DriveTime Automotive Group Inc.

4020 E. Indian School Road
Phoenix, Arizona 85018
U.S.A.
Telephone: (602) 852-6600
Toll Free: (800)TO-DRIVE
Fax: (602) 852-6686
Web site: http://www.drivetime.com

Private Company
Incorporated: 1977 as Ugly Duckling Rent-A-Car System, Inc.
Employees: 2,049
Sales: $729 million (2003)
NAIC: 441120 Used Car Dealers; 52222 Sales Financing; 551112 Offices of Other Holding Companies

DriveTime Automotive Group Inc. is a leading independent retailer of used automobiles in the United States. Using a "buy here/pay here" financing model, the company caters to buyers with subprime credit and finances the sales itself. The group has about 80 lots in eight states; it was formerly known as Ugly Duckling. Traditionally based in the Sun Belt, the chain's operations are located in 11 major metropolitan areas as diverse as Los Angeles and Richmond, Virginia.

Origins

The Ugly Duckling story began in 1977 when Ugly Duckling Rent-A-Car System, Inc. was formed in Tucson by 63-year-old Thomas S. Duck, Sr., a retired insurance salesman. Just to keep busy, he started his company by using $10,000 of his savings to buy a few used cars to sell. Soon his franchise business expanded into other states.

Ugly Duckling Rent-A-Car entered a growing industry dominated by the Big Three: Avis and Hertz, both started in 1947, and National. In the 1970s all rental car firms struggled with the energy shortage. In the 1980s price wars engulfed the industry, encouraged by the success of low-cost rental companies like Budget Rent-A-Car and, of course, Ugly Duckling. By 1985 Ugly Duckling was the nation's fifth largest car rental company. Its sales reached $65 million from 550 franchises at the end of 1985, but in 1989 the company declared bankruptcy, thus ending phase one of this story.

Acquired by Garcia in 1990

A transition period began in 1990 with the involvement of Ernest C. Garcia II. Born in Gallup, New Mexico, in 1957, Garcia studied business at the University of Arizona in Tucson before working in real estate, banking, and securities. In 1990 he formed a company called Duck Ventures, Inc., which purchased the assets of Ugly Duckling Rent-A-Car. Meanwhile, Garcia had to work through some major financial and legal difficulties before moving on.

In October 1990 Garcia pled guilty to felony bank fraud related to the savings-and-loan crisis of the 1980s. In 1987 Garcia had obtained a $20 million loan from Charles Keating's Lincoln Savings & Loan. That gave Garcia's real estate development company the funds it needed to buy back some stock from an investor. Garcia also agreed at the time of the loan, however, to buy land from a Lincoln subsidiary. The Resolution Trust Company found that the two transactions were improperly linked, without directly blaming Garcia. In December 1993 the U.S. District Court for the Central District of California sentenced Garcia with a $50 fine and a three-year probation, a light penalty due to Garcia's full cooperation with the authorities. Meanwhile, his real estate company had declared Chapter 11 bankruptcy and he had filed personally for Chapter 7 bankruptcy.

In 1992, while his case was still in the district court, Garcia incorporated Ugly Duckling Holdings, Inc., an Arizona firm that purchased Duck Ventures, Inc. and made it a subsidiary. He started out by buying a small used car dealership in Phoenix and later in 1992 purchased a second dealership in Tucson.

Garcia could have changed the company's name, but he stuck with Ugly Duckling. "We have enormous fun with the duck and we go with the name tongue in cheek," said Garcia in the August 25, 1996 Arizona Tribune. "We're just using it to have fun. We're not saying our cars are ugly or anything else, because if you look at our facilities, if you look at the automobiles . . . we're clearly selling a very competitive and clean product."

Ups and Downs from 1993 to 1995

In 1993 Garcia acquired three Ugly Duckling dealerships. The next year the company built four brand new dealerships with an improved upscale look. Although the firm still catered to those with lower incomes, it wanted to do so in a more positive atmosphere, compared with the dirty and dusty lots of some subprime dealerships.

Ugly Duckling closed one dealership in 1994 because it did not measure up to the firm's high standards. In addition, in late 1995 it closed its dealership in Gilbert, Arizona, because the firm's experiment to sell later model used cars there failed. The Gilbert dealership had tried to sell cars two to seven years newer and often twice the cost of those at other Ugly Duckling dealerships, but the company's infrastructure and financing programs could not accommodate those kinds of vehicles. Ugly Duckling sold the land and dealership building for $1.7 million.

By the mid-1990s Ugly Duckling was gaining popularity in its Arizona home base. "You go to Tucson or Phoenix and people know The Duck," said William Gibson, Cruttenden Roth's senior investment analyst in the October 14, 1996 Investor's Business Daily. "It's an icon in those cities."

To help its customers buy a used car and establish a positive credit rating, Ugly Duckling offered several innovations. From January through March, it offered to help customers prepare their income tax returns and even pay preparation fees. In return, a customer could use his or her forthcoming tax refund for credit toward a car down payment, instead of waiting extra weeks for the government to send a refund check.

Another program was established as an incentive to make installment payments on time. If customers paid all or almost all of their payments when due, they were refunded their down payment when the contract was completed. Down payments accounted for 10 to 15 percent of the purchase price, so this was a substantial refund.

Third, Ugly Duckling offered qualified customers the chance to gain a Visa credit card. The company actually secured those cards by paying a $250 deposit to the credit card firm. This demonstrated a great deal of confidence in Ugly Duckling customers and gave them an opportunity to rebuild positive credit histories.

Fourth, the company dealerships had onsite repair facilities to service the used cars it sold. Broken-down cars were a major reason for customers no longer making their car payments, so Ugly Duckling offered repair contracts to their used car customers. Not surprisingly, these optional contracts were financed.

Since many Ugly Duckling customers did not have credit cards, the company allowed them to pay cash for their monthly installments at their dealerships. Most car dealers did not give customers that option.

In 1994 Ugly Duckling acquired Champion Financial Services from Steve Darak. Champion became a subsidiary and Darak became Ugly Duckling's chief financial officer. Acquired mainly because of its management's skills and its contract servicing software, Champion Financial became Ugly Duckling's second source of making money. When it was purchased in 1994, Champion had subprime contracts worth $1.9 million.

Through a network of branch offices, the first one opening in April 1995, Champion Financial Services purchased subprime car installment contracts from third-party used car dealers. Those contracts generally were with customers with more resources than those who purchased a used car from an Ugly Duckling dealership.

At the end of 1995, after four years in business, Ugly Duckling's financial picture was quite mixed. The good news was that total revenues, of which used car sales comprised the bulk, had consistently increased, reaching $58.2 million ($47.8 million from car sales alone) at the end of 1995. In three of those four years, however, the company lost money, including losses of $2 million and $4 million in 1994 and 1995, respectively.

Growth and Competition in 1996 and 1997

In April 1996 the Arizona firm of Ugly Duckling Holdings, Inc. reincorporated in Delaware under the new name of Ugly Duckling Corporation. As Ugly Duckling expanded its used car sales, it simultaneously reduced its rental car business. By August 1996 it had closed more than 100 rental franchises, leaving about 40 still in operation. The firm planned to completely end that type of business when its last franchise contracts expire within ten years.

In June 1996 Ugly Duckling became a public corporation. On the NASDAQ under the symbol "UGLY," its initial public offering consisted of 2.3 million shares of common stock sold at $6.75 per share. It was underwritten by Cruttenden Roth Inc. of Irvine, California. Later in the month more stock was sold for a total of 3.1 million shares. That month's offerings raised $17.8 million in additional equity, including $14.8 million in cash and the conversion of $3 million in subordinated debt to common stock. The firm raised $65 million in its secondary stock offering at $15 per share in November 1996, underwritten by Cruttenden Roth and also Friedman, Billings, Ramsey & Company of Arlington, Virginia. Ugly Duckling used funds from these stock offerings to open a new Arizona dealership but mainly to reduce its total debt from $49.8 million in 1995 to $26.9 million at the end of 1996.

Company Perspectives:

Mission Statement: To be the auto dealership and finance company of choice for people with less than perfect credit. DriveTime means Innovative Credit Solutions, Quality Vehicles and Outstanding Customer Service.

In 1997 Ugly Duckling continued to raise money through stock sales and other means. In February 1997 it announced that it had sold to institutional investors five million shares of common stock at $18.625 per share. The investors included Boston's Wellington Management Company and Fort Lee, New Jersey's Kramer Spellman L.P., the owner of 5 percent of Ugly Duckling's shares. Some stock analysts were surprised by the success of this offering, since many stocks in the subprime auto sales and financing industry had declined recently by about 30 percent. In the February 12, 1997 Wall Street Journal, one of Kramer Spellman's managers stated, "There are good companies and bad companies and I think we're seeing some of the shakeout."

That same article described how Ugly Duckling was taking advantage of the problems in other car financing companies. In early 1997 Mercury Finance admitted to "accounting irregularities." Chairman Garcia said that 30 of his 35 managers formerly worked for Mercury, adding, "Up until last week it [Mercury Finance] was a great thing. Whatever their problems . . . for 12 years they were the leader in the industry and we consider their people to be the best trained."

In May 1997 GE Capital increased its line of credit available to Ugly Duckling Corporation from $50 million to $100 million. Under the terms of that Revolving Credit Facility, GE Capital had the power to limit Ugly Duckling's decisions such as incurring more debt, making loans or cash advances to company leaders, paying dividends, and merging with another firm.

Ugly Duckling announced in July 1997 that it had signed an agreement with First Merchants Acceptance Corporation to provide it up to $10 million in "debtor in possession" financing. Earlier First Merchants had filed a Chapter 11 bankruptcy petition, so the Bankruptcy Court had to approve any financing provided by Ugly Duckling to First Merchants.

Ugly Duckling aggressively opened several used car dealerships in 1997. It started in January by purchasing five subprime car dealerships and $35 million in finance contracts from Seminole Finance Corporation in the Tampa/St. Petersburg, Florida area. In April 1997 it completed its acquisition of some of the assets of E-Z Plan, Inc., a subprime sales and finance firm based in San Antonio, Texas. For $26.3 million, Ugly Duckling purchased seven "Red McCombs EZ Motors" used car dealerships, including vehicle inventory and finance contracts. The same week it also opened its first dealership in Las Vegas. Later in the year it added two other dealerships in New Mexico.

By August 1, 1997, Ugly Duckling operated a total of 24 dealerships in Arizona, New Mexico, Florida, Texas, and Nevada, which made it the largest public "buy here, pay here" chain in the nation. Most dealerships included 100 to 300 used vehicles of all kinds, ranging in age from five to ten years old with an average price of about $7,100.

In addition, Ugly Duckling by August 1, 1997, operated a total of 64 branch offices in 17 states. These offices had purchased finance contracts from about 2,710 third-party dealers through Champion Financial Services, Inc. The finance contracts purchased by Ugly Duckling from third-party dealers usually required customers to buy casualty insurance within 30 days of purchasing a vehicle. Most bought insurance on their own, but Ugly Duckling was able to purchase a policy for them and then charge them the premiums. The firm through its Drake Insurance Agency subsidiary contracted with American Bankers Insurance Group to force customers to get their car insurance. By the end of December 1996 Ugly Duckling had signed up through this process about 1,200 customers. Although not a major part of Ugly Duckling operations, the firm was considering expanding its services to cover life, disability, and unemployment insurance.

In September 1996 Ugly Duckling announced that it was adding a third revenue generator to its portfolio, to supplement its used car sales and Champion Financial income. It formed Cygnet Finance, Inc. as a subsidiary to offer a source of alternative credit to buy-here pay-here independent used car dealers. Ugly Duckling's leaders felt that many of the nation's independent dealers were undercapitalized and had trouble gaining access to more traditional sources of financing, so Cygnet could bridge that gap. By the end of 1996 Cygnet had hired a former GE Capital employee to be Cygnet's vice-president, tested its proprietary software used to closely monitor participating dealers, and enrolled its first independent dealer in its finance program.

To promote these various services, in November 1996 Ugly Duckling hired two new advertising firms. First, it replaced Moses & Anshell of Phoenix with the Riester Corporation of Phoenix to conduct its general marketing. Second, it hired the Dallas firm Dieste & Partners to start Ugly Duckling advertising in Spanish. With the number of Spanish speakers rapidly growing in the Southwest, that last move was indeed timely.

Since loan defaults were an obvious problem in Ugly Duckling's industry, the firm used its Champion Acceptance Corporation to verify loan application data and use collection techniques for both owned and serviced loans.

Ugly Duckling's overall financial performance showed definite improvement in 1996, when total 1996 revenues increased almost 30 percent to $75.6 million. Instead of losing money as it had in 1992, 1994, and 1995, Ugly Duckling in 1996 had net earnings of $5.9 million. The company's first quarter 1997 report showed revenues of $30.6 million, up 58 percent from first quarter 1996, and net earnings reached $3.3 million, compared with $1.1 million in first quarter 1996.

This 1997 expansion was reflected in the number of company employees. From 652 employees on December 31, 1996, the firm had increased to 1,776 employees by early September 1997.

Key Dates:

1977:

Ugly Ducking is formed.

1990:

Ernest Garcia II acquires the assets of bankrupt Ugly Duckling.

1994:

Ugly Duckling buys Champion Financial Services.

1996:

Ugly Duckling goes public on the NASDAQ.

1997:

The company undergoes aggressive expansion in Florida, Texas.

2002:

Ugly Duckling is taken private in a management buyout, becoming DriveTime Automotive Group.

Although Ugly Duckling had made major strides in just a few years, it faced some tough competitors in the late 1990s. The used car business really boomed in the 1990s, with many players entering this volatile industry. The basic incentive was that used cars earned about a 10 percent profit per car, compared with just 2 percent for each new car sold. Many new car dealers and rental car agencies began selling their good used cars. In addition, several large companies entered the used car market. For example, Circuit City started CarMax, a huge chain of used car dealerships. Another player was AutoNation, USA, which purchased Alamo-Rent-a-Car to have a ready source of more than 100,000 used cars every year. Of course, many of these operations sold newer cars to more affluent customers than those targeted by Ugly Duckling.

Although Ugly Duckling gained most of its revenue from used car sales, that percentage dropped significantly from 82 percent in 1995 to 71 percent in 1996. The firm in 1996 saw major increases in its revenues from interest income, gain on sale of loans, and servicing and other income. Since the company financed almost all the cars it sold, one analyst in the November 11, 1996 Washington Post said Ugly Duckling was "a bank masquerading as a used-car lot." That was a good way of describing what seemed to be Ugly Duckling's strategy: to continue to sell used cars but also strive to be a major player in the financial and credit aspects of the subprime used car retail industry.

Still Expanding in the Late 1990s

As the chain expanded across the Sun Belt to 46 dealerships, Ugly Duckling's sales continued their impressive growth, rising 150 percent to $191 million in 1997. Net income rose from $5.9 million to $9.4 million.

The group's buying power meant it could stock its lots with more vehicles than the Mom & Pop's that made up most of the country's 58,000 independent car dealers. "And as far as we know, there's not a significant regional or national competitor," Chief Financial Officer Steven T. Darak told Knight Ridder's Dallas Morning News. Ugly Duckling also could afford to buy much more advertising, CEO Gregory Sullivan told the Wall Street Transcript in 2000.

In 1999, Garcia made a brief takeover run at an Ohio rival, troubled National Auto Credit Inc. After building up a 10 percent holding and gaining voting control from one of National's majority owners, Garcia sold his shares back to the company at a premium.

Ugly Duckling closed its Champion Financial Services branches in early 1998 to focus on lending operations at its own dealerships. At the time, the company was providing financing or collections assistance to two bankrupt auto lenders, First Merchants Acceptance Corp. of Deerfield, Illinois and Reliance Acceptance Group Inc. of San Antonio.

Garcia bought Ugly Duckling's Cygnet Deal Finance unit for about $37.5 million in late 1999, about a year after its planned spinoff was canceled. CEO Greg Sullivan told the Arizona Republic that Cygnet, which provided financing to other dealers, was sold off to make Ugly Duckling more of a pure player in used car sales for investors. Garcia soon formed the Zoomlot.com e-business venture to attract independent dealers to Cygnet. Ugly Duckling's other businesses, apart from the dealership chain, were divested by December 1999.

Ugly Duckling also was embracing the Internet as a way to connect to its own customers. According to Sullivan, many were leery of applying for a car loan in person due to the potential embarrassment of rejection. Around the beginning of 1999, the company installed its proprietary "CLASS" Car Loan Accounting and Servicing Software, Sullivan told the Wall Street Transcript. This allowed the transaction, from car purchase through the life of the loan, to be managed through one source. Ugly Duckling sold 46,120 used vehicles in 1999. Profits rose from $3.5 million to $8.7 million. The Ugly Duckling company itself also made two acquisitions in 1999, in Orlando, Florida and Richmond, Virginia. According to Sullivan, it was the only dealer actively acquiring others that year.

By the beginning of 2000, the chain had 72 dealerships, making it one of the largest of the country's 60,000 independent car dealers. Ugly Duckling had annual sales of $541.7 million in 2001, when it employed 2,200 people. According to Sullivan, the subprime auto market was a $100 billion-a-year industry.

The company's corporate headquarters was moved to a former Mega Foods grocery store in 2001. The abandoned big box location may have seemed like an unusual choice but the Business Journal of Phoenix praised its economical approach and clever renovation.

In January 2002 Garcia and Sullivan bought Ugly Duckling for $15.5 million. Garcia owned 65 percent of shares before the deal and 92 percent afterward. The company name was changed to DriveTime Automotive Group Inc. Seeking to publicize its new name and expand its client base, the company hired the advertising firm O'Leary and Partners in 2003, dedicating some $10 million for radio and television advertising. Management of the newly restructured DriveTime also sought to computerize and streamline its inventories, investing in new business intelligence software for those purposes.

Principal Competitors

AutoNation Inc.; CarMax; Ricart; Sonic Automotive Inc.; United Auto Group Inc.

Further Reading

Box, Terry, "Dallas Dealership's Low-End Car Sales Rake in High-End Profits," Knight Ridder/Tribune Business News, June 2, 1998.

Byrne, John A., "Keeping Out of Mischief Now," Forbes, October 8, 1984, p. 238.

Cecil, Mark, "Chairman Garcia: Gimme All of Ugly; Ugly Chairman Needs Someone to Show Him the Money, However," Mergers and Acquisitions Report, September 25, 2000.

"Chain of Used Car Dealers Is Bought by Its Chairman," New York Times, December 11, 2001, p. C4.

Croft, Nancy L., "It's Never Too Late," Nation's Business, September 1986, p. 18.

Dunaj, Diana, "Ugly: Tucson Car Rental Firm Turns Beautiful Profits," Arizona Business Gazette, December 30, 1985, p. A1.

Eldridge, Earle, "Ugly Duckling Fits Bill for Drivers with Bad Credit; Car Chain Charges High Interest to Fill Buyers' Needs," USA Today, August 17, 2000, p. 6B.

——, "Ugly Duckling Officers See Beauty of Going Private," USA Today, January 22, 2002, p. 10B.

Elliott, Alan R., "Swan-To-Be," Investor's Business Daily, October 14, 1996.

Flass, Rebecca, "O'Leary Invites 'Credit-Challenged' to DriveTime," ADWEEK, Western ed., January 28, 2004.

"Gauger + Santy Rebrands Ugly Duckling," ADWEEK, Western ed., September 2, 2002, p. 6.

Giblin, Paul, "Ugly Duckling Looks to Turn into a Swan with Expansion," Arizona Tribune, August 25, 1996.

Gregory, Michael, "Duckling Works Subprime Niche," Private Placement Letter, August 7, 2000.

Knight, Jerry, "Dealing in Stock Cars, Both New and Used," Washington Post, November 11, 1996, p. WB27.

Miller, Joe, "Ugly Duckling Keeps Cygnet in the Fold," Automotive News, October 12, 1998, p. 44.

Murray, Teresa Dixon, "National Auto Credit Agrees to Buy Out Major Shareholder," Plain Dealer (Cleveland), May 14, 1999, p. 2C.

Nickell, Naaman, "Phoenix, Ariz.-Based Used-Car Dealership Continues to Grow," Arizona Republic, January 24, 2000.

"Prizes Found in Empty Boxes," Business Journal—Serving Phoenix & the Valley of the Sun, October 19, 2001, p. 62.

Pulliam, Susan, "Ugly Duckling, Subprime Auto Lender Run by Convicted Felon, Manages to Raise Money," Wall Street Journal, February 12, 1997, p. C2.

Root, Kim O'Brien, "Newport News, Va., Used-Car Dealership Is Sued Over Name," Daily Press (Newport), October 21, 2004.

Sawyers, Arlena, "Ugly Duckling Thriving in Subprime Pool," Automotive News, June 12, 2000, p. 40.

Serres, Christopher, "Nat'l Auto Interests Rival CEO: Ugly Duckling Exec Owns 7% of Car Lender," Crain's Cleveland Business, September 21, 1998, p. 5.

Swafford, Michelle, "Two Arizona-Based Auto Businesses Battle Over 'Drive Time' Name," East Valley Tribune (Mesa, Arizona), September 17, 2002.

Teichgraeber, Tara, "Garcia's Latest Venture Puts Car Lots on Superhighway," Business Journal—Serving Phoenix & the Valley of the Sun, May 12, 2000, p. 10.

"Ugly Duckling Corporation CEO Discusses Product Line," Wall Street Transcript, June 12, 2000.

"Ugly Duckling Offering Shareholders a Way Out," Arizona Republic, December 20, 1998, p. D1.

Vandeveire, Mary, "Sub-Prime Auto Lending Expanding Operations Here," Business Journal—Serving Phoenix & the Valley of the Sun, March 13, 1998, p. 4.

—David M. Walden
—update: Frederick C. Ingram