senior Creditors for so long as the Senior Security Interests shall continue, upon any sale or other disposition with the prior written consent of the Senior Creditors or, at such time as the Senior Obligations shall have been paid in full, the Collateral Agent, acting at the written direction of the Secured Party, or the Secured Party shall have the right to deliver, assign and transfer to the purchaser thereof (including the Secured Party) the FMARC Collateral so sold or disposed of, subject to the Senior Security Interests if such sale or disposition is made prior to the payment in full of the Senior Obligations, and free from any other claim or right of whatever kind, including any equity or right of redemption of the Pledgor. The Pledgor specifically waives, to the extent permitted by applicable law, all rights of redemption, stay or appraisal which it may have under any rule of law or statute now existing or hereafter adopted; or (g) Neither the Collateral Agent nor the Secured Party shall be obligated to make any sale or other disposition of the FMARC Collateral permitted under this Pledge Agreement, unless the terms thereof shall be satisfactory to the Secured Party. The Collateral Agent or the Secured Party may, without notice or publication, adjourn any such private or public sale, and, upon five (5) days' prior written notice to the Pledgor, hold such sale at any time or place to which the same may be so adjourned. In case of any such sale of all or any part of the FMARC Collateral on credit or future delivery, the FMARC Collateral so sold may be retained by the Collateral Agent or the Secured Party until the selling price is paid by the purchaser thereof, but neither the Collateral Agent nor the Secured Party shall incur any liability in case of the failure of such purchaser to take up and pay for the property so sold and, in case of any such failure, such property may again be sold as herein provided. (h) All of the rights and remedies granted to the Collateral Agent and the Secured Party, including but not limited to the foregoing, shall be cumulative and not exclusive and shall be enforceable alternatively, successively or concurrently as the Secured Party may deem expedient. 12 (i) Notwithstanding anything to the contrary in this Section 12, the security interest of the Collateral Agent and the Agent shall secure only the guaranty of the Secured Claim Recovery Amount. Any excess value or proceeds in or from the FMARC Collateral shall accrue to Pledgor except as otherwise agreed in writing by the Pledgor. Section 13. Limitation on Liability. (a) Neither the Collateral Agent nor the Secured Party, nor any of their respective directors, officers, employees or agents, shall be liable to the Pledgor or to the FMARC Entities for any action taken or omitted to be taken by it or them hereunder, or in connection herewith, except that the Collateral Agent and the Secured Party shall each be liable for its own gross negligence, bad faith or willful misconduct. (b) The Collateral Agent shall incur no liability to the Secured Party except for the Collateral Agent's negligence, bad faith or willful misconduct in carrying out its duties hereunder. (c) The Collateral Agent shall be protected and shall incur no liability to any party in relying upon the accuracy, acting in reliance upon the contents, and assuming the genuineness of any notice, demand, certificate, signature, instrument or other document a Responsible Officer of the Collateral Agent reasonably believes to be genuine and to have been duly executed by the appropriate signatory, and (absent actual knowledge to the contrary of any Responsible Officer of the Collateral Agent) the Collateral Agent shall not be required to make any independent investigation with respect thereto. The Collateral Agent shall at all times be free to establish independently to its reasonable satisfaction, but shall have no duty to independently verify, the existence or nonexistence of facts that are a condition to the exercise or enforcement of any right or remedy hereunder. (d) The Collateral Agent may consult with qualified counsel, financial advisors or accountants and shall not be liable for any action taken or omitted to be taken by it hereunder in good faith and in accordance with the advice of such counsel, financial advisors or accountants. (e) The Collateral Agent shall not be under any obligation to exercise any of the rights, powers or duties vested in it by this Pledge Agreement unless it shall have received reasonable security or indemnity satisfactory to the Collateral Agent against the costs, expenses and liabilities which it might incur. (f) Whenever in the administration of this Agreement, the Collateral Agent shall deem it necessary or desirable that a matter be proved or established prior to taking or suffering or 13 omitting to take any action hereunder, such matter (unless other evidence in respect thereof be herein specifically prescribed) may, in the absence of gross negligence, bad faith or wilful misconduct on the part of the Collateral Agent, be deemed to be conclusively proved and established by an officers' certificate of the Secured Party delivered to the Collateral Agent, and such certificate, in the absence of gross negligence, bad faith or wilful misconduct on the part of the Collateral Agent, shall be a warranty to the Collateral Agent for any action taken, suffered or omitted to be taken by the Collateral Agent under the provisions of this Agreement in reliance on such certificate. Section 14. Performance of Duties. The Collateral Agent shall have no duties or responsibilities with respect to the Secured Party except those expressly set forth in this Pledge Agreement or as directed in writing by the Secured Party pursuant to this Pledge Agreement. Section 15. Appointment of and Powers of Collateral Agent. Subject to the rights of the Senior Creditors for so long as the Senior Security Interests shall continue, the Secured Party appoints Harris Trust and Savings Bank as its Collateral Agent and Harris Trust and Savings Bank accepts such appointment and agrees to act as Collateral Agent on behalf of the Secured Party to maintain custody and possession of the FMARC Collateral and to perform the other duties of the Collateral Agent in accordance with the provisions of this Pledge Agreement. The Collateral Agent shall, subject to the other terms and provisions of this Pledge Agreement and subject to the rights of the Senior Creditors for so long as the Senior Security Interests shall continue, act upon and in compliance with the Secured Party's written instructions delivered pursuant to this Pledge Agreement as promptly as possible following receipt of such written instructions. Receipt of written instructions shall not be a condition to the exercise by the Collateral Agent of its express duties hereunder, unless this Pledge Agreement provides that the Collateral Agent is permitted to act only following receipt of such written instructions. Section 16. Successor Collateral Agent. (a) Merger. Any Person into which the Collateral Agent may be converted or merged, or with which it may be consolidated, or to which it may sell or transfer its trust business and assets as a whole or substantially as a whole, or any person resulting from any such conversion, merger, consolidation, sale or transfer to which the Collateral Agent is a party, shall (provided it is otherwise qualified to serve as the Collateral Agent hereunder) be and become a successor Collateral Agent hereunder and, subject to the rights of the Senior Creditors for so long as the Senior Security Interests shall continue, be vested with all of the title to and interest in the FMARC Collateral, all of the duties and obligations provided herein and all of the trusts, powers, immunities, privileges and other matters as was its predecessor at 14 the time of such conversion, merger or consolidation, without the execution or filing of any instrument or any further act, deed or conveyance on the part of any of the parties hereto, anything herein to the contrary notwithstanding. (b) Resignation. Subject to the rights of the Senior Creditors for so long as the Senior Security Interests shall continue, the Collateral Agent and any successor Collateral Agent may not resign (i) without the prior written consent of both the Senior Creditors and the Secured Party (which consent will not be unreasonably withheld) or, at such time as the Senior Obligations shall have been paid in full, of the Secured Party (ii) unless the Collateral Agent is unable to perform its duties hereunder as a matter of law as evidenced by an opinion of counsel acceptable to both the Senior Creditors and the Secured Party or, at such time as the Senior Obligations shall have been paid in full, the Secured Party. Upon the occurrence of (i) or (ii) above, the Collateral Agent shall give notice of its resignation by registered or certified mail to the Pledgor (with a copy to the Secured Party, and to the Senior Creditors for so long as the Senior Security Interests shall continue). Any resignation by the Collateral Agent shall take effect only upon the date which is the later of (x) the effective date of the appointment pursuant hereto of a successor Collateral Agent, and the acceptance in writing by such successor Collateral Agent of such appointment and (y) the date on which the FMARC Collateral is delivered to the successor Collateral Agent. Notwithstanding the preceding sentence, if by the contemplated date of resignation specified in the written notice of resignation delivered as described above, no successor Collateral Agent has been appointed or becomes the Collateral Agent pursuant to subsection (d) below, the resigning Collateral Agent may petition a court of competent jurisdiction for the appointment of a successor. In the event of any resignation pursuant to this Section 16(b), the Pledgor shall pay to the Collateral Agent its fees and expenses then due and owing in accordance with Section 20 hereof. (c) Removal. The Collateral Agent may be removed (i) by the Senior Creditors for so long as the Senior Security Interests shall continue, and (ii) at such time as the Senior Obligations shall have been paid in full, by the Secured Party, at any time, with or without cause, by an instrument or concurrent instruments in writing delivered to the Collateral Agent and a written copy thereof shall be promptly furnished to the Pledgor. The Collateral Agent shall provide the Secured Party and the Pledgor with a copy of any such notice received from the Senior Creditors by the Collateral Agent pursuant to (i) above. Any removal pursuant to the provisions of this subsection (c) shall take effect only upon the later to occur of (i) the effective date of the appointment of a successor Collateral Agent and the acceptance in writing by such successor Collateral Agent of such appointment and of its obligation to perform its duties hereunder in accordance with the 15 provisions hereof and (ii) the date on which the FMARC Collateral is delivered to a successor Collateral Agent. In the event of any removal pursuant to this Section 16(c), the Pledgor shall pay the Collateral Agent its fees and expenses then due and owing in accordance with Section 20 hereof. (d) Appointment of and Acceptance by Successor. (i) For so long as the Senior Security Interests shall continue, the Senior Creditors shall have the right to appoint any successor Collateral Agent and, at such time as the Senior Obligations shall have been paid in full, the Secured Party shall have the sole right, pursuant to this Pledge Agreement, to appoint any successor Collateral Agent. Every successor Collateral Agent appointed or approved hereunder shall execute, acknowledge and deliver to its predecessor, to the Pledgor, to the Senior Creditors for so long as the Senior Security Interests shall continue and, at such time as the Senior Obligations shall have been paid in full, to the Secured Party, an instrument in writing accepting such appointment hereunder, and the relevant predecessor shall execute, acknowledge and deliver such other documents and instruments as will effectuate the delivery of all FMARC Collateral to the successor Collateral Agent, whereupon such successor, without any further act, deed or conveyance, shall become fully vested with all the estates, properties, rights, powers, duties and obligations of its predecessor. Such predecessor shall, nevertheless, on the written request of the Secured Party, and, at such time as the Senior Obligations shall have been paid in full, execute and deliver an instrument transferring to such successor all the estates, properties, rights and powers of such predecessor hereunder. (ii) Every predecessor Collateral Agent shall assign, transfer and deliver all FMARC Collateral held by it as Collateral Agent hereunder to its successor as Collateral Agent. (iii) Should any instrument in writing from the Pledgor be reasonably required by a successor Collateral Agent for the purpose of more fully and certainly vesting in such successor the estates, properties, rights, powers, duties and obligations vested or intended to be vested hereunder in the Collateral Agent, any and all such written instruments shall, at the request of the successor Collateral Agent, be forthwith executed, acknowledged and delivered by the Pledgor. (iv) The designation of any successor Collateral Agent and the instrument or instruments removing any Collateral Agent and appointing a successor hereunder, together with all other instruments provided for herein, shall be maintained with the records relating to the FMARC Collateral and, to the extent required by applicable law, filed or recorded by the successor Collateral Agent in each place where such filing or recording is 16 necessary to effect the transfer of the FMARC Collateral to the successor Collateral Agent or to protect and preserve the security interest granted hereunder. (v) Neither the original Collateral Agent nor any successor Collateral Agent named under this Section 16 shall be liable for the acts or omissions of any successor Collateral Agent named under this Section 16 in connection with fulfilling its duties as Collateral Agent hereunder. Section 17. Indemnification. The Pledgor shall indemnify solely from the FMARC Collateral each of the Secured Party, its affiliates and subsidiaries, the Collateral Agent, and their respective directors, officers, employees and agents, for, and hold each of the Secured Party, its affiliates and subsidiaries, the Collateral Agent, and their respective directors, officers, employees and agents harmless against, any loss, liability or reasonable expense (including the reasonable costs and expenses of defending against any claim of liability) arising out of or in connection with this Pledge Agreement and the transactions contemplated hereby, except any such loss, liability or expense as shall result from the respective gross negligence, bad faith or willful misconduct of each of the Secured Party, its affiliates and subsidiaries, the Collateral Agent or their respective directors, officers, employees or agents. The obligation of the Pledgor under this Section shall survive the resignation or removal of the Collateral Agent and the satisfaction of all of the Obligations. The Secured Party shall indemnify the Collateral Agent for the foregoing on a recourse basis. Section 18. Representations and Warranties of the Collateral Agent. The Collateral Agent represents and warrants to Pledgor and to the Secured Party as follows: (a) Due Organization. The Collateral Agent is an Illinois banking corporation, duly organized, validly existing and in good standing under the laws of the State of Illinois and is duly authorized and licensed under applicable law to conduct its business as presently conducted. (b) Corporate Power. The Collateral Agent has all requisite right, power and authority to execute and deliver this Pledge Agreement and to perform all of its duties as Collateral Agent hereunder and thereunder. (c) Due Authorization. The execution and delivery by the Collateral Agent of this Pledge Agreement and the performance by the Collateral Agent of its duties hereunder, have been duly authorized by all necessary corporate proceedings and no further approvals or filings, including any governmental approvals, are required for the valid execution and delivery by the Collateral Agent, or the performance by the Collateral Agent, of this Pledge 17 Agreement. (d) Valid and Binding Agreement. The Collateral Agent has duly executed and delivered this Pledge Agreement and this Pledge Agreement constitutes the legal, valid and binding obligation of the Collateral Agent, enforceable against the Collateral Agent in accordance with its respective terms, except as (i) such enforceability may be limited by bankruptcy, insolvency, reorganization and similar laws relating to or affecting the enforcement of creditors' rights generally and (ii) rights of acceleration and the availability of equitable remedies may be limited by equitable principles of general applicability. Section 19. Termination. This Pledge Agreement shall continue in full force and effect until the Final Date. Subject to any sale or other disposition of the FMARC Collateral pursuant to and in accordance with this Pledge Agreement or the Senior Pledge Agreements, and subject further to the rights of the Senior Creditors for so long as the Senior Security Interests shall continue, the FMARC Collateral shall be returned to the Pledgor on the Final Date. Section 20. Compensation and Reimbursement. The Pledgor agrees for the benefit of the Secured Party and as part of the Obligations (a) to pay to the Collateral Agent, from time to time, reasonable compensation for all services rendered by it hereunder not to exceed $2,500 per annum and (b) to reimburse the Collateral Agent upon its request for all reasonable expenses, disbursements and advances incurred or made by the Collateral Agent in accordance with any provision of, or carrying out its duties and obligations under, this Pledge Agreement (including the reasonable compensation and fees and the reasonable expenses and disbursements of its agents, any independent certified public accountants and independent counsel), except any expense, disbursement or advances as may be attributable to negligence, bad faith or willful misconduct on the part of the Collateral Agent. Such fees and expenses shall be considered administrative expenses of Pledgor entitled to priority under 11 U.S.C. section 503. Section 21. Foreclosure Expenses of the Collateral Agent and the Secured Party. All reasonable expenses (including reasonable fees and disbursements of counsel) incurred in compliance with this Pledge Agreement, by the Collateral Agent on behalf of the Secured Party or by the Secured Party in connection with any actual or attempted sale, exchange of, or any enforcement, collection, compromise or settlement respecting this Pledge Agreement or the FMARC Collateral, or any other action taken in compliance with this Pledge Agreement, by the Collateral Agent on behalf of the Secured Party or by the Secured Party hereunder, whether directly or as attorney-in-fact pursuant to a power of attorney or other authorization herein conferred, for the purpose of satisfaction of the Obligations shall be deemed an Obligation 18 for all purposes of this Pledge Agreement and the Collateral Agent (with the consent of the Secured Party) and the Secured Party may apply the FMARC Collateral to payment of or reimbursement of itself for such liability; provided, however, that any fees, expenses or disbursements incurred in connection with this Pledge Agreement which are attributable to the gross negligence, bad faith or willful misconduct of the Secured Party or the Collateral Agent shall not be considered an Obligation hereunder and shall not be subject to payment or reimbursement from the FMARC Collateral. Section 22. Notices. Any notice or other communication given hereunder shall be in writing and shall be sent to the recipient as follows: If to UDC, to: Ugly Duckling Corporation 2525 E. Camelback Road, Suite 1150 Phoenix, Arizona 85016 Attention: Steven P. Johnson, Esq. Facsimile No.: (602) 852-6696 With a copy to: Snell & Wilmer L.L.P. One Arizona Center Phoenix, Arizona 85004 Attention: Timothy W. Moser, Esq. Facsimile No.: (602) 382-6070 If to the Pledgor, to: First Merchants Acceptance Corporation 570 Lake Cook Road, Suite 126 Deerfield, Illinois 60015 Attention: Howard Adamski Facsimile No.: (847) 945-2556 With a copy to: Sonnenschein Nath & Rosenthal Suite 8000 Sears Tower 233 S. Wacker Drive Chicago, Illinois 60606 Attention: Robert E. Richards, Esq. Facsimile No.: (312) 876-7934 If to the Agent, to: LaSalle National Bank 120 South LaSalle Street Chicago, Illinois 60603 19 Attention: Commercial Lending Department With a copy to: Jenner & Block One IBM Plaza Chicago, Illinois 60611 Attention: Jeffrey Elegant, Esq. Telecopy No.: (312) 527-0484 With a copy to: Snell & Wilmer L.L.P. One Arizona Center 400 East Van Buren Phoenix, Arizona 85004-0001 Attention: Timothy W. Moser, Esq. Telephone: (602) 382-6000 Telecopy No.: (602) 382-6070 If to FSA, to: Financial Security Assurance, Inc. 350 Park Avenue New York, New York 10022 Attention: Surveillance Department Facsimile No.: (212) 339-3518 With a copy to: Paul Hastings Janofsky & Walker, L.L.P. 555 S. Flower Street Los Angeles, California 90071 Attention: Carl Anderson Facsimile No.: (213) 627-0705 20 If to Greenwich, to: Greenwich Capital Financial Products, Inc. 600 Steamboat Road Greenwich, Connecticut 06830 Attention: Craig Eckes Telephone: (203) 622-5651 Telecopy No.: (203) 629-9640 With a copy to: Office of the General Counsel Greenwich Capital Financial Products, Inc. 600 Steamboat Road Greenwich, Connecticut 06830 Telephone: (203) 622-5651 Telecopy No.: (203) 629-9640 If to Collateral Agent, to: Harris Trust and Savings Bank 311 West Monroe Street Chicago, Illinois 60606 Attention: Indenture Trust Department Telephone: (312) 461-6030 Facsimile No.: (312) 461-3525 Each such notice or other communication, together with appropriate copies, shall be (a) mailed by United States registered or certified mail, return receipt requested, postage prepaid, (b) delivered by overnight delivery service such as Federal Express, providing for signed receipts, (c) delivered by personal service in the manner provided for service of legal process, or (d) transmitted by facsimile at the above facsimile numbers, with a copy by United States mail as provided in subsection (a) hereof. Counsel to a party may give notice for its client provided such notice is otherwise made in accordance with the provisions of this Section. Notices shall be effective on the first business day following the date of mailing or transmission, or upon receipt or personal service. Section 23. General Provisions. (a) The Collateral Agent on behalf of the Secured Party and its successors and permitted assigns shall have no obligation in respect of the FMARC Collateral, except to use reasonable care in holding the FMARC Collateral and to hold and dispose of the same in accordance with the terms of this Pledge Agreement. (b) The failure of the Collateral Agent or the Secured Party to exercise, or delay in exercising, any right, power or remedy hereunder, shall not operate as a waiver thereof, nor shall 21 any single or partial exercise by the Collateral Agent or the Secured Party of any right, power or remedy hereunder preclude any other or future exercise thereof, or the exercise of any other right, power or remedy. The remedies herein provided are cumulative and are not exclusive of any remedies provided by law or any other agreement. (c) The representations, covenants and agreements of the Pledgor herein contained shall survive until the Final Date. (d) Neither this Pledge Agreement nor the provisions hereof can be changed, waived or terminated unless any such change, waiver or termination shall be in writing, signed by the parties hereto; no modification that would be adverse to the Senior Creditors shall be made without the prior written consent of the Senior Creditors for so long as the Senior Security Interests shall continue and any Senior Obligations are unpaid. This Pledge Agreement, subject to the rights of the Senior Creditors for so long as the Senior Security Interests shall continue, shall be binding upon and inure to the benefit of the parties hereto, and their respective successors, legal representatives and permitted assigns. If any provision of this Pledge Agreement shall be invalid or unenforceable in any respect or in any jurisdiction, the remaining provisions shall remain in full force and effect and shall be enforceable to the maximum extent permitted by law. (e) This Pledge Agreement may be executed in counterparts, each of which shall constitute an original but all of which, when taken together, shall constitute one instrument. (f) This Pledge Agreement is fully assignable by the Secured Party, including, but not limited to, assignment to any subsequent purchaser of the Owned Loans or to UDC, any affiliate of UDC, or any successor-in-interest, assign or purchaser of the assets of UDC or any affiliate of UDC. Any assignee, successor or transferee of the Secured Party shall have the right to enforce all the provisions of this Agreement as though such assignee were a signatory hereto. (g) THE VALIDITY OF THIS PLEDGE AGREEMENT, THE CONSTRUCTION, INTERPRETATION, AND ENFORCEMENT HEREOF, AND THE RIGHTS OF THE PARTIES HERETO WITH RESPECT TO ALL MATTERS ARISING HEREUNDER OR RELATED HERETO SHALL BE DETERMINED UNDER, GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF ARIZONA. THE PARTIES AGREE THAT ALL ACTIONS OR PROCEEDINGS ARISING IN CONNECTION WITH THIS PLEDGE AGREEMENT MAY BE TRIED AND LITIGATED IN THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF DELAWARE. PLEDGOR, COLLATERAL AGENT AND THE SECURED PARTY WAIVE, TO THE EXTENT PERMITTED UNDER APPLICABLE LAW, ANY RIGHT EACH MAY HAVE TO ASSERT THE DOCTRINE OF FORUM NON CONVENIENS OR TO OBJECT TO VENUE TO THE EXTENT ANY PROCEEDING IS BROUGHT IN ACCORDANCE WITH THIS 22 SECTION. IN WITNESS WHEREOF, the parties hereto have executed and delivered this Pledge Agreement on the date first above written. FIRST MERCHANTS ACCEPTANCE CORPORATION, a Delaware corporation By: /s/ William H. Plamondon ---------------------------------------- Name: William H. Plamondon -------------------------------------- Title: President CEO ------------------------------------- LaSALLE NATIONAL BANK, as Agent By: /s/ James Thompson ---------------------------------------- Name: James Thompson -------------------------------------- Title: Senior Vice President ------------------------------------- HARRIS TRUST AND SAVINGS BANK, as Collateral Agent By: /s/ Jeffrey L. Kinney ---------------------------------------- Name: Jeffrey L. Kinney -------------------------------------- Title: Assistant Vice President ------------------------------------- UGLY DUCKLING CORPORATION By: /s/ Steven P. Johnson ---------------------------------------- Name: Steven P. Johnson -------------------------------------- Title: Senior Vice President and Secretary ------------------------------------- 23 SCHEDULE I DEFINITIONS "1997-2 Securitized Pool" means the pool of contracts the Debtor securitized through FMARC II on May 1, 1997. "Acquisition Date" means August 21, 1997. "Agent" means LaSalle National Bank in its capacity as agent under the Warehouse Facility, or any successor agent thereunder. "Bank Group" means the Current Bank Group and the Original Bank Group. "Bank Group Claim" means all amounts owed to the Bank Group under the Warehouse Facility. "Bankruptcy Case" means the Debtor's chapter 11 bankruptcy case pending in the United States District Court for the District of Delaware entitled In re First Merchants Acceptance Corporation, Case No. 97-1500(JJF)(D. Del., July 11, 1997). "B Pieces" means all of the residual interests and certificates in the Securitized Pools held by FMARC or FMARC II. "Chapter 11 Plan" means a chapter 11 plan of the Debtor containing terms consistent with the terms of the Modified Plan Agreement. "Committee" means the Official Committee of Unsecured Creditors of First Merchants Acceptance Corporation. "Contracts" means retail installment automobile loan contacts originated or purchased by the Debtor. "Contribution Agreement" means that certain Contribution Agreement dated as of December 15, 1997 between FMAC and UDC. "Court" means the United States District Court for the District of Delaware. "Current Bank Group" means as of December 15, 1997, UDC, Cerberus Partners, L.P., and Bear, Stearns Co., Inc., solely in their capacities as assignees of the Original Bank Group and as the current holders of the Bank Group Claim. "Debtor" means First Merchants Acceptance Corporation. 24 "DIP Facility" means that certain Final Order (1) Authorizing Debtor in Possession Financing; (2) Granting Liens and Superpriority Administrative Claims; (3) Modifying the Automatic Stay; (4) Specifying Use of Cash Collateral; and (5) Granting Adequate Protection Therefor Pursuant to Sections 361 and 363 of the Bankruptcy Code dated August 28, 1997, as amended by that Stipulation and Agreed Order to Amend DIP Facility dated as of December 15, 1997. "Exercise Date" means the date on which UDC will exercise the Stock Option. "Excess Collections Split" means the sharing arrangement between the Debtor and UDC on the proceeds and collections of the Owned Loans and the B Pieces whereby, after payment in full of the Secured Claim Recovery Amount, the DIP Facility and the Modified UDC Fee, the Debtor and UDC will share all excess collections and proceeds on the Owned Loans and the B Pieces, with 82 1/2% of such excess collections and proceeds to be paid to the Debtor and 17 1/2% of such excess collections and proceeds to be paid to UDC, as more particularly described in and subject to the terms of the Contribution Agreement (including adjustments in the sharing percentages upon the occurrence of certain events as set forth in the Contribution Agreement). "FMAC" means First Merchants Acceptance Corporation. "FMARC" means First Merchants Auto Receivables Corporation. "FMARC II" means First Merchants Auto Receivables Corporation II. "FSA" means Financial Security Assurance, Inc. "GE" means General Electric Capital Corporation. "Greenwich" means Greenwich Financial Products, Inc. "Greenwich Collateral" means all Contracts and related collateral securing repayment of the Debtor's obligations to Greenwich. "Modified Plan Agreement" means that certain Binding Agreement To Propose and Support Modified Plan Agreement dated as of December 15, 1997, by and among the Debtor, UDC and the Committee. "Modified UDC Fee" means a $450,000.00, non-recourse, flat fee, payable by the Debtor to UDC prior to initiation of the Excess Collections Split on the B Pieces and solely from collections from and proceeds of the B Pieces and secured by a pledge of the B Pieces subordinate only to the DIP Facility and the Secured Claim Recovery Amount. 25 "Option Notice" means 15 days' advance written notice to be delivered by UDC to the Debtor, and a public announcement by UDC on the same date as the giving of the notice, specifying the Exercise Date and the Stock Option Shares. "Original Bank Group" means LaSalle National Bank; NBD Bank; Firstar Bank Milwaukee, N.A.; Harris Trust and Savings Bank; Nationsbank, N.A.; First Bank, National Association; CoreStates Bank, N.A.; Fleet Bank, National Association, f/k/a Natwest Bank, N.A.; and Mellon Bank, N.A.; solely in their capacity as lenders to FMAC pursuant to the terms of the Warehouse Facility. "Overadvance Cap" means additional advances under the DIP Facility (in excess of the prior limit of $10,000,000 on such advances) to pay administrative and post-Plan Confirmation operating expenses of the Debtor as set forth in that certain Stipulation and Agreed Order to Amend DIP Facility dated as of December 15, 1997 and the Modified Plan Agreement; provided, however, that the total amount of advances outstanding at any time under the DIP Facility shall not exceed $16,500,000.00. "Owned Loans" means all of the Debtor's owned Contracts, other than the Greenwich Collateral, whether current, delinquent, or charged off, together with all of the Debtor's rights in the collateral securing such Contracts and all related repossessed vehicles. "Owned Loan Servicing Fee" means a charge, calculated on a monthly basis for each such Contract, from and after the date on which UDC or its permitted assigns begin to service the Owned Loans, of the greater of (i) 1/12 of 3-1/4% of the then outstanding principal balance of the applicable Contracts, or (ii) $15.00 per Contract, in each case applied only to Contracts which constitute part of the Owned Loans and are less than 120 days past due at the end of such month and for which the related vehicle has not been repossessed. "Petition Date" means July 11, 1997. "Plan Confirmation" means confirmation of the Chapter 11 Plan. "Purchase Price" means the entire amount of the Bank Group Claim as of the Sale Date, including, but not limited to, any and all outstanding principal, plus accrued and unpaid interest through the Sale Date (including default interest from and after the Petition Date through and including the Sale Date), plus an agreed amount of $150,000.00 of attorneys' fees, costs and expenses of the Original Bank Group incurred through the Acquisition Date and stipulated as allowable under 11 U.S.C. Section 506(b), plus all attorneys fees, costs and expenses of the Bank Group incurred after the Acquisition Date allowable under 11 U.S.C. Section 506(b); provided, that, attorneys fees, costs and expenses of the Bank Group incurred after the Acquisition Date will be assumed to be $450,000 for purposes of determining the Purchase Price; and provided further, that, if 26 (i) there are objections by the Debtor, the Committee or any other party-in-interest to the attorneys' fees, costs and expenses of the Bank Group incurred after the Acquisition Date after review of detailed supporting invoices provided by the Bank Group, and (ii) at a subsequent hearing, the Court reduces or increases the amount of such attorneys' fees, costs and expenses allowable under 11 U.S.C. Section 506(b), the Purchase Price will be reduced or increased by an amount equal to the reduction or increase in such fees, costs and expenses. "Replacement Lien" means the lien granted by the Debtor to the Agent on the stock of FMARC and FMARC II to secure the Debtor's non-recourse guaranty of the Secured Claim Recovery Amount. "Retained Property" means all assets of the Debtor other than the Owned Loans, including, but not limited to, the Tax Refunds and other tax attributes of the Debtor, the Greenwich Collateral, and the Debtor's furniture, fixtures, equipment, general intangibles and causes of action. "Sale" means the sale of the Owned Loans by the Debtor to the Agent. "Sale Date" means December 15, 1997. "Secured Claim Recovery Amount" means any shortfall between (i) collections on, net proceeds from sales of charged off Contracts constituting, and net proceeds of collateral securing payment of, the Owned Loans after the Sale Date, and (ii) the Purchase Price plus interest at the rate of 11% from and after the Sale Date until paid in full plus the Owned Loan Servicing Fee, provided, however, that in the event the servicing of the Owned Loans is transferred to an entity other than UDC or a wholly-owned subsidiary of UDC or an entity agreed upon by the Debtor, UDC and the Committee in the Chapter 11 Plan without the prior written consent of the Debtor, which consent will not be unreasonably withheld, the Secured Claim Recovery Amount shall be limited to $10,000,000. "Securitized Pools" means the pools of Contracts the Debtor securitized through FMARC and FMARC II, but excluding the 1997-2 Securitized Pool, unless the Debtor or UDC becomes the servicer for the 1997-2 Securitized Pool. "Securitized Pools Servicing Fee" means, subject to FSA approval (or any other consents required pursuant to governing documents), the base servicing fee UDC and/or the Debtor will receive after the Sale Date for servicing and collection of the Securitized Pools, equal to the greater of 1/12 of 3 1/4%, or $15.00 per Contract, calculated on a monthly basis, on the outstanding principal balance of the Securitized Pools, applied only to Contracts in the Securitized Pools which are less than 120 days past due at the end of such month, and for which the related vehicle has not been repossessed, together with all 27 other amounts, fees, costs and expenses payable under the servicing agreements for the Securitized Pools. "Stock Option" means UDC's option to distribute Stock Option Shares to the Debtor for the benefit of the Debtor's unsecured creditors (and, if applicable, stockholders), or if the Debtor so requests, at the Debtor's expense and solely in accordance with the Debtor's instructions (and UDC shall have no liability to any party in connection with any distribution made in accordance with such instructions), to make direct distribution to the Debtor's unsecured creditors (and if applicable, stockholders), in lieu of the Debtor's right to retain a portion of the Debtor's share of the Excess Collections Split in cash, which UDC may exercise by giving the Option Notice, subject to the following conditions: (a) UDC may exercise the Stock Option one time only, with exercise being the actual delivery of the Stock Option Shares; (b) Revocation of the Option Notice shall not be deemed to be an exercise of the Stock Option by UDC; (c) In the event that UDC exercises the Stock Option, and delivers the Stock Option Shares to the Debtor for the benefit of the Debtor's unsecured creditors (and, if applicable, stockholders), UDC shall be entitled to receive the Debtor's share of cash distributions under the Excess Collections Split from and after the Exercise Date until UDC has received cash distributions equal to the Stock Option Value (this is in addition to UDC's right to receive its share of cash distributions under the Excess Collections Split); (d) Once UDC has received cash distributions equal to the Stock Option Value (without regard to any post-issuance change in the market value of the issued Stock Option Shares), the Debtor shall be entitled to and shall retain the remaining portion of the Debtor's share of cash distributions under the Excess Collections Split, if any, in excess of the Stock Option Value; (e) In no event shall UDC be entitled to receive any portion of the Debtor's share of cash distributions under the Excess Collections Split in excess of the Stock Option Value, nor shall UDC be entitled to recover any portion of the Stock Option Value from any source other than the Debtor's share of the Excess Collections Split; and (f) UDC shall not be entitled to exercise the Stock Option unless and until (i) the value of UDC common stock on the Exercise Date and the closing price for UDC common stock on each day during the previous ten trading days shall be at least $8.00 per share, (ii) UDC shall have caused (at UDC's sole cost and expense) the Stock Option Shares to be (x) registered under the 28 Securities Act of 1933, as amended, (y) unrestricted and (z) fully transferable and shall have taken all steps necessary to allow the Debtor to distribute the Stock Option Shares to the Debtor's unsecured creditors, and if applicable, shareholders, and (iii) UDC shall not have purchased any of its common stock (except upon the exercise of previously issued and outstanding options, warrants, stock appreciation rights or other rights) or announced any stock repurchase programs from and after the delivery of the Option Notice to the Debtor through the Exercise Date. "Stock Option Shares" means the number of shares of UDC common stock that UDC will issue to the Debtor on the Exercise Date. "Stock Option Value" means that aggregate value of the Stock Option Shares, determined by multiplying the Stock Option Shares by 98% of the average of the closing prices of UDC common stock on the NASDAQ National Market or on such other market as such stock may be traded, for the 10 trading days immediately preceding the Exercise Date. "Tax Refunds" means the Debtor's uncollected state and federal income tax refunds for 1996 and prior years. "UDC" means Ugly Duckling Corporation. "UDC Warrants" means 3-year warrants to purchase 325,000 shares of UDC common stock at a price of $20.00 per share which will be callable by UDC when UDC common stock trades at a price of $28.50 per share, or greater, for 10 consecutive trading days, which UDC will issue to the Debtor pursuant to the terms of the Warrant Agreement. "Warehouse Facility" means the Debtor's warehouse loan facility pursuant to that certain Fourth Amended and Restated Loan and Security Agreement, dated as of February 28, 1996, as subsequently amended, by and among FMAC, the Agent and the Original Bank Group. "Warrant Agreement" means that certain Warrant Agreement to be entered into between UDC and Harris Trust Company of California, as warrant agent. EX-10.33 4 EX-10.33 1 Exhibit 10.33 INDEMNIFICATION AGREEMENT BY AND BETWEEN UGLY DUCKLING CORPORATION AND FIRST MERCHANTS ACCEPTANCE CORPORATION Indemnification Agreement (this "Agreement") dated as of February 11, 1998, by and between Ugly Duckling Corporation, a Delaware corporation ("UDC") and First Merchants Acceptance Corporation, a Delaware corporation ("FMAC"). RECITALS: WHEREAS, FMAC filed for reorganization under Title 11 of the United States Code (the "Bankruptcy Code") on July 11, 1997, in the United States Bankruptcy Court for the District of Delaware, case number 97-1500 (the "Bankruptcy Case"); and WHEREAS, FMAC filed a Joint Disclosure Statement of Debtors in connection with solicitation of ballots with respect to the Joint Plan (the "Joint Plan") under Chapter 11 of the United States Bankruptcy Code (the "Disclosure Statement") with such bankruptcy court; and WHEREAS, as part of said reorganization, UDC will assume certain servicing rights and certain interests in securitization rights, and will issue to FMAC or the unsecured creditors and/or equity holders of FMAC common stock and warrants pursuant to a registration statement filed by UDC on Form S-1, dated December 22, 1997, file no. 333-42973 (the "Registration Statement"). The Prospectus (as defined herein) included in the Registration Statement at the time the Registration Statement is declared effective by the Securities and Exchange Commission will be attached as an exhibit to the Disclosure Statement. NOW, THEREFORE, in consideration of the mutual covenants contained herein, the parties hereto agree as follows: SECTION 1 INDEMNIFICATION 1.1 INDEMNIFICATION BY UDC. UDC agrees to indemnify and hold harmless FMAC and its respective affiliates, directors, officers, employees, agents, counsel, and representatives (collectively, the "FMAC Parties") against any losses, claims, damages, or liabilities to which such FMAC Parties or any one or more of them may become subject under the Securities Act of 1933 or otherwise, insofar as such losses, claims, damages, or liabilities (or actions or proceedings in respect thereof) arise out of or are based upon (i) any untrue statement or alleged untrue statement of any 2 2 material fact contained in the Registration Statement, any related prospectus ("Prospectus"), or any amendment or supplement thereto, or (ii) the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading in light of the circumstances under which they were made, and will reimburse each FMAC Party for any reasonable legal or other expense incurred by such FMAC Party in connection with investigating or defending any such loss, claim, damage, liability, action or proceeding; provided, however, that UDC will not be liable in any such case to the extent that any such loss, claim, damage, or liability arises out of or is based upon an untrue statement, or alleged untrue statement or omission or alleged omission made in the Registration Statement, any Prospectus, or such amendment or supplement thereto in reliance upon and in conformity with written information furnished to UDC by or through FMAC specifically for use in the preparation thereof (the "FMAC Information"). UDC expressly assumes responsibility to provide FMAC with copies of the Prospectus (and any Prospectus as amended or supplemented) in sufficient time and in sufficient quantities for FMAC to distribute the Prospectuses to each person entitled to vote on the Joint Plan and, in the event that the Warrants and/or the Stock Option Shares are distributed by UDC directly to FMAC and FMAC elects to offer or sell the "Warrants," related "Warrant Shares," or "Stock Option Shares," as such terms are defined in the Prospectus, in lieu of distributing the Warrants, related Warrant Shares, or Stock Option Shares to its unsecured creditors and/or existing equity holders, to each person to whom FMAC offers or sells such Warrants, related Warrant Shares, or Stock Option Shares and FMAC expressly assumes responsibility to timely notify UDC of the quantities required and to ensure that Prospectuses are distributed to all such persons in accordance with applicable law. UDC's responsibility in the immediately preceding sentence to timely provide copies of Prospectuses to FMAC is qualified by the following: (i) with respect to Prospectuses to be distributed to those persons entitled to vote on the Joint Plan, UDC will use its best efforts to provide the quantity of Prospectuses requested by FMAC to the location requested by FMAC as soon as practicable after the Registration Statement has been declared effective by the SEC and (ii) with respect to Prospectuses to be distributed thereafter, UDC's responsibilities herein are qualified by reference to Section 14(a) of the Warrant Agreement to be entered into between UDC and the Warrant Agent (described therein) under which UDC will issue the Warrants, which Section references the fact that there may be periods during which UDC will be required to supplement or amend the Registration Statement and during which trading of the securities registered thereby will be suspended. This Agreement will be in addition to any liability that UDC may otherwise have. 1.2 INDEMNIFICATION BY FMAC. FMAC will indemnify and hold harmless UDC and its respective affiliates, directors, officers, employees, agents, counsel, and representatives (collectively, the "UDC Parties") against any losses, claims, damages or liabilities to which the UDC Parties or any one or more of them may become subject, under the Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions or proceedings in respect thereof) arise out of or are based upon (i) any untrue statement or alleged untrue statement of any material fact contained in the Disclosure Statement (excluding the Prospectus provided by UDC attached as Exhibit V thereto, other than the FMAC Information contained therein), or any amendment or supplement thereto, (ii) the omission or alleged omission to state in the Disclosure Statement (excluding the Prospectus provided by UDC attached as Exhibit V thereto, other than the FMAC Information contained 2 3 therein), or any amendment or supplement thereto, a material fact required to be stated therein or necessary to make the statements therein not misleading in light of the circumstances under which they were made, (iii) offers of Warrants, related Warrant Shares, or Stock Option Shares, if any, made in violation of applicable securities laws as a result of FMAC's dissemination of the draft disclosure statement, filed with the United States Bankruptcy Court for the District of Delaware, on or about December 15, 1997, to interested parties, or (iv) the failure of FMAC to file any required federal or state registrations as a broker dealer in connection with the distribution of the securities covered by the Registration Statement (other than the Bank Group Warrants (as defined in the Prospectus) and the shares issuable on exercise thereof) (the "Securities"), and will reimburse any reasonable legal or other expense reasonably incurred by the UDC Parties in connection with investigating or defending any such loss, claim, damage, liability, action or proceeding. This Agreement will be in addition to any liability which FMAC may otherwise have. 1.3 INDEMNIFICATION PROCEDURE. In case any proceeding (including any governmental investigation) shall be instituted involving any person in respect of which indemnity may be sought pursuant to this Section 1.3, such person (the "Indemnified Party") shall promptly notify the person against whom such indemnity may be sought (the "Indemnifying Party") in writing. No indemnification provided for in Sections 1.1 or 1.2 shall be available to any party who shall fail to give notice as provided in this Section 1.3 if the party to whom notice was not given was unaware of the proceeding to which such notice would have related and was materially prejudiced by the failure to give such notice, but the failure to give such notice shall not relieve the Indemnifying Party or Parties of any liability which it or they may have to the Indemnified Party for contribution or otherwise then on account of the provisions of Sections 1.1 or 1.2. In case any such proceeding shall be brought against any Indemnified Party and it shall notify the Indemnifying Party of the commencement thereof, the Indemnifying Party shall be entitled to participate therein and, to the extent that it shall wish, jointly with any other Indemnifying Party similarly notified, to assume the defense thereof, with counsel reasonably satisfactory to such Indemnified Party and shall pay as incurred the reasonable fees and disbursements of such counsel related to such proceeding. In any such proceeding, any Indemnified Party shall have the right to retain its own counsel at its own expense. Notwithstanding the foregoing, the Indemnifying Party shall pay as incurred the reasonable fees and expenses of the counsel retained by the Indemnified Party in the event (i) the Indemnifying Party and the Indemnified Party shall have mutually agreed to the retention of such counsel or (ii) the named parties to any such proceeding (including any impleaded parties) include both the Indemnifying Party and the Indemnified Party and representation of both parties by the same counsel would be inappropriate due to actual or potential differing interests between them. It is understood that the Indemnifying Party shall not, in connection with any proceeding or related proceedings in the same jurisdiction, be liable for the reasonable fees and expenses of more than one separate firm and local counsel as appropriate for all such indemnified parties. Such firm shall be designated in writing by FMAC in the case of parties indemnified pursuant to Section 1.1 and by UDC in the case of parties indemnified pursuant to Section 1.2 and shall be subject to the reasonable consent of the other party. The Indemnifying Party shall not be liable for any settlement of any proceeding effected without its written consent but if settled with such consent or if there be a final judgment for the 3 4 plaintiff, the Indemnifying Party agrees to indemnify the Indemnified Party from and against any loss or liability by reason of such settlement or judgment. 1.4 CONTRIBUTION. If the indemnification provided for in this Section 1 is unavailable or insufficient to hold harmless an indemnified party under Section 1.1 or 1.2 above in respect of any losses, claims, damages or liabilities (or actions or proceedings in respect thereof) referred to therein, then each Indemnifying Party shall contribute to the amount paid or payable by such Indemnified Party as a result of such losses, claims, damages or liabilities (or actions or proceedings in respect thereof) in such proportion as is appropriate to reflect the relative benefits received by UDC on the one hand and FMAC, on the other from the offering of the Securities. If, however, the allocation provided by the immediately preceding sentence is not permitted by applicable law or if the Indemnified Party failed to give the notice required under Section 1.3 above and the Indemnifying Party was materially prejudiced thereby, then each Indemnifying Party shall contribute to such amount paid or payable by such Indemnified Party in such proportion as is appropriate to reflect not only such relative benefits but also the relative fault of UDC, on the one hand and FMAC, on the other in connection with the statements or omissions which resulted in such lawsuits, claims, damages or liabilities (or actions or proceedings in respect thereof), as well as any other relevant equitable considerations. The relative fault shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by UDC or any UDC Party, on the one hand or FMAC or any FMAC Party, on the other and the parties relative intent, knowledge, access to information, an opportunity to correct or prevent such statement or omission. UDC and FMAC agree that it would not be just and equitable if contributions pursuant to this Section 1.4 were determined by pro rata allocation or by any other method of allocation that does not take into account the equitable considerations referred to above in this Section 1.4. The amount paid or payable by an Indemnified Party as a result of the losses, claims, damages or liabilities (or actions or proceedings in respect thereof) referred to above in this Section 1.4 shall be deemed to include any legal or other expenses reasonably incurred by such Indemnified Party in connection with investigating or defending any such action or claim. Notwithstanding the provisions of this Section 1.4, no person guilty of fraudulent misrepresentations (within the meaning of Section 11 (f) of the Act) shall be entitled to contribution from any person who is not guilty of such fraudulent misrepresentation. 1.5 JURISDICTION. Any proceeding relating to this Agreement and the transactions contemplated hereby shall be brought in a state court of Delaware or a federal court located in Delaware. Each party hereto hereby consents to personal jurisdiction in any such action brought in any such Delaware or federal court, agrees that process issuing from such court may be served upon him or it by any other party and consents to the service of such process, and waives any objection to venue in any such Delaware or federal court and any claim that any such Delaware or federal court is an inconvenient forum. 4 5 1.6 INFORMATION. Prior to the execution and delivery of this Agreement, FMAC will provide to UDC a letter specifying those sections of or that material in the Prospectus that will be deemed to have been provided to UDC by FMAC specifically for inclusion therein for purposes of this Agreement. If at any time in the future, UDC proposes to amend any such information, UDC will give prior written notice and the opportunity to review and comment on the revised material to FMAC and thereafter, to the extent that FMAC approves the revision in writing, the revised material will continue to be deemed to have been provided to UDC by FMAC specifically for inclusion in the Prospectus for purpose of this Agreement. 1.7 ADMINISTRATIVE CLAIMS; BAR DATE; CONDITIONS TO OBLIGATIONS. FMAC's obligations hereunder are entitled to administrative expense priority in the Bankruptcy Case under 11 U.S.C. s. 503. In the event the Joint Plan is confirmed, FMAC agrees that any obligation hereunder owing UDC by FMAC shall be paid by Debtor from the B Pieces and any other asset of the estate after payment to UDC of the Secured Claim Recovery Amount and the Modified UDC Fee, and prior to any payments to the FMAC estate or creditors thereof. FMAC further agrees to, in connection with confirmation of the Joint Plan, set a "bar" date on or before which creditors or other interested parties can file a claim against FMAC or any other person relating to information contained or omitted from the Disclosure Statement. This bar date will be set at 60 days after confirmation. Any creditors or parties in interest not filing claims on or before the bar date shall be forever barred and enjoined from asserting any claims against any of FMAC and/or any other person on account of any liabilities hereunder. To the extent the Joint Plan is not confirmed and the Break-up Fee is payable, UDC will have no obligations under this Agreement. Capitalized terms used in this Section 1.7 and not otherwise defined will have the meanings given in the Joint Plan. SECTION 2 MISCELLANEOUS 2.1. GOVERNING LAW. The interpretation and construction of this Agreement, and all matters relating hereto, shall be governed by the laws of the State of Delaware applicable to agreements executed and to be performed solely within such state without regard to conflict of laws rules thereof. 2.2. CAPTIONS. The Article and Section captions used herein are for reference purposes only and shall not in any way affect the meaning or interpretation of this Agreement. 2.3 NOTICES. Any notice or other communication required or permitted under this Agreement shall be sufficiently given in delivered in person or sent by telecopy or by registered or certified mail, postage prepaid, addressed as follows: 5 6 If to any FMAC Party: First Merchants Acceptance Corporation 570 Lake Cook Road, Suite 126 Deerfield, Illinois 60015 Facsimile: (847) 948-9303 With a copy to: Mitchell L. Hollins, Esq. Sonnenschein Nath & Rosenthal 8000 Sears Tower Chicago, Illinois 60606 Facsimile: (312) 876-7934 If to any UDC Party: Ugly Duckling Corporation 2525 E. Camelback Road, Suite 1150 Phoenix, Arizona 85016 Facsimile: (303) 852-6696 With a copy to: Steven D. Pidgeon, Esq. Snell & Wilmer, L.L.P. One Arizona Center Phoenix, Arizona 85004-0001 Facsimile: (303) 832-6070 or such other address or number as shall be furnished in writing by any such party, and such notice or communication shall be deemed to have been given as of the date so delivered, sent by facsimile or mail. 2.4 PARTIES IN INTEREST. This Agreement shall be binding upon UDC and FMAC and shall inure to the benefit of the UDC Parties and FMAC Parties and their respective heirs, executors, administrators, successors, and permitted assigns. 2.5 ASSIGNMENT. Neither this Agreement nor the rights and obligations of the parties hereunder may be assigned by either party without the prior written consent of the other party. 2.6 COUNTERPARTS. This Agreement may be executed in two or more counterparts, all of which taken together shall constitute one instrument. 6 7 2.7 ENTIRE AGREEMENT. This Agreement, including the other documents referred to herein and therein which form a part hereof and thereof, contain the entire understanding of the parties hereto with respect to the subject matter contained herein and therein. This Agreement supersedes all prior agreements and understandings between the parties with respect to such subject matter. 2.8 AMENDMENTS. This Agreement may not be changed orally but only by an agreement in writing signed by both FMAC and UDC. 2.9 SEVERABILITY. In case any provision of this Agreement shall be held invalid, illegal or unenforceable, the validity, legality, and enforceability of the remaining provisions hereof will not in any way be affected or impaired thereby. IN WITNESS WHEREOF, the parties hereto have executed or caused this Agreement to be duly executed on their respective behalf, by their respective officers thereunto duly authorized, all as of the day and year first above written. UGLY DUCKLING CORPORATION: By: Steven P. Johnson ----------------------------------- Its: Senior Vice President and Secretary ----------------------------------- FIRST MERCHANTS ACCEPTANCE CORPORATION: By: William H. Plamondon ----------------------------------- Its: President ----------------------------------- 7 EX-12 5 EX-12 1 Exhibit 12 Ugly Duckling Corporation Ratio Of Earnings to Fixed Charges
(dollar amounts in thousands) 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- Fixed Charges: Interest expense $ 5,260 $5,262 $ 5,956 $ 3,037 $ 893 Capitalized interest 229 0 54 142 0 Interest factor in rent expense (1) 1,764 790 784 462 161 ------- ------ ------- ------- ------- $ 7,253 $6,052 $ 6,794 $ 3,641 $ 1,054 ======= ====== ======= ======= ======= Earnings: Earnings (Loss) from operations $16,024 $ 5,966 $(3,972) $(2,301) $ 728 Fixed charges 7,253 6,052 6,794 3,641 1,054 ------- ------- ------- ------- ------- $23,277 $12,018 $ 2,822 $ 1,340 $ 1,782 ======= ======= ======= ======= ======= Ratio of Earnings to fixed charges 3.21 1.99 0.42 (2) 0.37 (2) 1.69 ======= ======= ======= ======= =======
(1) One-third of rent expense is deemed to be representative of the interest factor. (2) Earnings are inadequate to cover fixed charges. The deficiency in 1994 and 1995 was $2,301 and $3,972, respectively. EX-21 6 EX-21 1 Exhibit 21 LIST OF SUBSIDIARIES
Name Jurisdiction of Incorporation - ---- ----------------------------- Duck Ventures, Inc. Arizona Ugly Duckling Car Sales, Inc. Arizona Champion Acceptance Corporation Arizona Champion Financial Services, Inc. Arizona Champion Receivables Corp. Delaware Cygnet Finance, Inc. Arizona Drake Insurance Services, Inc. Arizona Drake Insurance Agency, Inc. Arizona Udrac Rentals, Inc. Arizona Ugly Duckling Car Sales Florida, Inc. Florida Ugly Duckling Car Sales New Mexico, Inc. New Mexico Udrac, Inc. Arizona Ugly Duckling Car Sales Texas, LLP Arizona Ugly Duckling Car Sales Georgia, Inc. Georgia Ugly Duckling Car Sales California, Inc. California Cygnet Finance Alabama, Inc. Arizona Drake Property & Casualty Life Insurance Company Turks & Caicos Drake Life Insurance Company Turks & Caicos Champion Receivables Corp. II Delaware
EX-23.1 7 EX-23.1 1 EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT The Board of Directors Ugly Duckling Corporation: We consent to incorporation by reference in the registration statements of Ugly Duckling Corporation on Form S-3 (File No. 333-31531) filed as of July 18, 1997, as amended by pre-effective amendment No. 1 to Form S-3 filed as of July 30, 1997; Form S-3 (File No. 333-22237) filed as post-effective amendment No. 2 to Form S-1 as of July 18, 1997, Form S-8 (File No. 333-32313) for Ugly Duckling Corporation Long-Term Incentive Plan filed as of July 29, 1997; Form S-8 (File No. 333-08457) for Ugly Duckling Corporation Long-Term Incentive Plan filed as of July 19, 1996; Form S-8 (File No. 333-06615) for Ugly Duckling Corporation Director Incentive Plan filed as of June 21, 1996 of our report dated February 10, 1998, relating to the consolidated balance sheets of Ugly Duckling Corporation and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1997, which report appears in the December 31, 1997, annual report on Form 10-K of Ugly Duckling Corporation. KPMG PEAT MARWICK LLP Phoenix, Arizona March 27, 1998 EX-24.1 8 EX-24.1 1 EXHIBIT 24.1 SPECIAL POWER OF ATTORNEY (for Robert J. Abrahams) KNOW ALL MEN BY THESE PRESENTS, that the undersigned constitutes and appoints Ernest C. Garcia II, Gregory B. Sullivan, and Steven T. Darak, and Steven P. Johnson, and each of them, his true and lawful attorney-in-fact and agent with full power of substitution and resubstitution, for him and in his name, place, and stead, in any and all capacities, to sign the Annual Report on Form 10-K for the fiscal year ended December 31, 1997, for filing with the Securities and Exchange Commission ("SEC") by Ugly Duckling Corporation, a Delaware corporation, together with any and all amendments to such Form 10-K, and to file the same with all exhibits thereto, and all documents in connection therewith, with the SEC, granting to such attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully and to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that such attorneys-in-fact and agents, or each of them, may lawfully do or cause to be done by virtue hereof. DATE: February 6, 1998 /s/ ROBERT J. ABRAHAMS EX-24.2 9 EX-24.2 1 EXHIBIT 24.2 SPECIAL POWER OF ATTORNEY (for Christopher D. Jennings) KNOW ALL MEN BY THESE PRESENTS, that the undersigned constitutes and appoints Ernest C. Garcia II, Gregory B. Sullivan, and Steven T. Darak, and Steven P. Johnson, and each of them, his true and lawful attorney-in-fact and agent with full power of substitution and resubstitution, for him and in his name, place, and stead, in any and all capacities, to sign the Annual Report on Form 10-K for the fiscal year ended December 31, 1997, for filing with the Securities and Exchange Commission ("SEC") by Ugly Duckling Corporation, a Delaware corporation, together with any and all amendments to such Form 10-K, and to file the same with all exhibits thereto, and all documents in connection therewith, with the SEC, granting to such attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully and to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that such attorneys-in-fact and agents, or each of them, may lawfully do or cause to be done by virtue hereof. DATE: February 6, 1998 /s/ CHRISTOPHER D. JENNINGS EX-24.3 10 EX-24.3 1 EXHIBIT 24.3 SPECIAL POWER OF ATTORNEY (for John N. MacDonough) KNOW ALL MEN BY THESE PRESENTS, that the undersigned constitutes and appoints Ernest C. Garcia II, Gregory B. Sullivan, and Steven T. Darak, and Steven P. Johnson, and each of them, his true and lawful attorney-in-fact and agent with full power of substitution and resubstitution, for him and in his name, place, and stead, in any and all capacities, to sign the Annual Report on Form 10-K for the fiscal year ended December 31, 1997, for filing with the Securities and Exchange Commission ("SEC") by Ugly Duckling Corporation, a Delaware corporation, together with any and all amendments to such Form 10-K, and to file the same with all exhibits thereto, and all documents in connection therewith, with the SEC, granting to such attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully and to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that such attorneys-in-fact and agents, or each of them, may lawfully do or cause to be done by virtue hereof. DATE: February 6, 1998 /s/ JOHN N. MACDONOUGH EX-24.4 11 EX-24.4 1 EXHIBIT 24.4 SPECIAL POWER OF ATTORNEY (for Arturo R. Moreno) KNOW ALL MEN BY THESE PRESENTS, that the undersigned constitutes and appoints Ernest C. Garcia II, Gregory B. Sullivan, and Steven T. Darak, and Steven P. Johnson, and each of them, his true and lawful attorney-in-fact and agent with full power of substitution and resubstitution, for him and in his name, place, and stead, in any and all capacities, to sign the Annual Report on Form 10-K for the fiscal year ended December 31, 1997, for filing with the Securities and Exchange Commission ("SEC") by Ugly Duckling Corporation, a Delaware corporation, together with any and all amendments to such Form 10-K, and to file the same with all exhibits thereto, and all documents in connection therewith, with the SEC, granting to such attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully and to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that such attorneys-in-fact and agents, or each of them, may lawfully do or cause to be done by virtue hereof. DATE: February 6 1998 /s/ ARTURO R. MORENO EX-24.5 12 EX-24.5 1 EXHIBIT 24.5 SPECIAL POWER OF ATTORNEY (for Frank P. Willey) KNOW ALL MEN BY THESE PRESENTS, that the undersigned constitutes and appoints Ernest C. Garcia II, Gregory B. Sullivan, and Steven T. Darak, and Steven P. Johnson, and each of them, his true and lawful attorney-in-fact and agent with full power of substitution and resubstitution, for him and in his name, place, and stead, in any and all capacities, to sign the Annual Report on Form 10-K for the fiscal year ended December 31, 1997, for filing with the Securities and Exchange Commission ("SEC") by Ugly Duckling Corporation, a Delaware corporation, together with any and all amendments to such Form 10-K, and to file the same with all exhibits thereto, and all documents in connection therewith, with the SEC, granting to such attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully and to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that such attorneys-in-fact and agents, or each of them, may lawfully do or cause to be done by virtue hereof. DATE: February 11, 1998 /s/ FRANK P. WILLEY EX-27 13 EX-27
5 This schedule contains summary financial information extracted from the Company's audited financial statements as of and for the year ended December 31, 1997, and is qualified in its entirety by reference to such statements. 1,000 12-MOS 12-MOS 12-MOS DEC-31-1997 DEC-31-1996 DEC-31-1995 DEC-31-1997 DEC-31-1996 DEC-31-1995 3,537 18,455 1,419 18,914 3,479 0 145,239 69,077 49,226 22,146 8,125 8,500 33,888 5,752 6,329 0 0 0 46,891 23,591 9,236 (5,639) (2,939) (1,439) 279,054 118,083 60,790 0 0 0 0 0 0 0 0 0 0 0 10,000 172,622 82,612 127 9,152 (293) (5,243) 279,054 118,083 60,790 123,814 53,768 47,824 191,118 75,629 58,203 66,509 29,890 27,964 0 0 0 79,250 24,700 19,896 24,075 9,811 8,359 5,260 5,262 5,956 16,024 5,966 (3,972) 6,579 100 0 0 0 0 0 0 0 0 0 0 0 0 0 9,445 5,866 (3,972) .53 .63 (.72) .52 .60 (.72) UNCLASSIFIEDBALANCESHEET
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