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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
Commission File Number: 1-14116
CONSUMER PORTFOLIO SERVICES, INC.
(Exact name of registrant as specified in its charter)
CALIFORNIA 33-0459135
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
16355 LAGUNA CANYON ROAD, IRVINE, CALIFORNIA 92618
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (949) 753-6800
Securities registered pursuant to section 12(b) of the Act:
Title of each class:
RISING INTEREST SUBORDINATED REDEEMABLE SECURITIES DUE 2006
10.50% PARTICIPATING EQUITY NOTES DUE 2004
Name of each exchange on which registered: New York Stock Exchange
Securities registered pursuant to section 12(g) of the Act:
COMMON STOCK, NO PAR VALUE
Indicate by check mark whether the registrant (1) filed all reports required to
be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months
(or for such shorter period that the registrant was required to file such
reports) and (2) has been subject to such filing requirements for the past 90
days. Yes / x / No / /
Indicate by check mark if there is no disclosure of delinquent filers pursuant
to Item 405 of Regulation S-K contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. / /
The aggregate market value on April 14, 1999 (based on the $3.50 closing price
on the Nasdaq Stock Market on that date) of the voting stock beneficially held
by non-affiliates of the registrant was $29,506,281. The number of shares of the
registrant's Common Stock outstanding on April 14, 1999 was 15,658,501.
DOCUMENTS INCORPORATED BY REFERENCE
The registrant's proxy statement for its 1999 annual meeting of shareholders is
incorporated by reference into Part III of this report.
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PART I
ITEM 1. BUSINESS
General
Consumer Portfolio Services, Inc. ("CPS," and together with its subsidiaries,
the "Company") is a consumer finance company specializing in the business of
purchasing, selling and servicing retail automobile installment contracts
("Contracts") originated by licensed motor vehicle dealers ("Dealers") in the
sale of new and used automobiles, light trucks and passenger vans. Through its
purchases, the Company provides indirect financing to Dealer customers with
limited credit histories, low incomes or past credit problems ("Sub-Prime
Customers"). The Company serves as an alternative source of financing for
Dealers, allowing sales to customers who otherwise might not be able to obtain
financing. The Company does not lend money directly to consumers. Rather, it
purchases installment Contracts from Dealers.
The Company has various wholly owned and partially owned subsidiaries. The
wholly owned subsidiaries include CPS Marketing, Inc., Alton Receivables Corp.
("Alton"), CPS Receivables Corp. ("CPSRC"), CPS Funding Corp. ("CPSFC") and CPS
Warehouse Corp. ("CPSWC"). Alton, CPSRC, CPSFC and CPSWC are limited purpose
corporations formed to accommodate the structures under which the Company
purchases and sells its Contracts. CPS Marketing, Inc. employs marketing
representatives who solicit business from Dealers. The Company's partially owned
subsidiaries include Samco Acceptance Corp., Linc Acceptance Company, LLC, and
CPS Leasing, Inc., each of which is 80% owned by the Company.
CPS was incorporated and began its operations in 1991. From inception through
December 31, 1998 the Company has purchased approximately $2.4 billion of
Contracts, and as of December 31, 1998, had an outstanding servicing portfolio
of approximately $1.5 billion. The Company makes the decision to purchase
Contracts exclusively from its headquarters location. It obtains the funds for
such purchases primarily by reselling the Contracts in securitization
transactions. The Company services the Contracts from two regional centers, one
in its California headquarters, and the other in Virginia.
Prior to December 11, 1995, the Company was a majority-owned subsidiary of
CPS Holdings, Inc., a Delaware corporation ("Holdings"). In September 1995, the
shareholders of the Company approved the merger of Holdings into the Company.
The merger was completed on December 11, 1995, and had no effect on the
Company's consolidated financial statements. Prior to the merger, Charles E.
Bradley, Sr., the Company's Chairman of the Board, was the principal shareholder
of Holdings.
The Market We Serve
The Company's automobile financing programs are designed to serve customers
who generally would not qualify for automobile financing from traditional
sources, such as commercial banks, credit unions and the captive finance
companies affiliated with major automobile manufacturers. Such customers
("Sub-Prime Customers") generally have limited credit histories, low incomes or
past credit problems, and are therefore often unable to obtain credit from
traditional sources of automobile financing. (The terms "prime" and "sub-prime"
reflect the Company's categorization of customers and bear no relationship to
the prime rate of interest or persons who are able to borrow at that rate.)
Because the Company serves customers who are unable to meet the credit standards
imposed by most traditional automobile financing sources, the Company generally
receives interest at rates higher than those charged by traditional automobile
financing sources. The Company also expects to sustain a higher level of credit
losses than traditional automobile financing sources since the Company provides
financing in a relatively high risk market.
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Marketing
The Company directs its marketing efforts to Dealers, rather than to
consumers. As of December 31, 1998, the Company was a party to its standard form
dealer agreements ("Dealer Agreements") with 4,547 Dealers. Approximately 93.0%
of these Dealers are franchised new car dealers that sell both new and used cars
and the remainder are independent used car dealers. For the year ended December
31, 1998, approximately 92.0% of the Contracts purchased by the Company
consisted of financing for used cars and the remaining 8.0% for new cars.
The Company establishes relationships with Dealers through Company
representatives who contact a prospective Dealer to explain the Company's
Contract purchase programs, and who and thereafter provide Dealer training and
support services. As of December 31, 1998, the Company had 72 representatives,
69 of whom are employees and 3 of whom are independent. The representatives are
contractually obligated to represent the Company's financing program
exclusively. The Company's representatives present the Dealer with a marketing
package, which includes the Company's promotional material containing the terms
offered by the Company for the purchase of Contracts, a copy of the Company's
standard-form Dealer Agreement, examples of monthly reports and required
documentation relating to Contracts. Marketing representatives have no authority
relating to the decision to purchase Contracts from Dealers. The Company's
acceptance of a Dealer is subject to its analysis of, among other things, the
Dealer's operating history.
Most of the Dealers under contract with CPS regularly submit Contracts to the
Company for purchase, although they are under no obligation to submit any
Contracts to the Company, nor is the Company obligated to purchase any
Contracts. During the year ended December 31, 1998, no Dealer accounted for more
than 1.0% of the total number of Contracts purchased by the Company. The
following table sets forth the geographical sources of the Contracts purchased
by the Company (based on the addresses of the customers as stated on the
Company's records) during the years ended December 31, 1998 and December 31,
1997:
Contracts Purchased During Year Ended
----------------------------------------------------------
December 31, 1998 December 31, 1997
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Number Percent Number Percent
------------- ---------- ----------- ------------
California 13,960 16.7% 9,035 18.1%
Florida 5,832 7.0% 3,404 6.8%
North Carolina 5,304 6.3% 1,613 3.2%
Texas 5,193 6.2% 3,649 7.3%
Alabama 4,707 5.6% 2,070 4.1%
Louisiana 4,355 5.2% 3,142 6.3%
Pennsylvania 4,239 5.1% 3,622 7.2%
Michigan 4,119 4.9% 1,954 3.9%
Illinois 3,808 4.6% 2,413 4.8%
Tennessee 2,997 3.6% 2,012 4.0%
Georgia 2,738 3.3% 1,503 3.0%
New York 2,690 3.2% 2,941 5.9%
South Carolina 2,152 2.6% 715 1.4%
Maryland 1,859 2.2% 1,586 3.2%
Ohio 1,768 2.1% 992 2.0%
Hawaii 1,585 1.9% 867 1.7%
Other States 16,261 19.5% 8,545 17.1%
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Total 83,567 50,063
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As discussed in greater detail below (see "Management's Discussion and
Analysis of Financial Condition and Results of Operation - Liquidity and Capital
Resources"), the Company has recently elected to conserve captial by materially
reducing its Contract purchase activities. In connection with this decision, the
Company has reduced the number of its marketing representatives to 48, as of
April 10, 1999, and as of that
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date was purchasing Contracts in 23 states. Dealers in such states under
contract with the Company totaled 2,837 as of April 10, 1999.
Origination of Contracts
Dealer Origination. When a retail automobile buyer elects to obtain financing
from a Dealer, the Dealer takes a credit application to submit to its financing
sources. Typically, a Dealer will submit the buyer's application to more than
one financing source for review. The Company believes the Dealer's decision to
finance the automobile purchase with the Company, rather than other financing
sources, is based primarily upon an analysis of the monthly payment that will be
offered to the automobile buyer, the discounted purchase price offered for the
Contract, the timeliness, consistency and predictability of response, the cash
resources of the financing source, and any conditions to purchase.
Upon receipt of an application from a Dealer, the Company's administrative
personnel order a credit report to document the buyer's credit history. If, upon
review by a Company loan officer, it is determined that the application meets
the Company's underwriting criteria, or would meet such criteria with
modification, the Company requests and reviews further information and
supporting documentation and, ultimately, decides whether to purchase the
Contract. When presented with an application, the Company attempts to notify the
Dealer within four hours as to whether it intends to purchase such Contract.
The actual agreement for purchase of the vehicle ("Contract") is prepared by
the Dealer. The Dealer also arranges for recording the Company's lien on the
vehicle. After the appropriate documents are signed by the Dealer and the
customer, the Dealer sells the Contract to the Company. The customer then
receives monthly billing statements.
Through December 1996, the Company had purchased Contracts from Dealers at
percentage discounts ranging from 0% to 10% of the total amount financed under
the Contracts, depending on the perceived credit risk of the Contract, plus a
flat acquisition fee, generally $200, for each Contract purchased. Percentage
discounts averaged 4.1% and 2.8% for the years ended December 31, 1995 and 1996,
respectively. The Company believes that the level of discounts and fees are a
significant factor in the Dealer's decision to submit a Contract to the Company
for purchase, and will continue to play such a role in the future. Effective
January 10, 1997, the Company began purchasing Contracts in general without a
percentage discount, charging Dealers only an acquisition fee ranging from zero
to $1,195 for each Contract purchased. The fees vary based on the perceived
credit risk and, in some cases, the interest rate on the Contract. The
acquisition fees instituted in January 1997 are larger, on average, than the
acquisition fees previously charged in conjunction with percentage discounts, so
as to result in a similar net purchase price on a typical Contract. For the
years ended December 31, 1998 and 1997, the average amount charged per Contract
purchased was $418 and $438, respectively, or 3.2% and 3.5%, respectively, of
the amount financed. In addition, during 1998 the Company began purchasing
certain Contracts of higher credit quality for which the Company pays a fee to
the Dealer. During 1998, the Company purchased 1,583 of these Contracts
representing approximately 1.9% of all Contracts purchased. The average fee paid
to Dealers on these Contracts was $531.
The Company attempts to control misrepresentation regarding the customer's
credit worthiness by carefully screening the Contracts it purchases, by
establishing and maintaining professional business relationships with Dealers,
and by including certain representations and warranties by the Dealer in the
Dealer Agreement. Pursuant to the Dealer Agreement, the Company may require the
Dealer to repurchase any Contract in the event that the Dealer breaches its
representations or warranties. There can be no assurance, however, that any
Dealer will have the financial resources to satisfy its repurchase obligations
to the Company.
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Objective Contract Purchase Criteria. To be eligible for purchase by the
Company, a Contract must have been originated by a Dealer that has entered into
a Dealer Agreement to sell Contracts to the Company. The Contracts must be
secured by a first priority lien on a new or used automobile, light truck or
passenger van and must meet the Company's underwriting criteria. In addition,
each Contract requires the customer to maintain physical damage insurance
covering the financed vehicle and naming the Company as a loss payee. The
Company or any purchaser of the Contract from the Company may, nonetheless,
suffer a loss upon theft or physical damage of any financed vehicle if the
customer fails to maintain insurance as required by the Contract and is unable
to pay for repairs to or replacement of the vehicle or is otherwise unable to
fulfill his or her obligations under the Contract.
The Company believes that its objective underwriting criteria enable it to
evaluate effectively the creditworthiness of Sub-Prime Customers and the
adequacy of the financed vehicle as security for a Contract. These criteria
include standards for price; term; amount of down payment, installment payment
and add-on interest rate; mileage, age and type of vehicle; principal amount of
the Contract in relation to the value of the vehicle; customer income level, job
and residence stability, credit history and debt serviceability; and other
factors. Specifically, the Company's guidelines limit the maximum principal
amount of a purchased Contract to 115% of wholesale book value in the case of
used vehicles or to 110% of the manufacturer's invoice in the case of new
vehicles, plus, in each case, sales tax, licensing and, when the customer
purchases such additional items, a service contract or a credit life or
disability policy. The Company does not finance vehicles that are more than
eight model years old or have in excess of 85,000 miles. Under most CPS
programs, the maximum term of a purchased Contract is 60 months; a shorter
maximum term may be applied based on the year and mileage of the vehicle, and
contracts with terms up to 72 months may be purchased if the customer is among
the more creditworthy of CPS' obligors. Contract purchase criteria are subject
to change from time to time as circumstances may warrant. Upon receiving this
information with the customer's application, the Company's underwriters verify
the customer's employment, residency, insurance and credit information provided
by the customer by contacting various parties noted on the customer's
application, credit information bureaus and other sources.
Credit Scoring. In November 1996, the Company implemented a proprietary
scoring model that assigns each Contract a numeric value, (a "credit score") at
the time the application is received from the Dealer and the customers credit
information is retrieved from the credit reporting agencies. The credit score is
based on a variety of parameters, such as the customer's job and residence
stability, the amount of the down payment, and the age and mileage of the
vehicle. The Company has developed the credit score as a means of identifying
Contracts where a review by a supervisor or manager, prior to approval, is
warranted. Regardless of the credit score a Contract originally receives, the
Company's underwriters perform the same extensive review and verification
procedures on all Contracts that are purchased. During 1998, the Company made
significant enhancements to its scoring model. These enhancements included
incorporating more of the obligor's past credit history.
Characteristics of Contracts. All of the Contracts purchased by the Company
are fully amortizing and provide for level payments over the term of the
Contract. The average original principal amount financed under Contracts
purchased in the year ended December 31, 1998 was approximately $12,903 with an
average original term of approximately 57 months and an average down payment of
14.6%. Based on information contained in customer applications, for this
twelve-month period, the retail purchase price of the related automobiles
averaged $13,202 (which excludes tax and license fees, and any additional costs
such as a maintenance contract), the average age of the vehicle at the time the
Contract was purchased was 3.5 years, and the Company's average customer at the
time of purchase was approximately 36 years old, with approximately $35,227 in
average annual household income and an average of 4.4 years' history with his or
her current employer.
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All Contracts may be prepaid at any time without penalty. In the event a
customer elects to prepay a Contract in full, the payoff amount is calculated by
deducting the unearned interest from the Contract balance, in the case of a
pre-computed Contract, or by adding accrued interest to the Contract balance, in
the case of a simple interest Contract.
Each Contract purchased by the Company prohibits the sale or transfer of the
financed vehicle without the Company's consent and allows for the acceleration
of the maturity of a Contract upon a sale or transfer without such consent. In
most circumstances, the Company will not consent to a sale or transfer of a
financed vehicle unless the related Contract is prepaid in full.
Dealer Compliance. The Dealer Agreement and related assignment contain
representations and warranties by the Dealer that an application for state
registration of each financed vehicle, naming the Company as secured party with
respect to the vehicle, was effected at the time of sale of the related Contract
to the Company, and that all necessary steps have been taken to obtain a
perfected first priority security interest in each financed vehicle in favor of
the Company under the laws of the state in which the financed vehicle is
registered. If a Dealer or the Company, because of clerical error or otherwise,
has failed to take such action in a timely manner, or to maintain such interest
with respect to a financed vehicle, neither the Company nor any purchaser of the
related Contract from the Company would have a perfected security interest in
the financed vehicle and its security interest may be subordinate to the
interest of, among others, subsequent purchasers of the financed vehicle,
holders of perfected security interests and a trustee in bankruptcy of the
customer. The security interest of the Company or the purchaser of a Contract
may also be subordinate to the interests of third parties if the interest is not
perfected due to administrative error by state recording officials. Moreover,
fraud or forgery by the customer could render a Contract unenforceable against
third parties. In such events, the Company could suffer a loss with respect to
the related Contract. In the event the Company suffers such a loss, it will
generally have recourse against the Dealer from which it purchased the Contract.
This recourse will be unsecured, and there can be no assurance that any Dealer
will have the financial resources to satisfy its repurchase obligations to the
Company.
Servicing of Contracts
General. The Company's servicing activities consist of collecting, accounting
for and posting of all payments received; responding to customer inquiries;
taking all necessary action to maintain the security interest granted in the
financed vehicle or other collateral; investigating delinquencies; communicating
with the customer to obtain timely payments; repossessing and reselling the
collateral when necessary; and generally monitoring each Contract and any
related collateral.
Collection Procedures. The Company believes that its ability to monitor
performance and collect payments owed from Sub-Prime Customers is primarily a
function of its collection approach and support systems. The Company believes
that if payment problems are identified early and the Company's collection staff
works closely with customers to address these problems, it is possible to
correct many of them before they deteriorate further. To this end, the Company
utilizes pro-active collection procedures, which include making early and
frequent contact with delinquent customers; educating customers as to the
importance of maintaining good credit; and employing a consultative and customer
service approach to assist the customer in meeting his or her obligations, which
includes attempting to identify the underlying causes of delinquency and cure
them whenever possible. In support of its collection activities, the Company
maintains a computerized collection system specifically designed to service
automobile installment sale contracts with Sub-Prime Customers and similar
consumer obligations.
With the aid of its high penetration auto dialer, the Company typically
attempts to make telephonic contact with delinquent customers on the sixth day
after their monthly payment due date. Using coded instructions from a collection
supervisor, the automatic dialer will attempt to contact customers based on
their physical
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location, state of delinquency, size of balance or other parameters. If the
automatic dialer obtains a "no-answer" or a busy signal, it records the attempt
on the customer's record and moves on to the next call. If a live voice answers
the automatic dialer's call, the call is transferred to a waiting collector at
the same time that the customer's pertinent information is simultaneously
displayed on the collector's workstation. The collector then inquires of the
customer the reason for the delinquency and when the Company can expect to
receive the payment. The collector will attempt to get the customer to make a
promise for the delinquent payment for a time generally not to exceed one week
from the date of the call. If the customer makes such a promise, the account is
routed to a pending queue and is not contacted until the outcome of the promise
is known. If the payment is made by the promise date and the account is no
longer delinquent, the account is routed out of the collection system. If the
payment is not made, or if the payment is made, but the account remains
delinquent, the account is returned to the automatic dialing queue for
subsequent contacts.
If a customer fails to make or keep promises for payments, or if the customer
is uncooperative or attempts to evade contact or hide the vehicle, a supervisor
will review the collection activity relating to the account to determine if
repossession of the vehicle is warranted. Generally, such a decision will occur
between the 45th and 90th day past the customer's payment due date, but could
occur sooner or later, depending on the specific circumstances.
If CPS elects to repossess the vehicle, it assigns the task to an independent
local repossession service. Such services are licensed and/or bonded as required
by law. When the vehicle is recovered, the repossessor delivers it to a
wholesale auto auction, where it is kept until sold, usually within 30 days of
the repossession. The UCC and other state laws regulate repossession sales by
requiring that the secured party provide the customer with reasonable notice of
the date, time and place of any public sale of the collateral, the date after
which any private sale of the collateral may be held and of the customer's right
to redeem the financed vehicle prior to any such sale and by providing that any
such sale be conducted in a commercially reasonable manner. Financed vehicles
repossessed generally are resold by the Company through unaffiliated wholesale
automobile networks or auctions, which are attended principally by used car
dealers. Net liquidation proceeds are applied to the customer's outstanding
obligation under the Contract.
Under the UCC and other laws applicable in most states (including
California), a creditor is entitled to obtain a deficiency judgment from a
customer for any deficiency on repossession and resale of the motor vehicle
securing the unpaid balance of such customer's Contract. However, some states
impose prohibitions or limitations on deficiency judgments. When obtained,
deficiency judgements are entered against defaulting individuals who may have
little capital or income. Therefore, in many cases, it may not be useful to seek
a deficiency judgment against a customer or, if one is obtained, it may be
settled at a significant discount.
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Credit Experience
The Company's financial results are dependent on the performance of the
Contracts it has purchased. The tables below document the delinquency,
repossession and net credit loss experience of all Contracts purchased by the
Company:
DELINQUENCY EXPERIENCE (1)
As of December 31,
----------------------------------------------------------------------------
1998 1997 1996
---- ---- ----
Number Number Number
of of of
Contracts Amount Contracts Amount Contracts Amount
--------- ---------- --------- ---------- --------- --------
(Dollars in thousands)
Gross servicing portfolio....... 141,396 $1,674,417 83,414 $1,031,573 47,187 $604,092
Period of delinquency (2)
31-60 days...................... 4,202 48,324 3,092 36,609 1,801 22,099
61-90 days...................... 1,869 22,335 1,243 15,303 724 9,068
91+ days........................ 1,694 20,096 1,393 17,869 768 9,906
------- ---------- ------ ---------- ------ --------
Total delinquencies(2).......... 7,765 90,755 5,728 69,781 3,293 41,073
Amount in repossession (3)...... 2,961 32,772 1,977 24,463 1,168 14,563
------- ---------- ------ ---------- ------ --------
Total delinquencies and amount
in repossession (2)............. 10,726 $123,527 7,705 $94,244 4,461 $55,636
======= ========== ====== ========== ====== ========
Delinquencies as a percent of
gross servicing portfolio....... 5.5% 5.4% 6.9% 6.8% 7.0% 6.8%
Total delinquencies and amount
in repossession as a percent of
gross servicing portfolio....... 7.6% 7.4% 9.2% 9.1% 9.5% 9.2%
(1) All amounts and percentages are based on the full amount remaining to be
repaid on each Contract, including, for pre-computed Contracts, any unearned
finance charges. The information in the table represents the principal
amount of all Contracts purchased by the Company, including Contracts
subsequently sold by the Company, which it continues to service.
(2) The Company considers a Contract delinquent when an obligor fails to make at
least 90% of a contractually due payment by the following due date, which
date may have been extended within limits specified in the Servicing
Agreements. The period of delinquency is based on the number of days
payments are contractually past due. Contracts less than 31 days delinquent
are not included.
(3) Amount in repossession represents financed vehicles that have been
repossessed but not yet liquidated.
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NET CHARGE-OFF EXPERIENCE(1)
Year Ended December 31,
----------------------------------
(Dollars in thousands)
1998 1997 1996
---------- -------- --------
Average servicing portfolio outstanding.... $1,300,519 $703,100 $397,430
Net charge-offs as a percent of average
servicing portfolio (2).................... 6.5% 5.9% 5.1%
(1) All amounts and percentages are based on the principal amount scheduled to
be paid on each Contract. The information in the table represents all
Contracts purchased by the Company including Contracts subsequently sold by
the Company that it continues to service.
(2) Net charge-offs include the remaining principal balance, after the
application of the net proceeds from the liquidation of the vehicle
(excluding accrued and unpaid interest).
Securitization and Sale of Contracts to Institutional Investors
The Company purchases Contracts with the primary intention of reselling them
to investors as asset-backed securities through securitizations. In connection
with the sale of the Contracts, the Company is required to make certain
representations and warranties, which are generally similar to the
representations and warranties made by Dealers in connection with the Company's
purchase of the Contracts. If the Company breaches any of its representations or
warranties to a purchaser of the Contracts, the Company will be obligated to
repurchase the Contract from such purchaser at a price equal to such purchaser's
purchase price less the related cash securitization reserve and any payments
received by such purchaser on the Contract. The Company may then be entitled
under the terms of its Dealer Agreement to require the selling Dealer to
repurchase the Contract at a price equal to the Company's purchase price, less
any payments made by the customer. Subject to any recourse against Dealers, the
Company will bear the risk of loss on repossession and resale of vehicles under
Contracts repurchased by it.
Upon the sale of a portfolio of Contracts, to an investor or a trust, the
Company mails to obligors monthly billing statements directing them to mail
payments on the Contracts to a lock-box account. The Company engages an
independent lock-box processing agent to retrieve and process payments received
in the lock-box account. This results in a daily deposit to the investor's or
the Trust's bank account of the entire amount of each day's lock-box receipts
and the simultaneous electronic data transfer to the Company of customer payment
data records. Pursuant to the Servicing Agreements, the Company is required to
deliver monthly reports to the investor or the Trust reflecting all transaction
activity with respect to the Contracts. The reports contain, among other
information, a reconciliation of the change in the aggregate principal balance
of the Contracts in the portfolio to the amounts deposited into the investor's
or the Trust's bank account as reflected in the daily reports of the lock-box
processing agent.
Pursuant to its securitization purchase commitments, the Company generally
warrants that, to the best of the Company's knowledge, no such liens or claims
are pending or threatened with respect to a financed vehicle, which may be or
become prior to or equal with the lien of the related Contracts. In the event
that any of the Company's representations or warranties proves to be incorrect,
the Trust or the investor would be entitled to require the Company to repurchase
the Contract relating to such financed vehicle.
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The Servicing Portfolio
The Company currently services all Contracts that it owns, as well as those
Contracts included in portfolios that it has sold to investors or securitization
trusts. Pursuant to the Company's usual form of servicing agreement (the
Company's servicing agreements with purchasers of portfolios of Contracts are
collectively referred to as the "Servicing Agreements"), CPS is obligated to
service all Contracts sold to the investors or Trusts in accordance with the
Company's standard procedures. The Servicing Agreements generally provide that
the Company will bear all costs and expenses incurred in connection with the
management, administration and collection of the Contracts serviced. The
Servicing Agreements also provide that the Company will take all actions
necessary or reasonably requested by the investor to maintain perfection and
priority of the investor's or the Trust's security interest in the financed
vehicles. CPS may in the future sell Contracts "servicing - released," that is,
with the purchaser assuming the future servicing of the purchased Contracts. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources."
The Company is entitled under most of the Servicing Agreements to receive a
base monthly servicing fee of 2.0% per annum computed as a percentage of the
declining outstanding principal balance of the non-defaulted Contracts in the
portfolio. Each month, after payment of the Company's base monthly servicing fee
and certain other fees, the investor or trust receives the paid principal
reduction of the Contracts in its portfolios and interest thereon at the fixed
rate that was agreed when the Contracts were sold to the Trust. If, in any
month, collections on the Contracts are insufficient to pay such amounts and any
principal reduction due to charge-offs, the shortfall is satisfied from the
"Spread Account" established in connection with the sale of the portfolio. The
"Spread Account" is an account established at the time the Company sells a
portfolio of Contracts, to provide security to the purchaser of the portfolio.
If collections on the Contracts exceed such amounts, the excess is utilized,
first, to build up or replenish the Spread Account to the extent required, next,
to cover deficiencies in Spread Accounts for other portfolios, and the balance,
if any, constitutes excess cash flows, which are distributed to the Company. The
Company has not received any such distributions since June 1998. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources." The Servicing Agreements also
provide that the Company is entitled to receive certain late fees collected from
customers.
Pursuant to the Servicing Agreements, the Company is generally required to
charge off the balance of any Contract by the earlier of the end of the month in
which the Contract becomes five scheduled installments past due or, in the case
of repossessions, the month that the proceeds from the liquidation of the
financed vehicle are received by the Company. In the case of a repossession, the
amount of the charge-off is the difference between the outstanding principal
balance of the defaulted Contract and the net repossession sale proceeds. In the
event collections on the Contracts are not sufficient to pay to the investors
the entire principal balance of Contracts charged off during the month, the
trustee draws on the related Spread Account to pay the investors. The amount
drawn would then have to be restored to the Spread Account from future
collections on the Contracts remaining in the portfolio before the Company would
again be entitled to receive excess cash. In addition, the Company would not be
entitled to receive any further monthly servicing fees with respect to the
defaulted Contracts. Subject to any recourse against the Company in the event of
a breach of the Company's representations and warranties with respect to any
Contracts and after any recourse to any insurer guarantees backing the
Certificates, the investor bears the risk of all charge-offs on the Contracts in
excess of the Spread Account. The investors' rights with respect to
distributions from the Trusts are senior to the Company's rights. Accordingly,
variation in performance of pools of Contracts affects the Company's ultimate
realization of value derived from such Contracts.
The Servicing Agreements are terminable by the trust (or by the insurer of
certificates issued by the trust) in the event of certain defaults by the
Company and under certain other circumstances. As of December 31, 1998, 7 of the
Company's 22 securitized pools had incurred cumulative losses exceeding certain
predetermined levels, which in turn has
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given the insurer the right to terminate the Servicing Agreements. To date, the
insurer has waived its right to terminate the Servicing Agreements.
Competition
The automobile financing business is highly competitive. The Company competes
with a number of national, local and regional finance companies with operations
similar to those of the Company. In addition, competitors or potential
competitors include other types of financial services companies, such as
commercial banks, savings and loan associations, leasing companies, credit
unions providing retail loan financing and lease financing for new and used
vehicles, and captive finance companies affiliated with major automobile
manufacturers such as General Motors Acceptance Corporation, Ford Motor Credit
Corporation, Chrysler Credit Corporation and Nissan Motors Acceptance
Corporation. Many of the Company's competitors and potential competitors possess
substantially greater financial, marketing, technical, personnel and other
resources than the Company. Moreover, the Company's future profitability will be
directly related to the availability and cost of its capital in relation to the
availability and cost of capital to its competitors. The Company's competitors
and potential competitors include far larger, more established companies that
have access to capital markets for unsecured commercial paper and investment
grade-rated debt instruments and to other funding sources which may be
unavailable to the Company. Many of these companies also have long-standing
relationships with Dealers and may provide other financing to Dealers, including
floor plan financing for the Dealers' purchase of automobiles from
manufacturers, which is not offered by the Company.
The Company believes that the principal competitive factors affecting a
Dealer's decision to offer Contracts for sale to a particular financing source
are the monthly payments made available to the vehicle purchaser, the purchase
price offered for the Contracts, the reasonableness of the financing source's
underwriting guidelines and documentation requests, the predictability and
timeliness of purchases and the financial stability of the funding source. The
Company believes that it can obtain from Dealers sufficient Contracts for
purchase at attractive prices by consistently applying reasonable underwriting
criteria and making timely purchases of qualifying Contracts.
Government Regulation
Several federal and state consumer protection laws, including the federal
Truth-In-Lending Act, the federal Equal Credit Opportunity Act, the federal Fair
Debt Collection Practices Act and the federal Trade Commission Act, regulate the
extension of credit in consumer credit transactions. These laws mandate certain
disclosures with respect to finance charges on Contracts and impose certain
other restrictions on Dealers. In many states, a license is required to engage
in the business of purchasing Contracts from Dealers. In addition, laws in a
number of states impose limitations on the amount of finance charges that may be
charged by Dealers on credit sales. The so-called Lemon Laws enacted by the
Federal government and various states provide certain rights to purchasers with
respect to motor vehicles that fail to satisfy express warranties. The
application of Lemon Laws or violation of such other Federal and state laws may
give rise to a claim or defense of a customer against a Dealer and its
assignees, including the Company and purchasers of Contracts from the Company.
The Dealer Agreement contains representations by the Dealer that, as of the date
of assignment of Contracts, no such claims or defenses have been asserted or
threatened with respect to the Contracts and that all requirements of such
Federal and state laws have been complied with in all material respects.
Although a Dealer would be obligated to repurchase Contracts that involve a
breach of such warranty, there can be no assurance that the Dealer will have the
financial resources to satisfy its repurchase obligations to the Company.
Certain of these laws also regulate the Company's servicing activities,
including its methods of collection.
Although the Company believes that it is currently in material compliance
with applicable statutes and regulations, there can be no assurance that the
Company will be able to maintain such compliance. The
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failure to comply with such statutes and regulations could have a material
adverse effect upon the Company. Furthermore, the adoption of additional
statutes and regulations, changes in the interpretation and enforcement of
current statutes and regulations or the expansion of the Company's business into
jurisdictions that have adopted more stringent regulatory requirements than
those in which the Company currently conducts business could have a material
adverse effect upon the Company. In addition, due to the consumer-oriented
nature of the industry in which the Company operates and the application of
certain laws and regulations, industry participants are regularly named as
defendants in litigation involving alleged violations of Federal and state laws
and regulations and consumer law torts, including fraud. Many of these actions
involve alleged violations of consumer protection laws. A significant judgment
against the Company or within the industry in connection with any such
litigation could have a material adverse effect on the Company's financial
condition, results of operations or liquidity. See "Legal Proceedings."
Alternative Marketing Programs
From 1996 through 1998, the Company invested in an 80 percent-owned
subsidiary, Samco Acceptance Corporation ("Samco"), which pursued a business
strategy of purchasing Contracts from independent finance companies that had in
turn purchased the Contracts from Dealers. The Contracts purchased from Samco
showed consistently higher losses than Contracts purchased by CPS directly from
Dealers. In December 1998, the Company ceased further investments in Samco, and
terminated all operations during the first quarter of 1999. The Company believes
that any credit losses related to Samco-originated Contracts have been
adequately reserved for, and that no material losses will result from Samco's
terminated operations.
For the year ended December 31, 1998, Samco purchased 5,337 Contracts with
original balances aggregating $64.3 million. During the first quarter of 1999,
the Company terminated all operations of Samco in conjunction with the Company's
plan to reduce the level of Contract purchases and thus to decrease future
capital requirements. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Liquidity and Capital Resources."
In May 1996, CPS formed LINC Acceptance Corp. ("LINC"), an 80 percent-owned
subsidiary based in Norwalk, Connecticut. LINC provides the Company's sub-prime
auto finance products to credit unions, banks and savings and loans ("Depository
Institutions"). The Company believes that Depository Institutions do not
generally make loans to Sub-Prime Customers, even though they may have
relationships with Dealers and have Sub-Prime Customers.
LINC calls on various Depository Institutions and presents them with a
financing program that is similar to those that CPS markets directly to Dealers
through its marketing representatives. The LINC program is intended to result in
a slightly more creditworthy customer than the Company's regular programs, by
requiring slightly higher income and lower debt-to-income ratios. LINC's
customers may offer its financing program to customers directly or to local
Dealers. Unlike Samco, which has employees who evaluate applications and make
decisions to purchase Contracts, LINC applications are submitted by the
Depository Institution directly to CPS, where the approval, underwriting and
purchase procedures are performed by CPS staff who work with LINC as well as
with CPS Dealers. Servicing and collection procedures on LINC Contracts are
performed entirely by the Company's collections personnel. For the year ended
December 31, 1998, LINC purchased 1,813 Contracts with original balances
aggregating $24.3 million. CPS intends to terminate the separate operations of
LINC during the second quarter of 1999. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources."
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Employees
As of December 31, 1998, the Company had 666 full-time and 2 part-time
employees, of whom 11 are senior management personnel, 316 are collections
personnel, 152 are Contract origination personnel, 81 are marketing personnel
(72 of whom are marketing representatives), 81 are operations and systems
personnel, and 27 are accounting and human resource personnel. The Company
believes that its relations with its employees are good. The Company is not a
party to any collective bargaining agreement.
ITEM 2. PROPERTY
The Company's headquarters are located in Irvine, California, where it leases
approximately 115,000 square feet of general office space from an unaffiliated
lessor. The annual rent is approximately $1.9 million for the first five years
of the lease term, and increases to $2.1 million for years six through ten. The
Company has the option to cancel the lease after five years without penalty. In
addition to the foregoing base rent, the Company has agreed to pay the property
taxes, maintenance and other expenses of the premises. Prior to November 1998,
the Company's headquarters were located in a different facility of approximately
51,400 square feet, also in Irvine, California. The Company has subleased its
former headquarters location, on terms that should yield immaterial sublease
income through the remainder of that lease.
The Company in March 1997 established a branch collection facility in
Chesapeake, Virginia. The Company leases approximately 27,988 square feet of
general office space in Chesapeake, Virginia at a base rent that is currently
$401,628 per year, increasing to $504,545 over a ten-year term.
ITEM 3. LEGAL PROCEEDINGS
CPS is party to litigation in the ordinary course of business, generally
involving actions against automobile purchasers to collect amounts due on
purchased Contracts or to recover vehicles. In one such case, relating to the
Chapter 13 bankruptcy of obligors Madeline and Darryl Brownlee, of Chicago,
Illinois, the obligors counterclaimed against CPS on June 30, 1997 in the
bankruptcy court for the Northern District of Illinois. The obligors seek
class-action treatment of their allegation that the cost of an extended service
contract on the automobile they purchased was inadequately disclosed by the
automobile dealer, Joe Cotton Ford of Carol Stream, Illinois. The disclosure
allegedly violated the federal Truth in Lending Act and Illinois consumer
protection statutes. The plaintiffs amended their complaint in September 1998,
dropping all Truth in Lending allegations against CPS. The court in February
1999, dismissed all remaining claims against CPS. The case remains pending
against the dealer, and there is a remote chance that a possible appeal could
result in a reinstatement of claims against the Company.
In another proceeding, arising out of efforts to collect a deficiency balance
from Joseph Barrios of Chicago, Illinois, the debtor has brought suit against
CPS alleging defects in the notice given upon repossession of the vehicle. This
lawsuit was filed on February 18, 1998, in the circuit court of Cook County,
Illinois and sought relief for a punitive class of persons who have received
such notice. A settlement of this litigation has been reached on a class basis,
which does not involve material expense.
It is management's opinion that all litigation of which it is aware,
including the matters discussed above, will not have a material adverse effect
on the Company's consolidated financial position, results of operations or
liquidity.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
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ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding the Company's executive officers follows:
Charles E. Bradley, Jr., 39, has been the President and a director of the
Company since its formation in March 1991. In January 1992, Mr. Bradley was
appointed Chief Executive Officer of the Company. From March 1991 until December
1995 he served as Vice President and a director of CPS Holdings, Inc. From April
1989 to November 1990, he served as Chief Operating Officer of Barnard and
Company, a private investment firm. From September 1987 to March 1989, Mr.
Bradley, Jr. was an associate of The Harding Group, a private investment banking
firm. Mr. Bradley, Jr. is currently serving as a director of NAB Asset
Corporation, Chatwins Group, Inc., Texon Energy Corporation, and Thomas Nix
Distributor, Inc. Charles E. Bradley, Sr., Chairman of the board of directors of
the Company, is his father.
Jeffrey P. Fritz, 39, has been Senior Vice President - Chief Financial
Officer and Secretary of the Company since March 1991. From December 1988 to
March 1991, Mr. Fritz was Vice President and Chief Financial Officer of Far
Western Bank. From 1985 to December 1988, Mr. Fritz was a management consultant
for Price Waterhouse in St. Louis, Missouri.
William L. Brummund, Jr., 46, has been Senior Vice President - Systems
Administration since March 1991. From 1986 to March 1991, Mr. Brummund was Vice
President and Systems Administrator for Far Western Bank.
Nicholas P. Brockman, 54, has been Senior Vice President - Asset Recovery &
Liquidation since January 1996. He was Senior Vice President of Contract
Originations from April 1991 to January 1996. From 1986 to March 1991, Mr.
Brockman served as a Vice President and Branch Manager of Far Western Bank.
Richard P. Trotter, 55, has been Senior Vice President-Contract Origination
since January 1996. He was Senior Vice President of Administration from April
1995 to December 1995. From January 1994 to April 1995 he was Senior Vice
President-Marketing of the Company. From December 1992 to January 1994, Mr.
Trotter was Executive Vice President of Lange Financial Corporation, Newport
Beach, California. From May 1992 to December 1992, he was Executive Director of
Fabozzi, Prenovost & Normandin, Santa Ana, California. From December 1990 to May
1992 he was Executive Vice President/Chief Operating Officer of R. Thomas
Ashley, Newport Beach, California. From April 1984 to December 1990, he was
President/Chief Executive Officer of Far Western Bank, Tustin, California.
Curtis K. Powell, 42, has been Senior Vice President - Marketing of the
Company since April 1995. He joined the Company in January 1993 as an
independent marketing representative until being appointed Regional Vice
President of Marketing for Southern California in November 1994. From June 1985
through January 1993, Mr. Powell was in the retail automobile sales and leasing
business.
Mark A. Creatura, 39, has been Senior Vice President - General Counsel since
October 1996. From October 1993 through October 1996, he was Vice President and
General Counsel at Urethane Technologies, Inc., a polyurethane chemicals
formulator. Mr. Creatura was previously engaged in the private practice of law
with the Los Angeles law firm of Troy & Gould Professional Corporation, from
October 1985 through October 1993.
Thurman Blizzard, 56, has been Senior Vice President - Collections since
January 1998. The Company had previously engaged Mr. Blizzard as a consultant
from October 1997 to December 1997 to provide recommendations to the Company
concerning its collections operation. Prior thereto, Mr. Blizzard served as
Chief Operations Officer of Monaco Finance from May 1994 to March 1997. Mr.
Blizzard was previously an Asset Liquidation Manager with the Resolution Trust
Corporation, from November 1991 to May 1994.
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PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the Nasdaq National Market System,
under the symbol "CPSS." The following table sets forth the high and low closing
prices reported for the Common Stock for the periods. Such quotations reflect
inter-dealer prices, without retail mark-up, mark-down or commission.
High Low
-------- --------
January 1 - March 31, 1997.................................. $ 13.875 $ 7.375
April 1 - June 30, 1997..................................... 12.375 7.000
July 1 - September 30, 1997................................. 18.250 10.500
October 1 - December 31, 1997............................... 17.750 7.500
January 1-March 31, 1998.................................... 12.750 9.000
April 1-June 30, 1998....................................... 15.063 10.000
July 1-September 30, 1998................................... 12.875 1.813
October 1-December 31, 1998................................. 5.125 2.000
As of April 13, 1999, there were 69 holders of record of the Company's Common
Stock. To date, the Company has not declared or paid any dividends on its Common
Stock. The payment of future dividends, if any, on the Company's Common Stock is
within the discretion of the Board of Directors and will depend upon the
Company's earnings, its capital requirements and financial condition, and other
relevant factors. The instruments governing the Company's outstanding debt place
certain restrictions on the payment of dividends. The Company does not intend to
declare any dividends on its Common Stock in the foreseeable future, but instead
intends to retain any earnings for use in the Company's operations.
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ITEM 6. SELECTED FINANCIAL DATA
Nine-Month
Period Ended Fiscal Year Ended
Year ended December 31, December 31, March 31,
--------------------------------------- ------------ -----------------
1998 1997 1996 1995 1995
----------- ---------- ---------- ------------ -----------------
(in thousands, except per share data)
STATEMENT OF INCOME DATA:
Gain on sale of Contracts, net .... $ 58,306 $ 35,045 $ 20,565 $ 10,721 $ 8,922
Interest income.................... 41,841 23,526 19,980 9,220 10,561
Servicing fees..................... 25,156 14,487 7,893 3,485 2,489
Total revenue...................... 126,280 75,251 48,438 23,426 21,972
Operating expenses ................ 81,960 43,292 24,746 10,769 10,825
Net income......................... $ 25,703 $ 18,532 $ 14,097 $ 7,575 $ 6,666
Basic earnings per share (1)....... $ 1.67 $ 1.29 $ 1.05 $ 0.65 $ 0.75
Diluted net earnings per share (1). $ 1.50 $ 1.17 $ 0.93 $ 0.52 $ 0.61
December 31, March 31,
-------------------------------------------- -------------------
1998 1997 1996 1995 1995 1994
-------- ------- ------- ------- ------- --------
(in thousands)
BALANCE SHEET DATA:
Contracts held for sale......... $ 165,582 $ 68,271 $ 21,657 $ 19,549 $ 21,896 $ 647
Residual interest in
securitizations............... 217,848 124,616 67,252 41,586 5,154 2,294
Total assets.................... 431,962 225,895 101,946 77,878 57,975 16,538
Total liabilities............... 312,881 143,288 44,989 36,397 30,981 6,337
Total shareholders' equity...... $ 119,081 $ 82,607 $ 56,957 $ 41,481 $ 26,994 $ 10,201
(1) All prior periods have been restated in accordance with Statement of
Financial Accounting Standards No. 128, "Earnings per Share."
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following analysis of the financial condition of the Company should be
read in conjunction with "Selected Financial Data" and the Company's
Consolidated Financial Statements and the Notes thereto and the other financial
data included elsewhere in this report.
Overview
Consumer Portfolio Services, Inc. (the "Company") and its subsidiaries
primarily engage in the business of purchasing, selling and servicing retail
automobile installment sale contracts ("Contracts") originated by automobile
dealers ("Dealers") located throughout the Unites States. Through its purchase
of Contracts, the Company provides indirect financing to Dealer customers with
limited credit histories, low incomes or past credit problems, who generally
would not be expected to qualify for financing provided by banks or by
automobile manufacturers' captive finance companies.
The Company generates revenue primarily from the gains recognized on the sale
or securitization of its Contracts, servicing fees earned on Contracts sold, and
interest earned on Residuals (as defined below) and on Contracts held for sale.
Revenues from gains on sale, interest and servicing fees for the year ended
December 31, 1998, were $58.3 million, $41.8 million, and $25.2 million,
respectively. Such revenues for the year ended December 31, 1997, were $35.0
million, $23.5 million, and $14.5 million, respectively, and for the year ended
December 31, 1996, such revenues were $20.6 million, $20.0 million and $7.9
million, respectively. The Company's income is affected by losses incurred on
Contracts, whether such Contracts are held for sale or have been sold in
securitizations. The Company's cash requirements have been and will continue to
be significant. Net cash used in operating activities for the years ended
December 31, 1998, 1997 and 1996, were $71.1 million, $26.1 million and $8.4
million, respectively. See "Liquidity and Capital Resources."
The Company purchases Contracts with the primary intention of reselling them
in securitization transactions as asset-backed securities. The securitizations
are generally structured as follows: First, the Company sells a portfolio of
Contracts to a wholly owned subsidiary ("SPS"), which has been established for
the limited purpose of buying and reselling the Company's Contracts. The SPS
then transfers the same Contracts to either a grantor trust or an owner trust
(the "Trust"). The Trust in turn issues interest-bearing asset-backed securities
(the "Certificates"), generally in an amount equal to the aggregate principal
balance of the Contracts. The Company typically sells these Contracts to the
Trust at face value and without recourse, except that representations and
warranties similar to those provided by the Dealer to the Company are provided
by the Company to the Trust. One or more investors purchase the Certificates
issued by the Trust; the proceeds from the sale of the Certificates are then
used to purchase the Contracts from the Company. The Company purchases a
financial guaranty insurance policy, guaranteeing timely payment of principal
and interest on the senior Certificates, from an insurance company (the
"Certificate Insurer"). In addition, the Company provides a credit enhancement
for the benefit of the Certificate Insurer and the investors in the form of an
initial cash deposit to an account ("Spread Account") held by the Trust. The
agreements governing the securitization transactions (collectively referred to
as the "Servicing Agreements") require that the initial deposits to the Spread
Accounts be supplemented by a portion of collections from the Contracts until
the Spread Accounts reach specified levels, and then maintained at those levels.
The specified levels are generally computed as a percentage of the principal
amount remaining unpaid under the related Certificates. The specified levels at
which the Spread Accounts are to be maintained will vary depending on the
performance of the portfolios of Contracts held by the Trusts and on other
conditions, and may also be varied by agreement among the Company, the SPS, the
Certificate Insurer and the trustee. Such levels have increased and decreased
from time to time based on performance of the portfolios, and have also been
varied by agreement. The specified levels applicable to the Company's sold pools
increased materially in 1998, and have recently been decreased, as is discussed
under the heading "Liquidity and Capital Resources."
At the closing of each securitization, the Company removes from its
consolidated balance sheet the Contracts held for sale and adds to its
consolidated balance sheet (i) the cash received and (ii) the estimated
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fair value of the ownership interest that the Company retains in the Contracts
sold in the securitization. That retained interest (the "Residual") consists of
(a) the cash held in the Spread Account and (b) the net interest receivables
("NIRs"). NIRs represent the estimated discounted cash flows to be received by
the Trust in the future, net of principal and interest payable with respect to
the Certificates, and certain expenses. The excess of the cash received and the
assets retained by the Company over the carrying value of the Contracts sold,
less transaction costs, equals the net gain on sale of Contracts recorded by the
Company.
The Company allocates its basis in the Contracts between the Certificates and
the Residuals retained based on the relative fair values of those portions on
the date of the sale. The Company recognizes gains or losses attributable to the
change in the fair value of the Residuals, which are recorded at estimated fair
value and accounted for as "held-for-trading" securities. The Company is not
aware of an active market for the purchase or sale of interests such as the
Residuals, and accordingly, the Company determines the estimated fair value of
the Residuals by discounting the amount and timing of anticipated cash flows
released from the Spread Account (the cash out method), using a discount rate
that the Company believes is appropriate for the risks involved. For that
valuation, the Company has used an effective discount rate of approximately 14%
per annum.
The Company receives periodic base servicing fees for the servicing and
collection of the Contracts. In addition, the Company is entitled to the cash
flows from the Residuals that represent collections on the Contracts in excess
of the amounts required to pay principal and interest on the Certificates, the
base servicing fees, and certain other fees (such as trustee and custodial
fees). At the end of each collection period, the aggregate cash collections from
the Contracts are allocated first to the base servicing fees and certain other
fees such as trustee and custodial fees for the period, then to the
Certificateholders for interest at the pass-through rate on the Certificates
plus principal as defined in the Servicing Agreements. If the amount of cash
required for the above allocations exceeds the amount collected during the
collection period, the shortfall is drawn from the Spread Account. If the cash
collected during the period exceeds the amount necessary for the above
allocations, and there is no shortfall in the related Spread Account, the excess
is released to the Company or in certain cases is transferred to other Spread
Accounts that may be below their required levels. Pursuant to certain Servicing
Agreements, excess cash collected during the period is used to make accelerated
principal paydowns on certain Certificates to create excess collateral
(over-collateralization or OC account). If the Spread Account balance is not at
the required credit enhancement level, then the excess cash collected is
retained in the Spread Account until the specified level is achieved. The cash
in the Spread Accounts is restricted from use by the Company. Cash held in the
various Spread Accounts is invested in high quality, liquid investment
securities, as specified in the Servicing Agreements. Spread Account balances
are held by the Trusts on behalf of the Company as the owner of the Residuals.
Such balances are generally defined as percentages of the principal amount
remaining unpaid on the balance.
The annual percentage rate ("APR") payable on the Contracts is significantly
greater than the interest rate payable on the Certificates. Accordingly, the
Residuals described above are a significant asset of the Company. In determining
the value of the Residuals described above, the Company must estimate the future
rates of prepayments, delinquencies, defaults and default loss severity as they
affect the amount and timing of the estimated cash flows. The Company estimates
prepayments by evaluating historical prepayment performance of comparable
Contracts and the effect of trends in the industry. The Company has used a
constant prepayment estimate of approximately 4% per annum. The Company
estimates defaults and default loss severity using available historical loss
data for comparable Contracts and the specific characteristics of the Contracts
purchased by the Company. In valuing the residuals, the Company estimates that
losses as a percentage of the original principal balance will total
approximately 14% cumulatively over the lives of the related Contracts.
In future periods, the Company would recognize additional revenue from the
Residuals if the actual performance of the Contracts were to be better than the
original estimate, or the Company would increase the estimated fair value of the
Residuals. If the actual performance of the Contracts were to be worse than the
original estimate, then a downward adjustment to the carrying value of the
Residuals would be required. Due
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to the inherent uncertainty of the future performance of the underlying
Contracts, the Company during 1998 established a provision for future losses on
the Residuals.
RESULTS OF OPERATIONS
The Year Ended December 31, 1998 Compared to the Year Ended December 31, 1997
Revenue. During the year ended December 31, 1998, revenue increased $51.0
million, or 67.8%, compared to the year ended December 31, 1997. Gain on sale of
Contracts, net, increased by $23.3 million, or 66.4%, and represented 46.2% of
total revenue for the year ended December 31, 1998. The increase in gain on sale
is largely due to the volume of Contracts which were sold in the period. During
the year ended December 31, 1998, the Company sold $948.3 million in Contracts,
compared to $573.3 million in the year ended December 31, 1997. For the years
ended December 31, 1998 and 1997, $3.5 million and $4.1 million, respectively,
of provision for losses on Contracts held for sale was charged against gain on
sale. Due to the inherent uncertainty of the future performance of the
underlying Contracts, the Company during 1998 established a provision for future
losses on the Residuals in the amount of $7.8 million that was charged against
gain on sale.
Interest income increased by $18.3 million, or 77.8%, representing 33.1% of
total revenues for the year ended December 31, 1998. The increase is due to the
increase in the volume of contracts purchased and held for sale. During the year
ended December 31, 1998, the Company purchased $1,076.5 million in Contracts
from Dealers, compared to $632.1 million in the year ended December 31, 1997.
The Company expects that Contract purchases in the near future will be
significantly reduced. Such a reduction in Contract purchases are expected to
cause a reduction in revenues (both interest and gain on sale) in future
periods. (See "Liquidity and Capital Resources").
Servicing fees increased by $10.7 million, or 73.6%, and represented 19.9% of
total revenue. The increase in servicing fees is due to the increase in Contract
purchase, sale and servicing activities. As of December 31, 1998, the Company
was earning servicing fees on 128,025 Contracts approximating $1,362.8 million
compared to 77,731 Contracts approximating $830.9 million as of December 31,
1997. In addition to the $1,362.8 million in sold Contracts on which servicing
fees were earned, the Company was holding for sale and servicing an additional
$176.1 million in Contracts for an aggregate servicing portfolio of $1,538.9
million. Amortization of NIRs increased by $22.2 million and represented 104.9%
of residual interest income for the year ended December 31, 1998, versus 59.0%
for year ended December 31, 1997. The increase is due to higher losses on the
servicing portfolio and the increase in the NIRs from 1997 to 1998.
Expenses. During the year ended December 31, 1998, operating expenses
increased $38.7 million, or 89.3%, compared to the year ended December 31, 1997.
Employee costs increased by $12.9 million, or 81.5%, and represented 35.2% of
total operating expenses. The increase is due to the addition of staff necessary
to accommodate the Company's growth and certain increases in salaries of
existing staff. In light of the Company's decision to reduce its level of
Contract purchases, it anticipates reducing certain expenses in the immediate
future, and maintaining such expenses at levels appropriate for the Company's
level of activity in future periods. General and administrative expenses
increased by $6.5 million, or 45.7% and represented 25.2% of total operating
expenses. Increases in general and administrative expenses included increases in
telecommunications, stationary, credit reports and other related items as a
result of increases in the volume of purchasing and servicing of Contracts.
Interest expense increased $12.8 million, or 139.7%, and represented 26.9% of
total operating expenses. The increase is due in part to the interest paid on an
additional $30.0 million in subordinated debt securities issued by the Company
during 1998 as well as interest paid on the outstanding balance on a revolving
line of credit (the "Residual Line"). Interest expense was also affected by the
volume of Contracts held for sale as well as by the Company's cost of borrowed
funds. (See "Liquidity and Captial Resources").
Marketing expenses increased by $5.0 million or 272.7%, and represented 8.4%
of total expenses. The increase is primarily due to the increase in printing,
travel, promotion and convention expenses. Fees paid to
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marketing representatives for their role in the submission of Contracts
ultimately purchased by the Company are included as a component in gain on sale
of Contracts, net.
Occupancy expenses increased by $863,000 or 61.5%, and represented 2.8% of
total expenses. Depreciation and amortization expenses increased by $498,000 or
65.8%, and represented 1.5% of total expenses. In November 1998, the Company
moved its headquarters to a new 115,000 square foot facility. The Company has
agreed to lease the new headquarters facility for a ten-year term, with base
rent of $1.9 million for the first five years, and $2.1 million for years six
through ten. In addition to base rent, the Company has agreed to pay property
taxes, maintenance, and other expenses of the property. Occupancy of the new
building can be expected to increase the Company's overall occupancy expenses in
the future beginning with commencement of the lease. The Company has subleased
its former headquarters location.
The result for the year ended December 31, 1998, includes a net operating
loss of $1.1 million from the Company's subsidiary Samco. For the year ended
December 31, 1997, Samco had net income of $1.2 million. The Company terminated
all operations of Samco during the first quarter of 1999.
The result for the year ended December 31, 1998, includes net income of $1.2
million from the Company's subsidiary LINC. For the year ended Decmber 31, 1997,
LINC had a net operating loss of $11,000. The Company intends to terminate the
operations of LINC during the second quarter of 1999.
The result for the year ended December 31, 1998, includes net income of
$298,000 from the Company's subsidiary CPS Leasing, Inc. For the year ended
Decmber 31, 1997, CPS Leasing, Inc. had a net operating loss of $88,000. The
Company intends to sell CPS Leasing, Inc. during the second quarter of 1999.
The results for the years ended December 31, 1998 and 1997, include $52,000
and $849,000, respectively, in net income from the Company's investment in 38%
of NAB Asset Corp.
The Company's effective tax rate was 42.0% for the years ended December 31,
1998 and 1997.
The Year Ended December 31, 1997 Compared to the Year Ended December 31, 1996
Revenue. During the year ended December 31, 1997, revenue increased $26.8
million, or 55.4%, compared to the year ended December 31, 1996. Gain on sale of
Contracts, net, increased by $14.5 million, or 70.4%, and represented 46.6% of
total revenue for the year ended December 31, 1997. The increase in gain on sale
is largely due to the volume of Contracts which were sold in the period. During
the year ended December 31, 1997, the Company sold $573.3 million in Contracts,
compared to $341.0 million in the year ended December 31, 1996. For the years
ended December 31, 1997 and 1996, $4.1 million and $2.8 million, respectively,
of provision for losses on Contracts held for sale was charged against gain on
sale.
Interest income increased by $3.5 million, or 17.7%, representing 31.3% of
total revenues for the year ended December 31, 1997. The increase is due to the
increase in the volume of contracts purchased and held for sale. During the year
ended December 31, 1997, the Company purchased $632.1 million in Contracts from
Dealers, compared to $351.4 million in the year ended December 31, 1996.
Servicing fees increased by $6.6 million, or 83.5%, and represented 19.3% of
total revenue. The increase in servicing fees is due to the Company's continued
expansion of its Contract purchase, sale and servicing activities. As of
December 31, 1997, the Company was earning servicing fees on 77,731 Contracts
approximating $830.9 million compared to 45,363 Contracts approximating $483.1
million as of December 31, 1996. In addition to the $830.9 million in sold
Contracts on which servicing fees were earned, the Company was holding for sale
and servicing an additional $71.8 million in Contracts for an aggregate
servicing portfolio of $902.7 million. Amortization of NIRs increased by $7.2
million and represented 59.0% of residual interest income for the year ended
December 31, 1997 versus 38.0% for year ended December 31, 1996. The increase is
primarily due to the increase in the average age of the Contracts making up the
Company's servicing portfolio and consequently the increase in charge-offs and
corresponding reduction of residual interest income. The Company expects these
increases in the ratio of amortization of NIRs to Residual interest income to
continue until the size and average age of the servicing portfolio stabilizes.
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Expenses. During the year ended December 31, 1997, operating expenses
increased $18.5 million, or 75.0%, compared to the year ended December 31, 1996.
Employee costs increased by $7.0 million, or 78.0%, and represented 36.7% of
total operating expenses. The increase is due to the addition of staff necessary
to accommodate the Company's growth and certain increases in salaries of
existing staff. General and administrative expenses increased by $6.9 million,
or 95.2% and represented 32.7% of total operating expenses. Increases in general
and administrative expenses included increases in telecommunications,
stationery, credit reports and other related items as a result of increases in
the volume of purchasing and servicing of Contracts.
Interest expense increased $3.4 million, or 58.9%, and represented 21.2% of
total operating expenses. The increase is due in part to the interest paid on an
additional $35.0 million in subordinated debt securities issued by the Company
during 1997. Interest expense was also impacted by the volume of Contracts held
for sale as well as by the Company's cost of borrowed funds.
Marketing expenses increased by $170,789 or 10.2%, and represented 4.3% of
total expenses. The increase is primarily due to the increase in printing,
travel, promotion and convention expenses. Fees paid to marketing
representatives for their role in the submission of Contracts ultimately
purchased by the Company are included as a component in gain on sale of
Contracts, net.
Occupancy expenses increased by $635,506 or 82.7%, and represented 3.2% of
total expenses. Depreciation and amortization expenses increased by $481,548 or
174.9%, and represented 1.8% of total expenses. During 1997, the Company
established a satellite collection branch in Chesapeake, Virginia and leased
additional office space near its headquarters in Irvine, California. This
resulted in an increase in base rent expense of $906,066 for the year ended
December 31, 1997. The increase in occupancy, depreciation and amortization is
due primarily to the establishment of this additional office space and the
related furniture, fixtures and equipment. The Company has agreed to lease a new
headquarters facility, which is currently under construction. The lease will be
for a ten-year term, with base rent of $1.9 million for the first five years,
and $2.1 million for years six through ten. In addition to base rent, the
Company has agreed to pay property taxes, maintenance, and other expenses of the
property. Occupancy of the new building can be expected to increase the
Company's overall occupancy expenses in the future beginning with commencement
of the lease, which will commence upon completion of the building, currently
scheduled for September 1998.
The results for the year ended December 31, 1997 include net income of $1.2
million from the Company's subsidiary Samco. For the year ended December 31,
1996, Samco incurred a net operating loss of $491,000.
The results for the year ended December 31, 1997 also include net operating
losses of $11,000 from the Company's subsidiary LINC. For the year ended
December 31, 1996, LINC incurred a net operating loss of $324,000.
In addition, the Company's results for the year ended December 31, 1997,
include $88,000 in net operating losses from the Company's subsidiary, CPS
Leasing, Inc., which was acquired in January 1997, and $849,000 in net income
from the Company's investment in 38% of NAB Asset Corp.
The Company's effective tax rate was 42.0% for the year ended December 31,
1997 and 40.5% for the year ended December 31, 1996. See note 12 to the Notes to
Consolidated Financial Statements.
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LIQUIDITY AND CAPITAL RESOURCES
Liquidity
The Company's business requires substantial cash to support its operating
activities. The Company's primary sources of cash from operating activities are
amounts borrowed under its various warehouse lines, servicing fees on portfolios
of Contracts previously sold, proceeds from the sales of Contracts, customer
payments on Contracts held for sale, interest earned on Contracts held for sale,
and releases of cash from Spread Accounts. The Company's primary uses of cash
are the purchases of Contracts, repayment of amounts borrowed under its various
warehouse lines, operating expenses such as employee, interest, and occupancy
expenses, the establishment of and further contributions to Spread Accounts and
income taxes. As a result, the Company is dependent on its warehouse lines of
credit and its residual financing facility in order to finance its continued
operations. If the Company's principal lenders decided to terminate or not to
renew any of these credit facilities with the Company, the loss of borrowing
capacity would have a material adverse effect on the Company's results of
operations unless the Company found a suitable alternative source.
Net cash used in operating activities was $71.1 million during the year ended
December 31, 1998, compared to net cash used of $26.1 million during the year
ended December 31, 1997. Cash used for purchasing Contracts was $1,076.5
million, an increase of $444.4 million, or 70.3%, over cash used for purchasing
Contracts in the year ended December 31, 1997. Cash provided from the
liquidation of Contracts was $975.6 million, an increase of $394.2 million, or
67.8%, over cash provided from liquidation of Contracts in the year ended
December 31, 1997.
On a day-to-day basis, the Company funds its purchases of Contracts from
Dealers by drawing on either of two warehouse lines of credit (collectively
referred to as the "Warehouse Lines"), and pledges the purchased Contracts to
one or the other warehouse lender. The amount borrowed under the Warehouse Lines
increases until the Company sells the pledged Contracts in a securitization
transaction, at which time the majority of the proceeds of the sale are used to
pay down the related balance of the Warehouse Lines. Securitization transactions
are typically completed on a quarterly basis. The amount of Contracts that the
Company can hold for sale prior to a securitization is limited by its available
cash and the Warehouse Lines, which permit borrowings of up to a maximum total
of $300.0 million.
The Company's cash requirements have been and will continue to be
significant. The Company may borrow under the Warehouse Lines no more than an
amount generally defined as a percentage ("advance rate") of the principal
amount of the Contracts pledged to the respective warehouse lenders. The
difference between what the Company may borrow and what it pays Dealers for
Contracts must come from the Company's working capital.
Under one of the Company's two Warehouse Lines, an affiliate of First Union
National Bank lends to the Company, with the loans funded by commercial paper
issued by that affiliate, and secured by Contracts pledged periodically by the
Company. The First Union line has a maximum lending amount of $200.0 million.
Under the Company's second warehouse line of credit, the Company borrows from
General Electric Capital Corporation ("GECC"). The GECC line was entered into in
November 1998, and replaced a prior line of credit arrangement under which an
affiliate of GECC lent money to the Company in a structure similar to that of
the First Union line. The GECC line has an aggregate maximum lending amount of
$100.0 million. The maximum amount outstanding under the GECC line or its
predecessor line in 1998 was $100.0 million and the average was $51.3 million.
Interest under the First Union line is at a variable rate, indexed to prevailing
rates for commercial paper. Interest under the GECC line is payable at a rate of
3.75% per annum over LIBOR. The two lines together had an outstanding balance of
$151.9 million at December 31, 1998, as compared to $61.7 million at December
31, 1997. The Company uses the two Warehouse Lines in tandem, pledging specific
Contracts to each lender alternatively.
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The amount of cash that the Company needs for daily operations is most
heavily dependent on (i) its level of Contract purchases, and (ii) the amount
that the Company may borrow under its Warehouse Lines, secured by the Contracts
purchased. Over the three-year period 1996 through 1998, the Company's annual
Contract purchases increased from $351.4 million in 1996 to $1,076.5 million in
1998. From January 1996 through November 1997, the Company was able to borrow,
under the predecessor to the GECC Line, 97% of the principal amount of the
Contracts purchased. The First Union Line allows the Company to borrow a varying
percentage (not in excess of 95%) of Contract balances, depending on the
performance of Contracts pledged to that lender. The advance rate under the
First Union Line decreased during 1998 to an average of approximately 91% in the
fourth quarter, and the Company has no expectation that it will be able to
borrow a higher percentage with respect to Contracts pledged to the First Union
Line in the immediate future. The GECC Line (entered into in November 1998)
allows the Company to borrow no more than 88% of the principal amount of the
pledged Contracts. The reduction in the relative advance rates under the
Warehouse Lines, combined with the Company's increased Contract purchase
activity in 1998 as compared with previous years, has materially increased the
Company's working capital requirements.
When the Company subsequently sells the warehoused Contracts in
securitization transactions, the Servicing Agreements require the Company
to make a significant initial cash deposit, for purposes of credit enhancement,
to the Spread Accounts. Excess cash flows from the securitized Contracts are
also deposited into the Spread Accounts until such time as the Spread Account
balance reaches its requisite level, which is computed as a specified percent of
the outstanding balance of the related asset-backed securities or collateral.
During the year ended December 31, 1998, cash used for initial deposits to
Spread Accounts was $45.6 million, an increase of $25.6 million, or 127.4%, from
the amount of cash used for initial deposits to Spread Accounts in the year
ended December 31, 1997. The cash used increased because (i) the Company sold
more Contracts in 1998 than in 1997, and (ii) in order to achieve the desired
ratings for the Certificates, the required percentage initial deposit was raised
from 3.5% in the prior year's transactions to 8.0% in the transaction completed
in the third quarter, with an additional credit enhancement of 2.0%
over-collateralization. The Company subsequently reached an agreement, discussed
below, that allowed a reduced initial cash deposit of 3.0% in the Company's
fourth quarter 1998 securitization transaction. Cash used for subsequent
deposits to Spread Accounts for the year ended December 31, 1998, was $54.0
million, an increase of $22.3 million, or 70.4%, over cash used for subsequent
deposits to Spread Accounts in the year ended December 31, 1997. Such subsequent
deposits into Spread Accounts in 1998 include $22.2 million of cash used to pay
down certain senior series of Certificates to create excess collateral in an
over-collateralization account. Cash released from Spread Accounts for the year
ended December 31, 1998, was $16.1 million, an increase of $229,000, or 1.5%,
over cash released from Spread Accounts in the year ended December 31, 1997.
Changes in deposits to and releases from Spread Accounts are affected by the
relative size, seasoning and performance of the various pools of sold Contracts
that make up the Company's Servicing Portfolio.
During 1998, 13 of the 22 Trusts incurred cumulative net losses as a
percentage of the original contract balance in excess of the predetermined
levels specified in the respective Servicing Agreements. Accordingly, pursuant
to the Servicing Agreements, the specified credit enhancement levels were
increased. As a result of this and certain cross collateralization arrangements,
excess cash flows that would otherwise have been released to the Company were
retained in the Spread Accounts to bring the balance of those Spread Accounts up
to a higher level. In addition to requiring higher Spread Account levels, the
Servicing Agreements provide the Certificate Insurer with certain other rights
and remedies which have been waived on a monthly basis by the Certificate
Insurer. Approximately $24.3 million of cash flows were delayed and retained in
the Spread Accounts as of December 31, 1998. The higher requisite Spread Account
levels ranged from 30% to 100% of the related outstanding balance of the
securitized pools. In April 1999, the Company entered into an amendment with the
Certificate Insurer of the Company's asset-backed securities to cap the amount
of cash retained in the Spread Accounts at 21% of the outstanding securities
balance for 19 of the Company's 22 securitized pools. The agreement is subject
to certain performance measures that may
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result in an increase in the maximum level to 25% of the outstanding principal
balance of the securities. The effectiveness of the amendment is contingent upon
approval by holders of certain subordinated interests in several of the Trusts.
As of March 31, 1999, the aggregate Spread Account balance of the related 19
securitized pools was 15.9% of the outstanding principal balance of the
securities.
The Servicing Agreements call for the requisite levels of the various Spread
Accounts to increase if the related receivables experience delinquencies,
repossessions or net losses in excess of certain predetermined levels. During
the Company's history, the predetermined levels have frequently been reached or
exceeded, causing the requisite levels of certain Spread Accounts to be raised.
During 1998, the requisite levels of the Spread Accounts were raised to the
extent that the Company did not receive any releases of cash from the Spread
Accounts subsequent to June 1998. The requisite levels of the Spread Accounts
may be returned to the original lower levels if the delinquency, repossession
and net loss performance of the related receivables is reduced below the
pre-determined levels. In addition, on two occasions, the parties to the
pertinent agreements have made modifications that effectively raised the
permissible delinquency, repossession and net loss levels, thus resulting in
Spread Accounts reverting to their original requisite levels. As of December 31,
1998, the Spread Accounts for 18 of the Company's 22 securitized pools had
greater cash balances than original requisite levels would require due to
delinquency, repossession or net loss performance of 13 of the 22 securitized
pools. Such Spread Account balances therefore included approximately $24.3
million more than would have been required at the original requisite levels.
Funding such increased balances has materially increased the Company's capital
requirements.
The Company did not sell any Contracts in the first quarter of 1999, and is
currently evaluating alternative structures for selling its Contracts during the
second quarter of 1999. Due to the absence of any gain on sale in the first
quarter, the Company expects to report a loss for such quarter. Alternatives
being considered by the Company include various securitization structures,
unsecuritized sale of Contracts, or perhaps, some combination of those
structures for future Contract sales. The Company expects that if an
unsecuritized sale of Contracts is completed on a servicing released basis, a
loss on sale of such Contracts would be incurred, which may result in the
Company's reporting a loss for the second quarter. The Company has entered into
a letter of intent regarding a proposed sale in the second quarter of up to
$300.0 million of Contracts on an unsecuritized basis, servicing-released. Such
a sale would be at a price in excess of the blended warehouse line advance rates
applicable to the Contracts to be sold, but slightly less than the Company's
cost basis in such Contracts. Accordingly, such a transaction (as to which there
can be no assurance) would result in the Company's (i) recording a loss on such
sale, and (ii) receiving net cash. Recording such a loss may result in the
Company reporting a loss for the second quarter. Cash received in such a
transaction would be applied to meet in part the Company's liquidity and capital
requirements identified herein. If the Company were to incur a loss for the
second quarter of 1999 it would be in default under its agreements regarding the
Residual Line. Unless waived by the lender, the default could result in
acceleration of the indebtedness under the Residual Line and a cross default on
the Warehouse Lines. The lender would receive any releases from Spread Accounts
to retire outstanding principal and interest. The Company believes that the
lender would waive such a default. In the event the lender does not waive the
default, the Company believes that cash flows from operations would be
sufficient to fund its obligations as they become due and payable. There can be
no assurance, however, that the lender would waive the default or that other
cash flows would be sufficient to fund the Company's operations.
The Company is also exploring additional financing possibilities, focusing
on issuance of additional secured debt. Although such explorations have
involved discussions with, and expressions of interest from, various
investment banks, there can be no assurance that any such transactions will
take place.
Capital Resources
The Company funds the increase in its servicing portfolio through off balance
sheet securitization transactions, as discussed above, and funds its other
capital needs with cash from operations and with the proceeds from the issuance
of long-term debt and/or equity. During the year ended December 31, 1998, the
Company completed four securitization transactions, borrowed $33.0 million under
a new revolving line of credit, issued $25.0 million of subordinated debt, sold
common stock to an affiliated party for $5.0 million, and received $5.0 million
in loans from affiliated parties. The interest rate payable on the senior
Certificates issued in the Company's 1998 securitization transactions ranged
from 5.47% - 6.09%, as compared with 6.07% - 6.65% payable on the similar
securities issued in 1997. The reduction in the rates payable is primarily due
to reductions in rates payable on U.S. Treasuries of similar maturity.
The table below documents the Company's history of Contract securitizations,
comprising sales to 25 securitization trusts.
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Securitized
Period Funded Dollar Amount Ratings(1) Rating Agency Pool Name
- - ------------- ------------- ---------- ------------- ---------
(In thousands)
April 1993 $4,990 A Duff & Phelps Alton Grantor Trust 1993-1
May 1993 3,933 A Duff & Phelps Alton Grantor Trust 1993-1
June 1993 3,467 A Duff & Phelps Alton Grantor Trust 1993-1
July 1993 5,575 A Duff & Phelps Alton Grantor Trust 1993-2
August 1993 3,336 A Duff & Phelps Alton Grantor Trust 1993-2
September 1993 3,578 A Duff & Phelps Alton Grantor Trust 1993-2
October 1993 1,921 A Duff & Phelps Alton Grantor Trust 1993-2
November 1993 1,816 A Duff & Phelps Alton Grantor Trust 1993-3
December 1993 6,694 A Duff & Phelps Alton Grantor Trust 1993-3
January 1994 1,998 A Duff & Phelps Alton Grantor Trust 1993-3
March 1994 20,787 A Duff & Phelps Alton Grantor Trust 1993-4
June 1994 24,592 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1994-1
September 1994 28,916 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1994-2
October 1994 13,136 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1994-3
December 1994 28,893 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1994-4
February 1995 20,084 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1995-1
June 1995 49,290 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1995-2
September 1995 45,009 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1995-3
September 1995 2,369 BB S&P CPS Auto Grantor Trust 1995-3
December 1995 53,634 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1995-4
December 1995 2,823 BB S&P CPS Auto Grantor Trust 1995-4
March 1996 63,747 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1996-1
March 1996 3,355 BB S&P CPS Auto Grantor Trust 1996-1
June 1996 (2) 84,456 Aaa/AAA Moody's/S&P Fasco Auto Grantor Trust 1996-1
June 1996 4,445 BB S&P Fasco Auto Grantor Trust 1996-1
September 1996 87,523 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1996-2
September 1996 4,606 BB S&P CPS Auto Grantor Trust 1996-2
December 1996 88,215 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1996-3
December 1996 4,643 BB S&P CPS Auto Grantor Trust 1996-3
March 1997 97,211 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1997-1
March 1997 5,116 BB S&P CPS Auto Grantor Trust 1997-1
May 1997 113,394 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1997-2
May 1997 5,968 BB S&P CPS Auto Grantor Trust 1997-2
August 1997 142,500 Aaa/AAA Moody's/S&P CPS Auto Receivables Trust 1997-3 (3)
August 1997 7,499 BB S&P CPS Auto Receivables Trust 1997-3 (3)
October 1997 100,568 Aaa/AAA Moody's/S&P CPS Auto Receivables Trust 1997-4 (3)
October 1997 5,293 BB S&P CPS Auto Receivables Trust 1997-4 (3)
December 1997 90,925 Aaa/AAA Moody's/S&P CPS Auto Receivables Trust 1997-5 (3)
December 1997 4,781 BB S&P CPS Auto Receivables Trust 1997-5 (3)
March 1998 177,607 Aaa/AAA Moody's/S&P CPS Grantor Trust 1998-1
March 1998 9,348 BB S&P CPS Grantor Trust 1998-1
May 1998 200,490 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1998-2
May 1998 10,552 BB S&P CPS Auto Grantor Trust 1998-2
July 1998 (4) 36,000 P-1/A-1+ Moody's/S&P CPS Auto Receivables Trust 1998-3 (3)
July 1998 199,532 Aaa/AAA Moody's/S&P CPS Auto Receivables Trust 1998-3 (3)
December 1998 32,500 P-1/A-1+ Moody's/S&P CPS Auto Receivables Trust 1998-4 (3)
December 1998 277,500 Aaa/AAA Moody's/S&P CPS Auto Receivables Trust 1998-4 (3)
---------
TOTAL 2,184,615
(1) Commencing with the securitization completed on June 28, 1994, the
principal and interest due on the asset-backed securities issued by the
various trusts have been guaranteed by Financial Security Assurance Inc.
("FSA"), enabling the issuer to obtain Aaa/AAA or P-1/A-1+ ratings for the
asset-backed securities issued in such transactions. See "Business --
Purchase and Sale of Contracts -- Securitization and Sale of Contracts to
Institutional Investors."
(2) Commencing with the securitization completed on June 27, 1996, asset-backed
securities with Aaa/AAA or P-1/A-1+ ratings have been sold through public
offerings pursuant to registration statements filed with the Securities and
Exchange Commission.
(3) These Trusts are structured as "owner trusts" rather than as "grantor
trusts".
(4) Commencing with the securitization completed on July 28, 1998, the Company
began using a structure that included a guaranteed money market tranche of
asset-backed securities, rated P-1/A-1+.
In April 1998, the Company established a $33.3 million Residual Line with
State Street Bank and Trust Company, Prudential Insurance and an affiliate of
Prudential. Borrowings under the Residual Line bear
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interest at LIBOR + 4.0%, and are secured by all of the Company's assets,
including its residual interest in securitizations. The Residual Line is a
revolving facility for one year, after which it converts into a loan with a
maximum term of four years, due and payable earlier if and to the extent that
the Company has "available cash," as defined in the Residual Line.
Due to the Company's continuing purchases of Contracts and the need to fund
Spread Accounts when those Contracts are sold in securitization transactions,
the Company has a continuing need for capital. The amount of capital required is
most heavily dependent on the rate of the Company's Contract purchases, the
required level of initial Spread Account deposits, and the extent to which the
Spread Accounts either release cash to the Company or capture cash from
collections on sold Contracts. As noted above, the absence of any releases of
cash from Spread Accounts since June 1998, together with the reduction in
advance rates available to the Company under its Warehouse Lines, has materially
increased the Company's capital requirements. To reduce its capital requirements
and to meet those requirements, the Company has begun to implement a three-part
plan: the plan includes (i) issuance of debt and equity securities, (ii)
agreements with the Certificate Insurer to reduce the level of initial Spread
Account deposits, and to reduce the maximum levels of the Spread Accounts, and
(iii) a reduction in the rate of Contract purchases.
As the first step in the plan, the Company in November 1998 issued $25.0
million of subordinated promissory notes due November 30, 2003, to an affiliate
of Levine Leichtman Capital Partners, Inc. ("LLCP"), and received the proceeds
(net of fees and expenses) of approximately $23.7 million. The Company also
issued warrants to purchase up to 3,450,000 shares of common stock at $3.00 per
share, exercisable through November 30, 2005. The debt bears interest at 13.5%
per annum, and may not be prepaid without penalty prior to November 1, 2002.
Simultaneously with the consummation of that transaction, certain affiliates of
the Company, who had lent the Company an aggregate of $5.0 million on a
short-term basis in August and September 1998, agreed to subordinate their
indebtedness to the indebtedness in favor of LLCP, to extend the maturity of
their debt until June 2004, and to reduce their interest rate from 15% to 12.5%.
Such affiliates received in return the option to convert such debt into an
aggregate of 1,666,667 shares of common stock at the rate of $3.00 per share
through maturity at June 30, 2004. The effective cost of this new capital is
affected by the valuation of the warrant and the conversion option, but in all
events represents a material increase in the cost of capital resources as
compared with the Company's previous issuances of senior or subordinated debt,
which are reviewed below. Additional capital will be required and the Company is
exploring its alternatives to raise such capital of approximately $15.0 million,
which could include sale of debt or equity instruments. Any debt issued may
involve some equity participation. The sale of any equity or convertible debt
could be dilutive to existing stockholders. The terms of any such additional
issuance have not been determined as of the date of this report, and there can
be no assurance that any such transaction will occur.
Also in November 1998, as the second step in its plan, the Company reached an
agreement with the Certificate Insurer regarding initial cash deposits. In this
agreement, the Certificate Insurer has committed to insure asset-backed
securities issued by the Trusts with respect to at least $560.0 million of
Contracts, while requiring an initial cash deposit of 3% of principal. The
commitment is subject to underwriting criteria and
26
27
market conditions. Of the $560.0 million committed, $310.0 million was used in
the Company's December 1998 securitization transaction. The Company expects to
use the balance of that commitment in its next securitization transaction. The
Company's agreement with the Certificate Insurer also required that the Company
issue to the Certificate Insurer or its designee warrants to purchase common
stock at $3.00 per share, exercisable through the fifth anniversary of the
warrant's issuance. Such warrants are exercisable with respect to 2,525,114 of
the Company's common shares, subject to standard anti-dilution adjustments. In
April 1999, the Company entered into an amendment with the Certificate Insurer
to reduce and limit the maximum levels for the Spread Accounts of certain pools
to 21% of the outstanding principal balance of the securities. The agreement is
subject to certain performance measures that may result in an increase in the
maximum level to 25% of the outstanding principal balance of the securities. The
effectiveness of the amendment is contingent upon approval of certain
subordinated Certificateholders.
As the third part of its plan, the Company reduced its planned level of
Contract purchases initially to not more than $200.0 million per quarter
beginning in November 1998. In the first quarter of 1999, the Company purchased
$158.0 million of Contracts. Since such time, the Company has further reduced
Contract purchases and expects to purchase less than $100.0 million for the
second quarter of 1999. Such reductions in Contract purchases will reduce
materially the Company's capital requirements.
Over the three-year period ended December 31, 1998, the Company has increased
its capitalization by issuing $33.0 million of senior debt, an aggregate of
$65.0 million of subordinated debt (which is convertible into, or was issued
with warrants to purchase, common stock), $20.0 million of related party debt
($15.0 million of which is partially convertible and $5.0 million which is
entirely convertible) and $5.0 million of capital stock. The following review of
the terms of such issuances shows that the cost of such capital increased
materially in 1998:
In April 1997 the Company issued, in a public offering, $20.0 million of
subordinated partially convertible notes due 2004, which bear an interest rate
of 10.50% per annum. These notes are convertible as to 25% of their principal
amount into common stock of CPS at $10.15 per share. In June 1997 the Company
issued to a related party $15.0 million of partially convertible notes due 2004.
These notes are convertible as to 20% of their principal amount into common
stock of CPS at $11.25 per share. In April 1998, the Company borrowed $33.0
million as a senior secured loan, which may commence amortization in April 1999.
This loan bears interest at a rate equal to 4% of per annum over LIBOR (9.54% at
December 31, 1998. CPS borrowed $5.0 million from related parties in August and
September 1998, the terms of which were renegotiated in November 1998, in
connection with the issuance of $25.0 million of subordinated notes to LLCP, now
restructured as described below. A related party also purchased $5.0 million of
Company common stock in July 1998, at $11.275 per share.
The cost of capital has increased further in 1999. To meet a portion of its
capital requirements, the Company on April 15, 1999, issued $5.0 million in
subordinated notes to LLCP (the "New LLCP Notes"). The notes bear interest at
14.5% per annum and include warrants to purchase 1,335,000 shares of the
Company's common stock at $0.01 per share. As part of the agreement to issue the
New LLCP Notes, the Company was required to restructure the terms of the $25.0
subordinated promissory notes discussed above. Such restructuring included an
increase in the interest rate from 13.5% to 14.5%, a reduction in the number of
warrants issued to purchase the Company's common stock from 3,450,000 to
3,115,000, a waiver by LLCP of certain defaults under the notes sold to LLCP in
November 1998, and a reduction in the exercise price of the warrants from $3.00
per share to $0.01 per share. Among the agreements entered into in connection
with the issuance of the New LLCP Notes are agreements by Stanwich Financial
Services Corp. ("SFSC"), an affiliate of the chairman of the Company's board of
directors, to purchase an additional $15.0 million of notes, and of the Company
to sell such notes. The terms of such notes are to be not less favorable to the
Company then (i) those that would be available in a transaction with a
non-affiliate, and (ii) those applicable to the New LLCP Notes. Sale of such
notes would likely therefore involve some degree of equity participation, which
could be dilutive to other holders of the Company's common stock. SFSC's
commitment in turn has been collateralized by certain assets pledged by the
chairman of the Company's board of directors and the president of the Company.
Additionally, the New LLCP Notes have been personally guaranteed by the chairman
of the Company's board of directors and the president of the Company.
27
28
Forward-Looking Statements
The descriptions of the Company's business and activities set forth in this
report and in other past and future reports and announcements by the Company may
contain forward-looking statements and assumptions regarding the future
activities and results of operations of the Company. Actual results may be
adversely affected by various factors including the following: increases in
unemployment or other changes in domestic economic conditions which adversely
affect the sales of new and used automobiles and may result in increased
delinquencies, foreclosures and losses on Contracts; adverse economic conditions
in geographic areas in which the Company's business is concentrated; changes in
interest rates, adverse changes in the market for securitized receivables pools,
or a substantial lengthening of the Company's warehousing period, each of which
could restrict the Company's ability to obtain cash for new Contract
originations and purchases; increases in the amounts required to be set aside in
Spread Accounts or to be expended for other forms of credit enhancement to
support future securitizations; the reduction or unavailability of warehouse
lines of credit which the Company uses to accumulate Contracts for
securitization transactions; increased competition from other automobile finance
sources; reduction in the number and amount of acceptable Contracts submitted to
the Company by its automobile Dealer network; changes in government regulations
affecting consumer credit; and other economic, financial and regulatory factors
beyond the Company's control. A further discussion of factors that may cause
actual results to differ, or may otherwise have an adverse effect on the
Company's financial condition or results of operations, is contained in the
exhibit to this report titled "cautionary statement," incorporated herein by
this reference.
New Accounting Pronouncements
The Company has adopted in 1998 and will adopt in future periods new
accounting pronouncements. For information on how adoption has affected and will
affect the Financial Statements, see Note 1 of Notes to Consolidated Financial
Statements.
Year 2000
Overview. The Year 2000 issue is predicated on the concept that some database
files may contain date fields that will not support century functions and that
some programs may not support century functions even if the date fields are
present. With the change of millennium, the inability to properly process
century functions may create halts or sort/calculation errors within programs
that use century information in calculation and functions.
The Company predominantly uses accounting and installment loan application
processing software against defined relational database files. Most financial
software has long ago been forced to deal with a four byte date field due to
long term maturity dates, bond yield calculations and mortgage amortization
schedules. The
28
29
Company has been cognizant of Year 2000 considerations since late 1994, when
contracts with maturity dates in the year 2000 were first purchased.
Plan. The Company's plan to assess the Year 2000 issue consists of a
three-phase process. The first phase of the process, which has been completed,
consisted of assessing all user programs of the Company's mainframe computer.
Those user programs that were not compliant were either corrected or the
necessary software patches have been identified and ordered. There were no
critical user programs identified that could not be modified to be compliant. In
addition, the Company's mainframe computer's operating system was also tested
and was deemed to be compliant as well.
The second phase of the Company's testing will consist of testing all
personal computers for compliance. The Company has engaged an outside specialist
to facilitate testing and administering corrective procedures where needed. The
Company estimates that phase two will be completed by June 30, 1999.
The third and final stage of testing consists of identifying key vendors of
the Company's operations and requesting that those vendors complete a Year 2000
compliance questionnaire. Any vendors found to be non-compliant will be
continuously monitored for progress towards compliance. The Company estimates
this phase of testing will also be completed by June 30, 1999.
Costs. As the majority of the testing was performed internally by the
Company's information systems department, the Company estimates the costs to
complete all phases of testing, including any necessary modifications, to be
insignificant to the results of operations.
At this time, the risks associated with the Company's Year 2000 issues, both
internally and as related to third party business partners and suppliers are not
completely known. Through the Company's plan of analysis and identification, it
expects to identify substantially all of its Year 2000 related risks. Although
the risks have not been completely identified, the Company believes that the
most realistic worst case scenario would be that the Company would suffer from
full or intermittent power outages at some or all of its locations. Depending
upon the locations affected and estimated duration, this would entail recovery
of the main application systems at other locations and or move to manual
processes. Manual processes have been developed as part of the overall
contingency plan. In relation to this, system data dumps are scheduled to take
place prior to the millennium date change to ensure access to all Company
mission critical data should any system not be accessible for any reason.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Interest Rate Risk
The Company's funding strategy is largely dependent upon issuing interest
bearing asset-backed securities and incurring debt. Therefore, upward
fluctuations in interest rates may adversely impact the Company's profitability,
while downward fluctuations may improve the Company's profitability. The Company
uses several strategies to minimize the risk of interest rate fluctuations,
including offering only fixed rate contracts to obligors, regular sales of auto
Contracts to the Trusts, and pre-funding securitizations, whereby the amount of
asset-backed securities issued in a securitization exceeds the amount of
Contracts initially sold to the Trusts. The proceeds from the pre-funded portion
are held in an escrow account until the Company sells the additional Contracts
to the Trust in amounts up to the balance of the pre-funded escrow account. In
pre-funded securitizations, the Company locks in the borrowing costs with
respect to the loans it subsequently delivers to the Trust. However, the Company
incurs an expense in pre-funded securitizations equal to the difference between
the money market yields earned on the proceeds held in escrow prior to
subsequent delivery of Contracts and the interest rate paid on the asset-backed
securities outstanding.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
This report includes Consolidated Financial Statements, Notes thereto and an
Independent Auditors' Report, at the pages indicated below. Certain unaudited
quarterly financial information is included in the Notes to Consolidated
Financial Statements, as Note 18.
INDEX TO FINANCIAL STATEMENTS
Page
Reference
---------
Independent Auditors' Report.............................................................................F-1
Consolidated Balance Sheets as of December 31, 1998, and 1997............................................F-2
Consolidated Statements of Income for the years ended December 31, 1998, 1997, and 1996..................F-3
Consolidated Statements of Shareholders' Equity for the years ended December 31,
1998, 1997, and 1996..................................................................................F-4
Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997, and 1996..............F-5
Notes to Consolidated Financial Statements for the years ended December 31, 1998, 1997, and 1996.........F-6
29
30
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
Information regarding directors of the registrant is incorporated by
reference to the registrant's definitive proxy statement for its annual meeting
of shareholders to be held in 1999 (the "1999 Proxy Statement"). The 1999 Proxy
Statement will be filed not later than April 30, 1999. Information regarding
executive officers of the registrant appears in Part I of this report, and is
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
Incorporated by reference to the 1999 Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated by reference to the 1999 Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference to the 1999 Proxy Statement.
30
31
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The financial statements listed above under the caption "Index to Financial
Statements" are filed as a part of this report. No financial statement schedules
are filed as the required information is inapplicable or the information is
presented in the consolidated financial statements or the related notes.
Separate financial statements of the Company have been omitted as the Company is
primarily an operating company and its subsidiaries are wholly owned and do not
have minority equity interests and/or indebtedness to any person other than the
Company in amounts which together exceed 5% of the total consolidated assets as
shown by the most recent year-end consolidated balance sheet.
The following exhibits are filed as part of this report:
3.1 Restated Articles of Incorporation (incorporated by reference to exhibit
filed with registrant's report on Form 10-KSB dated December 31, 1995)
3.2 Amended and Restated Bylaws. (incorporated by reference to exhibit filed
with registrant's report on Form 10-K dated December 31, 1997)
4.1 Indenture re Rising Interest Subordinated Redeemable Securities ("RISRs")
(incorporated by reference to exhibit filed with registrant's report on
Form 8-K filed December 26, 1995)
4.2 First Supplemental Indenture re RISRs (incorporated by reference to
exhibit filed with registrant's report on Form 8-K filed December 26,
1995)
4.3 Form of Indenture re 10.50% Participating Equity Notes ("PENs")
(incorporated by reference to exhibit filed with registrant's
registration statement on Form S-3, no. 333-21289)
4.4 Form of First Supplemental Indenture re PENs (incorporated by reference
to exhibit filed with registrant's registration statement on Form S-3,
no. 333-21289)
10.1 1991 Stock Option Plan & forms of Option Agreements thereunder
(incorporated by reference to exhibit filed with registrant's report on
Form 10-KSB dated March 31, 1994)
10.2 1997 Long-Term Incentive Stock Plan (incorporated by reference to exhibit
filed with registrant's report on Form 10-K dated December 31, 1997)
10.3 Purchase Agreement relating to PENs. (incorporated by reference to
exhibit filed with registrant's registration statement on Form S-3 no.
333-21289)
10.4 Lease Agreement, First Amendment to Lease, Assignment and Assumption of
Lease (incorporated by reference to exhibit filed with registrant's
registration statement on Form S-1, no. 33-49770)
10.5 Amendment #2 to Lease Agreement, First Amendment to Lease and Assignment
and Assumption of Lease. (incorporated by reference to exhibit filed with
registrant's report on Form 10-KSB, dated March 31, 1995)
10.6 Lease Agreement re Chesapeake Collection Facility. (incorporated by
reference to exhibit filed with registrant's report on Form 10-K dated
December 31, 1996)
10.7 Consulting Agreement. (incorporated by reference to exhibit filed with
registrant's report on Form 10-KSB dated December 31, 1995)
10.8 Agreement to Build and Lease Headquarters Building. (incorporated by
reference to exhibit filed with registrant's report on Form 10-Q dated
September 30, 1997)
10.9 Lease of Headquarters Building. (incorporated by reference to exhibit
filed with registrant's report on Form 10-Q dated September 30, 1997)
31
32
10.10 Amended and Restated Motor Vehicle Installment Contract Loan and Security
Agreement re Redwood Warehouse Line. (incorporated by reference to
exhibit filed with registrant's report on Form 10-KSB dated December 31,
1995)
10.11 The Receivables Funding and Servicing Agreement re Redwood Warehouse
Line. (incorporated by reference to exhibit filed with registrant's
report on Form 10-KSB dated December 31, 1995)
10.12 Partially Convertible Subordinated Note. (incorporated by reference to
exhibit filed with registrant's report on Form 10-Q dated September 30,
1997)
10.13 Registration Rights Agreement. (incorporated by reference to exhibit
filed with registrant's report on Form 10-Q dated September 30, 1997)
10.14 Receivables Funding and Servicing Agreement relating to First Union
Warehouse Line (incorporated by reference to exhibit filed with
registrant's report on Form 10-K dated December 31, 1997)
10.14a Amendment dated July 17, 1998 to the Receivables Funding and Servicing
Agreement relating to First Union Warehouse Line (incorporated by
reference to exhibit filed with registrant's report on Form 10-Q filed
August 14, 1998)
10.15 Receivables Transfer Agreement relating to First Union Warehouse Line
(incorporated by reference to exhibit filed with registrant's report on
Form 10-K dated December 31, 1997)
10.16 Residual Interest in Securitizations Revolving Credit and Term Loan
Agreement dated as of April 30, 1998, between registrant and State Street
Bank and Trust Company (incorporated by reference to exhibit filed with
registrant's report on 10-Q filed 5/15/98)
10.16a Second Amendment Agreement dated November 17, 1998 re: State Street
residual interest in Securitizations Revolving Credit and Term Loan
Agreement (filed herewith)
10.17 Pledge and Security Agreement dated as of April 30, 1998, between the
Company and State Street Bank and Trust Company (incorporated by
reference to exhibit filed with registrant's report on Form 10-Q filed
May 15, 1998)
10.18 Revolving Credit and Term Note dated April 30, 1998, (the "State Street
Note") (incorporated by reference to exhibit filed with registrant's
report on Form 10-Q filed May 15, 1998)
10.19 Subscription Agreement regarding shares issued in July 1998 (incorporated
by reference to exhibit filed with registrant's report on Form 10-Q filed
August 14, 1998)
10.20 Registration Rights Agreement regarding shares issued in July 1998
(incorporated by reference to exhibit filed with registrant's report on
Form 10-Q filed August 14, 1998)
10.21 Line of Credit Note Issued to Stanwich Financial Services Corp. (the "
1998 Stanwich Note") (incorporated by reference to exhibit filed with
registrant's report on Form 10-K filed March 3, 1998)
10.22 Amended and Restated Motor Vehicle Installment Contract Loan and Security
Agreement (filed herewith)
10.23 FSA Warrant Agreement dated November 30, 1998 (filed herewith)
10.24 Securities Purchase Agreement dated November 17, 1998 (incorporated by
reference to exhibit filed with the statement on Schedule 13D filed with
respect to the registrant on November 25, 1988, by Levine Leichtman
Capital Partners II L.P. and others (the "LLCP report")
32
33
10.25 Senior Subordinated Primary Note dated November 17, 1998 (incorporated by
reference to exhibit filed with the LLCP report)
10.26 Primary Warrant to purchase 3,450,000 shares of common stock dated
November 17, 1998 (incorporated by reference to exhibit filed with the
LLCP report)
10.27 Investor Rights Agreement dated November 17, 1998 (incorporated by
reference to exhibit filed with the LLCP report)
10.28 Registration Rights Agreement dated as of November 17, 1998 (incorporated
by reference to exhibit filed with the LLCP report)
10.29 Subordination Agreement dated as of November 17, 1998 re: Stanwich Note
and Poole Note (filed herewith)
10.30 Consolidated Registration Rights Agreement dated November 17, 1998 re:
1997 Stanwich Notes (filed herewith)
23.1 Consent of independent auditors. (filed herewith)
27 Financial Data Schedule. (filed herewith)
99.1 Cautionary Statements.*
- - ----------
* To be filed by amendment
(b) REPORTS ON FORM 8-K
During the last quarter of the fiscal year ended December 1998, the Company
filed ten reports on Form 8-K.
Five of the ten reports on Form 8-K were monthly servicing reports for
several of the Company's trusts. The following five reports were monthly
servicing reports for several securitization trusts sponsored by the Company:
(i) report dated March 15, 1996 and filed October 1, 1998; (ii) report dated
October 15, 1998 and filed October 30, 1998; (iii) report dated November 16,
1998 and filed November 17; (iv) report dated November 15 and filed November 25,
1998; and (v) report dated December 15, 1998 and filed December 28, 1998. These
reports include monthly performance statements (which are not financial
statements) of certain of the Company's securitization trusts.
Each of the remaining five reports on Form 8-K related to the Company's
December 1998 securitization transaction. Three of these six reports were made
pursuant to Item 7, as follows: (i) report dated November 16, 1998 and filed
November 17, 1998; (ii) report dated and filed November 25, 1998; and (iii)
report dated and filed December 1, 1998. The remaining two reports on Form 8-K
were made pursuant to Items 5 and 7, as follows: (i) report dated December 4,
1998 and filed December 18, 1998; and (ii) report dated December 18, 1998 and
filed December 31, 1998. None of the reports included financial statements.
33
34
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
CONSUMER PORTFOLIO SERVICES, INC. April 15, 1999
(Registrant)
By: /s/ Charles E. Bradley, Jr.
-------------------------------
Charles E. Bradley, Jr.,
President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
By: /s/ Charles E. Bradley, Sr. April 15, 1999
----------------------------
Charles E. Bradley, Sr.
Chairman of the Board
By: /s/ Charles E. Bradley, Jr. April 15, 1999
----------------------------
Charles E. Bradley, Jr., Director,
President and Chief Executive Officer
(Principal Executive Officer)
By: /s/ William B. Roberts April 15, 1999
----------------------------
William B. Roberts, Director
By: /s/ John G. Poole April 15, 1999
----------------------------
John G. Poole, Director
By: /s/ Thomas L. Chrystie April 15, 1999
----------------------------
Thomas L. Chrystie, Director
By: /s/ Robert A. Simms April 15, 1999
----------------------------
Robert A. Simms, Director
By: /s/ Jeffrey P. Fritz April 15, 1999
----------------------------
Jeffrey P. Fritz, Chief Financial Officer
(Principal Financial Officer)
By: /s/ James L. Stock April 15, 1999
----------------------------
James L. Stock, Controller
(Principal Accounting Officer)
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35
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Consumer Portfolio Services, Inc.:
We have audited the accompanying consolidated balance sheets of Consumer
Portfolio Services, Inc. and subsidiaries as of December 31, 1998 and 1997, and
the related consolidated statements of income, shareholders' equity and cash
flows for each of the years in the three-year period ended December 31, 1998.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Consumer
Portfolio Services, Inc. and subsidiaries as of December 31, 1998 and 1997, and
the results of their operations and their cash flows for each of the years in
the three-year period ended December 31, 1998, in conformity with generally
accepted accounting principles.
KPMG LLP
Orange County, California
March 3, 1999, except as to
notes 13, 16 and 17 to the
consolidated financial statements,
which are as of April 15, 1999.
F-1
36
PART I - FINANCIAL INFORMATION
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
December 31, December 31,
1998 1997
------------ ------------
ASSETS
Cash $ 1,940 $ 1,745
Restricted cash (note 2) 1,619 --
Contracts held for sale (note 3) 165,582 68,271
Servicing fees receivable 11,148 5,425
Residual interest in securitizations (note 4) 217,848 124,616
Furniture and equipment, net (note 8) 4,272 3,128
Taxes receivable (note 12) -- 1,528
Deferred financing costs (note 13) 2,817 1,840
Investment in unconsolidated affiliates (note 9) 4,145 3,892
Related party receivables (note 9) 3,268 7,295
Other assets (notes 9 and 10) 19,323 8,155
--------- ---------
$ 431,962 $ 225,895
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Accounts payable & accrued expenses $ 9,267 $ 10,426
Warehouse lines of credit (note 13) 151,857 61,666
Taxes payable (note 12) 1,821 --
Deferred tax liability (note 12) 27,247 13,143
Capital lease obligations (note 11) 2,132 1,492
Notes payable (note 13) 2,557 1,506
Residual financing (note 13) 33,000 --
Subordinated debt (note 13) 65,000 40,000
Related party debt (note 9) 20,000 15,055
--------- ---------
312,881 143,288
Shareholders' Equity (notes 10 and 13)
Preferred stock, $1 par value; authorized
5,000,000 shares; none issued -- --
Series A preferred stock, $1 par value;
authorized 5,000,000 shares; 3,415,000
shares issued; none outstanding -- --
Common stock, no par value; authorized
30,000,000 shares; 15,658,501 and 15,210,042
shares issued and outstanding at December 31,
1998 and December 31, 1997, respectively 52,533 42,262
Notes receivable from exercise of options -- (500)
Retained earnings 66,548 40,845
--------- ---------
119,081 82,607
--------- ---------
Commitments and contingencies (notes 3,4,6,11
12,13,and 14) $ 431,962 $ 225,895
========= =========
See accompanying notes to consolidated financial statements
F-2
37
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Year Ended December 31,
------------------------------------
1998 1997 1996
-------- -------- --------
Revenues:
Gain on sale of contracts, net (notes 3, 4 and 5) $ 58,306 $ 35,045 $ 20,565
Interest income (note 6) 41,841 23,526 19,980
Servicing fees 25,156 14,487 7,893
Other (note 9) 977 2,193 --
-------- -------- --------
126,280 75,251 48,438
-------- -------- --------
Expenses:
Employee costs 28,812 15,875 8,921
General and administrative (note 9) 20,618 14,147 7,247
Interest 22,019 9,185 5,780
Marketing 6,891 1,849 1,679
Occupancy 2,267 1,404 769
Depreciation and amortization 1,255 757 275
Related party consulting fees (note 9) 98 75 75
-------- -------- --------
81,960 43,292 24,746
-------- -------- --------
Income before income taxes 44,320 31,959 23,692
Income taxes (note 12) 18,617 13,427 9,595
-------- -------- --------
Net income $ 25,703 $ 18,532 $ 14,097
======== ======== ========
Earnings per share (note 1):
Basic $ 1.67 $ 1.29 $ 1.05
Diluted $ 1.50 $ 1.17 $ 0.93
Number of shares used in computing
earnings per share (note 1):
Basic 15,412 14,332 13,489
Diluted 17,500 16,053 15,330
See accompanying notes to consolidated financial statements
F-3
38
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS)
Series A
Preferred Stock Common Stock Notes Receivable
------------------ -------------------- From Exercise Retained
Shares Amount Shares Amount of Options Earnings Total
------ -------- ------ -------- ---------------- -------- --------
Balance at December 31, 1995 -- $ -- 13,299 $ 33,265 $ -- $ 8,216 $ 41,481
Common stock issued upon exercise
of warrants (note 10) -- -- 86 259 -- -- 259
Common stock issued upon exercise
of options (note 10) -- -- 395 1,121 -- -- 1,121
Net income -- -- -- -- -- 14,097 14,097
------ -------- ------ -------- -------- -------- --------
Balance at December 31, 1996 -- $ -- 13,780 $ 34,645 $ -- $ 22,313 $ 56,958
Common stock issued upon exercise
of warrants (note 10) -- -- 14 42 -- -- 42
Common stock issued upon exercise
of options (note 10) -- -- 937 2,464 (500) -- 1,964
Common stock issued upon
conversion of debt (note 13) -- -- 480 3,000 -- -- 3,000
Income tax benefit from
exercise of options (note 12) -- -- -- 2,111 -- -- 2,111
Net income -- -- -- -- -- 18,532 18,532
------ -------- ------ -------- -------- -------- --------
Balance at December 31, 1997 -- $ -- 15,211 $ 42,262 $ (500) $ 40,845 $ 82,607
Common stock issued upon exercise
of options (note 10) -- -- 5 43 500 -- 543
Common stock issued (note 9) -- -- 443 5,000 -- -- 5,000
Valuation of warrants issued (note 13) -- -- -- 5,228 -- -- 5,228
Net income -- -- -- -- -- 25,703 25,703
------ -------- ------ -------- -------- -------- --------
Balance at December 31, 1998 -- $ -- 15,659 $ 52,533 $ -- $ 66,548 $119,081
====== ======== ====== ======== ======== ======== ========
See accompanying notes to consolidated financial statements
F-4
39
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
Year Ended December 31,
-----------------------------------------------
1998 1997 1996
----------- ----------- -----------
Cash flows from operating activities:
Net income $ 25,703 $ 18,532 $ 14,097
Adjustments to reconcile net income to net cash
used in operating activities:
Depreciation and amortization 1,255 757 275
Amortization of NIRs 35,540 13,310 6,119
Amortization of deferred financing costs 356 268 157
Provision for credit losses 3,544 4,088 2,756
Provision for loss on NIRs 7,762 -- --
NIR gains recognized (52,990) (34,767) (18,665)
Loss on sale of fixed asset -- 13 --
Gain on sale of subsidiary (56) -- --
(Gain) loss on investment in unconsolidated affiliates (187) (912) 595
Gain on redemption of related party preferred stock -- (145) --
Changes in operating assets and liabilities:
Restricted cash (1,619) -- --
Purchases of contracts held for sale (1,076,457) (632,096) (351,350)
Liquidation of contracts held for sale 975,602 581,394 346,486
Servicing fees receivable (5,723) (2,338) (1,631)
Initial deposits to spread accounts (45,623) (20,064) (12,270)
Deposits to spread accounts and overcollateralization
accounts (53,996) (31,689) (18,790)
Release of cash from spread accounts 16,075 15,846 17,941
Deferred tax liability 14,104 6,116 5,384
Other assets (7,163) (2,146) (2,053)
Accounts payable and accrued expenses (962) 8,269 355
Warehouse lines of credit 90,191 48,401 5,765
Taxes payable/receivable 3,509 1,032 (3,523)
----------- ----------- -----------
Net cash used in operating activities (71,135) (26,131) (8,352)
Cash flows from investing activities:
Proceeds from sale of subordinated certificates -- -- 2,022
Related party receivables (3,239) (9,987) (1,308)
Repayment of related party receivables 7,266 4,000 --
Purchase of related party preferred stock -- (14,500) --
Proceeds from sale of related party preferred stock -- 14,645 --
Investment in unconsolidated affiliate (65) (716) (4,277)
Purchases of furniture and equipment (1,308) (1,032) (358)
Payments received on subordinated certificates -- -- 152
Net cash from sale of subsidiary 382 -- --
Purchase of subsidiary, net of cash acquired -- 92 --
----------- ----------- -----------
Net cash provided by (used in) investing activities 3,036 (7,498) (3,769)
Cash flows from financing activities:
Increase in residual financing 33,000 -- --
Issuance of related party debt 5,000 54,500 --
Issuance of subordinated debt 25,000 20,000 --
Issuance of notes payable 2,461 -- --
Repayment of capital lease obligations (553) (166) --
Repayment of notes payable (824) (10) --
Repayment of related party debt -- (39,945) --
Payment of financing costs (1,333) (1,165) --
Issuance of common stock 5,000 -- --
Exercise of options and warrants 543 2,006 1,380
----------- ----------- -----------
Net cash provided by financing activities 68,294 35,220 1,380
----------- ----------- -----------
Increase (decrease) in cash 195 1,591 (10,741)
Cash at beginning of year 1,745 154 10,895
----------- ----------- -----------
Cash at end of year $ 1,940 $ 1,745 $ 154
=========== =========== ===========
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest $ 21,542 $ 8,476 $ 5,214
Income taxes $ 1,013 $ 6,204 $ 6,679
Supplemental disclosure of non-cash investing and financing
activities:
Issuance of common stock upon conversion of debt $ -- $ 3,000 $ --
Note receivable from exercise of options $ -- $ 500 $ --
Income tax benefit from exercise of options $ -- $ 2,111 $ --
Furniture and equipment acquired through capital leases $ 1,193 $ 1,658 $ --
Issuance of common stock warrants $ 5,228 $ -- $ --
Purchase of CPS Leasing, Inc.
Assets acquired $ -- $ 2,718 $ --
Liabilities assumed -- (2,638) --
----------- ----------- -----------
Cash paid to acquire business -- 80 --
Less: cash acquired -- (172) --
----------- ----------- -----------
Net cash received upon acquisition $ -- $ (92) $ --
=========== =========== ===========
Sale of PIC Leasing, Inc.
Net assets sold $ 706 $ -- $ --
Net assets retained (155) -- --
Gain on sale of subsidiary 56 -- --
----------- ----------- -----------
Cash received from sale of subsidiary 607 -- --
Less: cash relinquished upon disposition (225) -- --
----------- ----------- -----------
Net cash received from sale of subsidiary $ 382 $ -- $ --
=========== =========== ===========
See accompanying notes to consolidated financial statements
F-5
40
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
Consumer Portfolio Services, Inc. ("CPS") was incorporated in California on
March 8, 1991. CPS and its subsidiaries (collectively, the "Company") engage
primarily in the business of purchasing, selling and servicing retail automobile
installment sale contracts ("Contracts") originated by dealers located
throughout the United States. The Company specializes in Contracts with obligors
who generally would not be expected to qualify for traditional financing, such
as that provided by commercial banks or automobile manufacturers' captive
finance companies. The Company's headquarters and principal collection
facilities are located in Irvine, California and a satellite collection facility
is located in Chesapeake, Virginia. The Company has purchased Contracts from
dealers in California since its inception. During the year ended December 31,
1998, Contract purchases relating to obligors who resided in California totaled
16.7% of all Contract purchases. Moreover, at December 31, 1998, obligors who
resided in California made up 20.0% of the servicing portfolio of Contracts
serviced by the Company. A significant adverse change in the economic climate in
California or other states could result in fewer Contracts available for sale
and potentially less revenue.
Principles of Consolidation
The consolidated financial statements include the accounts of Consumer
Portfolio Services, Inc. and its wholly-owned subsidiaries, CPS Marketing, Inc.,
Alton Receivables Corp. ("Alton"), CPS Receivables Corp. ("CPSRC"), CPS Funding
Corp. ("CPSFC") and CPS Warehouse Corp. ("CPSWC"). Alton, CPSRC, CPSFC and CPSWC
are limited purpose corporations formed to accommodate the structures under
which the Company purchases and sells its Contracts. CPS Marketing, Inc. employs
marketing representatives who solicit business from dealers. The consolidated
financial statements also include the accounts of Samco Acceptance Corp., LINC
Acceptance Company, LLC, and CPS Leasing, Inc., which are 80% owned
subsidiaries. All significant intercompany balances and transactions have been
eliminated in consolidation. Investments in unconsolidated affiliates that are
not majority owned are reported using the equity method. The excess of the cost
of the stock over the Company's share of the net assets at the acquisition date
("goodwill") is being amortized over a period of up to fifteen years.
Contracts Held for Sale
Contracts held for sale include automobile installment sales contracts on
which interest is precomputed and added to the face of the loan. The interest on
such contracts is included in unearned financed charges. Unearned financed
charges are amortized using the interest method over the remaining period to
contractual maturity. Contracts held for sale are stated at the lower of cost or
market value. Market value is determined by purchase commitments from investors
and prevailing market prices. Gains and losses are recorded as appropriate when
Contracts are sold. The Company considers a transfer of Contracts where the
Company surrenders control over the Contracts to be a sale to the extent that
consideration other than beneficial interests in the transferred Contracts is
received in exchange for the Contracts.
Allowance for Credit Losses
The Company estimates an allowance for credit losses, which management
believes provides adequately for known and inherent losses that may develop in
the Contracts held for sale. Provision for losses are charged to gain on sale of
Contracts. Charge-offs, net of recoveries, are charged to the allowance.
Management evaluates the adequacy of the allowance by examining current
delinquencies, the characteristics of the portfolio, the value of underlying
collateral and general economic conditions and trends.
Contract Acquisition Fees and Discounts
Upon purchase of a Contract from a dealer, the Company generally charges the
dealer an acquisition fee or purchases the Contract at a discount from its face
value. The acquisition fees and discounts associated with Contract purchases are
F-6
41
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
deferred until the Contracts are sold, at which time the deferred acquisition
fees or discounts are recognized as a component of the gain on sale.
Investments
The Company determines the appropriate classification of its investments in
debt securities at the time of purchase or creation. Debt securities for which
the Company does not have the intent or ability to hold to maturity are
classified as available for sale. Securities available for sale are carried at
fair value, with unrealized gains and losses, net of tax, reported in a separate
component of shareholders' equity as accumulated other comprehensive income.
The amortized cost of debt securities classified as available for sale is
adjusted for amortization of premiums and accretion of discounts, over the
estimated life of the security. Such amortization and interest earned on the
debt securities are included in interest income.
Residual Interest in Securitizations and Gain on Sale of Contracts
The Company purchases Contracts with the primary intention of reselling them
in securitization transactions as asset-backed securities. The securitizations
are generally structured as follows: First, the Company sells a portfolio of
Contracts to a wholly owned subsidiary ("SPS"), which has been established for
the limited purpose of buying and reselling the Company's Contracts. The SPS
then transfers the same Contracts to either a grantor trust or an owner trust
(the "Trust"). The Trust in turn issues interest-bearing asset-backed securities
(the "Certificates"), generally in an amount equal to the aggregate principal
balance of the Contracts. The Company typically sells these Contracts to the
Trust at face value and without recourse, except that representations and
warranties similar to those provided by the Dealer to the Company are provided
by the Company to the Trust. One or more investors purchase the Certificates
issued by the Trust; the proceeds from the sale of the Certificates are then
used to purchase the Contracts from the Company. The Company purchases a
financial guaranty insurance policy, guaranteeing timely payment of principal
and interest on the senior Certificates, from an insurance company (the
"Certificate Insurer"). In addition, the Company provides a credit enhancement
for the benefit of the Certificate Insurer and the investors in the form of an
initial cash deposit to an account ("Spread Account") held by the Trust. The
agreements governing the securitization transactions (collectively referred to
as the "Servicing Agreements") require that the initial deposits to the Spread
Accounts be supplemented by a portion of collections from the Contracts until
the Spread Accounts reach specified levels, and then maintained at those levels.
The specified levels are generally computed as a percentage of the principal
amount remaining unpaid under the related Certificates. The specified levels at
which the Spread Accounts are to be maintained will vary depending on the
performance of the portfolios of Contracts held by the Trusts and on other
conditions, and may also be varied by agreement among the Company, the SPS, the
Certificate Insurer and the trustee. Such levels have increased and decreased
from time to time based on performance of the portfolios, and have also been
varied by agreement. The specified levels applicable to the Company's sold pools
increased materially in 1998 and have recently been decreased. See note 16 -
"Liquidity".
At the closing of each securitization, the Company removes from its
consolidated balance sheet the Contracts held for sale and adds to its
consolidated balance sheet (i) the cash received and (ii) the estimated fair
value of the ownership interest that the Company retains in Contracts sold in
securitization. That retained interest (the "Residual") consists of (a) the cash
held in the Spread Account and (b) the net interest receivables ("NIRs"). NIRs
represent the estimated discounted cash flows to be received from the Trust in
the future, net of principal and interest payable with respect to the
Certificates, and certain expenses. The excess of the cash received and the
assets retained by the Company over the carrying value of the Contracts sold,
less transaction costs, equals the net gain on sale of Contracts recorded by the
Company.
The Company allocates its basis in the Contracts between the Certificates and
the Residuals retained based on the relative fair values of those portions on
the date of the sale. The Company recognizes gains or losses attributable to the
change in the fair value of the Residuals, which are recorded at estimated fair
value and accounted for as "held-for-trading" securities. The Company is not
aware of an active market for the purchase or sale of interests such as the
F-7
42
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Residuals, and accordingly, the Company determines the estimated fair value of
the Residuals by discounting the amount and timing of anticipated cash flows
released from the Spread Account (the cash out method), using a discount rate
that the Company believes is appropriate for the risks involved. For that
valuation, the Company has used an effective discount rate of approximately 14%
per annum.
The Company receives periodic base servicing fees for the servicing and
collection of the Contracts. In addition, the Company is entitled to the cash
flows from the Residuals that represent collections on the Contracts in excess
of the amounts required to pay principal and interest on the Certificates, the
base servicing fees, and certain other fees (such as trustee and custodial
fees). At the end of each collection period, the aggregate cash collections from
the Contracts are allocated first to the base servicing fees and certain other
fees such as trustee and custodial fees for the period, then to the
Certificateholders for interest at the pass-through rate on the Certificates
plus principal as defined in the Servicing Agreements. If the amount of cash
required for the above allocations exceeds the amount collected during the
collection period, the shortfall is drawn from the Spread Account. If the cash
collected during the period exceeds the amount necessary for the above
allocations, and there is no shortfall in the related Spread Account, the excess
is released to the Company or in certain cases is transferred to other Spread
Accounts that may be below their required levels. Pursuant to certain Servicing
Agreements, excess cash collected during the period is used to make accelerated
principal paydowns on certain Certificates to create excess collateral
(over-collateralization or OC account). If the Spread Account balance is not at
the required credit enhancement level, then the excess cash collected is
retained in the Spread Account until the specified level is achieved. The cash
in the Spread Accounts is restricted from use by the Company. Cash held in the
various Spread Accounts is invested in high quality, liquid investment
securities, as specified in the Servicing Agreements.Spread Account balances are
held by the Trusts on behalf of the Company as the owner of the Residuals. Such
balances are generally defined as as percentages of the principal amount
remaining unpaid on the balance.
The annual percentage rate ("APR") payable on the Contracts is significantly
greater than the pass through rate on the Certificates. Accordingly, the
Residuals described above are a significant asset of the Company. In determining
the value of the Residuals described above, the Company must estimate the future
rates of prepayments, delinquencies, defaults and default loss severity as they
affect the amount and timing of the estimated cash flows. The Company estimates
prepayments by evaluating historical prepayment performance of comparable
Contracts and the effects of trends in the industry. The Company has used a
constant prepayment estimate of approximately 4% per annum. The Company
estimates defaults and default loss severity using available historical loss
data for comparable Contracts and the specific characteristics of the Contracts
purchased by the Company. In valuing the residuals, the Company estimates that
losses as a percentage of the original principal balance will total
approximately 14% cumulatively over the lives of the related Contracts.
In future periods, the Company would recognize additional revenue from the
Residuals if the actual performance of the Contracts were to be better than the
original estimate, or the Company would increase the estimated fair value of the
Residuals. If the actual performance of the Contracts were to be worse than the
original estimate, then a downward adjustment to the carrying value of the
Residuals would be required. Due to the inherent uncertainty of the future
performance of the underlying Contracts, the Company during 1998, established a
provision for losses on the Residuals.
Servicing
Servicing fees are reported as income when earned. Servicing costs are
charged to expense as incurred. Servicing fees receivable represent fees earned
but not yet remitted to the Company by the trustee.
Furniture and Equipment
Furniture and equipment are stated at cost net of accumulated depreciation.
The Company calculates depreciation using the straight-line method over the
estimated useful lives of the assets which range from three to five years.
Assets held under capital leases and leasehold improvements are amortized over
the lesser of the estimated useful lives of the assets or the related lease
terms.
F-8
43
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Earnings per Share
The following table illustrates the computation of basic and diluted earnings
per share:
Year ended December 31,
---------------------------------
1998 1997 1996
------- ------- -------
(in thousands, except per share data)
Numerator:
- - ----------
Numerator for basic earnings per share --
net income ................................... $25,703 $18,532 $14,097
Interest on borrowings, net of tax effect on
conversion of convertible subordinated debt .... 590 313 170
------- ------- -------
Numerator for diluted earnings per share ....... $26,293 $18,845 $14,267
======= ======= =======
Denominator:
- - ------------
Denominator for basic earnings per share --
weighted average number of common shares
outstanding during the year .................. 15,412 14,332 13,489
Incremental common shares attributable to
exercise of outstanding options and warrants . 881 1,212 1,361
Incremental common shares attributable to
conversion of subordinated debt .............. 1,207 509 480
------- ------- -------
Denominator for diluted earnings per share ..... 17,500 16,053 15,330
======= ======= =======
Basic earnings per share ....................... $ 1.67 $ 1.29 $ 1.05
======= ======= =======
Diluted earnings per share ..................... $ 1.50 $ 1.17 $ 0.93
======= ======= =======
Income Taxes
The Company and its subsidiaries file a consolidated Federal income and
combined state franchise tax returns. The Company utilizes the asset and
liability method of accounting for income taxes, under which deferred income
taxes are recognized for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and
liabilities and their respective tax bases. Deferred tax assets and liabilities
are measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred taxes of a change in tax rates is recognized in
income in the period that includes the enactment date.
Stock Split
Effective March 7, 1996, all outstanding shares of common stock were split
two-for-one. All references in the consolidated financial statements to number
of shares, per share amounts and market prices of the Company's common stock
have been retroactively restated to reflect the increased number of common
shares outstanding.
Stock Option Plan
As permitted by Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" ("SFAS No. 123"), the Company accounts
for stock-based employee compensation plans in accordance with Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and
related interpretations. The Company provides the pro forma net income, pro
forma earnings per share, and stock based compensation plan disclosure
requirements set forth in SFAS No. 123.
Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of
The Company reviews identifiable intangibles, goodwill and other long-lived
assets for impairment whenever events or circumstances indicate the carrying
amounts may not be recoverable. If the sum of the expected future cash flows
(undiscounted and without interest charges) is less than the carrying amount of
an asset, an impairment loss is recognized.
F-9
44
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Segment Reporting
The Company adopted, effective December 31, 1997, Statement of Financial
Accounting Standards No. 131, "Diclosures about Segments of an Enterprise and
Related Information," ("SFAS No. 131"). SFAS No. 131 establishes standards for
reporting financial and descriptive information about an enterprise's operating
segments in its annual financial statements and selected segment information in
interim financial reporting.
Operations are managed and financial performance is evaluated on a Company
wide basis by chief decision makers. Accordingly, all of the Company's
operations are considered by management to be aggregated in one reportable
operating segment.
New Accounting Pronouncements
In June 1998, the FASB issued Statement of Financial Accounting Standard No.
133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No.
133"). SFAS No. 133 establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts (collectively referred to as derivatives), and for hedging
activities. It requires that an entity recognize all derivatives as either
assets or liabilities in the statement of financial position and measure those
instruments at fair value. If certain conditions are met, a derivative may be
specifically designated as (a) a hedge of the exposure to changes in the fair
value of a recognized asset or liability or an unrecognized firm commitment, (b)
a hedge of the exposure to variable cash flows of a forecasted transaction, or
(c) a hedge of the foreign currency exposure of a net investment in foreign
operation, an unrecognized firm commitment, an available for sale security, or a
foreign-currency-denominated forecasted transaction.
Under SFAS No. 133, an entity that elects to apply hedge accounting is
required to establish at the inception of the hedge the method it will use for
assessing the effectiveness of the hedging derivative and the measurement
approach for determining the ineffective aspect of the hedge. Those methods must
be consistent with the entity's approach to managing risk. This statement is
effective for all fiscal quarters of fiscal years beginning after June 15, 1999.
Management is in the process of assessing the effect of implementing SFAS No.
133, which is effective for all fiscal quarters of fiscal years beginning after
June 15, 1999.
In October 1998, the FASB issued Statement of Financial Accouting Standards
No. 134 ("SFAS No. 134"), "Accounting for Mortgage-Backed Securities after the
Securitization of Mortgage Loans Held for Sale by a Mortgage Banking
Enterprise." SFAS No. 134 amends SFAS No. 65 to require that, after the
securitization of mortgage loans held for sale, an entity engaged in mortgage
banking activities, classify, in accordance with the provisions of SFAS No. 115,
the resulting mortgage-backed securities or other retained interests, based on
its ability and intent to sell or hold those investments. However, a mortgage
banking enterprise must classify as held for trading any retained
mortgage-backed securities that it commits to sell before or during the
securitization process. This Statement is effective for the first fiscal quarter
beginning after December 15, 1998. Management does not anticipate the adoption
of this statement will have a material affect on the Company's financial
condition and results of operations.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities as of the date of the
financial statements, as well as the reported amounts of income and expenses
during the reported periods. Specifically, a number of estimates were made in
connection with determining an appropriate allowance for credit losses, valuing
the Residuals and computing the related gain on sale on the transactions that
created the Residuals. Actual results could differ from those estimates
depending on the future performance of the related Contracts.
Reclassification
Certain amounts for the prior years have been reclassified to conform to the
current year's presentation.
F-10
45
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(2) RESTRICTED CASH
Restricted cash in the amount of $1.6 million is required as part of the
agreement related to a $33.3 million revolving line of credit established by the
Company in April 1998 (see note 13). The agreement requires the Company to post
a cash reserve equal to the greater of $1.0 million or six months of interest
based on the outstanding balance of the line at the end of the month. Borrowings
under the revolving line bear interest at LIBOR + 4% (9.54% at December 31,
1998).
(3) CONTRACTS HELD FOR SALE
The following table presents the components of Contracts held for sale:
December 31,
-------------------------
1998 1997
--------- ---------
(in thousands)
Gross receivable balance .............. $ 183,876 $ 81,645
Unearned finance charges .............. (10,949) (10,078)
Deferred acquisition fees and discounts (4,594) (1,092)
Allowance for credit losses ........... (2,751) (2,204)
--------- ---------
$ 165,582 $ 68,271
========= =========
The following table presents the activity in the allowance for credit losses:
Year ended December 31,
-----------------------------------
1998 1997 1996
------- ------- -------
(in thousands)
Balance, beginning of year ....... $ 2,204 $ 723 $ 330
Provisions ....................... 3,544 4,088 2,756
Charge-offs ...................... (2,535) (2,935) (2,755)
Allowance allocated to repossessed
inventory ...................... (1,349) (261) --
Recoveries ....................... 887 589 392
------- ------- -------
Balance, end of year .......... $ 2,751 $ 2,204 $ 723
======= ======= =======
The Company is required to represent and warrant certain matters with respect
to the Contracts sold to investors, which generally duplicate the substance of
the representations and warranties made by the dealers in connection with the
Company's purchase of the Contracts. In the event of a breach by the Company of
any representation or warranty, the Company is obligated to repurchase the
Contracts from the investors at a price equal to the investors' purchase price
less the related credit enhancement and any principal payments received from the
obligor. In most cases, the Company would then be entitled under the terms of
its agreements with dealers to require the selling dealer to repurchase the
Contracts at the Company's purchase price less any principal payments received
from the obligor.
As of December 31, 1998 and 1997, the Company had commitments to purchase
$2.3 million and $3.8 million, respectively, of Contracts from Dealers in the
ordinary course of business.
F-11
46
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(4) RESIDUAL INTEREST IN SECURITIZATIONS
The following table presents the components of the residual interest in
securitizations:
December 31,
----------------------
1998 1997
-------- --------
(in thousands)
Cash, commercial paper, US government
securities and other qualifying
investments (Spread Account) ........ $130,394 $ 68,513
NIRs .................................. 54,800 45,112
OC accounts ........................... 31,836 9,621
Funds held by investor ................ 480 579
Investment in subordinated certificates 338 791
-------- --------
$217,848 $124,616
======== ========
The following table presents the activity of the NIRs :
Year ended December 31,
--------------------------------------
1998 1997 1996
-------- -------- --------
(in thousands)
Balance, beginning of year .. $ 45,112 $ 23,655 $ 11,109
NIR gains recognized (note 5) 52,990 34,767 18,665
Amortization of NIRs (note 6) (35,540) (13,310) (6,119)
Provision for loss on NIRs .. (7,762) -- --
-------- -------- --------
Balance, end of year ........ $ 54,800 $ 45,112 $ 23,655
======== ======== ========
The following table presents the estimated remaining undiscounted credit
losses included in the fair value estimate of the Residuals as a percentage of
the Company's servicing portfolio subject to recourse provisions:
December 31,
--------------------------------------------
1998 1997 1996
---------- ---------- ----------
(in thousands)
Undiscounted estimated credit losses ... $ 169,110 $ 90,814 $ 45,881
Servicing subject to recourse provisions $1,362,801 $ 830,918 $ 483,106
========== ========== ==========
Undiscounted estimated credit losses
as percentage of servicing subject to
recourse provisions ................... 12.41% 10.93% 9.50%
========== ========== ==========
F-12
47
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(5) GAIN ON SALE OF CONTRACTS
The following table presents the components of the net gain on sale of
Contracts:
Year ended December 31,
--------------------------------------
1998 1997 1996
-------- -------- --------
(in thousands)
NIR gains recognized ........ $ 52,990 $ 34,767 $ 18,665
Deferred acquisition fees
and discounts ............. 23,330 8,925 6,890
Provision for loss on NIRs .. (7,762) -- --
Expenses related to sales ... (6,708) (4,559) (2,234)
Provision for credit losses . (3,544) (4,088) (2,756)
-------- -------- --------
$ 58,306 $ 35,045 $ 20,565
======== ======== ========
(6) INTEREST INCOME
The following table presents the components of interest income:
Year ended December 31,
--------------------------------------
1998 1997 1996
-------- -------- --------
(in thousands)
Interest on Contracts held for sale $ 43,493 $ 14,279 $ 9,981
Residual interest income .......... 33,888 22,557 16,118
Amortization of NIRs .............. (35,540) (13,310) (6,119)
-------- -------- --------
$ 41,841 $ 23,526 $ 19,980
======== ======== ========
(7) SERVICING
The following table presents the components of the Company's servicing
portfolio:
December 31,
------------------------------------------
1998 1997 1996
---------- ---------- ----------
(in thousands)
Contracts held for sale ................. $ 176,108 $ 71,829 $ 22,827
Servicing subject to recourse provisions:
Whole loan portfolios .............. 1,463 4,839 11,212
Alton Receivables Corp. ............ 259 3,073 10,241
CPS Receivables Corp. .............. 1,361,079 823,006 461,653
---------- ---------- ----------
$1,538,909 $ 902,747 $ 505,933
========== ========== ==========
(8) FURNITURE AND EQUIPMENT
The following table presents the components of furniture and equipment:
December 31,
---------------------
1998 1997
------- -------
(in thousands)
Furniture and fixtures ....................... $ 2,973 $ 1,869
Computer equipment ........................... 2,365 1,895
Leasing assets ............................... 882 916
Leasehold improvements ....................... 644 127
Other fixed assets ........................... 34 55
------- -------
6,898 4,862
Less accumulated depreciation and amortization (2,626) (1,734)
------- -------
$ 4,272 $ 3,128
======= =======
F-13
48
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(9) RELATED PARTY TRANSACTIONS
Investment in Unconsolidated Affiliates
Investment in unconsolidated affiliates primarily consists of a 38% interest
in NAB Asset Corporation ("NAB") that was acquired by the Company on June 6,
1996, for approximately $4.3 million. At the time of the acquisition, NAB had
approximately $3.5 million in cash and no significant operations. The Company's
investment in NAB exceeded the Company's share of the net assets of NAB at the
acquisition date by approximately $1.4 million. This amount, which is included
in other assets in the accompanying balance sheet, has been recorded by the
Company as goodwill. Based on the closing price on the Nasdaq, the market value
of the investment in NAB was approximately $2.9 million and $4.0 million at
December 31, 1998 and 1997, respectively. Charles E. Bradley, Sr., Chairman of
the Company's Board of Directors and principal shareholder and Charles E.
Bradley, Jr., President, Chief Executive Officer and a member of the Company's
Board of Directors are both on the Board of Directors of NAB. Included in
general and administrative expenses for the year ended December 31, 1996, is
$595,352, which represents the Company's share of NAB's loss from June 6,
through December 31, 1996.
Subsequent to the Company's investment in NAB, NAB purchased Mortgage
Portfolio Services, Inc. ("MPS") from the Company for $300,000. MPS, formed by
the Company in April 1996, is a mortgage broker-dealer based in Texas. In July
1996, NAB formed CARSUSA, Inc. ("CARSUSA"), which purchased, and now owns and
operates, a Mitsubishi automobile dealership in Southern California. On June 27,
1997, NAB sold CARSUSA to Charles E. Bradley, Sr. and Charles E. Bradley, Jr.,
for $1.5 million. Included in other income for the years ended December 31, 1998
and 1997, is $51,593 and $848,920, respectively, which represents the Company's
share of NAB's net income.
Related Party Receivables
The following table presents the components of related party receivables:
December 31,
------------------
Related Party 1998 1997
- - ------------- ------ ------
(in thousands)
NAB Asset Corporation $2,100 $5,602
CARSUSA, Inc. 904 1,351
Service and Management Cooperative, Inc. 139 128
Loan to Subsidiary Officer 125 --
Global Equipment Leasing, LLC -- 114
Stanwich Partners, Inc. -- 100
------ ------
$3,268 $7,295
====== ======
Included in the receivable from CARSUSA at December 31, 1998 and 1997, is
$329,500 and $790,000, respectively, related to a flooring line of credit
provided to CARSUSA. The remainder relates to amounts owed by CARSUSA for other
borrowings.
During fiscal 1998 and 1997, respectively, the Company sold 51 and 107
automobiles to CARSUSA and received proceeds of $432,790 and $749,800,
respectively. Additionally, the Company purchased 296 and 183 Contracts from
CARSUSA, with an aggregate principal balance of approximately $4.2 million and
$2.4 million, respectively.
Included in the receivable from NAB at December 31, 1997, is $5.5 million
arising from the issuance of two promissory notes totaling $9.5 million, bearing
interest at 13% annually. On December 31, 1997, one of the promissory notes for
$4.0 million was sold to Stanwich Financial Services Corp. ("SFSC") for $4.0
million, the proceeds of which were received on December 31, 1997. Charles E.
Bradley, Sr., Charles E. Bradley, Jr., and John G. Poole, who are officers and
directors of the Company, collectively own 92.5% of the common stock of Stanwich
Holdings, Inc. ("Stanwich Holdings"), and Mr. Bradley, Sr., is the president and
a director of Stanwich Holdings. SFSC is a wholly-owned subsidiary of Stanwich
Holdings. During 1998, NAB repaid approximately $3.4 million of the $5.5 million
promissory note, leaving a balance of approximately $2.1 million at December 31,
1998. The remaining unpaid balance of the note is due April 30, 1999.
F-14
49
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
In June 1998, the Company issued an additional promissory note to NAB for
$3.0 million, bearing interest at 14% annually. During 1998, the note was
repaid in full.
On March 2, 1998, NAB acquired Stanwich Holdings. At that time the Company
received a note from NAB for $530,835 in exchange for an option it had held to
acquire 100% of the outstanding common stock of Stanwich Holdings. In June 1998,
NAB rescinded the transaction to acquire Stanwich Holdings, with an effective
date of March 2, 1998.
At December 31, 1998 and 1997, respectively, $139,229 and $128,421 is due
from Service and Management Cooperative, Inc. These amounts represent
liabilities incurred by Service and Management Cooperative, Inc., which were
paid for by the Company. Certain officers of the Company's subsidiary Samco were
officers of Service and Management Cooperative, Inc.
In July 1998, the president of Samco issued to the Company a promissory note
in the amount of $125,000. The loan bears interest at the rate of 10% per annum
and is due July 2001.
At December 31, 1997, $114,275 is due from Global Equipment Leasing, LLC.
These amounts represent payments by the Company's subsidiary CPS Leasing, Inc.,
of certain debt obligations of Global Equipment Leasing, LLC., which is 50%
owned by CPS Leasing, Inc. In January 1998, the amount due from Global Equipment
Leasing, LLC, was repaid in full.
The amount due from Stanwich Partners, Inc. ("SPI") at December 31, 1997, is
related to investment banking services performed by the Company in connection
with the Company's January 2, 1997 acquisition of CPS Leasing, Inc. The Chairman
of the Board of Directors of the Company is a principal shareholder of SPI.
The Company is a party to a consulting agreement with SPI that calls for
monthly payments of $6,250 through December 31, 1999. Included in the
accompanying consolidated statements of income for the year ended December 31,
1998, 1997 and 1996, is $75,000, $75,000 and $75,000, respectively, of
consulting expense related to this consulting agreement.
In November 1998, the Company issued $25.0 million of subordinated promissory
notes due November 30, 2003, to an affiliate of Levine Leichtman Capital
Partners, Inc. ("LLCP") (see note 13). As part of the transaction, the Company
entered into a consulting agreement with LLCP, calling for monthly consulting
fees of $22,917 through November 2003. Included in the accompanying consolidated
statements of income for the year ended December 31, 1998, are $22,917 of
consulting fees related to this consulting agreement.
Related Party Debt
In May 1997, the Company entered into two transactions with a related party:
(i) the Company purchased $14.5 million of preferred stock of Stanwich Holdings
with dividends cumulative at the rate of 9% per annum and redeemable at an
aggregate price of $14.6 million, plus accrued dividends, and (ii) the Company
borrowed $14.5 million with an interest rate of 8% per annum under a 60-day
related party loan from SFSC. In August 1997, the Company received $14.9 million
in redemption of its preferred stock of Stanwich Holdings and repaid the 60-day
related party loan in its entirety. In August 1997, the Company entered into a
line of credit agreement with SFSC ("Stanwich Line"), to supplement its working
capital resources. Under the Stanwich Line, SFSC agreed to lend up to $25.0
million to the Company from time to time upon request, through December 19,
1997. Any amount outstanding at December 31, 1997 would be due at that time.
Borrowings under the Stanwich Line bear interest at the rate of 10% per annum,
and the Company paid a $250,000 (one percent) commitment fee to SFSC in
connection with opening the line of credit. The Company drew the full amount of
the line at its inception, none of which remained outstanding at December 31,
1997.
The Company has also received long-term financing from SFSC. In June 1997 the
Company borrowed $15.0 million on an unsecured and subordinated basis from SFSC.
This loan ("RPL") is due 2004, and has a fixed rate of interest of 9% per
F-15
50
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
annum, payable monthly beginning July 1997. The Company may pre-pay the RPL
without penalty at any time after three years. At maturity or repayment of the
RPL, the holder thereof will have an option to convert 20% of the principal
amount into common stock of the Company, at a conversion rate of $11.86 per
share. The balance of the RPL at December 31, 1998 and 1997, was $15.0 million.
During 1998, the Company borrowed an additional $4.0 million on an unsecured
basis from SFSC. This loan ("RPL2") is due 2004, has a fixed rate of interest of
12.5% per annum payable monthly beginning December 1998. The Company may pre-pay
the RPL2, without penalty, anytime after June 12, 2000. At maturity or repayment
of the RPL2, the holder thereof will have the option to convert the entire
principal balance of the note, or a portion thereof, into common stock of the
Company, at a conversion rate of $3.00 per share. The balance of the RPL2 at
December 31, 1998, was $4.0 million.
During 1998, the Company borrowed $1.0 million on an unsecured basis from
John G. Poole, a director of the Company. The terms of this note ("RPL3") are
the same as RPL2. The balance of the RPL3 at December 31, 1998, was $1.0
million.
Related Party Stock Sale
In July 1998, the Company sold 443,459 shares of common stock in a private
placement to SFSC for $5.0 million. As of December 31, 1998, the above shares of
common stock had not been registered for public sale.
(10) SHAREHOLDERS' EQUITY
Common Stock
Holders of the common stock are entitled to such dividends as the Company's
Board of Directors, in its discretion, may declare out of funds available,
subject to the terms of any outstanding shares of preferred stock and other
restrictions. In the event of liquidation of the Company, holders of common
stock are entitled to receive, pro rata, all of the assets of the Company
available for distribution, after payment of any liquidation preference to the
holders of outstanding shares of preferred stock. Holders of the shares of
common stock have no conversion or preemptive or other subscription rights and
there are no redemption or sinking fund provisions applicable to the common
stock.
The Company is required to comply with various operating and financial
covenants defined in the agreements governing the warehouse lines, residual
financing, subordinated debt, and related party debt. The covenants restrict the
payment of certain distributions, including dividends.
Options and Warrants
In 1991, the Company adopted and gained sole shareholder approval of the 1991
Stock Option Plan (the "1991 Plan") pursuant to which the Company's Board of
Directors may grant stock options to officers and key employees. The Plan, as
amended, authorizes grants of options to purchase up to 2,700,000 shares of
authorized but unissued common stock. Stock options are granted with an exercise
price equal to the stock's fair market value at the date of grant. Stock options
have terms that range from 7 to 10 years and vest over a range of 0 to 7 years.
In addition to the 1991 Plan, in fiscal 1995, the Company granted 60,000 options
to certain directors of the Company that vest over three years and expire nine
years from the grant date.
In July 1997, the Company adopted and gained shareholder approval of the 1997
Long-Term Incentive Plan (the "1997 Plan") pursuant to which the Company's Board
of Directors may grant stock options, restricted stock and stock appreciation
rights to employees, directors or employees of entities in which the Company has
a controlling or significant equity interest. Options that have been granted
under the 1997 Plan have in all cases been granted at an exercise price equal to
the stock's fair market value at the date of the grant, with terms of 10 years
and vesting over 5 years. The 1997
F-16
51
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Plan provides that an aggregate maximum of 1,500,000 shares of the Company's
common shares may be subject to awards under the 1997 Plan.
In October 1998, the Company's Board of Directors approved a plan to cancel
and reissue certain stock options previously granted to key employees of the
Company. All options granted prior to October 22, 1998, with an option price
greater than $3.25, were repriced to $3.25. In conjunction with the repricing, a
one year period of non-exercisability was placed on all repriced options, which
expires October 21, 1999.
At December 31, 1998, there were 341,000 additional shares available for
grant under the 1991 Plan and 1997 Plan. Of the options outstanding at December
31, 1998, 1997 and 1996, 194,040, 584,920 and 1,319,420, respectively, were
exercisable with weighted-average exercise prices of $2.68, $6.77 and $4.02,
respectively. The per share weighted-average fair value of stock options granted
during the years ended December 31, 1998, 1997 and 1996, was $1.87, $5.79, and
$4.99, respectively, at the date of grant using the Black-Scholes option-pricing
model with the following weighted average assumptions:
Year ended December 31,
---------------------------------
1998 1997 1996
----- ----- -----
Expected life (years) ...... 6.41 6.50 5.86
Risk-free interest rate .... 4.95% 6.48% 6.23%
Volatility ................. 20.00% 52.04% 46.20%
Expected dividend yield .... -- -- --
The Company applies APB Opinion No. 25 in accounting for its plans and,
accordingly, no compensation cost has been recognized for its stock options in
the consolidated financial statements. Had the Company determined compensation
cost based on the fair value at the grant date for its stock options under
Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based
Compensation", the Company's net income and net earnings per share would have
been reduced to the pro forma amounts indicated below.
Year ended December 31,
----------------------------------
1998 1997 1996
--------- -------- -------
(in thousands, except per share data)
Net income
As reported....................... $25,703 $18,532 $14,097
Pro forma......................... $24,639 $18,182 $13,550
Net earnings per share - basic
As reported....................... $ 1.67 $ 1.29 $ 1.05
Pro forma......................... $ 1.60 $ 1.27 $ 1.00
Net earnings per share - diluted
As reported....................... $ 1.50 $ 1.17 $ 0.93
Pro forma......................... $ 1.48 $ 1.17 $ 0.90
Pro forma net income and net earnings per share reflect only options granted
in the year ended December 31, 1998, 1997, and 1996. Therefore, the full impact
of calculating compensation cost for stock options under SFAS No. 123 is not
reflected in the pro forma net income amounts presented above because
compensation cost is reflected over the options' vesting period and compensation
cost for options granted prior to April 1, 1995 is not considered.
F-17
52
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Stock options activity during the periods indicated is as follows:
Number of Weighted-Average
Shares Exercise Price
--------- ----------------
(in thousands, except per share data)
Balance at December 31, 1995.......................... 2,161 $ 3.56
Granted.......................................... 513 9.60
Exercised........................................ 395 2.82
Canceled......................................... 125 5.23
----- -------
Balance at December 31, 1996.......................... 2,154 5.04
Granted.......................................... 321 9.76
Exercised........................................ 937 2.64
Canceled......................................... 145 11.69
----- -------
Balance at December 31, 1997.......................... 1,393 7.05
Granted.......................................... 3,515 5.42
Exercised........................................ 5 8.50
Canceled......................................... 2,412 8.64
----- -------
Balance at December 31, 1998.......................... 2,491 $ 3.22
===== =======
At December 31, 1998, the range of exercise prices, the number, weighted-
average exercise price and weighted-average remaining term of options
outstanding and the number and weighted-average price of options currently
exercisable are as follows:
Weighted- Weighted Weighted-
Average Average Average
Number Remaining Exercise Number Exercise
Range of Exercise Prices Outstanding Term Price Exercisable Price
- - ------------------------ ----------- --------- -------- ----------- ---------
(in thousands, except per share data)
$2.50 - $2.88............... 224 3.99 $2.64 192 $2.62
$3.00 - $3.00............... 47 8.16 $3.00 -- $ --
$3.25 - $3.25............... 2,194 7.87 $3.25 -- $ --
$4.13 - $4.56............... 24 9.86 $4.45 -- $ --
$7.75 - $8.50............... 2 8.05 $8.30 2 $8.30
In connection with the Company's initial public offering, the Company sold to
the underwriter of the offering, for an aggregate price of $120, warrants to
purchase up to 240,000 shares of the Company's common stock at an exercise price
of $3.00 per share. The warrants were exercisable during the four year period
commencing one year from the date of the offering. The shares represented by the
warrants have been registered for public sale. During the year ended December
31, 1997 and 1996, the underwriter exercised 14,000 and 86,000 warrants,
respectively. At December 31, 1997 all warrants had been exercised.
On November 17, 1998, in conjunction with issuance of the $25.0 million
subordinated promissory note from an affiliate of LLCP, the Company issued
warrants to purchase up to 3,450,000 of common stock at $3.00 per share,
exercisable through November 30, 2005. The value of the warrants, $3.0 million,
is included in other assets as deferred interest expense to be amortized over
the expected life of the related debt, five years. As of December 31, 1998, the
warrants had not been registered for public sale. However, the holder of the
warrants has the right to require the Company register the warrants for public
sale in the future.
Also in November 1998, the Company entered into an agreement with the
Certificate Insurer of its asset-backed securities. The agreement commits the
Certificate Insurer to provide insurance for the securitization of $560.0
million in asset-backed securities, of which $250.0 million remained at December
31, 1998. The agreement provides for a 3% initial Spread Account deposit. As
consideration for the agreement, the Company issued warrants to purchase up to
2,525,114 shares of common stock at $3.00 per share. The warrants are fully
exercisable on the date of grant and expire in November 2003. The value of the
warrants, $2.2 million, is included in other assets as deferred securitization
expense to be amortized over five years. As of December 31, 1998, the warrants
had not been registered for public sale. However, the holder of the warrants has
the right to require the Company register the warrants for public sale in the
future.
F-18
53
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(11) COMMITMENTS AND CONTINGENCIES
Leases
The Company leases its facilities and certain computer equipment under
non-cancelable operating and capital leases, which expire through 2008. Future
minimum lease payments at December 31, 1998, under these leases are as follows:
Capital Operating
------- ---------
(in thousands)
1999 ........................... $ 858 $ 3,113
2000 ........................... 678 3,001
2001 ........................... 579 2,452
2002 ........................... 400 2,376
2003 ........................... 53 2,394
Thereafter ..................... -- 11,935
------- -------
Total minimum lease payments ... 2,568 $25,271
=======
Less: amount representing
interest ..................... 436
-------
Present value of net minimum
lease payments ............... $ 2,132
=======
Included in furniture and equipment in the accompanying consolidated balance
sheets are the following assets held under capital leases at December 31, 1998:
Computer equipment .................. $ 811
Furniture and fixtures .............. 2,044
---------
2,855
Less: accumulated depreciation ...... 669
---------
$ 2,186
=========
Rent expense for the years then ended December 31, 1998, 1997 and 1996, was
$1,973,304, $1,036,677 and $463,592, respectively. The Company's facility lease
contains certain rental concessions and escalating rental payments, which are
recognized as adjustments to rental expense and are amortized on a straight-line
basis over the term of the lease.
In November 1998, the Company entered into a sublease agreement for the space
which served as the Company's former headquarters in Irvine, California. The
sublease agreement extends beyond the term of the lease and provides for the
tenant to pay a base rent in excess of the lease payment required by the
Company, plus all common area maintenance charges and property taxes. During
1998, the Company received $64,289 of sublease income, which is included in
occupancy expenses. Future minimum sublease payments totaled $1,511,858 at
December 31, 1998.
Litigation
The Company is party to litigation in the ordinary course of business,
generally involving actions against automobile purchasers to collect amounts due
on purchased Contracts or to recover vehicles. In one such case, relating to the
Chapter 13 bankruptcy of obligors Madeline and Darryl Brownlee, of Chicago,
Illinois, the obligors counterclaimed against the Company on June 30, 1997 in
the bankruptcy court for the Northern District of Illinois. The obligors seek
class-action treatment of their allegation that the cost of an extended service
contract on the automobile they purchased was inadequately disclosed by the
automobile dealer, Joe Cotton Ford of Carol Stream, Illinois. The disclosure
allegedly violated the federal Truth in Lending Act and Illinois consumer
protection statutes. The plaintiffs amended their complaint in September 1998,
dropping all Truth in Lending allegations against the Company. The court in
February 1999 dismissed all remaining claims against the Company. The case
remains pending against the dealer, and there is a remote chance that a possible
appeal could result in a reinstatement of claims against the Company.
In another proceeding, arising out of efforts to collect a deficiency balance
from Joseph Barrios of Chicago, Illinois, the debtor has brought suit against
the Company alleging defects in the notice given upon repossession of the
vehicle. This
F-19
54
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
lawsuit was filed on February 18, 1998 in the circuit court of Cook County,
Illinois. A settlement of this litigation has been reached on a class basis,
which does not involve material expense.
It is management's opinion that all litigation of which it is aware,
including the matters discussed above, will not have a material adverse effect
on the Company's consolidated financial position, results of operations or
liquidity.
(12) INCOME TAXES
Income taxes consist of the following:
Year ended December 31,
---------------------------------
1998 1997 1996
------- ------- -------
(in thousands)
Current
Federal ......................... $ 3,318 $ 4,278 $ 3,060
State ........................... 1,195 922 1,151
------- ------- -------
4,513 5,200 4,211
Deferred
Federal ......................... 10,451 4,505 4,565
State ........................... 3,653 1,611 819
------- ------- -------
14,104 6,116 5,384
Income tax benefit from exercise of options
Credited to shareholders'
equity ........................... -- 2,111 --
------- ------- -------
Income taxes ................ $18,617 $13,427 $ 9,595
======= ======= =======
The Company's effective tax expense for the years ended December 31, 1998,
1997 and 1996, differs from the amount determined by applying the statutory
federal rate of 35% to income before income taxes as follows:
Year ended December 31,
--------------------------------------
1998 1997 1996
-------- -------- --------
(in thousands)
Expense at federal tax rate ............... $ 15,512 $ 11,186 $ 8,292
California franchise tax, net of
federal income tax benefit .............. 3,151 1,672 1,280
State tax benefit from exercise of options,
net of federal income tax benefit,
credited to shareholders' equity ........ -- 586 --
Other ..................................... (46) (17) 23
-------- -------- --------
$ 18,617 $ 13,427 $ 9,595
======== ======== ========
The tax affected cumulative temporary differences that give rise to deferred tax
assets and liabilities as of December 31, 1998 and 1997, are as follows:
December 31,
--------------------
1998 1997
------- -------
(in thousands)
Deferred Tax Assets:
Accrued liabilities ......... $ 1,296 $ 559
Furniture and equipment ..... 212 27
Provision for credit losses.. -- 1,106
State taxes ................. 403 1,851
Other ....................... -- 289
------- -------
1,911 3,832
Deferred Tax Liabilities:
NIRs ........................ 21,054 16,409
Provision for credit losses.. 7,511 --
Equity investments .......... 593 566
------- -------
29,158 16,975
------- -------
Net deferred tax liability... $27,247 $13,143
======= =======
F-20
55
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
In determining the possible future realization of deferred tax assets, future
taxable income from the following sources is taken into account: (a) the
reversal of taxable temporary differences, and (b) future operations exclusive
of reversing temporary differences.
The Company believes that the deferred tax asset will more likely than not be
realized due to the reversal of the deferred tax liability and expected future
taxable income.
The Company files its tax returns on a fiscal March 31, year end. During
1998, the Company's federal income tax return for the tax year ended March 31,
1995, was audited by the Internal Revenue Service. As a result of the audit, the
Company was required to pay approximately $150,000 in payroll taxes and
interest. The audit was concluded and closed during 1998.
(13) DEBT
In June 1995, the Company entered into two warehouse line of credit
agreements (collectively the "Redwood Line"). The Redwood Line provided the
Company with an interim financing facility to hold Contracts for sale prior to
being sold. The primary agreement provided for loans by Redwood Receivables
Corporation ("Redwood") to the Company, funded by commercial paper issued by
Redwood and secured by Contracts pledged periodically by the Company. The
Redwood Line provided for a maximum of $100.0 million of advances to the
Company, with interest at a variable rate indexed to prevailing commercial paper
rates. The second agreement was a standby line of credit with General Electric
Capital Corporation ("GECC"), also with a $100.0 million maximum, which the
Company would have been entitled to use only if and to the extent that Redwood
did not provide funding as described above. The GECC line was secured by
Contracts and substantially all the other assets of the Company. Both agreements
expired November 30, 1998.
In November 1998, the Company entered into a new warehouse line of credit
agreement with GECC directly ("the GECC Line"). The GECC Line provides for
warehouse facility advances up to a maximum of $100.0 million at a variable
interest rate of LIBOR + 3.75% (8.87% at December 31, 1998). The GECC Line
expires November 30, 1999.
The Company is charged a non-utilization fee of .25% per annum on the unused
portion of the GECC Line. The balance outstanding at December 31, 1998 and 1997
under the GECC and Redwood warehouse lines of credit was $21.7 million and $30.8
million, respectively.
In November 1997, the Company entered into a warehouse line of credit
agreement with First Union Capital Markets ("First Union Line"). The First Union
Line provides for a maximum of $150.0 million of advances to the Company, with
interest at a variable rate (5.05% at December 31, 1998) indexed to prevailing
commercial paper rates. In July 1998, the advance amount was increased to $200.0
million. In conjunction with the increase in maximum advance amount under the
agreement, the expiration date was changed to July 31, 1999, and is renewable
for one year with the mutual consent of the Company and First Union Capital
Markets. The balance outstanding under the First Union Line at December 31, 1998
and 1997 was $130.2 million and $30.9 million, respectively.
When the Company wishes to securitize Contracts, a majority of the proceeds
received from investors is paid to the providers of the warehouse lines,
simultaneously with their release of the pledged Contracts for transfer to a
pass-through securitization trust.
In December 1996, the Company entered into an overdraft financing facility,
with a bank, that provides for maximum borrowings of $2.0 million. Interest is
charged on the outstanding balance at the bank's reference rate (7.75% at
December 31, 1998) plus 1.75%. During 1997, the overdraft facility was increased
to $4.0 million. There were no borrowings outstanding under this facility at
December 31, 1998. The facility expires on June 1, 1999.
In April 1998, the Company established a $33.3 million revolving credit line
(the "Residual Line") with State Street Bank and Trust Company, Prudential
Insurance and an affiliate of Prudential. Borrowings under the Residual Line
bear
F-21
56
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
interest at LIBOR + 4.0% (9.54% at December 31, 1998), and are secured by all
the Company's assets, including its residual interest in securitizations. The
Residual Line is a revolving facility for one year, after which it converts into
a loan with a maximum term of four years. At December 31, 1998, the balance
outstanding under the Residual Line was $33.0 million.
In November 1998, the Company issued $25.0 million of subordinated promissory
notes due November 30, 2003, to an affiliate of Levine Leichtman Capital
Partners, Inc. ("LLCP"), and received the proceeds (net of $1.3 million of
capitalized issuance costs), of approximately $23.7 million. The Company also
issued warrants to purchase up to 3,450,000 shares of common stock at $3.00 per
share, exercisable through November 30, 2005 (see note 10). The debt bears
interest at 13.5% per annum, and may not be prepaid without penalty prior to
November 1, 2002. Simultaneously with the consummation of that transaction,
certain affiliates of the Company, who had lent the Company an aggregate of $5.0
million on a short-term basis in August and September 1998, agreed to
subordinate their indebtedness to the indebtedness in favor of LLCP, to extend
the maturity of their debt until June 2004, and to reduce their interest rate
from 15% to 12.5%. Such affiliates received in return the option to convert such
debt into an aggregate of 1,666,667 shares of common stock at the rate of $3.00
per share through maturity at June 30, 2004. Additionally, SFSC also agreed to
subordinate $6.0 million, or 40%, of its RPL in favor of LLCP.
On April 15, 1997, the Company issued $20.0 million in subordinated
participating equity notes ("PENs") due April 15, 2004. The PENs are unsecured
general obligations of the Company. Interest on the PENs is payable on the
fifteenth of each month, commencing May 15, 1997, at an interest rate of 10.5%
per annum. In connection with the issuance of the PENs, the Company incurred and
capitalized issuance costs of $1.2 million. The Company recognizes interest and
amortization expense related to the PENs using the effective interest method
over the expected redemption period. The PENs are subordinated to certain
existing and future indebtedness of the Company as defined in the indenture
agreement. The Company may at its option elect to redeem the PENs from the
registered holders, in whole but not in part, at any time on or after April 15,
2000, at 100% of their principal amount, subject to limited conversion rights,
plus accrued interest to and including the date of redemption. At maturity, upon
the exercise by the Company of an optional redemption, or upon the occurrence of
a "Special Redemption Event," each holder will have the right to convert into
common stock of the Company ("Common Stock"), 25% of the aggregate principal
amount of the PENs held by such holder at the conversion price of $10.15 per
share of Common Stock. "Special Redemption Events" are certain events related to
a change in control of the Company.
On December 20, 1995, the Company issued $20.0 million in rising interest
subordinated redeemable securities due January 1, 2006 (the "Notes"). The Notes
are unsecured general obligations of the Company. Interest on the Notes is
payable on the first day of each month, commencing February 1, 1996, at an
interest rate of 10.0% per annum. The interest rate increases 0.25% on each
January 1 for the first nine years and 0.50% in the last year. In connection
with the issuance of the Notes, the Company incurred and capitalized issuance
costs of $1.1 million. The Company recognizes interest and amortization expense
related to the Notes using the effective interest method over the expected
redemption period. The Notes are subordinated to certain existing and future
indebtedness of the Company as defined in the indenture agreement. The Company
is required to redeem, subject to certain adjustments, $1.0 million of the
aggregate principal amount of the Notes through the operation of a sinking fund
on each of January 1, 2000, 2001, 2002, 2003, 2004 and 2005. The Notes are not
redeemable at the option of the Company prior to January 1, 1998. The Company
may at its option elect to redeem the Notes from the registered holders of the
Notes, in whole or in part, at any time, on or after January 1, 1998, and prior
to January 1, 1999, at 102% of their principal amount, on or after January 1,
1999, and prior to January 1, 2000, at 101% of their principal amount, and on or
after January 1, 2000, at 100% of their principal amount, in each case plus
accrued interest to and including the date of redemption.
During the year ended December 31, 1997 the Company acquired CPS Leasing,
Inc. At December 31, 1998 and 1997, CPS Leasing, Inc. had borrowings to banks
of $2.6 million and $1.5 million, respectively
On November 16, 1993, the Company issued a $3.0 million five year convertible
subordinated note ("Note 1") to an institutional investor in conjunction with an
agreement by that investor to commit to purchase an additional $50.0 million
F-22
57
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
of the Company's Contracts. Interest accrued at 9.5% and was payable
semi-annually. On January 17, 1997, the holder converted Note 1 into 480,000
shares of the Company's common stock.
The GECC Line, First Union Line, Residual Line, PENs, Notes, LLCP notes, and
the overdraft financing facility contain various restrictive and financial
covenants. With respect to the Residual Line, certain of the pools' performance
resulted in the right for the lender of that facility to accelerate the
repayment of the outstanding borrowings. On a monthly basis to date and as of
December 31, 1998, the lender has waived their right to accelerate repayment.
With respect to the LLCP notes, as of December 31, 1998, the Company was in
violation of certain covenants. As of April 15, 1999, the holder of such notes
has waived such violations. With respect to all other borrowings listed above,
the Company is in compliance with all related financial covenants as of December
31, 1998.
(14) EMPLOYEE BENEFITS
The Company sponsors a pretax savings and profit sharing plan (the "401(k)
Plan") qualifed under section 401(k) of the Internal Revenue Code. Under the
401(k) Plan, eligible employees are able to contribute up to 15% of their
compensation (subject to stricter limitation in the case of highly compensated
employees). The Company matches 100% of employees' contributions up to $600 per
employee per calendar year. The Company's contributions to the 401(k) Plan were
$250,428, $115,684, and $63,801 for the years ended December 31, 1998, 1997 and
1996, respectively.
(15) FAIR VALUE OF FINANCIAL INSTRUMENTS
The following summary presents a description of the methodologies and
assumptions used to estimate the fair value of the Company's financial
instruments. Much of the information used to determine fair value is highly
subjective. When applicable, readily available market information has been
utilized. However, for a significant portion of the Company's financial
instruments, active market values do not exist. Therefore, considerable
judgments were required in estimating fair value for certain items. The
subjective factors include, among other things, the estimated timing and amount
of cash flows, risk characteristics, credit quality and interest rates, all of
which are subject to change. Since the fair value is estimated as of December
31, 1998 and 1997, the amounts that will actually be realized or paid at
settlement or maturity of the instruments could be significantly different. The
estimated fair values of financial assets and liabilities at December 31, 1998
and 1997, were as follows:
December 31,
--------------------------------------------------
1998 1997
---------------------- ----------------------
Carrying Carrying
Value or Value or
Notional Fair Notional Fair
Financial Instrument Amount Value Amount Value
- - -------------------- -------- -------- -------- --------
(in thousands)
Cash ............................... $ 1,940 $ 1,940 $ 1,745 $ 1,745
Restricted cash .................... 1,619 1,619 -- --
Contracts held for sale ............ 165,582 169,958 68,271 70,900
Residual interest in securitizations 217,848 217,848 124,616 124,616
Related party receivables .......... 3,268 3,268 7,295 7,295
Commitments ........................ 2,313 61 3,774 145
Warehouse lines of credit .......... 151,857 151,857 61,666 61,666
Notes payable ...................... 2,557 2,557 1,506 1,506
Residual financing ................. 33,000 33,000 -- --
Subordinated debt .................. 65,000 65,000 40,000 40,000
Related party debt ................. 20,000 20,000 15,055 15,055
Cash and Restricted Cash
The carrying value equals fair value.
F-23
58
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Contracts Held for Sale
The fair value of the Company's contracts held for sale is determined by
purchase commitments from investors and prevailing market rates.
Residual Interest in Securitizations
The fair value is estimated by discounting future cash flows using credit and
discount rates that the Company believes reflect the estimated credit, interest
rate and prepayment risks associated with similar types of instruments.
Related Party Receivables
The carrying value approximates fair value because the related interest rates
are estimated to reflect current conditions for similar types of investments.
Commitments
The fair value of commitments to purchase contracts from Dealers is
determined by purchase commitments from investors and prevailing market rates.
Warehouse Line of Credit
The carrying value approximates fair value because the warehouse line of
credit is short-term in nature and the related interest rates are estimated to
reflect current market conditions for similar types of instruments.
Notes Payable, Residual Financing, Subordinated and Related Party Debt
The carrying value approximates fair value because the related interest rates
are estimated to reflect current market conditions for similar types of
instruments.
(16) LIQUIDITY
The Company's business requires substantial cash to support its operating
activities. The Company's primary sources of cash from operating activities are
amounts borrowed under its various warehouse lines, servicing fees on portfolios
of Contracts previously sold, proceeds from the sales of Contracts, customer
payments on Contracts held for sale, interest earned on Contracts held for sale,
and releases of cash from Spread Accounts. The Company's primary uses of cash
are the purchases of Contracts, repayment of amounts borrowed under its various
warehouse lines, operating expenses such as employee, interest, and occupancy
expenses, the establishment of and further contributions to Spread Accounts and
income taxes. As a result, the Company is dependent on its warehouse lines of
credit and its residual financing facility in order to finance its continued
operations. If the Company's principal lenders decided to terminate or not to
renew any of these credit facilities with the Company, the loss of borrowing
capacity would have a material adverse effect on the Company's results of
operations unless the Company found a suitable alternative source.
The Servicing Agreements call for the requisite levels of the various Spread
Accounts to increase if the related receivables experience delinquencies,
repossessions or net losses in excess of certain predetermined levels. At
December 31, 1998, 18 of the Company's 22 securitized pools were at higher than
original requisite levels due to the delinquency, repossession or net loss
performance of 13 of the 22 securitized pools. Such Spread Account balances
therefore included approximately $24.3 million more than would have been
required at the original requisite levels. The higher requisite Spread Account
levels ranged from 30% to 100% of the related outstanding balance of the
securitized pools. In April 1999, the Company entered into an amendment with the
Certificate Insurer of the Company's asset-backed securities to cap the amount
of cash retained in the Spread Accounts at 21% of the outstanding securities
balance for 19 of the Company's 22 securitized pools. The effectiveness of the
amendment is contingent upon approval of certain subordinated
F-24
59
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Certificateholders. This new cap on the Spread Accounts described above is
expected to provide cash flows to the Company during 1999. The amendment is
subject to certain performance measures that may result in an increase in the
cap from 21% to 25%. There can be no assurance that such cash flows will occur.
In addition to requiring higher Spread Account levels, the Servicing Agreements
provide the Certificate Insurer with certain other rights and remedies, which
have been waived on a monthly basis by the Certificate Insurer.
On April 15, 1999, the Company issued $5.0 million of subordinated promissory
notes to LLCP and received proceeds (net of $250,000 of capitalized issuance
costs) of approximately $4.75 million. The debt includes certain covenants one
of which is the infusion of $15.0 million of debt during 1999 by SFSC. SFSC's
commitment in turn has been collateralized by certain assets pledged by the
chairman of the Company's board of directors and the president of the Company.
Additionally, the $5.0 million has been personally guaranteed by the chairman of
the Company's board of directors and the president of the Company.
The Company did not sell any Contracts in the first quarter of 1999, and is
currently evaluating alternatives for selling its Contracts during the second
quarter of 1999. Alternatives being considered by the Company include various
securitization structures, unsecuritized sale of Contracts, or perhaps, some
combination of both alternatives. The Company has received a letter of intent
from an investor to purchase up to $300.0 million of the Company's Contracts on
an unsecured basis in the second quarter. There can be no assurance that such a
sale will take place.
In the event the Company incurs a net loss in two consecutive quarters it
would be in default of its agreements for the Residual Line. Unless waived by
the lender, the default could result in acceleration of the Residual Line and a
cross default on the Warehouse Lines. The lender would receive any releases from
Spread Accounts to retire outstanding principal and interest. The Company
believes that the lender would waive the default. In the event the lender does
not waive the default, the Company believes that cash flows from operations
would be sufficient to fund its obligations as they become due and payable.
There can be no assurance, however, that the lender would waive the default or
that other cash flows will be sufficient to fund the Company's operations.
(17) SUBSEQUENT EVENTS
In an effort to conserve capital, the Company intends to dispose of and/or
terminate the operations of three of its subsidiaries; Samco, LINC and CPS
Leasing, Inc. During the first quarter of 1999, all operations of Samco were
terminated and all personnel were laid off. The Company is utilizing the
building and equipment that is owned and/or leased as an asset recovery
facility.
On April 15, 1999, the Company issued $5.0 million of subordinated promissory
notes bearing interest at 14.50% per annum, to LLCP and received proceeds (net
of $250,000 of capitalized issuance costs) of approximately $4.75 million. The
Company also issued warrants to purchase 1,335,000 shares of the Company's
common stock at $0.01 per share to LLCP. The warrants are subject to shareholder
approval and if approved, will be exerciseable through April 2009. As part of
the purchase agreement, the interest rate on the previous LLCP notes will
increase to 14.50% and the 3,450,000 warrants to purchase shares of the
Company's common stock at $3.00 per share were reduced to 3,115,000 at a price
of $0.01 per share.
F-25
60
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(18) SELECTED QUARTERLY DATA (UNAUDITED)
QUARTER QUARTER QUARTER QUARTER
ENDED ENDED ENDED ENDED
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
--------- -------- ------------- ------------
(in thousands, except per share data)
1998
Revenues .............. $24,782 $29,724 $34,577 $37,197
Income before income taxes 9,658 10,240 10,744 13,678
Net income ............ 5,603 5,925 6,238 7,937
Earnings per share:
Basic ............... $ 0.37 $ 0.39 $ 0.40 $ 0.51
Diluted ............. $ 0.34 $ 0.36 $ 0.38 $ 0.44
1997
Revenues .............. $15,230 $17,542 $20,231 $22,248
Income before income taxes 7,143 7,549 8,309 8,958
Net income ............ 4,145 4,386 4,816 5,185
Earnings per share:
Basic ............... $ 0.29 $ 0.31 $ 0.34 $ 0.36
Diluted ............. $ 0.27 $ 0.28 $ 0.30 $ 0.32
1996
Revenues .............. $ 9,699 $11,763 $12,910 $14,066
Income before income taxes 5,101 5,517 6,451 6,623
Net income ............ 3,051 3,271 3,834 3,941
Earnings per share:
Basic ............... $ 0.23 $ 0.24 $ 0.28 $ 0.29
Diluted ............. $ 0.20 $ 0.22 $ 0.25 $ 0.26
F-26
61
EXHIBIT INDEX
Exhibit
Number Description
- - ------ -----------
3.1 Restated Articles of Incorporation (incorporated by reference to exhibit
filed with registrant's report on Form 10-KSB dated December 31, 1995)
3.2 Amended and Restated Bylaws. (incorporated by reference to exhibit filed
with registrant's report on Form 10-K dated December 31, 1997)
4.Indenture re Rising Interest Subordinated Redeemable Securities
("RISRs") (incorporated by reference to exhibit filed with registrant's
report on Form 8-K filed December 26, 1995)
4.2 First Supplemental Indenture re RISRs (incorporated by reference to
exhibit filed with registrant's report on Form 8-K filed December 26,
1995)
4.3 Form of Indenture re 10.50% Participating Equity Notes ("PENs")
(incorporated by reference to exhibit filed with registrant's
registration statement on Form S-3, no. 333-21289)
4.4 Form of First Supplemental Indenture re PENs (incorporated by reference
to exhibit filed with registrant's registration statement on Form S-3,
no. 333-21289)
10.1 1991 Stock Option Plan & forms of Option Agreements thereunder
(incorporated by reference to exhibit filed with registrant's report on
Form 10-KSB dated March 31, 1994)
10.2 1997 Long-Term Incentive Stock Plan (incorporated by reference to exhibit
filed with registrant's report on Form 10-K dated December 31, 1997)
10.3 Purchase Agreement relating to PENs. (incorporated by reference to
exhibit filed with registrant's registration statement on Form S-3 no.
333-21289)
10.4 Lease Agreement, First Amendment to Lease, Assignment and Assumption of
Lease (incorporated by reference to exhibit filed with registrant's
registration statement on Form S-1, no. 33-49770)
10.5 Amendment #2 to Lease Agreement, First Amendment to Lease and Assignment
and Assumption of Lease. (incorporated by reference to exhibit filed with
registrant's report on Form 10-KSB, dated March 31, 1995)
10.6 Lease Agreement re Chesapeake Collection Facility. (incorporated by
reference to exhibit filed with registrant's report on Form 10-K dated
December 31, 1996)
10.7 Consulting Agreement. (incorporated by reference to exhibit filed with
registrant's report on Form 10-KSB dated December 31, 1995)
10.8 Agreement to Build and Lease Headquarters Building. (incorporated by
reference to exhibit filed with registrant's report on Form 10-Q dated
September 30, 1997)
10.9 Lease of Headquarters Building. (incorporated by reference to exhibit
filed with registrant's report on Form 10-Q dated September 30, 1997)
62
10.10 Amended and Restated Motor Vehicle Installment Contract Loan and Security
Agreement re Redwood Warehouse Line. (incorporated by reference to
exhibit filed with registrant's report on Form 10-KSB dated December 31,
1995)
10.11 The Receivables Funding and Servicing Agreement re Redwood Warehouse
Line. (incorporated by reference to exhibit filed with registrant's
report on Form 10-KSB dated December 31, 1995)
10.12 Partially Convertible Subordinated Note. (incorporated by reference to
exhibit filed with registrant's report on Form 10-Q dated September 30,
1997)
10.13 Registration Rights Agreement. (incorporated by reference to exhibit
filed with registrant's report on Form 10-Q dated September 30, 1997)
10.14 Receivables Funding and Servicing Agreement relating to First Union
Warehouse Line (incorporated by reference to exhibit filed with
registrant's report on Form 10-K dated December 31, 1997)
10.14a Amendment dated July 17, 1998 to the Receivables Funding and Servicing
Agreement relating to First Union Warehouse Line (incorporated by
reference to exhibit filed with registrant's report on Form 10-Q filed
August 14, 1998)
10.15 Receivables Transfer Agreement relating to First Union Warehouse Line
(incorporated by reference to exhibit filed with registrant's report on
Form 10-K dated December 31, 1997)
10.16 Residual Interest in Securitizations Revolving Credit and Term Loan
Agreement dated as of April 30, 1998, between registrant and State Street
Bank and Trust Company (incorporated by reference to exhibit filed with
registrant's report on 10-Q filed 5/15/98)
10.16a Second Amendment Agreement dated November 17, 1998 re: State Street
residual interest in Securitizations Revolving Credit and Term Loan
Agreement (filed herewith)
10.17 Pledge and Security Agreement dated as of April 30, 1998, between the
Company and State Street Bank and Trust Company (incorporated by
reference to exhibit filed with registrant's report on Form 10-Q filed
May 15, 1998)
10.18 Revolving Credit and Term Note dated April 30, 1998, (the "State Street
Note") (incorporated by reference to exhibit filed with registrant's
report on Form 10-Q filed May 15, 1998)
10.19 Subscription Agreement regarding shares issued in July 1998 (incorporated
by reference to exhibit filed with registrant's report on Form 10-Q filed
August 14, 1998)
10.20 Registration Rights Agreement regarding shares issued in July 1998
(incorporated by reference to exhibit filed with registrant's report on
Form 10-Q filed August 14, 1998)
10.21 Line of Credit Note Issued to Stanwich Financial Services Corp. (the "
1998 Stanwich Note") (incorporated by reference to exhibit filed with
registrant's report on Form 10-K filed March 3, 1998)
10.22 Amended and Restated Motor Vehicle Installment Contract Loan and Security
Agreement (filed herewith)
10.23 FSA Warrant Agreement dated November 30, 1998 (filed herewith)
10.24 Securities Purchase Agreement dated November 17, 1998 (incorporated by
reference to exhibit filed with the statement on Schedule 13D filed with
respect to the registrant on November 25, 1988, by Levine Leichtman
Capital Partners II L.P. and others (the "LLCP report")
63
10.25 Senior Subordinated Primary Note dated November 17, 1998 (incorporated by
reference to exhibit filed with the LLCP report)
10.26 Primary Warrant to purchase 3,450,000 shares of common stock dated
November 17, 1998 (incorporated by reference to exhibit filed with the
LLCP report)
10.27 Investor Rights Agreement dated November 17, 1998 (incorporated by
reference to exhibit filed with the LLCP report)
10.28 Registration Rights Agreement dated as of November 17, 1998 (incorporated
by reference to exhibit filed with the LLCP report)
10.29 Subordination Agreement dated as of November 17, 1998 re: Stanwich Note
and Poole Note (filed herewith)
10.30 Consolidated Registration Rights Agreement dated November 17, 1998 re:
1997 Stanwich Notes (filed herewith)
23.1 Consent of independent auditors. (filed herewith)
27 Financial Data Schedule. (filed herewith)
99.1 Cautionary Statement.*
- - ----------
* To be filed by amendment