-----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, HNEhJWZOL4RrUzeWm3oDx0LpRoXvYDfHZzeQU2R++L6HVA3qz+UceEZMURQouync 0beJZV1Vxk0/MITZtXCRrQ== 0001012704-01-500064.txt : 20020410 0001012704-01-500064.hdr.sgml : 20020410 ACCESSION NUMBER: 0001012704-01-500064 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20011112 FILED AS OF DATE: 20011114 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-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-14759 FILM NUMBER: 1791534 BUSINESS ADDRESS: STREET 1: 2525 E CAMELBACK ROAD STREET 2: STE 500 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-Q 1 f10qtxt.txt F10Q ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 --------------- FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended: September 30, 2001 Commission File Number 000-20841 UGLY DUCKLING CORPORATION (Exact name of registrant as specified in its charter) Delaware 86-0721358 (State or other jurisdiction of (I.R.S. employer incorporation or organization) Identification no.) 4020 E. Indian School Road Phoenix, Arizona 85018 (Address of principal executive (Zip Code) offices) (602) 852-6600 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No --------------- INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE ISSUER'S CLASSES OF COMMON STOCK, AS OF THE LATEST PRACTICABLE DATE: At November 12, 2001, there were approximately 12,274,000 shares of Common Stock, $0.001 par value, outstanding. This document serves both as a resource for analysts, shareholders, and other interested persons, and as the quarterly report on Form 10-Q of Ugly Duckling Corporation (Ugly Duckling) to the Securities and Exchange Commission, which has taken no action to approve or disapprove the report or pass upon its accuracy or adequacy. Additionally, this document is to be read in conjunction with the consolidated financial statements and notes thereto included in Ugly Duckling's Annual Report on Form 10-K, for the year ended December 31, 2000. ================================================================================ UGLY DUCKLING CORPORATION FORM 10-Q TABLE OF CONTENTS
Page Part I - FINANCIAL STATEMENTS Item 1. FINANCIAL STATEMENTS Condensed Consolidated Balance Sheets-- September 30, 2001 and December 31, 2000 1 Condensed Consolidated Statements of Operations-- Three and Nine Months Ended September 30, 2001 and 2000 2 Condensed Consolidated Statements of Cash Flows-- Nine Months Ended September 30, 2001 and 2000 3 Notes to Condensed Consolidated Financial Statements 4 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 10 Item 3. MARKET RISK 24 Part II.-- OTHER INFORMATION Item 1. LEGAL PROCEEDINGS 24 Item 2. CHANGES IN SECURITIES 25 Item 3. DEFAULTS UPON SENIOR SECURITIES 25 Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 25 Item 5. OTHER INFORMATION 25 Item 6. EXHIBITS AND REPORTS ON FORM 8-K 25 SIGNATURES 25
ITEM 1. UGLY DUCKLING CORPORATION Consolidated Balance Sheets (In thousands, except share amounts) (Unaudited)
September 30, December 31, 2001 2000 ------------------ ----------------- ASSETS Cash and Cash Equivalents $ 7,384 $ 8,805 Finance Receivables, Net 501,048 500,469 Note Receivable from Related Party 12,000 12,000 Inventory 47,414 63,742 Property and Equipment, Net 39,487 38,679 Intangible Assets, Net 11,808 12,527 Other Assets 34,555 11,724 Net Assets of Discontinued Operations 4,044 4,175 ------------------ ----------------- $ 657,740 $ 652,121 ================== ================= LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Accounts Payable $ 3,104 $ 2,239 Accrued Expenses and Other Liabilities 42,268 36,830 Notes Payable - Portfolio 386,572 406,551 Other Notes Payable 41,646 16,579 Subordinated Notes Payable 32,600 34,522 ------------------ ----------------- Total Liabilities 506,190 496,721 ------------------ ----------------- Stockholders' Equity: Preferred Stock $.001 par value, 10,000 shares authorized none issued and outstanding - - Common Stock $.001 par value, 100,000 shares authorized; 18,764 issued; and 12,275 and 12,292 outstanding, respectively 19 19 Additional Paid-in Capital 173,741 173,723 Retained Earnings 18,141 21,772 Treasury Stock, at cost (40,351) (40,114) ------------------ ----------------- Total Stockholders' Equity 151,550 155,400 Commitments and Contingencies - - ------------------ ----------------- $ 657,740 $ 652,121 ================== ================= See accompanying notes to Condensed Consolidated Financial Statements.
1 UGLY DUCKLING CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS Three and Nine Months Ended September 30, 2001 and 2000 (In thousands, except cars sold and earnings per share amounts) (Unaudited)
Three Months Ended Nine Months Ended September 30, September 30, ---------------------------- ------------------------------ 2001 2000 2001 2000 ============================ ============================== Sales of Used Cars $110,237 $ 126,636 $ 346,342 $ 380,949 Less: Cost of Used Cars Sold 62,622 70,760 196,102 212,119 Provision for Credit Losses 48,755 36,092 119,985 102,877 ---------------------------- ------------------------------ (1,140) 19,784 30,255 65,953 ---------------------------- ------------------------------ Other Income (Expense): Interest Income 35,000 31,436 103,744 86,838 Portfolio Interest Expense (7,489) (7,318) (23,500) (18,344) ---------------------------- ------------------------------ Net Interest Income 27,511 24,118 80,244 68,494 ---------------------------- ------------------------------ Income before Operating Expenses 26,371 43,902 110,499 134,447 Operating Expenses: Selling and Marketing 6,084 7,187 19,945 22,748 General and Administrative 26,807 27,523 81,462 78,253 Depreciation and Amortization 2,339 2,285 7,181 6,724 ---------------------------- ------------------------------ Operating Expenses 35,230 36,995 108,588 107,725 ---------------------------- ------------------------------ Income (loss) before Other Interest Expense (8,859) 6,907 1,911 26,722 Other Interest Expense 2,695 2,360 8,648 7,237 ---------------------------- ------------------------------ Earnings (loss) before Income Taxes (11,554) 4,547 (6,737) 19,485 Income Taxes (Benefit) (4,737) 1,864 (2,762) 7,971 ---------------------------- ------------------------------ Earnings (loss) before Extraordinary Item (6,817) 2,683 (3,975) 11,514 Extraordinary Item - Gain on early extinguishment of debt, net - - 344 - ---------------------------- ------------------------------ Net Earnings (loss) $ (6,817) $ 2,683 $ (3,631) $ 11,514 ============================ ============================== Earnings (loss) per Common Share before Extraordinary Item: Basic $ (0.56) $ 0.21 $ (0.32) $ 0.83 ============================ ============================== Diluted $ (0.56) $ 0.21 $ (0.32) $ 0.82 ============================ ============================== Net Earnings (loss) per Common Share: Basic $ (0.56) $ 0.21 $ (0.30) $ 0.83 ============================ ============================== Diluted $ (0.56) $ 0.21 $ (0.30) $ 0.82 ============================ ============================== Weighted Average Shares Used in Computation: Basic Shares Outstanding 12,276 12,597 12,289 13,847 ============================ ============================== Diluted Shares Outstanding 12,276 12,747 12,289 14,044 ============================ ============================== See accompanying notes to Condensed Consolidated Financial Statements.
2 UGLY DUCKLING CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS Nine Months ended September 30, 2001 and 2000 (In thousands) (Unaudited)
Nine Months Ended September 30, ----------------------------- 2001 2000 ----------------------------- Cash Flows from Operating Activities: Net Earnings (Loss) $ (3,631) $ 11,514 Adjustments to Reconcile Net Earnings to Net Cash Provided by Operating Activities: Provision for Credit Losses 119,985 102,877 Depreciation and Amortization 10,632 10,453 (Gain) Loss from Disposal of Property and Equipment 755 3 Collections from Residuals in Finance Receivables Sold 1,136 13,055 Decrease in Inventory 16,328 19,126 (Increase) Decrease in Other Assets (16,068) 600 Increase (Decrease) in Accounts Payable, Accrued Expenses and Other Liabilities (499) 14,040 Increase (Decrease) in Income Taxes Payable 6,802 (558) ----------------------------- Net Cash Provided by Operating Activities 135,440 171,110 ----------------------------- Cash Flows Used in Investing Activities: Increase in Finance Receivables (313,376) (392,788) Collections on Finance Receivables 184,926 157,067 Decrease in Investments Held in Trust on Finance Receivables Sold 1,398 7,969 Proceeds from Disposal of Property and Equipment 2,542 3,142 Purchase of Property and Equipment (10,569) (11,625) ----------------------------- Net Cash Used in Investing Activities (135,079) (236,235) ----------------------------- Cash Flows from Financing Activities: Initial Deposits at Securitization into Investments Held in Trust (6,407) (20,738) Additional Deposits into Investments Held in Trust (69,358) (10,849) Collections from Investments Held in Trust 81,118 17,544 Additions to Notes Payable Portfolio 447,328 554,153 Repayment of Notes Payable Portfolio (469,638) (469,481) Additions to Other Notes Payable 44,232 1,267 Repayment of Other Notes Payable (19,873) (20,133) Repayment of Subordinated Notes Payable (9,333) (1,500) Proceeds from Issuance of Common Stock 18 437 Acquisition of Treasury Stock - (11,114) ----------------------------- Net Cash (Used)Provided by Financing Activities (1,913) 39,586 ----------------------------- Net Cash Provided by Discontinued Operations 131 28,411 ----------------------------- Net Increase (Decrease) in Cash and Cash Equivalents (1,421) 2,872 Cash and Cash Equivalents at Beginning of Period 8,805 3,683 ----------------------------- Cash and Cash Equivalents at End of Period $ 7,384 $ 6,555 ============================= Supplemental Statement of Cash Flows Information: Interest Paid $ 28,437 $ 20,712 ============================= Income Taxes Paid $ 4,258 $ 8,524 ============================= Acquisition of Treasury Stock with Subordinated Debt $ - $ 8,005 ============================= Acquisition of Treasury Stock in Conjunction with Severance Agreement $ 237 $ - ============================= See accompanying notes to Condensed Consolidated Financial Statements.
3 UGLY DUCKLING CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 1. Basis of Presentation Our accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and pursuant to rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by such accounting principles generally accepted in the United States of America for a complete financial statement presentation. In our opinion, such unaudited interim information reflects all adjustments, consisting only of normal recurring adjustments, necessary to present our financial position and results of operations for the periods presented. Our results of operations for interim periods are not necessarily indicative of the results to be expected for a full fiscal year. Our Condensed Consolidated Balance Sheet as of December 31, 2000 was derived from our audited consolidated financial statements as of that date but does not include all the information and footnotes required by accounting principles generally accepted in the United States of America. For a complete financial statement presentation, we suggest that these condensed consolidated financial statements be read in conjunction with the audited consolidated financial statements included in our Annual Report on Form 10-K, for the year ended December 31, 2000. All amounts are in thousands with the exception of per share, per unit and per car data, unless otherwise noted. Note 2. Summary of Finance Receivables A summary of Finance Receivables, net, follows:
September 30, December 31, 2001 2000 ----------------- ----------------- Contractually Scheduled Payments $ 727,051 $ 696,220 Unearned Finance Charges (189,105) (181,274) ----------------- ----------------- Principal Balances, net 537,946 514,946 Accrued Interest 5,981 5,655 Loan Origination Costs 7,233 7,293 ----------------- ----------------- Principal Balances, net 551,160 527,894 Investments Held in Trust 64,388 71,139 Residuals in Finance Receivables Sold - 1,136 ----------------- ----------------- Finance Receivables 615,548 600,169 Allowance for Credit Losses (114,500) (99,700) ----------------- ----------------- Finance Receivables, net $ 501,048 $ 500,469 ================= ================= Allowance as % of Ending Principal Balances, net 21.3% 19.4% ================= =================
Investments Held in Trust represent funds held by trustees on behalf of our securitization bondholders. Note 3. Related Party Transactions On September 21, 2001, Mr. Ernest C. Garcia II, the Company's Chairman of the Board and largest shareholder, confirmed to the Board of Directors the withdrawal of his offer to purchase all of the outstanding stock of the Company not owned by him. In May 2001, Verde purchased one of the Company properties at its book value of approximately $1,650,000. Verde has leased the property back to the Company under a 20-year lease, which expires May 2021. The lease is a triple net lease with an increase approximately 2% in year two and annual CPI adjustments thereafter. The Note Receivable - Related Party originated from the Company's December 1999 sale of its Cygnet Dealer Finance subsidiary to Cygnet Capital Corporation, an entity controlled by Ernest C. Garcia II, Chairman and principal shareholder of the Company. The $12.0 million note from Cygnet Capital Corporation has a 10-year term, with interest payable quarterly at 9%, due December 2009. The note is secured by the capital stock of Cygnet Capital Corporation and guaranteed by Verde Investments, Inc. ("Verde"), an affiliate of Mr. Garcia. Under the terms of the agreement, Mr. Garcia will be allowed to reduce 4 the principal balance up to a maximum of $8.0 million by surrendering to the Company shares of Ugly Duckling common stock (valued at 98% of the average of the closing prices of the stock on NASDAQ for the ten trading days prior to the surrender) as long as Mr. Garcia's ownership interest of the Company voting stock does not fall below 15% and the acceptance of such stock by the Company does not result in a breach of a covenant. Note 4. Notes Payable Notes Payable, Portfolio A summary of Notes Payable, Portfolio at September 30, 2001 and December 31, 2000:
September 30, December 31, 2001 2000 ---------------- ---------------- Revolving Facility for $125.0 million with GE Capital, secured by substantially all assets of the Company, terminated April 2001 $ - $ 53,326 Revolving Facility for $75.0 - $100.0 million with Greenwich Capital Financial Products, Inc, secured by substantially all assets of the Company, not otherwise pledged 64,476 - Class A obligations issued pursuant to the Company's Securitization Program, secured by underlying pools of finance receivables and investments held in trust totaling $482.5 million and $543.0 million at September 30, 2001, and December 31, 2000, respectively 325,024 355,972 ---------------- ---------------- Subtotal 389,500 409,298 Less: Unamortized Loan Fees 2,928 2,747 ---------------- ---------------- Total $ 386,572 $ 406,551 ================ ================
Effective April 2001, the Company replaced the warehouse receivables portion of the GE Capital facility. The new warehouse allows for maximum borrowings of $75 million during the period May 1 through November 30 increasing to $100 million during the period December 1 through April 30. The term of the facility is 364 days with a renewal option, upon mutual consent, for an additional 364-day period. The borrowing base consists of up to 65% of the principal balance of eligible loans originated from the sale of used cars. The lender maintains an option to adjust the advance rate to reflect changes in market conditions or portfolio performance. The interest rate on the facility is LIBOR plus 2.80% (6.18% at September 30, 2001). At September 30, 2001, the Company was not in compliance with the interest coverage ratio covenant of this facility and received a waiver from the lender. The Company was in compliance with all other required covenants. Class A obligations have interest payable monthly at rates ranging from 3.44% to 7.26%. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Securitizations" for further information on the Class A bonds. Other Notes Payable A summary of Other Notes Payable at September 30, 2001 and December 31, 2000 follows:
September 30, December 31, 2001 2000 ----------------- ----------------- Note payable, secured by the capital stock of UDRC II, UDRC III, UDRC IV, and certain other receivables $ 29,000 $ 11,141 Revolving Facility for $36.0 million with Automotive Finance Corporation, secured by the Company's automobile inventory 7,105 - Other notes payable bearing interest at rates ranging from 7.5% to 11% due through October 2015, secured by certain real property and certain property and equipment 6,340 5,637 ----------------- ----------------- Subtotal 42,445 16,778 Less: Unamortized Loan Fees 799 199 ----------------- ----------------- Total $ 41,646 $ 16,579 ================= =================
Effective August 31, 2001, the Company replaced the inventory line of credit portion of the GE Capital facility. The new revolving inventory facility is for $36 million, an $11 million increase from the prior facility, and expires in June of 2003. The borrowing base is calculated on advance rates on inventory purchased, ranging from 80% to 100% of the purchase price. The interest rate on the facility is PRIME plus 6.0% (12.0% at September 30, 2001). The facility is secured with the Company's automobile inventory. At September 30, 2001, the Company was not in compliance with certain interest coverage ratios and received a waiver from the lenders. The Company was in compliance with all other required covenants. 5 Subordinated Notes Payable A summary of Subordinated Notes Payable at September 30, 2001 and December 31, 2000 follows:
September 30, December 31, 2001 2000 ----------------- ----------------- $13.5 million senior subordinated notes payable to unrelated parties, bearing interest at 15% per annum payable quarterly, principal due February 2003 and is senior to subordinated debentures $ 6,000 $ 11,500 $17.5 million subordinated debentures, interest at 12% per annum (approximately 18.8% effective rate) payable semi-annually, principal balance due October 23, 2003 13,839 17,479 $11.9 million subordinated debentures, interest at 11% per annum (approximately 19.7% effective rate) payable semi-annually, principal balance due April 15, 2007 11,940 11,940 $7.0 million senior subordinated note payable to a related party, bearing interest at LIBOR plus 6% per annum payable quarterly, principal due February 2010 6,000 - ----------------- ----------------- Subtotal 37,779 40,919 Less: Unamortized Loan Fees - 915 Unamortized Discount - subordinated debentures 5,179 5,482 ----------------- ----------------- Total $ 32,600 $ 34,522 ================= =================
In June 2001, the Company repurchased in the open market and retired approximately $3.6 million of the $17.5 million in subordinated debentures for approximately $2.6 million. The after tax impact, net associated unamortized discount, of the transaction was a gain from extinguishment of debt of $0.3 million. The gain has been classified as "Extraordinary Item - Gain on Early Extinguishment of Debt" on the Condensed Consolidated Statement of Operations. Note 5. Common Stock Equivalents Net Earnings (Loss) per common share amounts are based on the weighted average number of common shares and common stock equivalents outstanding for the three and nine-month periods ended September 30, 2001, and 2000.
Net Earnings (Loss) per common share are as follows: Three Months Ended Nine Months Ended September 30, September 30, -------------------------------- ----------------------------- 2001 2000 2001 2000 -------------------------------- ----------------------------- Net Earnings (Loss) before Extraordinary Item $ (6,817) $ 2,683 $ (3,975) $ 11,514 ================================ ============================= Net Earnings (Loss) $ (6,817) $ 2,683 $ (3,631) $ 11,514 ================================ ============================= Basic Earnings (Loss) Per Share before Extraordinary Item $ (0.56) $ 0.21 $ (0.32) $ 0.83 ================================ ============================= Diluted Earnings (Loss) Per Share before Extraordinary Item $ (0.56) $ 0.21 $ (0.32) $ 0.82 ================================ ============================= Basic Net Earnings (Loss) Per Share $ (0.56) $ 0.21 $ (0.30) $ 0.83 ================================ ============================= Diluted Net Earnings (Loss) Per Share $ (0.56) $ 0.21 $ (0.30) $ 0.82 ================================ ============================= Basic EPS-Weighted Average Shares Outstanding 12,276 12,597 12,289 13,847 Effect of Diluted Securities: Stock Options - 147 - 187 Warrants - 3 - 10 -------------------------------- ----------------------------- Dilutive EPS-Weighted Average Shares Outstanding 12,276 12,747 12,289 14,044 ================================ ============================= Warrants Not Included in Diluted EPS Since Antidilutive 351 1,124 351 1,124 ================================ ============================= Stock Options Not Included in Diluted EPS Since Antidilutive 1,430 845 1,453 857 ================================ =============================
In the three-month period ending September 30, 2001, under severance agreements, the Company acquired approximately $237,000 of treasury stock in satisfaction of three former officers' notes payable to the Company. 6 Note 6. Business Segments The Company has three distinct business segments. These consist of retail car sales operations (Retail Operations), the income resulting from the finance receivables generated at the Company dealerships (Portfolio Operations), and corporate and other operations (Corporate Operations). Identifiable assets by business segment are those assets used in each segment of Company operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Business Segment Information" for further Business Segment information. A summary of operating activity by business segment for the three and nine-month periods ended September 30, 2001 and 2000 follows: Retail Portfolio Corporate Total ------------- ------------- ------------- ------------- Three months ended September 30, 2001 Sales of Used Cars $ 110,237 $ - $ - $ 110,237 Less: Cost of Cars Sold 62,622 - - 62,622 Provision for Credit Losses 23,223 25,532 - 48,755 ------------- ------------- ------------- ------------- 24,392 (25,532) - (1,140) Net Interest Income - 27,511 - 27,511 ------------- ------------- ------------- ------------- Income before Operating Expenses 24,392 1,979 - 26,371 ------------- ------------- ------------- ------------- Operating Expenses: Selling and Marketing 6,084 - - 6,084 General and Administrative 13,867 7,286 5,654 26,807 Depreciation and Amortization 1,419 236 684 2,339 ------------- ------------- ------------- ------------- 21,370 7,522 6,338 35,230 ------------- ------------- ------------- ------------- Operating Income (Loss) before Other Interest Expense $ 3,022 $ (5,543) $ (6,338) $ (8,859) ============= ============= ============= ============= Capital Expenditures $ 273 $ 131 $ 2,043 $ 2,447 ============= ============= ============= ============= Identifiable Assets, Excluding Net Assets of Discontinued Operations $ 84,344 $ 496,775 $ 72,577 $ 653,696 ============= ============= ============= ============= Retail Portfolio Corporate Total ------------- ------------- ------------- ------------- Three months ended September 30, 2000: Sales of Used Cars $ 126,636 $ - $ - $ 6,636 Less: Cost of Cars Sold 70,760 - - 70,760 Provision for Credit Losses 26,162 9,930 - 36,092 ------------- ------------- ------------- ------------- 29,714 (9,930) - 19,784 Net Interest Income - 24,006 112 24,118 ------------- ------------- ------------- ------------- Income before Operating Expenses 29,714 14,076 112 43,902 ------------- ------------- ------------- ------------- Operating Expenses: Selling and Marketing 7,187 - - 7,187 General and Administrative 14,570 7,411 5,542 27,523 Depreciation and Amortization 1,201 278 806 2,285 ------------- ------------- ------------- ------------- 22,958 7,689 6,348 36,995 ------------- ------------- ------------- ------------- Operating Income (Loss) before Other Interest Expense $ 6,756 $ 6,387 $ (6,236) $ 6,907 ============= ============= ============= ============= Capital Expenditures $ 2,161 $ 615 $ 2,338 $ 5,114 ============= ============= ============= ============= Identifiable Assets, Excluding Net Assets of Discontinued Operations $ 78,542 $ 516,377 $ 19,353 $ 614,272 ============= ============= ============= =============
7
Retail Portfolio Corporate Total ------------- ------------- ------------- ------------- Nine Months Ended September 30, 2001 Sales of Used Cars $ 346,342 $ - $ - $ 346,342 Less: Cost of Cars Sold 196,102 - - 196,102 Provision for Credit Losses 71,773 48,212 - 119,985 ------------- ------------- ------------- ------------- 78,467 (48,212) - 30,255 Net Interest Income - 80,114 130 80,244 ------------- ------------- ------------- ------------- Income before Operating Expenses 78,467 31,902 130 110,499 ------------- ------------- ------------- ------------- Operating Expenses: Selling and Marketing 19,945 - - 19,945 General and Administrative 43,380 22,653 15,429 81,462 Depreciation and Amortization 4,108 732 2,341 7,181 ------------- ------------- ------------- ------------- 67,433 23,385 17,770 108,588 ------------- ------------- ------------- ------------- Operating Income (Loss) before Other Interest Expense $ 11,034 $ 8,517 $ (17640) $ 1,911 ============= ============= ============= ============= Capital Expenditures $ 3,517 $ 718 $ 6,334 $ 10,569 ============= ============= ============= ============= Identifiable Assets, Excluding Net Assets of Discontinued Operations $ 84,344 $ 496,775 $ 72,577 $ 653,696 ============= ============= ============= ============= Retail Portfolio Corporate Total Nine Months Ended September 30, 2000 ------------- ------------- ------------- ------------- Sales of Used Cars $ 380,949 $ - $ - 380,949 Less: Cost of Cars Sold 212,119 - - 212,119 Provision for Credit Losses 77,994 24,883 - 102,877 ------------- ------------- ------------- ------------- 90,836 (24,883) - 65,953 Net Interest Income - 68,162 332 68,494 ------------- ------------- ------------- ------------- Income before Operating Expenses 90,836 43,279 332 134,447 ------------- ------------- ------------- ------------- Operating Expenses: Selling and Marketing 22,748 - - 22,748 General and Administrative 43,353 18,904 15,996 78,253 Depreciation and Amortization 3,405 858 2,461 6,724 ------------- ------------- ------------- ------------- 69,506 19,762 18,457 107,725 ------------- ------------- ------------- ------------- Operating Income (Loss) before Other Interest Expense $ 21,330 $ 23,517 $ (18,125) $ 26,722 ============= ============= ============= ============= Capital Expenditures $ 5,654 $ 909 $ 5,062 $ 11,625 ============= ============= ============= ============= Identifiable Assets, Excluding Net Assets of Discontinued Operations $ 78,542 $ 516,377 $ 19,353 $ 614,272 ============= ============= ============= =============
Note 7. Use of Estimates The preparation of our condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from our estimates. Note 8. Reclassifications We have made certain reclassifications to previously reported information to conform to the current presentation. Note 9. Subsequent Events In October 2001, a special transaction committee of the board recommended and the board approved a $10 million repurchase program under which the company is authorized to repurchase its common stock and/or subordinated debentures, or any combination of both, subject to certain conditions, including any required lender approvals and further committee and board approval of stock repurchases over $3 million. 8 In October 2001, the Company completed its 21st securitization, consisting of approximately $145.9 million in principal balances and the issuance of approximately $103.6 million in Class A bonds, including a pre-funded amount of approximately $25.9 million. The Company will subsequently provide an additional $36.5 million of the $145.9 million in loans as collateral for the pre-funded amount. The coupon rate on the Class A bonds is 3.44%, the initial deposit into the Reserve Account was 2.25% and the Reserve Account maximum is 8%. 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Introduction We operate the largest chain of buy-here/pay-here used car dealerships in the United States. At September 30, 2001, we operated 76 dealerships located in eleven metropolitan areas in eight states. We have one primary line of business: to sell and finance quality used vehicles to customers within what is referred to as the sub-prime segment of the used car market. The sub-prime market is comprised of customers who typically have limited credit histories, low incomes or past credit problems. References to Ugly Duckling Corporation as the largest chain of buy-here/pay-here used car dealerships in the United States is management's belief based upon the knowledge of the industry and not on any current independent third party study. As a buy-here/pay-here dealer, we offer the customer certain advantages over more traditional financing sources including: o expanded credit opportunities, o flexible payment terms, including structuring loan payment due dates as weekly or biweekly, often coinciding with the customer's payday, o the ability to make payments in person at thedealerships. This is an important feature to many sub-prime borrowers who may not have checking accounts or are otherwise unable to make payments by the due date through use of the mail due to the timing of paydays. We distinguish our retail operations from those of typical buy-here/pay-here dealers through our: o dedication to customer service, o advertising and marketing programs, o larger inventories of used cars, o upgrading facilities, and o network of multiple locations, o centralized purchasing. We finance substantially all of the used cars that we sell at our dealerships through retail installment loan contracts. Subject to certain underwriting standards and the discretion of our dealership or sales managers, potential customers must meet our formal underwriting guidelines before we will agree to finance the purchase of a vehicle. Our employees analyze and verify the customer credit application information and subsequently make a determination whether to provide financing to the customer. Our business is divided into three operating segments: Retail, Portfolio and Corporate Operations. Information regarding our operating segments can be found in Note (6) of the Notes to Condensed Consolidated Financial Statements contained herein. Operating segment information is also included in "Management's Discussion and Analysis of Financial Condition and Results of Operations - Business Segment Information" found below. In December 1999, we sold the Cygnet Dealer Finance (CDF) subsidiary and also decided to end any efforts to acquire third party loans or servicing rights to additional third party portfolios. As a result, CDF, Cygnet Servicing and the associated Cygnet Corporate segment assets and liabilities are classified as net assets from discontinued operations. We plan to complete the servicing of the portfolios that we currently service. In the following discussion and analysis, we explain the results of operations and general financial condition of Ugly Duckling and its subsidiaries. In particular, we analyze and explain the changes in the results of operations of our business segments for the three and nine-month periods ended September 30, 2001 and 2000. All amounts are presented in thousands except per share, per unit and per car data, unless otherwise noted. 10 UGLY DUCKLING CORPORATION SELECTED CONSOLIDATED FINANCIAL DATA ($ and shares in millions, except per share, per unit data and number of loan data) (Unaudited)
At or For the Three Months Ended -------------------------------------------------------------------- Selected Consolidated Financial Data Sept June Mar Dec Sept June Mar 2001 2001 2001 2000 2000 2000 2000 --------- ------- ------- ------- ------- ------ ------ Operating Data: Total Revenues $ 145.2 $140.8 $164.0 $ 135.2 $158.1 $151.4 $158.3 Sales of Used Cars $ 110.2 $105.9 $130.2 $ 102.3 $126.6 $121.5 $132.8 Net Earnings (Loss) per Share $ (0.56) $ 0.11 $ 0.15 $(0.20) $ 0.21 $ 0.31 $ 0.30 EBITDA $ 1.0 $ 14.5 $ 17.1 $ 8.7 $ 16.5 $ 18.2 $ 17.1 E-Commerce Sales as % of Sales of Used Cars 14.2% 14.4% 11.6% 13.6% 9.5% 5.3% 4.3% Number Dealerships in Operation 76 77 77 77 77 77 75 Average Sales per Dealership per Month 52 50 64 51 64 62 70 Number of Used Cars Sold 11,907 11,607 14,851 11,874 14,825 14,369 15,802 Sales Price - Per Car Sold $ 9,258 $9,125 $8,766 $8,618 $8,542 $8,458 $8,403 Cost of Sales - Per Car Sold $ 5,259 $5,224 $4,905 $4,727 $4,773 $4,761 $4,616 Gross Margin - Per Car Sold $ 3,999 $3,901 $3,861 $3,891 $3,769 $3,696 $3,787 Provision - Per Car Sold $ 4,095 $2,775 $2,627 $3,292 $2,435 $2,242 $2,188 Total Operating Expense - Per Car Sold $ 2,959 $3,092 $2,523 $2,832 $2,495 $2,425 $2,271 Total Operating Income - Per Car Sold $ (744) $ 396 $ 416 $(168) $ 466 $ 691 $ 626 Total Operating Income (Loss) $ (8.9) $ 4.6 $ 6.2 $ (2.0) $ 6.9 $ 9.9 $ 9.9 Earnings (Loss) before Income Taxes $ (11.6) $ 1.7 $ 3.1 $ (4.2) $ 4.5 $ 7.3 $ 7.6 Cost of Used Cars as % of Sales 56.8% 57.3% 56.0% 54.8% 55.9% 56.3% 54.9% Gross Margin as % of Sales 43.2% 42.7% 44.0% 45.2% 44.1% 43.7% 45.1% Provision - % of Originations 44.7% 31.1% 31.0% 38.8% 29.0% 27.1% 27.0% Total Operating Expense - % of Total Revenues 24.3% 25.5% 22.8% 24.9% 23.4% 23.0% 22.7% Segment Operating Expense Data: Retail Operating Expense - Per Car Sold $ 1,795 $1,934 $1,590 $1,710 $1,549 $1,611 $1,481 Retail Operating Expense -% of Used Car Sales 19.4% 21.2% 18.1% 19.8% 18.1% 19.1% 17.6% Corporate/Other Expense - Per Car Sold $ 532 $ 503 $ 376 $ 417 $ 428 $ 418 $ 387 Corporate/Other Expense - % of Total Revenue 4.4% 4.1% 3.4% 3.7% 4.0% 4.0% 3.9% Portfolio Exp. Annualized - % of End of Period Managed Principal 5.6% 5.8% 6.2% 6.6% 5.9% 4.6% 5.5% Balance Sheet Data: Finance Receivables, net $ 501.0 $544.6 $522.9 $500.5 $491.9 $451.2 $407.3 Inventory $ 47.4 $ 40.8 $ 43.4 $ 63.7 $ 43.7 $ 45.9 $ 49.1 Total Assets $ 657.7 $679.0 $659.5 $652.1 $618.5 $577.5 $548.0 Notes Payable - Portfolio $ 386.6 $415.9 $390.6 $406.6 $362.3 $316.0 $282.9 Subordinated Notes Payable $ 32.6 $ 35.0 $ 40.8 $ 34.5 $ 36.1 $ 37.3 $ 28.9 Total Debt $ 460.8 $493.3 $470.9 $457.7 $416.3 $381.0 $345.2 Common Stock $ 173.8 $173.8 $173.7 $173.7 $173.7 $173.7 $173.7 Treasury Stock $ (40.4) $(40.1) $(40.1) $(40.1) $(39.4) $(28.4) $(20.3) Total Stockholder's Equity $ 151.6 $158.6 $157.2 $155.4 $158.5 $166.8 $170.6 Common Shares Outstanding - End of Period 12,275 12,302 12,292 12,292 12,378 13,899 14,980 Book Value per Share $ 12.35 $12.89 $12.79 $12.64 $12.81 $12.00 $11.39 Tangible Book Value per Share $ 11.38 $11.91 $11.79 $11.62 $11.78 $11.02 $10.43 Total Debt to Equity 3.0 3.1 3.0 2.9 2.6 2.3 2.0 Loan Portfolio Data: Interest Income $ 35.0 $ 34.9 $ 33.8 $ 32.9 $ 31.4 $ 29.9 $ 25.5 Average Yield on Portfolio 26.5% 26.7% 26.3% 26.1% 26.1% 26.8% 26.2% Portfolio Interest Expense $ 7.5 $ 7.5 $ 8.5 $ 8.4 $ 7.3 $ 6.0 $ 5.0 Average Borrowing Cost 8.0% 8.3% 8.9% 8.7% 10.7% 8.6% 8.0% Principal Balances Originated $ 109.1 $103.6 $126.0 $100.8 $124.4 $118.8 $128.1 Principal Balances Originated as % of Sales 99.0% 97.8% 96.8% 98.5% 98.2% 97.7% 96.5% Number of Loans Originated 11,844 11,558 14,776 11,906 14,748 14,291 15,721 Average Original Amount Financed $ 9,215 $8,965 $8,528 $8,468 $8,433 $8,311 $8,150 Number of Loans Originated as % of Units Sold 99.5% 99.6% 99.5% 100.3% 99.5% 99.5% 99.5% Managed Portfolio Delinquencies: Current 67.4% 76.4% 78.6% 66.1% 72.4% 71.9% 74.8% 1 to 30 days 24.0% 16.8% 15.7% 26.1% 19.3% 20.9% 19.9% 31 to 60 days 5.3% 4.1% 3.3% 4.7% 4.9% 4.5% 3.4% Over 60 days 3.3% 2.7% 2.4% 3.1% 3.4% 2.7% 1.9% Principal Outstanding - Managed $ 537.9 $534.8 $535.0 $519.0 $525.5 $500.0 $461.8 Principal Outstanding - Retained $ 537.9 $534.8 $535.0 $514.9 $512.8 $472.3 $418.9 Number of Loans Outstanding - Managed 85,961 86,446 87,033 84,864 85,240 81,407 75,496 Number of Loans Outstanding - Retained 85,961 86,446 87,033 82,598 79,848 71,518 62,459
11 Sales of Used Cars and Cost of Used Cars Sold
Three Months Ended Nine Months Ended September 30, Percentage September 30, Percentage ----------------------------- ---------------------------- 2001 2000 Change 2001 2000 Change -------------- ------------- ------------- -------------- ------------ ------------- Number of Used Cars Sold 11,907 14,825 (19.7%) 38,365 44,996 (14.7%) ============== ============= ============== ============ Sales of Used Cars $ 110,237 $ 126,636 (13.0%) $ 346,342 $ 380,949 (9.1%) Cost of Used Cars Sold 62,622 70,760 (11.5%) 196,102 212,119 (7.6%) -------------- ------------- -------------- ------------ Gross Margin $ 47,615 $ 55,876 (14.8%) $ 150,240 $ 168,830 (11.0%) ============== ============= ============== ============ Gross Margin % 43.2% 44.1% 43.4% 44.3% Per Car Sold: Sales $ 9,258 $ 8,542 8.4% $ 9,028 $ 8,466 6.6% Cost of Used Cars Sold 5,259 4,773 10.2% 5,112 4,714 8.4% -------------------------------- -------------------------------- Gross Margin $ 3,999 $ 3,769 6.1% $ 3,916 $ 3,752 4.4% ================================ ================================
For the three and nine-month periods ended September 30, 2001, the number of cars sold decreased by 19.7% and 14.7%, respectively, over the same periods of the prior year and Sales of Used Cars decreased 13.0% and 9.1%, respectively, over the same periods in 2000. During the latter half of 2000, we developed a risk management department, which is focusing on developing credit risk models. We believe the decrease in both units sold and revenues is primarily the result of initiatives which have put more stringent underwriting guidelines in place including income qualifications and down payment requirements in an effort to improve the quality of loans generated from used car sales. To a lesser extent, we believe a general softening of the economy has led to reduced retail activity in the sub-prime market. Our Internet site continues to be a valuable tool generating a steady flow of credit applications and sales. We accept credit applications from potential customers via our website, located at http://www.uglyduckling.com. Credit inquiries received over the web are reviewed by our employees, who then contact the customers and schedule appointments. Internet applications continue to provide an increasing amount of Sales of Used Cars. During the third quarter of 2001, applications received via our internet site generated 1,730 cars sold and $15.7 million in revenue, up from 1,686 cars sold and $15.2 million in revenue during the second quarter and1,725 cars sold and $15.1 million in revenue during the first quarter of 2001. The Cost of Used Cars Sold for the three and nine-month periods ended September 30, 2001 decreased 11.5% and 7.6%, respectively, over the comparable periods of the previous year. The decrease is due to a decline in the number of used cars sold, partially offset by an increase in the Cost of Used Cars Sold. The Cost of Used Cars Sold on a per car basis increased 10.2% and 8.4% for the three and nine-month periods ended September 30, 2001, respectively, over the same periods of the prior year. The increase is due to an effort to purchase higher quality vehicles as a result of research completed by our risk management department, which indicated better loan performance on the loans associated with the higher cost inventory. This increase was offset by an increase in the per unit sales price. The gross margin on used car sales (Sales of Used Cars less Cost of Used Cars Sold excluding Provision for Credit Losses) as a percentage of related revenue decreased to 43.2% and 43.4% for the three and nine-months ended September 30, 2001 versus 44.1% and 44.3% for the three and nine-month periods ended September 30, 2000. The decrease is due to the per unit cost of used cars sold rising at a higher pace than the related sales revenue. For the three months ended September 30, 2001 as compared with the three months ended September 30, 2000, gross margin on a per car sold basis increased $230 to $3,999 per car from $3,769 for the same quarter of the previous year and increased $164 to $3,916 for the nine month period ended September 30, 2001 from $3,752 during the same period of the previous year. This increase is due to an increase in the overall revenue earned per car, partially offset by the increase in the per unit cost of used cars sold. 12 We finance substantially all of our used car sales. The percentage of cars sold financed and the percentage of sales revenue financed has remained relatively constant for both the three and nine-month periods ended September 30, 2001 versus the comparable periods of 2000. The following table indicates the percentage of sales units and revenue financed:
Three Months Ended Nine Months Ended September 30, September 30, ------------------------- ------------------------- 2001 2000 2001 2000 ------------ ------------ ------------ ------------ Percentage of used cars sold financed 99.5% 99.5% 99.5% 99.5% ============ ============ ============ ============ Percentage of sales revenue financed 99.0% 98.2% 97.8% 97.5% ============ ============ ============ ============
Provision for Credit Losses The following is a summary of the Provision for Credit Losses:
Three Months Ended Nine Months September 30, Percentage September 30, Percentage --------------------------------- ------------------------------- 2001 2000 Change 2001 2000 Change ---------------- ---------------- ------------ -------------- --------------- ------------- Provision for Credit Losses $48,755 $36,092 35.1% $119,985 $102,877 16.6% ================ ================ ============== =============== Provision per loan originated $4,116 $2,447 68.2% $3,143 $2,298 36.8% ================ ================ ============== =============== Provision as a percentage of principal balances originated 44.7% 29.0% 35.4% 27.7% ================ ================ ============== ===============
The Company's results for third quarter of 2001 reflect a significant increase in the Provision for Loan Losses (Provision) to 44.7% of the total amount financed versus 31% in the prior quarters of 2001, and versus 29% in the third quarter of 2000. While early indications reflect actual improvements in loan loss experience on 2001 originations due to improvement in underwriting, it was necessary to increase the quarter's Provision as a percent of the quarter's loan originations due to resulting lower loan origination volume. Company policy is to maintain an Allowance for Credit Losses (Allowance) for all loans in its portfolio to cover estimated net charge offs for the next 12 months. Our loans have experienced lifetime losses in the 31% to 34% range for the past few years. With origination growth over this time we have been able to maintain an adequate Allowance in accordance with Company policy and with GAAP by providing between 27% to 31% of the quarter's amount financed. As the speed of portfolio growth has slowed due to the reduced loan originations, an increase to the Provision as a percentage of lower originations is necessary unless there is a significant decrease in loss rates. The increase in the Provision was also due to loss levels for prior years' originations emerging at levels higher than previously estimated as well as the economic environment and its likely effect on our portfolio performance. More specifically, with the economic and political events occurring in the third quarter of 2001, management intensified its review of general trends in the economy, specific economic events in many of its markets and the impact of such factors on the market segments in which its customers are employed. As a result of this evaluation, management concluded that these factors offset other evidence that supported that its 2001 originations will ultimately perform better than loans originated in fiscal year 1999 and 2000. While the Company believes loans originated in 2001 were underwritten to higher credit standards and its transition to a dealership centered collection methodology will produce more effective collection results, uncertainties in the economy and our customers' ongoing employment opportunities could offset these positive factors. Accordingly, the Company adjusted upward its estimate of loan losses for its 2001 originations to a level generally equal to that actually being experienced on its fiscal year 2000 originations. We will continue to monitor the adequacy of our Allowance and depending upon our Allowance evaluations, the rate of Provision charged may need to be increased in future quarters. While we believe the Allowance balance as of September 30, 2001 remains at a level we estimate to be adequate to cover net charge-offs over the next 12 months, we currently expect to need a Provision in excess of 31% again in the fourth quarter of 2001 because of expected net charge-offs beyond this 12 month period. See "Static Pool Analysis" below for further Provision for Credit Loss discussion. 13 Net Interest Income
Three Months Ended Nine Months Ended -------------------------- ------------------------- September 30, Percentage September 30, Percentage -------------------------- ------------------------- 2001 2000 Change 2001 2000 Change ------------ ------------ ------------- ------------ ------------ -------------- Interest Income $ 35,000 $ 31,436 11.3% $103,744 $ 86,838 19.5% Portfolio Interest Expense (7,489) (7,318) 2.3% (23,500) (18,344) 28.1% ------------ ------------ ------------ ------------ Net Interest Income $ 27,511 $ 24,118 14.1% $80,244 $ 68,494 17.2% ============ ============ ============ ============ Average Effective Yield 26.5% 26.1% 26.5% 26.4% ============ ============ ============ ============ Average Borrowing Cost 8.0% 10.7% 8.1% 10.5% ============ ============ ============ =============
Interest Income consists primarily of interest on finance receivable principal balances retained on our balance sheet. Retained principal balances, net grew to $537.9 million at September 30, 2001 from $512.8 million at September 30, 2000. The growth in retained principal balances is primarily due to the change in the way we structure our securitizations to the collateralized borrowing method during the fourth quarter of 1998. Since that time, all securitized loans are retained on our balance sheet and the income is recognized over the life of the loan. Portfolio interest expense increased to $7.5 million and $23.5 million for the three and nine-month periods ending September 30, 2001, respectively, versus $7.3 million and $18.3 million, respectively, for the same periods of the previous year. The increase is due to the increase in Portfolio Notes Payable, which consist of our Class A obligations related to our securitization program, along with our revolving warehouse facility. Lower borrowing costs help offset the growth in the portfolio. This increase in interest expense is offset by the additional interest income earned from the growth in finance receivables retained on our balance sheet. Income before Operating Expenses Income before Operating Expenses decreased 39.9% to $26.4 million for the three-month period ended September 30, 2001 and decreased 17.8% to $110.5 million for the nine-month period ended September 30, 2001 as compared to $43.9 million and $134.4 million for the three and nine-month periods ended September 30, 2000, respectively. The decrease resulted from a decrease in Used Car Sales and an increase in the amount charged to current operations for the Provision, and an increase in interest expense resulting from additional portfolio notes payable, partially offset by an increase in interest income due to the growth in the finance receivables portfolio. Operating Expenses
Three Months Ended Nine Months Ended September 30, Percentage September 30, Percentage -------------------------- -------------------------- 2001 2000 Change 2001 2000 Change ------------ ------------ -------------- ------------ ------------ ------------- Operating Expenses $ 35,230 $ 36,995 (4.8%) $ 108,588 $107,725 0.8% ============ ============ ============ ============ Per Car Sold $ 2,959 $ 2,495 18.6% $ 2,830 $ 2,394 18.2% ============ ============ ============ ============ As % of Total Revenue 24.3% 23.4% 24.1% 23.0% ============ ============ ============ ============
Operating expenses, which consist of selling, marketing, general and administrative and depreciation/amortization expenses, decreased slightly quarter over quarter, and increased slightly for the nine months ended September 30, 2001 versus 2000 but remained relatively constant as a percentage of total revenues. Included in these expenses for the nine-month period ended September 30, 2001, is a pre-tax charge of approximately $600,000, taken during the first quarter of 2001, for the closing of the collection and loan administration centers in Florida and Texas. During the first quarter of 2001, we initiated a plan to close our collections and loan administration operations in Clearwater, Florida; Plano, Texas; and Dallas, Texas and 14 move them to our dealerships or to our Gilbert, Arizona collection facility. As a result of these closings, we took an after tax charge of approximately $368,000 to cover payroll, severance and certain property related expenses. We have taken a charge of approximately $230,000 related to the cost of abandoned assets in Plano, Texas. For the Clearwater Facility we estimate an additional restructuring charge in the fourth quarter related to costs of abandoned assets with a carrying value of approximately $500,000. The impact resulting from the shut down of these operations, including the impact of future charges, is estimated to be break even over the remainder of 2001 and to decrease operating expenses by $1.5 million annually beginning in 2002. In August of 2001 the lease on the Company's corporate headquarters expired and the Company relocated to another location in Phoenix. Third quarter 2001 operating expenses include approximately $500,000 in non-recurring costs associated with the corporate relocation. Beginning in the third quarter of 2001, the Company also began the process of implementing numerous cost savings initiatives to reduce operating expenses including the relocation of its corporate headquarters. Further, in early October of 2001 the Company continued this process by implementing a reduction in force of primarily corporate staff. Beginning in 2002, this reduction in staff, the relocation of its corporate headquarters and other cost saving initiatives are expected to decrease annual operating expenses by approximately $6.0 million. Also included in Operating Expenses in the third quarter is $350,000 related to legal and other expenses associated with the offer from Mr. Ernest C. Garcia II, the Company's Chairman of the Board and largest shareholder, to the Board of Directors to purchase all of the outstanding stock of the Company not owned by him. Other Interest Expense Interest expense arising from our other, non-portfolio debt totaled $2.7 million and $8.6 million for the three and nine-month periods ended September 30, 2001, versus $2.4 million and $7.2 million for the comparable periods of the prior year. The increase is primarily attributable to interest expense arising from our senior secured loan facility, which was renewed during the first quarter of 2001. Income Taxes Income tax benefit totaled ($4.7) million and ($2.8) million for the three and nine month periods ended September 30, 2001, respectively, versus $1.9 million and $8.0 million in income taxes, respectively, for same equivalent periods in 2000. Our effective tax rate was 41% for all periods presented. Earnings (Loss) before Extraordinary Item Earnings (Loss) before Extraordinary Item totaled ($6.8) million and ($4.0) million for the three and nine month periods ended September 30, 2001, respectively, versus $2.7 million and $11.5 million, respectively, for the same periods of the previous year. The decrease resulted from a decrease in Used Car Sales and an increase in the amount charged to current operations for the Provision, and an increase in interest expense resulting from additional portfolio notes payable, partially offset by an increase in interest income due to the growth in the finance receivables portfolio. Gain on Early Extinguishment of Debt During the nine months ended September 30, 2001, we repurchased in the open market and retired approximately $3.2 million, net of unamortized discount, of our exchange offer debt due October 2003, for approximately $2.6 million. The after tax impact of the purchase was a gain from extinguishment of debt of $0.3 million. Net Earnings (Loss) Net Earnings (Loss) totaled ($6.8) million and ($3.6) million for the three and nine months ended September 30, 2001, respectively, as compared with $2.7 million and $11.5 million for the same periods of the prior year. The decrease resulted from a decrease in Used Car Sales and an increase in the amount charged to current operations for the Provision, and an increase in interest expense resulting from additional portfolio notes payable, partially offset by an increase in interest income due to the growth in the finance receivables portfolio. 15 Business Segment Information We report our operations based on three operating segments. These segments are reported as Retail, Portfolio and Corporate Operations. These segments were previously reported as Company Dealership, Company Dealership Receivables and Corporate and Other, respectively. See Note 6 to the Condensed Consolidated Financial Statements. Operating Expenses for our business segments, along with a description of the included activities, for the three and nine-month periods ended September 30, 2001 and 2000 are as follows: Retail Operations. Operating expenses for our Retail segment consist of Company marketing efforts, maintenance and development of dealership and inspection center sites, and direct management oversight of used car acquisition, reconditioning and sales activities. A summary of retail operating expenses follows:
Three Months Ended Nine Months Ended September 30, September 30, ------------------------------- -------------------------------- 2001 2000 2001 2000 --------------- -------------- -------------- ---------------- Retail Operations: Selling and Marketing $ 6,084 $ 7,187 $ 19,945 $ 22,748 General and Administrative 13,867 14,570 43,380 43,353 Depreciation and Amortization 1,419 1,201 4,108 3,405 --------------- -------------- -------------- ---------------- Retail Expense $ 21,370 $ 22,958 $ 67,433 $ 69,506 =============== ============== ============== ================ Per Car Sold: Selling and Marketing $ 511 485 520 506 General and Administrative 1,165 983 1,131 963 Depreciation and Amortization 119 81 107 76 --------------- -------------- -------------- ---------------- Total $ 1,795 $ 1,549 $ 1,758 $ 1,545 =============== ============== ============== ================ As % of Used Cars Sold Revenue: Selling and Marketing 5.5% 5.7% 5.8% 6.0% General and Administrative 12.6% 11.5% 12.5% 11.4% Depreciation and Amortization 1.3% 1.0% 1.2% 0.9% --------------- -------------- -------------- ---------------- Total 19.4% 18.2% 19.5% 18.3% =============== ============== ============== ================
Selling and Marketing expenses on a per car sold basis have increased due to a decrease in the number of cars sold without a proportionate decrease in expenses, for both the three and nine months ended September 30, 2001, versus the same period of the previous year. However, selling and marketing costs as a percentage of Sales of Used Cars have remained relatively constant primarily due to an increase of $716 and $562 in the average sales price per car for the three and nine months ended September 30 , 2001, respectively. General and Administrative expenses increased both on a per car sold basis as well as on a percentage of related revenue basis for the three and nine-month periods ended September 30, 2001, principally due to a reduction in the amount of cars sold and the resulting high proportion of fixed general and administrative costs. 16 Portfolio Operations. Operating expenses for our Portfolio segment consist of loan servicing and collection efforts, securitization activities, and other operations pertaining directly to the administration and collection of the loan portfolio.
Three Months Ended Nine Months Ended September 30, September 30, ----------------------------------- --------------------------------- 2001 2000 2001 2000 ---------------- ----------------- ---------------- --------------- Portfolio Expense: General and Administrative $ 7,286 $ 7,411 $ 22,653 $ 18,904 Depreciation and Amortization 236 278 732 858 ---------------- ----------------- ---------------- --------------- Portfolio Expense $ 7,522 $ 7,689 $ 23,385 $ 19,762 ================ ================= ================ =============== Average Expense per Month per Loan Serviced $ 28.99 $ 28.73 $ 29.60 $ 25.38 ================ ================= ================ =============== Annualized Expense as % of End of Period Managed Principal Balances 5.6% 5.8% 5.8% 5.0% ================ ================= ================ ===============
Portfolio expenses slightly decreased for the three months ended September 30, 2001, versus the same period of 2000. For the nine-month period, the increase in both Portfolio expenses and the Average Expense per Month per Loan serviced is partly attributed to $600,000 of cost incurred in relation to the closing of the collections and loan administration centers in Florida and Texas during the first quarter of 2001. Corporate Operations. Operating expenses for our Corporate segment consist of costs to provide managerial oversight, provide financings and reporting for the Company, develop and implement policies and procedures, and provide expertise to the Company in areas such as finance, legal, human resources and information technology.
Three Months Ended Nine Months Ended September 30, September 30, ----------------------------------- ----------------------------------- 2001 2000 2001 2000 ---------------- ---------------- ---------------- ----------------- Corporate Expense: General and Administrative $ 5,654 $ 5,542 $ 15,429 $ 15,996 Depreciation and Amortization 684 806 2,341 2,461 ----------------- ---------------- ---------------- ----------------- Corporate Expense $ 6,338 $ 6,348 $ 17,770 $ 18,457 ----------------- ---------------- ---------------- ----------------- Per Car Sold $ 532 $ 428 $ 463 $ 410 ================= ================ ================ ================= As % of Total Revenues 4.4% 4.0% 3.9% 3.9% ================= ================ ================ ==================
Operating expenses related to our Corporate segment as a percent of total revenue remained relatively consistent for the three and nine-months ended September 30, 2001, versus the same period of 2000. However, on a per car sold basis corporate expenses increased $104 and $53 per car for the three and nine months ended September 30, 2001, respectively, as compared to the same periods of the previous year. The increase on a per car sold basis is due to a decline in used cars sold for both the three and nine months ended September 30, 2001 without a proportionate reduction in expenses. We are implementing a cost savings plan in an effort to reduce overall operating expenses. Financial Position The following table reflects the growth in principal balances retained on our balance sheet measured in terms of the principal balances and the number of loans outstanding.
Managed Loans Outstanding ------------------------------------------------------------------------------------ Principal Balances Number of Loans ------------------------------------- ------------------------------------------- September 30, December 31, September 30, December 31, 2001 2000 2001 2000 ------------------ ---------------- ---------------------- ------------------ Principal - Managed $ 537,946 $ 519,005 $ 85,961 $ 84,864 Less: Principal - Securitized and Sold - 4,059 - 2,266 ------------------ ---------------- ---------------------- ------------------ Principal - Retained on Balance Sheet $ 537,946 $ 514,946 $ 85,961 $ 82,598 ================== ================ ====================== ==================
17 At September 30, 2001, the entire loan portfolio is on balance sheet. Principal - Retained on Balance Sheet has increased 4.5% from December 31, 2000. As we continue to focus on enhanced underwriting guidelines, we do not expect the portfolio balance to grow as significantly as in past quarters. The number of loans originated were 11,844 for the quarter ended September 30, 2001, versus 14,748 during the same quarter of the prior year. For the nine months ended September 30, the number of loans originated totaled 38,178 in 2001 versus 44,760 in 2000. Although the volume of loans originated is declining and the number of loans outstanding is leveling, we believe the quality of the loans written is improving, with the ultimate goal of reducing loan losses. The following table reflects activity in the Allowance for Credit Losses, as well as information regarding charge off activity, for the three and nine months ended September 30, 2001 and 2000:
Three Months Ended Nine Months Ended September 30, September 30, Allowance Activity: 2001 2000 2001 2000 ---------------- ---------------- ---------------- ---------------- Balance, Beginning of Period $ 101,589 $ 98,533 $ 99,700 $ 76,150 Provision for Credit Losses 48,755 36,092 119,985 102,877 Other Allowance Activity (127) (1,250) (133) (2,250) Net Charge Offs (35,717) (33,332) (105,052) (76,734) ---------------- ---------------- ---------------- --------------- Balance, End of Period $ 114,500 $ 100,043 $ 114,500 $ 100,043 ================ ================ ================ =============== Allowance as % Ending Principal Balances 21.3% 19.5% 21.3% 19.5% ================ ================ ================ =============== Charge off Activity: Principal Balances $ (45,655) $ (41,934) $ (134,416) $ (99,076) Recoveries, Net 9,938 8,602 29,364 22,342 ----------------- ---------------- ----------------- --------------- Net Charge Offs $ 35,717) $ (33,332) $ (105,052) $ (76,734) ====================== ================ ================ ===============
The Allowance for Credit Losses is maintained at a level that in management's judgment is adequate to provide for estimated probable net credit losses inherent in our portfolio for the next 12 months. See - Static Pool Analysis section and the Provision for Credit Losses section of "Management's Discussion and Analysis of Financial Condition and Results of Operations. " Charge offs, net of recoveries, for the three months ended September 30, 2001 and 2000 were $35.7 million and $33.3 million, respectively. As a percentage of average principal balances, net charge offs for the same periods were 6.6% and 6.7%, respectively. For the nine-month periods ended September 30, 2001 and 2000, net charge offs were $105.1 million and $76.7 million, respectively. Net charge offs as a percentage of average principal balances for the same periods were 19.7% and 17.0%, respectively. During the second quarter of 2001, we placed 31-60 day collectors into the majority of the dealerships. Upon initial deployment of the 31-60 day collectors, we experienced some negative performance as the collectors and collection managers adapted to collecting and managing the mid-range delinquencies and a decentralized environment. Adjustments were subsequently made to address the negative performance issues and we expect to improve collection performance as a result of the relocation of these collectors. Static Pool Analysis We use a "static pool" analysis to monitor performance for loans we have originated at our dealerships. In a static pool analysis, we assign each month's originations to a unique pool and track the charge offs for each pool separately. We calculate the cumulative net charge offs for each pool as a percentage of that pool's original principal balances, based on the number of complete payments made by the customer before charge off. The table below displays the cumulative net charge offs of each pool as a percentage of original loan cumulative balances, based on the quarter the loans were originated. The table is further stratified by the number of payments made by our customer's prior to charge off. For periods denoted by "x", the pools have not seasoned sufficiently to allow us to compute cumulative losses. For periods denoted by "-", the pools have not yet reached the indicated cumulative age. While we monitor static pools on a monthly basis, for presentation purposes we are presenting the information in the table below on a quarterly basis. 18 Currently reported cumulative losses may vary from those previously reported due to ongoing collection efforts on charged off accounts, and the difference between final proceeds on the sale of repossessed collateral versus our estimates of the sale proceeds. Management, however, believes that such variation will not be material. The following table sets forth as of October 31, 2001, the cumulative net charge offs as a percentage of original loan cumulative (pool) balances, based on the quarter of origination and segmented by the number of monthly payments completed by customers before charge off. The table also shows the percent of principal reduction for each pool since inception and cumulative total net losses incurred (TLI).
Pools' Cumulative Net Losses as Percentage of Pools' Original Aggregate Principal Balance ($ in thousands) Monthly Payments Completed by Customer Before Charge Off --------------------------------------------------------- Orig. 0 3 6 12 18 24 TLI Reduced ------- --- --- --- --- --- --- ---- ------- 1993 $12,984 8.8% 21.4% 27.6% 32.8% 34.8% 35.3% 36.8% 100.0% 1994 $23,589 5.3% 14.6% 19.6% 25.2% 27.5% 28.2% 28.8% 100.0% 1995 $36,569 1.9% 8.1% 13.1% 19.0% 22.1% 23.4% 24.1% 100.0% 1996 $48,996 1.5% 8.1% 13.9% 22.1% 26.2% 27.9% 28.9% 100.0% 1997 1st Quarter $16,279 2.1% 10.7% 18.2% 24.8% 29.8% 32.0% 33.5% 100.0% 2nd Quarter $25,875 1.5% 9.9% 15.8% 22.7% 27.3% 29.4% 30.6% 100.0% 3rd Quarter $32,147 1.4% 8.3% 13.2% 22.4% 26.9% 29.1% 30.6% 100.0% 4th Quarter $42,529 1.4% 6.8% 12.6% 21.8% 26.0% 28.7% 29.9% 100.0% 1998 1st Quarter $69,708 0.9% 6.9% 13.4% 20.9% 26.3% 28.7% 29.9% 100.0% 2nd Quarter $66,908 1.1% 8.1% 14.2% 21.7% 27.2% 29.1% 30.2% 99.8% 3rd Quarter $71,027 1.0% 7.9% 13.2% 22.9% 27.7% 30.2% 30.9% 99.7% 4th Quarter $69,583 0.9% 6.6% 13.1% 24.2% 28.9% 31.3% 32.1% 98.9% 1999 1st Quarter $103,068 0.8% 7.4% 15.0% 23.5% 29.3% 31.5% 32.3% 96.9% 2nd Quarter $95,768 1.1% 9.9% 16.7% 25.3% 31.3% 33.7% 34.1% 93.0% 3rd Quarter $102,585 1.0% 8.3% 14.1% 25.2% 30.8% x 33.2% 88.4% 4th Quarter $80,641 0.7% 5.9% 12.6% 23.6% 29.0% -- 30.2% 81.8% 2000 1st Quarter $128,123 0.3% 6.5% 14.6% 24.1% x -- 29.1% 74.6% 2nd Quarter $118,778 0.6% 8.6% 15.9% 25.9% -- -- 28.4% 66.3% 3rd Quarter $124,367 0.7% 7.7% 14.3% x -- -- 23.8% 55.5% 4th Quarter $100,823 0.6% 6.6% 13.6% -- -- -- 18.0% 43.4% 2001 1st Quarter $126,015 0.4% 6.4% x -- -- -- 11.4% 31.9% 2nd Quarter $103,615 5.7% x -- -- -- -- 4.5% 18.4% 3rd Quarter $109,037 x -- -- -- -- -- 0.4% 3.9%
19 The following table sets forth the principal balances delinquency status as a percentage of total outstanding loan principal balances.
September 30, September 30, December 31, Days Delinquent: 2001 2000 2000 ---------------- ---------------- ----------------- Current 67.4% 72.4% 66.1% 1-30 Days 24.0% 19.3% 26.1% 31-60 Days 5.3% 4.9% 4.7% 61-90 Days 3.3% 3.4% 3.1% ---------------- ----------------- ----------------- Total Portfolio 100.0% 100.0% 100.0% ================ ================= =================
In accordance with our charge off policy, there are no accounts more than 90 days delinquent as of September 30, 2001. Delinquencies rose during the third quarter of 2001 versus the second quarter of this year, primarily due to seasonality. In addition, the Company is also seeing an increase in delinquencies versus the prior year as a result of the economic environment. The Company believes the transition of the 31-60 day collectors into the dealerships has had a positive impact on collections. Securitizations Under the current legal structure of our securitization program, we sell loans to our bankruptcy remote subsidiaries that then securitize the loans by transferring them to separate trusts that issue several classes of notes and certificates collateralized by the loans. The securitization subsidiaries then sell Class A bonds or certificates (Class A obligations or Notes Payable) representing approximately 71% of the total finance receivable balance for the most recent securitizations to investors and subordinate classes are retained by us. We continue to service the securitized loans. The Class A obligations have historically been structured so as to receive investment grade ratings. To secure the payment of the Class A obligations, the securitization subsidiaries obtain an insurance policy from MBIA Insurance Corporation that guarantees payment of amounts to the holders of the Class A obligations. Additionally, we also establish a cash "reserve" account for the benefit of the Class A obligation holders. The cash reserve accounts are classified in our condensed consolidated financial statements as Investments Held in Trust and are a component of Finance Receivables, net. Reserve Account Requirements. Under our current securitization structure, we make an initial cash deposit into a reserve account, generally equivalent to 2.25%-6.0% of the initial underlying Finance Receivables principal balance, and pledge this cash to the reserve account agent. The trustee then makes additional deposits to the reserve account out of collections on the securitized receivables as necessary to fund the reserve account to a specified percentage, ranging from 8.0% to 11.0%, of the underlying Finance Receivables' principal balance. The trustee makes distributions to us when:
o the reserve account balance exceeds the specified percentage, o the required periodic payments to the Class A certificate holders are current, and o the trustee, servicer and other administrative costs are current. Liquidity and Capital Resources We require capital for: o increases in our loan portfolio, o the seasonal purchase of inventories, and o working capital and general corporate purposes, o the purchase or lease of property and equipment. o equity or debt repurchases, We fund our capital requirements primarily through: o operating cash flow, o our revolving warehouse and inventory credit lines, and o securitization transactions, o supplemental borrowings. While to date we have met our liquidity requirements as needed, there can be no assurance that we will be able to continue to do so in the future.
20 Cash Flow Net cash provided by operating activities decreased $35.7 million to $135.4 million in the nine months ended September 30, 2001. The decrease is primarily due to an increase in other assets, a decrease in net earnings (loss) and a decrease in other liabilities at September 30, 2001. Net cash used in investing activities decreased $101.1 million to $135.1 million during the nine months ended September 30, 2001 as compared to $236.2 million used during the same period of 2000. The decrease is due to increased collections on finance receivables and a decline in the increase of finance receivables. Financing activities used $1.9 million for the nine months ended September 30, 2001, versus generating $39.6 million during the nine months ended September 30 , 2000. The change is primarily due to a decrease in Additions to Notes Payable Portfolio, an increase in Additional Deposits into Investments Held in Trust, an increase in Collections from Investments Held in Trust, and an increase in Additions to Other Notes Payable. Financing Resources Revolving Facility. In April 2001, the Company replaced their warehouse receivables facility and in August 2001, the Company replaced their inventory facility. Both lines of credit were previously with GE Capital. Our new revolving warehouse facility is with Greenwich Capital Financial Products, Inc. and allows for maximum borrowings of $75 million during the period May 1 through November 30 increasing to $100 million during the period December 1 through April 30. The term of the facility is 364 days with a renewal option, upon mutual consent, for an additional 364-day period. The borrowing base consists of up to 65% of the principal balance of eligible loans originated from the sale of used cars. The lender maintains an option to adjust the advance rate to reflect changes in market conditions or portfolio performance. The interest rate on the facility is LIBOR plus 2.80%. The facility is secured with substantially all Company assets. At September 30, 2001, the Company was not in compliance with the interest coverage ratio covenant of this facility and received a waiver from the lender. The Company was in compliance with all other required covenants. The new revolving inventory facility is for $36 million, an $11 million increase from the prior facility, and expires in June of 2003. Advance rates on inventory purchased range from 80% to 100% of the purchase price. The interest rate on the facility is PRIME plus 6.00%. The facility is secured with the Company's automobile inventory. At September 30, 2001, the Company was not in compliance with the interest coverage ratio covenant of this facility and received a waiver from the lender. The Company was in compliance with all other required covenants. Securitizations. The Company's securitization program is a primary source of our working capital. Securitizations generate cash flow for us from the sale of Class A obligations, ongoing servicing fees, and excess cash flow distributions from collections on the loans securitized after payments on the Class A obligations, payment of fees, expenses, and insurance premiums, and required deposits to the reserve accounts. Securitization also allows us to fix our cost of funds for a given loan portfolio. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Securitizations" for a more complete description of our securitization program. Supplemental Borrowings. In January 2001, the Company entered into a $35 million senior secured loan facility as a renewal for our $38 million senior loan facility originated in May 1999. The new facility has a term of 25 months. Per the agreement, the Company must make principal payments of $1.0 million per month during months 4 through 22. Thereafter through maturity, the agreement requires minimum payments of the greater of $3.0 million per month or 50% of the cash flows from classes of notes issued through securitization that are subordinate to the Class A bonds. Interest is payable monthly at LIBOR plus 600 basis points. The balance on this note was $29.0 million at September 30, 2001. As a condition to the $35 million senior secured loan agreement, Verde Investments, Inc., an affiliate of Mr. Garcia, was required to invest $7 million in us through a subordinated loan. The funds were placed in escrow as additional collateral for the $35 million senior secured loan. The funds were to be released in July 2001 if, among other conditions, the Company had at least $7 million in pre-tax income through June of 2001 and, at that time, Mr. Garcia would have guaranteed 33.3% of the $35 million facility. The Company did not meet this pre-tax income requirement for the first six months of 2001. Therefore, per the loan agreement, Mr. Garcia is now entitled to receive warrants from the Company for 1.5 million shares of stock, vesting over a one-year period, at an exercise price of $4.50 subject to certain conditions. Under the terms of the senior secured loan agreement, any necessary shareholder approval is a condition of the issuance of the warrants. NASDAQ has advised the 21 Company that they believe that shareholder approval is required. We are requesting approval of the warrants at our December 2001 annual meeting. Also as consideration for the loan, the Company released all options to purchase real estate that were then owned by Verde and leased to the Company. We also granted Verde the option to purchase, at book value, any or all properties currently owned by the Company, or acquired by the Company prior to the earlier of December 31, 2001, or the date the loan is repaid. Verde agreed to lease the properties back to the Company, on terms similar to our current leases, if it exercises its option to purchase any of the properties. The loan is secured by residual interests in the Company's securitization transactions but is subordinate to the senior secured loan facility. The loan requires quarterly interest payments at LIBOR plus 600 basis points and is subject to pro rata reductions if certain conditions are met. An independent committee of the Company's board reviewed and negotiated the terms of this subordinated loan and the Company also received an opinion from an investment banker, which deemed the loan fair from a financial point of view both to the Company's stockholders and the Company. The balance of the note with Verde was $6.0 million at September 30, 2001. Capital Expenditures and Commitments In November 2000, Verde Investments, Inc. ("Verde"), an affiliate of Mr. Garcia, purchased a certain property located in Phoenix, Arizona and simultaneously leased the property to us pursuant to among other terms the following: 20 year term which expires December 31, 2020; rent payable monthly with 5% annual rent adjustments; triple net lease; four five-year options to renew; and an option to purchase the property upon prior notice and at Verde's cost. Subsequently, we surrendered this option as part of the $7 million subordinated loan with Verde. In May 2001, Verde purchased one of the Company properties at its approximate book value of $1,650,000. Verde has leased the property back to the Company under a 20-year lease, which expires May 2021. The lease is a triple net lease with an increase approximately 2% in year two and an annual CPI adjustments thereafter. Accounting Matters In August 2001, the Financial Accounting Standards Board issued FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (Statement 144), which supersedes both FASB Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of (Statement 121) and the accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of Operations--Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions (Opinion 30), for the disposal of a segment of a business (as previously defined in that Opinion). Statement 144 retains the fundamental provisions in Statement 121 for recognizing and measuring impairment losses on long-lived assets held for use and long-lived assets to be disposed of by sale, while also resolving significant implementation issues associated with Statement 121. For example, Statement 144 provides guidance on how a long-lived asset that is used as part of a group should be evaluated for impairment, establishes criteria for when a long-lived asset is held for sale, and prescribes the accounting for a long-lived asset that will be disposed of other than by sale. Statement 144 retains the basic provisions of Opinion 30 on how to present discontinued operations in the income statement but broadens that presentation to include a component of an entity (rather than a segment of a business). Unlike Statement 121, an impairment assessment under Statement 144 will never result in a write-down of goodwill. Rather, goodwill is evaluated for impairment under Statement No. 142, Goodwill and Other Intangible Assets. The Company is required to adopt Statement 144 no later than the year beginning after December 15, 2001, and plans to adopt its provisions for the quarter ending March 31, 2002. Management does not expect the adoption of Statement 144 for long-lived assets held for use to have a material impact on the Company's financial statements because the impairment assessment under Statement 144 is largely unchanged from Statement 121. The provisions of the Statement for assets held for sale or other disposal generally are required to be applied prospectively after the adoption date to newly initiated disposal activities. Therefore, management cannot determine the potential effects that adoption of Statement 144 will have on the Company's financial statements. In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations, which requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if reasonable estimate of fair value can be made. The associated asset retirement costs would be capitalized as part of the carrying amount of the long-lived asset and depreciated over the life of the asset. The liability is accreted at the end of each period through charges to operating expense. If the obligation is settled for other than the carrying amount of the liability, the Company will recognize a gain or loss on settlement. The provisions of SFAS No. 143 are effective for fiscal years beginning after June 15, 2002. The Company has not yet determined the impact, if any, of adoption of SFAS No. 143. In June 2001, the FASB issued Statement No. 141, Business Combinations, and Statement No. 142, Goodwill and Other Intangible Assets. Statement 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001 as well as all purchase method business combinations completed after June 30, 2001. Statement 141 also specifies criteria intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill. Statement 142 will 22 require that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of Statement 142. Statement 142 will also require that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. The Company is required to adopt the provisions of Statement 141 immediately and Statement 142 effective January 1, 2002. Furthermore, any goodwill and any intangible asset determined to have an indefinite useful life that are acquired in a purchase business combination completed after June 30, 2001 will not be amortized, but will continue to be evaluated for impairment in accordance with the appropriate pre-Statement 142 accounting literature. Goodwill and intangible assets acquired in business combinations completed before July 1, 2001 will continue to be amortized prior to the adoption of Statement 142. Statement 141 will require upon adoption of Statement 142, that the Company evaluate its existing intangible assets and goodwill that were acquired in a prior purchase business combination, and make any necessary reclassifications in order to conform with the new criteria in Statement 141 for recognition apart from goodwill. Upon adoption of Statement 142, the Company will be required to reassess the useful lives and residual values of all intangible assets acquired in purchase business combinations, and make any necessary amortization period adjustments by the end of the first interim period after adoption. In addition, to the extent an intangible asset is identified as having an indefinite useful life, the Company will be required to test the intangible asset for impairment in accordance with the provisions of Statement 142 within the first interim period. Any impairment loss will be measured as of the date of adoption and recognized as the cumulative effect of a change in accounting principle in the first interim period. As of January 1, 2002, the Company expects to have unamortized goodwill of approximately $11.6 million and no unamortized identifiable intangible assets. The goodwill will be subject to the transition provisions of Statements 141 and 142. Amortization expense related to goodwill was approximately $1.0 million, $0.2 million and $0.7 million for the year ended December 31, 2000 and for the three and nine months ended September 30 , 2001, respectively. Because of the extensive effort needed to comply with adopting Statements 141 and 142, it is not practicable to reasonably estimate the impact of adopting these Statements on the Company's financial statements at the date of this report, including whether any transitional impairment losses will be required to be recognized as a result of the cumulative effect of this change in accounting principle. In September 2000, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" (SFAS No. 140). SFAS No. 140 replaces SFAS No. 125 and revises the standards for accounting for securitizations and other transfers of financial assets and collateral. This statement is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. This statement is effective for recognition and reclassification of collateral and for disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. The adoption of SFAS No. 140 did not have a material impact on us. In June 2000, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities" (SFAS No. 138). SFAS No. 138 amends a limited number of issues causing implementation difficulties for entities that apply SFAS No. 133. SFAS No. 138 is effective for fiscal years beginning after June 15, 2000. Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS No. 133) required all derivatives to be recorded on the balance sheet at fair value and establishes new accounting rules for hedging instruments. The adoption of SFAS No. 138 or No. 133 did not have a material effect on us. We Make Forward Looking Statements This report includes statements that constitute forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. We claim the protection of the safe-harbor for our forward-looking statements. Forward-looking statements are often characterized by the words "may," "anticipates," "believes," "estimates," "projects," "expects" or similar expressions and do not reflect historical facts. Forward-looking statements in this report relate, among other matters, to: adverse economic conditions; anticipated financial results, such as sales, other revenues and loan portfolios, improvements in underwriting, adequacy of the allowance for credit losses, and improvements in recoveries and loan performance, including delinquencies and charge offs; our ability to retain our inventory and warehouse lines of credit; roll-out of collectors to our dealerships; the success of cost savings initiatives; improvements in inventory and inventory mix; favorable interest rate environment; and e-commerce related growth and loan performance. Forward looking statements include risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from those expressed or implied by such forward looking statements, some of which we cannot predict or quantify. 23 Factors that could affect our results and cause or contribute to differences from these forward-looking statements include, but are not limited to: any decline in consumer acceptance of our car sales strategies or marketing campaigns; any inability to finance our operations in light of a tight credit market for the sub-prime industry and our current financial circumstances; any deterioration in the used car finance industry or increased competition in the used car sales and finance industry; any inability to monitor and improve our underwriting and collection processes; any changes in estimates and assumptions in, and the ongoing adequacy of, our allowance for credit losses; any inability to continue to reduce operating expenses as a percentage of sales; increases in interest rates; adverse economic conditions; any material litigation against us or material, unexpected developments in existing litigation; any new or revised accounting, tax or legal guidance that adversely affect used car sales or financing; and developments with respect to Mr. Garcia's offer to take us private. Future events and actual results could differ materially from the forward-looking statements. When considering each forward-looking statement, you should keep in mind the risk factors and cautionary statements found in the sections entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Risk Factors," in our most recent report on Form 10-K, in Exhibit 99 attached to this Quarterly Report on Form 10-Q and elsewhere in our Securities and Exchange Commission filings. In addition, the foregoing factors may affect generally our business, results of operations and financial position. There may also be other factors that we are currently unable to identify or quantify, but may arise or become known in the future. Forward-looking statements speak only as of the dated the statement was made. We are not obligated to publicly update or revise any forward looking statements, whether as a result of new information, future events, or for any other reason. ITEM 3. Market Risk We are exposed to market risk on our financial instruments from changes in interest rates. We do not use financial instruments for trading purposes or to manage interest rate risk. Our earnings are substantially affected by our net interest income, which is the difference between the income earned on interest-bearing assets and the interest paid on interest bearing notes payable. Increases in market interest rates could have an adverse effect on profitability. Our financial instruments consist primarily of fixed rate finance receivables, residual interests in pools of fixed rate finance receivables, short-term variable rate revolving Notes Receivable, and variable and fixed rate Notes Payable. Our finance receivables are classified as subprime loans and generally bear interest at the lower of 29.9% or the maximum interest rate allowed in states that impose interest rate limits. At September 30, 2001, the scheduled maturities on our finance receivables ranged from one to 48 months, with a weighted average maturity of 23.8 months. The interest rates we charge our customers on finance receivables has not changed as a result of fluctuations in market interest rates, although we may increase the interest rates we charge in the future if market interest rates increase. A large component of our debt at September 30, 2001 is the Collateralized Notes Payable (Class A obligations) issued under our securitization program. Issuing debt through our securitization program allows us to mitigate our interest rate risk by reducing the balance of the variable revolving line of credit and replacing it with a lower fixed rate note payable. We are subject to interest rate risk on fixed rate Notes Payable to the extent that future interest rates are lower than the interest rates on our existing Notes Payable. We believe that our market risk information has not changed materially from December 31, 2000. PART II. OTHER INFORMATION Item 1. Legal Proceedings. We sell our cars on an "as is" basis. We require all customers to acknowledge in writing on the date of sale that we disclaim any obligation for vehicle-related problems that subsequently occur. Although we believe that these disclaimers are enforceable under applicable laws, there can be no assurance that they will be upheld in every instance. Despite obtaining these disclaimers, in the ordinary course of business, we receive complaints from customers relating to vehicle condition problems as well as alleged violations of federal and state consumer lending or other similar laws and regulations. Most of these complaints are made directly to us or to various consumer protection organizations and are subsequently resolved. However, customers occasionally name us as a defendant in civil suits filed in state, local, or small claims courts. Additionally, in the ordinary course of business, we are a defendant in various other types of legal proceedings, and are the subject of regulatory or governmental investigations. Although we cannot determine at this time the amount of the ultimate exposure from such matters, if any, we do not expect the final outcome to have a material adverse effect on us. There has also been litigation filed in connection with or related to the intent and/or offer of our chairman, Mr. Garcia, to purchase all of our outstanding common stock not owned by him. On March 20, 2001, a shareholder derivative complaint was filed, purportedly on behalf of Ugly Duckling Corporation, in the Court of Chancery for the State of Delaware in New Castle County, captioned Berger v. Garcia, et al., No. 18746NC. The complaint alleges that our current directors breached fiduciary duties owed to us in connection with certain transactions between us and Mr. Garcia and various entities controlled by Mr. Garcia. The complaint was amended on April 17, 2001 to add a 24 second cause of action, on behalf of all persons who own our common stock, and their successors in interest, which alleges that our current directors breached fiduciary duties in connection with the proposed acquisition by Mr. Garcia of all of the outstanding shares of Ugly Duckling common stock. Ugly Duckling is named as a nominal defendant in the action. The original cause of action seeks to void all transactions deemed to have been approved in breach of fiduciary duty and recovery by Ugly Duckling of alleged compensatory damages sustained as a result of the transactions. The second cause of action seeks to enjoin us from proceeding with the proposed acquisition by Mr. Garcia, or, in the alternative, awarding compensatory damages to the class. Following Mr. Garcia's offer in early April 2001, five additional and separate purported shareholder class action complaints were filed between April 17 and April 25, 2001 in the Court of Chancery for the State of Delaware in New Castle County. They are captioned Turberg v. Ugly Duckling Corp., et al., No. 18828NC, Brecher v. Ugly Duckling Corp., et al., No. 18829NC, Suprina v. Ugly Duckling Corporation, et al., No. 18830NC, Benton v. Ugly Duckling Corp., et al., No. 18838NC, and Don Hankey Living Trust v. Ugly Duckling Corporation, et al., No. 18843NC. Each complaint alleges that Ugly Duckling, and its directors, breached fiduciary duties in connection with the proposed acquisition by Mr. Garcia of all of the outstanding shares of the Ugly Duckling common stock. The complaints seek to enjoin the proposed acquisition by Mr. Garcia and to recover compensatory damages caused by the proposed acquisition and the alleged breach of fiduciary duties. These cases were consolidated in June 2001. In September 2001 Mr. Garcia withdrew his offer. If plaintiffs continue to pursue their claims we intend to vigorously defend against the plaintiff's allegations and believe that the actions are without merit. Item 2. Changes in Securities and Use of Proceeds. (a) None (b) None (c) None (d) Not Applicable Item 3. Defaults Upon Senior Securities. We recently obtained waiver letters for financial ratio covenant breaches under our revolving credit facility and our senior secured loan facility. Item 4. Submission of Matters to a Vote of Security Holders. None Item 5. Other Information. None Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits Exhibit 10.1 - Loan and Security Agreement dated as of August 24, 2001between the Registrant and Automotive Finance Corporation Exhibit 10.2 - Covenant Waiver Letter dated November 1, 2001 between the Registrant and Automotive Finance Corporation Exhibit 10.3 - Covenant Waiver Letter dated November 9, 2001 between the Registrant and Greenwich Capital Financial Products, Incorporated Exhibit 10.4 - Covenant Waiver Letter dated November 9, 2001 between the Registrant and Sun America Life Insurance Company Exhibit 99 - Statement Regarding Forward Looking Statements and Risk Factors 25 (b) Reports on Form 8-K. During the third quarter of 2001, the Company filed three reports on Form 8-K. The first report on Form 8-K, dated September 14, 2001 and filed September 14, 2001, reported Ugly Duckling's closing of an Inventory Line of Credit, filed as an exhibit to the Form 8-K, was a press release dated September 6, 2001, entitled "Ugly Duckling Announces Closing of an Inventory Line of Credit". The second report on Form 8-K dated September 25, 2001 and filed September 25, 2001, reported the withdrawal of an offer made by Mr. Ernest C. Garcia II, Ugly Duckling's Chairman and largest stockholder, to purchase all of the outstanding shares of common stock of Ugly Duckling not already owned by Mr. Garcia, and filed as an exhibit to the Form 8-K was a press release dated September 24, 2001 entitled "Ugly Duckling Reports Withdrawal of Chairman's April 2001 Offer to Purchase Outstanding Common Stock." The third report on Form 8-K, dated October 25, 2001 and filed October 25, 2001, reported Ugly Duckling's third quarter 2001 earnings, and filed as an exhibit to the Form 8-K was a press release dated October 25, 2001 entitled "Ugly Duckling Reports Third Quarter and Nine Month Results." 26 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. UGLY DUCKLING CORPORATION /s/ STEVEN T. DARAK ------------------------------------------- STEVEN T. DARAK Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) Date: November 14, 2001 27
EXHIBIT INDEX Exhibit Number Description ------- ----------- 10.1 Loan and Security Agreement dated as of August 24, 2001 between the Registrant and Automotive Finance Corporation 10.2 Covenant Waiver Letter dated November 1, 2001 between the Registrant and Automotive Finance Corporation 10.3 Covenant Waiver Letter dated November 9, 2001 between the Registrant and Greenwich Capital Financial Products, Incorporated 10.4 Covenant Waiver Letter dated November 9, 2001 between the Registrant and Sun America Life Insurance Company 99 Statement Regarding Forward Looking Statements and Risk Factors
EX-10.1 3 ex101txt.txt AFC LOAN AND SECURITY AGREEMENT 1 Loan and Security Agreement (AFC-Duck Final)LOAN AND SECURITY AGREEMENT This Loan and Security Agreement ("Agreement") is entered into by and between Ugly Duckling Corporation, successor in interest to Ugly Duckling Holdings, Inc. ("Ugly Duckling"), a Delaware corporation;; Ugly Duckling Car Sales and Finance Corporation ("UDCSFC"), an Arizona corporation formerly known as Duck Ventures, Inc.; Ugly Duckling Credit Corporation ("UDCC") formerly known as Champion Acceptance Corporation, an Arizona corporation; Ugly Duckling Car Sales, Inc. ("Sales"); an Arizona corporation; Champion Financial Services, Inc. ("Champion"), an Arizona corporation; Ugly Duckling Car Sales Florida, Inc. ("Car Sales Florida"), a Florida corporation;; Cygnet Financial Corporation ("Cygnet"), a Delaware corporation; Cygnet Support Services, Inc. ("Services"), an Arizona corporation; Cygnet Financial Services, Inc. ("Cygnet Services"), an Arizona corporation; Cygnet Financial Portfolio, Inc. ("Cygnet Portfolio"), an Arizona corporation; Ugly Duckling Portfolio Partnership, L.L.P. ("UDPP"), an Arizona limited liability partnership; and Ugly Duckling Finance Corporation ("UDFC"), an Arizona corporation (all of the foregoing entities collectively referred to herein as "Borrower"); and Automotive Finance Corporation, an Indiana corporation (hereinafter referred to as "Lender"). The obligations of Borrower to Lender under this Agreement are the joint and several liability of each Borrower. In consideration of the mutual covenants and agreements contained herein, Borrower and Lender agree as follows: ARTICLE I - DEFINITIONS. Section 1.0. Definitions. ----------- Capitalized terms used in this Agreement shall have the meanings given to such terms in Section 14 of this Agreement. When such defined terms are used in this Agreement in the plural, the terms shall have the plural of such meanings. All other terms contained in this Agreement shall, unless the context indicates otherwise, have the meanings provided for by the UCC to the extent the same are defined therein. ARTICLE II - LOAN: GENERAL TERMS Section 2.0. Single Loan. ----------- All Advances by Lender to Borrower under Section 2.1 shall constitute one loan and all indebtedness and obligations of Borrower to Lender under the Loan Documents shall constitute an obligation secured by Lender's security interest in all of the Collateral. Borrower's obligation to pay the Indebtedness is evidenced by this Agreement. Borrower shall pay all Indebtedness to Lender when due in accordance with the terms of this Agreement. The actual amount Borrower is obligated to pay Lender hereunder shall be determined by this Agreement and the records of Lender. Section 2.1. Inventory Facility. ------------------- Subject to all of the terms and conditions of this Agreement, Lender agrees to loan funds in an amount up to the Inventory Facility Limit to Borrower from time to time in a series of Advances during the term of this Agreement. Funds may be borrowed, repaid and re-borrowed on a revolving basis subject to the terms and conditions set forth in this Agreement, provided that the amount outstanding under the Inventory Facility shall not at any time exceed the Inventory Advance Value. The dollar amount set forth in this Section 2.1 is an aggregate combined total for Borrower. Section 2.2. General Interest Rate. --------------------- Except as modified by Sections 2.4 and 13.1, the average daily balance of the Indebtedness shall bear interest, calculated on the basis of a 360-day year, at a per annum rate equal to the most recent prime rate published in The Wall Street Journal plus six percent (6%), compounded daily. The interest rate shall automatically adjust each time the prime rate as so published changes. 1 Section 2.3. Loan Term; Right to Terminate. -------------------------------- Unless sooner terminated as hereinafter provided, this Agreement shall terminate without any notice requirement on June 30, 2003 if not renewed or extended by a mutual written agreement. Upon the occurrence of an Event of Default, Lender may, without prior notice to Borrower, immediately terminate this Agreement. A prepayment in full of the Indebtedness shall be a termination of this Agreement. Notwithstanding termination of this Agreement in any manner, the Indebtedness shall be payable in accordance with this Agreement, and all rights and remedies granted to Lender hereunder or pursuant to applicable law shall continue until all obligations of Borrower to Lender have been fully paid and performed. Section 2.4. Maximum Lawful Rate. ------------------- (A) Interest Rate. Notwithstanding any provision in this Agreement, or in any other document, if at any time before the payment in full of the Indebtedness, any of the rates of interest specified in this Agreement (the "Stated Rates") exceeds the highest rate of interest permissible under any law which a court of competent jurisdiction shall, in a final determination, deem applicable hereto (the "Maximum Lawful Rate"), then in such event and so long as the Maximum Lawful Rate would be so exceeded, the rate of interest payable shall be equal to the Maximum Lawful Rate; provided, however, that if at any time thereafter the Stated Rates shall be less than the Maximum Lawful Rate, then, subject to (B) below, Borrower shall continue to pay interest at the Maximum Lawful Rate until such time as the total interest received by Lender is equal to the total interest which Lender would have received had the Stated Rates been (but for the operation of this Section 2.4(A)) the interest rates payable; thereafter, the interest rates payable shall be the Stated Rates unless and until any of the Stated Rates shall again exceed the Maximum Lawful Rate, in which event this Section 2.4(A) shall again apply. In the event interest payable hereunder is calculated at the Maximum Lawful Rate, such interest shall be calculated at a daily rate equal to the Maximum Lawful Rate divided by the number of days in the year in which such calculation is made. (B) Amount of Interest. In no event shall the total interest contracted for, charged, received or owed pursuant to the terms of this Agreement exceed the amount which Lender may lawfully receive. In the event that a court of competent jurisdiction, notwithstanding the provisions of this Section 2.4, shall make a final determination that Lender has received, charged, collected, or contracted for interest hereunder in excess of the amount which Lender could lawfully have, Lender shall, to the extent permitted by law, promptly apply such excess first to any interest due (calculated at the Maximum Lawful Rate if applicable) and not yet paid, then to the prepayment of principal, and any excess remaining thereafter and after application to any other amounts Borrower owes Lender shall be refunded to Borrower. In determining whether the interest exceeds the Maximum Lawful Rate or the maximum amount which Lender could lawfully have received, the total amount of interest shall, to the extent allowed by law, be spread over the term of the Loan. Any provisions of this Agreement regarding the time during which interest accrues on Advances are only elements of the formula for calculating interest on the Indebtedness and are not intended to cause interest to be applied to specific Advances for usury determination purposes. ARTICLE III - LOAN DISBURSEMENTS Section 3.0. Loan. ---- Provided that there does not then exist an Event of Default or a Pre-Default Event, Lender shall, upon written request of Borrower and subject to all of the terms and conditions of this Agreement, make Advances to Borrower pursuant to Section 3.1. Section 3.1. Procedure for Borrowing. ----------------------- (A) Borrower may request an Advance by providing Lender with a certificate in a form acceptable to Lender certifying that (i) no Event of Default has occurred or is continuing, and (ii) Borrower is in complete compliance with the terms and conditions of this Agreement. No Advance shall exceed the Inventory Advance Value. Lender is not obligated to make an Advance (x) if the amount available or requested is less than One Hundred Thousand Dollars ($100,000.00); (y) Borrower has not provided Lender with sufficient information to calculate the Inventory Advance Value; or (z) an Event of Default or a Pre-Default Event has occurred and is continuing Lender's use of the information provided by Borrower to determine the amount available for Advances is not an admission by Lender as to the accuracy of the information, and Lender reserves the right to verify the information and re-determine the amount available for Advances. If at any time Borrower is in default on any obligation to a third party who is claiming an interest in or is encumbering the Collateral, Lender may, in its sole discretion, but is not required, to elect to make a payment or transfer on Borrower's behalf to the third party, in any amount up to the total obligation owed by Borrower to the third party, as a means of satisfying 2 Borrower's obligation to the third party in whole or in part. If Lender elects to make any such payments or transfers, they shall be deemed additional Indebtedness under this Agreement from the date on which the payment or transfer is made. Such payments or transfers may be made without prior notice to Borrower and without regard to the Inventory Advance Value or the Inventory Facility Limit. (B) Lender shall disburse each Advance requested by Borrower on the same Business Day as Lender receives Borrower's written request for the Advance, as long as Borrower's written request indicates that Borrower requires such Advance on the same Business Day and as long as the aggregate of all Advances within such Business Day is equal to or less than Two Million Dollars ($2,000,000.00). Borrower's written request for an Advance shall be made no later than 8:30 a.m. EST or Lender shall not be required to make the Advance until the following Business Day. Lender shall disburse each Advance requested by Borrower, at the expense of Borrower, by means of a wire transfer of the funds to Borrower. ARTICLE IV - LOANS: PAYMENTS Section 4.0. Payments by Borrower. -------------------- (A) Accrued interest shall be paid by Borrower to Lender at the end of each Accounting Period and upon termination of this Agreement. All payments by Borrower to Lender shall be via wire transfer as per the wire instructions listed on Exhibit 4.0(A). (B) Upon the effective date of termination of this Agreement, Borrower shall pay to Lender the entire Indebtedness and all accrued interest thereon. If there is an Event of Default, Borrower shall pay the entire Indebtedness and all accrued interest thereon, on demand if the Indebtedness is accelerated pursuant to Section 13.2. (C) Whenever Lender shall notify Borrower that the Indebtedness exceeds the Inventory Advance Value or the Inventory Facility Limit, Borrower shall within one (1) Business Day after receipt of such notice, pay down the Indebtedness by the amount of such excess. (D) The payment of all elements of the Indebtedness not covered by Subsections (B) or (C) above shall be payable by Borrower to Lender as and when provided in the Loan Documents, and, if not specified, then on demand. (E) Borrower has the right to prepay the Indebtedness and all accrued interest thereon in full or in part at any time without penalty; however, if after the Indebtedness has exceeded Three Million Five Hundred Thousand Dollars ($ 3,500,000.00), the dollar value of the Indebtedness falls below Three Million Five Hundred Thousand Dollars ($3,500,000.00) for at least ten (10) Business Days, then Borrower shall pay the entire Indebtedness and all accrued interest thereon upon Lender's demand and Borrower's payment in full of such Indebtedness and all accrued interest thereon shall constitute a termination of this Agreement. ARTICLE V - ADMINISTRATION Section 5.0. Borrower Administration. ----------------------- Borrower shall furnish to Lender such reports in such form that Lender determines are necessary for it to track and monitor Motor Vehicles, Eligible Vehicles, Inventory and the Inventory Advance Value. Such reports shall be in a format and on a medium readable by Lender's computer software, or such other format or medium acceptable to Lender. Lender agrees that providing the reports in paper form to Lender is a medium/format acceptable to Lender. The reports shall include but not be limited to those reports set forth on Exhibit 5.0(C) attached hereto and made a part hereof, and shall be delivered to Lender in accordance with such Exhibit. ARTICLE VI - COLLATERAL: GENERAL TERMS 3 Section 6.0. Security Interest. ----------------- To secure the performance and payment of the Indebtedness and all of Borrower's existing and future obligations to Lender whether arising under or related to this Agreement or otherwise, Borrower hereby grants to Lender a continuing security interest in and to all of the following property of Borrower, whether now owned or existing or hereafter arising or acquired and regardless of where located: Inventory; Motor Vehicles; certificates of title related to Inventory and the Motor Vehicles; insurance policies, and benefits and rights under insurance policies, all as related to Inventory and the Motor Vehicles, which Borrower is solely or jointly the owner of, insured under, the lienholder or loss payee under, or the beneficiary of; accessions to, substitutions for and all replacements, products and proceeds of, any of the foregoing property; and books and records (including, without limitation, financial statements, accounting records, customer lists, credit files, computer programs, electronic data, print-outs and other computer materials and records) of Borrower pertaining to any of the foregoing property; provided however, that the Collateral (including without limitation, proceeds of Collateral) shall not include the Contract Collateral or other property not described above. Section 6.1. Disclosure of Security Interest. ------------------------------- Borrower shall make appropriate entries upon its financial statements and its books and records disclosing Lender's security interest in the Collateral. Section 6.2. Additional Acts. --------------- Borrower shall perform all other acts requested by Lender for the purpose of perfecting, protecting, maintaining and enforcing Lender's security interest in the Collateral and the priority of such security interest. Borrower agrees that a carbon, photographic, photostatic, or other reproduction of this Agreement or of a financing statement is sufficient as a financing statement. Borrower, upon request of Lender, shall either pay or reimburse Lender for all costs, filing fees, and taxes associated with the perfection of Lender's security interest. Section 6.3. Inspection and Access. --------------------- Lender and its agents (including but not limited to representatives of AutoVIN, Inc.) shall have the right, at any time, to (i) during Borrower's usual business hours, inspect the Collateral and the premises upon which any of the Collateral is located; (ii) during Borrower's usual business hours, inspect, audit and make copies or extracts from any of Borrower's records, computer systems, files, and books of account related to the Collateral; (iii) during Borrower's usual business hours, monitor Borrower's performance of its obligations with respect to this Agreement; and (iv) obtain information about Borrower's affairs and finances from any Person; and (v) verify, in Lender's name or in the name of Borrower, the validity, amount, quality, quantity, value and condition of, or any other matter relating to, the Collateral. Borrower shall, upon Lender's request from time to time, instruct its vendors, banking and other financial institutions and its accountants to make available to Lender and discuss with Lender such information and records as Lender may reasonably request. Borrower authorizes Lender, if requested by a Person other than a credit reporting agency and without request if the Person is a credit reporting agency, to provide that Person with information about the Indebtedness, Collateral and Borrower's performance of this Agreement. If Borrower maintains or stores any data with respect to Collateral on a computer data system, Borrower shall upon request of Lender provide Lender with (y) on-line access to such computer data system or (z) deliver to Lender duplicate copies of the requested data in machine readable form acceptable to Lender along with a printout or other hard copy of such data. If at any time during the Agreement, Lender establishes on-line access to Borrower's computer system, Lender shall exercise such care as it exercises with respect to its own computer systems regarding the integrity and confidentiality of Borrower's information therein, Lender shall restrict its access to those parts of the Borrower's computer system that relate to the Collateral and Lender shall observe all reasonable security requirements relating to Borrower's computer system as Lender is advised of by Borrower, provided however, that such observance shall in no way prevent Lender from accessing Borrower's information. Borrower agrees to pay for six (6) audits per year at each of Borrower's 4 applicable Places of Business. Each such audit will be used to determine Borrower's compliance with this Agreement including minimum levels of Inventory. Borrower agrees to pay Lender a Sixty-Five Dollar ($65) fee for each audit described above plus One Dollar ($1) for every Motor Vehicle audited at any one location in excess of sixty (60) Motor Vehicles to cover the cost of such audits. Section 6.4. Lender Authorization. -------------------- By execution of this Agreement, Borrower authorizes Lender and any of its officers or employees to execute and file, on behalf of Borrower and without Borrower's signature, original financing statements, amendments, continuation statements, and any other documents Lender deems necessary or desirable to protect its interests. Borrower authorizes Lender to supply any omitted information and correct errors in any document executed by or on behalf of Borrower. Section 6.5. Change of Collateral, Location, Office or Structure. --------------------------------------------------- Borrower shall keep the Motor Vehicles and Inventory at Borrower's Places of Business and shall, at Lender's request, advise Lender of the location of any other Collateral. Borrower shall not change its name, tradename, principal place of business and chief executive office or the location of any service center as listed in Exhibit 8.0(A), unless Borrower gives Lender at least sixty (60) days prior written notice of such change and prior thereto has taken all action Lender requires to maintain the priority and perfection of its security interest in, and access to, the Collateral. Provided, however, that Lender acknowledges Borrower has notified Lender that Borrower will be changing its corporate headquarters address sometime in the month of August to: 4020 E. Indian School Road, Phoenix, AZ 85018. Section 6.6. Termination of Security Interest. -------------------------------- Lender's security interest in the Collateral shall continue until performance and payment in full of all of Borrower's obligations to Lender in accordance with the terms of agreements creating such obligations; and if, at any time, all or part of a payment or transfer made by Borrower or any other Person and applied by Lender to Borrower's obligations to Lender is rescinded or otherwise must be returned by Lender for any reason whatsoever (including, without limitation, the insolvency, bankruptcy or reorganization of Borrower or such other Person), the security interest granted hereunder or under any other present or future agreement between Borrower and Lender, and all rights of Lender, shall be reinstated as to the obligations which were satisfied by the payment or transfer rescinded or returned, all as though such payment or transfer had not been made, and Borrower shall take the action requested by Lender to re-perfect all terminated security interests and to reinstate all satisfied obligations. Lender shall release its security interest in Contracts which are sold or pledged to other Persons in accordance with Section 12.8. ARTICLE VII - CONDITIONS TO ADVANCES Section 7.0. Conditions to Each Advance. -------------------------- Notwithstanding any other provision of this Agreement and without affecting in any manner the rights of Lender hereunder, Lender shall not be obligated to make any Advances (including the initial Advance) unless at the time of the Advance, all of the following conditions shall, in Lender's sole determination, be satisfied: (A) All of the representations and warranties of Borrower in all of the Loan Documents shall be true and correct on and as of the date of such Advance as though they were made on and as of such date and Borrower shall have performed all of its obligations contained in the Loan Documents required to be performed as of such date; (B) The making of the Advance will not cause or constitute an Event of Default or Pre-Default Event; (C) There shall have been no material adverse change in the financial condition of Borrower; (D) No claim has been asserted or proceeding commenced challenging this Agreement or Lender's rights under this Agreement, and no claim has been asserted which if true would be a breach of a representation and warranty in the Loan Documents; 5 (E) No Event of Default shall have occurred, and no Pre-Default Event shall have occurred and still be in existence; (F) Lender has a first priority perfected security interest in the Inventory and Motor Vehicles and has a perfected security interest in the Collateral except to the extent otherwise allowed by this Agreement or Lender in writing; (G) Lender's most recent inspection of the Collateral or Borrower's records or operations has been satisfactory to Lender; and (H) Borrower shall have provided such additional information and documents as Lender may reasonably request. ARTICLE VIII - REPRESENTATIONS AND WARRANTIES OF BORROWER Section 8.0. Representations of Borrower. --------------------------- Borrower, jointly and severally hereby makes the following representations and warranties. The representations and warranties are made as of the execution and delivery of the Agreement, and each time Borrower requests an Advance the representations and warranties are deemed to be made again at that time. Lender's knowledge of any breach of the representations and warranties contained herein shall not void any of the representations or warranties or affect Lender's rights with respect to the breach. (A) Organization, Good Standing, Name, and Location. Borrower is a corporation duly organized, validly existing and in good standing under the laws of the States where it conducts business, with power and authority to own its properties and to conduct its business, and, at all relevant times, has the power, authority and legal right to acquire, own, and pledge the Pledged Contracts. Borrower has, is in good standing under, and is in compliance with, all governmental approvals, licenses, permits, certificates, inspections, consents and franchises necessary to conduct its business, to enter into and perform this Agreement, and to own and operate its business. Borrower's places of business including without limitation the locations where Borrower conducts Borrower's retail sales of Inventory and Motor Vehicles, Borrower's principal place of business and chief executive office and Borrower's proposed places of business including without limitation the locations where Borrower conducts Borrower's retail sales of Inventory and Motor Vehicles, Borrower's principal place of business and chief executive office are the Borrower addresses set forth in Exhibit 8.0(A). During the preceding five (5) years, Borrower has not, been known by or used any other corporate, trade or fictitious name, except as disclosed in Exhibit 8.0(A). (B) Due Qualification. Borrower has, and is in good standing under, all licenses, permits, and approvals in all jurisdictions that are required for Borrower's performance of this Agreement. (C) Power and Authority. Borrower has the power and authority to execute this Agreement and carry out its terms, and the execution and performance of the Agreement have been duly authorized by all necessary corporate action. The execution and performance of this Agreement by Borrower does not require the consent or approval of any Person. (D) Valid and Binding Obligations. The Agreement constitutes a valid loan obligation of Borrower and a valid granting of a security interest in the Collateral to Lender, and is a legal, valid and binding obligation of Borrower enforceable in accordance with its terms. Borrower's use of the Advances is a legal and proper corporate use. Borrower has not used Advances to give any preference to any creditor or to make a fraudulent transfer. (E) No Violation. Borrower's execution and performance of this Agreement does not conflict with, result in any breach of, nor constitute (with or without notice or lapse of time) a default under, (i) the articles of incorporation or bylaws of Borrower, or (ii) any indenture, instrument, agreement, or court order by which it is bound, or (iii) nor does it result in the creation or imposition of any lien upon any of Borrower's properties other than that granted to Lender. 6 (F) No Proceedings. Except as otherwise set forth on Exhibit 8.0 (F), there are no proceedings or investigations pending, or to the best of Borrower's knowledge, threatened, before any court, regulatory body, administrative agency, or other governmental instrumentality having jurisdiction over Borrower or its properties, which (i) assert the invalidity of the Agreement, (ii) seek to prevent the consummation of any of the transactions contemplated by the Agreement, (iii) seek any determination or ruling that, if determined adversely to Borrower, would materially and adversely affect the Collateral, Borrower's ability to perform its obligations under the Agreement, the validity or enforceability of the Agreement, Lender's rights under the Agreement, or Borrower's financial condition or business, or (iv) allege that Borrower is in violation of any statute, regulation, rule or ordinance of any governmental entity, including, without limitation, the United States of America, any state, city, town, municipality, county or of any other jurisdiction, or of any agency thereof except in connection with complaints of Contract Debtors made in the normal course of Borrower's business and not of a material nature. (G) Collateral. Borrower has good and marketable ownership of the Collateral, and the Collateral is free and clear of all liens, claims, charges, defenses, counterclaims, offsets, encumbrances and security interests of any kind or nature, except the Permitted Liens. Unless specifically provided otherwise herein the security interests granted to Lender in the Motor Vehicles and Inventory pursuant hereto are perfected first priority security interests, assuming the filing of a UCC financing statement with the collateral description in Exhibit 8.0(G) with the office of Secretary of State of the state of incorporation or organization of each Borrower and with the Secretary of State of Florida for each Borrower, and no claim of ownership or other interest has been asserted which would be a breach of this Section 8.0(G). (H) Taxes. All required federal, state and local tax returns of Borrower have been accurately prepared and duly and timely filed (within the initial or extended time period allowed therefore) and all federal, state and local taxes required to be paid with respect to the periods covered by such returns have been paid. Borrower has not been delinquent in the payment of any tax, assessment or other governmental charge which could adversely affect in any way the Collateral. (I) Brokers. No Person has, or as a result of the transactions contemplated hereby will have by reason of any Borrower conduct or any agreement to which Borrower is a party, any right, interest or claim against Borrower, Lender or the Collateral for any commission, fee or other compensation as a finder or broker or in any similar capacity. (J) Status and Condition. Borrower is solvent, in stable financial condition and is able to and does pay its liabilities as they mature. Borrower is not a party to any collective bargaining contract. (K) Disclosure. There is no fact known to Borrower which Borrower has not disclosed to Lender in writing with respect to the Collateral or the assets, liabilities, financial condition or activities of Borrower or its Affiliates which would or may be likely to have a material adverse effect upon the Collateral or Borrower's ability to perform its obligations under the Agreement. All information and documents prepared by Borrower and provided to Lender at any time are true and accurate at the time of delivery. Borrower does not have knowledge that any information or documents, not prepared by Borrower but delivered by Borrower to Lender were not true and accurate at the time of delivery. (L) Articles of Incorporation and Certificates of Good Standing. The Borrower's Articles of Incorporation received by Lender pursuant to this Agreement have not been modified. Borrower has not taken or allowed any action that would result in it not being in good standing. Borrower has not received notice of any actual or threatened action to revoke its articles of incorporation or good standing. (M) Financial Statements. All financial statements of Borrower and Affiliates delivered to Lender fairly present the assets, liabilities and financial condition and income as of the dates thereof. There are no material omissions from the financial statements and there has been no adverse change in the assets, liabilities or financial condition since the date of the most recently delivered financial statements. There exists no equity or long-term investments in, or outstanding advances to, or guaranties of, any Person except such equity, 7 investment, advances, or guaranties disclosed in the financial statements. The financial statements accurately disclose all transactions with Affiliates. (N) Conditions. Each time Borrower requests an Advance, the Conditions in Section 8.0 have been met. (O) No Defaults. No event has occurred and no condition exists which would, upon the execution and delivery of this Agreement or Borrower's performance hereunder, constitute an Event of Default. Borrower is not in default, and no event has occurred and no condition exists which constitutes, or with the passage of time or the giving of notice or both, would constitute, a default under any material agreement between Borrower and any Person, including the payment of any debt or other obligation permitted under this Agreement to any Person for borrowed funds, or any obligation relating to the securitization of any assets of Borrower or any Affiliate of Borrower. ARTICLE IX - REPRESENTATIONS AND WARRANTIES OF THE LENDER Section 9.0. Representations of Lender. ------------------------- The Lender hereby makes the following representations and warranties: (A) Due Organization. The Lender is a corporation, duly organized, validly existing and in good standing under the laws of the State of Indiana, and has the power to own its assets and to transact the business in which it is presently engaged with regard to this Agreement; (B) Requisite Power. The Lender has the power to execute, deliver and perform this Agreement, and has taken all necessary action to authorize the execution, delivery and performance of this Agreement; and (C) Binding Agreement. This Agreement has been duly executed and delivered by the Lender and constitutes the legal, valid and binding obligation of the Lender, enforceable in accordance with its terms. ARTICLE X - INDEMNITIES Section 10.0. Indemnity. --------- Borrower shall indemnify and hold Lender harmless from any and all losses, claims, damages, costs, good faith settlements, expenses, taxes, reasonable attorneys' fees or other liabilities, including but not limited to costs of investigation, litigation fees and expenses, and costs in successfully asserting the right to indemnification hereunder, (collectively, "Losses") incurred by Lender at any time and pertaining to (i) facts which are, or allegations which if true would be, a breach of any representation, warranty, obligation, agreement or covenant of Borrower contained in the Loan Documents, or (ii) Lender entering into the Loan Documents or making Advances, (iii) an Event of Default or a Pre-Default Event, (iv) activities, operations or conduct of Borrower or Affiliates or (v) or administering Pledged Contracts in the Event of Default. ARTICLE XI - AFFIRMATIVE COVENANTS The following covenants shall remain in effect until the full payment and performance of all of Borrower's obligations to Lender: Section 11.0. Financing Statements. -------------------- At the request of Lender, Borrower shall execute such financing statements as Lender determines may be required by law to perfect, maintain and protect the interest of Lender in the Collateral and in the proceeds thereof. Section 11.1. Books and Records. ----------------- Borrower shall maintain accurate and complete books and records with respect to the Collateral, Borrower's business. All accounting books and records shall be maintained in accordance with generally accepted accounting principles consistently applied. 8 Section 11.2. Payment of Fees and Expenses. ---------------------------- Borrower shall pay to Lender, on demand, any and all fees, costs or expenses which Lender pays to a bank or other similar institution arising out of or in connection with the forwarding to Borrower, or any other Person on behalf of Borrower, by Lender of Advances pursuant to this Agreement. Section 11.3. Continuity of Business and Compliance with Agreement. ---------------------------------------------------- Borrower shall maintain its corporate existence and shall continue in business in a prudent, reasonable and lawful manner with all necessary licenses, permits, and qualifications necessary to perform this Agreement. Borrower shall maintain Borrower's warehouse Borrower shall take the steps necessary for the representations and warranties in Article VIII to be true at all times. In the event that Borrower learns that a representation and warranty in Article VIII is no longer true, it shall notify Lender within one (1) Business Day after learning thereof. Section 11.4. Financial Statements and Access to Records. ------------------------------------------ Borrower shall provide Lender with quarterly unaudited consolidated financial statements within forty-five (45) days of the end of each of Borrower's fiscal quarters, and with audited annual consolidated financial statements within one hundred and twenty (120) days of Borrower's fiscal year-end audited by an independent certified public accounting firm acceptable to Lender. Upon request of Lender, Borrower shall provide Lender with unaudited (or audited if Borrower so chooses) consolidated and consolidating monthly financial statements. Borrower shall deliver to Lender with each financial statement a certificate by Borrower's chief financial officer in the form of Exhibit 11.4. Section 11.5. Subsequent Actions. ------------------ At the request of Lender, Borrower shall execute and deliver to Lender after execution of this Agreement such documents or take such further action as Lender deems necessary to carry out the Agreement. Section 11.6. Financial Condition. ------------------- (A) Each of unsecured debt or obligation owed by Borrower to any third party is set forth in Exhibit 11.6(A). Borrower shall not allow its Debt Ratio to exceed 4.50:1. (B) Borrower shall maintain a Net Worth of at least One Hundred Fifty Million Dollars ($150,000,000.00). If Borrower is in default of any securitized tranche/trust, Net Worth shall be reduced by the residual value associated with the defaulted securitization. (C) Borrower shall maintain a cash flow Interest Coverage ratio in 2001 and through the first quarter of 2002 of 1.0:1.00, and beginning as of the end of the first quarter of 2002, 1.25:1.00. (D) Borrower's Rolling Average Delinquency shall not exceed 8.5%. (E) Borrower's three-month Rolling Average Managed Portfolio Delinquency ratio shall not exceed ten percent (10%). (F) Borrower's three (3) month Average Charged-Off Losses for all Managed Portfolio Contracts shall not exceed two and three-quarters percent (2.75%). (G) Borrower shall notify Lender in writing, promptly upon its learning of any material adverse change in the financial condition of Borrower. (H) Borrower shall provide Lender a daily report on Borrower's Motor Vehicle inventory detailing Borrower's purchase price for all such inventory as set out in Exhibit 5.0 (c). Section 11.7. Litigation Matters. ------------------ Borrower shall notify Lender in writing, promptly upon its learning thereof, of any litigation, arbitration or administrative proceeding which Borrower 9 reasonably believes may materially or adversely affect the operations, financial condition or business of Borrower or Borrower's ability to perform this Agreement or which in any way involve Lender's security interest in the Collateral or other rights under the Loan Documents. Section 11.8. Value of Collateral. ------------------- Borrower shall provide Lender with written notice within one (1) Business Day of any third party lender's determination that any of the Collateral has materially decreased in value, other than through ordinary depreciation, and has requested, demanded, or otherwise required Borrower to either provide enough additional collateral or to reduce Borrower's indebtedness or other obligation to such third party lender. In addition if in Lender's judgment the Inventory or the Motor Vehicles have materially decreased in value, other than through ordinary depreciation, Borrower shall either provide enough additional Collateral to satisfy Lender or reduce the Indebtedness by an amount sufficient to satisfy Lender. Section 11.9. Payment of Obligations. ---------------------- Borrower shall pay and perform, as and when due, all of its obligations, including, without limitation, all of its obligations to Lender. Section 11.10. Borrower Insurance. ------------------ Borrower represents that Borrower is self-insured for any loss or damage to the Inventory, but in the event that Borrower shall incur an otherwise insurable loss in any single occurrence of One Hundred Fifty Thousand Dollars ($150,000) or more with respect to the Inventory, then with respect to the Inventory, Borrower shall exercise good faith best effort to promptly seek and obtain Umbrella Liability Insurance in an amount equal to at least Ten Million Dollars ($10,000,000.00) and Comprehensive Insurance in an amount equal to at least Ten Million Dollars ($10,000,000.00) per occurrence and in the aggregate. Borrower shall provide Lender, or Lender's designees, with certificates as to policies of such insurance covering the Inventory together with evidence that the premium therefore has been paid and that Lender has been named as loss payee and additional insured on such policies. The proceeds of loss under such policies are hereby assigned to Lender. If Lender determines that Borrower has not maintained the required insurance coverage for the Inventory, Lender may, but has no obligation to, purchase a policy or policies of insurance (through forced placement or otherwise) any may treat amounts so expended as additional Indebtedness. The risk of loss or damage to the Collateral shall at all times remain solely with Borrower. Section 11.11. Unencumbered Inventory. ---------------------- Sales shall at all times maintain the Inventory and Motor Vehicles free and clear of all liens, security interests and encumbrances, excepting the liens and encumbrances granted to Lender, and the value of the Inventory and Motor Vehicles shall not be valued at less than Five Million Dollars ($5,000,000.00) in the aggregate. Section 11.13. Borrower Agent. -------------- Borrower hereby irrevocably appoints Ugly Duckling Corporation as its agent for the purpose of dealing with Lender (including receiving notices from Lender and making requests for Advances) in connection with the Indebtedness and this Agreement. This appointment and authorization is for the convenience of the parties and does not relieve any Borrower of any of its obligations to Lender. Section 11.14. Primary Floorplan Source; Adesa. ------------------------------- Borrower shall utilize this Inventory Facility as Borrower's primary floorplan source for a period of twelve (12) months following the Closing Date. If Borrower fails to utilize this Inventory Facility as Borrower's primary floorplan source throughout the twelve month period, then Borrower shall pay Lender a one time separation fee of Twenty-Five Thousand Dollars ($25,000) as liquidated damages. Throughout the term of the Inventory Facility, Borrower shall comply with the ADESA use requirements as set out in the letter agreement with Lender dated July 6, 2001, attached hereto and incorporated by reference herein as Exhibit 11.14. 10 ARTICLE XII - NEGATIVE COVENANTS Borrower covenants and agrees that hereafter, without Lender's prior written consent, which Lender may or may not give, in its sole discretion, until all of Borrower's obligations to Lender with respect to this Agreement are performed and paid in full: Section 12.0. Mergers, etc. ------------ Borrower shall not merge with, consolidate with, acquire or otherwise combine with, or sell or transfer all or substantially all of it assets to any Person, transfer any division or segment of its operations to any Person or form any subsidiary, except for investments in other Borrowers; provided, however, that Lender acknowledges that Borrower intends to merge Car Sales Florida into Car Sales and Lender consents to Borrower doing so, and the chairman of Guarantor is attempting to take Guarantor private and Lender consents to that transaction. Section 12.1. Investments. ----------- Borrower shall not make any investment in any Person through the direct or indirect holding of securities or otherwise nor shall Borrower use Advances or proceeds of Inventory to purchase margin stock except as set out in Section 12.0. Section 12.2. Dividends. --------- Borrower shall not declare or pay dividends except in accordance with all applicable laws and any dividends declared or paid shall not exceed, in the aggregate, fifteen percent (15%) of each year's net income available for distribution and except as set out in Section 12.0, Borrower shall not redeem, retire, purchase or otherwise acquire, directly or indirectly, any of Borrower's stock. Section 12.3. Loans and Advances. ------------------ Except for routine and customary salary advances, Borrower shall not make any unsecured loans or other advances of money to officers, directors, employees, stockholders or Affiliates in excess of Two Million Dollars ($2,000,000.00) in total. Borrower shall not incur any long term or working capital debt (other than the Indebtedness) secured by Inventory. All obligations and security interests owned by any Borrower with respect to any other Borrower are subordinated to the Indebtedness and the Lender's security interest in the Collateral. Section 12.4. Capital Structure. ----------------- Borrower shall not make any change in any of its business objectives, purposes and operations that might in any way adversely affect the payment or performance of, or Borrower's ability to pay and perform, its obligations to Lender with respect to this Agreement. Borrower shall not allow a transfer of ownership of Borrower that results in less than fifteen percent (15%) of the voting stock of Borrower being owned by Ernest C. Garcia, II. Section 12.5. Transactions with Affiliate. --------------------------- Borrower shall not enter into, or be a party to, any transaction with any Affiliate, or stockholder of Borrower, except, consistent with Borrower's practice before entering into this Agreement, in the ordinary course of, and pursuant to the reasonable requirements of, Borrower's business and upon fair and reasonable terms which are fully disclosed to Lender and are no less favorable to Lender than would obtain in a comparable arm's length transaction with a Person not an Affiliate or stockholder of Borrower. Section 12.6. Adverse Transactions. -------------------- Borrower shall not enter into any transaction that adversely affects the Collateral or Borrower's ability to perform this Agreement or Lender's rights under the Loan Documents. Section 12.8. Collateral. ---------- Except as otherwise expressly permitted in the Loan Documents, Borrower shall not convey or allow any ownership, security, or other, interest in the Collateral other than Borrower's ownership interest and Permitted Liens. Borrower may sell or pledge Contracts. Borrower may sell Motor Vehicles and Inventory to bona fide retail customers. ARTICLE XIII - EVENTS OF DEFAULT Section 13.0. Events of Default. ----------------- An Event of Default means the occurrence or existence of one or more of the following events or conditions (whatever the reason for the Event of Default and 11 whether voluntary, involuntary or caused by operation of law) which is not waived in writing by Lender or cured to the extent a cure is applicable: (A) A breach by Borrower of any representation, warranty or obligation contained herein or in the other Loan Documents or in any other agreement with Lender including without limitation failure to make any payment of principal, interest, or any other amount provide for in this Agreement when due. (B) A breach by an Affiliate of any representation, warranty, or obligation contained in any other agreement with Lender. (C) Any default by Borrower or any Affiliate of Borrower (including but not limited to a default due to non-payment, or a default relating to the securitization of any assets of Borrower or any Affiliate of Borrower) under any material agreement, document or instrument to which it is a party or by which any of its property is bound, creating or relating to any debt or other obligation (other than the Indebtedness hereunder), if the payment or maturity of such debt or obligation is accelerated as a consequence of such default or demand for payment thereof is made. (D) The Collateral or any other of Borrower's or an Affiliate's assets are attached, seized, levied upon or subjected to a writ or distress warrant, or come within the possession of any receiver, trustee, custodian or assignee for the benefit of creditors and the same is not dissolved within thirty (30) days thereafter; an application is made by any Person other than Borrower for the appointment of a receiver, trustee, or custodian for the Collateral or any other of Borrower's or an Affiliate's assets and the same is not dismissed within thirty (30) days after the application therefore; or Borrower or an Affiliate shall have concealed, removed or permitted to be concealed or removed, any part of its property, with intent to hinder, delay or defraud its creditors or made or suffered a transfer of any of its property which may be fraudulent under any bankruptcy, fraudulent conveyance or other similar law. Provided, however, if any of the foregoing occurs with respect to Inventory or a Motor Vehicle, Borrower may cure the default by not designating it as an Eligible Vehicle(s). (E) An application is made by Borrower or an Affiliate for the appointment of a receiver, trustee or custodian for the Collateral or any other of Borrower's or an Affiliate's assets; a petition under any section or chapter of the Bankruptcy Code or any similar federal or state law or regulation shall be filed by Borrower or an Affiliate; Borrower or an Affiliate shall make an assignment for the benefit of its creditors or any case or proceeding is filed by Borrower or an Affiliate for its dissolution, liquidation, or termination; Borrower ceases to conduct its Contract purchase and servicing business. (F) Borrower is enjoined, restrained or in any way prevented by court order from conducting all or any material part of its business affairs, or a petition under any section or chapter of the Bankruptcy Code or any similar federal or state law or regulation is filed against Borrower or an Affiliate, or any case or proceeding is filed against Borrower or an Affiliate for its dissolution or liquidation, and such injunction, restraint, petition, case or proceeding is not dismissed within thirty (30) days after the entry or filing thereof. (G) A notice of lien, levy or assessment is filed of record with respect to all or any of Borrower's or an Affiliate's assets by the United States, or any department, agency or instrumentality thereof, or by any state, county, municipal or other governmental agency and it is not released within thirty (30) days after the filing; or if any taxes or debts become a lien or encumbrance upon the Collateral or any other of Borrower's or an Affiliate's assets, and the same is not released within thirty (30) days after the same becomes a lien or encumbrance. (H) Borrower or an Affiliate becomes insolvent or admits in writing to its inability to pay its debts as they mature. 12 (I) There occurs or exists any situation which leads Lender to believe, in good faith, that Borrower may not, or may be unable to, pay in the normal course one or more payment obligations to Lender, and Lender has given Borrower at least ten (10) days' notice thereof. (J) A financial statement of Borrower or an Affiliate reveals that its financial condition has materially adversely deteriorated after the execution of this Agreement. (K) An audited financial statement of Borrower is not unqualified. (L) Any other event occurs which will, in Lender's reasonable opinion, have a material adverse effect on the Collateral, Lender's rights under the Loan Agreements, or on Borrower's financial or business condition, operations or prospects, and Lender has given Borrower at least ten (10) days' notice thereof. (M) Borrower's termination or failure to maintain a warehouse facility substantially similar to the facility identified in Exhibit 13.0(M). Section 13.1. Default Rate of Interest. ------------------------ Upon and after an Event of Default and subject to Section 2.4, Borrower's obligations to Lender shall continue to bear interest, calculated daily on the basis of a 360-day year at the per annum rate set forth in Section 2.2, plus additional post-default interest of four percent (4%) compounded daily until paid in full. Section 13.2. Lender's Remedies. ----------------- Whenever a Pre-Default Event or an Event of Default has occurred, Lender may without prior notice immediately suspend making Advances. Upon and after an Event of Default, Lender shall have the following rights and remedies. The rights and remedies shall be cumulative, and none exclusive, except to the extent required by law. Lender's exercise of any right, remedy, or attorney-in-fact appointment shall not relieve Borrower of any of its obligations to Lender. (A) The right, at Lender's discretion and without notice, (i) to immediately cease further Advances and/or terminate this Agreement, and (ii) to declare Borrower's obligations to Lender immediately due and payable, whereupon Borrower's obligations shall become and be due and payable, without presentment, demand, protest or further notice or process of any kind, all of which are expressly waived by Borrower. Borrower's obligations to Lender shall be immediately due and payable without declaration by Lender if the Event of Default consists of an event set forth in Section 13.0(E), (F), or (H). (B) All of the rights and remedies of a secured party under the UCC and other applicable laws, including the right to appoint a receiver. (C) The right at any time to (i) enter through self-help and without judicial process, upon the premises of Borrower, without any obligation to pay rent to Borrower, or to enter any other place or places where the Collateral is located and kept, and remove the Collateral or remain on and use the premises for the purpose of collecting or disposing of the Collateral, and (ii) require Borrower to assemble the Collateral and make it available to Lender at a place to be designated by Lender. (D) The right to sell or otherwise dispose of all or any of the Collateral at public or private sale, as Lender in its sole discretion may deem advisable; and such sales may be adjourned from time to time with or without notice. Lender shall have the right to conduct such sales on Borrower's premises without charge for such time and Collateral as Lender may see fit. Lender is hereby granted a license or other applicable right to use, without charge, Borrower's labels, patents, copyrights, rights of use of any name, trade secrets, trade names, trademarks and advertising matter, or any property of a similar nature, as it pertains to the Collateral, in advertising for sale and selling any Collateral and Borrower's rights under all licenses and all franchise agreements shall inure to Lender's benefit for this purpose. Lender shall have the right to sell, lease or otherwise dispose of the Collateral, or any part thereof, for cash, credit or any combination thereof, and Lender may purchase all or any part of the Collateral at public or, if permitted by law, private sale and, in lieu of actual payment of such purchase price, may set off the amount of such price against Borrower's obligations to Lender. If any 13 deficiency shall arise from the disposition of Collateral, Borrower shall remain liable to Lender therefore. Borrower agrees that the Inventory and Motor Vehicles are a type of collateral customarily sold on a recognized market. (E) The right at any time and from time to time thereafter, at Lender's sole discretion and without notice to Borrower, (i) to collect and foreclose, by legal proceedings or otherwise, the Collateral in the name of Lender or Borrower and (ii) to take control, in any manner, of any item of payment for or proceeds of the Collateral. Lender is not obligated to pursue the Collateral or any other Person in order to enforce Borrower's obligations to Lender. (G) The right to carry out the actions within the scope of Borrower's appointment of Lender as attorney-in-fact. Section 13.3. Injunctive Relief. ----------------- Borrower recognizes that if there is an Event of Default then, depending on the nature of the Event of Default, it may be that no remedy at law will provide complete or adequate relief to Lender, and Lender shall be entitled to temporary and permanent injunctive relief in any such case without the necessity of proving actual damages. The injunctive relief shall not be a waiver of Lender's rights to other relief and remedies. Section 13.4. Notice. ------ Any notice required to be given by Lender of a sale, lease, or other disposition of the Collateral which is given pursuant to Section 15.1 at least ten (10) days prior to such proposed action, shall constitute commercially reasonable and fair notice thereof to Borrower. Notice of less duration shall not be presumed to be commercially unreasonable or unfair. Section 13.5. Appointment of Lender as Borrower's Lawful Attorney. --------------------------------------------------- Borrower irrevocably appoints Lender (and all persons designated by Lender) as Borrower's true and lawful attorney-in- fact to act in Borrower's place in Borrower's or Lender's name to: (i) if permitted by applicable law, sell or assign the Collateral upon such terms, for such amounts and at such time or times as Lender deems advisable; (ii) take control, in any manner, of any item of Collateral or any payment or proceeds with respect to the Collateral; (iii) prepare, file and sign Borrower's name on any notice of lien, assignment or satisfaction of lien or similar document in connection with the Collateral; (iv) do all acts and things necessary, in Lender's sole discretion, to exercise Lender's rights granted in or referred to in Section 13.2 of this Agreement; (v) endorse the name of Borrower upon any item of payment or proceeds consisting of or relating to the Collateral and deposit the same to the account of Lender for application to the Indebtedness; (vi) use the information recorded on or contained in any data processing equipment and computer hardware and software relating to the Collateral to which Borrower has access; (vii) open Borrower's mail to collect Collateral and direct the Post Office to deliver Borrower's mail to an address designated by Lender; and (viii) do all things necessary to carry out and enforce this Agreement which Borrower has failed to do. Borrower ratifies and approves all acts of Lender as Borrower's attorney-in-fact. Lender shall not, when acting as attorney-in-fact, be liable for any acts or omissions as or for any error of judgment or mistake of fact or law, except for actions taken in bad faith or resulting from Lender's gross negligence or willful misconduct. This power, being coupled with an interest, is irrevocable until all payment and performance obligations of Borrower to Lender have been fully satisfied. Borrower shall upon request of Lender execute powers of attorney to separately evidence the foregoing powers granted to Lender. All costs, fees and expenses incurred by Lender, or for which Lender becomes obligated, in connection with exercising any of the foregoing powers shall be payable to Lender by Borrower on demand by Lender and until paid shall be part of the Indebtedness. Section 13.6. Lender's Default. ------------ In the event of any default of the Loan Documents by Lender or any claim by Borrower related to the Loan Documents, Borrower's sole and exclusive remedy against Lender shall be a cause of action sounding in contract with damages limited to actual and direct damages incurred. Lender shall in no event be liable for ordinary negligence, delay in performance or any consequential, special, punitive, incidental or indirect damages, including without limitation, loss of profit or goodwill. Lender shall in no event be liable for any loss or damage directly or indirectly resulting from the furnishing of services or reports under this Agreement. With respect to any goods and services provided by 14 Lender, LENDER MAKES NO warranties, whether expressed or implied, including, without limitation, implied WARRANTIES OF MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE. Borrower shall have no cause of action against Lender for a default of the Loan Documents unless Borrower first notices Lender of the default and allows Lender a reasonable time of at least thirty (30) Business Days to cure the default and Lender fails to cure the default. Section 13.7. Borrower's Right to Cure. ------------------------ In the event of an unintentional Pre-Default Event by Borrower with respect to payment obligations, Borrower shall have three (3) Business Days to cure the Pre-Default Event before Lender exercises its remedies as set forth in this Article XIII. In the event of any other type of unintentional default by Borrower (other than an Event of Default under Section 13.0 (E), (F), or (H), Borrower shall have thirty (30) calendar days to cure the default before Lender exercises its remedies as set forth in this Article XIII. Regardless of whether Borrower cures a default, Lender shall be entitled to indemnification pursuant to Article XII with respect to any Losses arising from claims asserted against Lender. ARTICLE XIV - DEFINITIONS Section 14.0. Defined Terms. ------------- Whenever used in this Agreement with such upper case letters as are shown below, the following terms shall have the respective meanings set forth below. When the terms are used in the plural, the plural forms of the meanings shall apply. Accounting Period: a calendar month, beginning with the month during which this Agreement is executed and ending with the calendar month during which the Indebtedness has been paid in full following termination of this Agreement. Advance: each of the advances described in Article III of this Agreement. Affiliate: any Person, now or in the future (i) directly or indirectly owned or controlled in whole or in part by Borrower, or (ii) under common ownership or control with Borrower. For the purpose of this definition, "control" shall mean the power to direct, or cause the direction of, management or policies, whether through the ownership of voting securities, by contract or otherwise. For the purpose of this definition, "owned" shall mean at least 10% ownership. Average Charged-Off Losses: (A) with respect to all Contracts, the Accounting Period average of the Charged-Off Losses of all Contracts for any six (6) consecutive Accounting Periods; provided that, until the first six (6) Accounting Periods have expired, the Average Charged-Off Losses shall be the Accounting Period average of the Charged-Off Losses for the Accounting Periods which have expired; and (B) with respect to Managed Portfolio Contracts, the Accounting Period average of the Charged-Off Losses of all Managed Portfolio Contracts for any three (3) consecutive Accounting Periods; provided that, until the first three (3) Accounting Periods have expired, the Average Charged-Off Losses shall be the Accounting Period average of the Charged-Off Losses for the Accounting Periods which have expired. Business Day: any day other than (i) a Saturday or Sunday, or (ii) a day on which banking institutions in the States of Arizona, Florida, Indiana and Texas are required by law to be closed. Certificate of Title: the certificate of title, manufacturer's certificate of origin or other document issued by a duly authorized state, province or government agency evidencing ownership of a Vehicle. Charged-Off Contract: a Pledged Contract (i) for which all or part of the Scheduled Payments are due and unpaid, ninety (90) days after the due date for such Scheduled Payments, (ii) for which the Financed Vehicle has been surrendered, repossessed, or unable to be located, or (iii) which has been settled for less than the Outstanding Principal Balance. 15 Charged-Off Losses: as of the end of an Accounting Period, the Outstanding Principal Balance of Charged-Off Contracts which become Charged-Off Contracts during the Accounting Period minus amounts received by Borrower during the Accounting Period and applied to Charged-Off Contracts which became Charged-Off Contracts during a previous Accounting Period, divided by the Outstanding Principal Balance of all Contracts owned by Borrower which are not Charged-Off Contracts; expressed as a percentage. Closing Date: the date of execution of this Agreement. Collateral: the property in which Lender is granted a security interest pursuant to Section 6 of this Agreement. Contract: an installment or conditional sale contract, with any amendments, owned or acquired by Borrower pursuant to which a Contract Debtor has: (i) purchased a new or used Motor Vehicle, (ii) granted a security interest in the Motor Vehicle to secure the Contract Debtor's payment obligations, and (iii) agreed to pay the unpaid purchase price and a finance charge in periodic installments no less frequently than monthly. Contract Collateral: this term has the meaning provided in Section 16 of this Agreement. Contract Debtor: the Person that has executed a Contract as a purchaser, and any guarantor, co-signer or other Person obligated to make payments under the Contract. Contract Debtor Documents: the original Certificate of Title, the original executed Contract with original Contract Debtor signatures and the other documents and instruments relating to the Contract. Contract Debtor Insurance: the liability insurance coverage required by law and any insurance, other insurance which insures a Financed Vehicle or a Contract Debtor's obligations under a Contract. (Added back) Contract Rights: with respect to Pledged Contracts, (i) Borrower's interest in the Financed Vehicle; (ii) all rights of Borrower regarding the Contract and Financed Vehicle, including but not limited to rights to electronic funds transfers and rights under all dealer agreements and purchase agreements pursuant to which the Contract was acquired by Borrower; (iii) all rights of Borrower with respect to Contract Debtor Insurance and any other policies of fire, theft or comprehensive insurance, collision insurance, public liability insurance or property damage insurance maintained with respect to the Financed Vehicle, the Contract, or the Contract Debtor; (iv) all rights of Borrower, if any, to prepaid dealer rate participation in connection with the Contract; (v) Remittances, and (vi) all rights of Borrower to the originals of all books, records (including electronic data), reports, files, and documents relating to the Contracts, including, but not limited to, Contract Debtor Documents, financial statements of Contract Debtors, and all payment reports or records relating to the Contracts. (Added back) Debt Ratio: the debt-to-equity ratio of Borrower, calculated in accordance with generally accepted accounting principles by comparing Borrower's total liabilities other than Subordinated Debt less amounts owed by any bankruptcy-remote subsidiary via associated securitization trusts to unaffiliated bondholders or certificate holders which are included in Borrower's on-book liabilities (including amounts owed to any bondholders who may not have any legal recourse to any non-bankruptcy remote subsidiaries), divided by Net Worth of Borrower. Delinquency Measurement: as of the end of an Accounting Period, the sum of the Outstanding Principal Balances of all Delinquency Measurement Contracts which have Scheduled Payments which are due and partially or completely unpaid more than thirty (30) days from the due date of such Scheduled Payments, divided by the sum of the Outstanding Principal Balances of all Delinquency Measurement Contracts; expressed as a percentage. 16 Delinquency Measurement Contracts: all Pledged Contracts which do not constitute Charged-Off Losses. Eligible Vehicle: a Motor Vehicle (i) which Borrower has purchased for at least $1,500 and not more than $15,000; (ii) which has been in Borrower's possession for no more than 150 days; (iii) which has not been repossessed by Borrower (unless subsequently re-purchased at auction); (iv) for which Borrower holds in its possession the title and purchase documentation, provided, however, that, if all other criteria for Eligible Vehicles are met, Motor Vehicles may be held in Borrower's possession for 40 days without title documentation; and (v) is not subject to any lien, encumbrance or security interest of any kind other than the interest of Lender as granted hereunder or any other agreement with Lender and as otherwise agreed to by Lender. Eligible Vehicle Advance Value: for each Eligible Vehicle in Borrower's inventory purchased by Borrower: (A) at an ADESA location, an amount equal to one hundred percent (100%) of the pre-confirmed purchase price for such item of Inventory plus up to One Thousand Dollars ($1,000) in approved reconditioning costs; (B) at a non-ADESA location, an amount equal to ninety percent (90%) of the applicable regional NADA trade value at the time of purchase for such item of Inventory plus up to One Thousand Dollars ($1,000) in approved reconditioning costs; or (C) at non-auction locations, an amount equal to eighty percent (80%) of the applicable regional NADA trade value at the time of purchase for such item of Inventory plus up to One Thousand Dollars ($1,000) in approved reconditioning costs. Provided, however, once any Eligible Vehicle has been in Borrower's possession for 120 days, the Eligible Vehicle Advance Value for that Motor Vehicle shall be reduced by 10%. Event of Default: this term has the meaning provided in Section 15.0 of this Agreement. Financed Vehicle: the new or used Motor Vehicle purchased by a Contract Debtor pursuant to a Contract, or any substituted vehicle which is properly documented and approved by Lender. (Added back) Indebtedness: the Advances and all other amounts, including but not limited to all other amounts advanced, expended or applied by Lender under this Agreement to or for the benefit of Borrower or to perform or enforce Borrower's covenants in this Agreement, attorney fees, costs of collection, and interest, that Borrower owes Lender in connection with this Agreement. Interest Coverage: the sum of Borrower's year-to-date pre-tax income plus Borrower's year to date interest expense, compared to Borrower's year-to-date interest expense. Inventory: goods, other than Contract Collateral, which are held for sale or lease or to be furnished under a contract of service. Inventory Advance Value: the lesser of (i) the Inventory Facility Limit or (ii) the cumulative Eligible Vehicle Advance Value for all Eligible Vehicles in Borrower's inventory. Inventory Facility: the loan facility described in Section 2.1 herein. Inventory Facility Limit: Thirty Six Million Dollars ($36,000,000.00). Loan Documents: this Agreement, the Note, the guaranties signed by the Guarantors, and the Supplemental Documentation. 17 Managed Portfolio Contracts: Installment contracts, serviced by Borrower, which were originated or purchased by Borrower, including but not limited to those contracts which have been subsequently sold to a third party, with the servicing retained by Borrower and with a residual interest in the installment contracts held by Borrower. Maximum Lawful Rate: this term has the meaning provided in Section 2.4. Motor Vehicle: A passenger motor vehicle, van, motorcycle, truck or light duty truck which is not manufactured for a particular commercial purpose and which can be registered for use on public highways and is not a "grey market" vehicle provided that Motor Vehicles shall not include Financed Vehicles. Net Worth: the total of shareholders' equity (including capital stock, additional paid-in capital, and retained earnings) plus Subordinated Debt, less (i) the total amount of loans and debts due from Affiliates, shareholders, officers, or employees, and (ii) the total amount of any intangible assets, including without limitation unamortized discounts, deferred charges, and goodwill. Outstanding Principal Balance: the outstanding principal balance of a Contract calculated by subtracting the unearned finance charge (determined by the finance charged refund method applicable to the Contract) from the sum of the unpaid Scheduled Payments. Permitted Lien: (i) any security interest or lien at any time granted in favor of Lender; (ii) liens securing claims of materialmen, mechanics, carriers, warehousemen, landlords and other similar Persons for labor, materials, supplies or rentals incurred in the ordinary course of Borrower's business; (iii) liens resulting from deposits made in the ordinary course of business in connection with workers compensation, unemployment insurance, social security and other similar laws; and (iv) liens agreed to in writing by Lender. Person: any individual, sole proprietorship, partnership, joint venture, trust, unincorporated organization, association, corporation, institution, entity, party, or government (including, any instrumentality or division thereof). Places of Business: those locations set forth in Exhibit 8.0(A), including any third party servicer locations to which Borrower may send a Motor Vehicle to prepare the Motor Vehicle for sale or for repair Pledged Contract: a Contract owned on the Closing Date or in the future by Borrower. Pre-Default Event: an event that with the passage of time, the giving of notice, or both, would constitute an Event of Default. Rolling Average Delinquency: the average of the Delinquency Measurements for any six (6) consecutive Accounting Periods; provided that, until the first six (6) Accounting Periods have expired, the Rolling Average Delinquency shall be the average of the Delinquency Measurements for the Accounting Periods which have expired. Rolling Average Managed Portfolio Delinquency: the average of the Managed Portfolio Delinquency Measurements for any three (3) consecutive Accounting Periods; provided that, until the first three (3) Accounting Periods have expired, the Rolling Average Managed Portfolio Delinquency shall be the average of the Managed Portfolio Delinquency Measurements for the Accounting Periods which have expired. Scheduled Payment: the periodic installment payment amount disclosed in a Contract. Stated Rate: this term has the meaning provided in Section 2.4. 18 Subordinated Debt: an unsecured debt obligation of Borrower as listed on Exhibit 11.6(A) which is subordinated to Lender pursuant to a subordination agreement which is in the form of Exhibit 14.0 or pursuant to some other agreement approved in writing by Lender, except as otherwise set forth in this Agreement Supplemental Documentation: all agreements, instruments, documents, certificates of title, financing statements, notices of assignment, powers of attorney, subordination agreements, and other written matter necessary or reasonably requested by Lender to perfect and maintain perfected Lender's security interest in the Collateral or to consummate the transactions contemplated by this Agreement. UCC: the Uniform Commercial Code as adopted and in effect in Indiana. Section 14.1. Other Terms: ----------- All other terms contained in this Agreement shall, unless the context indicates otherwise, have the meanings provided in the UCC to the extent the same are defined therein. Section 14.2. Accounting Terms. ---------------- Any accounting terms used in this Agreement which are not specifically defined shall have the meanings customarily given them in accordance with generally accepted accounting principles. ARTICLE XV - GENERAL TERMS AND CONDITIONS Section 15.0. Applicable Law. --------------- This Agreement shall be governed and construed in accordance with the laws of the State of Indiana. Section 15.1. Notices. ------- Any notice, request, demand, instruction or other communication to be given any party hereto in writing shall be effective upon delivery during regular business hours at the offices of Borrower and Lender hereinafter set forth or at such other offices that either party notifies the other of in writing. The failure to deliver a copy as set forth below shall not affect the validity of the notice to the Borrower or Lender. Such communications shall be given by telecopy, commercial delivery service, or sent by certified mail, postage prepaid and return receipt requested, as follows: If to Borrower: Ugly Duckling Corporation 2525 East Camelback Road, Suite 1150 Phoenix, Arizona 85016 Electronic FAX (602) 852-6696 ATTN: Treasurer With a copy to the General Counsel at the same address. As of no later than September 1, 2001, notices shall go to the address set forth in Section 6.5 hereof. If to Lender: Automotive Finance Corporation 310 East 96th Street, Suite 300 Indianapolis, IN 46240 Electronic FAX (317) 815-9650 Attention: C.O.O. Section 15.2. Headings. -------- Paragraph headings have been inserted in this Agreement as a matter of convenience for reference only. The paragraph headings shall not be used in the interpretation of this Agreement. Section 15.3. Severability. ------------ If any one or more of the provisions of this Agreement are held to be invalid, illegal or unenforceable in any respect for any reason, the validity, legality 19 and enforceability of any such provision or provision in every other respect and of the remaining provisions of this Agreement shall not be in any way impaired. Section 15.4. Offset. ------ Lender has the right to offset, apply, or recoup any obligation of Borrower to Lender, arising under the Loan Documents or otherwise, against any obligations or payments Lender owes to Borrower, arising under the Loan Documents or otherwise, or against any property of Borrower held by Lender. Borrower waives any right to offset, apply, or recoup against any obligation it owes to Lender. Lender is not obligated to pursue any of the Collateral or any of Lender's rights at any time as a condition to payment and performance by Borrower. Section 15.5. Independent Contractor. ----------------------- Borrower is an independent contractor in all matters relating to this Agreement and the Collateral and is not an agent or representative of Lender. Borrower has no authority to act on behalf of or bind Lender. Section 15.6. Expenses. -------- Each party shall bear the expenses of its own performance of this Agreement. Section 15.7. Modification of Loan Documents; Sale of Interest. ------------------------------------------------ This Agreement may not be modified, altered or amended, except by an agreement in writing signed by Borrower and Lender. The rights of Lender granted in or referred to in this Agreement shall apply to any modification of or supplement to the Loan Documents. Borrower may not without Lender's prior written permission sell, assign or transfer any of the Loan Documents, or any portion thereof, including, without limitation, Borrower's rights, title, interests, remedies, powers and duties thereunder. Any sale, assignment, or transfer by Borrower without Lender's permission shall be void ab initio. Borrower hereby consents to Lender's participation, sale, assignment, transfer or other disposition, at any time or times hereafter, of any of the Loan Documents, or of any portion thereof, including, without limitation, Lender's rights, title, interests, remedies, powers and duties thereunder. The Loan Documents shall be binding upon and inure to the benefit of the permitted successors and assigns of Borrower and Lender. Section 15.8. Attorneys' Fees and Lender's Expenses. ------------------------------------- If Lender shall in good faith employ counsel for advice or other representation or shall incur other costs and expenses in connection with entering into any future amendments or modifications to the Agreement; or if, following an Event of Default, Lender shall in good faith employ counsel for advice or other representation or shall incur other costs and expenses in connection with (i) any litigation, contest, dispute, suit, proceeding or action (whether instituted by Lender, Borrower or any other Person) in any way relating to the Collateral, any of the Loan Documents or any other agreements executed or delivered in connection herewith, (ii) any attempt to enforce, or enforcement of, any rights of Lender against Borrower or any other Person, that may be obligated to Lender by virtue of any of the Loan Documents, or (iii) any actual or attempted inspection, audit, monitoring, verification, protection, collection, sale, liquidation or other disposition of the Collateral; then, in any such event, the attorneys' fees arising from such services and all expenses, costs, charges and other fees (including expert's fees) incurred by Lender in any way arising from or relating to any of the events or actions described in this Section shall be payable to Lender by Borrower on demand by Lender and until paid shall be part of the Indebtedness. Section 15.9. Waiver by Lender. ---------------- Lender's failure, at any time or times hereafter, to require strict performance by Borrower of any provision of this Agreement or any of the other Loan Documents shall not waive, affect or diminish any right of Lender thereafter to demand strict performance therewith. Any suspension or waiver by Lender of an Event of Default by Borrower under the Loan Documents shall not suspend, waive or affect any other Event of Default by Borrower under the Loan Documents, whether the same is prior or subsequent thereto and whether of the same or of a different type. None of the undertakings, agreements, warranties, covenants and representations of Borrower contained in the Loan Documents and no Event of Default by the Borrower under the Loan Documents shall be deemed to have been suspended or waived by Lender unless such suspension or waiver is by an instrument in writing signed by a manager of Lender and identifies the matter 20 waived or suspended. Any consent or approval by Lender pursuant to this Agreement is not a waiver by Lender of, or an admission by Lender of the truth of, any of Borrower's representations and warranties in this Agreement. Section 15.10. Waiver by Borrower. ----------------------- Except as otherwise provided for in this Agreement, Borrower waives (i) notice and consummation of presentment, demand, protest, dishonor, intent to accelerate, acceleration; (ii) all rights to notice and a hearing prior to taking possession or control of, or Lender's replevy, attachment or levy upon, the Collateral; (iii) any bond or security in a judicial proceeding as a condition to Lender exercising any of Lender's remedies; (iv) the benefit of all valuation, appraisement and exemption laws, and (v) TRIAL BY JURY in any dispute with Lender arising out of or related to any of the Loan Documents. The failure or delay of Borrower to strictly enforce the terms of this Agreement shall not be a waiver of Borrower's right to do so. Section 15.11. Counterparts. ------------ This Agreement may be executed in two or more counterparts, with the same effect as if all parties had signed the same document. All such counterparts shall be deemed an original, shall be construed together and shall constitute one and the same instrument. Section 15.12. Entire Agreement. ---------------- This Agreement contains the entire agreement among the parties regarding the loan by Lender to Borrower based on Contracts and supersedes all prior agreements, whether written or oral, with respect thereto. Section 15.13. Statements of Account. --------------------- Each report, billing statement, payment transcript, or other statement which is prepared by Lender shall, except for manifest errors, be deemed final, binding and conclusive upon Borrower in all respects as to all matters reflected therein, and shall constitute an account stated between Borrower and Lender, unless thereafter waived in writing by Lender or unless, within thirty (30) days after Borrower's receipt of such document, Borrower delivers to Lender notice of a written objection thereto specifying the claimed error. In the event of such an error, only those items expressly objected to in such notice shall be deemed to be disputed by Borrower and Lender's only liability to Borrower shall be to issue a corrected document. Section 15.14. Publicity. --------- Borrower shall not (i) issue any press release or make any public announcement or otherwise publicize the consummation of this Agreement with Lender, or (ii) make a public disclosure of any kind regarding the subject matter hereof, or (iii) make use of Lender's name, tradename, logo or trademark without the express written consent of Lender, except that Borrower may publicly disclose information relating to this Agreement if Borrower gives Lender 48 hours advance written notice (or if upon advice of counsel Borrower or Guarantor cannot wait 48 hours then upon such notice as Borrower or Guarantor may reasonably provide to Lender) prior to releasing any disclosure required by law or in connection with its registration of securities with the U.S. Securities and Exchange Commission or any state securities commission, or in connection with a filing pursuant to Borrower's listing with a national securities exchange or governmental entity. Lender shall not (i) issue any press release or make any public announcement or otherwise publicize the consummation of this Agreement with Borrower, or (ii) make a public disclosure of any kind regarding the subject matter hereof, or (iii) make use of Borrower's name, tradename, logo or trademark without the express written consent of Borrower. Section 15.15. Faxed Documents. --------------- In order to expedite the acceptance and execution of this Agreement and any of the Supplemental Documents, each of the parties hereto agrees that a faxed copy of any original executed document shall have the same binding effect on the party so executing the faxed document as an original handwritten executed copy thereof. Section 16. Contract Collateral. ------------------- Lender agrees that the definition of "Collateral: in this Agreement may not be amended to include additional types of property without the consent of Greenwhich Capital Financial Products, Inc. and its successors and assigns and other lenders in connection with "warehouse" lending facilities so long as Greenwich Capital Financial Products or such successors and assigns remain as `warehouse' lenders. Lender further agrees that Lender shall not have any lien or security interest with respect to Contract Collateral. As used herein "Contract Collateral" shall mean each Contract owned by the Borrower and each of the following items with respect to such Contract: 21 (A) the Contract Debtor Documents; (B) the Contract Rights; (C) any payments from a bank account of, and any electronic funds transfers from, any Contract Debtor or Contract Rights Payor (subject to the terms and conditions of the Master Agency Agreement); (D) any associated chattel paper, lease, instrument, installment sale contract or installment loan contract; (E) all rights of the Borrower in and to the related Financed Vehicle, including any repossessed Financed Vehicle, and in and to any other collateral securing such Contract, including any security deposit; (F) any contract purchase discount; (G) any rights of Borrower to dealer reserves or rate participation with respect to such Contract, if any; (H) any money, payments or proceeds of any insurance policies with respect to any or all Contracts or any Financed Vehicles with respect to which Borrower is solely or jointly the owner or is insured or is the loss payee or is a beneficiary, including any insurance proceeds; (I) all books and records of the Borrower (including financial statements, accounting records, customer lists, credit files, computer programs, electronic data print-outs and other computer materials and records) with respect to such Contract; (J) all accessions to, substitutions for and all replacements and products of, any of the foregoing property; and (K) all moneys, instruments and other proceeds of the foregoing. Each such secured creditor and transferee, purchaser and assignee of Contract Collateral will be a third party beneficiary of this provision. [Signature Pages to follow - End of Page] 22 EXHIBIT 4.0(A) AFC WIRE INSTRUCTIONS BANK NAME: SUNTRUST BANK ORLANDO PO BOX 3833 ORLANDO, FL 32802-3833 ABA (ROUTING) : 063-102-152 ACCOUNT #: 0215252159679 BENEFICIARY: AFC FUNDING CORP. 310 E. 96TH ST. SUITE 300 INDPLS , IN 46240 OTHER INFORMATION: DEALER NAME: UGLY DUCKLING CORPORATION DEALER #: EXHIBIT 4.0(A) AFC WIRE INSTRUCTIONS BANK NAME: SUNTRUST BANK ORLANDO PO BOX 3833 ORLANDO, FL 32802-3833 ABA (ROUTING) : 063-102-152 ACCOUNT #: 0215252159679 BENEFICIARY: AFC FUNDING CORP. 310 E. 96TH ST. SUITE 300 INDPLS , IN 46240 OTHER INFORMATION: DEALER NAME: UGLY DUCKLING CORPORATION DEALER #: Exhibit 8.0 (A) CAR SALES LIST OF LOCATIONS, page 7 EXHIBIT 8.0 (A) UGLY DUCKLING CAR SALES - LIST OF LOCATIONS CORPORATE OFFICE ---------------- 4020 E. Indian School Road Phoenix, AZ 85018 Credit Corp. Offices Ugly Duckling Credit Corp. 6225 Ulmerton Road Clearwater, FL 33760 Mailing Address: P. O. Box 3096 Seminole, FL 33775-3096 Ugly Duckling Credit Corp. 1030 North Colorado Street Gilbert, AZ 85233 Ugly Duckling Credit Corp. - - 600 N. Pearl Street, Suite 2000 Dallas, TX 75201 Plano Servicing Center 1600 Plano Parkway Suite 150 Plane, TX Administrative Service Offices 1905 S. MacDonald Ste.2 Mesa, AZ 85210 LOS ANGELES (WEST) DOWNEY 9262 Firestone Blvd. Downey, CA 90241 VAN NUYS 5555 Van Nuys Blvd. Van Nuys, CA 91401 TORRANCE 18313 Hawthorne Blvd. Torrance, CA 90504 WILMINGTON 1500 W. Pacific Coast Hwy. Wilmington, CA 90744 EL MONTE (H) 12039 Valley Blvd. El Monte, CA 91732 OXNARD 950 Oxnard Blvd. Oxnard, CA 93030 SAN FERNANDO (H) 1661 San Fernando Rd. San Fernando, CA 91340 WILMINGTON INSPECTION CENTER 1500 W. Pacific Coast Hwy. Wilmington, CA 90744 ATLANTA MEMORIAL 5554 Memorial Drive Stone Mountain, GA 30083 JONESBORO 3852 Jonesboro Road Atlanta, GA 30354 MARIETTA 502 Cobb Parkway Marietta, GA 30060 COLLEGE PARK 5620 Old National Highway College Park, GA 30349 SMYRNA 3350 South Cobb Drive Smyrna, GA 30080 RIVERDALE 640 Valley Hill Road Riverdale, GA 30274 BANKHEAD 3051 E. Bankhead Hwy. Lithia Springs, GA 30122 DOUGLASVILLE 5669 Fairburn Road Douglasville, GA 30134 DORAVILLE 5690 Buford Highway Doraville, GA 30340 DOUGLASVILLE INSPECTION CENTER 5669 Fairburn Road Douglasville, GA 30134 MEMORIAL DRIVE INSPECTION CTR 5554 Memorial Drive Stone Mountain, GA 30083 DALLAS GARLAND ROAD 12180 Garland Road Dallas, TX 75218 REDBIRD 4201 W. Camp Wisdom Rd. Dallas, TX 75237 FIRST STREET 301 S. First Street Garland, TX 75040 ARLINGTON 310 N. Collins St. Arlington, TX 76011 HARRY HINES (H) 10501 Harry Hines Dallas, TX 75220 ALTA MERE 3333 Alta Mere Drive Fort Worth, TX 76116 ALTA MERE SRV CTR 3333 Alta Mere Drive Fort Worth, TX 76116 HALTOM CITY 4720 E. Belknap Haltom City, TX 76117 BUCKNER 2030 S. Buckner Dallas, TX 75217 GRAND PRAIRIE 1018 E. Main St. Grand Prairie, TX 75050 Dallas REDBIRD INSP CTR 4201 W. Camp Wisdom Rd. Dallas, TX 75237 PHOENIX 24th STREET 330 N. 24th Street Phoenix, AZ 85006 BELL ROAD 1515 E. Bell Road Phoenix, AZ 85022 GLENDALE 5104 W. Glendale Avenue Glendale, AZ 85301 MESA 333 S. Alma School Road Mesa, AZ 85210 APACHE TRAIL 10820 E. Apache Trail Apache Junction, AZ 85220 CHANDLER 400 N. Arizona Avenue Chandler, AZ 85225 SOUTH CENTRAL (H) 4121 S. Central Avenue Phoenix, AZ 85040 PHOENIX INSPECTION CENTER 4515 E. Miami St. Phoenix, AZ 85034 TAMPA 56th STREET 5803 56th Street North Tampa, FL 33610 WEST HILLSBOROUGH (H) 6601 W. Hillsborough Avenue Tampa, FL 33634 LAKELAND 1825 W. Memorial Blvd. Lakeland, FL 33815 NEW PORT RICHEY 6901 US Highway 19 North New Port Richey, FL 34652 PINELLAS PARK 11700 US Highway 19 North Clearwater, FL 33764 DALE MABRY 7501 North Dale Mabry Tampa, FL 33614 DALE MABRY SVC CTR 7501 North Dale Mabry Tampa, FL 33614 BRADENTON 1709 W. Cortez Road Bradenton, FL 34207 FLORIDA AVENUE 11704 N. Florida Avenue Tampa, FL 33612 BRANDON 8805 E. Adamo Dr. Tampa, FL 33619 CLEARWATER INSPECTION CENTER 5253 126th Ave. North Clearwater, FL 33760-4602 SAN ANTONIO BANDERA 1511 Bandera Road San Antonio, TX 78228 WW WHITE 414 S. WW White Road San Antonio, TX 78219 LOOP 410 2235 NW Loop 410 San Antonio, TX 78230 SW MILITARY 2755 SW Military Dr. San Antonio, TX 78224 PERRIN BEITEL 11612 Perrin Beitel San Antonio, TX 78217 SAN PEDRO 5703 San Pedro San Antonio, TX 78212 BROADWAY 3303 Broadway San Antonio, TX 78209 SE MILITARY (H) 1231 SE Military Dr. San Antonio, TX 78214 I-35 1901 SW Military Dr. San Antonio, TX 78221 SOUTHSIDE INSPECTION CENTER 1219 S.E. Military Drive San Antonio, TX 78214 BROADWAY INSPECTION CENTER 3303 Broadway San Antonio, TX 78209 TUCSON SPEEDWAY 3901 E. Speedway Tucson, AZ 85712 PARK (H) 3737 S. Park Avenue Tucson, AZ 85713 GRANT 2301 N. Oracle Tucson, AZ 85705 TUCSON TUCSON INSPECTION CTR 1901 W. Copper Tucson, AZ 85745 NEVADA FREMONT 3333 East Fremont Street Las Vegas, NV 89104 NORTH VEGAS 3545 Las Vegas Blvd., North Las Vegas, NV 89115 FREMONT INSPECTION CENTER 3333 East Fremont Street Las Vegas, NV 89104 NEW MEXICO CENTRAL SW (H) 5306 Central Avenue SW Albuquerque, NM 87105 WYOMING 700 Wyoming Blvd., NE Albuquerque, NM 87123 GRIEGOS 4700 4th Street NW Albuquerque, NM 87107 WYOMING INSPECTION CENTER 700 Wyoming Blvd., NE Albuquerque, NM 87123 ORLANDO OCALA 3550 South Pine Avenue Ocala, FL 34471 LEESBURG 8736 Hwy 441 South Leesburg, FL 34788 WEST COLONIAL 4225 West Colonial Drive Orlando, FL 32808 EAST COLONIAL 5310 E. Colonial Drive Orlando, FL 32807 KISSIMMEE 920 West Vine Street Kissimmee, FL 34741 DELAND 3000 S. Woodland Blvd. Deland, FL 32721 SANFORD 2904 S. Orlando Drive Sanford, FL 32773 ORLANDO INSPECTION CTR 2451 McCraken Road Sanford, FL 32771 RICHMOND MIDLOTHIAN 5300 Midlothian Trnpk Richmond, VA 23225 MECHANICSVILLE 3517 Mechanicsville Trnpk Richmond, VA 23223 BROAD STREET 4112 West Broad Street Richmond, VA 23230 PETERSBURG 2535 South Crater Road Petersburg, VA 23805 ROUTE 1 4950 Jefferson Davis Hwy Richmond, VA 23234 MIDLOTHIAN INSPECTION CENTER 5300 Midlothian Trnpk Richmond, VA 23225 LOS ANGELES (EAST) GARDEN GROVE 13650 Harbor Blvd. Garden Grove, CA 92843 RIVERSIDE 8341 Indiana Ave. Riverside, CA 92504 MONTCLAIR 10477 Central Avenue Montclair, CA 91763 FONTANA 9135 Sierra Avenue Fontana, CA 92335 STANTON 11792 Beach Boulevard Stanton, CA 90680 COSTA MESA 2167 Harbor Boulevard Costa Mesa, CA 92627 MONTCLAIR INSPECTION CENTER 10477 Central Avenue Montclair, CA 91763 Exhibit 8.0 (F) Litigation 1. Maria Eschevarria v. Ugly Duckling Car Sales Florida, Ugly Duckling --------------------------------------------------------------------------- Corporation, Ugly Duckling Credit Corporation; Florida. ------------------------------------------------------- Filed December 16, 1998. Purportedly a class action; class has not been certified. Alleged claims include (i) violations of the Florida Deceptive and Unfair Trade Practices Act, (ii) unconscionable purchase contract, and (iii) violation of the Florida Uniform Commercial Code in repossessing the automobile. The second and third counts were dismissed with prejudice; the first count was dismissed with leave to amend, which amended complaint was filed. Ugly Duckling Corporation and Ugly Duckling Credit Corporation have been dismissed from the action. Answer was filed on August 21, 2000. Almost no activity since that time other than a few nominal discovery requests. 2. Delaware Lawsuits Related to Garcia Offer to Take the Company Private. ----------------------------------------------------------------------- On March 20, 2001, a shareholder derivative complaint was filed, purportedly on behalf of UDC, in the Court of Chancery for the State of Delaware in New Castle Court, captioned Berger v. Garcia, et al., No. 18746NC. The complaint alleges that UDC's current directors breached fiduciary duties owed to UDC in connection with certain transactions between UDC and Mr. Ernest C. Garcia II, UDC's Chairman and majority stockholder, and various entities controlled by Mr. Garcia. The complaint was amended on April 17, 2001 to add a second cause of action, on behalf of all persons who own UDC common stock, and their successors in interest, which alleges that UDC's current directors breached fiduciary duties in connection with the proposed acquisition by Mr. Garcia of all of the outstanding shares of UDC common stock not owned by him. UDC is named as a nominal defendant in the action. The original cause of action seeks to void all transactions deemed to have been approved in breach of fiduciary duty and recovery by UDC of alleged compensatory damages sustained as a result of the transactions. The second cause of action seeks to enjoin UDC from proceeding with the proposed acquisition by Mr. Garcia, or, in the alternative, awarding compensatory damages to the class. Following Mr. Garcia's offer in early April 2001 to purchase all outstanding shares of UDC common stock, five additional and separate purported shareholder class action complaints were filed between April 17 and April 25, 2001 in the Court of Chancery for the State of Delaware in New Castle County. They are captioned Turberg v. Ugly Duckling Corp., et al., No. 18828NC, Brecher v. Ugly Duckling Corp., et al., No. 18829NC, Suprina v. Ugly Duckling Corporation, et al., No. 18830NC, Benton v. Ugly Duckling Corp., et al., No. 18838NC, and Don Hankey Living Trust v. Ugly Duckling Corporation, et al., No. 18843NC. Each complaint alleges that UDC, and its directors, breached fiduciary duties in connection with the proposed acquisition by Mr. Garcia of all of the outstanding shares of UDC common stock not owned by him. The complaints seek to enjoin the proposed acquisition by Mr. Garcia and to recover compensatory damages caused by the proposed acquisition and the alleged breach of fiduciary duties. These cases were consolidated in June, 2001. EXHIBIT 8.0(G) AFC's UCC Collateral Description for the Ugly Duckling Loan All now owned or hereafter acquired goods which are held for sale or lease or to be furnished under a contract of service and all now owned or hereafter acquired passenger motor vehicles, vans, motorcycles, trucks or light duty trucks; and all certificates of title, accessions to, substitutions for and all replacements, products and proceeds of, all the foregoing property and any and all books and records (including, without limitation, financial statements, accounting records, customer lists, credit files, computer programs, electronic data, print-outs and other computer materials and records) of debtor pertaining to any or all of the foregoing property; provided however, that the following shall not be included as secured party's collateral: any and all installment or conditional sale contracts, and any amendments (collectively "Contracts"), owned or acquired by debtor and proceeds thereof including without limitation any and all right or rights to payment or payments under any or all of the Contracts. EXHIBIT 11.4 CERTIFICATE OF CHIEF FINANCIAL OFFICER The undersigned, ________________ the duly authorized chief financial officer of Ugly Duckling Corporation, a Delaware corporation ("UDC") DOES HEREBY CERTIFY, for purposes of the Loan and Security Agreement dated as of August __, 2001 (the "Agreement") between UDC and Automotive Finance Corporation that: (i) the attached financial statements are accurate in all material respects and present the true financial condition of UDC as of the dates shown, (ii) the assets of the Company shown on the financial statements exist, are solely owned by UDC, are not subject to any liens other than the lien of Automotive Finance Corporation and those disclosed in the financial statements or allowed by the Agreement, and are accurately valued on the financial statements, (iii) the attached financial statements were prepared in accordance with generally accepted accounting principals, and (iv) there has been no material adverse change in the financial condition of UDC after the dates that the financial statements cover. IN WITNESS WHEREOF, the undersigned has hereto set his hand the __ day of ________, 200_. - ------------------------------------ Sr. Vice President and Chief Financial Officer Exhibit 8.0 (A) CAR SALES LIST OF LOCATIONS, page 2 EXHIBIT 11.6 (A) SUBORDINATED INDEBTEDNESS 1. That certain Loan Agreement, dated as of February 12, 1998, between Ugly Duckling Corporation ("UDC") and certain Lenders (the "Duck Kayne Anderson Lenders"), as amended, whereby the Duck Kayne Anderson Lenders loaned UDC the sum of $15,000,000 and were issued by UDC subordinated notes bearing interest at 15% and maturing on February 12, 2003. 2. That certain Indenture, dated October 15, 1998, from UDC to Harris Trust and Savings Bank, as trustee, whereby UDC issued 12% subordinated debentures which mature on October 23, 2003. 3. That certain Indenture, dated April 15, 2000, from UDC to Harris Trust and Savings Bank, as trustee, whereby UDC issued 11% subordinated debentures which mature on April 15, 2007. 4. That certain Loan Agreement, dated as of January 11, 2001, between UDC and Verde, whereby Verde loaned UDC the sum of $7,000,000 and was issued by UDC (i) a subordinated Promissory Note bearing interest at LIBOR plus 600 basis points and maturing on December 31, 2003 and (ii) 1,500,000 warrants to purchase common stock of UDC, which may be exercised by Verde incrementally after July 25, 2001 if the Note is not paid in full by July 25, 2001. Automotive Finance Corporation July 6,2001 Mr. Steven Darak, Chief Financial Officer Ugly Duckling Corporation 2525 East Camelback Road, Suite 500 Phoenix, AZ 85016 Dear Steve: Automotive Finance Corporation ("AFC") is pleased to advise you that it will approve the credit facility~ (the "Line") to Ugly Duckling Corporation (the "Borrower") as described below subject to the terms and conditions set forth herein. Except as otherwise provided herein, this letter does not constitute a legally binding and enforceable agreement. Moreover, this letter is not a complete statement of the parties' intentions and agreements with respect to the matters addressed herein. Nevertheless, upon acceptance by the Borrower, this letter will serve as an expression of the parties' mutual intent to proceed in good faith with the negotiation and execution of definitive agreements providing for the transactions described herein and with the other steps necessary to consummate such transactions. The date upon which such transactions shall be consummated shall be a mutually agreed date within 30 days after completion of the parties' due diligence investigations described herein and is referred to herein as the "Closing Date". The material terms of our Line are summarized below~ Borrower: Ugly Duckling Corporation (the "Borrower") Loan Facility: $36,000,000 Revolving Purchase Money Inventory Line Purpose: To finance the purchase of used vehicles for retail sa1e at the Borrower's dealership locations. Term: The Line will be established through July 30, 2002, at which it is due and payable in full. An annual review will be due by the above date at which time AFC will determine the Line's continuation. (to be discussed) Fees and Rates: Each vehicle will be charged at a variable rate, adjusted each business day, based upon the most recent prime rate published in the Wall Street Journal plus 6.0 % per annum on the outstanding principal amount per vehicle. Period/Curtailment Date: Vehicles may be floored on the Line for a maximum of 150 days, and will have a 10% curtailment due at day 120 with full payoff due at day 150. Two PARK WOOD CROSSING 310 EAST 96TH STREET SUITE 300 INDIANAPOLIS, IN 46240 317-815-9645 FAX 317-815-9650 Mr. Steven Darak, Chief Financial Officer Ugly Duckling Corporation July 6, 2001 Page 2 Advance Rate: a. ADESA Auction Purchased Vehicles: 100% of pre- confirmed purchase price plus up to $1,000 in reconditioning costs (with supporting documentation). b. Non-ADESA Auction Purchased Vehicles: 90% of clean black book value (no add-on's) plus up to $1,000 in reconditioning costs (with supporting documentation). c. Non-Auction Purchased Vehicles: 80% of clean black book value (no add-on's) plus up to $1,000 in reconditioning costs (with supporting documentation). Collateral: A perfected first priority purchase money security interest, as applicable, and a perfected security interest in all inventory, equipment, and general intangibles as described in the UCC financing statements. (to be discussed) Guarantors: All subsidiary companies of Ugly Duckling Corporation. Insurance: Acquire Umbrella Liability and Comprehensive insurance immediately after any loss at any one time of $150,000 or more for an amount equal to $10,000,000 with AFC listed as additional insured and loss payee. (to be discussed) Borrower Commitment: Borrower will keep AFC and the above facility in place as its primary floorplan source for a period of 12 months. If the Borrower chooses not to keep AFC as its primary floorplan source within the 12 month period, the Borrower will pay AFC a separation fee of $25,000. Origination Fee: $5,000 non-refundable, due within 5 business days of the complete execution of this agreement. The following sets forth additional material terms and conditions of the Line. Additional terms and conditions may be a part of the final documentation: 1. Each vehicle financed on the Floorplan Line is to be paid off within two (2) business days from the date the vehicle is sold or otherwise disposed of 2. Floorplan audits will be conducted 6 times per year at each of the Borrower's locations. Audits will focus on the physical inventory and collateral security as well as "deal audits" which will consist of a comparison of dates associated within the making of a car deal: i.e. sold, funded and pay-off dates. An event of default will occur if more than 5% of the vehicles are sold out of trust ("SOT") during any one lot audit. SOT occurs when the Borrower fails to payoff a specific vehicle within 2 business days after the disposition by sale of the vehicle. There will be a charge of $50 per vehicle for the first seven days it remains SOT. From the 8th through the 14th day that it is SOT there will be a charge of $100 per vehicle. From the l5t~~ through the 21St that it is SOT there will be a charge of Mr. Steven Darak, Chief Financial Officer Ugly Duckling Corporation July 6, 2001 Page 3 $100 per vehicle. If there are SOT vehicles over 21 days old at any one location that location will be in default and all obligations for the vehicles at that location will be immediately due and payable. The Borrower will be assessed a $65 charge per audit plus $1 for every vehicle audited in excess of 60 vehicles to cover the cost of such audits. 3. Financial Covenants: (to be discussed) a. Audited financial statements within 120 days of each fiscal year end. b. Quarterly financial statements within 45 days of each quarter end. c. The Borrower will maintain an interest coverage ratio of at all times. d. The Borrower will maintain a minimum net worth of__________ at all times. 4. The Line will be cross-defaulted with all of the Borrower's other credit facilities. AFC may periodically conduct a title audit at the Borrower's premises. 5. As a condition for AFC offering this Line, The Borrower agrees that: a. 50% of all repo'd vehicles and 25% of all wholesale returned vehicles sold at auction will be sold at an ADESA auction and b. ADESA will experience a 30% increase in auction purchases as A direct result of Borrower's purchases; c. Borrower will test ADESA's post-sale "full-disclosure" inspection @ $50 per vehicle to protect Borrower from unseen mechanical difficulties and will adopt the program if it proves to be commercially viable; and d. Borrower will provide ADESA and AFC with access to Borrower's wholesalers for marketing of ADESA auctions and AFC floorplan services. 6. The final documentation may contain additional terms as AFC deems necessary or desirable for this type of loan facility. 7. The Borrower will pay any reasonable costs incurred by AFC to document this loan, together with any out of pocket costs for attorneys, recording fees, and title work. A preliminary estimate of these costs is approximately $10,000. If you are in agreement with the terms and conditions contained herein, please sign below and return: this letter to my attention. AFC `s receipt of this signed letter, along with the commitment fee of $5,000 will constitute our acceptance to begin the documentation of the loan subject to AFC's due diligence. A formal loan agreement evidencing the terms of this letter will be our final binding agreement. Best Regards, /s/ John Fuller John Fuller President Mr. Steven Darak, Chief Financial Officer Ugly Duckling Corporation July 6, :2001 Page 4 Accepted this 9th day of July, 2001 ---- ------ Ugly Duckling Corporation By: (sign) /s/ C. R. Fulton ---------------- By: (Print) C.R. FULTON ----------- Title-Vice President & Treasurer cc: Robert Fulton February 20, 2001 Mr. Ernest C. Garcia II Chairman Ugly Duckling Corporation 2575 East Camelback Road Suite 700 Phoenix, AZ 85016 Mr. Gregory B. Sullivan Chief Executive Officer Ugly Duckling Corporation 2525 East Camelback Road Suite 500 Phoenix, AZ 85016 Gentlemen: This letter agreement (the "Agreement") confirms the commitment of Greenwich Capital Financial Products, Inc. and its applicable affiliates (collectively, "Greenwich") to Ugly Duckling Corporation and its applicable affiliates (collectively, "UDC") to provide, and of UDC to accept, subject to the Summary of Terms attached hereto and incorporated herein by reference, as well as the further conditions set forth herein below, the senior financing facility described herein (the "Senior Facility"). The obligation of Greenwich to complete the transaction described herein is subject to satisfaction of the conditions precedent set forth in the Summary of Terms and completion of documentation in respect of such Senior Facility as described in the Summary of Terms satisfactory to Greenwich and UDC. This agreement may be executed in one or more counterparts, all of which taken together shall constitute one and the same agreement. The commitment contained herein shall terminate if this letter is not fully executed and returned to Greenwich by Friday, March 2, 2001. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed by their respective officers as of the day and year first above written. GREENWICH CAPITAL FINANCIAL PRODUCTS, INC. By: /s/ IRA J. PLATT Name: IRA J. PLATT Its: Senior Vice President Date: March 1, 2001 AGREED AND ACCEPTED, UGLY DUCKLING CORPORATION By: /s/ GREGORY B. SULLIVAN Name: GREGORY B. SULLIVAN Its: President Date: March 5, 2001 Ugly Duckling Corporation $75 / $100 million Revolving Credit Facility Summary of Terms Borrower: A [bankruptcy-remote] special purpose subsidiary of Ugly Duckling Corporation ("UDC"). Lender: Greenwich Capital Financial Products, Inc. or an affiliate thereof ("Greenwich") Guarantor: Ugly Duckling Corporation Facility Size: $75,000,000. For the period from December 1st through March 31St, the Facility Size will be expanded to $100,000,000 to accommodate the seasonality of IJDC ` s origination cycle. Facility Term: 364-day term, renewable upon the conclusion of the initial term for an additional 364-day period at Greenwich's sole discretion with not less than 90 days' advance notice. Subsequent renewals require mutual consent of both the Borrower and the Lender. Commitment Fee: $750,000, due at closing. Renewal Fee: $250,000, due upon receipt of Lender notice of intent to renew. Interest Rate: One month LIBOR plus 2.80% Contract: A retail installment contract, secured by a motor vehicle, which was originated or acquired by UDC in the ordinary course of its business. Collateral: The Facility will be secured by a direct pledge of (a) all UDC Contracts and (b) a blanket lien on all tangible and intangible assets of UDC in existence and as created by UDC and its affiliates. Servicer: Ugly Duckling Credit Corporation Facility Advance: For each UDC Eligible Contract (as defined hereinbelow), the product of such Eligible Contract's unpaid principal balance and the least of: (a) The UDC Securitization Net Advance (as defined hereinbelow) less 4.00% for the most recently completed UDC securitization transaction; (b) The weighted average of the three IJDC Securitization Net Advances less 4.00% from the most recently completed UDC securitization transactions; and (c) 65.00% For the purposes of determining the Facility Advance, the UDC Securitization Net Advance shall equal the Class A Advance Rate less the Class A Reserve Fund Initial Deposit (expressed as a percentage of the Initial Pool Balance); each capitalized term being defined as expressed in the transaction documentation for such securitization transaction Existing non-UDC originated Contracts which are submitted for inclusion to the Facility will receive a Facility Advance equal to that provided under the existing GECC Facility. In the event that UDC acquires Contracts from an originator subsequent to the implementation of this Facility, the Lender will review the Contract portfolio attributes and the portfolio's prior performance history and, in its sole discretion determine an appropriate Facility Advance for such Contracts. UDC Eligible Contract: Substantially similar to GECC Facility, but specifically excluding Contracts which: i) Are more than 59 days contractually delinquent and not designated by the Servicer as out for or in repossession; ii) Are 30 or more days contractually delinquent, and when taken together with all other Contracts which are 30 or more days contractually delinquent, exceed [3.001% of the aggregate principal balance of IJDC Eligible Contracts; iii)The Lender shall not have received expressed written confirmation from the Custodian of its possession of the related retail installment contract and other customary documentation for such Contract. Contraet Collections: The Servicer shall establish a bank account (the "Collection Account") in the name of the Lender to which collections and recoveries on pledged Contracts (irrespective of Facility eligibility) will be swept on a daily basis and within 24 hours of identification by the Servicer. It is anticipated that all collections will be identified and swept to this Collection Account within three business days of receipt by the Servicer. Funds deposited into the Collection Account shall be applied, on a daily basis, to first pay the Lender interest and fees or expenses which have accrued on the Facility and then to reduce amounts borrowed under the Facility. Borrowing Base Calculation: UDC will deliver to Greenwich, on a daily basis, a report and accompanying data file (in format and content acceptable to Greenwich) delineating the Contracts pledged to the Facility, newly calculated UDC Eligible Contracts and the related maximum permitted borrowings as of such date. Monthly Reports: Complete Covenant analysis and any other data and reporting information as reasonably requested by the Lender. Aging Constraints: UDC Eligible Contracts originated prior to the cut-off date of the most recent UDC securitization may only comprise the greater of (i) $12,500,000 of Borrowing Base or (ii) 20% of the aggregate Facility Advance. Custodian: [Bank of New York] Hot Backup Servicer: Wells Fargo Financial Corporation. In the event that Servicing transfers to the Hot Backup Servicer, such party will be paid a fee equal to that provided in their proposal letter dated October 10, 2000. Affirmative and Negative Covenants: The Lender will include the following financial and portfolio performance covenants in the Facility, which covenants shall be satisfactory to Greenwich: Liquidity Test-- {$7.Slmm cash and/or warehouse availability Gross Margin Maintenance Test Net Worth Test Cash Flow Interest Coverage Test Debt to EB1TDA Test 3 month Rolling Average Delinquency and Gross Loss Tests for both the Facility and for UDC Managed Assets Remedies: To include Advance Rate adjustment (margin call), Capital Calls (as described hereinbelow in a UDC post-privatization environment) and the termination and wind down of the Facility. Conditions Precedent to Implementation of the Facility: To include: i) Execution of documentation and receipt of legal opinions in form and content acceptable to the Lender and its counsel; ii) Receipt of the Facility Commitment Fee; and iii)Receipt by the Lender of an executed Commitment Letter providing UDC with an Inventory Finance Facility of not less than $25 million with terms reasonably acceptable to the Lender. Conditions Precedent to the Privatization of UDC: The Guarantor will covenant that the privatization of UDC will meet the following conditions precedent: i) UDC will not use more than [$10] million of corporate cash will be used in a stock tender; ii) TJDC will not incur more than [$32] million of incremental subordinated term debt with a maturity of not less than [five] years in any stock tender; iii)Neither Ernie Garcia nor Greg Sullivan will participate in such tender offer; iv) TJDC will have executed an inventory finance facility of not less than $25 million; v) MBIA shall have expressed written approval of the proposed transaction and its willingness and intent to continue as surety provider for UDC securitizations; vi) Kayne Anderson shall have committed in writing to receive not more than $4mm per annum (in not more than $1 mm per quarter installments) in repayment of its subordinated debt until such debt is retired OR Ernie Garcia shall personally commit to meeting any repayment demand by Kayne Anderson in excess of the aforementioned proposed repayment schedule; and vii)None of UDC's MBIA-wrapped term securitizations will be in breach of either a Performance or Event of Default Trigger, each as defined in such transaction's documentation when such privatization effort is commenced or executed upon. Post-Privatization Constraints: If UDC management should succeed in effecting a privatization of the Company, the Guarantor shall make the following additional covenants: i) The Company shall not sell UDC equity to a third-party without the Lenders express written consent; ii) Subject to the maintenance of [Gross Margin Maintenance / Liquidity I Other? Tests], UDC may bear up to [$2,000,000] of Verde corporate expenses per annum to be applied evenly on a monthly basis. Verde expenses paid by UDC are subject to a Capital Call at the Lender's discretion in the event that a Facility financial covenant is breached; iii)Ernie Garcia Bonus I Dividend formula subject to Lender approval. The Lender may request a capital call on tax adjusted bonus distributions if [Gross Margin Maintenance / Liquidity I Other? Tests] are breached. Distributions will be constrained so as to ensure a minimum of $10 million TJDC Liquidity as of the most recent TJIDC Covenant Report and are subject to Lenders sign-off on pro-forma financial projections evidencing not less than $10 million of UDC Liquidity for the next twelve months; and iv) Any effort to convert UDC into a Subchapter S Corporation is subject to the prior written approval of the Lender. Pursuit of a Facility Rating: In the event that Greenwich elects to pursue an investment-grade rating for the Facility, UDC agrees to accept any reasonable modification to the operating attributes of the Facility as mandated by such rating agency as a requirement for obtaining the rating letter. UDC further agrees to pay the costs and expenses of the rating agency related to obtaining such rating letter. In the event that an investment-grade rating is obtained for the Facility, Greenwich agrees to increase the Facility Size to $100,000,000 throughout the calendar year. Costs and Expenses: UDC to bear all costs and expenses associated with any due diligence associated with the creation and maintenance of the Facility as well as all legal costs (including, but not limited to the out-of-pocket expenses of Greenwich's counsel) associated with the creation and enforcement of the Facility. Underwriting Commitment: UDC to execute an Underwriting Commitment with Greenwich for AAA-rated securities with an underwriting fee equal to 0.40% on the face amount of securities purchased. This commitment will provide Greenwich with underwriting exclusivity for all receivables originated or purchased by UDC during the Facility's term (as extended), irrespective of whether they were financed by Greenwich. SUBORDINATION AND STANDSTILL AGREEMENT THIS SUBORDINATION AND STANDSTILL AGREEMENT ("Agreement") is entered into by and among UGLY DUCKLING CORPORATION, a Delaware corporation ("UDC"), VERDE TNVESTMENTS, INC., an Arizona corporation ("Verde') and Automotive Finance Corporation ("Senior Lender') under that certain Senior Secured Loan Agreement dated January 11,2001. RECITALS A. UDC has borrowed money and obtained credit from Verde pursuant to that certain Loan Agreement dated January 11,2001 among UDC and Verde ("Junior Loan Agreement"); B. UDC is also in the process of obtaining a loan from the Senior Lender pursuant to the Senior Loan Agreement (as defined below); and C The Senior Lender has indicated that it will enter into the Senior Loan Agreement if certain conditions are met, including, without limitation, the requirement that Verde execute this Agreement, NOW, THEREFORE, as an inducement to the Senior Lender to enter into the Senior Loan Agreement and any future credit between Senior Lender and UDC, and for other valuable consideration, the parties hereto agree as follows: 1- INDEBTEDNESS AND LIENS SUBORDINATED. Verde subordinates (1) all indebtedness and other obligations of every typo and nature created under or in connection with the Junior Loan Agreement, including any amendments or modifications thereto, and now or at any time hereafter owing from UDC to Verde pursuant to the Junior Loan Agreement (including, without limitation, interest thereon which may accrue subsequent to IJDC becoming subject to any state or federal debtor-relief statute) ("Junior Debt") and (ii) all liens and/or security interests held by Verde in any Collateral ("Junior Liens") to the prior payment in full in cash of all Senior Debt (as defined below) and all liens and/or security interests, if any, held by the Senior Lender in the Collateral ("Senior Liens"). Subject to the provisions of Section 2, Verde irrevocably agrees and directs that all Senior Debt shall be paid in full in cash prior to UDC making any payment on any Junior Debt, unless the Senior Lender authorize such payments on the Senior Debt. Verde will, and the Senior Lender is authorized in the name of Verde from time to time to, execute and file such financing statements and other documents as the Senior Lender may require in order to give notice to other persons and entities of the terms and provisions of this Agreement. For purposes hereof, the term "Senior Debt" means the "Obligations" (as such term is defined in the Senior Loan Agreement), together with (a) any partial or complete refinancing of the Obligations, (b) any amendments, restatements, modifications, renewals or extensions of any of the foregoing, and (c) any interest accruing on any of the foregoing before or after the commencement of any bankruptcy, insolvency, reorganization or similar proceeding, without regard to whether or not such interest is an allowed claim. For purposes hereof, the term "Senior Loan Agreement" means that certain Loan and Security Agreement by and among UDC, certain UDC subsidiaries, and Senior Lender, dated as of August --, 2001, as the same may be amended, supplemented or otherwise modified from time to time. For purposes hereof, the tent UGLY DUCKLING CORPORATION, a Delaware corporation By: /s/ JON EHLINGER Name: JON EHLINGER Title: Secretary VERDE INVESTMENTS, INC., an Arizona Corporation By: /s/ STEVEN P. JOHNSON Name: STEVEN P. JOHNSON Title: Vice President & Secretary AFC By: /s/ JOEL G. GARCIA Name: JOEL G. GARCIA Title: Secretary EX-10.2 4 ex102txt.txt AFC COVENANT WAIVER UGLY DUCKLING CORPORATION November 1, 2001 Curt Phillips Chief Financial Officer Automotive Finance Corporation 310 East 96th Street Suite 300 Indianapolis, IN 46240 RE: Ugly Duckling Corporation Master Loan and Security Agreement dated as of August 24, 2001 Dear Sir: With this letter we are requesting a waiver of the Cashflow Interest Coverage Ratio contained in 11.6 (c) of the above referenced loan agreement for the quarter ended September 30, 2001 and the quarter ending December 31, 2001. We are in compliance with all other covenants of the agreement. The reason for the current and expected shortfall in this covenant is due to a number of changes we are making in the business to improve long term portfolio performance. These changes include: 1. Enhancing underwriting criteria through the implementation of credit scoring and increasing down payment requirements, resulting in slower sales, a smaller portfolio than forecasted and lower interest income from the smaller portfolio. 2. The increase of loan loss reserves to the balance sheet resulting from higher than expected losses from older portfolios and a smaller base of originations in the quarter, as previously discussed. In addition to the above, we are also making provision for the impact of a recession in the economy. Although we are making many improvements in our business model and we are confident we are underwriting better loans, we do not have the history to accurately assess the impact of a recession on our customer base. We have chosen to assume the portfolio in 2001 will not perform better than the portfolio of 2000 and adjusted the provision accordingly in the quarter and will take an additional provision in the last quarter of the year. We would also like to request a waiver of Section 12.2 of the above referenced loan agreement to repurchase up to $10 million in our stock and/or bonds. Our stock is currently trading at less than 25% of book value and the purchase of our bonds would produce a return in excess of 20% based on the last trades. We recently received approval from our Board of Directors to complete either of these transactions in aggregate up to the $10 million limit. Thank you for your time and consideration. I have provided an area on an attached page for your signature authorizing the waiver. Please call me with any further questions at 602-852-6635. Sincerely, /s/ BOB FULTON --------------------------------------------------------------- Bob Fulton Treasurer Ugly Duckling Corporation The undersigned hereby waive the covenants requested: Automotive Finance Corporation By: /s/ CURTIS L. PHILLIPS --------------------------------------------- Name: Curtis L. Phillips -------------------------- Title: CFO -------------------------- EX-10.3 5 ex103txt.txt GREENWICH COVENANT WAIVER GREENWICH CAPITAL November 9, 2001 Mr. Greg Sullivan Chief Executive Officer Ugly Duckling Corporation 4020 East Indian School Road Phoenix, AZ 85018 Dear Greg: By execution of this letter and upon receipt of a $10,000 waiver fee, Greenwich Capital Financial Products, Inc. ("Greenwich") hereby grants Ugly Duckling Corporation and its related subsidiaries a waiver of the Cashflow Interest Coverage Ratio contained in Section 7.15(c) of the Ugly Duckling Corporation Master Loan and Security Agreement dated April 13. 2001 (the "Agreement") for the quarter ended September 30, 2001. Except as expressly amended hereby, the Agreement shall remain in full force and effect in accordance with its terms, without any waiver, amendment or modification of any provision thereof. Sincerely, GREENW1CH CAPITAL FINANCIAL PRODUCTS, INC. /S/ IRA J. PLATT ---------------------------------------------------------- Ira J. Platt Senior Vice President Greenwich Capital Financial Products. Inc. 600 Steamboat Road Greenwich, Connecticut 06830 Telephone {203) 62S-2100 EX-10.4 6 ex104txt.txt SUNAMERICA COVENANT WAIVER November 9, 2001 KZH Soleil --2 LLC c/o The Chase Manhattan Bank 140 East 45th Street ~11th Floor New York, NY 10017 Galaxy CLO 1999-1, Ltd. c/o Chase Bank of Texas, National Association 600 Travis Street--48th Floor, 48-CTH-304 Houston, TX 77002 Sun America Life Insurance Company I SunAmerica Center - 34th Floor Century City Los Angeles, CA 90067-6002 RE: Ugly Duckling Corporation Senior Secured Loan Agreement Dated as of January 11, 2001 Dear Sirs: With this letter we are requesting a waiver of the Minimum Other Interest and the EBITDA to Interest Expense coverage ratios contained in Section 6.18 of the above referenced loan agreement for the quarter ended September 30, 2001 and the quarter ending December 3 1, 2001. As agreed upon, in return for the waiver of these covenants we will wire you $55,000 or 25 basis points of the current outstanding principal balance less funds held in the cash collateral account. We are in compliance with all other covenants of the agreement. As we shared with you in the second quarter of this year, the reason for the shortfall in these covenants in the quarter is due to a number of changes we are making in the business to improve long term portfolio performance. These changes include: 1. Enhancing underwriting criteria through the implementation of credit scoring and increasing down payment requirements, resulting in slower sales, a smaller portfolio than forecasted and lower interest income from the smaller portfolio. 2. The increase of loan loss reserves to the balance sheet resulting from higher than expected losses from older portfolios and a smaller base of originations in the quarter, as previously discussed. In addition to the above, we are also making provision for the impact of a recession in the economy. Although we are making many improvements in our business model arid we are confident we are underwriting better loans, we do not have the history to accurately assess the impact of a recession on our customer base. We have chosen to assume the portfolio in 2001 will not perform better than the portfolio of 2000 and adjusted the provision accordingly. As we have discussed with you we expect to take an additional charge to earnings in the fourth quarter of approximately $6 million pre-tax. Based on this charge we would expect the EBITDA to Interest coverage and the Minimum Interest coverage to be 0.75 and 0.00 respectively in the fourth quarter and request you waive these covenants to these levels for that period. In light of these changes and the impact to our profitability in the first nine months of 2001, the "B-piece" contracts securing your loan continue to perform at consistently high levels. Cash generated from these loans through September 2001 was $66.9 million, which is approximately $12.0 million greater than the first nine months of last year. In addition to the improvements in the portfolio, we closed our twenty-first receivables securitization on October 18th with a loan principal balance $145.9 million and Class A bonds issued of $103.6 million. This securitization included a prefunding mechanism allowing us to borrow an additional $25.9 million against loans to be originated in the next 90 days following the close of the deal. The coupon on the A bonds issued in the securitization was 3.44% with an initial funding of 2.25%, down from 6.80% and 6.00% respectively from the securitization we completed last year at this time. We have also recently completed a revolving loan with Automotive Finance Corporation to provide the company with a $36 million inventory line of credit, which is a $10 million larger facility than the GE loan we are replacing. We have now completely replaced the GE lending relationship and do not have any loan facilities maturing for the remainder of 2001. Thank you for your time and consideration. I have provided an area below for your signature authorizing the waiver. Please call me with any further questions at 602-852- 6635. Sincerely, Bob Fulton Treasurer Ugly Duckling Corporation The undersigned hereby waive the covenants requested: KZH Soleil - 2 LLC By: /s/ Susan Lee ------------------------------------------ Name: Susan Lee Title: Authorized Agent Galaxy CLO 1999-1, Ltd. By: SAl Investment Advisors, Inc. its Collateral Manager By: /s/ John Lapham ------------------------------------------ Name: John Lapham Sun America Life Insurance Company By: /s/ John Lapham ------------------------------------------ Name: John Lapham Title: Authorized Agent EX-99 7 ex99txt.txt FLS AND RISK FACTORS Risk Factors There are various risks in purchasing our securities and investing in our business, including those described below. You should carefully consider these risk factors together with all other information included in this Form 10-Q. We make forward looking statements. This Report includes statements that constitute forward-looking statements within the meaning of the safe harbor provisions of the Private and Securities Litigation Reform Act of 1995. We claim the protection of the safe-harbor for our forward looking statements. Forward-looking statements are often characterized by the words "may," "anticipates," "believes," "estimates," "projects," "expects" or similar expressions and do not reflect historical facts. Forward-looking statements in this report relate, among other matters, to: adverse economic conditions; anticipated financial results, such as sales, other revenues and loan portfolios, improvements in underwriting, adequacy of the allowance for credit losses, and improvements in recoveries and loan performance, including delinquencies and charge offs; retaining the inventory lines of credit; roll-out of collectors to our dealerships; the success of cost savings initiatives; improvements in inventory and inventory mix; and e-commerce related growth and loan performance. Forward looking statements include risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from those expressed or implied by such forward looking statements, some of which we cannot predict or quantify. Factors that could affect our results and cause or contribute to differences from these forward-looking statements include, but are not limited to: any decline in consumer acceptance of our car sales strategies or marketing campaigns; any inability to finance our operations in light of a tight credit market for the sub-prime industry and our current financial circumstances; any deterioration in the used car finance industry or increased competition in the used car sales and finance industry; any inability to monitor and improve our underwriting and collection processes; any changes in estimates and assumptions in, and the ongoing adequacy of, our allowance for credit losses; any inability to continue to reduce operating expenses as a percentage of sales; increases in interest rates; adverse economic conditions; any material litigation against us or material, unexpected developments in existing litigation; and any new or revised accounting, tax or legal guidance that adversely affect used car sales or financing and developments with respect to any offer by Mr. Garcia's offer to take us private. Forward-looking statements speak only as of the date the statement was made. Future events and actual results could differ materially from the forward-looking statements. When considering each forward-looking statement, you should keep in mind the risk factors and cautionary statements found throughout this Form 10-Q and specifically those found below. We are not obligated to publicly update or revise any forward looking statements, whether as a result of new information, future events, or for any other reason. References to Ugly Duckling Corporation as the largest chain of buy-here pay-here used car dealerships in the United States is management's belief based upon the knowledge of the industry and not on any current independent third party study. Our majority stockholder can control substantially all matters put to a vote of stockholders. Ernest C. Garcia II, our Chairman, is the beneficial owner of a majority of our outstanding common stock. Mr. Garcia is now in a position to control the election of our directors or the approval of any merger, reorganization or other business combination transaction submitted to a vote of our shareholders or other extraordinary transaction. Mr. Garcia could vote to approve such a transaction on terms, which might be considered more favorable to Mr. Garcia than to unaffiliated stockholders. The terms of any such transaction could require stockholders other than Mr. Garcia to dispose of their shares of common stock for cash or other consideration even if the stockholders would prefer to continue to hold their shares of our common stock for investment. Any such transaction could also result in Ugly Duckling's common stock being delisted from the Nasdaq National Market or being held of record by fewer than 300 persons and, therefore, eligible for termination of registration pursuant to Section 12(g)(4) of the Securities Exchange Act of 1934. In filings with the Securities and Exchange Commission, Mr. Garcia has expressed a continuing interest in taking us private. Future losses could impair our ability to raise capital or borrow money and consequently affect our stock price. While we have been profitable in the past, we cannot assure you that we will be profitable in future periods. Losses in future periods could impair our ability to raise additional capital or borrow money as needed and could affect our stock price. We may not be able to continue to obtain the financing we need to fund our operations and, as a result, our business and profitability could be materially adversely affected. Our operations require large amounts of capital. We have borrowed, and will continue to borrow, substantial amounts to fund our operations. If we cannot obtain the financing we need on a timely basis and on favorable terms, our business and profitability could be materially adversely affected. As a result of our primary lender, GE Capital Corporation, exiting the automobile finance business, our portfolio performance, and a general tightening in the credit markets, we have recently experienced a less favorable borrowing environment than in the past. We currently obtain financing through four primary sources: o a warehouse facility with Greenwich Capital Financial Products, Inc. ("Greenwich"); o an inventory facility with Automotive Finance Corporation ("AFC") o securitization transactions; and o loans from other sources. Warehouse Facility with Greenwich. When our prior warehouse lender, GE Capital Corporation, announced that it was exiting the automobile finance market, we had to replace our GE credit facility with a new facility. Our new warehouse facility with Greenwich is now our primary source of operating capital. We have pledged substantially all of our assets to Greenwich to secure the borrowings we make under this facility. The warehouse facility expires in April 2002. Under our securitizations, we are required to have a credit facility reasonably acceptable to the insurer on April 30th of each year. Failure to maintain such a facility would constitute a termination event under our securitizations and, our liquidity would be materially adversely affected. Inventory Line of Credit with GECC. We have entered into a $36 million inventory line of credit with AFC in August of 2001. If we are unable to maintain an inventory line of credit, our liquidity could be materially adversely affected. Securitization Transactions. We restore capacity under the warehouse facility from time to time by securitizing portfolios of finance receivables. Our ability to successfully and efficiently complete securitizations may be affected by several factors, including: o the condition of securities markets generally; o conditions in the asset-backed securities markets specifically; o the credit quality of our loan portfolio; and o the performance of our servicing operations. In past periods, we experienced a tightening of the restrictive covenants in our securitization transactions as well as increases in the credit enhancements required to close our securitizations. High delinquency levels and charge offs or other events, such as our failure to have a warehouse facility acceptable to the insurer of our securitization transactions in place on April 30 of each year, can also cause a "termination event" under our securitization transactions, which could result in our being replaced as servicer under those securitizations or in a liquidation and sale of the securitized portfolios. These types of occurrences could also cause a "portfolio performance event," which could result in all cash flow from the securitized receivables otherwise distributable on the junior obligations held by us being retained in the trust as additional security for senior securities. Any of these consequences could have a material adverse effect on our business and financial condition. Contractual Restrictions. The warehouse facility, the inventory line of credit, the securitization program, and our other credit facilities contain various restrictive covenants, including financial tests. Failure to satisfy the covenants in our credit facilities or our securitization program could result in a default (and could preclude us from further borrowing under the defaulted facility), could cause cross defaults to our other debt, and could prevent us from securing alternate sources of funds necessary to operate our business. Any of these events would have a material adverse effect on our business and financial condition. From time to time, we incur technical or other breaches under our material credit facilities, and we have obtained waivers from the applicable lenders. There can be no assurance we will continue to receive waivers and our inability to obtain these waivers may cause cross defaults to our other debt and have a material impact on our ability to obtain or retain operating capital. We have a high risk of credit losses because of the poor creditworthiness of our borrowers. Substantially all the sales financing we extend and the loans that we service are with "sub-prime" borrowers. Sub-prime borrowers generally cannot borrow money from traditional lending institutions, such as banks, savings and loans, credit unions, and captive finance companies owned by automobile manufacturers, because of their poor credit histories and/or low incomes. Loans to sub-prime borrowers are difficult to collect and are subject to a high risk of loss. We have established an allowance for credit losses to cover our anticipated credit losses. We periodically review and may make upward or downward adjustments to the allowance based upon whether we believe the allowance is adequate to cover our anticipated credit losses. However, our allowance may not be sufficient to cover our credit losses and we may need to increase our provision or allowance if certain adverse factors arise, including adverse economic events or material increases in delinquencies or charge-offs. A significant variation in the timing of or increase in credit losses in our portfolio or a substantial increase in our allowance or provision for credit losses would have a material adverse effect on our net earnings. We could have a system failure if our current contingency plan is not adequate, which could adversely affect our ability to collect on loans and comply with statutory requirements. We depend on our loan servicing and collection facilities and on long-distance and local telecommunications access to transmit and process information among our various facilities. We use a standard program to prepare and store off-site backup tapes of our main system applications and data files on a routine basis. We regularly revise our contingency plan. However, the plan as revised may not prevent a systems failure or allow us to timely resolve any systems failures. Also, a natural disaster, calamity, or other significant event that causes long-term damage to any of these facilities or that interrupts our telecommunications networks could have a material adverse effect on our operations and profitability. We have slowed our growth, which, eventually, could negatively affect our earnings and profitability. Since 1999, we have slowed our growth. Our ability to continue our growth is limited by our access to capital. We are also committed to slowing our growth until we improve our loan loss experience. As additional capital is secured, we will consider whether to resume or accelerate our expansion plans or to continue repurchasing our stock or debt. This slowdown in growth has adversely impacted earnings in 2001. We expect that a failure to grow could affect our earnings and/or profitability in future periods as well. Even if we make acquisitions, such acquisitions may be unsuccessful or strain or divert our resources from more profitable operations. Although we have decided to slow our growth during the foreseeable future, we intend to consider additional acquisitions, alliances, and transactions involving other companies that could complement our existing business if we can do so with little or no capital or if we can raise capital sufficient for any such transaction. However, we may not be able to identify suitable acquisition parties, joint venture candidates, or transaction counter parties. Even if we can identify suitable parties, we may not be able to consummate these transactions on terms that we find favorable or obtain required consents or approvals. We may also not be able to successfully integrate any businesses that we acquire into our existing operations. If we cannot successfully integrate any future acquisitions, our operating expenses may increase, which would affect our net earnings. Moreover, these types of transactions may result in the incurrence of additional debt and amortization of expenses related to goodwill and intangible assets, all of which could adversely affect our profitability. These transactions also involve numerous other risks, including the diversion of management attention from other business concerns, entry into markets in which we have had no or only limited experience, and the potential loss of key employees of acquired companies. Occurrence of any of these risks could have a material adverse effect on us. We have continuing risks relating to the First Merchants transactions. We have entered into several transactions in the bankruptcy proceedings of First Merchants Acceptance Corporation. We have the right to 17.5% of recoveries on First Merchants' residual interests in certain securitized loan pools and other loans. However, if we lose our right to service these loans, our share of these residual interests could be reduced or eliminated. This could affect our future cash flow and profitability. Interest rates affect our profitability. Much of our financing income results from the difference between the rate of interest that we pay on the funds we borrow and the rate of interest that we earn on the loans in our portfolio. While we earn interest on the loans that we own at a fixed rate, we pay interest on our borrowings under our warehouse facility and certain other debt at a floating rate. When interest rates increase, our interest expense increases and our net interest margins decrease. Increases in our interest expense that we cannot offset by increases in interest income will lower our profitability. Laws that limit the interest rates that we can charge can adversely affect our profitability. We operate in many states that impose limits on the interest rate that a lender may charge. When a state limits the amount of interest that we can charge on our installment sales loans, we may not be able to offset any increased interest expense caused by rising interest rates or greater levels of borrowings under our credit facilities. Therefore, these interest rate limitations can adversely affect our profitability. Government regulations may limit our ability to recover and enforce receivables or to repossess and sell collateral. We are subject to ongoing regulation, supervision, and licensing under various federal, state, and local statutes, ordinances, and regulations. If we do not comply with these laws, we could be fined or certain of our operations could be interrupted or shut down. Failure to comply could, therefore, have a material adverse effect on our operations. We believe that we are currently in substantial compliance with all applicable material federal, state, and local laws and regulations. We may not, however, be able to remain in compliance with such laws. In addition, the adoption of additional statutes and regulations, changes in the interpretation of existing statutes and regulations, or our entry into jurisdictions with more stringent regulatory requirements could also have a material adverse effect on our operations. We are subject to pending actions and investigations relating to our compliance with various laws and regulations. While we do not believe that ultimate resolution of these matters will result in a material adverse effect on our business or financial condition (such as fines, injunctions or damages), there can be no assurance in this regard. Increased competition could adversely affect our operations and profitability. Our primary competitors are the numerous small buy-here/pay-here used car dealers that operate in the sub-prime segment of the used car sales industry and the banks and/or finance companies that purchase their loans. We attempt to distinguish ourselves from our competitors through name recognition and other factors. However, the advertising and infrastructure required by these efforts increase our operating expenses. There is no assurance that we can successfully distinguish ourselves and compete in this industry. In addition, in recent years, a number of larger companies with significant financial and other resources have entered or announced plans to enter the used car sales and/or finance industry. Although these companies may not currently compete with us in our portion of the sub-prime segment of the market, they compete with us in the purchase of inventory, which can result in increased wholesale costs for used cars and lower margins. They could also enter into direct competition with us at any time. Increased competition may cause downward pressure on the interest rates that we charge on loans originated by our dealerships. Either change could have a material effect on our earnings and the value of our securities. The success of our operations depends on certain key personnel. We believe that our ability to successfully implement our business strategy and to operate profitably depends on the continued employment of our senior management team. The unexpected loss of the services of any of our key management personnel or our inability to attract new management when necessary could have a material adverse effect on our operations. We do not currently maintain key person life insurance on any member of our senior management team other than Gregory B. Sullivan, our President and Chief Executive Officer. We may issue stock in the future that will dilute the value of our existing stock. We have the ability to issue common stock or securities exercisable for or convertible into common stock, which may dilute the securities our existing stockholders now hold. In particular, issuance of some or all of the following securities may dilute the value of the securities that our existing stockholders now hold: o since we went public we have granted warrants to purchase a total of approximately 700,000 shares of our common stock to various parties, with exercise prices ranging from $6.75 to $10.81 per share; o we may issue additional warrants in connection with future transactions; o we may issue common stock under our various stock option plans; and o we have committed to issue 1.5 million warrants to Mr. Garcia, subject to certain conditions. There is a potential anti-takeover or dilutive effect if we issue preferred stock. Our certificate of incorporation authorizes us to issue "blank check" preferred stock. Our board of directors may fix or change from time to time the designation, number, voting powers, preferences, and rights of this stock. Such issuances could make it more difficult for a third party to acquire us by reducing the voting power or other rights of the holders of our common stock. Preferred stock can also reduce the market value of the common stock. There may be adverse consequences from issuing blank check common stock, including a potential anti-takeover or dilutive effect. Our certificate of incorporation authorizes us to issue additional series of common stock, which we refer to as "blank check" common stock. Our board of directors may create new series of common stock from time to time in addition to the existing common stock and may fix: o the designation, voting powers, liquidation rights, conversion rights, redemption rights, dividends and distributions, preferences and relative, participating, optional and other rights, if any, of each such series; o the qualifications, limitations or restrictions, if any, of each such series; and o the number of shares constituting each such series. Blank check common stock could also: o negatively affect shareholder rights and the value of existing common stock; o have rights that are preferential or superior to the existing common stock; o track the performance of certain assets, groups of assets, businesses or subsidiaries of the company; o increase the complexity and administrative costs of our capital structure, which could negatively impact our financial condition and the value of our common stock; o create potential conflicts of interest and our board of directors could make decisions that adversely affect holders of our existing common stock; and/or o give rise to occasions when the interests of holders of one series might diverge or appear to diverge from the interests of holders of another series. Blank check common stock also may be viewed as being an "anti-takeover" device. Our board could create and issue series of common stock with terms that could make a takeover attempt by a third party more difficult to complete and such stock may also be used in connection with the issuance of a stockholder rights plan, sometimes called a "poison pill." -----END PRIVACY-ENHANCED MESSAGE-----