-----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, Oj5/Co6v/GU8INHODq3t0Ur9ViQWgn4RYCnTVnVvUEYr6Af1yIoHL4+LFdRm+Pav En141kMWwG7H5s4Y4OjefQ== 0000950153-98-000577.txt : 19980518 0000950153-98-000577.hdr.sgml : 19980518 ACCESSION NUMBER: 0000950153-98-000577 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19980331 FILED AS OF DATE: 19980515 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: UGLY DUCKLING CORP CENTRAL INDEX KEY: 0001012704 STANDARD INDUSTRIAL CLASSIFICATION: PERSONAL CREDIT INSTITUTIONS [6141] IRS NUMBER: 860721358 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-20841 FILM NUMBER: 98625772 BUSINESS ADDRESS: STREET 1: 2525 E. CAMELBACK #1150 STREET 2: STE 1150 CITY: PHOENIX STATE: AZ ZIP: 85016 BUSINESS PHONE: 6028526600 MAIL ADDRESS: STREET 1: 2525 E CAMELBACK RD STREET 2: STE 1150 CITY: PHOENIX STATE: AZ ZIP: 85016 10-Q 1 10-Q 1 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 MARCH 31, 1998 Commission File Number 000-20841 U G L Y D U C K L I N G C O R P O R A T I O N (Exact name of registrant as specified in its charter) Delaware 86-0721358 (State or other jurisdiction of (I.R.S. employer incorporation or organization) identification no.) 2525 E. Camelback Road, Suite 1150 Phoenix, Arizona 85016 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (602) 852-6600 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE ISSUER'S CLASSES OF COMMON STOCK, AS OF THE LATEST PRACTICABLE DATE: At May 12, 1998, there were 18,593,285 shares of Common Stock, $0.001 par value, outstanding. This document serves both as a resource for analysts, shareholders, and other interested persons, and as the quarterly report on Form 10-Q of Ugly Duckling Corporation (Company) to the Securities and Exchange Commission, which has taken no action to approve or disapprove the report or pass upon its accuracy or adequacy. Additionally, this document is to be read in conjunction with the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K, for the year ended December 31, 1997. 2 UGLY DUCKLING CORPORATION FORM 10-Q TABLE OF CONTENTS Page Part I. - FINANCIAL STATEMENTS Item 1. FINANCIAL STATEMENTS Condensed Consolidated Balance Sheets - March 31, 1998 and December 31, 1997 Condensed Consolidated Statements of Operations - Three Months Ended March 31, 1998 and March 31, 1997 Condensed Consolidated Statements of Cash Flows - Three Months Ended March 31, 1998 and March 31, 1997 Notes to Condensed Consolidated Financial Statements Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Part II. - OTHER INFORMATION Item 1. LEGAL PROCEEDINGS Item 2. CHANGES IN SECURITIES Item 3. DEFAULTS UPON SENIOR SECURITIES Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Item 5. OTHER INFORMATION Item 6. EXHIBITS AND REPORTS ON FORM 8-K SIGNATURES S-1 Exhibit 4.1 Warrant Agreement between the Registrant and Reliance Acceptance Corporation and Harris Trust of California, as warrant agent, dated as of February 9, 1998 Exhibit 10.1 Credit and Security Agreement between Registrant and First Merchants Acceptance Corp. ("FMAC"), dated as of July 17, 1997 Exhibit 10.1(a) First Amendment to Credit and Security Agreement between Registrant and FMAC, dated as of January 21, 1998 Exhibit 10.1(b) Second Amendment to Credit and Security Agreement between Registrant and FMAC, dated as of April 1, 1998 Exhibit 10.2 Letter Agreement to Amend the Amended and Restated Loan and Security Agreement between Registrant and General Electric Capital Corp. ("GECC"), dated as of October 20, 1997 Exhibit 10.3 Letter Agreement to Amend the Amended and Restated Loan Agreement between Registrant and GECC, dated as of March 25, 1998 Exhibit 27 Financial Data Schedule Exhibit 99 Cautionary Statement Regarding Forward Looking Statements and Risk Factors 3 ITEM 1. UGLY DUCKLING CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
MARCH 31, DECEMBER 31, 1998 1997 --------- ------------ ASSETS Cash and Cash Equivalents $ 514 $ 3,537 Finance Receivables, net 53,009 60,778 Investments Held in Trust 15,181 11,637 Inventory 25,458 32,372 Property and Equipment, net 43,505 39,182 Goodwill and Trademarks, net 14,657 16,366 Other Assets 12,164 9,350 Net Assets of Discontinued Operations 124,375 102,996 -------- -------- $288,863 $276,218 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Accounts Payable $ 1,784 $ 2,867 Accrued Expenses and Other Liabilities 15,765 14,406 Notes Payable 63,304 65,171 Subordinated Notes Payable 27,000 12,000 -------- -------- Total Liabilities 107,853 94,444 -------- -------- Stockholders' Equity: Common Stock 173,724 172,622 Retained Earnings 7,286 9,152 -------- -------- Total Stockholders' Equity 181,010 181,774 -------- -------- $288,863 $276,218 ======== ========
See accompanying notes to Condensed Consolidated Financial Statements. 4 UGLY DUCKLING CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS THREE MONTHS ENDED MARCH 31, 1998 AND 1997 (IN THOUSANDS, EXCEPT EARNINGS PER SHARE AMOUNTS)
1998 1997 -------- -------- Sales of Used Cars $ 72,972 $ 18,211 Cost of Used Cars Sold 40,363 9,164 Provision for Credit Losses 15,034 3,261 -------- -------- 17,575 5,786 -------- -------- Interest Income 3,879 1,512 Gain on Sale of Finance Receivables 4,614 1,131 Servicing Income 3,837 1,014 Other Income 146 428 -------- -------- 12,476 4,085 -------- -------- Income before Operating Expenses 30,051 9,871 Operating Expenses: Selling and Marketing 5,326 1,532 General and Administrative 16,669 6,379 Depreciation and Amortization 1,152 529 -------- -------- 23,147 8,440 -------- -------- Operating Income 6,904 1,431 Interest Expense 647 177 -------- -------- Earnings before Income Taxes 6,257 1,254 Income Taxes 2,511 499 -------- -------- Income from Continuing Operations 3,746 755 Discontinued Operations: Earnings (Loss) from Operations of Discontinued Operations, net of income taxes of ($492) and $1,653 respectively (785) 2,507 Loss on Disposal of Discontinued Operations net of income taxes of ($3,024) and $0, respectively (4,827) -- -------- -------- Net Earnings (Loss) $ (1,866) $ 3,262 ======== ======== Earnings per Common Share from Continuing Operations: Basic $ 0.20 $ 0.05 ======== ======== Diluted $ 0.20 $ 0.05 ======== ======== Net Earnings (Loss) per Common Share: Basic $ (0.10) $ 0.21 ======== ======== Diluted $ (0.10) $ 0.20 ======== ======== Shares Used in Computation-Continuing Operations: Basic 18,557 15,904 ======== ======== Diluted 19,093 16,580 ======== ======== Shares Used in Computation-Net Earnings (Loss): Basic 18,557 15,904 ======== ======== Diluted 18,557 16,580 ======== ========
See accompanying notes to Condensed Consolidated Financial Statements. 5 UGLY DUCKLING CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS THREE MONTHS ENDED MARCH 31, 1998 AND 1997 (IN THOUSANDS)
1998 1997 -------- -------- Cash Flows from Operating Activities: Net Earnings (Loss) $ (1,866) $ 3,262 Adjustments to Reconcile Net Earnings (Loss) to Net Cash Provided by Operating Activities: Loss (Earnings) from Discontinued Operations 5,612 (2,507) Provision for Credit Losses 15,034 3,261 Gain on Sale of Finance Receivables (4,614) (1,131) Purchase of Finance Receivables (69,708) (12,838) Proceeds from Sale of Finance Receivables 62,556 10,662 Collections of Finance Receivables 5,935 730 Decrease (Increase) in Deferred Income Taxes (2,205) 573 Depreciation and Amortization 1,152 529 Decrease (Increase) in Inventory 6,915 (528) Increase in Other Assets (2,157) (3,804) Increase in Accounts Payable, Accrued Expenses, and Other Liabilities 1,120 576 Increase in Income Taxes Receivable/Payable 792 1,564 -------- -------- Net Cash Provided by Operating Activities 18,566 349 -------- -------- Cash Flows Used In Investing Activities: Increase in Investments Held in Trust (3,543) (984) Net Decrease in Notes Receivable 38 38 Purchase of Property and Equipment (5,202) (3,929) Payment for Acquisition of Assets -- (3,449) -------- -------- Net Cash Used in Investing Activities (8,707) (8,324) -------- -------- Cash Flows from Financing Activities: Issuance of Notes Payable 30,000 -- Repayment of Notes Payable (31,867) (12,107) Issuance (Repayment) of Subordinated Notes Payable 15,000 (2,000) Proceeds from Issuance of Common Stock 202 88,662 Other, Net (126) (69) -------- -------- Net Cash Provided by Financing Activities 13,209 74,486 -------- -------- Cash Used in Discontinued Operations (26,091) (11,729) -------- -------- Net Increase (Decrease) in Cash and Cash Equivalents (3,023) 54,782 Cash and Cash Equivalents at Beginning of Period 3,537 18,455 -------- -------- Cash and Cash Equivalents at End of Period $ 514 $ 73,237 ======== ======== Supplemental Statement of Cash Flows Information: Interest Paid .......................................... $ 2,222 $ 843 ======== ======== Income Taxes Paid ...................................... $ 408 $ 15 ======== ======== Assumption of Debt in Connection with Acquisition of Assets .............................................. $ -- $ 29,900 ======== ======== Purchase of Property and Equipment with Capital Leases $ -- $ 211 ======== ========
See accompanying notes to Condensed Consolidated Financial Statements. 6 UGLY DUCKLING CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) NOTE 1. BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements of Ugly Duckling Corporation (Company) have been prepared in accordance with generally accepted accounting principles for interim financial information and pursuant to rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for a complete financial statement presentation. In the opinion of management, such unaudited interim information reflects all adjustments, consisting only of normal recurring adjustments, necessary to present the Company's financial position and results of operations for the periods presented. The results of operations for interim periods are not necessarily indicative of the results to be expected for a full fiscal year. The Condensed Consolidated Balance Sheet as of December 31, 1997 was derived from audited consolidated financial statements as of that date but does not include all the information and footnotes required by generally accepted accounting principles. It is suggested that these condensed consolidated financial statements be read in conjunction with the Company's audited consolidated financial statements included in the Company's Annual Report on Form 10-K, for the year ended December 31, 1997. NOTE 2. DISCONTINUED OPERATIONS In February 1998, the Company announced its intention to close its branch office network (the "Branch Offices") through which the Company purchased retail installment contracts, and exit this line of business in the first quarter of 1998. The closure was substantially complete as of March 31, 1998. The Company is continuing to negotiate lease settlements and terminations with respect to its Branch Office network closure. Further, in April 1998, the Company announced that its Board of Directors had directed management to proceed with separating current operations into two publicly held companies. The Company's continuing operations will focus exclusively on the retail sale of used cars through its chain of dealerships, as well as the collection and servicing of the resulting loans. The Company would also retain its existing securitization program (the "Securitization Program") and the residual interests in all securitization transactions previously effected by the Company, its existing insurance operations relating to its dealership activities, and its rent-a-car franchise business (which is generally inactive) (the "Continuing Operations"). It is anticipated that a new company will be formed to operate all non-dealership operations. As a result of these two announcements, the Company has reclassified in the accompanying condensed consolidated balance sheets and condensed consolidated statements of operations, the results of operations of the discontinued operations of the Branch Office network and the operations that the Company intends to split-off to discontinued operations in accordance with Accounting Principles Board 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." Included within the Company's discontinued operations is a collateralized dealer financing program ("Cygnet Dealer Program"), pursuant to which the Company provides qualified independent used car dealers ("Third Party Dealers") with warehouse purchase facilities and operating credit lines primarily secured by the dealers' retail installment contract portfolio. Discontinued operations also include the bulk purchase and/or servicing of contracts originated by other subprime lenders, which the Company believes is a more efficient method of purchasing or obtaining servicing rights to sub-prime automobile contracts than through the closed Branch Office network. The Company intends to split-off the Cygnet Dealer Program and the operations that bulk purchase and/or service contracts by other subprime lenders. Further, discontinued operations include the Branch Office network which the Company closed in February 1998 and which will not be included in the anticipated split-off. The components of Net Assets of Discontinued Operations as of March 31, 1998 and December 31, 1997 follow (in thousands):
MARCH 31, DECEMBER 31, 1998 1997 --------- --------- Finance Receivables, net $ 71,089 $ 46,218 Residuals in Finance Receivables Sold 13,511 16,099 Investments Held in Trust 6,868 7,277 Notes Receivable 29,900 25,686 Furniture and Equipment 3,490 2,070 Capitalized Start-up Costs -- 2,453 Other Assets, net of Accounts Payable and Accrued Liabilities (483) 3,193 --------- --------- $ 124,375 $ 102,996 ========= =========
7 Following is a summary of the operating results of the Discontinued Operations for the three month periods ended March 31, 1998 and 1997 (in thousands):
MARCH 31, 1998 1997 -------- -------- Revenues $ 6,520 $ 8,854 Expenses (15,648) (4,694) -------- -------- Earnings (Loss) before Income Tax Benefit (9,128) 4,160 Income Taxes (Benefit) (3,516) 1,653 -------- -------- Earnings (Loss) from Discontinued Operations $ (5,612) $ 2,507 ======== ========
NOTE 3. SUMMARY OF FINANCE RECEIVABLES, NET Following is a summary of Finance Receivables, net, as of March 31, 1998 and December 31, 1997 (in thousands):
March 31, December 31, 1998 1997 -------- ---------- Installment Sales Contract Principal Balances $ 33,265 $ 55,965 Add: Accrued Interest 331 461 Loan Origination Costs 825 1,431 -------- -------- Principal Balances, net 34,421 57,857 Residuals in Finance Receivables Sold 24,741 13,277 -------- -------- 59,162 71,134 Less Allowance for Credit Losses (6,153) (10,356) ======== ======== Finance Receivables, net $ 53,009 $ 60,778 ======== ======== The finance receivables are classified as follows: Finance Receivables Held for Sale $ 31,000 $ 52,000 Finance Receivables Held for Investment 3,421 5,857 -------- -------- $ 34,421 $ 57,857 ======== ========
As of March 31, 1998 and December 31, 1997, the Residuals in Finance Receivables Sold were comprised of the following (in thousands):
March 31, December 31, 1998 1997 --------- --------- Retained interest in subordinated securities (B Certificates) $ 43,729 $ 25,483 Net interest spreads, less present value discount 22,150 10,622 Reduction for estimated credit losses (41,138) (22,828) --------- --------- Residuals in finance receivables sold $ 24,741 $ 13,277 ========= ========= Securitized principal balances outstanding $ 185,240 $ 127,356 ========= ========= Estimated credit losses as a % of securitized principal balances outstanding 22.2% 17.9% ========= =========
8 The following table reflects a summary of activity for the Residuals in Finance Receivables Sold for the three month periods ended March 31, 1998 and 1997, respectively (in thousands).
THREE MONTHS ENDED MARCH 31, ----------------------- 1998 1997 -------- ------- Balance, Beginning of Period $ 13,277 $ 8,512 Additions 13,858 2,339 Amortization (2,394) (769) -------- ------- Balance, End of Period $ 24,741 $10,082 ======== =======
NOTE 4. NOTES PAYABLE Following is a summary of Notes Payable as of March 31, 1998 and December 31, 1997 (in thousands):
March 31, December 31, 1998 1997 -------- ----------- Revolving Facility with GE Capital $48,264 $56,950 Mortgage loan with finance company 7,273 7,450 Note Payable to a finance company 7,000 -- Others 767 771 ------- ------- $63,304 $65,171 ======= =======
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 month periods ended March 31, 1998, and 1997 as follows (in thousands, except for per share amounts):
THREE MONTHS ENDED --------------------------- MARCH 31, --------- 1998 1997 -------- ---------- Income from Continuing Operations $ 3,746 $ 755 ======== ========== Net Earnings (Loss) ............................ $ (1,866) $ 3,262 ======== ========== Basic EPS-Weighted Average Shares Outstanding ................................... 18,557 15,904 ======== ========== Basic Earnings (Loss) Per Share from: Continuing Operations $ 0.20 $ 0.05 ======== ========== Net Earnings (Loss) $ (0.10) $ 0.21 ======== ========== Basic EPS-Weighted Average Shares Outstanding .................................... 18,557 15,904 Effect of Diluted Securities: Warrants ..................................... 87 176 Stock Options ................................ 449 500 -------- ---------- Dilutive EPS-Weighted Average Shares Outstanding .................................... 19,093 16,580 ======== ========== Diluted Earnings (Loss) Per Share from: Continuing Operations $ 0.20 $ 0.05 ======== ========== Net Earnings (Loss) $ (0.10) $ 0.20 ======== ========== Warrants Not Included in Diluted EPS Since Antidilutive ................................. 715 -- ======== ========== Stock Options Not Included in Diluted EPS Since Antidilutive ........................... 603 128 ======== ==========
9 NOTE 6. BUSINESS SEGMENTS The Company has three distinct business segments. These consist of retail car sales operations (Company Dealerships), operations attributable to the administration and collection of finance receivables generated at the Company Dealerships (Company Dealership Receivables), and corporate and other operations. These segments exclude the activities of the discontinued operations. A summary of Operating Expenses by business segment for the three month periods ended March 31, 1998 and 1997, respectively, follows:
COMPANY COMPANY DEALERSHIP CORPORATE DEALERSHIPS RECEIVABLES AND OTHER TOTAL ----------- ----------- ---------- -------- (IN THOUSANDS) 1998: Sales of Used Cars .............. $ 72,972 $ -- $ -- $ 72,972 Less: Cost of Cars Sold ......... 40,363 -- -- 40,363 Provision for Credit Losses . 15,034 -- -- 15,034 -------- -------- -------- -------- 17,575 -- -- 17,575 -------- -------- -------- -------- Interest Income ................. -- 3,815 64 3,879 Gain on Sale of Loans ........... -- 4,614 -- 4,614 Servicing Income ................ -- 3,837 -- 3,837 Other Income .................... 101 -- 45 146 -------- -------- -------- -------- Income before Operating Expenses .................... 17,676 12,266 109 30,051 -------- -------- -------- -------- Operating Expenses: Selling and Marketing ......... 5,290 -- 36 5,326 General and Administrative .... 9,537 4,255 2,877 16,669 Depreciation and Amortization . 613 338 201 1,152 -------- -------- -------- -------- 15,440 4,593 3,114 23,147 -------- -------- -------- -------- Income (Loss) before Interest Expense ..................... $ 2,236 $ 7,673 $ (3,005) $ 6,904 ======== ======== ======== ======== 1997: Sales of Used Cars .............. $ 18,211 $ -- $ -- $ 18,211 Less: Cost of Cars Sold ......... 9,164 -- -- 9,164 Provision for Credit Losses . 3,261 -- -- 3,261 -------- -------- -------- -------- 5,786 -- -- 5,786 -------- -------- -------- -------- Interest Income ................. -- 1,083 429 1,512 Gain on Sale of Loans ........... -- 1,131 -- 1,131 Servicing Income ................ -- 1,014 -- 1,014 Other Income .................... 204 -- 224 428 -------- -------- -------- -------- Income before Operating Expenses ...................... 5,990 3,228 653 9,871 -------- -------- -------- -------- Operating Expenses: Selling and Marketing ......... 1,525 -- 7 1,532 General and Administrative .... 3,244 1,488 1,647 6,379 Depreciation and Amortization . 200 206 123 529 -------- -------- -------- -------- 4,969 1,694 1,777 8,440 -------- -------- -------- -------- Income (loss) before Interest Expense ....................... $ 1,021 $ 1,534 $ (1,124) $ 1,431 ======== ======== ======== ========
NOTE 7. ACQUISITION On January 15, 1997, the Company acquired substantially all of the assets of Seminole Finance Corporation and related companies ("Seminole"), including four dealerships in Tampa/St. Petersburg and a contract portfolio of approximately $31.1 million (6,953 contracts) in exchange for approximately $2.5 million in cash and the assumption of $29.9 million in debt. The following summary, prepared on a pro forma basis, combines the consolidated results of operations (unaudited) for the three months ended March 31, 1997 as if the acquisition had 10 been consummated as of January 1, 1997. These proforma results are not necessarily indicative of the future results of operations of the Company or the results that would have been obtained had the acquisition taken place on January 1, 1997 (in thousands, except per share data).
Three months ended March 31, 1997 ------------------ Sales of Used Cars $22,642 Interest Income 1,512 Other Income 2,593 ------- Total Revenues 26,747 Earnings before Discontinued Operations 686 Net Earnings 3,192 Earnings per share from Continuing Operations: Basic 0.04 Diluted 0.04 Net Earnings per share: Basic 0.20 Diluted 0.19
NOTE 8. USE OF ESTIMATES The preparation of financial statements requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statement and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. These include the provision for loss on discontinued operations that was recorded in the accompanying condensed consolidated financial statements for the three month period ended March 31, 1998, which provision is based upon management's best estimate of the amounts expected to be realized from the closure of the Branch Office network as well as from the split-off of certain operations. The amounts the Company will ultimately realize could differ materially from the amounts assumed in arriving at the loss anticipated on disposal of the discontinued operations. NOTE 9. BANKRUPTCY REMOTE ENTITIES Champion Receivables Corporation ("CRC") and Champion Receivables Corporation II ("CRC II") (collectively referred to as "Securitization Subsidiaries"), are the Company's wholly-owned special purpose "bankruptcy remote entities." Their assets, including assets included in Discontinued Operations, include Residuals in Finance Receivables Sold and Investments Held In Trust, in the amounts of approximately $38.3 million and $20.8 million, respectively, at March 31, 1998, which amounts would not be available to satisfy claims of creditors of the Company on a consolidated basis. NOTE 10. RECLASSIFICATIONS Certain reclassifications have been made to previously reported information to conform to the current presentation. 11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Quarterly Report on Form 10-Q contains forward looking statements. Additional written or oral forward looking statements may be made by the Company from time to time in filings with the Securities and Exchange Commission or otherwise. Such forward looking statements are within the meaning of that term in Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such statements may include, but not be limited to, projections of revenues, income, or loss, capital expenditures, plans for future operations, including plans for the expected split-off, financing needs or plans, and plans relating to products or services of the Company, as well as assumptions relating to the foregoing. The words "believe," "expect," "intend," "anticipate," "estimate," "project," and similar expressions identify forward looking statements, which speak only as of the date the statement was made. Forward looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified. Future events and actual results could differ materially from those set forth in, contemplated by, or underlying the forward looking statements. The Company undertakes no obligation to publicly update or revise any forward looking statements, whether as a result of new information, future events, or otherwise. Statements in this Quarterly Report, including the Notes to the Condensed Consolidated Financial Statements and "Management's Discussion and Analysis of Financial Condition and Results of Operations," describe factors, among others, that could contribute to or cause such differences. Additional risk factors that could cause actual results to differ materially from those expressed in such forward looking statements are set forth in Exhibit 99 which is attached hereto and incorporated by reference into this Quarterly Report on Form 10-Q. INTRODUCTION General. Ugly Duckling Corporation ("Company") operates a chain of "buy here-pay here" used car dealerships in the United States and underwrites, finances, and services retail installment contracts generated from the sale of used cars by its dealerships ("Company Dealerships") and by third party used car dealers ("Third Party Dealers") located in selected markets throughout the country. As part of its financing activities, the Company has initiated a collateralized dealer financing program ("Cygnet Dealer Program") pursuant to which it provides qualified independent used car dealers with warehouse facilities and operating lines of credit secured by the dealers' retail installment contract portfolios and inventory. The Company targets its products and services to the sub-prime segment of the automobile financing industry, which focuses on selling and financing the sale of used cars to persons who have limited credit histories, low incomes, or past credit problems. The Company commenced its used car sales and finance operations with the acquisition of two Company Dealerships in 1992. During 1993, the Company acquired three additional Company Dealerships. In 1994, the Company constructed and opened four new Company Dealerships that were built specifically to meet the Company's new standards of appearance, reconditioning capabilities, size, and location. During 1994, the Company closed one Company Dealership because the facility failed to satisfy these new standards and, at the end of 1995, closed its Gilbert, Arizona dealership. In January 1997, the Company acquired selected assets of a group of companies engaged in the business of selling and financing used motor vehicles, including four dealerships located in the Tampa Bay/St. Petersburg market ("Seminole"). In March 1997, the Company opened its first used car dealership in the Las Vegas market. In April 1997, the Company acquired selected assets of a company in the business of selling and financing used motor vehicles, including seven dealerships located in the San Antonio market ("EZ Plan"). In addition, the Company opened two additional dealerships in the Albuquerque market and one additional dealership in the Phoenix market during the second quarter of 1997. In August 1997, the Company closed a dealership in Prescott, Arizona. In September 1997, the Company acquired selected assets of a company in the business of selling used motor vehicles, including six dealerships in the Los Angeles market, two in the Miami market, two in the Atlanta market and two in the Dallas market ("Kars"). Although the Company did not acquire the loan portfolio of Kars, it did acquire Kars' loan servicing assets and began servicing Kars retained portfolio and portfolios previously securitized by Kars. During the first quarter of 1998, the Company opened one store in the Phoenix, Tampa and Dallas markets, respectively. The Company operated 46 and 14 dealerships at March 31, 1998 and 1997, respectively. In 1994, the Company acquired Champion Financial Services, Inc., an independent automobile finance company. In April 1995, the Company initiated an aggressive plan to expand the number of contracts purchased from its Third Party Dealer Branch Office network (the "Branch Offices"). The Company operated 83 Branch Offices at December 31, 1997. In February 1998, the Company announced its intention to close its Branch Office network, and exit this line of business in the first quarter of 1998. In lieu thereof, the Company intends to focus on the bulk purchase of loan portfolios which the Company believes is a more efficient method of obtaining loans. In conjunction therewith, the Company recorded a pre-tax charge to discontinued operations totaling approximately $9.1 million (approximately $5.6 million, net of income taxes) during the first quarter of 1998. The restructuring was substantially complete by the end of the first quarter of 1998 12 and included the termination of approximately 400 employees, substantially all of whom were employed at the Company's 76 Branch Offices that were in place on the date of the announcement. The Company is continuing to negotiate lease settlements and terminations with respect to its Branch Office network closure. On April 28, 1998, the Company announced that its Board of Directors had directed management to proceed with separating current operations into two publicly held companies. The Company's continuing operations would focus exclusively on the retail sale of used cars through its chain of dealerships, as well as the collection and servicing of the resulting loans. The Company would also retain its existing securitization program (the "Securitization Program") and the residual interests in all securitization transactions previously effected by the Company, its existing insurance operations relating to its dealership activities, and its rent-a-car franchise business (which is generally inactive) (the "Continuing Operations"). A new company would be formed to operate all non-dealership operations. Non-dealership operations generally consist of the Company's Cygnet Dealer Program pursuant to which the Company provides qualified independent used car dealers with warehouse purchase facilities and operating credit lines primarily secured by the dealers' retail installment contract portfolio, as well as the bulk purchasing of loan portfolios and the servicing of loan portfolios on behalf of unrelated third parties (other than the Kars loan portfolio). As a result of these two events, the Company has reclassified in the accompanying condensed consolidated balance sheets and condensed consolidated statements of operations, the results of operations of the Branch Office network and the operations that the Company intends to split-off to discontinued operations. There can be no assurance that a viable plan for separation of the Company's operations into two separate publicly-held company groups can be effected; that all of the conditions to the separation will be satisfied or that the separation will be favorably concluded. There can be no assurance that the Company's shareholders will approve the split-off. Further, the split-off may have income tax consequences to either the Company or it's stockholders, which as of this time, have yet to be determined. Unless otherwise noted, the following discussion relates to Continuing Operations only. The following discussion and analysis provides information regarding the Company's consolidated financial position as of March 31, 1998 and December 31, 1997, and its results of operations for the three month periods ended March 31, 1998 and 1997, respectively. Growth in Finance Receivables. Contract receivables serviced increased by 31.2% to $183.5 million at March 31, 1998 (including $150.2 million in contracts serviced under the Company's Securitization Program) from $139.8 million at December 31, 1997 (including $83.8 million in contracts serviced under the Company's Securitization Program). The following tables reflect the growth in period end balances measured in terms of the principal amount and the number of contracts. TOTAL CONTRACTS OUTSTANDING: (IN THOUSANDS, EXCEPT NUMBER OF CONTRACTS)
MARCH 31, DECEMBER 31, ------------------------ ------------------------ 1998 1997 ------------------------ ------------------------ PRINCIPAL NO. OF PRINCIPAL NO. OF AMOUNT CONTRACTS AMOUNT CONTRACTS ---------- --------- --------- ---------- Principal Amount $218,505 39,734 $183,321 35,762 Less: Portfolios Securitized and Sold 185,240 35,237 127,356 27,769 -------- ------ -------- ------ Company Total $ 33,265 4,497 $ 55,965 7,993 ======== ===== ======== =====
In addition to the loan portfolio summarized above, the Company also services loan portfolios totaling approximately $243.6 million ($98.8 million for Kars and $144.8 million from Branch Office originations) as of March 31, 1998 and $267.9 million ($127.3 million for Kars and $140.6 million from Branch Office originations) as of December 31, 1997. 13 The following tables reflect the growth in contract originations measured in terms of the principal amount and the number of contracts. TOTAL CONTRACTS ORIGINATED/PURCHASED: (IN THOUSANDS, EXCEPT NUMBER OF CONTRACTS AND AVERAGE PRINCIPAL)
THREE MONTHS ENDED MARCH 31, 1998 1997 ----------- ----------- Principal Amount $69,708 $47,345 Number of Contracts 9,339 9,063 Average Principal $ 7,464 $ 5,223
Finance Receivable Principal Balances originated/purchased during the three months ended March 31, 1998 increased by 47.2% to $69.7 million from $47.3 million in the three month period ended March 31, 1997. During the three month period ended March 31, 1997, finance receivable principal balances purchased were affected by the purchase of approximately $31.1 million (6,953 contracts) in finance receivables from Seminole. RESULTS OF OPERATIONS FOR THREE MONTHS ENDED MARCH 31, 1998 COMPARED TO THREE MONTHS ENDED MARCH 31, 1997 The prices at which the Company sells its cars and the interest rates that it charges to finance these sales take into consideration that the Company's primary customers are high-risk borrowers, many of whom ultimately default. The Provision for Credit Losses reflects these factors and is treated by the Company as a cost of both the future interest income derived on the contract receivables originated at Company Dealerships as well as a cost of the sale of the cars themselves. Accordingly, unlike traditional car dealerships, the Company does not present gross profits in its Statements of Operations calculated as Sales of Used Cars less Cost of Used Cars Sold. Sales of Used Cars. Sales of Used Cars increased by 300.7% to $73.0 million for the three month period ended March 31, 1998 from $18.2 million for the three month period ended March 31, 1997. This growth reflects a significant increase in the number of used car dealerships in operation from 14 dealerships in operation during the three month period ended March 31, 1997 compared to 46 dealerships in operation during the three month period ended March 31, 1998. Units sold increased by 281.8% to 9,439 units in the three month period ended March 31, 1998 from 2,472 units in the three month period ended March 31, 1997. Same store sales increased by 17.1% in the three month period ended March 31, 1998 compared to the three month period ended March 31, 1997. This increase is primarily due to the timing of store openings within the first quarter of 1997. Management expects same store sales to remain relatively stable in future periods. The average sales price per car increased to $7,731 for the three month period ended March 31, 1998 from $7,367 for the three month period ended March 31, 1997. Cost of Used Cars Sold and Gross Margin. The Cost of Used Cars Sold increased by 340.5% to $40.4 million for the three month period ended March 31, 1998 from $9.2 million for the three month period ended March 31, 1997. On a per unit basis, the Cost of Used Cars Sold increased by 15.3% to $4,276 for the three month period ended March 31, 1998 from $3,709 for the three month period ended March 31, 1997. The gross margin on used car sales (Sales of Used Cars less Cost of Used Cars Sold excluding Provision for Credit Losses) increased by 260.4% to $32.6 million for the three month period ended March 31, 1998 from $9.0 million for the three month period ended March 31, 1997. As a percentage of sales, the gross margin was 44.7% and 49.7% for the three month periods ended March 31, 1998 and 1997, respectively. On a per unit basis, the gross margin per car sold was $3,455 and $3,660 for the three month periods ended March 31, 1998 and 1997, respectively. The increase in the average cost per unit and for the decline in gross margin percent and per car sold is primarily the result of an increase in vehicle reconditioning costs from the prior comparable period. Provision for Credit Losses. A high percentage of Company Dealership customers ultimately do not make all of their contractually scheduled payments, requiring the Company to charge off the remaining principal balance due. As a result, the Company recognizes a Provision for Credit Losses in order to establish an Allowance for Credit Losses. The Provision for Credit Losses increased by 361.0% to $15.0 million in the three month period ended 14 March 31, 1998 from $3.3 million for the three month period ended March 31, 1997. The Provision for Credit Losses per unit originated at Company Dealerships increased by 4.2% to $1,610 per unit in the three month period ended March 31, 1998 from $1,545 per unit in the three month period ended March 31, 1997. As a percentage of contract balances originated at Company Dealerships, the Provision for Credit Losses averaged 21.6% and 20.1%, for the three month periods ended March 31, 1998 and 1997, respectively. Interest Income. Interest Income consists primarily of interest on finance receivables from Company Dealership sales, and income from Residuals in Finance Receivables Sold. Interest Income increased by 156.5% to $3.9 million for the three month period ended March 31, 1998 from $1.5 million for the three month period ended March 31, 1997. Interest Income was reduced by the sale of finance receivables with remaining principal balances of $185.2 million and $48.5 million as of March 31, 1998 and 1997 , respectively, pursuant to the Securitization Program, and will continue to be affected in future periods by additional securitizations. A primary element of the Company's sales strategy is to provide financing to customers with poor credit histories who are unable to obtain automobile financing through traditional sources. The Company financed 95.5% of sales revenue and 98.9% of the used cars sold at Company Dealerships for the three month period ended March 31, 1998, compared to 89.2% of sales revenue and 85.4% of the used cars sold for the three month period ended March 31, 1997. The average amount financed decreased to $7,464 for the three month period ended March 31, 1998 from $7,699 for the three month period ended March 31, 1997. The decrease in the average amount financed, despite an increase in the average sales price from the comparable period in the prior year, is due to an increase in the average down payment collected on financed sales. Primarily as a result of its expansion into markets with interest rate limits, the Company's yield on its Company Dealership Receivable portfolio has trended downward. The effective yield on Finance Receivables from Company Dealerships was 26.0% and 28.0%, for the three month periods ended March 31, 1998 and 1997, respectively. The Company's policy is to charge 29.9% per annum on its Company Dealership contracts. However, in those states that impose usury limits, the Company charges the maximum interest rate permitted. Gain on Sale of Finance Receivables. Champion Receivables Corporation ("CRC") and Champion Receivables Corporation II ("CRC II") (collectively referred to as the "Securitization Subsidiaries"), are the Company's wholly owned special purpose "bankruptcy remote" entities. During the first quarter of 1996, the Company initiated a Securitization Program under which CRC sold securities backed by contracts to SunAmerica Life Insurance Company ("SunAmerica"). Beginning with the third fiscal quarter of 1997, the Company expanded the Securitization Program to include CRC II and sales of CRC II securities through private placement of securities to investors other than SunAmerica. Under the Securitization Program, the Securitization Subsidiaries assign and transfer the contracts to separate trusts ("Trusts") pursuant to Pooling and Servicing Agreements (the "Pooling Agreements"). Pursuant to the Pooling Agreements, Class A Certificates and subordinated Class B Certificates are issued to the Securitization Subsidiaries. The Securitization Subsidiaries then sell the Class A Certificates to the investors. The transferred contracts are serviced by Champion Acceptance Corporation ("CAC"), another subsidiary of the Company. For the Company's securitizations that took place prior to July 1, 1997, the Company's Class A Certificates received ratings from Standard & Poors ranging from "BBB" to "A". To obtain these ratings from Standard & Poors, CRC was required to provide a credit enhancement by establishing and maintaining a cash spread account for the benefit of the certificate holders. For the securitization transactions that were consummated after July 1, 1997, the Company's Class A Certificates received a "AAA" rating from Standard & Poors, and a "Aaa" rating from Moody's Investors Service. To obtain these ratings, CRC II (1) obtained an insurance policy from MBIA Insurance Corporation which unconditionally and irrevocably guaranteed full and complete payment of the Class A guaranteed distribution (as defined), and (2) provided a credit enhancement by establishing and maintaining a cash spread account for the benefit of the certificate holders. The Securitization Subsidiaries make an initial cash deposit into the spread account, ranging from 3% to 4% of the initial underlying finance receivables principal balance and pledge this cash to the Trusts. The Securitization Subsidiaries are also required to then make additional deposits to the spread account from the residual cash flow (through the trustees) as necessary to attain and maintain the spread account at a specified percentage, ranging from 6.0% to 12.0%, of the underlying finance receivables principal balance. Distributions are not made to the Securitization Subsidiaries on the Class B Certificates unless the spread account has the required balance, the required periodic payments to the Class A Certificate holders are current, and the trustee, servicer and other administrative costs are current. The Company recognizes a Gain on Sale of Loans equal to the difference between the sales proceeds for the finance receivables sold and the Company's recorded investment in the finance receivables sold. The Company allocates the recorded investment in the finance receivables between the portion of the finance receivables sold and the portion retained based on the relative fair values on the date of sale. To the extent that actual cash flows on a securitization are below original estimates, and differ materially from 15 the original securitization assumptions and, in the opinion of management, those differences appear to be other than temporary in nature, the Company would be required to revalue the Residuals in Finance Receivables Sold and record a charge to earnings based upon the reduction. CRC made an initial spread account deposit totaling $3.5 million during the three months ended March 31, 1998 in conjunction with a single securitization. Based upon securitizations in effect as of March 31, 1998, the Company's continuing operations were required to maintain an aggregate balance in its spread accounts of $18.6 million, a portion of which may be funded over time. As of March 31, 1998, the Company maintained an aggregate spread account balance of $13.9 million which satisfied the funding requirement for all of the securitization transactions consummated prior to the three month period ended March 31, 1998. Accordingly, an additional $4.7 million related to the securitization consummated during the three month period ended March 31, 1998 will need to be funded from future cash flows. The additional funding requirements will decline as the trustees deposit additional cash flows into the spread account and as the principal balance of the underlying finance receivables declines. In addition to the spread account balance of $13.9 million, the Company had deposited a total of $1.3 million in trust accounts in conjunction with certain other agreements. The Company also maintains spread accounts for the securitization transactions that were consummated by the Company's discontinued operations. The Company has satisfied its funding obligation of $6.9 million as of March 31, 1998, with respect to these securitization transactions. The assumptions utilized in prior securitizations may not necessarily be the same as those utilized in future securitizations. The Company classifies the residuals as "held-to-maturity" securities in accordance with SFAS No. 115. The Company securitized an aggregate of $86.6 million in contracts, issuing $62.6 million in securities during the three months ended March 31, 1998. In conjunction with this transaction, the Company reduced its Allowance for Credit Losses by $17.1 million during the three months ended March 31, 1998 and retained a Residual in Finance Receivables Sold of $13.9 million for a balance of $ 24.7 million at March 31, 1998. The Company recorded Gain on Sale of Loans during the three months ended March 31, 1998 of $4.6 million. The Company recognized Gain on Sale of Loans of $1.1 million during the three month period ended March 31, 1997. The Gain on Sale of Loans as a percentage of principal balances securitized was 5.3% and 7.5% in the three month periods ended March 31, 1998 and 1997, respectively. The decrease in the gain on sale percentage is due to the contracts carrying a lower average contract rate than those securitized in the comparable period last year, and the utilization of a higher cumulative net loss assumption for the 1998 securitization. In addition, the contracts in the 1998 securitization were more seasoned than the contracts in the 1997 securitization resulting in less future interest income available for gain recognition. During the three month period ended March 31, 1998, the Trust issued certificates at a yield of 6.11% resulting in net spread, before net credit losses and after servicing, insurer, and trustee fees, of 17.0%. The Company's net earnings may fluctuate from quarter to quarter in the future as a result of the timing and size of its securitizations. The Securitization Subsidiaries are the Company's wholly-owned special purpose "bankruptcy remote entities." Their assets, including assets included in Discontinued Operations, include Residuals in Finance Receivables Sold and Investments Held In Trust, in the amounts of approximately $38.3 million and $20.8 million, respectively, at March 31, 1998, which amounts would not be available to satisfy claims of creditors of the Company on a consolidated basis. Other Income. Other Income consists primarily of servicing income, insurance premiums earned on force placed insurance policies, earnings on investments from the Company's cash and cash equivalents, and franchise fees from the Company's rent-a-car franchisees. This income increased to $4.0 million for the three months ended March 31, 1998 from $1.4 million for the three months ended March 31, 1997. The Company services the securitized contracts for monthly fees ranging from .25% to .33% of the beginning of period principal balances (3.0% to 4.0% annualized). In addition, in September 1997, the Company began servicing the Kars loan portfolio and recognizes income from servicing that portfolio at a rate of approximately .33% (4.0% annualized) of beginning of period principal balances. Servicing income for the three months ended March 31, 1998 increased to $3.8 million from $1.0 million in the three month period ended March 31, 1997. This increase is due to the increase in the principal balance of contracts being serviced pursuant to the Securitization Program and the addition of servicing of the third party portfolio. The Company no longer actively engages in the rent-a-car franchise business. 16 Income before Operating Expenses. As a result of the Company's continued expansion, Income before Operating Expenses grew by 204.4% to $30.1 million for the three month period ended March 31, 1998 from $9.9 million for the three month period ended March 31, 1997. Growth of Sales of Used Cars, Interest Income on the loan portfolios and Other Income were the primary contributors to the increase. Operating Expenses. Operating Expenses consist of Selling and Marketing Expenses, General and Administrative Expenses, and Depreciation and Amortization. Selling and Marketing Expenses. For the three month periods ended March 31, 1998 and 1997, Selling and Marketing Expenses were comprised almost entirely of advertising costs and commissions relating to Company Dealership operations. Selling and Marketing Expenses increased by 247.7% to $5.3 million for the three month period ended March 31, 1998 from $1.5 million for the three month period ended March 31, 1997. As a percentage of Sales of Used Cars, these expenses averaged 7.3% for the three month period ended March 31, 1998 and 8.4% for the three month period ended March 31, 1997. On a per unit sold basis, Selling and Marketing Expenses of Company Dealerships decreased to $564 per unit for the three month period ended March 31, 1998 from $620 per unit for the three month period ended March 31, 1997. This decrease is primarily due to a general reduction in marketing expenses in the Tampa market compared to the same period in the prior year. In the prior year, upon entering the Tampa market, the Company incurred significant marketing costs in an effort to establish brand recognition. General and Administrative Expenses. General and Administrative Expenses increased by 161.3% to $16.7 million for the three month period ended March 31, 1998 from $6.4 million for the three month period ended March 31, 1997. These expenses represented 19.5% and 28.6% of total revenues for three month periods ended March 31, 1998, and 1997, respectively. The increase in General and Administrative Expenses is a result of the Company's increased number of used car dealerships. However, the decrease in General and Administrative Expenses as a percent of total revenues is primarily due to the disproportionate increase in revenues over the incremental costs required to manage the Company as it adds additional dealerships. Depreciation and Amortization. Depreciation and Amortization consists of depreciation and amortization on the Company's property and equipment and amortization of the Company's goodwill and trademarks. Depreciation and amortization increased by 117.8% to $1.2 million for the three month period ended March 31, 1998 from $529,000 for the three month period ended March 31, 1997. The increase was due primarily to the increase in amortization of goodwill associated with the Company's recent acquisitions, and increased depreciation expense from the addition of used car dealerships. Interest Expense. Interest expense increased by 265.5% to $647,000 in the three month period ended March 31, 1998 from $177,000 in the three month period ended March 31, 1997. The increase in interest expense over the prior comparable period is due primarily to increased borrowings to support the Company's increasing finance receivable portfolio, property and equipment and inventory. A total of $2.0 million and $594,000 in interest expense was allocated to discontinued operations for the three month periods ended March 31, 1998 and 1997, respectively. Income Taxes. Income taxes totaled $2.5 million and $499,000 during the three month periods ended March 31, 1998 and 1997 respectively, an effective rate of 40.1% and 39.7%, respectively. ALLOWANCE FOR CREDIT LOSSES The Company has established an Allowance for Credit Losses ("Allowance") to cover anticipated credit losses on the contracts currently in its portfolio. The Allowance has been established through the Provision for Credit Losses. 17 The following table reflects activity in the Allowance, as well as information regarding charge off activity, for the three month periods ended March 31, 1998 and 1997, in thousands.
THREE MONTHS ENDED MARCH 31, ------------------ 1998 1997 ---------- --------- Allowance Activity: Balance, Beginning of Period $ 10,356 $ 1,626 Provision for Credit Losses 15,034 3,261 Discount Acquired -- 9,033 Reduction Attributable to Loans Sold (17,090) (3,100) Net Charge Offs (2,147) (1,597) -------- -------- Balance, End of Period $ 6,153 $ 9,223 ======== ======== Allowance as Percent of Period End Balances 18.5% 28.4% ======== ======== Charge off Activity: Principal Balances $ 3,197 $ 2,263 Recoveries, Net (1,050) (666) -------- -------- Net Charge Offs $ (2,147) $ (1,597) ======== ======== Net Charge Offs as % of Average Principal Outstanding 13.1% 18.2% ======== ========
The Allowance on contracts was 18.5% of outstanding principal balances as of March 31, 1998 and December 31, 1997 and 28.4% at March 31, 1997. The Allowance at March 31, 1997 was significantly effected by the Seminole portfolio acquisition in which the Company obtained $9.0 million of discount acquired on a total loan portfolio of $31.1 million, resulting in a significant increase in the Allowance as a percentage of outstanding principal balances. Recoveries as a percentage of principal balances charged off averaged 32.8% for the three month period ended March 31, 1998 compared to 29.4% for the three month period ended March 31, 1997. Static Pool Analysis. To monitor contract performance, beginning in June 1995, the Company implemented "static pool" analysis for contracts originated since January 1, 1993. Static pool analysis is a monitoring methodology by which each month's originations and subsequent charge offs are assigned a unique pool and the pool performance is monitored separately. Improving or deteriorating performance is measured based on cumulative gross and net charge offs as a percentage of original principal balances, based on the number of complete payments made by the customer before charge off. The table below sets forth the cumulative net charge offs as a percentage of original contract cumulative balances, based on the quarter of origination and segmented by the number of payments made prior to charge off. For periods denoted by "x", the pools have not seasoned sufficiently to allow for computation of cumulative losses. For periods denoted by "--", the pools have not yet attained the indicated cumulative age. While the Company monitors its static pools on a monthly basis, for presentation purposes the information in the tables is presented on a quarterly basis. Effective January 1, 1997, the Company modified its methodology to reflect additional historical experience in computing "Monthly Payments Completed by Customer Before Charge Off" as it relates to loan balances charged off after final insurance settlements and on loans modified from their original terms. Resulting adjustments affect the timing of previously reported interim cumulative losses, but do not impact ending cumulative losses. For loan balances charged off after insurance settlement principal reductions, the revised calculation method only gives credit for payments actually made by the customer and excludes credit for reductions arising from insurance proceeds. For modified loans, completed payments now reflect customer payments made both before and after the loan was modified. The numbers presented below reflect the adoption of the revised calculation method. Currently reported cumulative losses may also vary from those previously reported due to ongoing collection efforts on charged off accounts and the difference between final proceeds on the liquidation of repossessed collateral versus original accounting estimates. Management believes that such variation will not be material. 18 The following table sets forth as of April 30, 1998, the cumulative net charge offs as a percentage of original contract cumulative (pool) balances, based on the quarter of origination and segmented by the number of monthly payments completed by customer before charge off. Additionally, set forth is the percent of principal reduction for each pool since inception and cumulative total net losses incurred (TLI). POOL'S CUMULATIVE NET LOSSES AS PERCENTAGE OF POOL'S ORIGINAL AGGREGATE PRINCIPAL BALANCE-
MONTHLY PAYMENTS COMPLETED BY CUSTOMER BEFORE CHARGE OFF ---------------------------------------------------------------------------- ORIG. 0 3 6 12 18 24 TLI REDUCED ------- ------- ------ ------- ------- ------- ------- ------ ------- 1993: 1st Quarter. $ 2,326 6.9% 18.7% 26.5% 31.8% 33.9% 35.1% 35.4% 100.0% 2nd Quarter. $ 2,942 7.2% 18.9% 25.1% 29.4% 31.7% 32.1% 32.4% 100.0% 3rd Quarter. $ 3,455 8.6% 19.5% 23.7% 28.5% 30.7% 31.6% 31.9% 100.0% 4th Quarter. $ 4,261 6.3% 16.1% 21.6% 27.0% 28.9% 29.5% 29.6% 100.0% 1994: 1st Quarter. $ 6,305 3.4% 9.9% 13.3% 17.8% 20.2% 20.8% 20.9% 100.0% 2nd Quarter. $ 5,664 2.8% 10.4% 14.1% 19.5% 21.5% 22.0% 22.1% 100.0% 3rd Quarter. $ 6,130 2.8% 8.0% 11.9% 16.2% 18.2% 19.0% 19.1% 100.0% 4th Quarter. $ 5,490 2.4% 7.6% 11.2% 16.6% 19.5% 20.4% 20.4% 100.0% 1995: 1st Quarter. $ 8,191 1.1% 7.3% 12.3% 17.4% 19.9% 20.8% 20.9% 99.8% 2nd Quarter. $ 9,846 1.7% 7.0% 11.8% 16.3% 18.9% 20.5% 20.7% 98.3% 3rd Quarter. $10,106 1.9% 6.9% 10.8% 17.6% 21.1% 22.7% 23.0% 94.6% 4th Quarter. $ 8,426 1.2% 5.6% 10.7% 17.2% 21.8% 23.4% 23.6% 91.7% 1996: 1st Quarter. $13,635 1.3% 7.5% 13.0% 20.0% 24.0% x 25.2% 85.9% 2nd Quarter. $13,462 2.2% 9.1% 13.3% 22.1% 25.9% -- 26.3% 78.4% 3rd Quarter. $11,082 1.6% 6.7% 12.4% 21.0% x -- 25.0% 70.4% 4th Quarter. $10,817 1.6% 8.4% 15.8% 24.0% -- -- 26.0% 63.6% 1997: 1st Quarter. $16,279 2.1% 10.4% 17.2% x -- -- 23.2% 55.8% 2nd Quarter. $25,875 1.4% 8.0% 12.8% -- -- -- 15.5% 41.5% 3rd Quarter. $32,147 1.1% 6.4% x -- -- -- 9.4% 25.7% 4th Quarter. $42,529 .9% x -- -- -- -- 3.9% 12.8% 1998: 1st Quarter. $69,708 x -- -- -- -- -- .2% 6.3%
The following table sets forth the principal balances 31 to 60 days delinquent, and 61 to 90 days delinquent as a percentage of total outstanding Company Dealership contract principal balances.
Retained Securitized Managed -------- ----------- ------- March 31, 1998: 31 to 60 days 1.2% 2.5% 2.2% 61 to 90 days 3.6% 0.9% 1.4% December 31,1997: 31 to 60 days 2.2% 4.5% 3.6% 61 to 90 days 0.6% 2.2% 1.5%
In accordance with the Company's charge off policy, there are no accounts more than 90 days delinquent as of March 31, 1998 and December 31, 1997. RESIDUALS IN FINANCE RECEIVABLES SOLD Residuals in Finance Receivables Sold represent the Company's retained potion of the securitization assets. The Company utilizes a number of estimates in arriving at the initial valuation of the Residuals in Finance Receivables Sold, which represent the expected present value of net cash flows into the Trust in excess of those required to pay principal and interest on the Class A certificates. The present value of expected cash flows are a function of a number of items including, but not limited to, charge off rates, repossession recovery rates, portfolio delinquency, prepayment rates, and Trust expenses. Subsequent to the initial recording of the Residuals in Finance Receivables Sold, the carrying value is adjusted for the actual cash flows into the respective Trusts in order to maintain a 19 carrying value which approximates the present value of the expected net cash flows into the Trust in excess of those required to pay all obligations of the respective Trust other than the obligations to the Class B certificates. To the extent that actual cash flows on a securitization are below original estimates, differ materially from the original securitization assumptions, and in the opinion of management, those differences appear to be other than temporary in nature, the Company would be required to revalue the residual portion of the securitization which it retains, and record a charge to earnings based upon the reduction. During the third fiscal quarter of 1997, the Company recorded a $5.7 million charge (approximately $3.4 million, net of income taxes) to continuing operations to write down the Residuals in Finance Receivables Sold. The Company determined a write down in the Residuals in Finance Receivables Sold was necessary due to an increase in net losses in the securitized loan portfolio. The charge which resulted in a reduction in the carrying value of the Company's Residuals in Finance Receivables Sold had the effect of increasing the cumulative net loss assumption to approximately 27.5%, for the securitization transactions that took place prior to June 30, 1997 which approximates the assumption used for the securitization transactions consummated during the final two quarters of 1997. For the securitization that was completed during the three month period ended March 31, 1998, net losses were estimated using total expected cumulative net losses at loan origination of approximately 29.5%, adjusted for actual cumulative net losses prior to securitization. The remaining allowance for credit losses inherent in the securitization assumptions as a percentage of the remaining principal balances of securitized contracts was approximately 22.2% as of March 31, 1998, compared to 17.9% as of December 31, 1997. There can be no assurance that the charge taken by the Company was sufficient and that the Company will not record additional charges in the future in order to write down the Residuals in Finance Receivables Sold. LIQUIDITY AND CAPITAL RESOURCES The Company requires capital to support increases in its contract portfolio, expansion of Company Dealerships, the purchase of inventories, the purchase of property and equipment, and for working capital and general corporate purposes. In addition, the Company intends to continue to acquire loans under the Cygnet Dealer Program until the split-off is complete. The Company funds its capital requirements through equity offerings, operating cash flow, the sale of finance receivables, and supplemental borrowings. The Company's Net Cash Provided by Operating Activities increased by 5219.8% or $18.2 million to $18.6 million for the three month period ended March 31, 1998 from $349,000 in the three month period ended March 31, 1997. The increase was primarily due to increases in proceeds from sales of finance receivables, collections of finance receivables, the provision for credit losses, decrease in inventory, offset by increases in the purchase of finance receivables, and Gain on Sale of Finance Receivables. The Net Cash Used in Investing Activities increased by 4.6% or $383,000 to $8.7 million in the three months ended March 31, 1998 from $8.3 million in the three months ended March 31, 1997. The increase was due to an increase in Investments Held in Trust and the purchase of Property and Equipment. Further, the Company used $3.5 million for the purchase of the assets of Seminole during the three month period ended March 31, 1997 compared to the three month period ended March 31, 1998 when no acquisition took place. The Company's Net Cash Provided by Financing Activities decreased by 82.3% or $61.3 million to $13.2 million in the three month period ended March 31, 1998 from $74.5 million in the three month period ended March 31, 1997. This decrease was primarily the result of the $88.7 million in proceeds from the Company's sale of common stock in the three month period ended March 31, 1997, net of increases in notes payable and subordinated notes payable. The Company's Net Cash Used in Discontinued Operations increased by 122.4% or $14.4 million to $26.1 million in the three month period ended March 31, 1998 from $11.7 million in the three month period ended March 31, 1997 due primarily to an increase in finance receivables originated and retained by the discontinued operations. Revolving Facility. The Company maintains a revolving credit facility (the "Revolving Facility") with General Electric Capital Corporation ("GE Capital") that has a maximum commitment of up to $100.0 million. Under the Revolving Facility, the Company may borrow up to 65.0% of the principal balance of eligible contracts originated from the sale of used cars and up to 86.0% of the principal balance of eligible contracts originated by the Branch Offices. However, an amount up to $10 million of the borrowing capacity under the Revolving Facility is not available at any time when the guarantee of the Company to the Contract Purchaser (defined below under "Transactions Regarding First Merchants Acceptance Corporation") is in effect. The Revolving Facility expires in December 1998. The facility is secured by substantially all of the Company's assets. As of March 31, 1998, the Company's borrowing capacity under the Revolving Facility was $61.9 million, the aggregate principal amount outstanding under the Revolving Facility was approximately $48.3 million, and the amount available to be borrowed under the facility was $13.6 million. The Revolving Facility bears interest at the 30-day LIBOR plus 3.15%, payable daily (total rate of 8.8% as of March 31, 1998). 20 The Revolving Facility contains covenants that, among other things, limit the Company's ability to, without GE Capital's consent: (i) incur additional indebtedness; (ii) make unsecured loans or other advances of money to officers, directors, employees, stockholders or affiliates in excess of $25,000 in total; (iii) engage in securitization transactions (other than the Securitization Program, for which GE Capital has consented); (iv) merge with, consolidate with, acquire or otherwise combine with any other person or entity, transfer any division or segment of its operations to another person or entity, or form new subsidiaries; (v) make any change in its capital structure; (vi) declare or pay dividends except in accordance with all applicable laws and not in excess of fifteen percent (15%) of each year's net earnings available for distribution; (vii) make certain investments and capital expenditures; and (viii) engage in certain transactions with affiliates. These covenants also require the Company to maintain specified financial ratios, including a debt ratio of 2.1 to 1 and a net worth of at least $75,000,000, and to comply with all laws relating to the Company's business. The Revolving Facility also provides that a transfer of ownership of the Company that results in less than 15.0% of the Company's voting stock being owned by Mr. Ernest C. Garcia II will result in an event of default under the Revolving Facility. Under the terms of the Revolving Facility, the Company is required to maintain an interest coverage ratio which the Company failed to satisfy during the first quarter of 1998. This was primarily as a result of the charges taken with respect to the closure of the Branch Office network, for which the Company incurred a loss from discontinued operations of $5.6 million (net of income tax benefit of $3.5 million.) GE Capital has waived the covenant violation as of March 31, 1998. The Company's Revolving Facility currently contains provision for borrowings based upon eligible finance receivable contracts and does not provide for borrowings based upon contracts or notes receivable acquired or issued pursuant to the Cygnet Dealer Program. Further, the Revolving Facility does not contain provision for borrowing against the Company's inventory. The Company considers these assets to be sources of additional liquidity and, therefore, is currently exploring alternatives regarding obtaining financing secured by the assets generated by the Cygnet Dealer Program and the Company's inventory. Subordinated Indebtedness and Preferred Stock. Prior to its public offering in June 1996, the Company historically borrowed substantial amounts from Verde Investments Inc. ("Verde"), an affiliate of the Company. The Subordinated Notes Payable balances outstanding to Verde totaled $12.0 million as of March 31, 1998 and December 31, 1997, respectively. Prior to June 21, 1996, these borrowings accrued interest at an annual rate of 18.0%. Effective June 21, 1996 the annual interest rate on these borrowings was reduced to 10.0%. The Company is required to make monthly payments of interest and annual payments of principal in the amount of $2.0 million. This debt is junior to all of the Company's other indebtedness and the Company may suspend interest and principal payments in the event it is in default on obligations to any other creditors. In July 1997, the Company's Board of Directors approved the prepayment of the $12.0 million in subordinated debt after the earlier of (1) the Company's completion of a debt offering; or (2) at such time as (a) the FMAC transactions (described below under "Transactions with First Merchants Acceptance Corporation") have been completed or the cash requirements for completion of said transaction are known, and (b) the company either has cash in excess of its current needs or has funds available under its financing sources in excess of its current needs. No such prepayment has been made as of the date of filing of this Form 10-Q. Any such prepayment would require the consent of the lenders in the Company's subordinated debt offering effected in February 1998 as described below. In February 1998, the Company executed senior subordinated notes payable agreements with unrelated parties for a total of $15.0 million in subordinated debt. The unsecured three year notes call for interest at 12% per annum payable quarterly and are senior to the Verde subordinated note payable. In connection with the issuance of the senior subordinated notes payable, the Company issued warrants, which were valued at approximately $900,000, to the lenders to purchase up to 500,000 shares of the Company's common stock at an exercise price of $10.00 per share exercisable at any time until the later of (1) February 2001, or (2) such time as the notes have been paid in full. Additional Financing. On January 28, 1998, the Company executed a $7.0 million note payable which accrued interest at 9.5% per annum. The Company paid this note payable in full on April 1, 1998. On February 19, 1998, the Company and certain of its affiliates executed a second short term $30.0 million standby repurchase credit facility. Pursuant to the terms of this facility, the lender agreed to purchase, subject to repurchase rights of the Company and its subsidiaries, certain eligible sub-prime automobile finance receivables originated and or purchased by the Company's affiliates for a purchase price (and corresponding repurchase obligation) of no more than $30.0 million. During the three month period ended March 31, 1998, the lender purchased approximately $30.0 million in contracts pursuant to the facility which accrued interest at a rate of 9.5% per annum. The Company exercised its repurchase obligation on March 24, 1998. 21 Securitizations. The Company's Securitization Program is a primary source of funding for the Company. Under this program, the Company sold approximately $170.4 million in certificates secured by contracts to SunAmerica through securitizations effected prior to June 30, 1997. Since June 30, 1997, the Company has consummated additional securitizations under the Securitization Program with private investors through Greenwich Capital Markets, Inc. ("Greenwich Capital"). In February 1998, the Company executed a commitment letter with Greenwich Capital under which, among other things, Greenwich Capital will become the exclusive securitization agent for the Company for up to $1.0 billion of AAA-rated surety wrapped securities as part of the Company's ongoing Securitization Program. At the closing of each securitization, the Securitization Subsidiaries receive payment for the certificates sold (net of Investments Held in Trust). The Company also generates cash flow under this program from ongoing servicing fees and excess cash flow distributions resulting primarily from the difference between the payments received from customers on the contracts and the payments paid on the Class A Certificates. In addition, securitization allows the Company to fix its cost of funds for a given contract portfolio, and broadens the Company's capital source alternatives. Failure to periodically engage in securitization transactions will adversely affect the Company. In connection with its securitization transactions, the Securitization Subsidiaries are required to make an initial cash deposit into an account held by the trustee (spread account) and to pledge this cash to the Trust to which the finance receivables were sold. The Trust in turn invests the cash in high quality liquid investment securities. In addition, the cash flows due to the B Certificates first are deposited into the spread account as necessary to attain and maintain the spread account at a specified percentage of the underlying finance receivables principal balance. In the event that the cash flows generated by the finance receivables sold to the Trust are insufficient to pay obligations of the Trust, including principal or interest due to certificate holders or expenses of the Trust, the trustee will draw funds from the spread account as necessary to pay the obligations of the Trust. The spread account must be maintained at a specified percentage of the principal balances of the finance receivables held by the Trust, which can be increased in the event delinquencies or losses exceed specified levels. If the spread account exceeds the specified percentage, the trustee will release the excess cash to the Securitization Subsidiaries from the pledged spread account. Debt Shelf Registration. On July 18, 1997, the Company filed a Form S-3 registration statement for the purpose of registering up to $200 million of its debt securities in one or more series at prices and on terms to be determined at the time of sale. The registration statement has been declared effective by the Securities and Exchange Commission and is available for future debt offerings. Transactions Regarding First Merchants Acceptance Corporation. The Company has been actively involved in the bankruptcy proceedings (the "Bankruptcy Case") of First Merchants Acceptance Corporation ("FMAC"). It is the Company's intent, with the consent of the transaction participants, to transfer all remaining contract rights and liabilities related to the FMAC transaction to the Company's discontinued operations in conjunction with the split-off. The Company believes that it will be required to provide certain guarantees or other consideration to certain participants in the FMAC transaction in order to obtain such consents. The transactions described below were consummated primarily by the Company's discontinued operations. In recent periods, the Company has been actively involved in the reorganization proceedings of FMAC. FMAC was in the business of purchasing and securitizing loans made primarily to sub-prime borrowers by various Third Party Dealers. On July 11, 1997 (the "FMAC Petition Date"), FMAC filed for reorganization under Title 11 of the United States Code (the "Bankruptcy Code"). FMAC emerged from bankruptcy on March 31, 1998, the effective date of FMAC's plan of reorganization (the "Plan of Reorganization"). During the pendency of the FMAC bankruptcy proceedings, the Company purchased approximately 78% of FMAC's senior bank debt (the "Senior Bank Debt") held by seven members (the "Selling Banks") of FMAC's original nine-member bank group for approximately $69 million, which represents a discount of 10% (the "Discount") of the outstanding principal amount of such debt. The Company may also be obligated to pay the Selling Banks additional consideration (the "Additional Consideration") if and to the extent certain unsecured creditors and equity holders of FMAC receive cash pursuant to FMAC's Plan of Reorganization in excess of 10% of their allowed claims. The amount of cash received by such unsecured creditors and equity holders in excess of 10% of their allowed claims, if any, is herein referred to as the "Excess Cash." The Additional Consideration payable by the Company would be an amount equal to the entire amount of such Excess Cash up to the full amount of the Discount. In connection with the purchase, the Company also issued to the Selling Banks warrants (the "Bank Group Warrants") to purchase up to 389,800 shares of the Company's Common Stock at an exercise price of $20.00 per share at any time through February 20,2000, and subject to a call feature by the Company if the closing market price of the Company's Common Stock equals or exceeds $27.00 per share for a period of five consecutive trading days. In December of 1997, the Company purchased the remaining 22% of FMAC's Senior Bank Debt. The Senior Bank Debt was originally secured by (1) automobile receivables directly owned by FMAC (the "Owned Contracts"), (2) all personal property of FMAC, (3) accounts, accounts receivable, including tax refunds, contract rights and other general intangibles, and (4) the common stock of FMARC (defined below) (collectively, the "Collateral"). On December 15, 1997, LaSalle National Bank, as Agent (the "Agent") for the holders of the Senior Bank Debt, credit bid the entire amount of the Senior Bank Debt plus certain interest and fees, costs and expenses relating to the Owned Contracts (collectively, the "Credit Bid Purchase Price"), and the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court") approved the proposed purchase subject to execution by FMAC of appropriate transfer documents. On December 18, 1997, FMAC executed the necessary transfer documents assigning the Owned Contracts to the Agent (the "Transfer"), and the Agent then sold the Owned Contracts to a third party purchaser (the "Contract Purchaser") for 86% of the principal balance of certain eligible Owned Contracts (approximately $78.9 million) (the "Base Price") plus a residual interest in the Owned Contracts. The Company has guaranteed to the Contract Purchaser a return on the Owned Contracts equal to the Base Price plus interest at the rate of 10.35% per annum, subject to a maximum guarantee amount of $10 million. The Company has the option to purchase the Owned Contracts from the Contract Purchaser at certain times upon certain events, including at any time after three years and if the principal balance on the remaining contracts is less than 10% of the balance of the Owned Contracts on the date of purchase, for a price to yield the Contact Purchaser 10.35%. Concurrently with the Transfer, the Agent released the lien of the Bank Group on the Collateral, allowing FMAC to retain all assets constituting any part of the Collateral other than the Owned Contracts (the "Retained Assets"), including but not limited to uncollected state and federal income tax refunds for 1996 and prior years (the "Tax Refunds"), certain receivables and related vehicles pledged to Greenwich Capital (the "Greenwich Collateral"), and FMAC's furniture, fixtures, equipment, general intangibles, and causes of action. In consideration for the Bank Group's release of its liens on the Retained Assets, FMAC subsequently (A) guaranteed on a non-recourse basis full and timely payment to the Agent and the Company of any shortfall between (i) the Credit Bid Purchase Price of the Owned Contracts plus interest thereon at the rate of 11% per annum from December 15, 1997, plus an additional charge for servicing the Owned Contracts (the "Owned Contracts Servicing Fee"), calculated on a monthly basis, of the greater of 1/12 of 3 1/4% of the outstanding principal balance of the Owned Contracts or $15.00 per Owned Contract, applied only to Owned Contracts that are less than 120 days past due and for which the related vehicle has not been repossessed and (ii) collections and proceeds of the Owned Contracts (collectively, the "Secured Claim Recovery Amount"), and (B) granted a lien (the "Replacement Lien") on the stock of First Merchants Auto Receivables Corporation ("FMARC") and First Merchants Auto Receivables Corporation II ("FMARC II"), the holders of the residual interests and certain equity certificates (collectively, the "B Pieces") of the various securitized loan pools ("Securitized Pools") of FMAC, to secure the Secured Claim Recovery Amount and the Modified UDC Fee (defined below). In the event that the Owned Contracts are not being serviced by the Company, a wholly-owned subsidiary of the Company, or another affiliate or assignee of the Company that meets certain conditions (an "Authorized Servicer"), without the prior written consent of FMAC (an "Owned Loan Servicing Change"), which consent will not be unreasonably withheld, the Secured Claim Recovery Amount will be limited to $10 million. Any recovery on the Owned Contracts in excess of the Secured Claim Recovery Amount will be shared with FMAC on the basis of 82 1/2% for the benefit of FMAC and 17 1/2% for the benefit of the Company (the "Excess Collections Split"). After payment in full of the Secured Claim Recovery Amount, the DIP Facility (defined below), the Modified UDC Fee (defined below), and certain other amounts, any further distributions from the B Pieces will be shared between the Company and FMAC on the same basis as the Excess Collections Split. In the event that an Owned Loan Servicing Change occurs, the Excess Collections Split will change to 85% for the benefit of FMAC and 15% to the Company with respect to the B Pieces and, subject to certain adjustments, 100% for the benefit of FMAC and 0% to the Company with respect to the Owned Contracts. The Company will not be entitled to receive any share of the Excess Collections Split relating to a Securitized Pool for any period during which it is not acting as servicer for such Securitized Pool. At the option of the Company, the Company may distribute up to 5,000,000 shares of Common Stock of the Company (the "Stock Option Shares") to FMAC or, at the request of FMAC and pursuant to its instructions, directly to the unsecured creditors of FMAC, in lieu of FMAC's right to receive all or a portion of distributions under the Excess Collections Split (including both recoveries under the Excess Collections Split from the Owned Contracts and the B Pieces) in cash (the "Stock Option"). If the Company decides to exercise the Stock Option, the Company must give FMAC at least 15 days advance written notice (the "Option Notice")(and make a public announcement on the same date as the giving of the notice) of the date on which the Company will exercise the Stock Option (the "Exercise Date") and the number of Stock Option Shares that the Company will issue on the Exercise Date. The Company may exercise the Stock Option one time only, with exercise being the actual delivery of the Stock Option Shares. Revocation of the Option Notice shall not be deemed to be an exercise of the Stock Option by the Company. On the Exercise Date, the aggregate value of the distribution shall be determined by multiplying the Stock Option Shares by 98% of the average of the closing prices for the previous 10 trading days of Company Common Stock on Nasdaq or such other market on which such stock may be traded (the "Stock Option Value"). After issuance and delivery of the Stock Option Shares, the Company will be entitled to receive FMAC's share of cash distributions under the Excess Collections Split (including both recoveries under the Excess Collections Split from the Owned Contracts and the B Pieces) from and after the Exercise Date until the Company has received such distributions equal to the Stock Option Value. This would be in addition to the Company's right to receive its share under the Excess Collections Split. Once the Company has received cash distributions equal to the Stock Option Value, FMAC will retain the remaining portion of its share of cash distributions under the Excess Collections Split, if any, in excess of the Stock Option Value. The Company will not be entitled to exercise the Stock Option unless (i) the value of its Common Stock on the Exercise Date and the closing price for its Common Stock on each day during the previous ten trading days shall be at least $8.00 per share, (ii) the Company shall have caused (at its sole cost and expense) the Stock Option Shares to be registered under the Securities Act of 1933, and be unrestricted and fully transferable, and shall have taken all steps necessary to allow FMAC to distribute the Stock Option Shares to its unsecured creditors, and (iii) the Company shall not have purchased any of its Common Stock (except upon the exercise of previously issued and outstanding options, warrants, stock appreciation rights, or other rights) or announced any stock repurchase programs from and after the delivery of the Option Notice through the Exercise Date. The Company has registered the Stock Option Shares under the Securities Act of 1933, but will be required to maintain such registration in order to meet the above condition. In the event that the Company is unable to issue the Stock Option Shares, FMAC will continue to receive cash collections from its share of the Excess Collections Split for the benefit of its unsecured creditors. If the receipt of such cash causes the relevant unsecured creditors to receive cash payments in excess of 10% of their allowed claims, the Company would be required to pay an amount equal to any such Excess Cash (up to the amount of the Discount) to the Selling Banks as Additional Consideration. In addition, the Company has agreed in a Contingent Sharing Agreement to pass through 10% of its share of the Excess Collections Split to Financial Security Assurance ("FSA"), the insurer of certain obligations to the senior certificates of the Securitized Pools, in exchange for FSA's consent to amendments to documents governing services of the Securitized Pools as described below. At the commencement of FMAC's bankruptcy proceedings, the Company agreed to provide up to $10 million of "debtor-in-possession" financing (the "DIP Facility"). Borrowings under the DIP Facility originally were to mature on February 28, 1998 and accrue interest at the rate of 12% per annum. The DIP Facility was originally secured by super priority liens on all of FMAC's assets then existing or thereafter acquired. The DIP Facility was subsequently amended (i) to provide for additional advances to pay administrative and post-plan confirmation operating expenses of FMAC, provided that total advances under the DIP Facility could not exceed $21.5 million, (ii) to be secured by the Retained Assets, including the Tax Refunds, (iii) to reduce the interest rate on borrowings outstanding under the DIP Facility to 10% per annum; and (iv) to waive the maturity date of the DIP Facility. The first $10 million of Tax Refunds will be used to pay down the DIP Facility and will permanently reduce the amount of the DIP Facility. Thereafter, the DIP Facility will be permanently paid down from distributions on the B Pieces, after payment of the Secured Claim Recovery Amount. Payments made from other sources on the DIP Facility will not permanently reduce the amount thereof and FMAC will be allowed to reborrow such amounts under the facility. The Company's increase in the DIP Facility to $21.5 million was agreed to in exchange for an agreement by the parties involved to assign the receivables in the Securitized Pools that were charged off prior to February 28, 1998 to the Company. Pursuant to such agreement, the Company is entitled to retain 27.5% of every dollar collected on the charged off receivables. The remaining 72.5% out of every dollar collected will be accumulated in an interest bearing escrow account ("Charged Off Receivable Funds"). The Charged Off Receivable Funds will be held in the escrow account and, if the Securitized Pools have inadequate funds to satisfy certain payments and distributions with respect to the senior certificates issued with respect to such pools, then withdrawals can be made from the escrow account to satisfy such payments and distributions. When the aggregate of the spread accounts in the Securitized Pools reaches a certain coverage (the "Coverage Point"), all monies previously transferred from the escrow account to satisfy such payments and distributions will be deposited back into the escrow account and the Charged Off Receivable Funds will be released from the escrow account. One percent of the face amount of all receivables charged off prior to or on November 30, 1997 and two percent of the face amount of all receivables charged off from December 1, 1997 to and including February 28, 1998 will be released back to the applicable pool and will be available for distribution in accordance with the Excess Collections Split. Any additional collections with respect to charged-off receivables relating to a Securitized Pool that has reached the Coverage Point would be retained by the Company. FMAC will pay the Company on a non-recourse basis a fee of $450,000 payable prior to any payments pursuant to the Excess Collections Split solely from collections of the B Pieces and secured by a pledge of the stock of FMARC and FMARC II, subordinate only to the DIP Facility, the Secured Claim Recovery Amount and prior pledges of the FMARC II stock (the "Modified UDC Fee"). The Company also received reimbursement of out-of-pocket expenses related to the DIP Facility of $100,000 in April of 1998. The Company entered into a Servicing Agreement dated December 18, 1997 (the "Owned Contracts Servicing Agreement") between the Company and the Contract Purchaser, pursuant to which the Owned Contracts would be serviced by the Company in the event that FMAC ceased to service the Owned Contracts. The Company began servicing the Owned Contracts on April 1, 1998. The Company will receive a servicing fee under the Owned Contracts Servicing Agreement. On April 1, 1998, the Company also entered into amendment(s) with FMAC and other parties thereto, to the existing Pooling and Servicing Agreements and Sale and Servicing Agreements that currently govern servicing of the receivables in the Securitized Pools of FMAC, which amendments provide for the Company to service such Securitized Pools. The Company began servicing these receivables on April 1, 1998. Under these agreements, the Company will receive a servicing fee for servicing the receivables in the Securitized Pools of the greater of (i) 3.25% per annum of the aggregate outstanding principal balance of substantially all of the non-defaulted receivables computed monthly on the basis of the declining balance of the receivables portfolio or (ii) $15 per receivable per month, plus, in either case, reimbursement of certain costs and expenses. On April 1, 1998, the Company also issued to FMAC warrants to purchase 325,000 shares of the Company's Common Stock at any time through April 1, 2001 at a price of $20.00 per share (the "FMAC Warrants"), subject to a call feature by the Company if the closing market price of the Company's Common Stock equals or exceeds $28.50 per share for a period of 10 consecutive trading days. The Company also contributed to FMAC all of its shares of FMAC common stock in exchange for the assets constituting FMAC's servicing platform. 22 Capital Expenditures and Commitments. The Company is pursuing an aggressive growth strategy. In the first quarter of 1998, the Company has opened three new dealerships. Further, the Company currently has one dealership in Phoenix, two dealerships in San Antonio, one dealership in Los Angeles, two dealerships in Atlanta, one dealership in Dallas, and two dealerships in Tampa currently under development. The Company believes that it will expend approximately $1.5 to $1.7 million to construct (excluding inventory) each Company Dealership. On July 11, 1997, the Company entered into an agreement, as amended, to provide "debtor in possession" financing to FMAC in an amount up to $21.5 million to be adjusted downward from time to time. As of May 12, 1998, the maximum commitment was reduced to $12.1 million and the outstanding balance on the DIP totaled $8.7 million. The Company expects the maximum commitment to be further reduced to $11.5 million in the next six months as FMAC receives income tax refunds from various taxing jurisdictions. The Company intends to finance these expenditures through operating cash flows and supplemental borrowings, including amounts available under the Revolving Facility and the Securitization Program, if any. Sale-Leaseback of Real Property. In March 1998, the Company executed a commitment letter with an investment company for the sale-leaseback of up to $37.0 million in real property. Pursuant to the terms of the agreement, the Company would sell certain real property to the investment company for its original cost and leaseback the properties for an initial term of twenty years. The Company would retain certain extension options, and pay monthly rents of approximately one-twelfth of 10.75% of the purchase price plus all occupancy costs and taxes. The agreement calls for annual increases in the monthly rents of not less than 2%. On May 14, 1998, the Company completed the first closing of the sales-leaseback transaction. In conjunction with this closing, the Company sold property for approximately $21.8 million. Substantially all of the proceeds from the sale were utilized to pay down the Revolving Facility. Common Stock Repurchase Program. In October 1997 the Company's Board of Directors authorized a stock repurchase program by which the Company may acquire up to one million shares of its common stock from time to time on the open market. Under the program, purchases may be made depending on market conditions, share price and other factors. The stock repurchase program will terminate on December 31, 1998, unless extended by the Company's Board of Directors, and may be discontinued at any time. As of the date of filing of this Form 10-Q, the Company had not repurchased any shares of common stock. Stock Option Grants. Effective January 15, 1998, the Compensation Committee of the Company's Board of Directors awarded 775,000 stock options to key officers of the Company at an exercise price of $8.25 per share, the market value of the Common Stock on the date of grant ("Awards"). Of these Awards, 500,000 options were granted to Gregory B. Sullivan, President and Chief Operating Officer of the Company. Two Hundred Fifty Thousand of the options granted to Mr. Sullivan were granted under the existing Ugly Duckling Long Term Incentive Plan, pursuant to the plan's general terms, including vesting in equal increments over a five-year period beginning on the first anniversary date of the grant. The other 250,000 options to Mr. Sullivan and the remaining 225,000 options granted to the other key officers were granted under the new Ugly Duckling 1998 Executive Incentive Plan, subject to approval of the stockholders at the upcoming 1998 Annual Meeting ("Existing Grants"). These options contain time and price vesting requirements. The Existing Grants will vest in equal increments over five years subject to continued employment by the Company and will also be subject to additional vesting hurdles based on the market value of the Company's Common Stock as traded on Nasdaq. The price hurdle for the first year of the grants is a 20% increase in such market value over the exercise price of the options, with the price hurdles increased for the next four years in additional 20% increments over the exercise price of the options. In order for the price hurdles to be met, the Common Stock must trade at the targeted value for a period of 10 consecutive trading days. The price hurdles can be met at any time before or after the time vesting requirements are satisfied, and will be completely met at such time as the Common Stock trades at 100% in excess of the exercise price of the options for 10 consecutive trading days. In any event, the Existing Grants will become fully vested on January 15, 2005, unless sooner exercised or forfeited. The Company believes that the Awards are material in the aggregate. As such, they will have the effect of diluting the ownership interest of existing stockholders of the Company. Reliance Transaction. In February 1998, the Company entered into servicing and transition servicing arrangements with Reliance Acceptance Corporation ("Reliance"), which company also filed for reorganization under the Bankruptcy Code the same month. Reliance, in consideration for entering into a servicing agreement with the Company, will receive privately issued warrants ("Reliance Warrants") to purchase shares of Common Stock of the Company as follows: 50,000 Reliance Warrants will be granted to Reliance upon the Company's receipt of certain charged-off receivables proceeds of Reliance; up to 100,000 Reliance Warrants will be granted to Reliance based upon the Company's receipt of up to $4.7 million of post-bank debt proceeds; and Reliance will be granted an additional 75,000 Reliance Warrants for every $1 million actually received by the Company through an incentive fee. The Reliance Warrants will have a strike price of $12.50 for the first 150,000 Reliance Warrants and a strike price for all other Reliance Warrants of the greater of $12.50 or 120% of the market price of the Common Stock on the date of issuance of the Reliance Warrants. The Reliance Warrants are exercisable for three years. Year 2000. The Company has commenced a study of its computer systems in order to assess its exposure to year 2000 issues. The Company expects to make the necessary modifications or changes to its computer information systems to enable proper processing of transactions relating to the year 2000 and beyond. The Company estimates that it will cost from $500,000 to $1.0 million to modify its existing systems, should it choose to do so. The Company will evaluate appropriate courses of action, including replacement of certain systems whose associated costs would be recorded as assets and subsequently amortized, or modification of its existing systems which costs would be expensed as incurred. Resolution of all year 2000 issues is critical to the Company's business. There can be no assurance that the Company will be able to completely resolve all year 2000 issues in a timely fashion or that the ultimate cost to identify and implement solutions to all year 2000 problems will not be material to the Company. 23 SEASONALITY Historically, the Company has experienced higher revenues in the first two quarters of the year than in the latter half of the year. The Company believes that these results are due to seasonal buying patterns resulting in part from the fact that many of its customers receive income tax refunds during the first half of the year, which are a primary source of down payments on used car purchases. INFLATION Increases in inflation generally result in higher interest rates. Higher interest rates on the Company's borrowings would decrease the profitability of the Company's existing portfolio. The Company will seek to limit this risk through its Securitization Program and, to the extent market conditions permit, for contracts originated at Company Dealerships, either by increasing the interest rate charged, or the profit margin on, the cars sold, or for contracts acquired from Third Party Dealers, either by acquiring contracts at a higher discount or with a higher APR. To date, inflation has not had a significant impact on the Company's operations. ACCOUNTING MATTERS In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS No. 130) which became effective for the Company January 1, 1998. SFAS No. 130 establishes standards for reporting and displaying comprehensive income and its components in a full set of general-purpose financial statements. The adoption of SFAS No. 130 did not have a material impact on the Company. In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" (SFAS No. 131) which became effective for the Company January 1, 1998. SFAS No. 131 establishes standards for the way that public enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim reports issued to stockholders. The adoption of SFAS No. 131 did not have a material impact on the Company. The Securities and Exchange Commission has approved rule amendments to clarify and expand existing disclosure requirements for derivative financial instruments. The amendments require enhanced disclosure of accounting policies for derivative financial instruments in the footnotes to the financial statements. In addition, the amendments expand existing disclosure requirements to include quantitative and qualitative information about market risk inherent in market risk sensitive instruments. The required quantitative and qualitative information are to be disclosed outside the financial statements and related notes thereto. As the Company believes that the derivative financial instrument disclosure contained within the notes to the consolidated financial statements of its 1997 Form 10-K substantially conform with the accounting policy requirements of these amendments, no further interim period disclosure has been provided. 24 PART II. OTHER INFORMATION Item 1. Legal Proceedings. Except for vehicles sold in Arizona under a limited warranty program, the Company sells its cars on an "as is" basis, and requires all customers to sign an agreement on the date of sale pursuant to which the Company disclaims any obligation for vehicle-related problems that subsequently occur. Although the Company believes that such disclaimers are enforceable under applicable law, there can be no assurance that they will be upheld in every instance. Despite obtaining these disclaimers, the Company, in the ordinary course of business, receives complaints from customers relating to such vehicle-related problems as well as alleged violations of federal and state consumer lending or other similar laws and regulations. While most of these complaints are made directly to the Company or to various consumer protection organizations and are subsequently resolved, the Company is named occasionally as a defendant in civil suits filed by customers in state, local, or small claims courts. There can be no assurance that the Company will not be a target of similar claims in the future. Although the amount of the ultimate exposure of the above, if any, cannot be determined at this time, the Company, based on the advice of counsel, does not expect the final outcome to have a material adverse effect on the Company. Additionally, in the ordinary course of business, the Company is a defendant in various other types of legal proceedings. There can be no assurance that the Company will not be a target of similar claims and legal proceedings in the future. The Company believes that the ultimate disposition of these matters on a cumulative basis will not have a material adverse effect on the Company. However, there can be no assurance in this regard. Item 2. Changes in Securities and Use of Proceeds. Warrants to purchase 500,000 shares of common stock of the Company at an exercise price of $10.00 per share were issued in a private placement under Section 4(2) of the Securities Act of 1933 to certain lenders in connection with the execution of loan documents with such lenders. For certain stock option grants during the first quarter of 1998, see a description of option grants to key officers of the Company. Further, the Company has executed certain agreements with Reliance regarding the issuance of warrants. See a description of these transactions herein under "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." Item 3. Defaults Upon Senior Securities. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources -- Revolving Facility." Item 4. Submission of Matters to a Vote of Security Holders. None. Item 5. Other Information. As discussed earlier in this Form 10-Q, on April 28, 1998, the Company announced that its Board of Directors had authorized management to proceed with separating current operations into two publicly held companies. The Company's continuing operations will focus exclusively on the retail sale and financing of used cars through its chain of dealerships, as well as the collection and servicing of the resulting loans. It is anticipated that a new company will be formed to operate all non-dealership operations. Under a proposal currently being considered, the Company will distribute rights to its stockholders to purchase stock in the newly formed company. Only stockholders of the Company who exercise their rights will acquire common equity in the new entity. However, details of any such rights offering, including the subscription price, back-up purchase rights, interests to be retained by the Company, capitalization of the new entity and other factors, are still under consideration. In addition, it was announced that the split-off will result in certain management changes at the Company. Any structure for the separation will be subject to the consent of various parties and applicable regulatory approvals and filings. The Company's Board has directed management to continue developing a specific plan for the separation. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits Exhibit 4.1 -- Warrant Agreement between the Registrant and Reliance Acceptance Corporation and Harris Trust of California, as warrant agent, dated as of February 9, 1998 (w/form of warrant attached as Exhibit A, thereto) Exhibit 10.1 -- Credit and Security Agreement between Registrant and First Merchants Acceptance Corp. ("FMAC"), dated as of July 17, 1997 Exhibit 10.1(a) -- First Amendment to Credit and Security Agreement between Registrant and FMAC, dated as of January 21, 1998 25 Exhibit 10.1(b) -- Second Amendment to Credit and Security Agreement between Registrant and FMAC, dated as of April 1, 1998 Exhibit 10.2 -- Letter Agreement to Amend the Amended and Restated Loan and Security Agreement between Registrant and General Electric Capital Corp. ("GECC"), dated as of October 20, 1997 Exhibit 10.3 -- Letter Agreement to Amend the Amended and Restated Loan Agreement between Registrant and GECC, dated as of March 25, 1998 Exhibit 27 -- Financial Data Schedule Exhibit 99 -- Cautionary Statement Regarding Forward Looking Statements and Risk Factors (b) Reports on Form 8-K. During the first quarter 1998, the Company filed four reports on Form 8-K. The first report on Form 8-K, dated December 15, 1997 and filed January 2, 1998, pursuant to Items 5 and 7 (1) reported the execution by the Company of a modified letter agreement, and related terms, which supersedes and replaces the Plan Letter Agreement regarding the FMAC Plan of Reorganization and other matters ("Final Plan Letter Agreement"), (2) reported the Company's expected gain of $6.0 to $7.0 million (before income taxes) during the fourth quarter of 1997 from the sale of certain contracts in connection with the FMAC transaction, (3) reported certain arrangements for the servicing of contracts in connection with FMAC, (4) disclosed the Company's directors and officers stock repurchase loan program, and (5) filed related agreements such as the Final Plan Letter Agreement, a purchase agreement and servicing agreement. The second report on Form 8-K, dated February 6, 1998 and filed February 9, 1998, pursuant to Item 5, reported (1) the Company's earnings for its year and quarter ended December 31, 1997, and (2) the closure of the Company's third party dealer branch network and related restructuring charge to be recorded in the first quarter of 1998. The third report on Form 8-K, dated January 28, 1998 and filed February 10, 1998, pursuant to Item 5, reported (1) the Reliance transaction, including the entering into of a servicing agreement and transition services agreement whereby the Company would services certain Reliance contracts and provide other services to Reliance, and (2) the Company's borrowing of $7 million from Greenwich Capital Financial Products, Inc. ("Greenwich"). The fourth report on Form 8-K, dated February 10, 1998 and filed February 20, 1998, pursuant to Items 5 and 7 (1) filed a copy of the Company's audited consolidated financial statements as of December 31, 1997 and 1996 and for each of the years in the three-year period ended December 31, 1997, (2) reported the Company's issuance of $15 million of 12% senior subordinated notes and warrants to acquire 500,000 shares of the Company's Common Stock at an exercise price of $10 per share, (3) reported the Company and certain of its subsidiaries and affiliates entering into a master repurchase agreement with Greenwich for Greenwich to purchase eligible contracts from the Company for a purchase price of no more than $30 million, and (4) filed agreements relating to the preceding, including the form of senior subordinated note, form of warrant, loan agreement, and the Company's audited consolidated financial statements. After the first quarter 1998, the Company has, thus far, not filed any reports on Form 8-K. 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 Date: May 15, 1998 ------------- /s/ Steven T. Darak - ------------------- Steven T. Darak Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) 27 EXHIBIT INDEX EXHIBIT NUMBER DESCRIPTION - ------------------------------------------------------------------------------- 4.1 Warrant Agreement between the Registrant and Reliance Acceptance Corporation and Harris Trust of California, as warrant agent, dated as of February 9, 1998 (w/form of warrant attached as Exhibit A, thereto) 10.1 Credit and Security Agreement between Registrant and First Merchants Acceptance Corp. ("FMAC"), dated as of July 17, 1997 10.1(a) First Amendment to Credit and Security Agreement between Registrant and FMAC, dated as of January 21, 1998 10.1(b) Second Amendment to Credit and Security Agreement between Registrant and FMAC, dated as of April 1, 1998 10.2 Letter Agreement to Amend the Amended and Restated Loan and Security Agreement between Registrant and General Electric Capital Corp. ("GECC"), dated as of October 20, 1997 10.3 Letter Agreement to Amend the Amended and Restated Loan Agreement between Registrant and GECC, dated as of March 25, 1998 27 Financial Data Schedule 99 Cautionary Statement Regarding Forward Looking Statements and Risk Factors EX-4.1 2 EX-4.1 1 EXHIBIT 4.1 UGLY DUCKLING CORPORATION WARRANT AGREEMENT THIS WARRANT AGREEMENT (the "Agreement"), dated as of February 9, 1998, is by and among UGLY DUCKLING CORPORATION, a Delaware corporation (the "Company"), RELIANCE ACCEPTANCE GROUP, INC., a Delaware corporation ("Reliance"), and HARRIS TRUST COMPANY OF CALIFORNIA, as warrant agent (the "Warrant Agent"). WHEREAS, the Company has entered into an Agreement dated as of February 9, 1998 (the "Servicing Agreement"), by and among the Company, Reliance, Reliance Acceptance Corporation, a Delaware corporation, and BankAmerica Business Credit, Inc., a Delaware corporation, as agent on behalf of itself and other lenders, pursuant to which the Company has agreed to service certain motor vehicle retail installment sale contracts of Reliance, all as set forth in, and subject to the terms and conditions of, the Servicing Agreement; and WHEREAS, pursuant to the Servicing Agreement, the Company has agreed to issue to Reliance warrants (the "Warrants") to purchase shares of common stock, $.001 par value per share ("Common Stock"), of the Company, subject to the terms and conditions of this Agreement; and WHEREAS, the Company desires the Warrant Agent to act on behalf of the Company, and the Warrant Agent is willing so to act, in connection with the issuance, registration, transfer, exchange, exercise, and redemption of the Warrants. NOW, THEREFORE, in consideration of the promises and the mutual agreements herein set forth, the parties agree as follows: Section 1. APPOINTMENT OF WARRANT AGENT. The Company hereby appoints the Warrant Agent to act as agent of the Company in accordance with the terms and conditions set forth in this Agreement, and the Warrant Agent hereby accepts such appointment. Section 2. ISSUANCE OF WARRANTS AND FORM OF WARRANTS. (a) Subject to the terms and conditions hereof, the Company shall issue to Reliance, as reorganized upon consummation of Reliance's Joint Plan of Reorganization dated February 9, 1998, as amended (the "Plan"), or any transferee of Reliance approved by the Company (an "approved transferee"), and Reliance or any such approved transferee shall accept from the Company, Warrants substantially in the form attached hereto as Exhibit A. For purposes of this Agreement, the term "Reliance" shall include any approved transferee or Reliance, as reorganized upon consummation of (the Plan). Reliance will be entitled to receive Warrants to purchase shares of Common Stock of the Company in the amounts and at the times set forth on Exhibit B hereto. 2 (b) Each Warrant shall entitle the registered holder of the certificate representing such Warrant to purchase upon the exercise thereof one share of Common Stock, subject to the adjustments provided for in Section 9 hereof, at any time until 5:00 p.m., New York City time, on the date that is three years after the date of its initial issuance. (c) The Warrant certificates shall be in registered form only. Each Warrant certificate shall be dated by the Warrant Agent as of the date of issuance thereof (whether upon initial issuance or upon transfer or exchange), and shall be executed on behalf of the Company by the manual or facsimile signature of its President or a Vice President, and attested to by the manual or facsimile signature of its Secretary or an Assistant Secretary. In case any officer of the Company who shall have signed any Warrant certificate shall cease to be such officer of the Company before such Warrant Certificate has been countersigned by the Warrant Agent or prior to the issuance thereof, such Warrant certificate may nevertheless be issued and delivered with the same force and effect as though the person who signed the same had not ceased to be such officer of the Company. Section 3. EXERCISE OF WARRANTS, DURATION AND WARRANT PRICE. Subject to the provisions of this Agreement, each registered holder of one or more Warrant certificates shall have the right, which may be exercised as provided in such Warrant certificates, to purchase from the Company (and the Company shall issue and sell to such registered holder) the number of shares of Common Stock or other securities to which the Warrants represented by such certificates are at the time entitled hereunder. (a) Each Warrant not exercised by its expiration date shall become void, and all rights thereunder and all rights in respect thereof under this Agreement shall cease on such date. (b) A Warrant may be exercised by the surrender of the certificate representing such Warrant to the Company, at the office of the Warrant Agent, or at the office of a successor to the Warrant Agent, with the subscription form set forth on the reverse thereof duly executed and properly endorsed with the signatures properly guaranteed, and upon payment in full to the Warrant Agent for the account of the Company of the Warrant Price (as hereinafter defined) for the number of shares of Common Stock or other securities as to which the Warrant is exercised. Such Warrant Price shall be paid in full either (i) in cash, or by certified check or bank draft payable in United States currency to the order of the Warrant Agent or (ii) delivery of a written notice to the Company and the Warrant Agent that the holder is exercising the Warrant (or a portion thereof) by authorizing the Warrant Agent on behalf of the Company to withhold from issuance a number of shares of Common Stock issuable upon such exercise of the Warrant, which, when multiplied by the Current Market Price (as such term is defined in Section 10 hereof) of the Common Stock as of the date of exercise, is equal to the Warrant Price (as defined in Section 3(c) hereof) for the number of shares of Common Stock or other securities as to which the Warrant is exercised (and such withheld shares shall no longer be issuable under this Warrant Agreement). 2 3 (c) Subject to adjustment in accordance with Section 9 hereof, the price per share of Common Stock at which each Warrant may be exercised (the "Warrant Price") shall be $12.50 for the first 150,000 Warrants issued and the greater of $12.50 or 120% of the Market Price of the Common Stock as of the date of issuance of the Warrants for all Warrants issued thereafter. For purposes of this Section 3(c), the term "Market Price" shall mean (i) if the Common Stock is quoted on the Nasdaq National Market or the Nasdaq SmallCap Market or on a national securities exchange, the average of the daily per share closing prices of the Common Stock as quoted on the Nasdaq National Market or the Nasdaq SmallCap Market or on the principal stock exchange on which it is listed for the 10 consecutive trading days ending on the third trading day prior to the date of issuance of the Warrants in question, or (ii) if the Common Stock is traded in the over-the-counter market and not quoted on the Nasdaq National Market or the Nasdaq SmallCap Market nor on any national securities exchange, the average of the daily closing bid prices of the Common Stock for the 10 consecutive trading days ending on the third trading day prior to the date of issuance of the Warrants in question, as reported by Nasdaq or an equivalent generally accepted reporting service. The closing price referred to in clause (i) above shall be the last reported sale price or, in case no such reported sale takes place on such day, the average of the reported closing bid and asked prices, in either case on the Nasdaq National Market or the Nasdaq SmallCap Market or on the national securities exchange on which the Common Stock is then listed. For purposes of clause (ii) above, if trading in the Common Stock is not reported by Nasdaq, the bid price referred to in said clause shall be the lowest bid price as quoted on the OTC Bulletin Board or reported in the "pink sheets" published by National Quotation Bureau, Incorporated. If the Market Price cannot be calculated in accordance with any of the procedures described above, the Market Price shall be the fair market value of the Common Stock on the applicable date of determination as reasonably determined by an investment banking firm selected by the holder and reasonably acceptable to the Company, with the costs of such appraisal to be borne by the Company. (d) Subject to the further provisions of this Section 3 and of Section 6 hereof, upon surrender of Warrant certificates and payment of the Warrant Price or other consideration for exercise pursuant to Section 3(b) hereof, the Company shall issue and cause to be delivered, as promptly as practicable to or upon the written order of the registered holder of such Warrants and in such name or names as such registered holder may designate, subject to applicable securities laws, a certificate or certificates for the number of securities so purchased upon the exercise of such Warrants, together with cash, as provided in Section 10 of this Agreement, in respect of any fraction of a share or security otherwise issuable upon such surrender. All shares of Common Stock or other such securities issued upon the exercise of a Warrant shall be duly authorized, validly issued, fully paid and nonassessable and free and clear of all liens and other encumbrances. (e) Certificates representing such securities shall be deemed to have been issued and any person so designated to be named therein shall be deemed to have become a holder of record of such securities as of the date of the surrender of such Warrants and payment of the Warrant Price or other consideration for exercise pursuant to Section 3(b) hereof; provided, however, that 3 4 if, at the date of surrender of such Warrants and payment of such Warrant Price or other consideration, the transfer books for the Common Stock or other securities purchasable upon the exercise of such Warrants shall be closed, the certificates for the securities in respect of which such Warrants are then exercised shall be issuable as of the date on which such books shall next be opened and until such date the Company shall be under no duty to deliver any certificate for such securities and the person to whom such securities are issuable shall not be deemed to have become a holder of record of such securities. The rights of purchase represented by each Warrant certificate shall be exercisable, at the election of the registered holder thereof, either as an entirety or from time to time for part of the number of securities specified therein and, in the event that any Warrant certificate is exercised in respect of less than all of the securities specified therein at any time prior to the expiration date of the Warrant certificate, a new Warrant certificate or certificates will be issued to such registered holder for the remaining number of securities specified in the Warrant certificate so surrendered. Section 4. COUNTERSIGNATURE AND REGISTRATION. (a) The Warrant Agent shall maintain books (the "Warrant Register") for the registration and the registration of transfer of the Warrants. Upon the initial issuance of the Warrants, the Warrant Agent shall issue and register the Warrants in the name of Reliance in accordance with Section 2 hereof. The Warrant certificates shall be countersigned manually or by facsimile by the Warrant Agent (or by any successor to the Warrant Agent then acting as such under this Agreement) and shall not be valid for any purpose unless so countersigned. Warrant certificates may be so countersigned, however, by the Warrant Agent and delivered by the Warrant Agent, notwithstanding that the persons whose manual or facsimile signatures appear thereon as proper officers of the Company shall have ceased to be such officers at the time of such countersignature or delivery. (b) Prior to due presentment for registration of transfer of any Warrant certificate, the Company and the Warrant Agent may deem and treat the person in whose name such Warrant certificate shall be registered upon the Warrant Register (the "registered holder") as the absolute owner of such Warrant certificate and of each Warrant represented thereby (notwithstanding any notation of ownership or other writing on the Warrant certificate made by anyone other than the Company or the Warrant Agent), for the purpose of any exercise thereof, of any distribution or notice to the holder thereof, and for all other purposes, and neither the Company nor the Warrant Agent shall be affected by any notice to the contrary. Section 5. TRANSFER AND EXCHANGE OF WARRANTS. (a) The Warrant Agent shall register the transfer, from time to time, of any outstanding Warrant or portion thereof upon the Warrant Register, upon surrender of the certificate evidencing such Warrant for transfer, properly endorsed with signatures properly guaranteed and accompanied by appropriate instructions for transfer. Upon any such transfer, a new Warrant certificate representing an equal aggregate number of Warrants so transferred shall 4 5 be issued to the transferee and the surrendered Warrant certificate shall be canceled by the Warrant Agent. In the event that only a portion of a Warrant is transferred at any time, a new Warrant certificate representing the remaining portion of the Warrant will also be issued to the transferring holder. The Warrant certificates so canceled shall be delivered by the Warrant Agent to the Company from time to time upon written request. Notwithstanding anything to the contrary herein, no transfer or exchange may be made except in compliance with applicable securities laws and Section 13 hereof. (b) Warrant certificates may be surrendered to the Warrant Agent, together with a written request for exchange, and thereupon the Warrant Agent shall issue in exchange therefor one or more new Warrant certificates as requested by the registered holder of the Warrant certificate or certificates so surrendered, representing an equal aggregate number of Warrants. (c) The Warrant Agent shall not be required to effect any registration of transfer or exchange which will result in the issuance of a Warrant certificate for a fraction of a Warrant. (d) No service charge shall be made for any exchange or registration of transfer of Warrant certificates. (e) The Warrant Agent is hereby authorized to countersign and to deliver, in accordance with the terms of this Agreement, the new Warrant certificates required to be issued pursuant to the provisions hereof, and the Company, whenever required by the Warrant Agent, will supply the Warrant Agent with certificates duly executed on behalf of the Company for such purpose. Section 6. PAYMENT OF TAXES. The Company will pay any documentary stamp taxes attributable to the initial issuance or delivery of the shares of Common Stock or other securities issuable upon the exercise of Warrants; provided, however, the Company shall not be required to pay any tax or taxes which may be payable in respect of any transfer of the Warrants or involved in the issuance or delivery of any Warrant certificate or certificates for shares of Common Stock in a name other than the registered holder of Warrants in respect of which such shares are issued, and in such case neither the Company nor the Warrant Agent shall be required to issue or deliver any certificate for shares of Common Stock or any Warrant certificate until the person requesting the same has paid to the Company the amount of such tax or has established to the Company's satisfaction that such tax has been paid. Section 7. MUTILATED OR MISSING WARRANTS. In case any of the Warrant certificates shall be mutilated, lost, stolen or destroyed, the Company may issue, and the Warrant Agent shall countersign and deliver in exchange and substitution for and upon cancellation of the mutilated Warrant certificate, or in lieu of and substitution for the Warrant certificate lost, stolen or destroyed, a new Warrant certificate representing an equal aggregate number of Warrants, but only upon receipt of evidence satisfactory to the Company and the Warrant Agent of such loss, theft or destruction of such Warrant certificate and reasonable indemnity, if requested, also 5 6 satisfactory to them. Applicants for such substitute Warrant certificates shall also comply with such other reasonable conditions and pay such reasonable charges as the Company or the Warrant Agent may prescribe. Section 8. RESERVATION OF COMMON STOCK. (a) There have been reserved, and the Company shall at all times keep reserved, out of its authorized and unissued shares of Common Stock, a number of shares sufficient to provide for the exercise of the rights of purchase represented by the Warrants then outstanding or issuable upon exercise, and the transfer agent for the Common Stock and every subsequent transfer agent for any shares of the Company's capital stock issuable upon the exercise of any of the rights of purchase aforesaid are hereby irrevocably authorized and directed at all times to reserve such number of authorized and unissued shares as shall be requisite for such purpose. The Company will keep a copy of this Agreement on file with the transfer agent for the Common Stock and with every subsequent transfer agent for any shares of the Company's capital stock issuable upon the exercise of the rights of purchase represented by the Warrants. (b) The Warrant Agent is hereby irrevocably authorized to requisition from time to time from such transfer agent stock certificates required to honor outstanding Warrants. The Company will supply such transfer agent with duly executed certificates for such purpose and will itself provide or otherwise make available any cash as provided in Section 10 of this Agreement. All Warrant certificates surrendered in the exercise of the rights thereby evidenced shall be canceled by the Warrant Agent and shall thereafter be delivered to the Company. Promptly after the expiration date of the Warrants, the Warrant Agent shall certify to the Company the aggregate number of such Warrants which expired unexercised, and after the expiration date of the Warrants, no shares of Common Stock shall be subject to reservation in respect of such Warrants. Section 9. ADJUSTMENT OF WARRANT PRICE AND NUMBER OF SHARES OF COMMON STOCK. The number and kind of securities purchasable upon the exercise of the Warrants and the Warrant Price shall be subject to adjustment from time to time upon the happening of certain events, as follows: 9.1 ADJUSTMENTS. The number of shares of Common Stock or other securities purchasable upon the exercise of each Warrant and the Warrant Price shall be subject to adjustment as follows: (a) If the Company (i) pays a dividend in Common Stock or makes a distribution in Common Stock, (ii) subdivides its outstanding Common Stock into a greater number of shares, (iii) combines its outstanding Common Stock into a smaller number of shares, or (iv) issues, by reclassification of its Common Stock, other securities of the Company, then the number and kind of shares of Common Stock or other securities purchasable upon exercise of a Warrant immediately prior thereto will be adjusted so that the holder of a Warrant will be entitled 6 7 to receive the kind and number of shares of Common Stock or other securities of the Company that such holder would have owned and would have been entitled to receive immediately after the happening of any of the events described above, had the Warrant been exercised immediately prior to the happening of such event or any record date with respect thereto. Any adjustment made pursuant to this subsection 9.1(a) will become effective immediately after the effective date of such event retroactive to the record date, if any, for such event. (b) If at any time there shall be a capital reorganization of the Company's Common Stock (other than a combination, reclassification, exchange, or subdivision of shares provided for elsewhere above) or merger or consolidation of the Company with or into another corporation, or the sale of the Company's properties and assets as, or substantially as, an entirety to any other person, then, as a part of such reorganization, merger, consolidation or sale, lawful provision shall be made so that the holder of this Warrant shall thereafter be entitled to receive upon exercise of this Warrant, during the period specified in this Warrant and upon payment of the Warrant Price then in effect, the number of shares of Common Stock or other securities or property of the Company, or of the successor corporation resulting from such merger or consolidation, to which a holder of the Common Stock deliverable upon exercise of this Warrant would have been entitled in such capital reorganization, merger, or consolidation or sale if this Warrant had been exercised immediately before that capital reorganization, merger, consolidation, or sale. In any such case, appropriate adjustment (as determined in good faith by the Company's Board of Directors) shall be made in the application of the provisions of this Warrant with respect to the rights and interests of the holder of this Warrant after the reorganization, merger, consolidation, or sale to the end that the provisions of this Warrant (including adjustment of the Warrant Price then in effect and number of shares purchasable upon exercise of this Warrant) shall be applicable after that event, as near as reasonably may be, in relation to any shares or other property deliverable after that event upon exercise of this Warrant. (c) No adjustment in the number of shares or securities purchasable pursuant to the Warrants shall be required unless such adjustment would require an increase or decrease of at least one percent in the number of shares or securities then purchasable upon the exercise of the Warrants; provided that, upon the occurrence of an adjustment hereunder any time after an event occurs which would, but for this subsection 9.1(c) require an adjustment hereunder, such adjustment will be increased or decreased to give effect to the adjustment that would have been made absent this subsection 9.1(c). (d) Whenever the number of shares or securities purchasable upon the exercise of the Warrants is adjusted, as herein provided, the Warrant Price for shares payable upon exercise of the Warrants shall be adjusted by multiplying such Warrant Price immediately prior to such adjustment by a fraction, the numerator of which shall be the number of shares purchasable upon the exercise of the Warrant immediately prior to such adjustment, and the denominator of which shall be the number of shares so purchasable immediately thereafter. 7 8 (e) Whenever the number of shares or securities purchasable upon the exercise of the Warrants and/or the Warrant Price is adjusted as herein provided, the Company shall cause to be promptly mailed to the Warrant Agent and each registered holder of a Warrant by first class mail, postage prepaid, notice of such adjustment and a certificate of the chief financial officer of the Company setting forth the number of shares or securities purchasable upon the exercise of the Warrants after such adjustment, the Warrant Price as adjusted, a brief statement of the facts requiring such adjustment and the computation by which such adjustment was made. The Warrant Agent shall be fully protected in relying on any such certificate and any adjustment therein contained, and shall not be obligated or responsible for calculating any adjustment nor shall it be deemed to have knowledge of such an adjustment unless and until it shall have received such certificate. (f) For the purpose of this subsection 9.1, the term "Common Stock" shall mean (i) the class of stock designated as the voting Common Stock of the Company at the date of this Agreement, or (ii) any other class of stock or securities resulting from successive changes or reclassifications of such Common Stock consisting solely of changes in par value, or from par value to no par value, or from no par value to par value. In the event that at any time, as a result of an adjustment made pursuant to this Section 9, a registered holder shall become entitled to purchase any securities of the Company other than shares of Common Stock, thereafter the number of such other securities so purchasable upon exercise of the Warrants shall be subject to adjustment from time to time in a manner and on terms as nearly equivalent as practicable to the provisions with respect to the shares contained in this Section 9. 9.2 NO ADJUSTMENT FOR DIVIDENDS. Except as provided in Subsection 9.1, no adjustment in respect of any dividends or distributions shall be made during the term of the Warrants or upon the exercise of the Warrants. 9.3 NO ADJUSTMENT IN CERTAIN CASES. No adjustments are required to be made pursuant to Section 9 hereof upon the issuance of shares of Common Stock or the Warrants (or the underlying shares of Common Stock) required hereunder or pursuant to the Agreement of Understanding dated as of February 9, 1998 between the Company and Reliance or the Servicing Agreement. 9.4 PRESERVATION OF PURCHASE RIGHTS UPON RECLASSIFICATION, CONSOLIDATION, ETC. In case of any consolidation of the Company with or merger of the Company into another corporation or in case of any sale or conveyance to another corporation of the property, assets or business of the Company as an entirety or substantially as an entirety, the Company or such successor or purchasing corporation, as the case may be, shall execute with the Warrant Agent an agreement that the registered holders of the Warrants shall have the right thereafter, upon payment of the Warrant Price in effect immediately prior to such action, to purchase, upon exercise of each Warrant, the kind and amount of shares and other securities and property which it would have owned or have been entitled to receive after the happening of such consolidation, merger, sale or conveyance had each Warrant been exercised immediately prior to such action. 8 9 Any such agreements referred to in this subsection 9.4 shall provide for adjustments, which shall be as nearly equivalent as may be practicable to the adjustments provided for in Section 9 hereof. The provisions of this subsection 9.4 shall similarly apply to successive consolidations, mergers, sales, or conveyances. 9.5 PAR VALUE OF SHARES OF COMMON STOCK. Before taking any action that would cause an adjustment reducing the Warrant Price below the then par value of the Common Stock issuable upon exercise of the Warrants, the Company will take any corporate action which may, in the opinion of its counsel, be necessary in order that the Company may validly and legally issue fully paid and nonassessable Common Stock at such adjusted Warrant Price. 9.6 INDEPENDENT PUBLIC ACCOUNTANTS. The Company may but shall not be required to retain a firm of independent public accountants of recognized regional or national standing (which may be any such firm regularly employed by the Company) to make any computation required under this Section 9, and a certificate signed by such firm shall be conclusive evidence of the correctness of any computation made under this Section 9 and the Company shall cause to be promptly mailed to the Warrant Agent and each registered holder of a Warrant by first class mail, postage prepaid, a copy of such certificate. 9.7 STATEMENT ON WARRANT CERTIFICATES. Irrespective of any adjustments in the Warrant Price or the number of securities issuable upon exercise of Warrants, Warrant certificates theretofore or thereafter issued may continue to express the same price and number of securities as are stated in the similar Warrant certificates initially issuable pursuant to this Agreement. However, the Company may, at any time in its sole discretion (which shall be conclusive), make any change in the form of Warrant certificate that it may deem appropriate and that does not affect the substance thereof; and any Warrant certificate thereafter issued, whether upon registration of, transfer of, or in exchange or substitution for, an outstanding Warrant certificate, may be in the form so changed. 9.8 NO RIGHTS AS STOCKHOLDER; NOTICES TO HOLDERS OF WARRANTS. If, at any time prior to the expiration of a Warrant and prior to its exercise, any one or more of the following events shall occur: (a) any action that would require an adjustment pursuant to subsection 9.1 or 9.4 hereof; or (b) a dissolution, liquidation or winding up of the Company (other than in connection with a consolidation, merger or sale of its property, assets and business as an entirety or substantially as an entirety) shall be proposed; then the Company must give notice in writing of such event to the registered holders of the Warrants, as provided in Section 20 hereof, at least 20 days, to the extent practicable, prior to the date fixed as a record date or the date of closing the transfer books for the determination of the stockholders entitled to any relevant dividend, distribution, subscription rights or other rights or for the determination of stockholders entitled to 9 10 vote on such proposed dissolution, liquidation or winding up. Such notice must specify such record date or the date of closing the transfer books, as the case may be. Failure to mail or receive such notice or any defect therein will not affect the validity of any action taken with respect thereto. Section 10. FRACTIONAL INTERESTS. The Company is not required to issue fractional shares of Common Stock on the exercise of a Warrant. If any fraction of a share of Common Stock would, except for the provisions of this Section 10, be issuable on the exercise of a Warrant (or specified portion thereof), the Company will in lieu thereof pay an amount in cash equal to the then Current Market Price for the business day immediately preceding the date of issuance multiplied by such fraction. For purposes of this Agreement, the term "Current Market Price" means (i) if the Common Stock is listed for quotation on the Nasdaq National Market or the Nasdaq SmallCap Market or on a national securities exchange, the per share closing price of the Common Stock on the date of determination as quoted by the Nasdaq National Market or the Nasdaq SmallCap Market or on the principal stock exchange on which it is listed, as the case may be, whichever is the higher, or (ii) if the Common Stock is traded in the over-the-counter market and is not listed for quotation on the Nasdaq National Market or the Nasdaq SmallCap Market nor on any national securities exchange, the per share closing bid price of the Common Stock on the date of determination, as reported by Nasdaq or an equivalent generally accepted reporting service. The closing price referred to in clause (i) above shall be the last reported sale price or, in case no such reported sale takes place on such day, the average of the reported closing bid and asked prices, in either case as quoted by the Nasdaq National Market or the Nasdaq SmallCap Market or on the national securities exchange on which the Common Stock is then listed. For purposes of clause (ii) above, if trading in the Common Stock is not reported by Nasdaq, the bid price referred to in said clause shall be the lowest bid price as reported on the OTC Bulletin Board or in the "pink sheets" published by National Quotation Bureau, Incorporated. If the Current Market Price cannot be calculated in accordance with any of the procedures described above, the Current Market Price shall be the fair market value of the Common Stock on the applicable date of determination as reasonably determined by an investment banking firm selected by the holder and reasonably acceptable to the Company, with the costs of such appraisal to be born by Company. Section 11. RIGHTS AS WARRANTHOLDERS. Nothing contained in this Agreement or in any of the Warrants shall be construed as conferring upon the holders thereof, as such, any of the rights of stockholders of the Company, including, without limitation, the right to receive dividends or other distributions, to exercise any preemptive rights, to vote or to consent or to receive notice as stockholders in respect of the meetings of stockholders or the election of directors of the Company or any other matter. Section 12. DISPOSITION OF PROCEEDS ON EXERCISE OF WARRANTS. The Warrant Agent must account promptly to the Company with respect to Warrants exercised, and must promptly pay to the Company all monies received by it upon the exercise of such Warrants, and agrees to 10 11 keep copies of this Agreement available for inspection by holders of Warrants during normal business hours. Section 13. RESTRICTIONS ON TRANSFER; REGISTRATION RIGHTS. (a) Each holder of a Warrant agrees that prior to making any disposition or transfer of the Warrants or shares issuable upon exercise of the Warrants ("Shares"), unless a registration statement under the Securities Act of 1933, as amended (the "Securities Act"), is in effect with regard thereto and the disposition may be effected in accordance therewith and with applicable state securities laws, the holder shall give written notice to the Company describing briefly the manner in which any such proposed disposition or transfer is to be made; and no such disposition shall be made except pursuant to an exemption from the registration requirements of all applicable federal and state securities laws, with the Company entitled to receive an opinion of counsel (which counsel shall be Kirkland & Ellis or such other counsel reasonably satisfactory to the Company) prior to the effectuation of any such disposition or transfer. (b) Each certificate evidencing the Warrants shall bear a legend in substantially the following form, and each certificate evidencing Shares issuable upon exercise of the Warrants shall bear such a legend until such time as such Shares have been sold pursuant to a registration statement contemplated in subsection (c) below or unless, in the opinion of legal counsel to the Company, such legend is not required in order to establish compliance with any provisions of applicable security laws: THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 OR ANY STATE SECURITIES LAWS AND MAY NOT BE SOLD, EXCHANGED, HYPOTHECATED OR OTHERWISE TRANSFERRED IN ANY MANNER EXCEPT IN COMPLIANCE WITH SECTION 13 OF THE WARRANT AGREEMENT DATED AS OF FEBRUARY 9, 1998, BETWEEN UGLY DUCKLING CORPORATION AND HARRIS TRUST COMPANY OF CALIFORNIA, AS WARRANT AGENT, AS THE SAME MAY BE AMENDED FROM TIME TO TIME. (c) Subject to the next sentence below, whenever during the one-year period beginning on each date that the Warrants issued hereunder become exercisable the Company proposes to file with the Commission a registration statement with respect to equity securities of the Company (other than as to securities issued pursuant to an employee benefit plan or as to a transaction subject to Rule 145 promulgated under the Securities Act or for which a Form S-4 Registration Statement could be used), it shall, at least 30 days prior to such filing, give written notice of such proposed filing to the holders of Warrants then exercisable and Shares which bear a legend as contemplated in Section 13(b) above and which shall not have previously been included in a registration statement filed under this Section 13(c), at their respective addresses as 11 12 they appear on the records of the Warrant Agent or the Company, and shall offer to include and shall include, subject to the provisions of this Section 13(c), in such filing any proposed disposition of such Shares upon receipt by the Company, not less than 10 days prior to the proposed filing date, of a request therefor setting forth the facts with respect to such proposed disposition and all other information with respect to the holders of such Warrants or the Shares requested to be included in such filing as shall be reasonably necessary to be included in such Registration Statement. Notwithstanding the above, after such time as the holders shall have been given two opportunities to include their Shares in a Registration Statement of the Company pursuant to the immediately preceding sentence, and all securities of holders who shall have requested such inclusion in accordance herewith and who have not withdrawn such request prior to the filing of such Registration Statement have been included in such a Registration Statement which shall have become effective and such securities shall have been effectively registered under the Securities Act, the Company will have no further obligation to such holders under this Section 13(c) and the Shares of such holders that have not been included previously in a Registration Statement under this Section 13(c) will have no further registration rights under this Agreement. In the event that (i) the managing underwriter for any such offering advises the Company in writing that the inclusion of such securities in the offering would be detrimental to the offering or (ii) in the event that there is no managing underwriter, if, in the good faith judgment of the Board of Directors of the Company, inclusion of the Shares in the registration would be seriously detrimental to the Company, then, such securities shall not be included in the Registration Statement. In the event that securities requested to be included in an offering are not included in accordance with the immediately preceding sentence, any notice given to holders of Warrants and Shares hereunder with respect to such offering shall not be counted against the limitation provided for in the second sentence of this Section 13(c). (d) All fees, disbursements, and out-of-pocket expenses incurred in connection with the filing of any Registration Statement under Section 13(c) hereof and in complying with applicable securities and Blue Sky laws shall be borne by the Company, provided, however, that any expenses of the holders of the Warrants or the Shares, including but not limited to attorneys' fees and discounts and commissions, shall be borne by such holders. The Company at its expense will supply the holders of the Shares included in a Registration Statement with copies of such Registration Statement and the prospectus or offering circular included therein in such quantities as may be reasonably requested by such holders. (e) Each holder of a Warrant or of Shares to be included in a Registration Statement pursuant to this Section 13 agrees to reasonably cooperate with the Company and to provide the Company on its request with all information concerning such holder and his Warrants and Shares that may reasonably be requested by the Company in order for the Company to perform its obligations under this Section 13. 12 13 Section 14. INDEMNIFICATION. (a) In the event of the filing of any Registration Statement with respect to the Shares pursuant to Section 13 above, the Company agrees to indemnify and hold harmless the holders of such Shares (for purposes of this Section 14, references to any holder of Shares shall refer only to such holders who have agreed to be bound by this Section 14), and each person who controls such holders within the meaning of the Securities Act and such holders' officers, directors, managers, members, partners, and principle equity holders (collectively, "Indemnitees") against all losses, claims, damages, expenses and liabilities, joint or several (which shall, for all purposes of this Agreement, include, but not be limited to, all costs of defense and investigation and all attorneys' fees and expenses), to which such Indemnitees may become subject, under the Securities Act or otherwise, insofar as such losses, claims, damages, expenses or liabilities (or actions in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement of any material fact contained in any such Registration Statement, or any related preliminary prospectus, final prospectus, offering circular, notification or amendment or supplement thereto, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances in which they were made, not misleading; provided, however, that the Company will not be liable in any such case to the extent that any such loss, claim, damage, expenses, or liability arises out of or is based upon an untrue statement or alleged untrue statement or omission or alleged omission made in such Registration Statement, preliminary prospectus, final prospectus, offering circular, notification or amendment or supplement thereto in reliance upon, and in conformity with, written information furnished to the Company by any such holder specifically for use in the preparation thereof and, provided further, that the indemnity agreement provided in this Section 14(a) with respect to any preliminary prospectus shall not inure to the benefit of any holder of Warrants or Shares from whom the person asserting any losses, claims, damages, liabilities or actions based upon any untrue statement or alleged untrue statement of material fact or omission or alleged omission to state therein a material fact purchased Warrants or Shares, if a copy of the prospectus in which such untrue statement or alleged untrue statement or omission or alleged omission was corrected had not been sent or given to such person within the time required by the Securities Act and the rules and regulations thereunder, unless such failure is the result of non-compliance by the Company with the last sentence of Section 13(d) hereof. This indemnity will be in addition to any liability which the Company may otherwise have. (b) Each holder of a Warrant and each holder of a Share agrees that he will indemnify and hold harmless the Company, each other person referred to in subparts (1), (2) and (3) of Section 11(a) of the Securities Act in respect of the Registration Statement, each officer of the Company, and each person who controls the Company within the meaning of the Securities Act, against any losses, claims, damages or liabilities (which shall, for all purposes of this Agreement, include, but not be limited to, all costs of defense and investigation and all attorneys' fees) to which the Company or any such director, officer or controlling person may become subject under the Securities Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions 13 14 in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement of any material fact contained in any such Registration Statement, or any related preliminary prospectus, final prospectus, offering circular, notification or amendment or supplement thereto, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, but in each case only to the extent that such untrue statement or alleged untrue statement or omission or alleged omission was made in such Registration Statement, preliminary prospectus, final prospectus, offering circular, notification or amendment or supplement thereto in reliance upon, and in conformity with, written information furnished to the Company by such holder specifically for use in the preparation thereof. This indemnity will be in addition to any liability which the holder may otherwise have. (c) Promptly after receipt by an indemnified party under this Section 14 of notice of the commencement of any action, such indemnified party will, if a claim in respect thereof is to be made against the indemnifying party under this Section 14, notify the indemnifying party of the commencement thereof. No indemnification provided for in this Section 14 shall be available to any party who shall fail to give the notice to the extent the party to whom such notice was not given was materially prejudiced by the failure to give the notice, but the omission so to notify the indemnifying party will not relieve the indemnifying party or parties from any liability which it may have to any indemnified party for contribution otherwise than as to the particular item as to which indemnification is then being sought solely pursuant to this Section 14. In case any such action is brought against any indemnified party, and it notifies the indemnifying party of the commencement thereof, the indemnifying party will be entitled to participate in, and, to the extent that it may wish, jointly with any other indemnifying party similarly notified, reasonably assume the defense thereof, subject to the provisions herein stated and after notice from the indemnifying party to such indemnified party of its election so to assume the defense thereof, the indemnifying party will not be liable to such indemnified party under this Section 14 for any legal or other expenses subsequently incurred by such indemnified party in connection with the defense thereof other than reasonable costs of investigation unless the indemnifying party shall not pursue the action to its final conclusion. The indemnified party shall have the right to employ separate counsel in any such action and to participate in the defense thereof, but the fees and expenses of such counsel shall not be at the expense of the indemnifying party. No settlement of any action against an indemnified party shall be made without the consent of the indemnifying party, which shall not be unreasonably withheld in light of all factors of importance to such indemnified party. Section 15. MERGER OR CONSOLIDATION OR CHANGE OF NAME OF WARRANT AGENT. (a) Any corporation into which the Warrant Agent may be merged or with which it may be consolidated, or any corporation resulting from any merger or consolidation to which the Warrant Agent shall be a party, or any corporation succeeding to the corporate trust business of the Warrant Agent, shall be the successor to the Warrant Agent hereunder without the execution or filing of any paper or any further act on the part of any of the parties hereto, provided that such 14 15 corporation would be eligible for appointment as a successor Warrant Agent under the provisions of Section 18 of this Agreement. In case at the time such successor to the Warrant Agent shall succeed to the agency created by this Agreement and any of the Warrant certificates shall have been countersigned but not delivered, any such successor to the Warrant Agent may adopt the countersignature of the original Warrant Agent and deliver such Warrant certificates so countersigned; and in case at that time any of the Warrant certificates shall not have been countersigned, any successor to the Warrant Agent may countersign such Warrant certificates either in the name of the predecessor Warrant Agent or in the name of the successor Warrant Agent, and in all such cases the Warrants represented by such Warrant certificates shall have the full force provided in the Warrant certificates and in this Agreement. Any such successor Warrant Agent shall promptly give notice of its succession as Warrant Agent to the Company and to the registered holder of each Warrant certificate. (b) If at any time the name of the Warrant Agent is changed and at such time any of the Warrant certificates have been countersigned but not delivered, the Warrant Agent may adopt the countersignature under its prior name and deliver Warrant certificates so countersigned; and if at that time any of the Warrant certificates have not been countersigned, the Warrant Agent may countersign such Warrant certificates either in its prior name or in its changed name; and in all such cases the Warrants represented by such Warrant certificates will have the full force provided in the Warrant certificates and in this Agreement. Section 16. CONCERNING THE WARRANT AGENT. The Company agrees to pay to the Warrant Agent reasonable compensation for all services rendered by it hereunder and, from time to time, on demand of the Warrant Agent, its reasonable expenses and counsel fees and other disbursements incurred in the administration and execution of this Agreement and the exercise and performance of its duties hereunder. The Company also agrees to indemnify the Warrant Agent, and its officers, agents and directors for, and to hold each of them harmless against, any loss, liability, or expense incurred without negligence or willful misconduct on the part of the Warrant Agent, for anything done or omitted by the Warrant Agent or such indemnified party in connection with the acceptance or administration of this Agreement or the exercise or performance of its duties hereunder, including the costs and expenses of defending against any claim of liability in the premises. The indemnification provided for hereunder shall survive the expiration of the Warrant, the termination of this Agreement and the resignation or removal of the Warrant Agent. The costs and expenses of enforcing this right of indemnification shall also be paid by the Company. The Warrant Agent may conclusively rely upon and shall be protected by the Company and shall incur no liability for, or in respect of any action taken, suffered or omitted by it in connection with, its administration of this Agreement or the exercise or performance of its duties hereunder in reliance upon any Warrant certificate or certificate for the Common Stock or for other securities of the Company, instrument of assignment or transfer, power of attorney, endorsement, affidavit, letter, notice, direction, consent, certificate, statement, or other paper or document believed by it to be genuine and to be signed, executed and, where necessary, verified 15 16 or acknowledged, by the proper person or persons, or otherwise upon the advice of counsel as set forth herein. Notwithstanding anything in this Agreement to the contrary, in no event shall the Warrant Agent be liable for special, indirect or consequential loss or damage of any kind whatsoever (including but not limited to lost profits), even if the Warrant Agent has been advised of the likelihood of such loss or damage and regardless of the form of the action. Section 17. DUTIES OF WARRANT AGENT. The Warrant Agent undertakes the duties and obligations expressly imposed by this Agreement, and no implied duties or obligations shall be read into this Agreement against the Warrant Agent, upon the following terms and conditions, by all of which the Company and the holders of Warrant certificates, by their acceptance thereof, shall be bound: (a) Before the Warrant Agent acts or refrains from acting, the Warrant Agent may consult with legal counsel (who may be legal counsel for the Company) and the opinion of such counsel shall be full and complete authorization and protection to the Warrant Agent as to any action taken or omitted by it in good faith and in accordance with such opinion. (b) Whenever in the performance of its duties under this Agreement the Warrant Agent shall deem it necessary or desirable that any fact or factual matter be proved or established by the Company prior to taking or suffering any action hereunder, such fact or matter (unless other evidence in respect thereof be herein specifically prescribed) may be deemed to be conclusively proved and established by a certificate signed by any person believed in good faith by the Warrant Agent to be one of the Chairman of the Board, the Chief Executive Officer, the President, any Vice President, the Treasurer or the Secretary of the Company and delivered to the Warrant Agent; and such certificate shall be full authorization to the Warrant Agent for any action taken or suffered in good faith by it under the provisions of this Agreement in reliance upon such certificate. (c) The Warrant Agent shall be liable hereunder to the Company and any other Person only for its own negligence, bad faith or wilful misconduct. (d) The Warrant Agent shall not be liable for or by reason of any of the statements of fact or recitals contained in this Agreement or in the Warrant certificates (except its countersignature thereof) or be required to verify the same, but all such statements and recitals are and shall be deemed to have been made by the Company only. (e) The Warrant Agent is serving as an administrative agent and, accordingly, shall not be under any responsibility in respect of the validity of any provision of this Agreement or the execution and delivery hereof (except the due execution hereof by the Warrant Agent) or in respect of the validity or execution of any Warrant certificate (except its countersignature thereof); nor shall it be responsible for any breach by the Company of any covenant or condition 16 17 contained in this Agreement or in any Warrant certificate; nor shall it be responsible for any change in the exercisability of the Warrant (including the Warrant becoming void) or any adjustment in the terms of the Warrant (including the manner, method or amount thereof) provided for herein, or the ascertaining of the existence of facts that would require any such change or adjustment (except with respect to the exercise of any Warrant evidenced by a Warrant certificate after actual notice to the Warrant Agent that such change or adjustment is required); nor shall it by any act hereunder be deemed to make any representation or warranty as to the authorization or reservation of any shares of Common stock to be issued pursuant to this Agreement or any Warrant certificate or as to whether any shares of Common stock will, when issued, be validly authorized and issued, fully paid and nonassessable. (f) The Company agrees that it will perform, execute, acknowledge and deliver or cause to be performed, executed, acknowledged and delivered all such further and other acts, instruments and assurances as may reasonably be required by the Warrant Agent for the carrying out or performing by the Warrant Agent of the provisions of this Agreement. (g) The Warrant Agent is hereby authorized and directed to accept instructions with respect to the performance of its duties hereunder from any person believed in good faith by the Warrant Agent to be one of the Chairman of the Board, the Chief Executive Officer, the President, any Vice President, the Treasurer, or the Secretary of the Company, and to apply to such officers for advice or instructions in connection with its duties, and it shall not be liable for any action taken or suffered by it in good faith in accordance with instructions of any such officer of for any delay in acting while waiting for those instructions. Any application by the Warrant Agent for written instructions from the Company may, at the option of the Warrant Agent, set forth in writing any action proposed to be taken or omitted by the Warrant Agent under this Agreement and the date on or after which such action shall be taken or such omission shall be effective. The Warrant Agent shall not be liable for any action taken by, or omission of, the Warrant Agent in accordance with a proposal included in any such application on or after the date specified in such application (which date shall not be less than ten Business Days after the date any officer of the Company actually receives such application, unless any such officer shall have consented in writing to an earlier date) unless, prior to taking any such action (or the effective date in the case of an omission), the Warrant Agent shall have received written instructions in response to such application subject to the proposed action or omission and/or specifying the action to be taken or omitted. (h) Subject to applicable law, the Warrant Agent and any stockholder, director, officer or employee of the Warrant Agent may buy, sell or deal in any of the Warrants or other securities of the Company or become pecuniarily interested in any transaction in which the Company may be interested, or contract with or lend money to the Company or otherwise act as fully and freely as though it were not Warrant Agent under this Agreement. Nothing herein shall preclude the Warrant Agent from acting in any other capacity for the Company or for any other legal entity. 17 18 (i) The Warrant Agent may execute and exercise any of the rights or powers hereby vested in it or perform any duty hereunder either itself or by or through its attorneys or agents, and the Warrant Agent shall not be answerable or accountable for any act, default, neglect or misconduct of any such attorneys or agents or for any loss to the Company resulting from any such act, default, neglect or misconduct, provided that reasonable care was exercised in the selection and continued employment thereof. (j) No provision of this Agreement shall require the Warrant Agent to expend or risk its own funds or otherwise incur any financial liability in the performance of any of its duties hereunder or in the exercise of its rights if there shall be reasonable grounds for believing that repayment of such funds or adequate indemnification against such risk or liability is not reasonably assured to it. (k) The Warrant Agent shall not be required to take notice or be deemed to have notice of any fact, event or determination (including, without limitation, any dates or events defined in this Agreement) under this Agreement unless and until the Warrant Agent shall be specifically notified in writing by the Company of such fact, event or determination. Section 18. CHANGE OF WARRANT AGENT. The Warrant Agent may resign and be discharged from its duties under this Agreement by giving the Company at least 30 days prior notice in writing, and by mailing notice in writing to the registered holders at the expense of the Company at their addresses appearing on the Warrant Register, of such resignation, at least 15 days prior to the date such resignation shall take effect and specifying a date when such resignation shall take effect. The Warrant Agent may be removed by like notice to the Warrant Agent from the Company and by like mailing of notice to the registered holders of the Warrants. If the Warrant Agent resigns or is removed or otherwise becomes incapable of acting, the Company shall appoint a successor to the Warrant Agent. If the Company fails to make such appointment within 30 days after such removal or after it has been notified in writing of such resignation or incapacity by the resigning or incapacitated Warrant Agent or by the registered holder of a Warrant (who shall, with such notice, submit his Warrant certificate for inspection by the Company), then the Warrant Agent or the registered holder of any Warrant may, at the expense of the Company, apply to any court of competent jurisdiction for the appointment of a successor to the Warrant Agent. Pending appointment of a successor to the Warrant Agent, either by the Company or such a court, the Company shall carry out the duties of the Warrant Agent. Any successor Warrant Agent, whether appointed by the Company or by such a court, must be registered and otherwise authorized to serve as a transfer agent pursuant to the Securities Exchange Act of 1934, as amended. If at any time the Warrant Agent ceases to be eligible in accordance with the provisions of this Section 18, it will resign immediately in the manner and with the effect specified in this Section 18. After acceptance in writing of the appointment, the successor Warrant Agent will be vested with the same powers, rights, duties and responsibilities as if it had been originally named as Warrant Agent without further act or deed; but the former Warrant Agent will deliver and transfer to the successor Warrant Agent any property at the time held by it hereunder, and execute and deliver any further assurance, conveyance, act or deed 18 19 necessary for this purpose. Upon request of any successor Warrant Agent, the Company will make, execute, acknowledge and deliver any and all instruments in writing for more fully and effectually vesting in and confirming to such successor Warrant Agent all such powers, rights, duties and responsibilities. Failure to file or mail any notice provided in this Section 18, however, or any defect therein, will not affect the legality or validity of the resignation or removal of the Warrant Agent or the appointment of the successor Warrant Agent, as the case may be. Section 19. IDENTITY OF TRANSFER AGENT. Following the appointment of any transfer agent for the Common Stock or of any subsequent transfer agent for shares of the Common Stock or other shares of the Company's capital stock issuable upon the exercise of the rights of purchase represented by the Warrants, the Company will file with the Warrant Agent a statement setting forth the name and address of such transfer agent. Section 20. NOTICES. Notices or demands authorized by this Agreement to be given or made by the Warrant Agent or by the holder of any Warrant certificate to or on the Company shall be sufficiently given or made if sent by registered or certified mail, addressed (until another address is filed in writing with the Warrant Agent) as follows (and shall be deemed given upon receipt): Ugly Duckling Corporation 2525 East Camelback Road Suite 1150 Phoenix, Arizona 85016 Attention: Steven P. Johnson, Senior Vice President, General Counsel and Secretary With a copy to: Steven D. Pidgeon Snell & Wilmer L.L.P. One Arizona Center Phoenix, Arizona 85004-0001 19 20 Notices or demands authorized by this Agreement to be given or made by the Company or by the holder of any Warrant certificate to or on the Warrant Agent shall be sent by registered or certified mail, addressed (until another address is filed in writing with the Company) as follows (and shall be deemed given upon receipt): Harris Trust Company of California 601 South Figueroa 49th Floor Los Angeles, CA 90017 Attention: Neil Rosso, Corporate Trust Notices or demands authorized by this Agreement to be given or made by the Company or the Warrant Agent to the holder of any Warrant certificate shall be sufficiently given or made if sent by first class mail, postage prepaid, addressed to such holder at the address of such holder as shown in the Warrant Register. The Company shall deliver a copy of any notice or demand it delivers to the holder of any Warrant certificate to the Warrant Agent. Section 21. SUPPLEMENTS AND AMENDMENTS. The Company and the Warrant Agent may from time to time supplement or amend this Agreement without the approval of any holders of Warrants in order to cure any ambiguity or to correct or supplement any provision contained herein which may be defective or inconsistent with any other provision herein, or to make any other provisions in regard to matters or questions arising hereunder which the Company and the Warrant Agent may deem necessary or desirable and which shall not be inconsistent with the provisions of the Warrants, or which shall not adversely affect the interests of the holders of Warrants (including reducing the Warrant Price or extending the redemption or expiration date). In any situation in which this Agreement cannot be amended pursuant to the next sentence above, this Agreement may be amended by the Company, the Warrant Agent and the holder or holders of a majority of the outstanding Warrants representing a majority of the shares of Common Stock underlying such Warrants; provided, however, that without the consent of each holder of a Warrant, there can be no increase of the Warrant Price or reduction of the exercise period for such holder's Warrants and provided, further, that no such supplement or amendment may affect the rights or duties of the Warrant Agent under this Agreement without the written consent of the Warrant Agent. Notwithstanding anything in this Agreement to the contrary, no supplement or amendment that changes the rights and duties of the Warrant Agent under this Agreement shall be effective against the Warrant Agent without the execution of such supplement or amendment by the Warrant Agent. Section 22. SUCCESSORS. All the covenants and provisions of this Agreement by or for the benefit of the Company, or the Warrant Agent or the registered holders of the Warrants will bind and inure to the benefit of their respective successors and assigns hereunder. Section 23. GOVERNING LAW. This Agreement will be deemed to be a contract made under the laws of the State of Arizona and for all purposes will be construed in accordance with 20 21 the laws of said State, except as to Sections 16, 17 and 21, which shall be governed by and construed in accordance with the laws of the State of Illinois. Each holder of a Warrant by its acceptance thereof agrees to submit to the jurisdiction of a court of competent jurisdiction in the State of Arizona, but to the State of Illinois as to Sections 16, 17 and 21, for the purpose of resolving any disputes arising with respect to the rights and obligations of the Warrant Agent. Section 24. BENEFITS OF THIS AGREEMENT. Nothing in this Agreement will be construed to give to any person or corporation other than the Company, the Warrant Agent and the registered holders of the Warrants any legal or equitable right, remedy or claim under this Agreement. This Agreement is for the sole and exclusive benefit of the Company, the Warrant Agent and the registered holders of the Warrants. Section 25. COUNTERPARTS. This Agreement may be executed in counterparts and each of such counterparts will for all purposes be deemed to be an original, and all such counterparts will together constitute but one and the same instrument. Section 26. DESCRIPTIVE HEADINGS. The descriptive headings of the several Sections of this Agreement are inserted for convenience only and do not control or affect the meaning or construction of any of the provisions hereof. IN WITNESS WHEREOF, the parties have caused this Agreement to be duly executed, as of the day and year first above written. UGLY DUCKLING CORPORATION By: /s/ Steven P. Johnson ------------------------------------ Name: Steven P. Johnson ------------------------------------ Its: Sr. V.P. & Secretary ------------------------------------ RELIANCE ACCEPTANCE GROUP, INC. By: /s/ James T. Moran ------------------------------------ Name: James T. Moran ------------------------------------ Its: President & CEO ------------------------------------ 21 22 HARRIS TRUST COMPANY OF CALIFORNIA, AS WARRANT AGENT By: /s/ Neil T. Rosso --------------------------------- Name: Neil T. Rosso ------------------------------- Its: Asst. V.P. -------------------------------- 22 23 Warrant No. ___ EXHIBIT A WARRANT TO PURCHASE ________ SHARES OF COMMON STOCK VOID AFTER 5:00 P.M., NEW YORK CITY TIME, ON ___________ ___, _____ UGLY DUCKLING CORPORATION This certifies that, for value received ________________________, the registered holder hereof or assigns (the "Holder"), is entitled to purchase from UGLY DUCKLING CORPORATION, a Delaware corporation (the "Company"), at any time after ________ ___, ______ and before 5:00 p.m., New York City time, on _______________ ___, _____ at the purchase price per share of $___ (the "Warrant Price"), the number of shares of Common Stock, par value $0.001 per share, of the Company set forth above (the "Shares"). The number of shares of Common Stock purchasable upon exercise of the Warrant evidenced hereby and the Warrant Price is subject to adjustment from time to time as set forth in the Warrant Agreement referred to below. The Warrants evidenced hereby may be exercised during the period referred to above, in whole or in part, by presentation of this Warrant certificate with the Purchase Form attached hereto duly executed and guaranteed and simultaneous payment of the Warrant Price (as defined in the Warrant Agreement and subject to adjustment as provided therein) at the principal office in Los Angeles, California, of Harris Trust Company of California (the "Warrant Agent"). Payment of such price may be made at the option of the Holder in cash or by certified check or bank draft or pursuant to a cashless exercise, all as provided in the Warrant Agreement. The Warrants evidenced hereby are part of a duly authorized issue of Warrants and are issued under and in accordance with the Warrant Agreement dated as of February 9, 1998, between the Company and the Warrant Agent, and are subject to the terms and provisions contained in such Warrant Agreement, which Warrant Agreement is hereby incorporated by reference herein and made a part hereof and is hereby referred to for a description of the rights, limitations, duties and indemnities thereunder of the Company and the Holder of the Warrants, and to all of which the Holder of this Warrant certificate by acceptance hereof consents. A copy of the Warrant Agreement may be obtained for inspection by the Holder hereof upon written request to the Warrant Agent. Upon any partial exercise of the Warrants evidenced hereby, there will be issued to the Holder a new Warrant certificate in respect of the Shares evidenced hereby that have not been exercised. This Warrant certificate may be exchanged at the office of the Warrant Agent by 1 24 surrender of this Warrant certificate properly endorsed either separately or in combination with one or more other Warrants for one or more new Warrants to purchase the same aggregate number of Shares as evidenced by the Warrant or Warrants exchanged. No fractional Shares will be issued upon the exercise of rights to purchase hereunder, but the Company will pay the cash value of any fraction upon the exercise of one or more Warrants, as provided in the Warrant Agreement. The Warrant Price and the number of shares of Common Stock issuable upon exercise of this Warrant is subject to adjustment as provided in Section 9 of the Warrant Agreement. The Warrant Agreement may be amended by the Company and the Warrant Agent in certain limited events and by the holder or holders of a majority of the outstanding Warrants representing a majority of the shares of Common Stock underlying such Warrants; provided that without the consent of each holder of a Warrant certain specified changes cannot be made to such holder's Warrants and no amendment may affect the rights and duties of the Warrant Agent without the consent of the Warrant Agent. Pursuant to the Warrant Agreement, by acceptance of a Warrant, each holder consents to the jurisdiction of a court of competent jurisdiction in the State of Arizona for the purpose of resolving any disputes arising with respect to the Warrants or the Warrant Agreement. The Holder hereof may be treated by the Company, the Warrant Agent and all other persons dealing with this Warrant certificate as the absolute owner hereof for all purposes and as the person entitled to exercise the rights represented hereby, any notice to the contrary notwithstanding, and until any transfer is entered on such books, the Company may treat the Holder hereof as the owner for all purposes. Notices and demands to be given to the Company or the Warrant Agent must be given by certified or registered mail at the addresses provided in the Warrant Agreement. All terms used in the Warrant Certificate that are defined in the Warrant Agreement shall have the respective meanings ascribed to such terms in the Warrant Agreement. Dated:________________ UGLY DUCKLING CORPORATION By:__________________________________ President ATTEST: _____________________________ Secretary 2 25 This is one of the Warrants referred to in the within mentioned Warrant Agreement. HARRIS TRUST COMPANY OF CALIFORNIA By:__________________________________ Authorized Representative 3 26 UGLY DUCKLING CORPORATION PURCHASE FORM Mailing Address: UGLY DUCKLING CORPORATION 2525 East Camelback Road Suite 1150 Phoenix, Arizona 85016 The undersigned hereby irrevocably elects to exercise the right of purchase represented by the within Warrant certificate for, and to purchase thereunder, _____________Shares of Common Stock provided for therein, and requests that certificates for such Shares be issued in the name of: ________________________________________________________________________________ ________________________________________________________________________________ (Please Print or Type Name, Address and Social Security Number) and that such certificates be delivered to ____________________________________ whose address is _______________________________________________________________ and, if said number of Shares shall not be all the Shares purchasable hereunder, that a new Warrant certificate for the balance of the Shares purchasable under the within Warrant certificate be registered in the name of the undersigned Holder or his or her Assignee as below indicated and delivered to the address stated below. Dated:_____________________ Name of Holder or Assignee: ________________________________________________________________________________ (Please Print) Address:________________________________________________________________________ ________________________________________________________________________________ Signature: __________________________________ NOTE: The above signature must correspond with the name as it appears upon the face of the within Warrant certificate in every particular, without alteration or enlargement or any change whatever, unless these Warrants have been assigned. Signature Guaranteed: __________________________________ THE SIGNATURE(S) SHOULD BE GUARANTEED BY AN ELIGIBLE GUARANTOR INSTITUTION (Banks, Stock Brokers, Savings and Loan Association, and Credit Unions) WITH MEMBERSHIP IN AN APPROVED SIGNATURE GUARANTEE MEDALLION PROGRAM PURSUANT TO S.E.C. RULE 17Ad-15. 27 ASSIGNMENT (To be signed only upon assignment of Warrants) FOR VALUE RECEIVED, the undersigned hereby sells, assigns and transfers unto _______________________________________________________________________________ (Name and Address of Assignee Must Be Printed or Typewritten) _______________________________________________________________________________ ______________ Warrants, hereby irrevocably constituting and appointing _______ Attorney to transfer said Warrants on the books of the Company, with full power of substitution in the premises. Dated:_______________________ _____________________________________ Signature of Registered Holder Note: The signature on this assignment must correspond with the name as it appears upon the face of the within Warrant certificate in every particular, without alteration or enlargement or any change whatever. Signature Guaranteed: ______________________________ THE SIGNATURE(S) SHOULD BE GUARANTEED BY AN ELIGIBLE GUARANTOR INSTITUTION (Banks, Stock Brokers, Savings and Loan Association, and Credit Unions) WITH MEMBERSHIP IN AN APPROVED SIGNATURE GUARANTEE MEDALLION PROGRAM PURSUANT TO S.E.C. RULE 17Ad-15. 5 28 EXHIBIT B The number of Warrants set forth below will be issuable upon satisfaction of the conditions set forth below and will be issued as soon as practicable after such conditions have been satisfied. (1) 50,000 Warrants to be issued as of February 9, 1998, subject to the receipt by the Company, Champion Acceptance Corporation ("CAC"), or another subsidiary or affiliate of the Company of $1.3 million in proceeds realized by Reliance from the sale of the pool of Charged-Off Receivables existing as of the Petition Date; (2) an additional 100,000 Warrants upon the receipt by the Company, CAC, or another subsidiary or affiliate of the Company of $4.7 million of post-Bank Claim Satisfaction Date Cash Flow from the Receivables Portfolio and in the event that less than $4.7 million of such post-Bank Claim Satisfaction Date Cash Flow is received, a number of Warrants corresponding pro-rata to the proportionate amount of such post-Bank Claim Satisfaction Date Cash Flow received, in increments of not less than $940,000 to be issued as of the last day of each quarter(1); and (3) an additional 75,000 Warrants for every $1 million actually received by the Company, CAC, or another subsidiary or affiliate of the Company on account of its Incentive Fee. For purposes of the above, the capitalized terms shall have the meanings ascribed to them in Reliance's Joint Plan of Reorganization dated February 9, 1998, as amended. - ---------- (1) The following is an example of the issuance of Warrants pursuant to paragraph (2) above. Assume $940,000 of post-Bank Claim Satisfaction Date Cash Flow has been received by the Company from the Receivables Portfolio by the end of the first quarter following the Petition Date. The Company must issue 20,000 Warrants to Reliance [($940,000 / $4,700,000) x 100,000] = 20,000. Assume an additional $900,000 is received by the end of the second quarter following the Petition Date, for a total of $1,840,000. No additional Warrants would be required to be issued because receipts had not reached the second increment of at least $940,000. Assume an additional $500,000 (in addition to the $1,840,000 received previously) is received by the end of the third quarter following the Petition Date, for a total of $2,340,000. The Company must issue 29,787 additional Warrants to Reliance [($2,340,000 / $4,700,000) x 100,000] = 49,787.23, which is then rounded to 49,787, less the 20,000 Warrants previously issued = 29,787 additional Warrants. 1 EX-10.1 3 EX-10.1 1 Exhibit 10.1 CREDIT AND SECURITY AGREEMENT DATED AS OF JULY 17, 1997 BY AND BETWEEN UGLY DUCKLING CORPORATION, A DELAWARE CORPORATION ("LENDER") AND FIRST MERCHANTS ACCEPTANCE CORPORATION, A DELAWARE CORPORATION ("BORROWER") $10,000,000.00 REVOLVING CREDIT FACILITY Lotsted\PHX\368160.10 2 TABLE OF CONTENTS Page ARTICLE I DEFINITIONS..........................................................1 1.1 Defined Terms...............................................1 1.2 Other Interpretive Provisions..............................10 1.3 Accounting Principles......................................11 1.4 Times......................................................12 ARTICLE II THE COMMITMENT......................................................12 2.1 Commitment.................................................12 2.2 Procedure for Advances.....................................12 2.3 Repayment and Mandatory Prepayment.........................12 2.4 Interest Rate..............................................13 2.5 Commitment Fee.............................................13 2.6 Computation of Fees and Interest...........................13 2.7 Payments by Borrower.......................................13 2.8 Maturity Date..............................................14 ARTICLE III SECURITY AGREEMENT AND COLLATERAL...................................14 3.1 Security for Obligations...................................14 3.2 Security Documents.........................................14 3.3 Lender's Duty Regarding Collateral.........................14 3.4 Borrower's Duties Regarding Collateral.....................14 3.5 Power of Attorney..........................................15 3.6 Collateral Inspections.....................................16 3.7 Return of Contract Delivery Documents. ....................16 ARTICLE IV CONDITIONS PRECEDENT; TERM OF AGREEMENT.............................16 4.1 Conditions Precedent to the Initial Advance................16 4.2 Conditions Precedent to Subsequent Advances................17 4.3 Term.......................................................17 4.4 Effect of Termination......................................17 4.5 Early Termination by Borrower..............................18 ARTICLE V REPRESENTATIONS AND WARRANTIES......................................18 5.1 No Encumbrances............................................18 5.2 Equipment..................................................18 5.3 Location of Inventory and Equipment........................18 i 3 5.4 Location of Chief Executive Office; FEIN...................18 5.5 Due Organization and Qualification; Subsidiaries...........18 5.6 Due Authorization; No Conflict.............................19 5.7 Litigation.................................................19 5.8 No Material Adverse Change.................................19 5.9 ERISA......................................................20 5.10 Environmental and Safety Matters...........................20 ARTICLE VI AFFIRMATIVE COVENANTS...............................................20 6.1 Financial Statements.......................................20 6.2 Inspection of Property.....................................21 6.3 Maintenance of Insurance...................................21 6.4 Default Disclosure.........................................21 6.5 Notices to Lender..........................................21 6.6 Books and Records..........................................22 6.7 Compliance and Preservation................................22 6.8 Perfection of Liens........................................22 6.9 Cooperation................................................22 ARTICLE VII NEGATIVE COVENANTS..................................................22 7.1 Indebtedness...............................................22 7.2 Liens......................................................23 7.3 Restrictions on Fundamental Changes........................23 7.4 Disposal of Assets.........................................23 7.5 Change Name................................................23 7.6 Guarantee..................................................23 7.7 Nature of Business.........................................23 7.8 Prepayments and Amendments.................................23 7.9 Change of Control..........................................24 7.10 Consignments...............................................24 7.11 Distributions..............................................24 7.12 Accounting Methods.........................................24 7.13 Investments................................................24 7.14 Transactions with Affiliates...............................24 7.15 Compensation...............................................24 7.16 Use of Proceeds............................................24 7.17 Change in Location of Chief Executive Office...............25 7.18 No Prohibited Transactions Under ERISA.....................25 ARTICLE VIII EVENTS OF DEFAULT/REMEDIES..........................................25 8.1 Event of Default...........................................25 8.2 Lender's Rights and Remedies...............................27 ii 4 ARTICLE IX MISCELLANEOUS.......................................................28 9.1 Amendments and Waivers.....................................28 9.2 Notices....................................................28 9.3 No Waiver: Cumulative Remedies.............................29 9.4 Costs and Expenses.........................................29 9.5 Indemnity..................................................30 9.6 Marshaling: Payments Set Aside............................30 9.7 Successors and Assigns.....................................30 9.8 Set-off....................................................30 9.9 Counterparts...............................................31 9.10 Severability...............................................31 9.11 No Third Parties Benefited.................................31 9.12 Time.......................................................31 9.13 Governing Law and Jurisdiction.............................31 9.14 Entire Agreement...........................................32 9.15 Interpretation.............................................32 9.16 Assignment.................................................32 9.17 Revival and Reinstatement of Obligations...................32 9.18 No Purchase of Contracts/Servicing.........................32 iii 5 SCHEDULES AND EXHIBITS [SCHEDULES & EXHIBITS NOT INCLUDED WITH THE EDGAR FILING WITH THE SEC.] SCHEDULE A The Interim Order SCHEDULE B Inventory Locations SCHEDULE C Borrower's Subsidiaries SCHEDULE D Warrants, Options, etc. SCHEDULE E Litigation EXHIBIT A Exhibit A to the Financing Statement(s) iv 6 CREDIT AND SECURITY AGREEMENT This CREDIT AND SECURITY AGREEMENT (the "Agreement"), is entered into as of July 17, 1997, between UGLY DUCKLING CORPORATION, a Delaware corporation ("Lender"), with a place of business located at 2525 East Camelback Road, Suite 1150, Phoenix, Arizona 85016, and FIRST MERCHANTS ACCEPTANCE CORPORATION, a Delaware corporation, the debtor and debtor-in-possession in the Reorganization Case ("Borrower") with a principal place of business located at 570 Lake Cook Road, Suite 126, Deerfield, Illinois 60015. Lender has agreed to make available to Borrower a revolving credit facility (the "Loan") upon the terms and conditions set forth in this Agreement. NOW, THEREFORE, in consideration of the mutual agreements, provisions and covenants contained herein, the parties agree as follows: ARTICLE I DEFINITIONS 1.1 Defined Terms. In addition to the terms defined elsewhere in this Agreement, the following terms have the following meanings: "Acceptable Plan" means a Chapter 11 plan of reorganization for Borrower that (i) has been approved by Lender or (ii) provides for payment in full in cash of the Obligations on the effective date of such plan. "Accounts" means all currently existing and hereafter arising accounts, accounts receivable, contract rights, chattel paper, rights in and to motor vehicle installment sales agreements and/or contracts, and all other forms of obligations owing to Borrower and any and all proceeds therefrom. "Advance" means the advance of monies by Lender on the Commitment. "Affiliate" means, as to any Person, any other Person which, directly or indirectly, is in control of, is controlled by, or is under common control with, such Person. A Person shall be deemed to control another Person if the controlling Person possesses, directly or indirectly, the power to direct or cause the direction of the management and policies of the other Person, whether through the ownership of voting securities, by contract or otherwise. Without limitation, any director, executive officer or beneficial owner of five percent (5%) or more of the equity of a Person shall for the purposes of this Agreement, be deemed to control the other Person. In no event shall Lender be deemed an "Affiliate" of Borrower. "Agreement" means this Credit and Security Agreement, as amended, supplemented or modified from time to time in accordance with the terms hereof. "Asset Disposition" means any sale, exchange, or other disposition, directly or indirectly (including any loss, destruction, or condemnation), of any of the properties or assets of Borrower. 1 7 "Attorney Costs" means and includes all fees and disbursements of any law firm or other external counsel. "Authorized Person" means the President, any Vice Presidents, Chief Financial Officer or Treasurer of Borrower. "Bankruptcy Code" means the United States Bankruptcy Code (11 U.S.C. Section 101 et seq.), as amended, and any successor statute. "Bankruptcy Court" means either (i) the United States Bankruptcy Court for the District of Delaware or (ii) the United States District Court for the District of Delaware, while acting pursuant to the grant of federal jurisdiction under 28 U.S.C. Sections 1334 and/or 157. "Bankruptcy Recoveries" means all actions, causes of action, and proceeds thereof arising or related to the assertion by Debtor, or its successor(s) of any claims under Sections 365, 544, 547, 548, 549, 550, 551, or 553(b) of the Bankruptcy Code. "Borrower's Books" means all of Borrower's books and records including: ledgers; records indicating, summarizing, or evidencing Borrower's properties or assets (including the Collateral and the assets of any Subsidiaries of Borrower) or liabilities; all information relating to Borrower's business operations or financial condition; and all computer programs, disk or tape files, printouts, runs, or other computer prepared information. "Business Day" means any day other than a Saturday, Sunday or national holiday. "CERCLA" shall mean the Comprehensive Environmental Response, Compensation and Liability Act (49 U.S.C. Section 9601, et seq.). "Certificate of Title" shall mean, with respect to a motor vehicle underlying a Contract, the certificate of title (or other evidence of ownership) issued by the Department of Motor Vehicles, or other appropriate governmental body, of the state in which such vehicle is to be registered, showing the obligor as owner, with either notation of Borrower's first lien or such other status indicated thereon which is necessary to perfect Borrower's security interest in the vehicle as a first priority interest, and showing no other actual or possible lien interest in the vehicle. "Change of Control" shall be deemed to have occurred at such time as a "person" or "group" (within the meaning of Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934) becomes the "beneficial owner" (as defined in Rule 13d3 under the Securities Exchange Act of 1934), directly or indirectly, of more than 10% of the total voting power of all classes of stock then outstanding of Borrower entitled to vote in the election of directors. "Closing Date" means the date on which all conditions precedent set forth in Section 4.1 are either satisfied or waived by Lender. "Code" means the Internal Revenue Code of 1986, as amended, and any regulations promulgated thereunder. "Collateral" means each of the following: (a) the Accounts, 2 8 (b) Borrower's Books, (c) the Equipment, (d) the General Intangibles, (e) the Inventory, (f) the Negotiable Collateral, (g) the Contracts, (h) the New Contracts, but only to the extent that a court determines that Lender's purchase of such New Contracts does not constitute a true sale of the New Contracts, (i) any real property owned by Borrower, (j) any and all assets, tangible and intangible belonging to an Affiliate of Borrower, which is subsequently consolidated with Borrower or Borrower's Bankruptcy estate, (k) tax refunds to which Borrower is, or may be entitled, (l) any money, or other assets of Borrower that now or hereafter come into the possession, custody, or control of either Borrower or Lender, except any Bankruptcy Recoveries, and (m) the proceeds and products, whether tangible or intangible, of any of the foregoing, including proceeds of insurance covering any or all of the Collateral, and any and all Accounts, Borrower's Books, Equipment, General Intangibles, Inventory, Negotiable Collateral, money, deposit accounts, or other tangible or intangible property resulting from the sale, exchange, collection, or other disposition of any of the foregoing, or any portion thereof or interest therein, and the proceeds thereof. "Commitment" means the commitment of Lender to extend a revolving line of credit in the Commitment Amount. "Commitment Amount" means the maximum principal amount of Ten Million and No/100 Dollars ($10,000,000). "Commitment Fee" means the amount of Five Hundred Thousand and No/100 Dollars ($500,000). "Contracts" means any and all installment sale agreements, chattel paper or other deferred payment obligations and all documents, instruments and agreements relating thereto, now existing or owned or hereafter arising or acquired by Debtor, together with all Related Security and all payments and other proceeds arising therefrom. "Contract Delivery Documents" shall mean, with respect to each Contract and the underlying motor vehicle, the original Certificate of Title, and the original executed Contract with the original Obligor and Dealer signatures, and bearing on its front and back surface an assignment to Lender. 3 9 "Contracts Purchase Agreement" means that certain Contracts Purchase Agreement, if any, by and between Borrower, as seller, and Lender, as buyer, the terms of which shall be approved by the Final Order. "Dealer" means a dealer that has sold a motor vehicle to an Obligor pursuant to a Contract. "Dealer Agreement" means an agreement between Borrower and a Dealer that governs the sale or assignment of Contracts from such Dealer to Borrower, including any provisions for assignment (whether without recourse, with recourse, with a repurchase obligation by the Dealer or with a guaranty by such Dealer) contained in such Contracts and Related Security with respect thereto. "Dealer Assignment" means a written assignment of a Contract by a Dealer to Borrower. "Debt" or "Indebtedness" means (i) indebtedness for borrowed money, (ii) obligations evidenced by bonds, debentures, notes, matured reimbursable obligations under letters of credit or other similar instruments, (iii) obligations to pay the deferred purchase price of property or services other than trade payables incurred in the ordinary course of business, (iv) obligations as lessee under leases that shall have been or should be, in accordance with GAAP recorded as capital leases, (v) obligations under direct or indirect guaranties in respect of, and obligations (contingent or otherwise) to purchase or otherwise acquire, or otherwise to assure a creditor against loss in respect of, indebtedness or obligations of others of the kinds referred to in clauses (i) through (iv), and (vi) liabilities in respect of unfunded vested benefits under Pension Plans covered by Title IV of ERISA. "Default" means any event or circumstance which, with the giving of notice, the lapse of time, or both, would (if not cured or otherwise remedied) constitute an Event of Default. "Designated Account" means an account of Borrower, authorized and established pursuant to the Bankruptcy Code, maintained with Borrower's Designated Account Bank. "Designated Account Bank" means a Bank, at which Borrower shall establish the Designated Account and whose address and ABA number shall be promptly supplied to Lender upon the opening of the Designated Account. "Dollars", "dollars" and "$" each mean lawful money of the United States. "Environmental and Safety Laws" means all Federal, state and local laws, regulations and ordinances, relating to the discharge, handling, disposition or treatment of Hazardous Materials and other substances or the protection of the environment or of employee health and safety, including, without limitation, CERCLA, the Hazardous Materials Transportation Act (49 U.S.C. Section 1801, et seq.), the Resource Conservation and Recovery Act (42 U.S.C. Section 7401, et seq.), the Clean Air Act (42 U.S.C. Section 7401, et seq.), the Toxic Substances Control Act (15 U.S.C. Section 2601, et seq.), the Occupational Safety and Health Act (29 U.S.C. Section 651, et seq.) and the Emergency Planning and Community Right-To-Know Act (42 U.S.C. Section 11001, et seq.), each as the same may be amended and supplemented. 4 10 "Environmental Liabilities and Costs" means, as to any Person, all liabilities, obligations, responsibilities, remedial actions, losses, damages, punitive damages, consequential damages, treble damages, contribution, cost recovery, costs and expenses (including all fees, disbursements and expenses of counsel, expert and consulting fees, and costs of investigation and feasibility studies), fines, penalties, sanctions and interest incurred as a result of any claim or demand, by any Person, whether based in contract, tort, implied or express warranty, strict liability, criminal or civil statute, permit, order or agreement with any Federal, state or local governmental authority or other Person, arising from environmental, health or safety conditions, or the release or threatened release of a contaminant, pollutant or Hazardous Material into the environment, resulting from the operations of such Person or its subsidiaries, or breach of any Environmental and Safety Law or for which such Person or its subsidiaries is otherwise liable or responsible. "Equipment" means all of Borrower's present and hereafter acquired machinery, machine tools, motors, equipment, furniture, furnishings, fixtures, vehicles (including motor vehicles and trailers), tools, parts, goods (other than consumer goods, farm products, or Inventory), wherever located, including, (a) any interest of Borrower in any of the foregoing, and (b) all attachments, accessories, accessions, replacements, substitutions, additions, and improvements to any of the foregoing. "ERISA" means the Employee Retirement Income Security Act of 1974, as amended from time to time, and regulations promulgated thereunder. "Event of Default" means any of the events or circumstances specified in Section 8.1. "FEIN" means Federal Employer Identification Number. "Final Order" means a final non-appealable order entered by the Bankruptcy Court in form and substance acceptable to Lender that approves, inter alia, the terms and conditions of the Loan. "Financing Statements" means the Form UCC-1 Financing Statements together with an Exhibit A in the form attached hereto, to perfect the security interests in the Collateral pursuant to the provisions of Article III that can be perfected by filing in the States in which Borrower maintains offices and/or Collateral. "Fiscal Quarter" means a fiscal quarter of Borrower. "Fiscal Year" means a fiscal year of Borrower. "GAAP" means generally accepted accounting principles set forth from time to time in the opinions and pronouncements of the Accounting Principles Board and the American Institute of Certified Public Accountants and statements and pronouncements of the Financial Accounting Standards Board (or agencies with similar functions of comparable stature and authority within the accounting profession), or in such other statements by such other entity as may be in general use by significant segments of the U.S. accounting profession, which are applicable to the circumstances as of the date of determination. "General Intangibles" means all of Borrower's present and future general intangibles and other personal property (including contract rights, rights arising under common law, statutes, 5 11 or regulations, choses or things in action, goodwill, patents, trade names, trademarks, servicemarks, copyrights, blueprints, drawings, purchase orders, customer lists, monies due or recoverable from pension funds, route lists, rights to payment and other rights under any royalty or licensing agreements, infringement claims, computer programs, information contained on computer disks or tapes, literature, reports, catalogs, deposit accounts, insurance premium rebates, tax refunds, and tax refund claims), other than goods, Accounts, and Negotiable Collateral. "Governmental Authority" means any nation or government, any state or other political subdivision thereof, any central bank (or similar monetary or regulatory authority) thereof, any entity, body, authority, bureau, department or instrumentality exercising executive, legislative, judicial, regulatory or administrative functions of or pertaining to government, and any corporation or other entity owned or controlled, through stock or capital ownership or otherwise, by any of the foregoing. "Hazardous Materials" means (a) any material or substance defined as or included in the definition of "hazardous substances" "hazardous wastes" "hazardous materials", "toxic substances" or any other formulations intended to define, list or classify substances by reason of their deleterious properties, (b) any oil, petroleum or petroleum derived substance, (c) any flammable substances or explosives, (d) any radioactive materials, (e) asbestos in any form, (f) electrical equipment that contains any oil or dielectric fluid containing levels of polychlorinated biphenyls in excess of fifty parts per million, (g) pesticides or (h) any other chemical, material or substance, exposure to which is prohibited, limited or regulated by any governmental agency or authority or which may or could pose a hazard to the health and safety of persons in the vicinity thereof. "Indemnified Liabilities" has the meaning specified in Section 9.5. "Indemnified Person" has the meaning specified in Section 9.5. "Initial Advance" means any Advance made pursuant to Section 4.1 of this Agreement, which Advances in the aggregate shall not exceed the Initial Advance Amount. "Initial Advance Amount" means any amounts advanced pursuant to the Interim Order, which amounts shall not exceed in the aggregate Five Million and No/100 Dollars ($5,000,000). "Instrument" has the meaning set forth in the UCC. "Intangible Assets" means all intangible assets under GAAP, including, without limitation, copyrights, franchises, goodwill, licenses, loan origination fees, non-competition covenants, organization or formation expenses, patents, shares of the capital stock of Borrower, service marks, service names, trademarks, tradenames, write-up in the book value of any asset in excess of the acquisition cost of the asset to Borrower, any amount, however designated on the balance sheet, representing the excess of the purchase price paid for assets or stock acquired over the value assigned thereto on the books of Borrower, loans and advances to stockholders, directors, officers and employees of Borrower, unamortized leasehold improvements expense not recoverable at the end of the lease term, unamortized debt discount, and deferred discount. "Interim Order" means those certain Interim Orders substantially in the form attached hereto as Schedule A, which orders were entered by the Bankruptcy Court effective as of July 14, 6 12 1997 and July 17, 1997 respectively, (i) authorizing debtor in possession financing; (ii) granting Liens and superpriority administrative claims; and (iii) modifying the automatic stay entered by the Bankruptcy Court. "Inventory" means all present and future inventory in which Borrower has any interest, including goods held for sale or lease or to be furnished under a contract of service and all of Borrower's present and future raw materials, work in process, finished goods, and packing and shipping materials, wherever located. "Lender Costs" or "Lender Expenses" means all: costs or expenses (including taxes, and insurance premiums) required to be paid by Borrower under any of the Loan Documents that are paid or incurred by Lender; reasonable out-of-pocket fees or charges paid or incurred by Lender in connection with Lender's transactions with Borrower, including, fees or charges for photocopying, notarization, couriers and messengers, telecommunication, public record searches (including tax lien, litigation, and UCC searches and including searches with the patent and trademark office, the copyright office, or the department of motor vehicles), filing, recording, publication, appraisals, due diligence, actual out-of-pocket costs and expenses incurred by Lender in the disbursement of funds to Borrower (by wire transfer or otherwise); actual out-of-pocket charges paid or incurred by Lender resulting from the dishonor of checks; reasonable out-of-pocket costs and expenses paid or incurred by Lender to correct any default or enforce any provision of the Loan Documents, or in gaining possession of, maintaining, handling, preserving, storing, shipping, selling, preparing for sale, or advertising to sell the Collateral, or any portion thereof, irrespective of whether a sale is consummated; reasonable costs and expenses paid or incurred by Lender in examining Borrower's Books; reasonable out-of pocket costs and expenses of third party claims or any other suit paid or incurred by Lender in enforcing or defending the Loan Documents or in connection with the transactions contemplated by the Loan Documents or Lender's relationship with Borrower; and Lender's reasonable attorneys fees and expenses incurred in advising, structuring, drafting, reviewing, administering, amending, terminating, enforcing (including local counsel fees and attorneys fees and expenses incurred in connection with a "workout" restructuring concerning Borrower), defending, or concerning the Loan Documents, irrespective of whether suit is brought. Lender's expenses shall not include costs and expenses which Lender may incur in connection with (i) any bid by Lender for the assets of Borrower, (ii) any proposed plan where Lender is a co-proponent or would otherwise acquire Borrower's business or (iii) any purchase by Lender of the claims held by other creditors of Borrower. "Lien or Encumbrance" and "Liens and Encumbrances" in addition to the definition set forth in the Bankruptcy Code, means any mortgage, deed of trust, pledge, hypothecation, assignment, charge or deposit arrangement, encumbrance, lien (statutory or other) or preference, priority or other security interest or preferential arrangement of any kind or nature whatsoever (including those created by, arising under or evidenced by any conditional sale or other title retention agreement, the interest of a Lessor under a capital lease obligation, any financing lease having substantially the same economic effect as any of the foregoing, or the filing of any financing statement naming the owner of the asset to which such lien relates as debtor, under the UCC or any comparable law) and any contingent or other agreement to provide any of the foregoing. "List of Contracts" shall mean a list prepared by Borrower which (i) identifies each Contract being purchased by account number, the name of the Obligor, the outstanding principal balance thereon, and the year, make, model, and VIN of the motor vehicle underlying the Contract, and (ii) shows the total number of Contracts being purchased and the total outstanding principal balances. 7 13 "Loan Documents" means this Agreement, the Stock Pledge Agreement, the Financing Statements, and all documents delivered to Lender in connection therewith. "Material Adverse Effect" or "Material Adverse Change" means a material adverse change in, or a material adverse effect upon, any of (a) the operations, business, properties, condition (financial or otherwise) or prospects of Borrower; (b) the ability of Borrower to perform under any Loan Document and avoid any Event of Default, or (c) the legality, validity, binding effect or enforceability of any Loan Document. "Maturity Date" has the meaning set forth in Section 2.9. "Negotiable Collateral" means one hundred percent (100%) of the issued and outstanding capital stock of First Merchants Auto Receivables Corporation II, a Delaware corporation. "Net Proceeds" means (a) the gross cash proceeds (including insurance proceeds, condemnation awards, and payments received from time to time in respect of installment obligations and other non-cash proceeds, if applicable) received by or on behalf of Borrower in respect of an Asset Disposition, less (b) the sum of (i) the amount, if any, of all taxes (other than income taxes) payable by Borrower, as applicable, in connection with such Asset Disposition, plus Borrower's good faith best estimate of the amount of all income taxes payable in connection with such Asset Disposition, (ii) the amount of any reasonable reserve established in accordance with GAAP against any liabilities associated with the properties or assets that were the subject of such Asset Disposition, provided that the amount of any subsequent reduction of such reserve (other than in connection with a payment in respect of any such liability) shall be deemed to be "Net Proceeds" of an Asset Disposition occurring on the date of such reduction, (iii) the amount applied to repay any Indebtedness secured by a Lien upon the properties or assets that were the subject of the Asset Disposition, to the extent such Indebtedness is required by its terms to be repaid as a result of such Asset Disposition, and (iv) reasonable and customary fees, including legal fees, commissions, and expenses and other costs paid by Borrower, in connection with such Asset Disposition (other than those payable to any Affiliate of Borrower), in each case only to the extent not already deducted in arriving at the amount referred to in clause (a). "New Contracts" shall mean any rights and/or interests purchased by Lender from Borrower (and created and available for purchase by Borrower following the entry of the Interim Order) pursuant to a Contracts Purchase Agreement between Borrower and Lender, which agreement shall and must be in a form and in substance acceptable to Lender in its sole and absolute discretion, but which includes, without limitation, (i) Accounts, (ii) security interests and any other interests in financed vehicles, (iii) any and all other security, warranties, guaranties and credit support with respect to the foregoing, (iv) any proceeds of claims on any physical damage, credit life and credit accident and health insurance policies or other insurance or certificates relating to financed vehicles or to originators of the New Contracts, (v) purchase agreements with dealers, (vi) installment sales, contracts or agreements, (vii) refunds for costs of extended service contracts with respect to financed vehicles, refunds of unearned premiums with respect to credit life and credit accident and health insurance policies or other insurance or certificates relating to financed vehicles or originators of the New Contracts, and (viii) the proceeds from any and all of the foregoing. "Notice of Advance" means a notice given by Borrower to Lender pursuant to Section 2.2 of this Agreement, in form and substance satisfactory to Lender. 8 14 "Obligor" means the Person obligated for the payment of principal or other money under any Contract. "Obligations" means all Advances, and other Debt, advances, debts, liabilities, obligations, covenants and duties owing by Borrower to Lender, of any kind or nature, present or future, whether or not evidenced by any note, guaranty or other instrument, arising under this Agreement, under any other Loan Document, the Contracts Purchase Agreement, the Servicing Agreement, or out of the Interim Order or the Final Order, absolute or contingent, due or to become due, now existing or hereafter arising and however acquired. "Ordinary Course of Business" means, in respect of any transaction involving Borrower, the ordinary course of such Person's (including Borrower) business, substantially as conducted by any such Person prior to or as of the Closing Date, and undertaken by such Person in good faith and not for purposes of evading any covenant or restriction in any Loan Document. "Permitted Liens" means (a) Liens held by Lender, and/or (b) any and all properly perfected, valid and enforceable liens existing at or prior to the date of this Agreement . "Permitted Protest" means the right of Borrower to protest any Lien other than any such Lien that secures the Obligations, tax (other than payroll taxes or taxes that are the subject of a United States federal tax lien), or rental payment, provided that (a) a reserve with respect to such obligation is established on the books of Borrower in an amount that is reasonably satisfactory to Lender, (b) any such protest is instituted and diligently prosecuted by Borrower in good faith, and (c) Lender is satisfied that, while any such protest is pending, there will be no impairment of the enforceability, validity, or priority of any of the Liens of Lender in and to the Collateral. "Person" means a natural Person, partnership, corporation, business trust, joint stock company, trust, unincorporated association, Joint Venture or Governmental Authority. "Related Security" means, with respect to a Contract: (a) all of Debtor's interest with respect to such Contract under the (i) Dealer Agreement pursuant to which such Contract was acquired and/or (ii) the Dealer Assignment from the Dealer from whom the Contract was required; (b) all motor vehicles underlying such Contract; and (c) all collateral, security agreements and property purported to be subject thereto held as security for such Contract, including all guaranties, indemnities, warranties, insurance proceeds and premium refunds and underwritings and property of whatever character at any time held as security for such Contract. "Reorganization Case" means the Chapter 11 case pending in the Bankruptcy Court and designated as Case No. 97-1500. "Requirement of Law" means, as to any Person, any law (statutory or common), treaty, rule or regulation or determination of an arbitrator or of a Governmental Authority, in each case applicable to or binding upon the Person or any of its property or to which the Person or any of its property is subject. 9 15 "Responsible Officer" means the chief executive officer or the president of Borrower, or any other officer having substantially the same authority and responsibility or, with respect to financial matters, the chief financial officer or the treasurer of Borrower, or any other officer having substantially the same authority and responsibility. "Security Documents" shall mean the writings described in Article III hereof, as they may hereafter be amended, modified and/or supplemented, and all other writings now or hereafter executed to create, evidence and/or perfect any Lien(s) to secure the Loan or any portion(s) thereof. "Servicing Agreement" means that certain Servicing Agreement, if any, by and between Borrower, as servicer, and Lender, as buyer, executed in connection with the Contracts Purchase Agreement. "Stock Pledge Agreement" means that certain Pledge Agreement (Stock), dated as of the date hereof, among Borrower, as pledgor, Lender, as lender, and Harris Trust and Savings Bank, an Illinois banking corporation, as collateral agent on behalf of Lender, pursuant to which Borrower grants Lender a security interest in the Negotiable Collateral. "Subsidiary" of a Person means a corporation, partnership, limited liability partnership, limited liability company, or other entity in which that Person directly or indirectly owns or controls the shares of stock or other ownership interests having ordinary voting power to elect a majority of the board of directors (or appoint other comparable managers) of such corporation, partnership, limited liability partnership, limited liability company, or other entity. "UCC" means the Uniform Commercial Code as in effect from time to time in the State of Arizona, and in any and all other states in which Borrower and/or any of its Subsidiaries conduct, or are authorized to conduct business. "United States" and "U.S." each means the United States of America. "Voidable Transfer" has the meaning set forth in Section 9.17. 1.2 Other Interpretive Provisions. (a) Defined Terms. Unless otherwise specified herein or therein, all terms defined in this Agreement shall have the defined meanings when used in any certificate or other document made or delivered pursuant hereto. The meaning of defined terms shall be equally applicable to the singular and plural forms of the defined terms. Terms (including uncapitalized terms) not otherwise defined herein, and that are defined either in the Bankruptcy Code or the UCC shall have the meanings therein described. (b) The Agreement. The words "hereof", "herein", "hereunder" and words of similar import when used in this Agreement shall refer to this Agreement as a whole and not to any particular provision of this Agreement; and section, schedule and exhibit references are to this Agreement unless otherwise specified. 10 16 (c) Certain Common Terms. (i) The term "documents" includes any and all instruments, documents, agreements, certificates, indentures, notices and other writings, however evidenced. (ii) The term "including" is not limiting and means "including without limitation". (iii) The term "or" has, except where otherwise indicated, the inclusive meaning represented by the phrase "and/or". (d) Performance; Time. Whenever any performance obligation hereunder (other than a payment obligation) shall be stated to be due or required to be satisfied on a day other than a Business Day, such performance shall be made or satisfied on the next succeeding Business Day. In the computation of periods of time from a specified date to a later specified date, the word "from" means "from and including"; the words "to" and "until" each mean "to but excluding", and the word "through" means "to and including". If any provision of this Agreement refers to any action taken or to be taken by any Person, or which such Person is prohibited from taking, such provision shall be interpreted to encompass any and all means, direct or indirect, of taking, or not taking, such action. (e) Contracts. Unless otherwise expressly provided herein, references to agreements and other contractual instruments shall be deemed to include all subsequent amendments and other modifications thereto, but only to the extent such amendments and other modifications are not prohibited by the terms of any Loan Document. (f) Laws. References to any statute or regulation are to be construed as including all statutory and regulatory provisions consolidating, amending, replacing, supplementing or interpreting the statute or regulation. (g) Captions. The captions and headings of this Agreement are for convenience of reference only and shall not affect the construction of this Agreement. (h) Independence of Provisions. The parties acknowledge that this Agreement and other Loan Documents may use several different limitations, tests or measurements to regulate the same or similar matters, and that such limitations, tests and measurements are cumulative and must each be performed, except as expressly stated to the contrary in this Agreement. 1.3 Accounting Principles. (a) Unless the context otherwise clearly requires, all accounting terms not expressly defined herein shall be construed, and all financial computations required under this Agreement shall be made, in accordance with GAAP, consistently applied. In the event that GAAP changes during the term of this Agreement such that the covenants contained in Article VIII would then be calculated in a different manner or with different components, (i) Borrower and Lender agree to amend this Agreement in such respects as are necessary to conform those covenants as criteria for evaluating Borrower's financial condition to substantially the same criteria as were effective prior to such change in GAAP and (ii) Borrower shall be deemed to be in compliance with the covenants contained in Article VIII following any such change in GAAP if and to the extent that 11 17 Borrower would have been in compliance therewith under GAAP as in effect immediately prior to such change. (b) References herein to "fiscal year" and "fiscal quarter" refer to such fiscal periods of Borrower. 1.4 Times. All times of the day herein are Mountain Standard Time. ARTICLE II THE COMMITMENT 2.1 Commitment. Lender, on the terms and conditions hereinafter set forth and the conditions precedent pursuant to Sections 4.1 and 4.2 of this Agreement, agrees to make Advances to Borrower from time to time on any Business Day during the period from the Closing Date to the Business Day prior to the Maturity Date, in an aggregate amount not to exceed at any time outstanding the Commitment Amount, with such borrowings to be used by Borrower for working capital purposes (including, without limitation, the repurchase of contracts pursuant to the Contracts Purchase Agreement), operating expenses, and Chapter 11 expenses; provided, however, that, after giving effect to any Advance, the aggregate principal amount of all outstanding Advances shall not exceed the Commitment Amount. Within the limits of the Commitment Amount, and subject to the other terms and conditions hereof, Borrower may borrow under this Section 2.1, repay or prepay pursuant to Section 2.3 and reborrow pursuant to this Section 2.1. 2.2 Procedure for Advances. (a) Each Advance subsequent to July 17, 1997 (including an Initial Advance and each Advance subsequent thereto) shall be made upon Borrower's irrevocable written notice to Lender in the form of a Notice of Advance, signed by an Authorized Person, which notice must be received by Lender prior to 10:30 a.m. one (1) Business Day prior to the requested Advance date, specifying: (i) the amount of the Advance; (ii) the requested Advance date, which shall be a Business Day; and (iii) the permitted purpose for which the Advance will be used by Borrower. (b) In addition to the Notice of Advance required pursuant to Subsection (a) above, if the purpose for which the Advance will be used by Borrower is the purchase of Contracts, each such Notice of Advance shall be accompanied by a List of Contracts and the applicable Contract Delivery Documents. (c) As to each Advance, Lender will make the amount available to Borrower by 12:00 p.m. on the Advance date requested by Borrower in funds immediately available to Borrower, by wire transfer to Borrower's Designated Account maintained at the Designated Account Bank. 12 18 2.3 Repayment and Mandatory Prepayment. Borrower shall repay the principal amount of all Advances on or prior to the Maturity Date. Borrower shall immediately prepay that portion of the principal amount of any Advances, at any time outstanding which exceeds the Commitment Amount. 2.4 Interest Rate. (a) All Advances (and all Obligations not paid when due) shall bear interest at a per annum rate of (i) ten and one/half percent (10.5%) from July 14, 1997 through July 16, 1997, and (ii) twelve percent (12%) on and after July 17, 1997. (b) While any Event of Default exists and is continuing or after acceleration, Borrower shall pay interest (after as well as before entry of judgment thereon to the extent permitted by law) on the principal amount of all Advances outstanding (and all other Obligations outstanding) at a rate per annum equal to the rate of fifteen percent (15%). (c) Interest payable hereunder shall be due and payable, in arrears, on the first day of each month during the term hereof. Borrower hereby authorizes Lender, at its option, without prior notice to Borrower, to charge such interest, the fees and charges provided for in Section 9.4, (as and when accrued or incurred if not paid within ten (10) days of demand), and all installments or other payments due under any Loan Document to the Loan, which amounts thereafter shall accrue interest at the rate then applicable to Advances hereunder. Any interest not paid when due shall be compounded and shall thereafter accrue interest at the rate then applicable to Advances hereunder, to the extent permissible under applicable law. (d) Anything herein to the contrary notwithstanding, the obligations of Borrower hereunder shall be subject to the limitation that payments of interest, plus any other amounts paid in connection herewith, shall not be required, to the extent (but only to the extent) that contracting for or receiving such payment by Lender would be contrary to the provisions of any law applicable to Lender limiting the highest rate of interest which may be lawfully contracted for, charged or received by Lender, and in such event Borrower shall pay Lender interest and other amounts at the highest rate permitted by applicable law. 2.5 Commitment Fee. Borrower shall unconditionally pay Lender the Commitment Fee which is earned in full, non-refundable, and due and payable as of the date hereof. Lender agrees, however, to forebear collection of the Commitment Fee until February 27, 1998. Moreover, in the event Lender acquires Borrower's business, either through an asset acquisition or a stock acquisition, on or before February 27, 1998, Lender waives its right to collect the Commitment Fee. 2.6 Computation of Fees and Interest. All computations of fees and interest under this Agreement shall be made on the basis of a 360-day year and actual days elapsed, which results in more interest being paid than if computed on the basis of a 365-day year. Interest and fees shall accrue during each period during which interest or such fees are computed from the first day thereof to the last day thereof. 2.7 Payments by Borrower. (a) All payments (including prepayments) to be made by Borrower on account of principal, interest, fees and other amounts required hereunder shall be made without set-off, deduction, recoupment or counterclaim and shall, except as otherwise expressly provided herein, 13 19 be made to Lender at Lender's office as set forth in the preamble hereto, in dollars and in immediately available funds, no later than 1:30 p.m. on the date specified herein. Any payment which is received by Lender later than 1:30 p.m. shall be deemed to have been received on the immediately succeeding Business Day and any applicable interest or fee shall continue to accrue. (b) Whenever any payment hereunder shall be stated to be due on a day, other than a Business Day, such payment shall be made on the next succeeding Business Day, and such extension of time shall in such case be included in the computation of interest or fees, as the case may be. (c) If any payment of principal, interest or Lender Expenses is not received by Lender, within five (5) days when due, Borrower shall pay to Lender a late charge in an amount equal to five percent (5%) of the amount not so paid. 2.8 Maturity Date. The Maturity Date shall be the date six (6) months from the date the Bankruptcy Court enters the Interim Order. ARTICLE III SECURITY AGREEMENT AND COLLATERAL 3.1 Security for Obligations. As security for the payment and performance of the Obligations under this Agreement and all other present and future debts, obligations and liabilities of any nature whatsoever of Borrower to Lender, and all modifications, renewals, replacements and extensions thereof, Borrower hereby grants to Lender a security interest in Borrower's right, title and interest in all of the Collateral. Borrower will execute any security agreements, collateral assignments, financing statements for filing and/or recording and any other Lien writings required by Lender to evidence and perfect the Liens and security interests of Lender. A carbon, photographic or other reproduced copy of this Agreement and/or any financing statement relating hereto shall be sufficient for filing and/or recording as a financing statement. 3.2 Security Documents. Borrower shall promptly execute or cause to be executed such Financing Statements as are necessary to properly perfect Lender's security interest in the states in which Borrower maintains Collateral. 3.3 Lender's Duty Regarding Collateral. Lender shall have no duty or obligation to protect, insure, collect or realize upon the Collateral or preserve rights in it against prior parties. Borrower releases Lender from, and shall indemnify Lender against, any liability for any act or omission relating to the Collateral, except for any liability directly resulting from Lender's gross negligence or willful misconduct. 3.4 Borrower's Duties Regarding Collateral. Subject to the rights of any person holding a prior lien in the Collateral, Borrower agrees as follows: (a) General Maintenance of Collateral. Borrower: (i) shall keep the Collateral free from all Liens (other than the Liens of ad valorem property taxes which are not delinquent, any statutory landlords' liens which are covered by Lien Waivers, mechanic's liens, Permitted Liens, and any Liens in favor of Lender); (ii) shall defend the Collateral against all claims and legal proceedings by persons other than Lender; (iii) shall pay and discharge when due all taxes, levies 14 20 and other charges upon the Collateral; (iv) shall not sell, lease or otherwise dispose of the Collateral or permit it to become a fixture or an accession to other goods, except for sales in the Ordinary Course of Business and except as specifically authorized in this Agreement; and (v) shall not permit the Collateral to be used in violation of any Legal Requirement or any policy of insurance. (b) Insurance. Borrower shall keep all tangible Collateral and Lender's interest in it insured. Borrower assigns and directs any insurer to pay to Lender the proceeds of all such insurance and any premium refunds, and authorizes Lender to endorse in the name of Borrower any instrument for such proceeds or refunds and, at the option of Lender, to apply such proceeds or refunds to any unpaid balance of the Obligations owing under this Agreement, whether or not due, and/or to the restoration of the Collateral, returning any excess to Borrower; provided, however, that if no uncured Event of Default then exists, Lender shall allow Borrower to apply such proceeds to the repair or restoration of the Collateral, subject to such reasonable safeguards and procedures for the disbursement of such proceeds as Lender may establish. Lender is authorized, in the name of Borrower or otherwise, to make, adjust or settle claims under or cancel any insurance on the Collateral. (c) Perfection and Priority. Borrower shall pay all Lender's expenses and, upon Lender's request, execute all writings and take all other actions reasonably deemed advisable by Lender to preserve the Collateral or to establish, and determine priority of, perfection, continued perfection or enforce Lender's interest in the Collateral. (d) Records. Upon reasonable notice to Borrower, Lender may examine and conduct audits of the Collateral and Borrower's records concerning it, wherever located, and make copies of such records, at any time during normal business hours, and Borrower shall assist Lender in so doing. Borrower shall keep accurate, complete and current records respecting the Collateral. In addition to the specific requirements of Section 6.1 , Borrower shall, within ten (10) Business Days of any request by Lender, furnish to Lender a detailed statement, certified as being substantially accurate by an Authorized Person, setting forth the current status, value and location of all or any portion of the Collateral. 3.5 Power of Attorney. Subject to the Provisions of the Bankruptcy Code, Borrower hereby makes, constitutes and appoints Lender the true and lawful attorney-in-fact of Borrower, in the name, place and stead of Borrower, or otherwise, upon the occurrence of any Event of Default which remains uncured following the receipt of a notice pursuant to Section 9.2: (a) To take all actions and to execute, acknowledge, obtain and deliver any and all writings necessary or deemed advisable by Lender in order to exercise any rights of Borrower with respect to the Collateral or to receive and enforce any payment or performance due to Borrower with respect to the Collateral; (b) To give any notices, instructions or other communications to any person or entity in connection with the Collateral; (c) To demand and receive all performances due under or with respect to the Collateral and to take all lawful steps to enforce such performances and to compromise and settle any claim or cause of action of Borrower arising from or related to the Collateral and give acquittances and other discharges relating thereto; and 15 21 (d) To file any claim or proceeding or to take any other action, in the name of Lender, Borrower or otherwise, to enforce performances due under or related to the Collateral or to protect and preserve the right, title and interest of Lender thereunder. The foregoing power of attorney is a power coupled with an interest and shall be irrevocable and unaffected by the disability of the principal so long as any portion of the Obligations remains contingent, unmatured, unliquidated, unpaid or unperformed. Lender shall have no obligation to exercise any of the foregoing rights and powers in any event. 3.6 Collateral Inspections. Lender shall have the right (but not the obligation) to do a physical on-site examination of the Collateral. All costs and expenses associated therewith shall be included in Lender Expenses. 3.7 Return of Contract Delivery Documents. For all Contracts that are paid in full by the Obligor, Lender shall, within two (2) Business Days of Borrower's notification thereof and written request, return to Borrower the applicable Contract Delivery Documents. In addition, provided there is no Default or Event of Default, Lender shall return the Contract Delivery Documents for the time and to the extent necessary for Borrower to make corrections or to enforce the Contracts or the obligations of the Obligor. Whenever Borrower is in possession or control of Contract Delivery Documents for Contracts not paid in full, Borrower shall at all times hold them in trust for Lender. ARTICLE IV CONDITIONS PRECEDENT; TERM OF AGREEMENT 4.1 Conditions Precedent to the Initial Advance. The obligation of Lender to make the Initial Advance hereunder is subject to the fulfillment, to the satisfaction of Lender and its counsel, of each of the following conditions on or before the Closing Date; provided, however, that Lender, in its sole and absolute discretion, may waive any of the following conditions, except the entering of the Interim Order by the Bankruptcy Court. (a) Lender shall have received each of the following documents, duly executed, and each such document shall be in full force and effect: (i) This Agreement executed by Borrower and Lender; (ii) The Stock Pledge Agreement executed by Borrower, Lender and Harris Trust and Savings Bank; (iii) The Financing Statements executed by Borrower and Lender. (b) The Bankruptcy Court shall have entered the Interim Order; (c) Lender shall have received copies of the resolutions of the board of directors of Borrower approving and authorizing the execution, delivery and performance by Borrower of this Agreement and the other Loan Documents to be delivered hereunder, and authorizing the Loan, certified as of the Closing Date by the Secretary or an Assistant Secretary of Borrower; 16 22 (d) Lender shall have received a certificate of the Secretary or Assistant Secretary of Borrower certifying the names and true signatures of the officers of Borrower authorized to execute, deliver and perform, as applicable, this Agreement, the Stock Pledge Agreement and all other Loan Documents to be delivered hereunder and Lender shall have received a good standing certificate for Borrower from the Secretary of State of Delaware; and (e) Borrower, from the Initial Advance on the Closing Date, shall have paid to Lender Fifty Thousand and No/100 Dollars ($50,000) as an initial retainer, for any and all Lender Costs incurred by Lender in conducing its due diligence, document preparation and other necessary investigations and analyses relating to the Loan. To the extent that Lender Costs relating to the foregoing exceed $50,000, Borrower shall pay Lender such excess amount within thirty (30) days of Lender's written notice to Borrower. In addition, each Initial Advance made after July 17, 1997, shall require a Notice of Advance to Lender, pursuant to Section 2.2. 4.2 Conditions Precedent to Subsequent Advances. The following shall be conditions precedent to all Advances subsequent to the Initial Advance: (a) The Bankruptcy Court shall have entered the Final Order; (b) Lender shall have received a Notice of Advance pursuant to Section 2.2; (c) The representations and warranties made by Borrower contained in Article V shall be true and correct on and as of such Advance date with the same effect as if made on and as of such Advance date (except to the extent such representations and warranties expressly refer to an earlier date, in which case they shall be true and correct as of such earlier date); (d) No Default or Event of Default shall exist or shall result from such Advance; and (e) If the purpose for which the Advance will be used by Borrower is the purchase of Contracts, Lender shall have received a List of Contracts and the Contract Delivery Documents pursuant to Section 2.2. Each Notice of Advance submitted by Borrower hereunder shall constitute a representation and warranty by Borrower hereunder, as of the date of each such notice or application and as of the date of each Advance, that the conditions in this Section 4.2 are satisfied. 4.3 Term. This Agreement shall become effective upon the execution and delivery hereby by Borrower and Lender and shall continue in full force and effect for a term ending on the earliest of (a) the confirmation of a Chapter 11 Plan of Reorganization, (b) the date of the conversion of Borrower's Chapter 11 case to one pursuant to Chapter 7 of the Bankruptcy Code, (c) the Maturity Date, or (d) the date of termination of this Agreement in accordance with its terms after the occurrence and during the continuation of an Event of Default. 4.4 Effect of Termination. Upon termination of the Agreement, all Obligations shall become due and payable immediately without notice or demand. No termination of this Agreement, however, shall relieve or discharge Borrower of Borrower's duties, Obligations, or covenants hereunder, and Lender's continuing security interest in the Collateral shall remain in effect until all 17 23 Obligations have been fully and finally discharged and Lender's obligation to provide additional credit hereunder is terminated. 4.5 Early Termination by Borrower. The provisions of Section 2.9 that allow termination of this Agreement on the Maturity Date notwithstanding, Borrower has the option, at any time, to terminate this Agreement by paying to Lender, in cash, the Obligations, in full. ARTICLE V REPRESENTATIONS AND WARRANTIES In order to induce Lender to enter into this Agreement, Borrower makes the following representations and warranties which shall be true, correct, and complete in all respects as of the date hereof, and shall be true, correct, and complete in all respects as of the Closing Date, and at and as of the date of the making of each Advance made thereafter, as though made on and as of the date of such Advance (except to the extent that such representations and warranties relate solely to an earlier date) and such representations and warranties shall survive the execution and delivery of this Agreement: 5.1 No Encumbrances. Borrower, as debtor and debtor in possession, has good and indefeasible title to the Collateral, free and clear of Liens except for Permitted Liens. 5.2 Equipment. All of the Equipment is used or held for use in Borrower's business. 5.3 Location of Inventory and Equipment. The Inventory and Equipment are not stored with a bailee, warehouseman, or similar party (without Lender's prior written consent) and are located only at the locations identified on Schedule B. 5.4 Location of Chief Executive Office; FEIN. The chief executive office of Borrower is located at the address indicated in the preamble to this Agreement and Borrower's FEIN is 36-3759045. 5.5 Due Organization and Qualification; Subsidiaries. (a) Borrower is duly organized and existing and in good standing under the laws of the jurisdiction of its incorporation and qualified and licensed to do business in, and in good standing in, any state where the failure to be so licensed or qualified reasonably could be expected to have a Material Adverse Change. (b) Set forth on Schedule C is a complete and accurate list of Borrower's direct and indirect Subsidiaries, showing: (i) the jurisdiction of their incorporation; (ii) the number of shares of each class of common and preferred stock authorized for each of such Subsidiaries; and (iii) the number and the percentage of the outstanding shares of each such class owned directly or indirectly by Borrower. All of the outstanding capital stock of each such Subsidiary has been validly issued and is fully paid and non-assessable. (c) Except as set forth on Schedule D, no capital stock (or any securities, instruments, warrants, options, purchase rights, conversion or exchange rights, calls, commitments or claims of any character convertible into or exercisable for capital stock) of any direct or indirect 18 24 Subsidiary of Borrower is subject to the issuance of any security, instrument, warrant, option, purchase right, conversion or exchange right, call, commitment or claim of any right, title, or interest therein or thereto. 5.6 Due Authorization; No Conflict. (a) The execution, delivery, and performance by Borrower of this Agreement and the Loan Documents to which it is a party have been duly authorized by all necessary corporate action. (b) The execution, delivery, and performance by Borrower of this Agreement and the Loan Documents to which it is a party do not and will not (i) violate any provision of federal, state, or local law or regulation (including Regulations G, T, U, and X of the Federal Reserve Board) applicable to Borrower, the Governing Documents of Borrower, or any order, judgment, or decree of any court or other Governmental Authority binding on Borrower, (ii) conflict with, result in a breach of, or constitute (with due notice or lapse of time or both) a default under any material contractual obligation or material lease of Borrower, (iii) result in or require the creation or imposition of any Lien of any nature whatsoever upon any properties or assets of such Borrower, other than Permitted Liens, or (iv) require any approval of stockholders or any approval or consent of any Person under any material contractual obligation of Borrower. The entry of the Interim Order may override the necessity of any such consent. (c) Other than (i) the obtaining of the Interim Order, and (ii) the taking of any other action expressly required under this Agreement and the Loan Documents, the execution, delivery, and performance by Borrower of this Agreement and the Loan Documents to which Borrower is a party do not and will not require any registration with, consent, or approval of, or notice to, or other action with or by, any federal, state, foreign, or other Governmental Authority or other Person. The entry of the Interim Order may override the necessity of any such consent. (d) This Agreement, the Loan Documents and all other documents contemplated hereby and thereby, when executed and delivered by Borrower will be the legally valid and binding obligations of Borrower, enforceable against Borrower in accordance with their respective terms, except as enforcement may be limited by equitable principles or by bankruptcy, insolvency, reorganization, moratorium, or similar laws relating to or limiting creditors' rights generally. (e) The Liens granted by Borrower to Lender in and to its properties and assets pursuant to this Agreement and the other Loan Documents are validly created, perfected, Liens, subject only to Permitted Liens. 5.7 Litigation. Except as set forth in Schedule E, there are no actions or proceedings pending by or against Borrower before any court or administrative agency and Borrower does not have knowledge or belief of any pending, threatened, or imminent litigation, governmental investigations, or claims, complaints, actions, or prosecutions involving Borrower, except for: (a) ongoing collection matters in which Borrower is the plaintiff; (b) Borrower's Chapter 11 proceeding before the Bankruptcy Court; and (c) matters arising after the date hereof that, if decided adversely to Borrower would not have a Material Adverse Change. 5.8 No Material Adverse Change. All financial statements relating to Borrower that have been delivered by Borrower to Lender have been prepared in accordance with GAAP (except, in the case of unaudited financial statements, for the lack of footnotes and being subject to year-end audit adjustments) and fairly present Borrower's financial condition as of the date thereof and 19 25 Borrower's results of operations for the period then ended, except as previously disclosed by Borrower to Lender. There has not been a Material Adverse Change with respect to Borrower since the date of the latest financial statements submitted to Lender on or before the Closing Date. 5.9 ERISA. No accumulated funding deficiency (as defined in Section 302 of ERISA and Section 412 of the Code), whether or not waived, exists with respect to any plan (other than a multiemployer plan). No liability to the Pension Benefit Guaranty Corporation has been or is expected by Borrower to be incurred with respect to any plan (other than a multiemployer plan) by Borrower which is or would have a Material Adverse Effect. Borrower has not incurred or does not presently expect to incur any withdrawal liability under Title IV of ERISA with respect to any multiemployer plan which is or would be materially adverse to Borrower. The execution and delivery of this Agreement and the other Loan Documents will not involve any transaction which is subject to the prohibitions of Section 406 of ERISA or in connection with which a tax could be imposed pursuant to section 4975 of the Code. For the purpose of this Section 5.9, the term "plan" shall mean an "employee pension benefit plan" (as defined in section 3 of ERISA) which is or has been established or maintained, or to which contributions are or have been made, by Borrower or by any trade or business, whether or not incorporated, which, together with Borrower, is under common control, as described in Section 414(b) or (c) of the Code; and the term "multiemployer plan" shall mean any plan which is a "multiemployer plan" (as such term is defined in Section 4001(a)(3) of ERISA). No plan providing welfare benefits to retired former employees of Borrower has been established or is maintained for which the present value of future benefits payable, in excess of irrevocably designated funds for such purpose, is or would have a Material Adverse Effect. 5.10 Environmental and Safety Matters. Borrower (a) has complied in all material respects with all applicable material Environmental and Safety Laws, and Borrower has not received (i) notice of any material failure so to comply, (ii) any letter or request for information under Section 104 of CERCLA or comparable state laws or (iii) any information that would lead it to believe that it is the subject of any Federal or state investigation concerning Environmental and Safety Laws; (b) does not manage, generate, discharge or store any Hazardous Materials in material violation of any material Environmental and Safety Laws; (c) does not own, operate or maintain any underground storage tanks or surface impoundments; and, (d) except as disclosed to Lender in writing, is not aware of any conditions or circumstances associated with its currently or previously owned or leased properties or operations (or those of its tenants) which may give rise to any Environmental Liabilities and Costs which could have a Material Adverse Effect. ARTICLE VI AFFIRMATIVE COVENANTS Borrower covenants and agrees that, so long as any credit hereunder shall be available and until full and final payment of the Obligations, and unless Lender shall otherwise consent in writing, Borrower shall do all of the following: 6.1 Financial Statements. Borrower shall deliver to Lender in form and detail satisfactory to Lender: (a) Within fifteen (15) days after the end of each calendar month: 20 26 (i) Any and all monthly operating reports filed with the Bankruptcy Court and required by the Bankruptcy Code and rules promulgated by Congress relating to the Bankruptcy Code; and (ii) Borrower's monthly financial statements, including balance statement, as of the last day of the preceding month and statement of income and cash flow for the preceding month, which may be prepared by Borrower. (b) promptly upon receipt thereof, a copy of each other report, if any, submitted to Borrower by independent accountants in connection with any annual, interim or special audit made by them of the books of Borrower; (c) promptly after its submission, copies of any other information or documents regularly provided by Borrower to any of its other lenders or holders of Borrower's Debt; and (d) with reasonable promptness, such other financial data as Lender may reasonably request. 6.2 Inspection of Property. Borrower shall permit any Person designated by Lender in writing, to visit and inspect any of the properties of Borrower, to examine the corporate books and financial records of Borrower and make copies thereof or extracts therefrom and to discuss the affairs, finances and accounts of any of such corporations with the principal officers of Borrower and its independent public accountants, all at such reasonable times and as often as Lender may reasonably request. 6.3 Maintenance of Insurance. Borrower shall maintain in type and amount, any and all insurance coverages in place on the Closing Date, including: (a) All Risk Property Damage Insurance Coverage; and (b) General Business Insurance covering property damage (including loss of use and occupancy) to any of Borrower's properties, public liability insurance, including coverage for contractual liability and workers' compensation. Upon the request of Lender, to deliver to Lender a copy of each insurance policy, or, if permitted by Lender, a certificate of insurance listing all insurance in force. 6.4 Default Disclosure. Borrower shall forthwith, upon a Responsible Officer of Borrower obtaining knowledge of an Event of Default or Default, promptly deliver to Lender a certificate of a Responsible Officer specifying the nature and period of existence thereof and what action the Borrower proposes to take with respect thereto. 6.5 Notices to Lender. Borrower shall promptly notify Lender in writing of: (a) Any lawsuit over Ten Thousand and No/100 Dollars ($10,000.00) against Borrower; as to which the Automatic Stay does not apply. (b) Any substantial dispute between Borrower and any Governmental Authority; 21 27 (c) Any change in Borrower's name, address, legal structure or the location of the Collateral. Borrower shall place Lender's counsel on the master service list in the Reorganization Case and Lender's counsel shall file a notice of appearance and request for copies of all pleadings. Borrower shall not be required to separately provide Lender with copies of any pleadings which are served on the master service list in the Reorganization Case. 6.6 Books and Records. Borrower shall maintain adequate books and records. 6.7 Compliance and Preservation. Borrower shall (a) Comply with the laws (including any fictitious name statute), regulations and orders of any government body with authority over Borrower's business; (b) Maintain and preserve all privileges and franchises Borrower now has; and (c) Make any repairs, renewals, or replacements reasonably necessary to keep Borrower's properties in good working condition. 6.8 Perfection of Liens. Borrower shall help Lender perfect and protect its security interests and liens. 6.9 Cooperation. Borrower shall take any reasonable action requested by Lender to carry out the intent of this Agreement. ARTICLE VII NEGATIVE COVENANTS Borrower covenants and agrees that, so long as any credit hereunder shall be available and until full and final payment of the Obligations, Borrower will not do any of the following without Lender's prior written consent: 7.1 Indebtedness. Create, incur, assume, permit, guarantee, or otherwise become or remain, directly or indirectly, liable with respect to any Indebtedness, except: (a) Indebtedness evidenced by this Agreement; (b) Indebtedness secured by Permitted Liens; (c) refinancings, renewals, or extensions of Indebtedness permitted under clause (b) of this Section 7.1 (and continuance or renewal of any Permitted Liens associated therewith) so long as: (i) the terms and conditions of such refinancings, renewals, or extensions do not materially impair the prospects of repayment of the Obligations by Borrower, (ii) the net cash proceeds of such refinancings, renewals, or extensions do not result in an increase in the aggregate principal amount of the Indebtedness so refinanced, renewed, or extended, (iii) such refinancings, renewals, refundings, or extensions do not result in a shortening of the average weighted maturity of the Indebtedness so refinanced, renewed, or extended, and (iv) to the extent 22 28 that Indebtedness that is refinanced was subordinated in right of payment to the Obligations, then the subordination terms and conditions of the refinancing Indebtedness must be at least as favorable to Lender as those applicable to the refinanced Indebtedness; (d) Indebtedness disclosed on Borrower's financial statements or the schedules in Borrower's Reorganization Case, in each case delivered by Borrower to Lender on or before the Closing Date. 7.2 Liens. Create, incur, assume, or permit to exist, directly or indirectly, any Lien on or with respect to any of its property or assets, of any kind, whether now owned or hereafter acquired, or any income or profits therefrom, except for Permitted Liens (including Liens that are replacements of Permitted Liens to the extent that the original Indebtedness is refinanced under Section 7.1(d) and so long as the replacement Liens only encumber those assets or property that secured the original Indebtedness). Anything contained herein to the contrary notwithstanding, in no event shall Borrower create, incur, assume, or permit to exist, directly or indirectly, any Lien on or with respect to the Bankruptcy Recoveries; provided that nothing in this sentence shall prohibit any attorney retained to prosecute Bankruptcy Recoveries from claiming an attorneys' Lien under applicable state law with respect to any Bankruptcy Recoveries prosecuted by such attorney. 7.3 Restrictions on Fundamental Changes. Except as entered into under the provisions of an Acceptable Plan (which may include a requirement that Borrower merge or consolidate with one of Borrower's Subsidiaries) or pursuant to the Contracts Purchase Agreement, enter into any merger, consolidation, reorganization, or recapitalization, or reclassify its capital stock, or liquidate, wind up, or dissolve itself (or suffer any liquidation or dissolution), or convey, sell, assign, lease, transfer, or otherwise dispose of, in one transaction or a series of transactions, all or any substantial part of its property or assets. 7.4 Disposal of Assets. Except as entered into under the provisions of an Acceptable Plan or pursuant to the Contracts Purchase Agreement except as expressly consented to by Lender in writing which consent shall not be unreasonably withheld, sell, lease, assign, transfer, or otherwise dispose of any of Borrower's properties or assets other than sales of Inventory to buyers in the Ordinary Course of Business as currently conducted. 7.5 Change Name. Change Borrower's name, FEIN, corporate structure (within the meaning of Section 9402(7) of the Code), or identity, or add any new fictitious name. 7.6 Guarantee. Guarantee or otherwise become in any way liable with respect to the obligations of any third Person except by endorsement of instruments or items of payment for deposit to the account of Borrower or which are transmitted or turned over to Lender. 7.7 Nature of Business. Make any change in the principal nature of Borrower's business. 7.8 Prepayments and Amendments. (a) Except as entered into under the provisions of an Acceptable Plan, and except in connection with a refinancing permitted by Section 7.l(d), prepay, redeem, retire, defease, purchase, or otherwise acquire any Indebtedness owing to any third Person, other than the Obligations in accordance with this Agreement, and 23 29 (b) Except as entered into under the provisions of an Acceptable Plan or except as expressly consented to by Lender in writing which consent shall not be unreasonably withheld, directly or indirectly, amend, modify, alter, increase, or change any of the terms or conditions of any agreement, instrument, document, indenture, or other writing evidencing or concerning Indebtedness permitted under Sections 7.1 (b), (c) or (d). 7.9 Change of Control. Cause, permit, or suffer, directly or indirectly, any Change of Control, except pursuant to an Acceptable Plan. 7.10 Consignments. Consign any Inventory or sell any Inventory on bill and hold, sale or return, sale on approval, or other conditional terms of sale. 7.11 Distributions. Make any distribution or declare or pay any dividends (in cash or other property, other than capital stock) on, or purchase, acquire, redeem, or retire any of Borrower's capital stock, of any class, whether now or hereafter outstanding. 7.12 Accounting Methods. Modify or change its method of accounting or enter into, modify, or terminate any agreement currently existing, or at any time hereafter entered into with any third party accounting firm or service bureau for the preparation or storage of Borrower's accounting records without said accounting firm or service bureau agreeing to provide Lender information regarding the Collateral or Borrower's financial condition. Borrower waives the right to assert a confidential relationship, if any, it may have with any accounting firm or service bureau in connection with any information requested by Lender pursuant to or in accordance with this Agreement, and agrees that Lender may contact directly any such accounting firm or service bureau in order to obtain such information. 7.13 Investments. Directly or indirectly make, acquire, or incur any liabilities (including contingent obligations) for or in connection with (a) the acquisition of the securities (whether debt or equity) of, or other interests in, a Person, (b) loans, advances, capital contributions, or transfers of property to a Person, or (c) the acquisition of all or substantially all of the properties or assets of a Person. 7.14 Transactions with Affiliates. Directly or indirectly enter into or permit to exist any material transaction with any Affiliate of Borrower except for transactions that are in the Ordinary Course of Business, upon fair and reasonable terms, that are fully disclosed to Lender, and that are no less favorable to Borrower than would be obtained in an arm's length transaction with a non-Affiliate. 7.15 Compensation. Increase the annual fee or per-meeting fees paid to directors over the prior year's fee; pay or accrue total cash compensation, during any year, to officers and senior management employees in excess of that paid or accrued in the prior year, other than in connection with the severance and retention program in an amount not to exceed Three Million Seven Hundred Thousand and No/100 Dollars ($3,700,000.00). 7.16 Use of Proceeds. Use the proceeds of the Advances made hereunder for any purpose other than (a) on the Closing Date, to pay Lender Costs incurred in connection with this Agreement, and (b) thereafter, consistent with the terms and conditions hereof, for its lawful and permitted corporate purposes. 24 30 7.17 Change in Location of Chief Executive Office. Relocate its chief executive office to a new location without providing 30 days prior written notification thereof to Lender and so long as, at the time of such written notification, Borrower provides any financing statements or fixture filings necessary to perfect and continue perfected Lender's security interests and also provides to Lender a Collateral access agreement with respect to such new location. 7.18 No Prohibited Transactions Under ERISA. Directly or indirectly: (a) engage, or permit any Subsidiary of Borrower to engage, in any prohibited transaction which is reasonably likely to result in a civil penalty or excise tax described in Sections 406 of ERISA or 4975 of the Code for which a statutory or class exemption is not available or a private exemption has not been previously obtained from the Department of Labor; (b) permit to exist with respect to any Benefit Plan any accumulated funding deficiency (as defined in Sections 302 of ERISA and 412 of the Code), whether or not waived; (c) fail, or permit any Subsidiary of Borrower to fail, to pay timely required contributions or annual installments due with respect to any waived funding deficiency to any Benefit Plan; (d) terminate, or permit any Subsidiary of Borrower to terminate, any Benefit Plan where such event would result in any liability of Borrower or any of its Subsidiaries under Title IV of ERISA; (e) fail, or permit any Subsidiary of Borrower to fail, to make any required contribution or payment to any Multiemployer Plan; (f) fail, or permit any Subsidiary of Borrower to fail, to pay any required installment or any other payment required under Section 412 of the Code on or before the due date for such installment or other payment; (g) amend, or permit any Subsidiary of Borrower to amend, a retirement plan resulting in an increase in current liability for the plan year such that either of Borrower or any Subsidiary of Borrower is required to provide security to such retirement plan under Section 401 (a)(29) of the Code; or (h) withdraw, or permit any Subsidiary of Borrower to withdraw, from any Multiemployer Plan where such withdrawal is reasonably likely to result in any liability of any such entity under Title IV of ERISA. ARTICLE VIII EVENTS OF DEFAULT/REMEDIES 8.1 Event of Default. Any of the following shall constitute an "Event of Default": (a) If Borrower fails to pay when due and payable or when declared due and payable, any portion of the Obligations (whether of principal, interest (including any interest which, 25 31 but for the provisions of the Bankruptcy Code, would have accrued on such amounts), fees and charges due Lender, reimbursement of Lender Costs, or other amounts constituting Obligations); (b) If Borrower fails to perform, keep, or observe any term, provision, condition, covenant, or agreement contained in this Agreement, in any of the Loan Documents, or in any other future agreement between Borrower and Lender, including without limitation the Contracts Purchase Agreement, if any, and the Servicing Agreement, if any; (c) If there is a Material Adverse Change; (d) If any third party obtains from the Bankruptcy Court relief from the automatic stay under the Bankruptcy Code to permit such Person to attach, seize, subject to a writ of distress warrant, or levy upon, or obtain possession of, a material portion of any Collateral in connection with a claim of such Person, unless such Collateral is not material to Borrower's business and Borrower does not have any material equity in such Collateral; (e) If Borrower's Chapter 11 case is converted to a case under Chapter 7 of the Bankruptcy Code, unless such conversion is stayed and Borrower continues to operate in Chapter 11; (f) If Borrower is enjoined or restrained, by court order from continuing to conduct all or any material part of its business affairs, unless such order is stayed; (g) If notices of Lien, levy, or assessment are filed of record with respect to any of Borrower's properties or assets which are not pre-petition or have not been cured within ten (10) days after the Lien has been filed, or a Bankruptcy Court order is entered, pursuant to 11 U.S.C. Sections 364(c) or (d), or otherwise, which grants a Lien, levy or assessment on any property of Borrower's bankruptcy estate which (a) represent claims which have priority over the security interests of Lender in the Collateral, or (b) represent claims which are junior to the security interests of Lender in the Collateral; (h) If a judgment or other claim becomes a Lien or encumbrance upon any material portion of Borrower's properties or assets and such judgment is not removed or released within 15 days of the entry of such judgment; (i) If Borrower makes any payment on account of Indebtedness that has been contractually subordinated in right of payment to the payment of the Obligations, except to the extent such payment is permitted by the terms of the subordination provisions applicable to such Indebtedness; (j) If any material misstatement or misrepresentation exists now or hereafter in any warranty, representation, statement, or report made to Lender by Borrower or any officer, employee, agent, or director of Borrower which has not been corrected to date, or if any such warranty or representation is withdrawn; (k) If the Interim Order or Final Order entered by the Court approving the Loan is vacated or otherwise materially modified, without the prior express written consent Lender of; (l) If a Chapter 11 Trustee or Chapter 11 Examiner with expanded management-type powers is appointed in Borrower's bankruptcy case; or 26 32 (m) If there is confirmation of a Chapter 11 plan without repayment of any and all sums due Lender under the Loan (including the Commitment Fee or Lender Costs which may be then owed) in full on the Effective Date of the plan. 8.2 Lender's Rights and Remedies. Subject to the provisions of the Bankruptcy Code, upon the occurrence, and during the continuation, of an Event of Default, Lender shall provide Borrower with written notice thereof and the option to cure. If Borrower fails to cure such Event of Default within twenty (20) days after delivery of such written notice, Lender may, at its sole and absolute discretion, without further notice, and without demand or further order of the Bankruptcy Court, except to the extent expressly required by the Interim Order or Final Order, as applicable, do any one or more of the following, all of which are authorized by Borrower: (a) Declare all Obligations, whether evidenced by this Agreement, by any of the other Loan Documents, or otherwise, immediately due and payable; (b) Cease advancing money or extending credit to or for the benefit of Borrower under this Agreement, under any of the Loan Documents, or under any other agreement between Borrower and Lender; (c) Terminate this Agreement and any of the other Loan Documents as to any future liability or obligation of Lender, but without affecting Lender's rights and security interests in the Collateral and without affecting the Obligations; (d) Settle or adjust disputes and claims directly with account debtors for amounts and-upon terms which Lender considers advisable, and in such cases, Lender will credit the Advances with only the net amounts received by Lender in payment of such disputed Accounts after deducting all fees and other expenses owed to Lender and incurred or expended in connection therewith; (e) Cause Borrower to hold all returned Inventory in trust for Lender, segregate all returned Inventory from all other property of Borrower or in Borrower's possession and conspicuously label said returned Inventory as the property of Lender; (f) Without notice to or demand upon Borrower, make such payments and do such acts as Lender considers necessary or reasonable to protect its security interests in the Collateral. (g) Without notice to Borrower (such notice being expressly waived), and without constituting a retention of any collateral in satisfaction of an obligation (within the meaning of Section 9-505 of the UCC), set off and apply to the Obligations any and all (i) balances and deposits of Borrower held by Lender, or (ii) indebtedness at any time owing to or for the credit or the account of Borrower held by Lender; (h) Apply to the Bankruptcy Court, upon three (3) Business Days notice to Borrower, Borrower's counsel, counsel for the official creditors committee in such case, and the United States Trustee (which three (3) Business Days notice hereby conclusively is agreed to be sufficient notice), for one or more of the following forms of relief: (a) appointment of an examiner for Borrower; (b) appointment of a trustee for Borrower; (c) conversion of Borrower's Chapter 11 case to a case under Chapter 7 of the Bankruptcy Code; or (d) dismissal of the bankruptcy case of Borrower. Borrower hereby expressly agrees that three (3) Business Days notice shall be adequate notice for the requesting of the foregoing specified forms of relief in the event of the occurrence and 27 33 continuation of an Event of Default hereunder, and Borrower expressly waives any right to object to the adequacy of notice in connection with a request for any of the foregoing specified forms of relief if such three (3) Business Days notice is given and an Event of Default is found to exist. Nothing in this paragraph shall limit the right of Lender to apply to the Bankruptcy Court for such other or further relief as may be justified and appropriate, and nothing in this paragraph shall limit the other rights and remedies of Lender provided for elsewhere in this Agreement or in any other Loan Document; Lender's rights and remedies under this Agreement, the Loan Documents, and all other agreements shall be cumulative. No exercise by Lender of one right or remedy shall be deemed an election, and no waiver by Lender of any Event of Default shall be deemed a continuing waiver. No delay by Lender shall constitute a waiver, election, or acquiescence by it. ARTICLE IX MISCELLANEOUS 9.1 Amendments and Waivers. No amendment or waiver of any provision of this Agreement or any other Loan Document, and no consent with respect to any departure by Borrower therefrom, shall be effective unless the same shall be in writing and signed by Lender and Borrower, and then such waiver shall be effective only in the specific instance and for the specific purpose for which given. 9.2 Notices. (a) All notices, requests and other communications provided for hereunder shall be in writing (including, unless the context expressly otherwise provides, by facsimile transmission, provided, that, any matter transmitted by facsimile (i) shall be immediately confirmed by a telephone call to the recipient, and (ii) shall be followed promptly by a hard copy original thereof by over-night courier to the address set forth below; or to such other address as shall be designated by such party in a written notice to the other party, and as directed to each other party, at such other address as shall be designated by Lender or Borrower in a written notice to Borrower and Lender. If to Borrower: FIRST MERCHANTS ACCEPTANCE CORPORATION 570 Lake Cook Road Suite 126 Deerfield, Illinois 60015 Attn: Howard Adamski Facsimile No.: (847) 945-2556 With a copy to: Sonnenschein Nath & Rosenthal 8000 Sears Tower Chicago, Illinois 60606-6404 Attn: Robert Richards, Esquire Facsimile No. (312) 876-7934 28 34 If to Lender: UGLY DUCKLING CORPORATION 2525 East Camelback Road Suite 1150 Phoenix, Arizona 85016 Attn: Steven Johnson Facsimile No.: (602) 852-6696 With a copy to: Snell & Wilmer L.L.P. One Arizona Center Phoenix, Arizona 85004-0001 Attn: Timothy W. Moser, Esquire Facsimile No.: (602) 382-6070 (b) All such notices, requests and communications shall, when transmitted by overnight delivery or faxed, be effective when delivered for overnight (next day) delivery, transmitted by facsimile machine, respectively, or if delivered, upon delivery, except that notices pursuant to Article II shall not be effective until actually received by Lender. (c) Borrower acknowledges and agrees that any agreement of Lender to receive certain notices by telephone and facsimile is solely for the convenience and at the request of Borrower. Lender shall be entitled to rely on the authority of any Person purporting to be a Person authorized by Borrower to give such notice and Lender shall not have any liability to Borrower or to other Person on account of any action taken or not taken by Lender in reliance upon such telephonic or facsimile notice. The obligation of Borrower to repay the Advances shall not be affected in any way or to any extent by any failure by Lender to receive written confirmation of any telephonic or facsimile notice or the receipt by Lender of a confirmation which is at variance with the terms understood by Lender to be contained in the telephonic or facsimile notice. 9.3 No Waiver: Cumulative Remedies. No failure to exercise and no delay in exercising, on the part of Lender, any right, remedy, power or privilege hereunder, shall operate as a waiver thereof; nor shall any single or partial exercise of any right, remedy, power or privilege hereunder preclude any other or further exercise thereof or the exercise of any other right, remedy, power or privilege. 9.4 Costs and Expenses. Borrower shall, whether or not the transactions contemplated hereby shall be consummated: (a) pay or reimburse Lender within ten (10) Business Days after demand for all Lender Costs incurred by Lender in connection with the development, preparation, delivery, administration and execution of (and any amendment, supplement, waiver or modification to in each case whether or not consummated), this Agreement, any Loan Document and any other documents prepared in connection herewith, or therewith, and the consummation of the transactions contemplated hereby and thereby, including the reasonable Attorney Costs incurred by Lender with respect thereto; (b) pay or reimburse Lender within ten (10) Business Days after demand for all Lender Costs incurred by Lender in connection with the enforcement, attempted enforcement, or preservation of any rights or remedies (including in connection with any "workout" or restructuring regarding the Advances, and including in any Insolvency Proceeding or appellate proceeding) 29 35 under this Agreement, any other Loan Document, and any such other documents, including reasonable Attorney Costs incurred by Lender; and (c) pay or reimburse Lender within ten (10) Business Days after demand for all reasonable appraisal (including the allocated cost of internal appraisal services), audit, due diligence, monitoring review, environmental inspection and review (including the allocated cost of such internal services), search and filing costs, fees and expenses, incurred or sustained by Lender in connection with the Loan, the Loan Documents, any of the Obligations and the matters referred to under (a) and (b) of this Section 9.4. 9.5 Indemnity. Borrower shall pay, indemnify, and hold Lender, its Affiliates and Subsidiaries, and their respective officers, directors, employees, counsel, agents and attorneys-in-fact (each, an "Indemnified Person") harmless from and against any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, charges, expenses or disbursements (including Attorney Costs) of any kind or nature whatsoever with respect to the execution, delivery, enforcement, performance and administration of this Agreement and any other Loan Documents, or the transactions contemplated hereby and thereby, and with respect to any investigation, litigation or proceeding (including any Insolvency Proceeding or appellate proceeding) related to this Agreement or the Advances or the use of the proceeds thereof, whether or not any Indemnified Person is a party thereto (all the foregoing, collectively, the "Indemnified Liabilities"); provided, that, Borrower shall have no obligation hereunder to any Indemnified Person with respect to Indemnified Liabilities arising from the gross negligence or willful misconduct of such Indemnified Person or the breach by Lender of its obligations hereunder. The agreements in this Section 9.5 shall survive payment of all other Obligations and the termination of this Agreement. 9.6 Marshaling: Payments Set Aside. Lender shall not be under any obligation to marshal any assets in favor of Borrower or any other Person or against or in payment of any or all of the Obligations. To the extent that Borrower makes a payment or payments to Lender, or to the extent Lender enforces its Liens or exercises its rights of set-off, and such payment or payments or the proceeds of such enforcement or set-off or any part thereof are subsequently invalidated, declared to be fraudulent or preferential, set aside or required to be repaid to a trustee, receiver or any other party in connection with any bankruptcy, or otherwise, then to the extent of such recovery the obligation or part thereof originally intended to be satisfied shall be revived and continued in full force and effect as if such payment had not been made or such enforcement or set-off had not occurred. 9.7 Successors and Assigns. The provisions of this Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns, except that Borrower may not assign or transfer any of its rights or delegate obligations under this Agreement or any of the Loan Documents without the prior written consent of Lender. 9.8 Set-off. In addition to any rights and remedies of Lender provided by law, if an Event of Default exists, and Borrower fails to cure such Event of Default within twenty (20) days after delivery of written notice thereof, Lender is authorized at any time and from time to time, without prior notice to Borrower, any such notice being waived by Borrower to the fullest extent permitted by law, to set off and apply any and all monies or deposits at any time held by, and other indebtedness at any time owing by, Lender to or for the credit or the account of Borrower against any and all Obligations owing to Lender, now or hereafter existing, irrespective of whether or not Lender shall have made demand under this Agreement or any Loan Document and although such Obligations may be contingent or unmatured. Lender agrees promptly to notify Borrower after any 30 36 such set-off and application made by Lender; provided, however, that, the failure to give such notice shall not affect the validity of such set-off and application. The rights of Lender under this Section 9.8 are in addition to the other rights and remedies (including other rights of set-off) which Lender may have. 9.9 Counterparts. This Agreement may be executed by one or more of the parties to this Agreement in any number of separate counterparts, each of which, when so executed, shall be deemed an original, and all of said counterparts taken together shall be deemed to constitute but one and the same instrument. A set of the copies of this Agreement signed by both parties shall be lodged with Borrower and Lender. 9.10 Severability. The illegality or unenforceability of any provision of this Agreement or any instrument or agreement required hereunder shall not in any way affect or impair the legality or enforceability of the remaining provisions of this Agreement or any instrument or agreement required hereunder. 9.11 No Third Parties Benefited. This Agreement is made and entered into for the sole protection and legal benefit of Borrower and Lender, and their permitted successors and assigns, and no other Person shall be a direct or indirect legal beneficiary of, or have any direct or indirect cause of action or claim in connection with, this Agreement or any of the other Loan Documents. Lender shall have no obligation to any Person not a party to this Agreement or other Loan Documents. 9.12 Time. Time is of the essence as to each term or provision of this Agreement and each of the other Loan Documents. 9.13 Governing Law and Jurisdiction. THE VALIDITY OF THIS AGREEMENT AND THE OTHER LOAN DOCUMENTS, THE CONSTRUCTION, INTERPRETATION, AND ENFORCEMENT HEREOF AND THEREOF, AND THE RIGHTS OF THE PARTIES HERETO AND THERETO WITH RESPECT TO ALL MATTERS ARISING HEREUNDER OR THEREUNDER OR RELATED HERETO OR THERETO SHALL BE DETERMINED UNDER, GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE UNITED STATES OF AMERICA (INCLUDING THE BANKRUPTCY CODE), IT BEING THE INTENT OF THE PARTIES THAT FEDERAL LAW SHALL GOVERN THE RIGHTS AND DUTIES OF THE PARTIES HERETO WITHOUT REGARD TO THE APPLICATION OF ANY PROVISION OF STATE LAW. TO THE EXTENT THAT FEDERAL LAW WOULD APPLY THE LAW OF ANY STATE AS THE FEDERAL RULE FOR THE PURPOSES OF THIS AGREEMENT, THE PARTIES AGREE THAT THE LAWS OF THE STATE OF ARIZONA SHALL BE USED TO SUPPLEMENT APPLICABLE FEDERAL LAW. THE PARTIES AGREE THAT ALL ACTIONS OR PROCEEDINGS ARISING IN CONNECTION WITH THIS AGREEMENT SHALL BE TRIED AND LITIGATED ONLY IN THE BANKRUPTCY COURT. BORROWER AND LENDER WAIVE, TO THE EXTENT PERMITTED UNDER APPLICABLE LAW, ANY RIGHT EACH MAY HAVE TO ASSERT THE DOCTRINE OF FORUM NON CONVENIENS OR TO OBJECT TO VENUE TO THE EXTENT ANY PROCEEDING IS BROUGHT IN ACCORDANCE WITH THIS SECTION 9.13. BORROWER AND LENDER HEREBY WAIVE THEIR RESPECTIVE RIGHTS TO A JURY TRIAL OF ANY CLAIM OR CAUSE OF ACTION BASED UPON OR ARISING OUT OF ANY OF THE LOAN DOCUMENTS OR ANY OF THE TRANSACTIONS CONTEMPLATED THEREIN, 31 37 INCLUDING CONTRACT CLAIMS, TORT CLAIMS, BREACH OF DUTY CLAIMS, AND ALL OTHER COMMON LAW OR STATUTORY CLAIMS. BORROWER AND LENDER REPRESENT THAT EACH HAS REVIEWED THIS WAIVER AND EACH KNOWINGLY AND VOLUNTARILY WAIVES ITS JURY TRIAL RIGHTS FOLLOWING CONSULTATION WITH LEGAL COUNSEL. IN THE EVENT OF LITIGATION, A COPY OF THIS AGREEMENT MAY BE FILED AS A WRITTEN CONSENT TO A TRIAL BY THE COURT. 9.14 Entire Agreement. This Agreement, together with the other Loan Documents, embodies the entire Agreement and understanding among Borrower and Lender and supersedes all prior or contemporaneous agreements and understandings of such Persons, verbal or written, relating to the subject matter hereof and thereof and any prior arrangements made with respect to the payment by Borrower (or any indemnification for) any Lender Costs incurred (or to be incurred) by or on behalf of Lender. 9.15 Interpretation. This Agreement is the result of negotiations between and has been reviewed by counsel to Lender, Borrower and other parties, and is the product of all parties hereto. Accordingly, this Agreement and the other Loan Documents shall not be construed against Lender merely because of Lender's involvement in the preparation of such documents and agreements. 9.16 Assignment. Lender may assign its rights hereunder and under the Loan Documents without the consent of Borrower, provided, however, that prior to September 13, 1997, Lender may so assign its rights without the consent of Borrower only by providing to Borrower written notice thirty (30) calendar days prior to the date upon which the assignment is to become effective. Borrower may not assign or delegate any of its rights, interest or obligations hereunder or under any of the Loan Documents. 9.17 Revival and Reinstatement of Obligations. If the incurrence or payment of the Obligations by Borrower or the transfer by Borrower to Lender of any property of either or both of such parties should for any reason subsequently be declared to be void or voidable under any state or federal law relating to creditors' rights, including provisions of the Bankruptcy Code relating to fraudulent conveyances, preferences, and other voidable or recoverable payments of money or transfers of property (collectively, a "Voidable Transfer"), and if Lender is required to repay or restore, in whole or in part, any such Voidable Transfer, or elects to do so upon the reasonable advice of its counsel, then, as to any such Voidable Transfer, or the amount thereof that Lender is required or elects to repay or restore, and as to all reasonable costs, expenses, and Attorney Costs of Lender related thereto, the liability of Borrower automatically shall be revived, reinstated, and restored and shall exist as though such Voidable Transfer had never been made. 9.18 No Purchase of Contracts/Servicing. Notwithstanding the provisions of the Term Sheet attached as Exhibit B to the Motion of Borrower for entry of the Interim Order, and referenced in the Interim Order, Borrower and Lender hereby acknowledge and agree that as of the date hereof, neither the Contracts Purchase Agreement nor the Servicing Agreement have been executed. Notwithstanding the foregoing, Borrower and Lender hereby reserve the right to discuss executing such documents at some later date. 32 38 IN WITNESS WHEREOF, the parties hereby have caused this Agreement to be executed as of the date first written above. FIRST MERCHANTS ACCEPTANCE CORPORATION, a Delaware corporation By: /s/ WILLIAM PLAMONDON ---------------------------------- Name: WILLIAM PLAMONDON Title: President & CEO UGLY DUCKLING CORPORATION, a Delaware corporation By: /s/ DONALD L. ADDINK ---------------------------------- Name: DONALD L. ADDINK Title: Vice President 33 EX-10.1.A 4 EX-10.1.A 1 Exhibit 10.1(a) ================================================================================ FIRST AMENDMENT TO CREDIT AND SECURITY AGREEMENT DATED AS OF JANUARY 21, 1998 BY AND BETWEEN UGLY DUCKLING CORPORATION, A DELAWARE CORPORATION ("LENDER") AND FIRST MERCHANTS ACCEPTANCE CORPORATION, A DELAWARE CORPORATION ("BORROWER") ================================================================================ JonesT\TUX\088655.04 2 FIRST AMENDMENT TO CREDIT AND SECURITY AGREEMENT This FIRST AMENDMENT TO CREDIT AND SECURITY AGREEMENT (the "Amendment to Agreement"), is entered into as of January 21, 1998, between UGLY DUCKLING CORPORATION, a Delaware corporation ("Lender"), with a place of business located at 2525 East Camelback Road, Suite 1150, Phoenix, Arizona 85016, and FIRST MERCHANTS ACCEPTANCE CORPORATION, a Delaware corporation, the debtor and debtor-in-possession in the Reorganization Case ("Borrower") with a principal place of business located at 570 Lake Cook Road, Suite 126, Deerfield, Illinois 60015. WHEREAS, Lender agreed to make available to Borrower a revolving credit facility (the "Loan") upon the terms and conditions set forth in that certain Credit and Security Agreement dated as of July 17, 1997, by and between Lender and Borrower; WHEREAS, pursuant to the terms of the Agreement, Lender agreed to loan Borrower up to Ten Million Dollars ($10,000,000.00); WHEREAS, the Lender and the Borrower have agreed modify the Agreement as set forth below to, among other things, increase the loan amount and extend the maturity. NOW, THEREFORE, in consideration of the mutual agreements, provisions and covenants contained herein, the parties agree to modify, amend and supplement the Agreement only as follows, all other provisions of the Agreement not effected hereby to remain in full force and effect: ARTICLE I DEFINITIONS 1.1 Defined Terms. Capitalized terms not defined herein are used as defined in the Agreement. Terms used herein shall also be used in conjunction with the interpretive provisions of Section 1.2 of the Agreement. The following capitalized terms have the meanings set forth immediately below: (a) Agent means LaSalle National Bank, as agent, under that certain Fourth Amended and Restated Loan and Security Agreement, dated as of February 28, 1996, as subsequently amended. (b) B Piece Distributions means all amounts received or to be received with respect to all of the residual interests, certificates in and all rights to payments under or related to any of the Securitized Pools held by Borrower, FMARC or FMARC II, without duplication, including, without limitation, all amounts distributable from any of the spread accounts. (c) Charged Off Receivables means Contracts charged off through December 31, 1997 and held in the Securitized Pools. (d) Charged Off Receivable Sale means the sale of the Charged Off Receivables, on terms acceptable to UDC, (1) to UDC for a purchase price equal to 1% of the outstanding principal balance of such Contracts charged off on or prior to September 30, 1997 and 2% of the outstanding principal balance of such Contracts charged off between October 1, 1997 and December 31, 1997 ("UDC's Initial Bid"), or (2) if UDC is not the successful bidder at such sale, where UDC is entitled to receive, and actually receives, fifty (50) percent of the proceeds in excess of UDC's Initial Bid (such recovery not to exceed Three Hundred and Fifty Thousand Dollars ($350,000)). JonesT\TUX\088655.04 1 3 (f) Contracts means retail installment motor vehicle contracts originated or purchased by FMAC. (g) Excess Greenwich Collateral means any remaining proceeds from collections on Greenwich Collateral after full repayment of all loan obligations to Greenwich secured thereby. (h) FMARC means First Merchants Auto Receivables Corporation, a Delaware corporation. (i) FMARC II means First Merchants Auto Receivables Corporation II, a Delaware corporation. (j) FSA means Financial Security Assurance Inc. (k) Greenwich means Greenwich Capital Financial Products, Inc. (l) Greenwich Collateral means all Contracts and related collateral securing repayment of amounts due Greenwich. (m) Securitized Pools means the pools of Contracts which FMAC securitized through FMARC and FMARC II. (n) Tax Refunds means any and all tax refunds to which the Borrower or any subsidiary of Borrower may be entitled under their return for tax year 1996 and prior tax years. ARTICLE II THE COMMITMENT 2.1 Increase In Commitment Amount. The definition of "Commitment Amount" set forth in Section 1.1 of the Agreement is hereby modified and replaced with the following definition: "Commitment Amount" means, prior to the Charged Off Receivable Sale, the maximum principal amount of Sixteen Million Five Hundred Thousand Dollars ($16,500,000.00) and, after the Charged Off Receivable Sale, the maximum principal amount of Eighteen Million Five Hundred Thousand Dollars ($18,500,000.00). 2.2 Modification of Commitment Fee. The definition of "Commitment Fee" set forth in Section 1.1 of the Agreement is hereby modified and replaced with the following definition: "Commitment Fee" means the sum of Four Hundred and Fifty Thousand Dollars ($450,000.00), such sum representing a fee for providing the Loan. 2.3 Repayment and Mandatory Prepayment. Section 2.3 of the Agreement is hereby amended and replaced with the following: Borrower shall repay all amounts due under the Loan on or prior to the Maturity Date. Borrower shall immediately prepay that portion of the principal amount of any Advances at any time outstanding which exceeds the Commitment Amount. In addition, Borrower shall be required to make the following payments until termination of the Agreement: JonesT\TUX\088655.04 2 4 (a) Borrower shall, within ten (10) days of receipt, remit to Lender all amounts received by Borrower with respect to the Tax Refunds, the first Ten Million Dollars ($10,000,000) of such monies to be applied to permanently reduce the Commitment Amount. (b) Borrower shall remit to Lender all amounts received by Borrower on account of, or from, the B Piece Distributions, such monies to be applied to permanently reduce the Commitment Amount. (c) Borrower shall remit to Lender all amounts received by Borrower on account of, or from, the Excess Greenwich Collateral, Tax Refunds in excess of Ten Million Dollars ($10,000,000.00), sales or liquidation of any of Borrower's furniture, fixtures and equipment, such monies shall not permanently reduce the Commitment Amount and the Borrower will be allowed to reborrow such amounts under the terms of this Agreement. (d) Borrower may, but is under no obligation to, use proceeds from the UDC Warrants and its causes of action to repay amounts due under this Agreement if it so elects and in the event it so elects, such repayment will not constitute a permanent paydown of the Commitment Amount and the Borrower will be allowed to reborrow such amounts under the terms of this Agreement. 2.4 Interest Rate. Section 2.4 of the Agreement shall be modified to include a new subsection (e) which provides: (e) Notwithstanding anything to the contrary in Section 2.4(a) hereof, from and after the effective date of the Borrowers' plan of reorganization (such date to be defined in such plan) confirmed with the consent and approval of Lender (the "Chapter 11 Plan"), all Advances (and all Obligations not paid when due) shall bear interest at a per annum rate of ten percent (10%). Nothing in this subsection (e) shall modify any other provisions in Section 2.4. 2.5 Commitment Fee. Section 2.5 of the Agreement is hereby amended and replaced with the following text:Borrower shall unconditionally pay Lender the Commitment Fee which is earned in full, non-refundable, and due and payable as of the date hereof. Lender agrees, however, that payment of such fees shall not accrue interest and shall be made by Borrower on the earlier of (1) in accordance with the Plan from the B Pieces (as defined in the Chapter 11 Plan) distributions, (2) conversion of the case to a case under Chapter 7 of the Bankruptcy Code, (3) appointment of a trustee or examiner under the Bankruptcy Code, or (4) confirmation of a plan of reorganization or liquidation that is not supported by Lender. 2.6 Maturity Date. Section 2.8 of the Agreement is hereby amended and restated to provide as follows: The Maturity Date shall be the earlier of (1) December 31, 2000 or (ii) the date when the Commitment Amount has been permanently reduced to zero. 2.7 Term. Section 4.3 of the Agreement shall be amended and replaced to provide that: This Agreement shall become effective upon the execution and delivery hereof by Borrower and Lender and shall continue in full force and effect for a term ending on the earliest of (a) the confirmation of a Chapter 11 Plan of Reorganization other than the Chapter 11 Plan, (b) the date of the conversion of Borrower's Chapter 11 case to one pursuant to Chapter 7 of the Bankruptcy Code, (c) the date a trustee or examiner is appointed in the Chapter 11 Case, (d) the Maturity Date, (e) dismissal of the Chapter 11 case, or (f) the date of termination of this Agreement in accordance with its terms after the occurrence and during the continuation of an Event of Default. JonesT\TUX\088655.04 3 5 2.8 Costs and Expenses. Borrower and Lender agree that Lender is entitled to, in satisfaction of Borrower's obligations under Section 9.4 of the Agreement, the sum of One Hundred Thousand Dollars ($100,000.00), such sum representing the agreed upon fees and expenses of Lender associated with the Loan and to be paid on the effective date of the Plan. ARTICLE III REPRESENTATIONS AND WARRANTIES In order to induce Lender to enter into this Amendment, Borrower represents and warrants that the Representations and Warranties made by Debtor in Article III of the Agreement are true, correct, and complete in all respects as of the date hereof. ARTICLE IV EVENTS OF DEFAULT/REMEDIES 4.1 Event of Default. Section 4.1(m) shall be deleted in its entirety. ARTICLE V MISCELLANEOUS 5.1 Amendments and Waivers. No amendment or waiver of any provision of this Amendment, the Agreement or any other Loan Document, and no consent with respect to any departure by Borrower therefrom, shall be effective unless the same shall be in writing and signed by Lender and Borrower, and then such waiver shall be effective only in the specific instance and for the specific purpose for which given. 5.2 Notices. (a) All notices, requests and other communications provided for hereunder shall be in writing (including, unless the context expressly otherwise provides, by facsimile transmission, provided, that, any matter transmitted by facsimile (i) shall be immediately confirmed by a telephone call to the recipient, and (ii) shall be followed promptly by a hard copy original thereof by over-night courier to the address set forth below; or to such other address as shall be designated by such party in a written notice to the other party, and as directed to each other party, at such other address as shall be designated by Lender or Borrower in a written notice to Borrower and Lender. If to Borrower: FIRST MERCHANTS ACCEPTANCE CORPORATION 570 Lake Cook Road Suite 126 Deerfield, Illinois 60015 Attn: Howard Adamski Facsimile No.: (847) 945-2556 JonesT\TUX\088655.04 4 6 With a copy to: Sonnenschein Nath & Rosenthal 8000 Sears Tower Chicago, Illinois 60606-6404 Attn: Robert Richards, Esquire Facsimile No. (312) 876-7934 If to Lender: UGLY DUCKLING CORPORATION 2525 East Camelback Road Suite 1150 Phoenix, Arizona 85016 Attn: Steven Johnson Facsimile No.: (602) 852-6696 With a copy to: Snell & Wilmer L.L.P. One Arizona Center Phoenix, Arizona 85004-0001 Attn: Timothy W. Moser, Esquire Facsimile No.: (602) 382-6070 (b) All such notices, requests and communications shall, when transmitted by overnight delivery or faxed, be effective when delivered for overnight (next day) delivery, transmitted by facsimile machine, respectively, or if delivered, upon delivery, except that notices pursuant to Article II shall not be effective until actually received by Lender. (c) Borrower acknowledges and agrees that any agreement of Lender to receive certain notices by telephone and facsimile is solely for the convenience and at the request of Borrower. Lender shall be entitled to rely on the authority of any Person purporting to be a Person authorized by Borrower to give such notice and Lender shall not have any liability to Borrower or to other Person on account of any action taken or not taken by Lender in reliance upon such telephonic or facsimile notice. The obligation of Borrower to repay the Advances shall not be affected in any way or to any extent by any failure by Lender to receive written confirmation of any telephonic or facsimile notice or the receipt by Lender of a confirmation which is at variance with the terms understood by Lender to be contained in the telephonic or facsimile notice. 5.3 No Waiver: Cumulative Remedies. No failure to exercise and no delay in exercising, on the part of Lender, any right, remedy, power or privilege hereunder, shall operate as a waiver thereof; nor shall any single or partial exercise of any right, remedy, power or privilege hereunder preclude any other or further exercise thereof or the exercise of any other right, remedy, power or privilege. 5.4 Counterparts. This Amendment may be executed by one or more of the parties to this Amendment in any number of separate counterparts, each of which, when so executed, shall be deemed an original, and all of said counterparts taken together shall be deemed to constitute but one and the same instrument. 5.5 Severability. The illegality or unenforceability of any provision of this Amendment or any instrument or agreement required hereunder shall not in any way affect or impair the legality or enforceability of the remaining provisions of this Amendment or any instrument or agreement required hereunder. JonesT\TUX\088655.04 5 7 5.6 No Third Parties Benefited. This Amendment is made and entered into for the sole protection and legal benefit of Borrower and Lender, and their permitted successors and assigns, and no other Person shall be a direct or indirect legal beneficiary of, or have any direct or indirect cause of action or claim in connection with, this Amendment or any of the other Loan Documents. Lender shall have no obligation to any Person not a party to this Amendment or other Loan Documents. 5.7 Time. Time is of the essence as to each term or provision of this Amendment and each of the other Loan Documents. 5.8 Governing Law and Jurisdiction. THE VALIDITY OF THIS AGREEMENT AND THE OTHER LOAN DOCUMENTS, THE CONSTRUCTION, INTERPRETATION, AND ENFORCEMENT HEREOF AND THEREOF, AND THE RIGHTS OF THE PARTIES HERETO AND THERETO WITH RESPECT TO ALL MATTERS ARISING HEREUNDER OR THEREUNDER OR RELATED HERETO OR THERETO SHALL BE DETERMINED UNDER, GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE UNITED STATES OF AMERICA (INCLUDING THE BANKRUPTCY CODE), IT BEING THE INTENT OF THE PARTIES THAT FEDERAL LAW SHALL GOVERN THE RIGHTS AND DUTIES OF THE PARTIES HERETO WITHOUT REGARD TO THE APPLICATION OF ANY PROVISION OF STATE LAW. TO THE EXTENT THAT FEDERAL LAW WOULD APPLY THE LAW OF ANY STATE AS THE FEDERAL RULE FOR THE PURPOSES OF THIS AGREEMENT, THE PARTIES AGREE THAT THE LAWS OF THE STATE OF ARIZONA SHALL BE USED TO SUPPLEMENT APPLICABLE FEDERAL LAW. THE PARTIES AGREE THAT ALL ACTIONS OR PROCEEDINGS ARISING IN CONNECTION WITH THIS AGREEMENT SHALL BE TRIED AND LITIGATED ONLY IN THE BANKRUPTCY COURT. BORROWER AND LENDER WAIVE, TO THE EXTENT PERMITTED UNDER APPLICABLE LAW, ANY RIGHT EACH MAY HAVE TO ASSERT THE DOCTRINE OF FORUM NON CONVENIENS OR TO OBJECT TO VENUE TO THE EXTENT ANY PROCEEDING IS BROUGHT IN ACCORDANCE WITH THIS SECTION 9.13. BORROWER AND LENDER HEREBY WAIVE THEIR RESPECTIVE RIGHTS TO A JURY TRIAL OF ANY CLAIM OR CAUSE OF ACTION BASED UPON OR ARISING OUT OF ANY OF THE LOAN DOCUMENTS OR ANY OF THE TRANSACTIONS CONTEMPLATED THEREIN, INCLUDING CONTRACT CLAIMS, TORT CLAIMS, BREACH OF DUTY CLAIMS, AND ALL OTHER COMMON LAW OR STATUTORY CLAIMS. BORROWER AND LENDER REPRESENT THAT EACH HAS REVIEWED THIS WAIVER AND EACH KNOWINGLY AND VOLUNTARILY WAIVES ITS JURY TRIAL RIGHTS FOLLOWING CONSULTATION WITH LEGAL COUNSEL. IN THE EVENT OF LITIGATION, A COPY OF THIS AGREEMENT MAY BE FILED AS A WRITTEN CONSENT TO A TRIAL BY THE COURT. 5.9 Entire Agreement. The Agreement, together with the other Loan Documents, embodies the entire Agreement and understanding among Borrower and Lender and supersedes all prior or contemporaneous agreements and understandings of such Persons, verbal or written, relating to the subject matter hereof and thereof and any prior arrangements made with respect to the payment by Borrower (or any indemnification for) any Lender Costs incurred (or to be incurred) by or on behalf of Lender. 5.10 Interpretation. This Amendment is the result of negotiations between and has been reviewed by counsel to Lender, Borrower and other parties, and is the product of all parties hereto. Accordingly, this Amendment, the Agreement and the other Loan Documents shall not be construed against Lender merely because of Lender's involvement in the preparation of such documents and agreements. JonesT\TUX\088655.04 6 8 5.11 Assignment. Lender may assign its rights under the Agreement, as amended hereby, and under the Loan Documents without the consent of Borrower. Borrower acknowledges that it understands that Lender intends to grant Greenwich a security interest in Lender's rights hereunder and under the Loan Documents. 5.12 Plan Controls. To the extent the Agreement, as amended hereby, contradicts or conflicts with the Chapter 11 Plan, the terms of the Chapter 11 Plan will control. IN WITNESS WHEREOF, the parties hereby have caused this Amendment to be executed as of the date first written above. FIRST MERCHANTS ACCEPTANCE CORPORATION, a Delaware corporation By: /s/ WILLIAM PLAMONDON ---------------------------------------------- Name: WILLIAM PLAMONDON Title: President & CEO UGLY DUCKLING CORPORATION, a Delaware corporation By: /s/ DONALD L. ADDINK ---------------------------------------------- Name: DONALD L. ADDINK Title: Vice President JonesT\TUX\088655.04 7 EX-10.1.B 5 EX-10.1.B 1 Exhibit 10.1(b) ================================================================================ SECOND AMENDMENT TO CREDIT AND SECURITY AGREEMENT DATED AS OF APRIL 1, 1998 BY AND BETWEEN UGLY DUCKLING CORPORATION, A DELAWARE CORPORATION ("LENDER") AND FIRST MERCHANTS ACCEPTANCE CORPORATION, A DELAWARE CORPORATION ("BORROWER") ================================================================================ JonesT\TUX\094898.03 2 SECOND AMENDMENT TO CREDIT AND SECURITY AGREEMENT This SECOND AMENDMENT TO CREDIT AND SECURITY AGREEMENT (the "Amendment to Agreement"), is entered into as of April 1, 1998, between UGLY DUCKLING CORPORATION, a Delaware corporation ("Lender"), with a place of business located at 2525 East Camelback Road, Suite 1150, Phoenix, Arizona 85016, and FIRST MERCHANTS ACCEPTANCE CORPORATION, a Delaware corporation, the debtor and debtor-in-possession in the Reorganization Case ("Borrower") with a principal place of business located at 570 Lake Cook Road, Suite 126, Deerfield, Illinois 60015. WHEREAS, Lender agreed to make available to Borrower a revolving credit facility (the "Loan") upon the terms and conditions set forth in that certain Credit and Security Agreement dated as of July 17, 1997, by and between Lender and Borrower (the "Agreement"); WHEREAS, the Agreement was amended by that certain First Amendment to Credit and Security Agreement, dated as of January 21, 1998. WHEREAS, the Lender and the Borrower have agreed as part of Borrower's Chapter 11 plan to modify the Agreement, as amended, as set forth below to, among other things, increase the loan amount and extend the maturity, which agreement is reflected herein. NOW, THEREFORE, in consideration of the mutual agreements, provisions and covenants contained herein, the parties agree to modify, amend and supplement the Agreement only as follows, all other provisions of the Agreement not effected hereby to remain in full force and effect: ARTICLE I THE COMMITMENT 1.1 Increase In Commitment Amount. The definition of "Commitment Amount" set forth in Section 1.1 of the Agreement is hereby modified and replaced with the following definition: "Commitment Amount" means the maximum principal amount of Twenty-One Million Five Hundred Thousand Dollars ($21,500,000.00). 1.2 Post-Confirmation Costs and Expenses. Borrower and Lender agree (1) that Borrower shall pay Lender the sum of $100,000.00 no later than April 13, 1998, such sum representing the agreed upon fees and expenses of Lender accruing prior to April 1, 1998 and (2) that the costs and expenses of the Lender, in its capacity as Lender hereunder, accruing after April 1, 1998 shall promptly be paid to Lender consistent with Section 9.4 of the Agreement. ARTICLE II REPRESENTATIONS AND WARRANTIES In order to induce Lender to enter into this Amendment, Borrower represents and warrants that the Representations and Warranties made by Debtor in Article III of the Agreement are true, correct, and complete in all respects as of the date hereof. JonesT\TUX\094898.03 1 3 ARTICLE III MISCELLANEOUS 3.1 Amendments and Waivers. No amendment or waiver of any provision of this Amendment, the Agreement or any other Loan Document, and no consent with respect to any departure by Borrower therefrom, shall be effective unless the same shall be in writing and signed by Lender and Borrower, and then such waiver shall be effective only in the specific instance and for the specific purpose for which given. 3.2 Notices. (a) All notices, requests and other communications provided for hereunder shall be in writing (including, unless the context expressly otherwise provides, by facsimile transmission, provided, that, any matter transmitted by facsimile (i) shall be immediately confirmed by a telephone call to the recipient, and (ii) shall be followed promptly by a hard copy original thereof by over-night courier to the address set forth below; or to such other address as shall be designated by such party in a written notice to the other party, and as directed to each other party, at such other address as shall be designated by Lender or Borrower in a written notice to Borrower and Lender. If to Borrower: FIRST MERCHANTS ACCEPTANCE CORPORATION 570 Lake Cook Road Suite 126 Deerfield, Illinois 60015 Attn: Howard Adamski Facsimile No.: (847) 945-2556 With a copy to: Sonnenschein Nath & Rosenthal 8000 Sears Tower Chicago, Illinois 60606-6404 Attn: Robert Richards, Esquire Facsimile No. (312) 876-7934 If to Lender: UGLY DUCKLING CORPORATION 2525 East Camelback Road Suite 1150 Phoenix, Arizona 85016 Attn: Steven Johnson Facsimile No.: (602) 852-6696 With a copy to: Snell & Wilmer L.L.P. One Arizona Center Phoenix, Arizona 85004-0001 Attn: Timothy W. Moser, Esquire Facsimile No.: (602) 382-6070 (b) All such notices, requests and communications shall, when transmitted by overnight delivery or faxed, be effective when delivered for overnight (next day) delivery, transmitted by facsimile machine, respectively, or if delivered, upon delivery, except that notices pursuant to Article II shall not be effective until actually received by Lender. JonesT\TUX\094898.03 2 4 (c) Borrower acknowledges and agrees that any agreement of Lender to receive certain notices by telephone and facsimile is solely for the convenience and at the request of Borrower. Lender shall be entitled to rely on the authority of any Person purporting to be a Person authorized by Borrower to give such notice and Lender shall not have any liability to Borrower or to other Person on account of any action taken or not taken by Lender in reliance upon such telephonic or facsimile notice. The obligation of Borrower to repay the Advances shall not be affected in any way or to any extent by any failure by Lender to receive written confirmation of any telephonic or facsimile notice or the receipt by Lender of a confirmation which is at variance with the terms understood by Lender to be contained in the telephonic or facsimile notice. 3.3 No Waiver: Cumulative Remedies. No failure to exercise and no delay in exercising, on the part of Lender, any right, remedy, power or privilege hereunder, shall operate as a waiver thereof; nor shall any single or partial exercise of any right, remedy, power or privilege hereunder preclude any other or further exercise thereof or the exercise of any other right, remedy, power or privilege. 3.4 Counterparts. This Amendment may be executed by one or more of the parties to this Amendment in any number of separate counterparts, each of which, when so executed, shall be deemed an original, and all of said counterparts taken together shall be deemed to constitute but one and the same instrument. 3.5 Severability. The illegality or unenforceability of any provision of this Amendment or any instrument or agreement required hereunder shall not in any way affect or impair the legality or enforceability of the remaining provisions of this Amendment or any instrument or agreement required hereunder. 3.6 No Third Parties Benefited. This Amendment is made and entered into for the sole protection and legal benefit of Borrower and Lender, and their permitted successors and assigns, and no other Person shall be a direct or indirect legal beneficiary of, or have any direct or indirect cause of action or claim in connection with, this Amendment or any of the other Loan Documents. Lender shall have no obligation to any Person not a party to this Amendment or other Loan Documents. 3.7 Time. Time is of the essence as to each term or provision of this Amendment and each of the other Loan Documents. 3.8 Governing Law and Jurisdiction. THE VALIDITY OF THIS AGREEMENT AND THE OTHER LOAN DOCUMENTS, THE CONSTRUCTION, INTERPRETATION, AND ENFORCEMENT HEREOF AND THEREOF, AND THE RIGHTS OF THE PARTIES HERETO AND THERETO WITH RESPECT TO ALL MATTERS ARISING HEREUNDER OR THEREUNDER OR RELATED HERETO OR THERETO SHALL BE DETERMINED UNDER, GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE UNITED STATES OF AMERICA (INCLUDING THE BANKRUPTCY CODE), IT BEING THE INTENT OF THE PARTIES THAT FEDERAL LAW SHALL GOVERN THE RIGHTS AND DUTIES OF THE PARTIES HERETO WITHOUT REGARD TO THE APPLICATION OF ANY PROVISION OF STATE LAW. TO THE EXTENT THAT FEDERAL LAW WOULD APPLY THE LAW OF ANY STATE AS THE FEDERAL RULE FOR THE PURPOSES OF THIS AGREEMENT, THE PARTIES AGREE THAT THE LAWS OF THE STATE OF ARIZONA SHALL BE USED TO SUPPLEMENT APPLICABLE FEDERAL LAW. THE PARTIES AGREE THAT ALL ACTIONS OR PROCEEDINGS ARISING IN CONNECTION WITH THIS AGREEMENT SHALL BE TRIED AND LITIGATED ONLY IN THE BANKRUPTCY COURT. BORROWER AND LENDER WAIVE, TO THE EXTENT PERMITTED UNDER APPLICABLE LAW, ANY JonesT\TUX\094898.03 3 5 RIGHT EACH MAY HAVE TO ASSERT THE DOCTRINE OF FORUM NON CONVENIENS OR TO OBJECT TO VENUE TO THE EXTENT ANY PROCEEDING IS BROUGHT IN ACCORDANCE WITH THIS SECTION 9.13. BORROWER AND LENDER HEREBY WAIVE THEIR RESPECTIVE RIGHTS TO A JURY TRIAL OF ANY CLAIM OR CAUSE OF ACTION BASED UPON OR ARISING OUT OF ANY OF THE LOAN DOCUMENTS OR ANY OF THE TRANSACTIONS CONTEMPLATED THEREIN, INCLUDING CONTRACT CLAIMS, TORT CLAIMS, BREACH OF DUTY CLAIMS, AND ALL OTHER COMMON LAW OR STATUTORY CLAIMS. BORROWER AND LENDER REPRESENT THAT EACH HAS REVIEWED THIS WAIVER AND EACH KNOWINGLY AND VOLUNTARILY WAIVES ITS JURY TRIAL RIGHTS FOLLOWING CONSULTATION WITH LEGAL COUNSEL. IN THE EVENT OF LITIGATION, A COPY OF THIS AGREEMENT MAY BE FILED AS A WRITTEN CONSENT TO A TRIAL BY THE COURT. 3.9 Entire Agreement. The Agreement, together with the other Loan Documents, embodies the entire Agreement and understanding among Borrower and Lender and supersedes all prior or contemporaneous agreements and understandings of such Persons, verbal or written, relating to the subject matter hereof and thereof and any prior arrangements made with respect to the payment by Borrower (or any indemnification for) any Lender Costs incurred (or to be incurred) by or on behalf of Lender. 3.10 Interpretation. This Amendment is the result of negotiations between and has been reviewed by counsel to Lender, Borrower and other parties, and is the product of all parties hereto. Accordingly, this Amendment, the Agreement and the other Loan Documents shall not be construed against Lender merely because of Lender's involvement in the preparation of such documents and agreements. IN WITNESS WHEREOF, the parties hereby have caused this Amendment to be executed as of the date first written above. FIRST MERCHANTS ACCEPTANCE CORPORATION, a Delaware corporation By: /s/ Howard J. Adamski ---------------------------------------------- Name: Howard J. Adamski Title: Vice President & Treasurer UGLY DUCKLING CORPORATION, a Delaware corporation By: /s/ Steven P. Johnson ---------------------------------------------- Name: Steven P. Johnson Title: Senior Vice President & Secretary JonesT\TUX\094898.03 4 EX-10.2 6 EX-10.2 1 Exhibit 10.2 [UGLY DUCKLING LETTERHEAD] UGLY DUCKLING CORPORATION October 20, 1997 VIA FACSIMILE (847-304-3338) & REGULAR MAIL Mr. Farhaan Hassan GE Capital Asset Based Financing 800 Hart Road, Suite 200 Barrington, Illinois 60010 Re: $100 million line of credit Dear Farhaan: As you know, Section 13.15 of the Amended and Restated Loan and Security Agreement provides that Ugly Duckling Corporation shall not invest more than $20 million into Cygnet Finance, Inc. On behalf of Ugly Duckling Corporation, Eric Splaver has requested an increase in the investment limitation to $30 million. I understand that you have agreed to this increase. The purpose of this letter is to confirm the agreement between General Electric Capital Corporation and Ugly Duckling Corporation to amend Section 13.15 of the Amended and Restated Loan and Security Agreement to increase the investment limitation in Cygnet Finance, Inc. from $20 million to $30 million. Please acknowledge your agreement to this amendment by signing this letter and returning it to me at your convenience. If you have any questions or instructions regarding this matter please contact me at any time. Your cooperation is appreciated. Cordially, /s/ Steven P. Johnson Steven P. Johnson General Counsel SPJ:ag Cc: Eric J. Splaver UDH.GE:CFH20.DOC 2 Acknowledged and accepted this 23 day of October, 1997. General Electric Capital Corporation By: /s/ Farhaan Hassan --------------------------------- Name: Farhaan Hassan --------------------------------- Its: Account Executive --------------------------------- 2 UDH.GE:CFH20.DOC EX-10.3 7 EX-10.3 1 EXHIBIT 10.3 [UGLY DUCKLING LETTERHEAD] UGLY DUCKLING CORPORATION March 25, 1998 VIA FACSIMILE (847-304-3338) Mr. Farhaan Hassan GE Capital Asset Based Financing 800 Hart Road, Suite 200 Barrington, Illinois 60010 Re: Requests for GECC approvals Dear Farhaan: Over the last few weeks I have submitted requests for GECC's approval of four matters relating to the Ugly Duckling Amended and Restated Loan Agreement (the "Loan Agreement"). You asked that I combine these four requests in a single letter. The four requests are restated as follows: 1. TIMING OF CONTRACT PAYMENTS. Section 4.1 of the Loan Agreement provides that all remittances received by the Borrower shall be deposited into the depository account "...as soon as possible, but no later than two business days following receipt..." Apparently, the agreements between Ugly Duckling and all other contract owners provide for deposit within three business days. I understand that you are aware of this and are willing to allow Ugly Duckling to deposit receipts within three business days rather than the two business days required by the Loan Agreement. 2. SALE LEASEBACK. Ugly Duckling Corporation has entered into a nonbinding commitment letter to sell and leaseback substantially all of the properties owned by the Ugly Duckling entities. The Buyer and Landlord is Imperial Credit Commercial Investment Corp. or one of its affiliates ("Imperial"). Enclosed is a copy of the Commitment Letter between Ugly Duckling and Imperial. We hope to close the sale/leaseback transaction within the next 30 days. The proceeds of the transaction will be used by Ugly Duckling for working capital. GECC has a lien on substantially all the assets of Ugly Duckling. However, GECC does not have mortgages on the Ugly Duckling properties. Therefore, the Ugly Duckling properties can be conveyed without a release of the security interests of GECC in the assets of Ugly Duckling. Nonetheless, I would like to obtain GECC's consent to the sale/leaseback transaction. 3. CYGNET FINANCE INVESTMENT. Section 13.15 of the Loan Agreement provides that Ugly Duckling Corporation shall not invest more than $20 million into Cygnet Finance, Inc. Last October, you agreed to increase the $20 million limit to $30 million. The investment in Cygnet Finance, Inc. is now or soon will be, in excess of $30 million. Eric Splaver of Ugly Duckling has spoken to you about an increase in the investment limitation to $40 million. I would appreciate your acknowledgment of the increase in the Cygnet investment limitation to $40 million. UDH.GE:CFH33.DOC 2 Farhaan Hassan March 25, 1998 Page Two 4. GREENWICH SECURITIZATION COMMITMENT. Ugly Duckling has entered into a securitization commitment with Greenwich Capital Markets. I have never requested GECC's consent to this securitization arrangement between Ugly Duckling and Greenwich. Enclosed is the commitment letter setting forth the terms of this securitization commitment. I would appreciate your acknowledgment and approval of the securitization arrangement between Ugly Duckling and Greenwich. Please acknowledge GECC's approval of these four requests by signing this letter and returning it to me at your earliest convenience. Thank you for your cooperation. Cordially, /s/ Steven P. Johnson Steven P. Johnson General Counsel SPJ:ag Accepted and approved this 30 day of March, 1998. General Electric Capital Corporation By: /s/ Farhaan Hassan ----------------------------------- Name: Farhaan Hassan ----------------------------------- Its: Account Executive ----------------------------------- UDH.GE:CFH33.DOC EX-27 8 EX-27
5 This financial data schedule for the quarter ended March 31, 1998 contains summary financial information which is incorporated by reference from the 1998 quarterly report and extracted from the Condensed Consolidated Balance Sheets, Condensed Consolidated Statements of Operations, and Condensed Consolidated Statements of Cash Flows, and is qualified in its entirety by reference to the financial statements and the notes thereto within this report on form 10-Q. Any item provided in the schedule, in accordance with the rules governing the schedule, will not be subject to liability under the federal securities laws, except to the extent that the financial statements and other information from which the data were extracted violate the federal securities laws. Also, pursuant to item 601(c)(1)(iv) of Regulation S-K promulgated by the Securities and Exchange Commission (SEC), the schedule shall not be deemed filed for purposes of Section 11 of the Securities Act of 1933, Section 18 of the Securities Exchange Act of 1934 and Section 323 of the Trust Indenture Act of 1939, or otherwise be subject to the liabilities of such sections, nor shall it be deemed a part of any registration statement to which it relates. 0001012704 UGLY DUCKLING CORP 1,000 3-MOS 3-MOS DEC-31-1997 DEC-31-1996 MAR-31-1998 MAR-31-1997 514 73,237 15,181 4,147 59,162 16,360 6,153 1,438 25,458 8,793 0 0 49,033 27,060 (5,528) (2,914) 288,863 205,015 0 0 0 0 0 0 0 0 173,724 171,274 7,286 2,969 288,863 205,015 72,972 18,211 85,448 22,296 40,363 9,164 0 0 23,147 8,440 15,034 3,261 647 177 6,257 1,254 2,511 499 3,746 755 (5,612) 2,507 0 0 0 0 (1,866) 3,262 (0.10) 0.21 (0.10) 0.20 Unclassified Balance Sheet
EX-99 9 EX-99 1 EXHIBIT-99 CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS AND RISK FACTORS The Company wishes to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995 and is filing this cautionary statement in connection with such safe harbor legislation. The Company's Form 10-K, this Form 10-Q, any other Form 10-Q, any Form 8-K, other SEC filings, or any other written or oral statements made by or on behalf of the Company may include forward looking statements which reflect the Company's current views with respect to future events and financial performance. The words "believe," "expect," "anticipate," "intend," "forecast," "project," and similar expressions identify forward looking statements. The Company wishes to caution investors that any forward looking statements made by or on behalf of the Company are subject to uncertainties and other factors that could cause actual results to differ materially from such statements. These uncertainties and other factors include, but are not limited to, the Risk Factors listed below (many of which have been discussed in prior SEC filings by the Company). Though the Company has attempted to list comprehensively these important factors, the Company wishes to caution investors that other factors may in the future prove to be important in affecting the Company's results of operations. New factors emerge from time to time and it is not possible for management to predict all of such factors, nor can it assess the impact of each such factor on the business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from forward looking statements. Investors are further cautioned not to place undue reliance on such forward looking statements as they speak only of the Company's views as of the date the statement was made. The Company undertakes no obligation to publicly update or revise any forward looking statements, whether as a result of new information, future events, or otherwise. RISK FACTORS Investing in the securities of the Company involves certain risks. In addition to the other information included elsewhere in this Form 10-Q, investors should give careful consideration to the following risk factors which may impact the Company's performance and the price of its stock. No Assurance of Profitability The Company began operations in 1992 and incurred significant operating losses in 1994 and 1995. The Company recorded net earnings of $5.9 million in 1996 and net earnings in 1997 of $9.5 million. However, the Company incurred net losses in the three month period ended March 31, 1998 of $1.9 million due primarily to a charge of $9.1 million (approximately $5.6 million, net of income taxes) for discontinued operations and in the three month period ended September 30, 1997 of $1.8 million due in large part to a charge of $10.0 million (approximately $6.0 million, net of income taxes) against Residuals in Finance Receivables Sold. There can be no assurance that the Company will return to profitability in future periods. The Company's ability to return to and subsequently sustain profitability will depend primarily upon its ability to: (i) expand its revenue generating operations while not proportionately increasing its administrative overhead; (ii) originate and purchase contracts with an acceptable level of credit risk; (iii) effectively collect payments due on the contracts in its portfolio; (iv) locate sufficient financing, with acceptable terms, to fund the expansion of used car sales and the origination and purchase of additional contracts; (v) adapt to the increasingly competitive market in which it operates; and (vi) properly execute the split-off transaction and related business strategy. Outside factors, such as the economic, regulatory, and judicial environments in which it operates, will also have an effect on the Company's business. The Company's inability to achieve or maintain any or all of these objectives could have a material adverse effect on the Company. Dependence on Securitizations In recent periods, the Company's earnings (loss) from operations have been significantly impacted by the sales of contract receivables and the earnings (loss) recorded by the Company on the Residuals in Finance Receivables Sold. The Company's ability to successfully complete securitizations in the future may be affected by several factors, including the condition of securities markets generally, conditions in the asset-backed securities markets specifically, and the credit quality of the Company's portfolio. The amount of any gain on sale in connection with securitizations is based upon certain estimates and assumptions, which may not subsequently be realized. To the extent that actual cash flows on a securitization differ materially from the original securitization assumptions, and in the opinion of management those differences appear to be other than temporary in nature, the Company is required 2 to revalue the Residuals in Finance Receivables Sold, and record a charge to earnings based upon the reduction. In addition, the Company records ongoing income based upon the cash flows on Residuals in Finance Receivables Sold. The income recorded on the Residuals in Finance Receivables Sold will vary from quarter to quarter based upon cash flows received in a given period. To the extent that cash flows are deficient, charge offs of finance receivables exceed estimates, or assumptions that were applied to the underlying portfolio are not realized, and in the opinion of management those differences appear to be other than temporary in nature, the Company is required to revalue the Residuals in Finance Receivables Sold, and record a charge to earnings. During the year ended December 31, 1997, the Company recorded a charge for continuing operations of $5.7 million ($3.4 million after taxes) against the Residuals in Finance Receivables Sold. The charge resulted from an upward revision in the Company's net charge off assumptions related to the underlying contract portfolios supporting the Company's Residuals in Finance Receivables Sold. Although the Company believes the charge was adequate to adjust the assumptions to a level which will more closely approximate future net losses in the underlying contract portfolio, there can be no assurance in that regard. CRC and CRC II (the Securitization Subsidiaries), are the Company's wholly-owned special purpose "bankruptcy remote" entities. Their assets include Residuals in Finance Receivables Sold and Investments Held in Trust, in the amounts of $24.7 million and $13.9 million, respectively, at March 31, 1998, which amounts would not be available to satisfy claims of creditors of the Company Dependence on External Financing; Cash Position The Company has borrowed, and will continue to borrow, substantial amounts to fund its operations. In this regard, the Company's operations, are highly capital intensive. Currently, the Company receives financing pursuant to the Revolving Facility with GE Capital, which has a maximum commitment of $100.0 million. Under the Revolving Facility, the Company may borrow up to 65.0% of the principal balance of eligible Company Dealership contracts and up to 86.0% of the principal balance of eligible Third Party Dealer contracts. However, an amount up to $10.0 million of the borrowing capacity under the Revolving Facility is not available at any time when the guarantee of the Company to the contract purchaser is in effect. The Revolving Facility is secured by substantially all of the Company's assets. In addition, the Revolving Facility and/or other credit facilities of the Company contain various restrictive covenants that limit, among other things, the Company's ability to engage in mergers and acquisitions, incur additional indebtedness, and pay dividends or make other distributions, and also requires the Company to meet certain financial tests. Although the Company believes it is currently in compliance with the terms and conditions of the Revolving Facility and such other facilities, other than the interest coverage ratio for which the Company obtained a waiver, there can be no assurance that the Company will be able to continue to satisfy such terms and conditions or that the Revolving Facility will be extended beyond its current expiration date. In addition, the Company has established a Securitization Program pursuant to which the Company is subject to numerous terms and conditions. Failure of the Company to engage in securitization transactions could have a material adverse effect on the Company. The Company's cash and cash equivalents decreased from $3.5 million at December 31, 1997 to $514,000 at March 31, 1998. This decrease is due in large part to the growth of the Cygnet Dealer Program loan portfolio and the making of debtor-in-possession loans in connection with the reorganization of FMAC as well as the growth in property and equipment and discontinued operations. The Company is currently evaluating its alternatives for the future financing of the Cygnet Dealer Program, including its financing, in part, through the split-off. On January 28, 1998, the Company borrowed $7 million from Greenwich Capital (the "Greenwich Loan"), the proceeds of which were utilized to reduce the Revolving Facility. The Greenwich Loan was repaid on April 1, 1998. The Company is currently evaluating other longer term financing options, including certain additional financing transactions that may be entered into with Greenwich Capital. There can be no assurance that any further securitizations will be completed or that the Company will be able to secure additional financing when and as needed in the future, or on terms acceptable to the Company. Poor Creditworthiness of Borrowers; High Risk of Credit Losses Substantially all of the contracts that the Company services are with Sub-Prime Borrowers. Due to their poor credit histories and/or low incomes, Sub-Prime Borrowers are generally unable to obtain credit from traditional financial institutions, such as banks, savings and loans, credit unions, or captive finance companies owned by automobile manufacturers. The Company has established an Allowance for Credit Losses, which approximated 18.5% as of contract principal balances as of March 31, 1998 and December 31, 1997, respectively, to cover anticipated credit losses on the contracts currently in its portfolio. The Company believes its current Allowance for 3 Credit Losses is adequate to absorb anticipated credit losses. However, there is no assurance that the Company has adequately provided for, or will adequately provide for, such credit risks or that credit losses in excess of its Allowance for Credit Losses will not occur in the future. A significant variation in the timing of or increase in credit losses on the Company's portfolio would have a material adverse effect on the Company. The Company's discontinued operations operate the Cygnet Dealer Program, pursuant to which the Company provides qualified Third Party Dealers with warehouse purchase facilities and operating lines of credit primarily secured by such dealers' retail installment contract portfolios and/or inventory. While the Company requires Third Party Dealers to meet certain minimum net worth and operating history criteria to be considered for inclusion in the Cygnet Dealer Program, the Company will, nevertheless, be extending credit to dealers who may not otherwise be able to obtain debt financing from traditional lending institutions such as banks, credit unions, and major finance companies. Consequently, similar to its other financing activities, the Company will be subject to a high risk of credit losses that could have a material adverse effect on the Company and on the Company's ability to meet its own financing obligations. Potential Change in Business Strategy-Discontinued Operations In February 1998, the Company announced its intention to close its Branch Office network, and exit this line of business in the first quarter of 1998. The closure was substantially complete by March 31, 1998. Further, in April 1998, the Company announced that its Board of Directors had directed management to proceed with separating current operation into two publicly held companies. The Company's continuing operations will focus exclusively on the retail sale of used cars through its chain of dealerships, as well as the collection and servicing of the resulting loans. The Company would also retain its existing securitization program and the residual interests in all securitization transactions previously effected by the Company, its existing insurance operations relating to its dealership activities, and its rent-a-car franchise business (which is generally inactive). It is anticipated that a new company will be formed to operate all non-dealership operations. There can be no assurance that the Company will effect a split-off of any business operation; what form that such a transaction would take if implemented, including whether stockholders will receive or be able to acquire equity interests in any operation split-off; or that any split-off would prove successful or economically beneficial to the Company or its stockholders. Further, failure to implement a split-off could adversely affect the Company's operations and financial condition, as well as the market for its Common Stock and warrants. In addition, under the Company's most recent securitizations, absent consent of the interested parties, a split-off of its servicing operations would constitute a "termination event," under which the insurer in respect of the securitization could terminate the Company's servicing rights. Further, upon a termination event, distributions in connection with the Company's residual interest in such securitization effectively would be suspended until the interest of third party holders is paid in full. In connection with its strategic evaluation, the Company determined to close its Branch Office network but to continue to pursue its Cygnet Dealer Program and the bulk purchase and/or servicing of contracts originated by other subprime lenders, which it believes is a more efficient method of purchasing or obtaining servicing rights to sub-prime automobile contracts. There can be no assurance that the restructuring of the Company's Third Party Dealer operations and focus on the purchase and/or servicing of large contract portfolios will prove successful, will enhance the Company's profitability or, if pursued, will facilitate a split-off, or other disposition of these operations. There can also be no assurance that the Company will be able to maintain sufficient liquidity to fund additional bulk contract purchases. During the three month period ended March 31, 1998, the Company recorded a charge of $9.1 million (approximately $5.6 million, net of income taxes) for discontinued operations. There can be no assurance that the charge will prove adequate or that upward or downward adjustments to the charge will not be required in future periods. Data Processing and Technology and Year 2000 The success of any participant in the sub-prime industry, including the Company, depends in part on its ability to continue to adapt its technology, on a timely and cost-effective basis, to meet changing customer and industry standards and requirements. The Company recently converted to a new loan servicing and collection data processing system at its Gilbert, Arizona facility which services the Company's Arizona, Nevada, and New Mexico Company Dealership loan portfolios as well as substantially all of the Third Party Dealer Branch Office loan portfolio. In connection with the conversion, the Company confronted various implementation and integration issues, which management believes have resulted in increases in both contract delinquencies and charge offs. Although many of these issues have been resolved, failure to promptly and fully resolve all issues could have a material adverse effect on the Company. The Company services its loan portfolios on loan servicing and collection data processing systems on various 4 platforms. The Company is in the process of converting substantially all of its Continuing Operations loan servicing and collection data processing to a single loan servicing and collection data processing system. Failure to successfully complete the conversion to a single loan servicing and data processing system could have a material adverse effect on the Company. The Company has commenced a study of its computer systems in order to assess its exposure to year 2000 issues. The Company expects to make the necessary modifications or changes to its computer information systems to enable proper processing of transactions relating to the year 2000 and beyond. The Company estimates that it will cost from $500,000 to $1.0 million to modify its existing systems, should it choose to do so. The Company will evaluate appropriate courses of action, including replacement of certain systems whose associated costs would be recorded as assets and subsequently amortized or modification of its existing systems which costs would be expensed as incurred. However, failure of the Company to fully address and resolve its year 2000 issues, including modification of its existing systems, replacement of such systems, or other matters could have a material adverse effect on the Company. The Company is dependent on its loan servicing and collection facilities as well as long-distance and local telecommunications access in order to transmit and process information among its various facilities. The Company maintains a standard program whereby it prepares and stores off site back ups of its main system applications and data files on a routine basis. Due primarily to the Company's recent acquisitions and significant growth, the Company believes that its current disaster response plan will need to be revised. Although management intends to update the disaster response plan during 1998, there can be no assurance a failure will not occur in the interim or that the plan as revised will prevent or enable timely resolution of any systems failure. Further, a natural disaster, calamity, or other significant event that causes long-term damage to any of these facilities or that interrupts its telecommunications networks could have a material adverse effect on the Company. Risks Relating to FMAC Transaction In recent periods, the Company's discontinued operations have been actively involved in the reorganization proceeding of FMAC. There can be no assurance that the servicing rights and interests in the residual interests in securitizations obtained by the Company's discontinued operations will prove valuable or profitable. None of the consideration given or to be given by the Company is conditioned upon the profit ultimately achieved by the Company's discontinued operations. Further, the FMAC Warrants, Bank Group Warrants and Stock Option Shares will further dilute the Company's equity and could adversely affect the market and price for the Common Stock. The Company has guaranteed a 10.35% return on certain contracts acquired from FMAC and sold to the an unrelated party, subject to a maximum guarantee of $10.0 million. Although FMAC has provided a similar guarantee to the Company payable out of certain distributions from residual interests held by FMAC in securitization transactions, there can be no assurance that there will be sufficient distributions from the residual interests to support the guarantee. The Company's debtor-in-possession loans to FMAC and certain fees payable to the Company would also be payable out of certain expected tax refunds of FMAC and/or distributions from residual interests in FMAC's securitization transactions. Although the Company's discontinued operations anticipates collecting such items, there can be no assurance that these loans or fees will be paid. Payments pursuant to the residual interests may not be made until the senior certificates in the securitization transactions are paid in full. Certain benefits to the Company and the Company's discontinued operations in the transaction would be contingent on the Company, a wholly-owned subsidiary of the Company, or an Authorized Servicer servicing the Owned Contracts and/or certain other receivables currently serviced by FMAC. In the event that the Company, its subsidiary, or an Authorized Servicer does not obtain or retain such servicing rights, the Company could be materially adversely affected. In addition, the Company has the ability to issue the Stock Option Shares to FMAC in lieu of FMAC's right to receive its portion of cash distributions from the Excess Collections Split for the benefit of its unsecured creditors. The Company's ability to issue the Stock Option Shares is subject to certain conditions. If the Company is unable to issue the Stock Option Shares, it may be required to pay Additional Consideration to certain of the banks from whom the Company acquired the Senior Bank Debt. Potential Issuance of Dilutive Securities In connection with the confirmed FMAC Plan of Reorganization, the Company has the right to issue the Stock Option Shares to FMAC in lieu of making cash distributions otherwise payable to FMAC from proceeds of certain residual interests in securities held by FMAC or its subsidiaries. Should the Company make such an election, it would issue all or a portion of the Stock Option Shares for 98% of the average of the closing prices of the Company's Common Stock for the ten trading days prior to the date of issuance and would thereafter retain the cash distributions collected from such residual interests. In addition, the Company has granted warrants to purchase a total of approximately 1.5 million shares of Common Stock of the Company to various parties with exercise prices ranging from $6.75 to $20.00 per share. Such issuances or warrant exercises could prove to be dilutive for the Company's then existing stockholders. No Assurance of Successful Acquisitions In 1997, the Company completed three significant acquisitions (Seminole, EZ Plan, and Kars) and intends to consider additional acquisitions, alliances, and transactions involving other companies that could complement the Company's existing business. There can be no assurance that suitable acquisition parties, joint venture candidates, or transaction counterparties can be identified, or that, if identified, any such transactions will be consummated on terms favorable to the Company, or at all. Furthermore, there can be no assurance that the Company will be able to integrate successfully such acquired businesses, including those recently acquired, into its existing operations, which could increase the Company's operating expenses in the short-term and adversely affect the Company. Moreover, these types of transactions by the Company may result in potentially dilutive issuances of equity securities, the incurrence of additional debt, and amortization of expenses related to goodwill and intangible assets, all of which could adversely affect the Company's profitability. As of March 31, 1998, the Company had goodwill totaling 5 approximately $14.7 million, the components of which will be amortized over a period of 15 to 20 years. These transactions involve numerous risks, such as the diversion of the attention of the Company's management from other business concerns, the entrance of the Company into markets in which it has had no or only limited experience, and the potential loss of key employees of the acquired company, all of which could have a material adverse effect on the Company. Highly Competitive Industry Although the used car sales industry has historically been highly fragmented, it has attracted significant attention from a number of large companies, including AutoNation, U.S.A. and Driver's Mart, which have entered the used car sales business or developed large used car sales operations. Many franchised new car dealerships have also increased their focus on the used car market. The Company believes that these companies are attracted by the relatively high gross margins that can be achieved in this market and the industry's lack of consolidation. Many of these companies and franchised dealers have significantly greater financial, marketing, and other resources than the Company. Among other things, increased competition could result in increased wholesale costs for used cars, decreased retail sales prices, and lower margins. Like the sale of used cars, the business of purchasing and servicing contracts originated from the sale of used cars to Sub-Prime Borrowers is highly fragmented and very competitive. Various companies have increased the competition for the purchase of contracts, in many cases purchasing contracts at prices that the Company believes are not commensurate with the associated risk. There are numerous financial services companies serving, or capable of serving, this market, including traditional financial institutions such as banks, savings and loans, credit unions, and captive finance companies owned by automobile manufacturers, and other non-traditional consumer finance companies, many of which have significantly greater financial and other resources than the Company. Increased competition may cause downward pressure on the interest rates the Company charges on contracts originated by its Company Dealerships or cause the Company to reduce or eliminate the nonrefundable acquisition discount on the contracts it purchases in bulk, which could have a material adverse effect on the Company. Similarly, increased competition may be another reason for a potential Company spin-off to third parties or shareholders of Third Party Dealer operations, including its third party purchasing and servicing operations, Cygnet Dealer Program, and all or portions of their related portfolios. General Economic Conditions The Company's business is directly related to sales of used cars, which are affected by employment rates, prevailing interest rates, and other general economic conditions. While the Company believes that current economic conditions favor continued growth in the markets it serves and those in which it seeks to expand, a future economic slowdown or recession could lead to decreased sales of used cars and increased delinquencies, repossessions, and credit losses that could hinder the Company's business. Because of the Company's focus on the sub-prime segment of the automobile financing industry, its actual rate of delinquencies, repossessions, and credit losses could be higher under adverse conditions than those experienced in the used car sales and finance industry in general. Industry Considerations and Legal Contingencies Several major used car finance companies have announced major downward adjustments to their financial statements, violations of loan covenants, related litigation, and other events. In addition, certain of these companies have filed for bankruptcy protection. These events have had a disruptive effect on the market for securities of sub-prime automobile finance companies, have resulted in a tightening of credit to the sub-prime markets, and could lead to enhanced regulatory oversight. Furthermore, companies in the used vehicle financing market have been named as defendants in an increasing number of class action lawsuits brought by customers alleging violations of various federal and state consumer credit and similar laws and regulations. There can be no assurance that these trends and events will not have significant negative impact on the Company. Need to Establish and Maintain Relationships with Third Party Dealers Pursuant to the Cygnet Dealer Program, the Company enters into financing agreements with qualified Third Party Dealers. The Company's Third Party Dealer financing activities depend in large part upon its ability to establish and maintain relationships with such dealers. While the Company believes that it has been successful in developing and maintaining relationships with Third Party Dealers in the markets that it currently serves, there can be no assurance that the Company will be successful in maintaining or increasing its existing Third Party Dealer base, or that a sufficient number of qualified dealers will become involved in the Cygnet Dealer Program. 6 Geographic Concentration Company Dealership operations are currently located in Arizona, Georgia, California, Texas, Florida, Nevada, and New Mexico. Because of this concentration, the Company's business may be adversely affected in the event of a downturn in the general economic conditions existing in the Company's primary markets. Sensitivity to Interest Rates A substantial portion of the Company's financing income results from the difference between the rate of interest it pays on the funds it borrows and the rate of interest it earns on the contracts in its portfolio. While the contracts the Company owns bear interest at a fixed rate, the indebtedness that the Company incurs under its Revolving Facility bears interest at a floating rate. In the event the Company's interest expense increases, it would seek to compensate for such increases by raising the interest rates on its Company Dealership contracts, increasing the acquisition discount at which it purchases portfolios in bulk, or raising the retail sales prices of its used cars. To the extent the Company were unable to do so, the Company's net interest margins would decrease, thereby adversely affecting the Company's profitability. Impact of Usury Laws Historically, a significant portion of the Company's used car sales activities were conducted in, and a significant portion of the contracts the Company services were originated in, Arizona, which does not impose limits on the interest rate that a lender may charge. However, the Company has expanded, and will continue to expand, its operations into states that impose usury limits, such as Florida and Texas. The Company attempts to mitigate these rate restrictions by raising the retail prices of its used cars or purchasing contracts originated in these states at a higher discount. The Company's inability to mitigate rate restrictions in states imposing usury limits would adversely affect the Company's planned expansion and its results of operations. There can be no assurance that the usury limitations to which the Company is or may become subject or that additional laws, rules, and regulations that may be adopted in the future will not adversely affect the Company's business. Dependence Upon Key Personnel The Company's future success will depend upon the continued services of the Company's senior management as well as the Company's ability to attract additional members to its management team with experience in the used car sales and financing industry. The unexpected loss of the services of any of the Company's key management personnel, or its inability to attract new management when necessary, could have a material adverse effect upon the Company. The Company has entered into employment agreements (which include non-competition provisions) with certain of its officers. The Company does not currently maintain any key person life insurance on any of its executive officers. Control by Principal Stockholder Mr. Ernest C. Garcia, II, the Company's Chairman, Chief Executive Officer, and principal stockholder, holds approximately 25.1% of the outstanding Common Stock, including 136,500 shares held by The Garcia Family Foundation, Inc., an Arizona non-profit corporation, and 20,000 shares held by Verde Investments, Inc., a real estate investment corporation, controlled by Mr. Garcia. As a result, Mr. Garcia has a significant influence upon the activities of the Company, as well as on all matters requiring approval of the stockholders, including electing or removing members of the Company's Board of Directors, causing the Company to engage in transactions with affiliated entities, causing or restricting the sale or merger of the Company, and changing the Company's dividend policy. Mr. Garcia has indicated that he intends to resign his position as Chief Executive Officer concurrent with the completion of the split-off transaction. Potential Anti-Takeover Effect of Preferred Stock The Company's Certificate of Incorporation authorizes the Company to issue "blank check" Preferred Stock, the designation, number, voting powers, preferences, and rights of which may be fixed or altered from time to time by the Board of Directors. Accordingly, the Board of Directors has the authority, without stockholder approval, to issue Preferred Stock with dividend, conversion, redemption, liquidation, sinking fund, voting, and other rights that could adversely affect the voting power or other rights of the holders of the Common Stock. The Preferred Stock could be utilized, under certain circumstances, to discourage, delay, or prevent a merger, tender offer, or change in control of 7 the Company that a stockholder might consider to be in its best interests. Although the Company has no present intention of issuing any shares of its authorized Preferred Stock, there can be no assurance that the Company will not do so in the future. Regulation, Supervision, and Licensing The Company's operations are subject to ongoing regulation, supervision, and licensing under various federal, state, and local statutes, ordinances, and regulations. Among other things, these laws require that the Company obtain and maintain certain licenses and qualifications, limit or prescribe terms of the contracts that the Company originates and/or purchases, require specified disclosures to customers, limit the Company's right to repossess and sell collateral, and prohibit the Company from discriminating against certain customers. The Company is also subject to federal and state franchising and insurance laws. The Company believes that it is currently in substantial compliance with all applicable material federal, state, and local laws and regulations. There can be no assurance, however, that the Company will be able to remain in compliance with such laws, and such failure could result in fines or interruption or cessation of certain of the business activities of the Company and could have a material adverse effect on the operations of the Company. In addition, the adoption of additional statutes and regulations, changes in the interpretation of existing statutes and regulations, or the Company's entrance into jurisdictions with more stringent regulatory requirements could have a material adverse effect on the Company. Possible Volatility of Stock Price The market price of the Common Stock has been and may continue to be volatile in response to such factors as, among others, variations in the anticipated or actual results of operations of the Company or other companies in the used car sales and finance industry, changes in conditions affecting the economy generally, analyst reports, or general trends in the industry. -----END PRIVACY-ENHANCED MESSAGE-----