Ugly Duckling Corporation

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Ugly Duckling Corporation

2525 East Camelback Road, Suite 1150
Phoenix, Arizona 85016
U.S.A.
(602) 852-6600
Fax: (602) 852-6696
Web site: http://www.uglyduckling.com

Public Company
Incorporated: 1977 as Ugly Duckling Rent-A-Car System, Inc.
Employees: 1,776
Sales: $75.6 million (1996)
Stock Exchanges: NASDAQ
SICs: 5611 New & Used Car Dealers; 6141 Personal
Credit Institutions; 6719 Holding Companies, Not
Elsewhere Classified

Ugly Duckling Corporation is a vertically integrated firm in the used car sales and financing industry. In the firm’s 1996 annual report, Chairman and CEO Ernest C. Garcia II stated, “We are the only major company that serves virtually all segments of the sub-prime auto finance market.” Ugly Duckling dealerships sell used cars to those with modest incomes and little or no credit. Those dealerships are part of one of the nation’s largest “buy-here pay-here” chains, for they finance almost all cars they sell. Ugly Duckling’s second source of income is through Champion Financial Services, which has a network of branch offices to buy sub-prime installment contracts from third-party used car dealers. Third, Ugly Duckling’s Cygnet Finance subsidiary offers independent used car dealers a line of credit which allows them to expand their operations. Although most of Ugly Duckling’s business occurs in its home state of Arizona, it is quickly expanding into other states in an attempt to consolidate a very fragmented industry.

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.

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. However, Garcia also agreed at the time of the loan to buy land from a Lincoln subsidiary. The Resolution Trust Company found 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.

Garcia in 1992, while his case was still in the district court, incorporated Ugly Duckling Holdings, Inc., an Arizona firm which 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 to the dirty and dusty lots of some sub-prime 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 tried in 1995 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. So 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 sub-prime contracts worth $1.9 million.

Through a network of branch offices, the first one opening in April 1995, Champion Financial Services purchased sub-prime 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, the bulk of which were comprised by used car sales, had consistently increased, reaching $58.2 million revenues ($47.8 million from car sales alone) at the end of 1995. However, in three of those four years 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 10 years.

Company Perspectives:

Ugly Duckling Corporation aspires to be the leader in the sub-prime used car sales and finance industry. To accomplish this, we must provide superior value and service to our customers, hire and retain the best employees by offering them a challenging, enjoyable, and rewarding work environment, and deliver an excellent return on investment to our stockholders.

In June 1996 Ugly Duckling became a public corporation. On the NASDAQ exchange under the symbol Ugly, its IPO 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.

In 1997 Ugly Duckling continued to raise money through stock sales and other means. In February 1997 it announced 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 SpelIman L.P., the owner of five 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 and that “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 sub-prime 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 sub-prime 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 10 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 Finance 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 and appeared to be continuing in 1997. 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 to $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.

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 to just two percent for each new car sold. Many new car dealers and also 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 over 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. And since the company finances almost all the cars it sells, 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 in 1997: to continue to sell used cars but also strive to be a major player in the financial and credit aspects of the sub-prime used car retail industry.

Principal Subsidiaries

Duck Ventures, Inc.; Ugly Duckling Car Sales, Inc.; Champion Acceptance Corporation; Champion Financial Services, Inc.; UDRAC, Inc.; Champion Receivables Corporation; Drake Insurance Services, Inc.