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UNITED STATES
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, 2003
[ ] 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: Name of each exchange on which registered:
10.50% Participating Equity Notes due 2004 New York Stock Exchange
Rising Interest Subordinated Redeemable Securities due 2006 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) has 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 disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not 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. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [ ] No [X]
The aggregate market value of common equity held by non-affiliates of the
registrant as of the last business day of the registrant's most recently
completed second fiscal quarter (June 30, 2003) was $38,463,000, based upon the
$2.74 per share closing price of the Common Stock on that date, as reported by
the Nasdaq Stock Market. The number of shares of the registrant's Common Stock
outstanding on March 16, 2004, was 20,705,324.
DOCUMENTS INCORPORATED BY REFERENCE
The registrant's proxy statement for its 2004 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 purchasing, selling
and servicing retail automobile installment purchase 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.
CPS was incorporated and began its operations in 1991. From inception through
December 31, 2003, the Company has purchased approximately $4.9 billion of
Contracts from Dealers. In addition, the Company obtained a total of
approximately $530 million of Contracts in its 2002 and 2003 acquisitions,
described below. As of December 31, 2003, the Company had a total managed
portfolio, net of unearned interest on pre-computed Contracts, of approximately
$741.1 million, including the remaining outstanding balance of Contracts
acquired in the two acquisitions.
ACQUISITIONS
In March 2002, the Company acquired MFN Financial Corporation and its
subsidiaries in a merger (the "MFN Merger"). In May 2003, the Company acquired
TFC Enterprises, Inc. and its subsidiaries in a second merger (the "TFC
Merger"). MFN Financial Corporation and its subsidiaries ("MFN") and TFC
Enterprises, Inc. and its subsidiaries ("TFC") were engaged in businesses
similar to that of the Company; buying Contracts from Dealers, repackaging those
Contracts in securitization transactions, and servicing those Contracts. The
Company acquired approximately $380 million of Contracts in the MFN Merger, and
approximately $150 million in the TFC Merger. MFN ceased acquiring Contracts in
March 2002; TFC continues to acquire Contracts under its "TFC Programs," on
terms and conditions similar to those it used prior to the TFC Merger. Contracts
purchased by TFC after the TFC Merger accounted for less than 10% of the total
purchases during the year.
SECURITIZATIONS
GENERALLY
Throughout the periods for which information is presented in this report, the
Company has purchased Contracts with the intention of repackaging them in
securitizations. All such securitizations have involved identification of
specific Contracts, sale of those Contracts (and associated rights) to a special
purpose subsidiary of the Company, and issuance of asset-backed securities to
fund the transactions. Depending on the structure of the securitization, the
transaction may be properly accounted for as a sale of the Contracts, or as a
secured financing.
When structured to be treated as a secured financing, the subsidiary is
consolidated with the Company. Accordingly, the sold Contracts and the related
securitization trust debt appear as assets and liabilities, respectively, of the
Company on its Consolidated Balance Sheet. The Company then recognizes interest
and fee income on the receivables and interest expense on the securities issued
in the securitization, and records as expense a provision for probable credit
losses on the receivables.
When structured to be treated as a sale, the subsidiary is not consolidated with
the Company. Accordingly, the securitization removes the sold Contracts from the
Company's Consolidated Balance Sheet, the asset-backed securities (debt of the
non-consolidated subsidiary) do not appear as debt of the Company, and the
Company shows as an asset a retained residual interest in the sold Contracts.
The residual interest represents the discounted value of what the Company
expects will be the excess of future collections on the Contracts over principal
and interest due on the asset-backed securities and other expenses. That
residual interest appears on the Company's Consolidated Balance Sheet as
"Residual interest in securitizations," and its value is dependent on estimates
of the future performance of the sold Contracts.
CHANGE IN POLICY
During August 2003 the Company announced that it would structure its future
securitization transactions to be reflected as secured financings for financial
accounting purposes. The first two term securitizations so structured occurred
in September and December 2003. The Company had structured all of its prior term
securitization transactions related to the CPS programs to be reflected as sales
for financial accounting purposes. In the MFN Merger and TFC Merger the Company
acquired finance receivables that had been previously securitized in term
securitization transactions that were reflected as secured financings. As of
December 31, 2003, the Company's Consolidated Balance Sheet included net finance
receivables of approximately $119.6 million and securitization trust debt of
$95.9 million related to finance receivables acquired in the two mergers, out of
totals of net finance receivables of approximately $266.2 million and
securitization trust debt of approximately $245.1 million.
CREDIT RISK RETAINED
Whether a securitization is treated as a secured financing or as a sale for
financial accounting purposes, the related special purpose subsidiary may be
unable to release excess cash to the Company if the credit performance of the
securitized Contracts falls short of pre-determined standards. Such releases
represent a material portion of the cash that the Company uses to fund its
operations. An unexpected deterioration in the performance of securitized
Contracts could therefore have a material adverse effect on both the Company's
liquidity and its results of operations, regardless of whether such Contracts
are treated as having been sold or as having been financed. For estimation of
the magnitude of such risk, it may be appropriate to look to the size of the
Company's "managed portfolio," which represents both financed and sold Contracts
as to which such credit risk is retained. The Company's managed portfolio as of
December 31, 2003 was approximately $741.1 million. See "-- Securitization of
Contracts," "-- The Servicing Agreements," "--Management's Discussion and
Analysis of Financial Condition and Results of Operations," and "--Liquidity and
Capital Resources."
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 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
sustains a higher level of credit losses than traditional automobile financing
sources since the Company provides financing in a relatively high risk market.
2
MARKETING
The Company directs its marketing efforts to Dealers, rather than to consumers.
As of December 31, 2003, the Company was a party to its standard form dealer
agreements ("Dealer Agreements") with over 3,000 Dealers. Approximately 95% of
these Dealers are franchised new car dealers that sell both new and used cars
and the remainders are independent used car dealers. For the year ended December
31, 2003, approximately 85% of the Contracts purchased by CPS (under the "CPS
programs") consisted of financing for used cars and the remaining 15% for new
cars, as compared to 88% used and 12% new in the year ended December 31, 2002.
The Company establishes relationships with Dealers through Company
representatives who contact a prospective Dealer to explain the Company's
Contract purchase programs, and who thereafter provide Dealer training and
support services. As of December 31, 2003, the Company had 42 representatives.
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.
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, 2003, no Dealer accounted for more
than 1% of the total number of Contracts purchased by the Company under the CPS
programs. The following table sets forth the geographical sources of the
Contracts purchased by the Company under the CPS programs (based on the
addresses of the customers as stated on the Company's records) during the years
ended December 31, 2003 and 2002. Contracts purchased by MFN are not included in
the table as MFN Contract purchases were terminated shortly after the MFN
Merger. Contracts purchased by TFC after the TFC Merger are not included because
such purchases accounted for less than 10% of the total purchases during the
year. All Contracts are acquired from Dealers located within the United States.
3
CONTRACTS PURCHASED DURING THE YEAR ENDED (1)
---------------------------------------------
DECEMBER 31, 2003 DECEMBER 31, 2002
------------------- ------------------
NUMBER PERCENT (2) NUMBER PERCENT (2)
------- ------ ------- ------
Texas .................. 2,333 9.8% 3,313 10.3%
Louisiana .............. 1,637 6.8 1,680 5.2
Pennsylvania ........... 1,567 6.6 1,539 4.8
Illinois ............... 1,466 6.1 2,274 7.1
California ............. 1,461 6.1 2,111 6.5
Ohio ................... 1,398 5.8 1,733 5.4
Florida ................ 1,343 5.6 1,453 4.5
North Carolina ......... 1,281 5.4 1,979 6.1
Michigan ............... 1,258 5.3 1,776 5.5
Maryland ............... 1,070 4.5 945 2.9
Georgia ................ 1,046 4.4 1,831 5.7
Kentucky ............... 948 4.0 1,449 4.5
New York ............... 932 3.9 1,215 3.8
Alabama ................ 814 3.4 1,288 4.0
Other States ........... 5,346 22.4 7,669 23.7
------- ------ ------- ------
Total .................. 23,900 100.0% 32,255 100.0%
======= ====== ======= ======
____________
(1) Excludes purchases under the TFC programs.
(2) Amounts may not total 100% due to rounding.
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 on the monthly payment that will be offered to the automobile buyer,
the 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 information 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 credit analyst, it is determined that the Contract 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
two hours as to whether it would purchase the related Contract. The Company's
TFC subsidiaries seek to finance only vehicle purchases by members of the United
States armed forces. The Contract purchase decision process for the TFC programs
does not make use of credit reports, but relies on verification of military
status.
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. During 2001 and the
first quarter of 2002 the Company immediately sold most of the Contracts that it
purchased, and held the remainder for its own account. See "--Flow Purchase
Program."
The Company purchases Contracts under the CPS programs from Dealers at a price
generally equal to the total amount financed under the Contracts, adjusted for
an acquisition fee, which varies based on the perceived credit risk and, in some
cases, the interest rate on the Contract. For the years ended December 31, 2003,
2002 and 2001, the average acquisition fee charged per Contract purchased under
the CPS programs was $372, $313 and $355, respectively, or 2.7%, 2.2% and 2.4%,
respectively, of the amount financed. The Company also purchases certain
Contracts under the CPS programs for a premium over the amount financed. The
4
Company is willing to pay a premium when it estimates the credit risk to be low,
compared to that of other Contracts that it purchases. During 2003, 2002 and
2001, respectively, the Company purchased 6,618, 9,971 and 9,962 of these
Contracts, representing approximately 27.7%, 30.9% and 21.7% of all Contracts
purchased under the CPS programs. The average premium paid to Dealers on these
Contracts was $447, $435 and $172, respectively.
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 willingness or the financial resources to satisfy its
repurchase obligations to the Company.
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 interest rate; mileage, age and type of vehicle; principal amount of the
Contract in relation to the value of the vehicle; customer income level,
employment and residence stability, credit history and debt service ability; and
other factors. Specifically, the Company's guidelines for the CPS programs limit
the maximum principal amount of a purchased Contract to 115% of wholesale book
value in the case of used vehicles or to 115% 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
seven model years old or have in excess of 85,000 miles. Under most CPS
programs, the maximum term of a purchased Contract is 72 months; a shorter
maximum term may be applied based on the mileage of the vehicle, and Contracts
with the maximum term of 72 months may be purchased if the customer is among the
more creditworthy of CPS's obligors and the vehicle is not more than two model
years old and has less than 30,000 miles. 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. In addition, prior to
purchasing a Contract under the CPS programs, CPS contacts each customer by
telephone to confirm that the Customer understands and agrees to the terms of
the related Contract.
CREDIT SCORING. Under the CPS programs, the Company uses a proprietary scoring
model to assign to each Contract a "credit score" at the time the application is
received from the Dealer and the customer's credit information is retrieved from
the credit reporting agencies. The credit score is based on a variety of
parameters, such as the customer's employment 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 improving its allocation of credit
evaluation resources, and managing the risk inherent in the sub-prime market.
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.
5
The average original principal amount financed under Contracts purchased, under
the CPS programs, and in the year ended December 31, 2003, was approximately
$13,738, with an average original term of approximately 60.2 months and an
average down payment amount of 13.5%. Based on information contained in customer
applications, for this 12-month period, the retail purchase price of the related
automobiles averaged $14,104 (which excludes tax, 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 three years, and CPS customers
averaged approximately 38 years of age, with approximately $37,440 in average
annual household income and an average of 5.3 years' history with his or her
current employer.
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. The
Company generally does 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 could render a Contract unenforceable. 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 particular Dealer will satisfy any such
repurchase obligations to the Company.
SERVICING OF CONTRACTS
GENERAL. The Company's servicing activities consist of mailing monthly billing
statements; 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 liquidating the collateral when necessary; and
generally monitoring each Contract and the 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.
6
With the aid of its high-penetration automatic dialer, as well as manual efforts
made by collection staff, 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 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 as 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 promise 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 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 the Company 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. The Uniform Commercial
Code ("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 that have been
repossessed are generally resold by the Company through unaffiliated automobile
auctions, which are attended principally by car dealers. Net liquidation
proceeds are applied to the customer's outstanding obligation under the
Contract. Such proceeds usually are insufficient to pay the customer's
obligation in full, resulting in a deficiency.
Under the UCC and other laws applicable in most states, a creditor is entitled
to obtain a judgment against a customer for such a deficiency. However, some
states impose prohibitions or limitations on deficiency judgments. When
obtained, deficiency judgments 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.
CREDIT EXPERIENCE
The Company's financial results are dependent on the performance of the
Contracts in which it retains an ownership interest. The tables below document
the delinquency, repossession and net credit loss experience of all Contracts
that the Company was servicing as of the respective dates shown. Credit
experience for CPS, MFN (since the date of the MFN Merger) and TFC (since the
date of the TFC Merger) is shown on both a combined and individual basis in the
tables below.
7
DELINQUENCY EXPERIENCE (1)
CPS, MFN AND TFC COMBINED
DECEMBER 31, 2003 DECEMBER 31, 2002 DECEMBER 31, 2001
--------------------- --------------------- ---------------------
NUMBER OF NUMBER OF NUMBER OF
CONTRACTS AMOUNT CONTRACTS AMOUNT CONTRACTS AMOUNT
--------- --------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
Gross servicing portfolio (1)... 84,860 $773,220 86,940 $616,519 44,080 $288,756
Period of delinquency (2)
31-60 days ..................... 2,506 17,982 3,658 18,388 2,149 12,409
61-90 days ..................... 1,340 8,942 1,541 6,595 721 4,018
91+ days ....................... 1,522 9,452 825 3,422 552 3,488
--------- --------- --------- --------- --------- ---------
Total delinquencies (2) ........ 5,368 36,376 6,024 28,405 3,422 19,915
Amount in repossession (3) ..... 1,242 11,751 1,402 10,835 787 5,757
--------- --------- --------- --------- --------- ---------
Total delinquencies and amount
in repossession (2) ......... 6,610 $ 48,127 7,426 $ 39,240 4,209 $ 25,672
========= ========= ========= ========= ========= =========
Delinquencies as a percentage of
gross servicing portfolio ... 6.3% 4.7% 6.9% 4.6% 7.8% 6.9%
Total delinquencies and
amount in repossession as
a percentage of gross
servicing portfolio ......... 7.8% 6.2% 8.5% 6.4% 9.6% 8.9%
CPS
DECEMBER 31, 2003 DECEMBER 31, 2002 DECEMBER 31, 2001
--------------------- --------------------- ---------------------
NUMBER OF NUMBER OF NUMBER OF
CONTRACTS AMOUNT CONTRACTS AMOUNT CONTRACTS AMOUNT
--------- --------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
Gross servicing portfolio (1)... 47,615 $543,776 43,244 $394,845 44,080 $288,756
Period of delinquency (2)
31-60 days ..................... 1,175 11,766 1,734 10,738 2,149 12,409
61-90 days ..................... 657 5,719 643 3,619 721 4,018
91+ days ....................... 393 3,105 282 1,508 552 3,488
--------- --------- --------- --------- --------- ---------
Total delinquencies (2) ........ 2,225 20,590 2,659 15,865 3,422 19,915
Amount in repossession (3) ..... 725 8,434 654 6,305 787 5,757
--------- --------- --------- --------- --------- ---------
Total delinquencies and amount
in repossession (2) ......... 2,950 $ 29,024 3,313 $ 22,170 4,209 $ 25,672
========= ========= ========= ========= ========= =========
Delinquencies as a percentage of
gross servicing portfolio.... 4.7% 3.8% 6.2% 4.0% 7.8% 6.9%
Total delinquencies and
amount in repossession as
a percentage of gross
servicing portfolio ......... 6.2% 5.3% 7.7% 5.6% 9.6% 8.9%
8
MFN
DECEMBER 31, 2003 DECEMBER 31, 2002
--------------------- ---------------------
NUMBER OF NUMBER OF
CONTRACTS AMOUNT CONTRACTS AMOUNT
--------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
Gross servicing portfolio (1) .. 20,282 $ 77,717 43,696 $221,674
Period of delinquency (2)
31-60 days ..................... 769 2,128 1,924 7,650
61-90 days ..................... 327 843 898 2,976
91+ days ....................... 227 532 543 1,914
--------- --------- --------- ---------
Total delinquencies (2) ........ 1,323 3,503 3,365 12,540
Amount in repossession (3) ..... 369 1,899 748 4,530
--------- --------- --------- ---------
Total delinquencies and amount
in repossession (2) ......... 1,692 $ 5,402 4,113 $ 17,070
========= ========= ========= =========
Delinquencies as a percentage of
gross servicing portfolio ... 6.5% 4.5% 7.7% 5.7%
Total delinquencies and
amount in repossession
as a percentage of gross
servicing portfolio ......... 8.3% 7.0% 9.4% 7.7%
9
TFC
DECEMBER 31, 2003
--------------------------
NUMBER OF
CONTRACTS AMOUNT
--------- ---------
(DOLLARS IN THOUSANDS)
Gross servicing portfolio (1) ................ 16,963 $151,727
Period of delinquency (2)
31-60 days ................................... 562 4,088
61-90 days ................................... 356 2,380
91+ days ..................................... 902 5,815
--------- ---------
Total delinquencies (2) ...................... 1,820 12,283
Amount in repossession (3) ................... 148 1,418
--------- ---------
Total delinquencies and amount
in repossession (2) ....................... 1,968 $ 13,701
========= =========
Delinquencies as a percentage of
gross servicing portfolio ................. 10.7% 8.1%
Total delinquencies and amount
in repossession as a percentage
of gross servicing portfolio .............. 11.6% 9.0%
____________
(1) All amounts and percentages are based on the amount remaining to be repaid
on each Contract, including, for pre-computed Contracts, any unearned interest.
The information in the table represents the gross principal amount of all
Contracts purchased by the Company on an other than flow basis, including
Contracts subsequently sold by the Company in securitization transactions that
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.
NET CHARGE-OFF EXPERIENCE (1)
CPS, MFN AND TFC COMBINED
YEAR ENDED DECEMBER 31,
---------------------------------------
2003 2002 2001
----------- ----------- -----------
(DOLLARS IN THOUSANDS)
Average servicing portfolio outstanding ...... $ 674,523 $ 524,286 $ 341,498
Net charge-offs as a percentage of average
servicing portfolio (2) (3) .................. 6.8% 8.6% 6.2%
CPS
YEAR ENDED DECEMBER 31,
---------------------------------------
2003 2002 2001
----------- ----------- -----------
(DOLLARS IN THOUSANDS)
Average servicing portfolio outstanding ...... $ 483,647 $ 291,863 $ 341,498
Net charge-offs as a percentage of average
servicing portfolio (2) ...................... 4.7% 5.0% 6.2%
10
MFN
YEAR ENDED DECEMBER 31,
-------------------------
2003 2002
----------- -----------
(DOLLARS IN THOUSANDS)
Average servicing portfolio outstanding ...... $ 123,140 $ 278,908
Net charge-offs as a percentage of average
servicing portfolio (2) ...................... 12.6% 11.0%
TFC
YEAR ENDED DECEMBER 31, 2003
----------------------------
(DOLLARS IN THOUSANDS)
Average servicing portfolio outstanding ...... $ 133,428
Net charge-offs as a percentage of average
servicing portfolio (2) (4) .................. 11.3%
___________
(1) All amounts and percentages are based on the principal amount scheduled to
be paid on each Contract, net of unearned income on pre-computed Contracts. The
information in the table represents all Contracts serviced by the Company.
(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).
(3) The fluctuation in net charge-offs as a percentage of the average servicing
portfolio between 2002 and 2001 is primarily due to the addition of MFN
Contracts, which are anticipated to charge off at rates greater than CPS
Contracts.
(4) TFC Contracts are expected to charge off at rates greater than CPS. To
partially compensate for this higher risk, TFC Contracts are purchased with a
higher acquisition fee than CPS Contracts.
FLOW PURCHASE PROGRAM
From May 1999 through the second quarter of 2002, the Company purchased
Contracts primarily for immediate and outright resale to non-affiliated third
parties. The Company sold such Contracts for a mark-up above what the Company
paid the Dealer. In such sales, the Company made certain representations and
warranties to the purchasers, normal in the industry, which related primarily to
the legality of the sale of the underlying motor vehicle and to the validity of
the security interest that conveyed to the purchaser. These representations and
warranties were generally similar to the representations and warranties given by
the originating Dealer to the Company. In the event of a breach of such
representations or warranties, the Company might incur liabilities in favor of
the purchaser(s) of the Contracts and there can be no assurance that the Company
would be able to recover, in turn, against the originating Dealer(s).
One of the two flow purchasers ceased to purchase Contracts in December 2001,
and the other ceased to purchase in May 2002. The flow purchase program
accordingly ended at that time.
SECURITIZATION OF CONTRACTS
The Company purchases Contracts for resale in or to be financed through
securitization transactions. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Liquidity and Capital
Resources" and Note 1 of Notes to Consolidated Financial Statements. During
2003, the Company funded such purchases primarily with proceeds from three
short-term revolving warehouse lines of credit. These warehouse lines of credit
included a $125 million floating rate variable funding note facility, a $75
million floating rate variable funding note facility and a $25 million floating
rate variable funding note facility. The first two warehouse facilities provided
funding for Contracts purchased under CPS' programs while the third facility
provided funding for Contracts purchased under TFC's programs. On February 21,
2004, the $75 million facility expired and, as a result, the Company's current
warehouse credit capacity is $150 million. These facilities are independent of
each other. Two different institutions purchased the notes issued by these
11
facilities and three different insurers insured the notes. Approximately 71.6%
to 73.0% of the principal balance of Contracts may be advanced to the Company
under these facilities, subject to collateral tests and certain other conditions
and covenants. Long-term funding for the purchase of Contracts is achieved by
the Company through term securitization transactions, in which the liabilities
(the asset-backed securities) are repaid as the underlying Contracts amortize.
Proceeds from term securitization transactions are used primarily to repay the
warehouse facilities. The Company completed four term securitization
transactions in 2003 and three term securitization transactions in 2002.
In a securitization, 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 the principal balance plus accrued and unpaid
interest. 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 principal 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 or financing of a portfolio of Contracts in a securitization
transaction, generally utilizing a trust that is specifically created for such
purpose ("Trust"), the Company retains the obligation to service the Contracts,
and receives a monthly fee for doing so. Among other services performed, the
Company mails to obligors monthly billing statements directing them to mail
payments on the Contracts to a lockbox account. The Company engages an
independent lockbox processing agent to retrieve and process payments received
in the lockbox account. This results in a daily deposit to the Trust's bank
account of the entire amount of each day's lockbox receipts and the simultaneous
electronic data transfer to the Company of customer payment data records.
Pursuant to the Servicing Agreements, as defined below, the Company is required
to deliver monthly reports to 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 Trust's bank account as
reflected in the daily reports of the lockbox processing agent.
In its securitization transactions, 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, that 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 would
be entitled to require the Company to repurchase the Contract relating to such
financed vehicle.
THE SERVICING AGREEMENTS
The Company currently services all Contracts that it owns, as well as those
Contracts included in portfolios that it has sold to securitization Trusts. The
Company does not service Contracts that were sold in its flow purchase program.
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 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 Company is entitled under most of the Servicing Agreements to receive a base
monthly servicing fee between 2.5% and 5.0% per annum computed as a percentage
of the declining outstanding principal balance of the non-defaulted Contracts in
12
the pool. Each month, after payment of the Company's base monthly servicing fee
and certain other fees, the Trust receives the paid principal reduction of the
Contracts in its pool 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 pool. The "Spread Account" is an account
established at the time the Company sells a pool of Contracts, to provide
security to the Note Insurers, as defined below. If collections on the Contracts
exceed such amounts, the excess is utilized, first, to build up or replenish the
Spread Account or other credit enhancement to the extent required, next, in
certain cases to cover deficiencies in Spread Accounts for other pools, and the
balance, if any, constitutes excess cash flows, which are distributed to the
Company.
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 or if the vehicle has been in
repossession inventory for more than 90 days. 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 holders
("Investors") of interests in the Trust 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
pool 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 Notes, as defined below, the Investors bear 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 insurers of certain of the
Trust's obligations ("Note Insurers") in the event of certain defaults by the
Company and under certain other circumstances. Were a Note Insurer in the future
to exercise its option to terminate the Servicing Agreements, such a termination
would have a material adverse effect on the Company's liquidity and results of
operations. The Company continues to receive Servicer extensions on a monthly
and/or quarterly basis, pursuant to the Servicing Agreements.
COMPETITION
The automobile financing business is highly competitive. The Company competes
with a number of national, regional and local 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 Finance 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 that 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.
13
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
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 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 past or future 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."
EMPLOYEES
As of December 31, 2003, the Company had 681 full-time and 11 part-time
employees, of whom 7 are senior management personnel, 404 are collections
personnel, 108 are Contract origination personnel, 56 are marketing personnel
(42 of whom are marketing representatives), 72 are operations and systems
personnel, and 34 are administrative personnel. The Company believes that its
relations with its employees are good. The Company is not a party to any
collective bargaining agreement.
14
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 base rent is approximately $1.9 million through October 2003,
and increases to $2.1 million for the following five years. In addition to base
rent, the Company pays the property taxes, maintenance and other expenses of the
premises.
In March 1997, the Company established a branch collection facility in
Chesapeake, Virginia. The Company leases approximately 28,000 square feet of
general office space in Chesapeake, Virginia, at a base rent that is currently
$454,525 per year, increasing to $501,545 over a 10-year term.
The remaining four regional servicing centers occupy a total of approximately
49,000 square feet of leased space in Orlando, Florida; Atlanta, Georgia;
Hinsdale, Illinois and Cleveland, Ohio. The termination dates of such leases
range from 2007 to 2008.
See Notes 2 and 14 of Notes to Consolidated Financial Statements.
ITEM 3. LEGAL PROCEEDINGS
STANWICH LITIGATION. CPS is currently a defendant in a class action (the
"Stanwich Case") pending in the California Superior Court, Los Angeles County.
The plaintiffs in that case are persons entitled to receive regular payments
(the "Settlement Payments") under out-of-court settlements reached with third
party defendants. Stanwich Financial Services Corp. ("Stanwich"), an affiliate
of the former Chairman of the Board of Directors of CPS, is the entity that is
obligated to pay the Settlement Payments. Stanwich has defaulted on its payment
obligations to the plaintiffs and in June 2001 filed for reorganization under
the Bankruptcy Code, in the federal Bankruptcy Court of Connecticut. CPS is also
a defendant in certain cross-claims brought by other defendants in the case,
which assert claims of equitable and/or contractual indemnity against CPS.
In November 2001, one of the defendants in the Stanwich Case, Jonathan Pardee,
asserted claims for indemnity against CPS in a separate action, which is now
pending in federal district court in Rhode Island. CPS has filed counterclaims
in the Rhode Island federal court against Mr. Pardee. CPS is defending this
matter and pursuing its counterclaims vigorously.
In February 2002, CPS entered into a term sheet with Stanwich, the plaintiffs in
the Stanwich Case and others, which provides for CPS's release upon its
repayment of the amounts concededly owed to Stanwich, all of which amounts have
been recorded in CPS's financial statements as indebtedness.
The California court in December 2003 preliminarily approved a settlement of the
Stanwich Case. That settlement will result in CPS being released from all claims
pending in the California court, other than an alleged contractual indemnity in
favor of one of the financial institution co-defendants. As to that institution,
CPS has an agreement in principle to settle its cross-claim. The court-approved
settlement requires of CPS only that it repay the amounts it concededly owes to
Stanwich, all of which amounts have been recorded in CPS's financial statements
as indebtedness.
The reader should consider that any adverse judgment against CPS in the Stanwich
Case (or the related case in Rhode Island) for indemnification, in an amount
materially in excess of any liability already recorded in respect thereof, could
have a material adverse effect.
OTHER LITIGATION. On November 15, 2000, Denice and Gary Lang filed a lawsuit
against CPS in South Carolina Common Pleas Court, Beaufort County, alleging that
they, and a purported nationwide class, were harmed by an alleged failure to
refer, in the notice given after repossession of their vehicle, to the right to
purchase the vehicle by tender of the full amount owed under the retail
installment contract. They sought damages in an unspecified amount. CPS filed a
counterclaim to recover any delinquent amounts owed by the members of the
putative class in the event that the class were to be certified. In February
2004, CPS reached an agreement to settle that case on a class basis for payment
of attorneys' fees and other immaterial consideration.
15
On September 26, 2001, Maggie Chandler, Bobbie Mike and Mary Ann Benford each
commenced a lawsuit against subsidiaries of MFN (now subsidiaries of CPS) in
three different state courts in Mississippi. A similar case was filed in
December 2002 in a fourth Mississippi court. Plaintiffs in all four cases
alleged deceptive practices related to various loans and the related purchase
and sale of insurance, and sought unspecified damages. In September 2003, the
defendant subsidiaries reached an agreement in principle to settle all such
cases, and any similar cases that might be brought by other clients of the same
plaintiff law firms.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding the Company's executive officers follows:
CHARLES E. BRADLEY, JR., 44, 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.
WILLIAM L. BRUMMUND, JR., 51, has been Senior Vice President - Operations since
March 1991. From 1986 to March 1991, Mr. Brummund was Vice President and Systems
Administrator for Far Western Bank, Tustin, California.
NICHOLAS P. BROCKMAN, 59, has been Senior Vice President - Collections 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.
MARK A. CREATURA, 44, 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.
CURTIS K. POWELL, 47, has been Senior Vice President - Contract Origination
since June 2001. Previously, he was the Company's Senior Vice President -
Marketing, from 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.
ROBERT E. RIEDL, 40, has been Senior Vice President - Chief Financial Officer
since August 2003. Mr. Riedl joined the Company as Senior Vice President - Risk
Management in January 2003. Mr. Riedl was a Principal at Northwest Capital
Appreciation ("NCA"), a middle market private equity firm, from 2000 to 2002.
For a year prior to joining Northwest Capital, Mr. Riedl served as Senior Vice
President for one of NCA's portfolio companies, SLP Capital. Mr. Riedl was an
investment banker for ContiFinancial Services Corporation from 1995 until
joining SLP Capital in 1999.
CHRISTOPHER TERRY, 36, has been Senior Vice President - Asset Recovery since
January 2003. He joined the Company in January 1995 as a loan officer, held a
series of successively more responsible positions, and was promoted to Vice
President - Asset Recovery in June 1999. Mr. Terry was previously a branch
manager with Norwest Financial from 1990.
16
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 sales prices
reported by Nasdaq for the Common Stock for the periods shown.
HIGH LOW
----- -----
January 1 - March 31, 2002.................................... 2.000 1.110
April 1 - June 30, 2002....................................... 3.250 1.750
July 1 - September 30, 2002................................... 2.650 1.410
October 1 - December 31, 2002................................. 2.290 1.550
January 1 - March 31, 2003.................................... 2.200 1.500
April 1 - June 30, 2003....................................... 3.455 1.630
July 1 - September 30, 2003................................... 3.700 2.480
October 1 - December 31, 2003................................. 4.180 2.750
As of March 15, 2004, there were 88 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 income, 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 cash flow for use in the Company's operations.
The table below presents information regarding outstanding options to purchase
the Company's Common Stock.
WEIGHTED-AVERAGE EXERCISE NUMBER OF SECURITIES REMAINING
NUMBER OF SECURITIES TO PRICE OF OUTSTANDING AVAILABLE FOR FUTURE ISSUANCE
BE ISSUED UPON EXERCISE OPTIONS, WARRANTS AND UNDER EQUITY COMPENSATION
OF OUTSTANDING OPTIONS, RIGHTS PLANS (EXCLUDING SECURITIES
PLAN CATEGORY WARRANTS AND RIGHTS DECEMBER 31, 2003 REFLECTED IN COLUMN (a))
------------- ----------------------- ------------------------- ------------------------------
(a) (b) (c)
Equity compensation plans
approved by security 3,872,269 $1.96 146,631
holders
Equity compensation plans
not approved by security None N/A N/A
holders
Total 3,872,269 $1.96 146,631
17
ITEM 6. SELECTED FINANCIAL DATA
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------
2003 2002 2001 2000 (1) 1999 (1)
---------- ---------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Gain (loss) on sale of Contracts, net (2) ......... $ 6,369 $ 16,444 $ 32,765 $ 16,234 $ (14,844)
Interest income ................................... 58,164 48,644 17,205 3,480 3,032
Servicing fees .................................... 17,058 14,621 10,666 15,848 27,761
Total revenue ..................................... 100,934 93,314 62,576 35,951 14,805
Operating expenses ................................ 103,973 93,252 62,256 68,354 86,968
Income (loss) before extraordinary item (3) ....... 395 2,996 320 (22,147) (44,532)
Extraordinary item (4) ............................ -- 17,412 -- -- --
Net income (loss) ................................. 395 20,408 320 (22,147) (44,532)
Basic income (loss) per share before ex. item ..... 0.02 0.15 0.02 (1.10) (2.38)
Diluted income (loss) per share before ex. item ... 0.02 0.14 0.02 (1.10) (2.38)
Basic income (loss) per share, ex. item ........... -- 0.87 -- -- --
Diluted income (loss) per share, ex. item ......... -- 0.83 -- -- --
Basic income (loss) per share ..................... 0.02 1.03 0.02 (1.10) (2.38)
Diluted income (loss) per share ................... 0.02 0.97 0.02 (1.10) (2.38)
DECEMBER 31,
-----------------------------------------------------------
2003 2002 2001 2000 1999
---------- ---------- ---------- ---------- ----------
(IN THOUSANDS)
BALANCE SHEET DATA:
Cash and restricted cash ...................... $ 100,486 $ 51,859 $ 13,924 $ 24,315 $ 3,324
Finance receivables, net ...................... 266,189 84,592 -- 18,830 2,421
Residual interest in securitizations .......... 111,702 127,170 106,103 99,199 172,530
Total assets .................................. 492,470 285,448 151,204 175,694 220,314
Term debt ..................................... 384,622 175,942 82,555 102,614 119,173
Total liabilities ............................. 410,310 202,874 89,518 113,572 135,877
Total shareholders' equity .................... 82,160 82,574 61,686 62,122 84,437
____________
(1) Beginning with the year ended December 31, 1999 and through December 31,
2000, the Company did not sell any Contracts in securitization transactions.
(2) The decrease in 2003 is primarily the result of the change in securitization
structure implemented in the third quarter of 2003.
(3) Results for 2003 and 2002, include a tax benefit of $3.4 million and $2.9
million, respectively.
(4) On March 8, 2002, CPS acquired 100% of MFN Financial Corporation and
subsidiaries, resulting in the recognition of $17.4 million of negative goodwill
as an extraordinary gain, which is reflected in the Company's 2002 Consolidated
Statement of Operations.
18
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. The Company's Consolidated Balance Sheet and
Consolidated Statement of Operations as of and for the year ended December 31,
2003 include the results of operations of TFC Enterprises, Inc. for the period
subsequent to May 20, 2003, the TFC Merger date, through December 31, 2003. The
Company's Consolidated Balance Sheet and Consolidated Statement of Operations as
of and for the year ended December 31, 2002 include the results of operations of
MFN Financial Corporation for the period subsequent to March 8, 2002, the MFN
Merger date, through December 31, 2002. See Note 2 of Notes to Consolidated
Financial Statements.
OVERVIEW
Consumer Portfolio Services, Inc. and its subsidiaries (collectively, the
"Company") specialize in purchasing, selling and servicing retail automobile
installment sale contracts ("Contracts") originated by automobile dealers
("Dealers") located throughout the United 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.
On March 8, 2002, the Company acquired MFN Financial Corporation and its
subsidiaries in a merger (the "MFN Merger"). On May 20, 2003, the Company
acquired TFC Enterprises, Inc. and its subsidiaries in a second merger (the "TFC
Merger"). Each merger was accounted for as a purchase. MFN Financial Corporation
and its subsidiaries ("MFN") and TFC Enterprises, Inc. and its subsidiaries
("TFC") were engaged in businesses similar to that of the Company: buying
Contracts from Dealers, repackaging those Contracts in securitization
transactions, and servicing those Contracts. MFN ceased acquiring Contracts in
May 2002; TFC continues to acquire Contracts under its "TFC Programs," which
provide financing for vehicle purchases exclusively by members of the United
States armed forces.
The Company historically has generated revenue primarily from the gains
recognized on the sale or securitization of Contracts, servicing fees earned on
Contracts sold, interest earned on Residuals, as defined below, and interest on
finance receivables. During the years ended December 31, 2002 and 2001, the
Company sold some Contracts on a servicing released basis, as part of a program
(the "flow purchase program") in which the Company sold Contracts to
unaffiliated third parties immediately after purchasing such Contracts from
Dealers. The flow purchase program ended in May 2002. During the years ended
December 31, 2002 and 2001, the Company's gain on sale of Contracts included,
$5.7 million and $16.6 million, respectively, representing mark-up on Contracts
sold in the flow purchase program.
SECURITIZATION
GENERALLY
Throughout the periods for which information is presented in this report, the
Company has purchased Contracts with the intention of repackaging them in
securitizations. All such securitizations have involved identification of
specific Contracts, sale of those Contracts (and associated rights) to a special
purpose subsidiary of the Company, and issuance of asset-backed securities to
fund the transactions. Depending on the structure of the securitization, the
transaction may properly be accounted for as a sale of the Contracts, or as a
secured financing.
When structured to be treated as a secured financing, the subsidiary is
consolidated with the Company. Accordingly, the sold Contracts and the related
securitization trust debt appear as assets and liabilities, respectively, of the
19
Company on its Consolidated Balance Sheet. The Company then recognizes interest
and fee income on the receivables and interest expense on the securities issued
in the securitization, and records as expense a provision for probable credit
losses on the receivables and other expenses.
When structured to be treated as a sale, the subsidiary is not consolidated with
the Company. Accordingly, the securitization removes the sold Contracts from the
Company's Consolidated Balance Sheet, the asset-backed securities (debt of the
non-consolidated subsidiary) do not appear as debt of the Company, and the
Company shows, as an asset, a retained residual interest in the sold Contracts.
The residual interest represents the discounted value of what the Company
expects will be the excess of future collections on the Contracts over principal
and interest due on the asset backed securities. That residual interest appears
on the Company's Consolidated Balance Sheet as "Residual interest in
securitizations," and its value is dependent on estimates of the future
performance of the sold Contracts.
CHANGE IN POLICY
During August 2003 the Company announced that it would structure its future
securitization transactions to be reflected as secured financings for financial
accounting purposes. The first two term securitizations so structured occurred
in September and December 2003. The Company had structured all of its prior term
securitization transactions to be treated as sales for financial accounting
purposes. In the MFN Merger and in the TFC Merger the Company acquired finance
receivables that had been previously securitized in term securitization
transactions that were reflected as secured financings. As of December 31, 2003,
the Company's Consolidated Balance Sheet included net finance receivables of
approximately $119.6 million and securitization trust debt of $95.9 million
related to finance receivables acquired in the two mergers, out of totals of net
finance receivables of approximately $266.2 million and securitization trust
debt of approximately $245.1 million.
CREDIT RISK RETAINED
Whether a securitization is treated as a secured financing or as a sale for
financial accounting purposes, the related special purpose subsidiary may be
unable to release excess cash to the Company if the credit performance of the
securitized Contracts falls short of pre-determined standards. Such releases
represent a material portion of the cash that the Company uses to fund its
operations. An unexpected deterioration in the performance of securitized
Contracts could therefore have a material adverse effect on both the Company's
liquidity and its results of operations, regardless of whether such Contracts
are treated as having been sold or as having been financed. For estimation of
the magnitude of such risk, it may be appropriate to look to the size of the
Company's managed portfolio, which represents both financed and sold Contracts
as to which such credit risk is retained. The Company's managed portfolio as of
December 31, 2003 was approximately $741.1 million.
CRITICAL ACCOUNTING POLICIES
The Company believes that its accounting policies related to (a) Allowance for
Finance Credit Losses, (b) Residual Interest in Securitizations and Gain on Sale
of Contracts and (c) Income Taxes could be considered critical. Such policies
are described below.
(a) ALLOWANCE FOR FINANCE CREDIT LOSSES
In order to estimate an appropriate allowance for losses to be incurred on
finance receivables, the Company uses a loss allowance methodology commonly
referred to as "static pooling," which stratifies its finance receivable
portfolio into separately identified pools. Using analytical and formula driven
techniques, the Company estimates an allowance for finance credit losses, which
management believes is adequate for known and inherent losses in its portfolio
of finance receivable Contracts. Provision for loss is charged to the Company's
Consolidated Statement of Operations. Net losses incurred on finance receivables
are charged to the allowance. Management evaluates the adequacy of the allowance
20
by examining current delinquencies, the characteristics of the portfolio and the
value of the underlying collateral. As conditions change, the Company's level of
provisioning and/or allowance may change as well.
(b) TREATMENT OF SECURITIZATIONS
Gain on sale may be recognized on the disposition of Contracts either outright
or in securitization transactions. In those securitization transactions that
were treated as sales for financial accounting purposes, the Company, or a
wholly-owned, consolidated subsidiary of the Company, retains a residual
interest in the Contracts that were sold to a wholly-owned, unconsolidated
special purpose subsidiary. The Company's securitization transactions include
"term" securitizations (the purchaser holds the Contracts for substantially
their entire term) and "continuous" or "warehouse" securitizations (which
finance the acquisition of the Contracts for future sale into term
securitizations).
As of December 31, 2002 the line item "Residual interest in securitizations" on
the Company's Consolidated Balance Sheet includes residual interests in both
term and warehouse securitizations. As of December 31, 2003 the line item
"Residual interest in securitizations" on the Company's Consolidated Balance
Sheet represents the residual interests in certain term securitizations but no
residual interest in warehouse securitizations, because the Company's warehouse
securitizations were restructured in July 2003 as secured financings. Subsequent
term securitizations in September 2003 and December 2003 were also structured as
secured financings. The warehouse securitizations are accordingly reflected in
the line items "Finance receivables" and "Warehouse lines of credit" on the
Company's Consolidated Balance Sheet, and the term securitizations are reflected
in the line items "Finance receivables" and "Securitization trust debt." The
"Residual interest in securitizations" represents the discounted sum of expected
future releases from securitization trusts. Accordingly, the valuation of the
residual is heavily dependent on estimates of future performance.
The key economic assumptions used in measuring all residual interests in
securitizations as of December 31, 2003 and 2002 are included in the table
below. The pre-tax discount rate remained constant at 14%.
2003 2002
------------- -------------
Prepayment speed (Cumulative)......... 18.1% - 22.1% 19.8% - 22.9%
Credit losses (Cumulative)............ 11.8% - 18.0% 10.0% - 15.4%
Key economic assumptions and the sensitivity of the current fair value of
residual cash flows to immediate 10% and 20% adverse changes in those
assumptions are as follows:
DECEMBER 31, 2003
-----------------
(DOLLARS IN
THOUSANDS)
Carrying amount/fair value of residual interest in securitizations............. $ 111,702
Weighted average life in years................................................. 3.74
Prepayment Speed Assumption (Cumulative)....................................... 18.1% - 22.1%
Estimated fair value assuming 10% adverse change............................... $ 110,938
Estimated fair value assuming 20% adverse change............................... 110,916
Expected Credit Losses (Cumulative)............................................ 11.8% - 18.0%
Estimated fair value assuming 10% adverse change............................... $ 100,907
Estimated fair value assuming 20% adverse change............................... 90,312
Residual Cash Flows Pre-tax Discount Rate (Annual)............................. 14.0%
Estimated fair value assuming 10% adverse change............................... $ 109,594
Estimated fair value assuming 20% adverse change............................... 107,477
These sensitivities are hypothetical and should be used with caution. As the
figures indicate, changes in fair value based on 10% and 20% percent variation
in assumptions generally cannot be extrapolated because the relationship of the
change in assumption to the change in fair value may not be linear. Also, in
21
this table, the effect of a variation in a particular assumption on the fair
value of the retained interest is calculated without changing any other
assumption; in reality, changes in one factor may result in changes in another
(for example, increases in market rates may result in lower prepayments and
increased credit losses), which could magnify or counteract the sensitivities.
The Company's securitization structure has generally been as follows:
The Company sells Contracts it acquires to a wholly-owned Special Purpose
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 another entity, typically a statutory trust ("Trust"). The Trust issues
interest-bearing asset-backed securities (the "Notes"); generally in a principal
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 Notes issued by the Trust; the proceeds from the sale of
the Notes are then used to purchase the Contracts from the Company. The Company
may retain subordinated Notes issued by the Trust. The Company purchases a
financial guaranty insurance policy, guaranteeing timely payment of principal
and interest on the senior Notes, from an insurance company (a "Note Insurer").
In addition, the Company provides "Credit Enhancement" for the benefit of the
Note Insurer and the investors in the form of an initial cash deposit to an
account ("Spread Account") held by the Trust, in the form of
overcollateralization of the Notes, where the principal balance of the Notes
issued is less than the principal balance of the Contracts, in the form of
subordinated Notes, or some combination of such Credit Enhancements. The
agreements governing the securitization transactions (collectively referred to
as the "Securitization Agreements") require that the initial level of Credit
Enhancement be supplemented by a portion of collections from the Contracts until
the level of Credit Enhancement reaches 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 Contracts. The specified
levels at which the Credit Enhancement is to be maintained will vary depending
on the performance of the pools of Contracts held by the Trusts and on other
conditions, and may also be varied by agreement among the Company, the SPS, the
Note Insurers and the trustee. Such levels have increased and decreased from
time to time based on performance of the various pools, and have also varied by
Securitization Agreement. The Securitization Agreements generally grant the
Company the option to repurchase the sold Contracts from the Trust when the
aggregate outstanding balance of the Contracts has amortized to a specified
percentage of the initial aggregate balance.
The prior securitizations that are treated as sales for financial accounting
purposes differ from secured financings in that the Trust to which the SPS sells
the Contracts meets the definition of a "qualified special purpose entity" under
Statement of Financial Accounting Standards No. 140 ("SFAS 140"). As a result,
assets and liabilities of the Trust are not consolidated into the Company's
Consolidated Balance Sheet.
The Company's warehouse securitization structures were similar to the above,
except that (i) the SPS that purchases the Contracts pledges the Contracts to
secure promissory notes which it issues, (ii) the promissory notes are in an
aggregate principal amount of not more than 71% to 73% of the aggregate
principal balance of the Contracts (that is, at least 27%
overcollateralization), and (iii) no increase in the required amount of Credit
Enhancement is contemplated unless certain portfolio performance tests are
breached. During the quarter ended September 30, 2003 the warehouse
securitizations related to the CPS programs were amended to cause the
transactions to be treated as secured financings for financial accounting
purposes. The Contracts held by the warehouse SPSs and the promissory notes that
they issue are therefore included in the Company's Consolidated Financial
Statements as of December 31, 2003 as assets and liabilities, respectively.
Upon each sale of Contracts in a securitization structured as a secured
financing, whether a term securitization or a warehouse securitization, the
Company retains on its Consolidated Balance Sheet the Contracts securitized as
assets and records the Notes issued in the transaction as indebtedness of the
Company.
22
Under the prior securitizations structured as sales for financial accounting
purposes, the Company removed from its Consolidated Balance Sheet the Contracts
sold and added to its Consolidated Balance Sheet (i) the cash received, if any,
and (ii) the estimated fair value of the ownership interest that the Company
retains in Contracts sold in the securitization. That retained or residual
interest (the "Residual") consists of (a) the cash held in the Spread Account,
if any, (b) overcollateralization, if any, (c) subordinated Notes retained, if
any, and (d) receivables from Trust, which include 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 Notes, 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. Until the maturity of these transactions, the Company's Consolidated
Balance Sheet will reflect both securitization transactions structured as sales
and others structured as secured financings.
With respect to securitizations structured as sales for financial accounting
purposes, the Company allocates its basis in the Contracts between the Notes
sold 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. The Company is not aware of an active market
for the purchase or sale of interests such as the Residuals; accordingly, the
Company determines the estimated fair value of the Residuals by discounting the
amount and timing of anticipated cash flows that it estimates will be released
to the Company in the future (the cash out method), using a discount rate that
the Company believes is appropriate for the risks involved. The anticipated cash
flows include collections from both current and charged off receivables. The
Company has used an effective pre-tax 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 Trusts that represent collections on the Contracts in excess of
the amounts required to pay principal and interest on the Notes, the base
servicing fees, and certain other fees (such as trustee and custodial fees).
Required principal payments are generally defined as the payments sufficient to
keep the principal balance of the Notes equal to the aggregate principal balance
of the related Contracts (excluding those Contracts that have been charged off),
or a pre-determined percentage of such balance. Where that percentage is less
than 100%, the related Securitization Agreements require accelerated payment of
principal until the principal balance of the Notes is reduced to the specified
percentage. Such accelerated principal payment is said to create
overcollateralization of the Notes.
If the amount of cash required for payment of fees, interest and principal
exceeds the amount collected during the collection period, the shortfall is
withdrawn from the Spread Account, if any. 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 or other form of Credit Enhancement, the
excess is released to the Company, or in certain cases is transferred to other
Spread Accounts that may be below their required levels. If the total Credit
Enhancement amount is not at the required level, then the excess cash collected
is retained in the Trust until the specified level is achieved. Although Spread
Account balances are held by the Trusts on behalf of the Company's SPS as the
owner of the Residuals (in the case of securitization transactions structured as
sales for financial accounting purposes) or the Trusts (in the case of
securitization transactions structured as secured financings for financial
accounting purposes), 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 Securitization
Agreements. The interest rate payable on the Contracts is significantly greater
than the interest rate on the Notes. As a result, the Residuals described above
are a significant asset of the Company. In determining the value of the
Residuals, the Company must estimate the future rates of prepayments,
delinquencies, defaults and default loss severity, and recovery rates, as all of
these factors affect the amount and timing of the estimated cash flows. The
Company estimates prepayments by evaluating historical prepayment performance of
comparable Contracts. The Company has used prepayment estimates of approximately
18.1% to 22.1% cumulatively over the lives of the related Contracts. The Company
estimates defaults and default loss severity using available historical loss
data for comparable Contracts and the specific characteristics of the Contracts
23
purchased by the Company. The Company estimates recovery rates of previously
charged off receivables using available historical recovery data and projected
future recovery levels. In valuing the Residuals, the Company estimates that
charge-offs as a percentage of the original principal balance will approximate
15.9% to 23.1% cumulatively over the lives of the related Contracts, with
recovery rates approximating 2.2% to 5.3% of the original principal balance.
Following a securitization that is structured as a sale for financial accounting
purposes, interest income is recognized on the balance of the Residuals at the
same rate as used for calculating the present value of the NIRs, which is 14%
per annum. In addition, the Company will recognize additional revenue from the
Residuals if the actual performance of the Contracts is better than the original
estimate. If the actual performance of the Contracts were worse than the
original estimate, then a downward adjustment to the carrying value of the
Residuals and a related expense would be required. In a securitization that is
structured as a secured financing for financial accounting purposes, interest
income is recognized when accrued under the terms of the related Contracts and,
therefore, presents less potential for fluctuations in performance when compared
to the approach used in a transaction structured as a sale for financial
accounting purposes.
In all the Company's term securitizations, whether treated as secured financings
or as sales, the Company has sold the receivables (through a subsidiary) to the
securitization Trust. The difference between the two structures is that in
securitizations that are treated as secured financings the Company reports the
assets and liabilities of the securitization Trust on its Consolidated Balance
Sheet. Under both structures the Noteholders and the related securitization
Trusts have no recourse to the Company for failure of the Contract obligors to
make payments on a timely basis. The Company's Residuals, however, are
subordinate to the Notes until the Noteholders are fully paid, and the Company
is therefore at risk to that extent.
(c) 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 the differences between the
financial statement values 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. The Company has estimated a valuation
allowance against that portion of the deferred tax asset whose utilization in
future periods is more likely than not.
In determining the possible realization of deferred tax assets, future taxable
income from the following sources are considered: (a) the reversal of taxable
temporary differences, (b) future operations exclusive of reversing temporary
differences, and (c) tax planning strategies that, if necessary, would be
implemented to accelerate taxable income into periods in which net operating
losses might otherwise expire.
See "Liquidity and Capital Resources" and Note 1 of Notes to Consolidated
Financial Statements.
RESULTS OF OPERATIONS
ACQUISITIONS
The Company's Consolidated Balance Sheet and Consolidated Statement of
Operations as of and for the years ended December 31, 2003 and 2002 include the
results of operations of MFN Financial Corporation for the period subsequent to
March 8, 2002, the date on which the Company acquired that corporation and its
subsidiaries in the MFN Merger. See Note 2 of Notes to Consolidated Financial
Statements, Acquisition of MFN Financial Corporation.
24
The Company's Consolidated Balance Sheet and Consolidated Statement of
Operations as of and for the year ended December 31, 2003 include the results of
operations of TFC Enterprises, Inc. for the period subsequent to May 20, 2003,
the date on which the Company acquired that corporation and its subsidiaries in
the TFC Merger. See Note 2 of Notes to Consolidated Financial Statements,
Acquisition of TFC Enterprises, Inc.
EFFECTS OF CHANGE IN SECURITIZATION STRUCTURE
The Company's July 2003 decision to structure future securitization transactions
as borrowings secured by receivables for financial accounting purposes, rather
than as sales of receivables, has affected and will affect the way in which the
transactions are reported. The major effects are these: (i) the finance
receivables are shown as assets of the Company on its balance sheet; (ii) the
debt issued in the transactions is shown as indebtedness of the Company; (iii)
cash posted to enhance the credit of the securitization transactions ("Spread
Accounts") is shown as "Restricted cash" on the Company's balance sheet; (iv)
the servicing fee that the Company receives in connection with such receivables
is recorded as a portion of the interest earned on such receivables; (v) the
Company has initially and will periodically record as expense a provision for
estimated credit losses on the receivables; and (vi) the portion of scheduled
payments on the receivables representing interest is recorded as revenue as
accrued.
These changes collectively represent a deferral of revenue and acceleration of
expenses, and thus a more conservative approach to accounting for the Company's
operations. The changes initially have resulted in the Company's reporting lower
earnings than it would have reported if it had continued to structure its
securitizations to require recognition of gain on sale. As a result, reported
earnings have been less than they would have been had the Company continued to
structure its securitizations to record a gain on sale and, accordingly,
reported net earnings may be negative or nominally positive for approximately
the next year. Growth in the Company's portfolio of receivables in excess of
current expectations would further delay achievement of positive net earnings.
The Company's cash availability and cash requirements should be unaffected by
the change in structure.
The Company's first two term securitizations structured as secured financings
closed in September and December 2003. The Company's MFN and TFC subsidiaries
completed term securitizations structured as secured financings prior to
becoming subsidiaries of the Company. The structures of the Company's two
warehouse securitization transactions that relate to the CPS programs were
amended in July 2003 to be treated as secured financings for financial
accounting purposes. The Company's third warehouse securitization credit
facility, which relates to the TFC programs, has been structured as a secured
financing for financial accounting purposes since the date of the TFC Merger.
THE YEAR ENDED DECEMBER 31, 2003 COMPARED TO THE YEAR ENDED DECEMBER 31, 2002
REVENUES. During the year ended December 31, 2003, revenues were $100.9 million,
an increase of $7.6 million, or 8.2%, from the prior year revenue of $93.3
million. With the change in securitization structure and consequent end to
recording gain on sale revenue in the third quarter of 2003, net gain on sale of
Contracts decreased $10.1 million, or 61.3%, to $6.4 million in 2003, compared
to $16.4 million in 2002. The 2003 gain on sale amount is net of a negative fair
value adjustment of $4.1 million related to the Company's analysis and estimate
of the expected ultimate performance of the Company's previously securitized
pools which are held by non-consolidated subsidiaries. The decrease in gain on
sale from 2002 to 2003 was partially offset by a negative fair value adjustment
of approximately $2.5 million recorded during the first quarter of 2002 related
to the Company's residual interest in securitizations. Also in the first quarter
of 2002, the Company recognized a charge of approximately $500,000 related to a
loss realized upon the sale of a subordinated certificate ("B Piece") from the
Company's 2002-A securitization.
Interest income for the year ended December 31, 2003 increased $9.5 million, or
19.6%, to $58.2 million in 2003 from $48.6 million in 2002. The primary reasons
for the increase in interest income are the change in securitization structure,
25
the interest income earned on the portfolio of Contracts acquired in the TFC
Merger and an increase in residual interest income. This increase was partially
offset by the decline in the balance of the portfolio of Contracts acquired in
the MFN Merger.
Servicing fees totaling $17.1 million in the year ended December 31, 2003
increased $2.4 million, or 16.7%, from $14.6 million in the same period a year
earlier. The increase in servicing fees can be attributed to the growth of the
Company's managed portfolio held by non-consolidated subsidiaries related to the
CPS programs. For the year ended December 31, 2003, the Company's managed
portfolio held by non-consolidated subsidiaries had an average outstanding
principal balance approximating $489.9 million, compared to $347.3 for the year
ended December 31, 2002. At December 31, 2003, the Company's managed portfolio
held by consolidated subsidiaries had an outstanding principal balance
approximating $315.6 million, compared to $117.1 million as of December 31,
2002. As a result of the decision to structure future securitizations as secured
financings, the Company's managed portfolio held by non-consolidated
subsidiaries will decline in future periods, and servicing fee revenue is
anticipated to decline proportionately.
At December 31, 2003, the Company was generating income and fees on a managed
portfolio with an outstanding principal balance approximating $741.1 million,
compared to a managed portfolio with an outstanding principal balance
approximating $595.2 million as of December 31, 2002. As the portfolio of
Contracts acquired in the MFN Merger amortizes, the portfolio of Contracts
originated under the CPS and TFC programs continues to expand. At December 31,
2003 and 2002, the managed portfolio composition was as follows:
DECEMBER 31, 2003 DECEMBER 31, 2002
-------------------- --------------------
AMOUNT % AMOUNT %
--------- ------- --------- -------
ORIGINATING ENTITY ($ IN MILLIONS)
CPS .................. $ 543.8 73.4% $ 394.3 66.2%
TFC .................. 123.6 16.7 -- --
MFN .................. 73.7 9.9 200.9 33.8
--------- ------- --------- -------
Total ................ $ 741.1 100.0% $ 595.2 100.0%
========= ======= ========= =======
Other income increased 42% to $19.3 million in 2003 from $13.6 million in 2002.
The period over period increase can be attributed in part to the receipt of
state sales tax refunds of $3.2 million during third quarter of 2003 and
recoveries on previously charged off MFN Contracts totaling $12.2 million for
the year ended December 31, 2003, compared to $10.5 million for the comparable
period in 2002.
EXPENSES. The Company's operating expenses consist primarily of personnel costs
and other operating expenses, which are incurred as applications and Contracts
are received, processed and serviced. Factors that affect margins and net income
include changes in the automobile and automobile finance market environments,
macroeconomic factors such as interest rates and the unemployment level, and mix
of business between Contracts purchased on a flow basis and Contracts purchased
on an other than flow basis. The Company ceased to purchase Contracts on a flow
basis in May 2002.
Personnel costs include base salaries, commissions and bonuses paid to
employees, and certain expenses related to the accounting treatment of
outstanding stock options, and are one of the Company's most significant
operating expenses. These costs (other than those relating to stock options)
generally fluctuate with the level of applications and Contracts processed and
serviced.
Other operating expenses consist primarily of interest expense, provisions for
credit losses, facilities expenses, telephone and other communication services,
credit services, computer services (including personnel costs associated with
information technology support), professional services, marketing and
advertising expenses, and depreciation and amortization.
Total operating expenses were $104.0 million for the year ended December 31,
2003, compared to $93.3 million for the same period in 2002. Total operating
26
expenses for the year ended December 31, 2003 would have been significantly
lower except for the $11.4 million provision for credit loss expense recorded
during the third and fourth quarters of 2003. Such provision for credit loss is
a result of the decision to structure securitizations as financings, rather than
as sales. Provisions for credit loss expense should be anticipated to increase
in future periods.
Personnel costs decreased to $37.1 million during the year ended December 31,
2003, representing 35.7% of total operating expenses, compared to $37.8 million
for the 2002 period, or 40.5% of total operating expenses. The decrease is
primarily the result of staff reductions since the MFN Merger in 2002 related to
the integration and consolidation of certain service and administrative
activities and the decline in the balance of the portfolio of Contracts acquired
in the MFN Merger. This decrease was partially offset by staff additions related
to the TFC Merger in May 2003.
In connection with the termination of MFN origination activities and the
integration and consolidation of certain activities (see above) related to the
MFN Merger and the TFC Merger, the Company has recognized certain liabilities
related to the costs to exit these activities and terminate the affected
employees of MFN and TFC. These activities include service departments such as
accounting, finance, human resources, information technology, administration,
payroll and executive management. Such exit and termination costs have been
charged against these liabilities and are not reflected in the Company's
Consolidated Statement of Operations.
General and administrative expenses increased to $21.3 million, or 20.5% of
total operating expenses, in the year ended December 31, 2003, from $20.1
million, or 21.6% of total operating expenses, in the same period of 2002. The
decrease as a percentage of total operating expenses is a result primarily of
the change in securitization structure during the third quarter of 2003 which
increased total expenses, and of continued general cost cutting during the
period, offset in part by an increase in legal and other corporate expenses.
Interest expense for the year ended December 31, 2003, decreased $64,000, or
0.3%, to $23.9 million in 2003. The slight decrease is the result of changes in
the amount and composition of securitization trust debt carried on the Company's
Consolidated Balance Sheet: such debt related to the MFN Merger declined as it
was paid down, partially offset by the addition of securitization trust debt
associated with the TFC Merger and with the securitizations subsequent to the
Company's change in securitization structure. As the Company continues to
structure future securitization transactions as secured financings, the balances
of securitization trust debt and the related interest expense are expected to
increase.
Marketing expenses decreased by $873,000, or 14.0%, and represented 5.2% of
total operating expenses. The decrease is primarily due to the decrease in
Contracts purchased by the Company during the year ended December 31, 2003.
Occupancy expenses decreased by $97,000, or 2.4%, and represented 3.8% of total
operating expenses. The decrease is primarily due to the closure during 2003 of
certain facilities acquired in the MFN Merger. The decrease was partially offset
by the addition of facilities acquired in the TFC Merger.
Depreciation and amortization expenses decreased by $138,000, or 12.1%, to $1.0
million from $1.1 million.
Income tax benefit of $3.4 million and $2.9 million was recorded in the 2003 and
2002 periods, respectively. The 2003 benefit is primarily the result of the
resolution of certain Internal Revenue Service examinations of previously filed
MFN tax returns, resulting in a tax benefit of $4.9 million, and other state tax
matters which have been included in the current period tax provision. The 2002
benefit is due to tax legislation passed in early 2002, which enabled the
Company to reverse a previously recorded valuation allowance of approximately
$3.2 million, as well as to record benefit during the same 2002 period. The
Company does not expect any comparable income tax benefit in future periods.
27
EXTRAORDINARY ITEM. The year ended December 31, 2002 included $17.4 million of
unallocated negative goodwill, which represented the difference between the net
assets acquired and the purchase price paid by the Company in connection with
the MFN Merger.
THE YEAR ENDED DECEMBER 31, 2002 COMPARED TO THE YEAR ENDED DECEMBER 31, 2001
REVENUE. During the year ended December 31, 2002, revenues increased $30.7
million, or 49.1%, to $93.3 million compared to $62.6 million for the year ended
December 31, 2001. Net gain on sale of Contracts decreased by $16.3 million,
from $32.8 million for the year ended December 31, 2001, to $16.4 million for
the year ended December 31, 2002. The primary reason for the decrease in the
gain on sale component of revenue is the decrease in Contract purchases to
$463.2 million in 2002 from $672.3 million in 2001. This reduction was primarily
a result of the termination of the flow purchase program in May 2002. The
Company securitized $281.2 million of Contracts during the year ended December
31, 2002, compared to $141.7 million during the year ended December 31, 2001.
During the year ended December 31, 2002, the Company sold $181.1 million of
Contracts on a flow basis compared to $537.9 million of Contracts in the year
ended December 31, 2001.
Gain on sale of Contracts also includes the effect of fluctuations in the
Company's estimate of the required provision for losses on certain CPS Contracts
and recovery of losses on such Contracts. During 2001, recoveries exceeded the
provision for losses; in 2002 the provision for losses was greater than
recoveries. During 2002, the amount of Contracts for which the Company recorded
a provision for credit losses increased, requiring the Company to provide for
losses on such Contracts in an amount exceeding related recoveries. For the year
ended December 31, 2002 the Company recorded a $2.6 million provision for credit
losses, compared to a reduction of the provision for Contract losses of $5.7
million for the year ended December 31, 2001. Also during 2002, as a result of
revised Company estimates resulting from analyses of the current and historical
performance of certain of the Company's securitized pools; the Company recorded
a pre-tax charge to gain on sale of approximately $2.5 million.
Interest income increased $31.4 million to $48.6 million in the year ended
December 31, 2002, from $17.2 million in the prior year. The increase in
interest income is primarily due to the expansion of the Company's managed
portfolio held by consolidated subsidiaries, primarily as a result of the MFN
Merger, as well as the addition of Contracts to the CPS portfolio and the
related increase in the Company's residual interest in securitizations as a
result of the increased level of securitizations. As of December 31, 2002, the
managed portfolio, net of unearned income on pre-computed Contracts, was $595.2
million ($200.9 million represented Contracts acquired in the MFN Merger),
compared to $285.5 million as of December 31, 2001.
Servicing fees increased by $4.0 million, or 37.1%, to $14.6 million for the
year ended December 31, 2002, from $10.7 million for the year ended December 31,
2001. Servicing fees consist of base fees, which are payable at the rate of 2.5%
per annum on the principal balance of the outstanding CPS Contracts (5.0% on MFN
Contracts) in the related Trusts, plus any other fees collected by the Company,
such as late fees and returned check fees. The increase in servicing fees is
primarily due to the increase in the Company's managed portfolio held by
non-consolidated subsidiaries. At December 31, 2002, the Company's managed
portfolio held by non-consolidated subsidiaries had an outstanding principal
balance approximating $478.1 million, compared to $281.5 million as of December
31, 2001. At December 31, 2002, the Company's managed portfolio held by
consolidated subsidiaries had an outstanding principal balance approximating
$117.1 million, compared to $4.0 million as of December 31, 2001. Although the
Company is paid a servicing fee on receivables held by consolidated
subsidiaries, such servicing fee is not recorded separately as revenue, but is
included in the interest accrued on such receivables.
Other income increased to $13.6 million in 2002 from $1.9 million in 2001. The
period over period increase can be attributed primarily to the recoveries on
previously charged off MFN Contracts totaling $10.5 million for the year ended
December 31, 2002.
EXPENSES. During the year ended December 31, 2002, operating expenses increased
by $31.0 million, or 49.8%, to $93.3 million, compared to the year ended
December 31, 2001 operating expenses of $62.3 million. The Company's operating
expenses consist primarily of personnel costs and other operating expenses,
which are incurred as applications and Contracts are received, processed and
serviced. Factors that affect margins and net income include changes in the
28
automobile and automobile finance market environments, macroeconomic factors
such as interest rates, and mix of business between Contracts purchased on a
flow basis and Contracts purchased on an other than flow basis. The overall
increase in expenses is primarily attributable to the MFN Merger. Personnel
costs increased $13.8 million, or 57.4%, to $37.8 million in 2002 from $24.0
million in 2001. Personnel costs include base salaries, commissions and bonuses
paid to employees, and certain expenses related to the accounting treatment of
outstanding warrants and stock options, and are the Company's most significant
operating expenses, representing approximately 40.5% of 2002 operating expenses.
These costs generally fluctuate with the level of applications and Contracts
processed and serviced, with the mix of revenue and with overall portfolio
performance. Other material operating expenses include facilities expenses,
telephone and other communication services, credit services, computer services
(including personnel costs associated with information technology support),
professional services, marketing and advertising expenses, and depreciation and
amortization.
In connection with the termination of MFN origination activities and the
integration and consolidation of certain activities related to the MFN Merger
(see above), the Company has recognized certain liabilities related to the costs
to exit these activities and terminate the affected employees of MFN. These
activities include service departments such as accounting, finance, human
resources, information technology, administration, payroll and executive
management. Such exit and termination costs have been charged against these
liabilities and are not reflected in the Company's Consolidated Statement of
Operations.
General and administrative expenses increased by $7.5 million, or 59.2%, and
represented 21.6% of total operating expenses. The increase in general and
administrative expenses is primarily due to the MFN Merger and an increase in
costs associated with servicing the Company's expanded portfolio. Also included
in 2002 general and administrative expenses is $669,000 related to the write off
a related party receivable from CARSUSA, Inc. See Note 13 of Notes to
Consolidated Financial Statements.
Interest expense increased by $9.6 million, or 66.9%, and represented 25.7% of
total operating expenses. The increase is due to the interest expense resulting
from the MFN acquisition, including interest expense related to acquisition debt
and the interest expense related to its managed portfolio held by consolidated
subsidiaries. See "Liquidity and Capital Resources."
Marketing expenses decreased by $843,000, or 11.9%, and represented 6.7% of
total operating expenses. The decrease is primarily due to the decrease in
Contracts purchased during the year ended December 31, 2002.
Occupancy expenses increased by $860,000, or 27.2%, and represented 4.3% of
total operating expenses. The increase is primarily due to the addition of
facilities acquired in the MFN Merger.
Depreciation and amortization expenses increased by $119,000, or 11.7%, to $1.1
million from $1.0 million.
The results for the years ended December 31, 2002 and 2001, include net income
of $116,732 and $161,710, respectively, from the Company's subsidiary CPS
Leasing, Inc.
Income tax benefit of $2.9 million, including the elimination of the valuation
allowance of $3.2 million, was recorded in the 2002 period pursuant to relevant
tax statutes and regulations. The Company's provision for income taxes was zero
for the year ended December 31, 2001.
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY
The Company's business requires substantial cash to support its purchases of
Contracts and other operating activities. The Company's primary sources of cash
have been cash flows from operating activities, including proceeds from sales of
Contracts, amounts borrowed under various revolving credit facilities (also
sometimes known as warehouse credit facilities), servicing fees on portfolios of
29
Contracts previously sold in securitization transactions, customer payments of
principal and interest on finance receivables, fees for origination of
Contracts, and releases of cash from securitized pools of Contracts in which the
Company has retained a residual ownership interest, and from the Spread Accounts
associated with such pools. The Company's primary uses of cash have been the
purchases of Contracts, repayment of amounts borrowed under lines of credit and
otherwise, operating expenses such as employee, interest, occupancy expenses and
other general and administrative expenses, the establishment of Spread Accounts
and initial overcollateralization, if any, and the increase of Credit
Enhancement to required levels in securitization transactions, and income taxes.
There can be no assurance that internally generated cash will be sufficient to
meet the Company's cash demands. The sufficiency of internally generated cash
will depend on the performance of securitized pools (which determines the level
of releases from those pools and their related Spread Accounts), the rate of
expansion or contraction in the Company's managed portfolio, and the terms upon
which the Company is able to acquire, sell, and borrow against Contracts.
Net cash provided by operating activities for the years ended December 31, 2003,
2002 and 2001 was $99.8 million, $146.9 million and $5.7 million, respectively.
Cash from operating activities is generally provided by the net releases from
the Company's securitization Trusts and from the amortization and liquidation of
Contracts offset by the purchase of finance receivables. The decrease in 2003
vs. 2002 is primarily a result of lower cash releases from the MFN Trusts as the
principal balance of the Contracts in those two pools has decreased
significantly year-over-year. The increase in net cash from operating activities
in 2002 compared to 2001 is primarily a result of the decrease in purchases of
contracts held for sale from $672.3 million in 2001 to $463.3 in 2002.
On May 20, 2003, the Company completed the TFC Merger (see Note 2 of Notes to
Consolidated Financial Statements). The acquisition cost was approximately $23.7
million, and was substantially funded by existing cash. Cash flows from the
underlying purchased assets are expected to provide adequate liquidity to repay
the assumed liabilities and generate positive cash flows from which to fund the
Company's operating activities. On March 8, 2002, the Company completed the MFN
Merger (see Note 2 of Notes to Consolidated Financial Statements). The
acquisition cost was approximately $123.2 million, and was substantially funded
by existing cash and borrowings. Cash flows from the underlying purchased assets
are expected to provide adequate liquidity to repay the acquisition borrowings,
as well as generate positive cash flows from which to fund the Company's
operating activities.
Net cash used in investing activities for the years ended December 31, 2003,
2002 and 2001, was $179.8 million, $29.8 million and $536,000, respectively.
With the change in the securitization structure implemented in the third quarter
of 2003, $175.3 million of Contracts were purchased for investment in 2003 as
compared to none in 2002 and 2001. Cash used in the TFC Merger, net of the cash
acquired in the transaction, totaled $10.2 million for the year ended December
31, 2003. Cash used in the acquisition of MFN Financial Corporation, net of the
cash acquired in the transaction, totaled $29.5 million for the year ended
December 31, 2002.
Net cash provided by financing activities for the year ended December 31, 2003,
was $80.3 million compared with net cash used in financing activities of $86.8
million and $21.7 million for the years ended December 31, 2002 and 2001,
respectively. Cash used or provided by financing activities is primarily
attributable to the repayment or issuance of debt. In connection with the TFC
Merger the Company assumed securitization trust debt related to three
securitization transactions held by consolidated subsidiaries (see Note 7 of
Notes to Consolidated Financial Statements) and assumed additional subordinated
debt (see Note 8 of Notes to Consolidated Financial Statements). In connection
with the MFN Merger the Company assumed securitization trust debt related to one
securitization transaction held by a consolidated subsidiary and one
securitization transaction held by a non-consolidated subsidiary (see Note 7 of
Notes to Consolidated Financial Statements) and incurred additional senior
secured debt (see Note 8 of Notes to Consolidated Financial Statements). Cash
used in financing activities is primarily attributable to the repayment of
outstanding debt. With the change in the securitization structure implemented in
the third quarter of 2003, $154.4 million of securitization trust debt was
issued in 2003 as compared to none in 2002 and 2001. In connection with the MFN
Merger the amount of outstanding debt, securitization trust debt and senior
secured debt, and the required repayment thereof, increased compared to prior
years.
30
The Company believes that cash flows generated as a result of the TFC Merger and
the MFN Merger will be sufficient to meet the obligations assumed or incurred as
a result of such mergers. There can be no assurance that internally generated
cash will be sufficient to meet such cash demands. The sufficiency of internally
generated cash will depend on the performance of the securitized pools. At the
time of the TFC Merger, TFC had outstanding $6.3 million in principal amount of
subordinated debt, which the Company assumed as part of the TFC Merger. Such
debt bears interest at the rate of 13.25% per annum payable monthly in arrears,
requires monthly amortization and is due in June 2005. At the time of the MFN
Merger, MFN had outstanding $22.5 million in principal amount of senior
subordinated debt, which was due and repaid in full on March 23, 2002. Such debt
bore interest at the rate of 11.00% per annum, payable quarterly in arrears.
Contracts are purchased from Dealers for a cash price approximating their
principal amount, and generate cash flow over a period of years. As a result,
the Company has been dependent on warehouse credit facilities to purchase
Contracts, and on the availability of cash from outside sources in order to
finance its continuing operations, as well as to fund the portion of Contract
purchase prices not financed under revolving warehouse credit facilities. As of
December 31, 2003, the Company had $225 million in warehouse credit capacity, in
the form of a $125 million facility, a $75 million facility and a $25 million
facility. The first two warehouse facilities provide funding for Contracts
purchased under CPS' programs while the third facility provides funding for
Contracts purchased under TFC's programs. On February 21, 2004, the $75 million
facility expired and, as a result, the Company's current warehouse credit
capacity is $150 million.
Through May 2002, the Company's Contract purchasing program consisted of both
(i) flow purchases for immediate resale to non-affiliates and (ii) purchases for
the Company's own account made on other than a flow basis, funded primarily by
advances under a revolving warehouse credit facility. Flow purchases allowed the
Company to purchase Contracts with minimal demands on liquidity. The Company's
revenues from the resale of flow purchase Contracts, however, were materially
less than those that may be received by holding Contracts to maturity or by
selling Contracts in securitization transactions. During the year ended December
31, 2003 the Company purchased $357.3 million of Contracts for its own account,
compared to $282.2 million for its own account and $181.1 million of Contracts
on a flow basis in 2002. For the year ended December 31, 2001, the Company
purchased $134.4 million of Contracts for its own account and $537.9 million on
a flow basis. The Company's flow purchase program ended in May 2002.
The $125 million warehouse facility is structured to allow CPS to fund a portion
of the purchase price of Contracts by drawing against a floating rate variable
funding note issued by CPS Warehouse Trust. This facility was established on
March 7, 2002, in the maximum amount of $100 million. Such maximum amount was
increased to $125 million in November 2002. Approximately 73% of the principal
balance of Contracts may be advanced to the Company under this facility, subject
to collateral tests and certain other conditions and covenants. Notes under this
facility accrue interest at a rate of one-month commercial paper plus 1.18% per
annum. This facility expires on April 4, 2004. The Company is currently in
discussions with the related parties to renew such facility.
The $75 million warehouse facility was similarly structured to allow CPS to fund
a portion of the purchase price of Contracts by drawing against a floating rate
variable funding note issued by CPS Funding LLC. Approximately 72.5% of the
principal balance of Contracts could be advanced to the Company under this
facility, subject to collateral tests and certain other conditions and
covenants. Notes under this facility accrued interest at a rate of one-month
LIBOR plus 0.75% per annum. This facility expired on February 21, 2004. The
Company is currently in discussions with several parties regarding a replacement
facility.
The $25 million warehouse facility is similarly structured to allow TFC to fund
a portion of the purchase price of Contracts by drawing against a floating rate
variable funding note issued by TFC Warehouse I LLC. Approximately 71% of the
principal balance of Contracts may be advanced to TFC under this facility,
subject to collateral tests and certain other conditions and covenants. Notes
under this facility accrue interest at a rate of one-month LIBOR plus 1.75% per
annum. This facility was entered into as part of the TFC Merger on May 20, 2003
and has a 364-day term. The Company is currently in discussions with the related
parties to renew such facility.
31
These facilities are independent of each other. Two different financial
institutions purchase the notes issued by these facilities, and three different
insurers insure the notes. Up through June 30, 2003, sales of Contracts to the
special purpose subsidiaries ("SPS") related to the first two facilities had
been treated as sales for financial accounting purposes. The Company, therefore,
removed these securitized Contracts and related debt from its Consolidated
Balance Sheet and recognized a gain on sale in the Company's Consolidated
Statement of Operations. Indebtedness related to Contracts funded by the third
facility, however, was retained on the Company's Consolidated Balance Sheet and
no gain on sale has ever been recognized in the Company's Consolidated Statement
of Operations. During July 2003, each of the first two facilities was amended,
with the effect that subsequent use of such facilities is treated for financial
accounting purposes as borrowing secured by such receivables, rather than as a
sale of receivables. The effects of that amendment are similar to those
discussed above with respect to the change in securitization structure.
The Company securitized $416.9 million of Contracts in four private placement
transactions during the year ended December 31, 2003. The first two such
transactions were structured as sales for financial accounting purposes,
resulting in a gain on sale of $6.4 million (net of a negative fair value
adjustment of $4.1 million related to the performance of previously securitized
pools). The final two transactions of 2003 were structured as secured financings
and, therefore, resulted in no gain on sale. The Company securitized $281.2
million of Contracts in three private placement transactions during the year
ended December 31, 2002. All of these transactions were structured as sales for
financial accounting purposes, resulting in a gain on sale of $16.9 million (net
of a pre-tax charge of $2.5 million related to the performance of previously
securitized pools). $141.7 million of Contracts were securitized in one private
placement transaction during the year ended December 31, 2001, resulting in a
gain on sale of $9.2 million. In March 2004 a wholly-owned bankruptcy remote
consolidated subsidiary of the Company issued $44 million of asset-backed notes
secured by its retained interest in eight term securitization transactions. The
notes, which have an interest rate of 10% per annum and a final maturity in
October 2009, are required to be repaid from the distributions on the underlying
retained interests. In connection with the issuance of the notes, the Company
incurred and capitalized issuance costs of $1.2 million.
Prior to June 2002, the Company also purchased Contracts on a flow basis, which,
as compared with purchases of Contracts for the Company's own account, involved
a materially reduced demand on the Company's cash. The Company's plan for
meeting its liquidity needs is to match its levels of Contract purchases to its
availability of cash.
Cash used to increase Credit Enhancement amounts to required levels for the
years ended December 31, 2003, 2002 and 2001 was $20.9 million, $24.2 million
and $24.6 million, respectively. Cash released from Trusts and their related
Spread Accounts to the Company for the years ended December 31, 2003, 2002 and
2001, was $25.9 million, $60.4 million and $43.7 million, respectively. Changes
in the amount of Credit Enhancement required for term securitization
transactions and releases from Trusts and their related Spread Accounts are
affected by the relative size, seasoning and performance of the various pools of
Contracts securitized that make up the Company's managed portfolio to which the
respective Spread Accounts are related. During the year ended December 31, 2003
the Company made initial deposits to Spread Accounts and funded initial
overcollateralization of $18.7 million related to its term securitization
transactions, compared to $16.7 million in the 2002 period and $2.5 million in
the 2001 period. The acquisition of Contracts for subsequent sale in
securitization transactions, and the need to fund Spread Accounts and initial
overcollateralization, if any, and increase Credit Enhancement levels when those
transactions take place, results in a continuing need for capital. The amount of
capital required is most heavily dependent on the rate of the Company's Contract
purchases (other than flow purchases), the required level of initial Credit
Enhancement in securitizations, and the extent to which the previously
32
established Trusts and their related Spread Accounts either release cash to the
Company or capture cash from collections on securitized Contracts. The Company
is currently limited in its ability to purchase Contracts due to certain
liquidity constraints. As of December 31, 2003, the Company had cash on hand of
$33.2 million and available Contract purchase commitments from its warehouse
credit facilities of $200.7 million. The Company's plans to manage the need for
liquidity include the completion of additional term securitizations that would
provide additional credit availability from the warehouse credit facilities, and
matching its levels of Contract purchases to its availability of cash. There can
be no assurance that the Company will be able to complete term securitizations
on favorable economic terms or that the Company will be able to complete term
securitizations at all. If the Company is unable to complete such
securitizations, interest income and other portfolio related income would
decrease.
The Company's primary means of ensuring that its cash demands do not exceed its
cash resources is to match its levels of Contract purchases to its availability
of cash. The Company's ability to adjust the quantity of Contracts that it
purchases and securitizes will be subject to general competitive conditions and
the continued availability of warehouse credit facilities. There can be no
assurance that the desired level of Contract acquisition can be maintained or
increased. Obtaining releases of cash from the Trusts and their related Spread
Accounts is dependent on collections from the related Trusts generating
sufficient cash to maintain the Spread Accounts and other Credit Enhancement in
excess of their respective requisite levels. There can be no assurance that
collections from the related Trusts will continue to generate sufficient cash.
Certain of the Company's securitization transactions and the warehouse credit
facilities contain various financial covenants requiring certain minimum
financial ratios and results. The Company was in violation of four of these
covenants as of December 31, 2003, including maximum leverage, minimum equity,
maximum financial loss and interest coverage. As of December 31, 2003, the
Company had received a waiver of such non-compliance from the controlling party.
In March 2004, each of these financial covenants was amended with the
controlling party such that all breaches have been cured.
The Servicing Agreements of the Company's securitization transactions and
warehouse credit facilities are terminable by the insurers of certain of the
Trust's obligations ("Note Insurers") in the event of certain defaults by the
Company and under certain other circumstances. Were a Note Insurer in the future
to exercise its option to terminate the Servicing Agreements, such a termination
would have a material adverse effect on the Company's liquidity and results of
operations. The Company continues to receive Servicer extensions on a monthly
and/or quarterly basis, pursuant to the Servicing Agreements.
CONTRACTUAL OBLIGATIONS
The following table summarizes the Companys's material contractual obligations
as of December 31, 2003 (dollars in thousands):
PAYMENT DUE BY PERIOD
------------------------------------------
LESS THAN 1 TO 3 3 TO 5 MORE THAN
--------- --------- --------- ---------
TOTAL 1 YEAR YEARS YEARS 5 YEARS
--------- --------- --------- --------- ---------
Long Term Debt ............ $102,465 $ 83,328 $ 14,000 $ 5,137 $ --
Operating Leases .......... $ 16,948 $ 4,511 $ 7,894 $ 4,543 $ --
Long term debt includes Senior secured, subordinated and related party debt.
CREDIT FACILITIES
The terms on which credit has been available to the Company for purchase of
Contracts have varied over the three-year period ended December 31, 2003, as
shown in the following recapitulation:
In November 2000, the Company (through its subsidiary CPS Funding LLC) entered
into a floating rate variable note purchase facility under which up to $75
million of notes may be outstanding at any time subject to collateral tests and
other conditions. The Company uses funds derived from this facility to purchase
Contracts under the CPS programs, which are pledged to secure the notes. The
collateral tests and other conditions generally allow the Company to borrow up
to approximately 72.5% of the price paid for such Contracts. Notes issued under
this facility bear interest at one-month LIBOR plus 0.75% per annum. The balance
of notes outstanding related to this facility at December 31, 2003 was zero.
This facility expired on February 21, 2004. The Company is currently in
discussions with several parties regarding a replacement facility.
33
Additionally, in March 2002, the Company (through its subsidiary CPS Warehouse
Trust) entered into a second floating rate variable note purchase facility,
under which up to $125.0 million of notes may be outstanding at any time,
subject to collateral tests and other conditions. The Company uses funds derived
from this facility to purchase Contracts under the CPS programs, which are
pledged to secure the notes. The collateral tests and other conditions generally
allow the Company to borrow up to approximately 73% of the price paid for such
Contracts. Notes issued under this facility bear interest at commercial paper
plus 1.18% per annum. The balance of notes outstanding related to this facility
at December 31, 2003 was $13.2 million. This facility expires on April 4, 2004.
The Company is currently in discussions with the related parties to renew such
facility.
One of the covenants within this warehouse credit facility and four of the six
term securitizations insured by this Note Insurer requires that the Company
maintain additional warehouse facilities with minimum borrowing capacity of
$75.0 million. With the expiration of the CPS Funding LLC facility described
above, the Company is in breach of such covenant. The Company has until June 20,
2004 to cure such breach prior to it becoming an event of default under this
warehouse facility and four term securitizations. While the Company is currently
in discussions with several parties about a replacement facility and believes
that it will be successful in replacing the facility within the required time
frame, there can be no assurances that it will do so. If the Company is
unsuccessful in these efforts, the Note Insurer will have the right to declare
an event of default. Remedies available to the Note Insurer in such event
include, among other things, transferring the servicing rights to the portfolio
that it insures to another servicer and trapping excess cash releases to the
Company from its warehouse facility and four term securitizations that it
insures. To the extent that the Note Insurer was to follow either of these
remedies, it would have a material adverse effect on the liquidity and the
operations of the Company.
In connection with the TFC Merger in May 2003, the Company (through its
subsidiary TFC Warehouse I LLC) entered in to a third floating rate variable
note purchase facility, under which up to $25.0 million of notes may be
outstanding at any time, subject to collateral tests and other conditions. The
Company uses funds derived from this facility to purchase Contracts under the
TFC programs, which are pledged to secure the notes. The collateral tests and
other conditions generally allow the Company to borrow up to approximately 71%
of the price paid for such Contracts. Notes issued under this facility bear
interest at LIBOR plus 1.75% per annum. The balance of notes outstanding related
to this facility at December 31, 2002 was $20.5 million. This facility expires
on May 19, 2004. The Company is currently in discussions with the related
parties to renew such facility.
CAPITAL RESOURCES
Prior to 1999, and again in 2001, 2002 and 2003, the Company has funded
increases in its managed portfolio through securitization transactions, as
discussed above, and funded its other capital needs with cash from operations
and with the proceeds from the issuance of long-term debt and/or equity.
The acquisition of Contracts for subsequent sale in securitization transactions,
and the need to fund Spread Accounts and initial overcollateralization, if any,
when those transactions take place, results in a continuing need for capital.
The amount of capital required is most heavily dependent on the rate of the
Company's Contract purchases (other than purchases made on a flow basis), the
required level of initial credit enhancement in securitizations, and the extent
to which the Trusts and related Spread Accounts either release cash to the
Company or capture cash from collections on secruritized Contracts. The Company
plans to adjust its levels of Contract purchases so as to match anticipated
releases of cash from the Trusts and related Spread Accounts with its capital
requirements.
34
CAPITALIZATION
Over the three-year period ended December 31, 2003, the Company has managed its
capitalization by issuing and restructuring debt and issuing/purchasing common
stock and equivalents, as summarized in the following table:
YEARS ENDED DECEMBER 31,
------------------------------------
2003 2002 2001
---------- ---------- ----------
(IN THOUSANDS)
Securitization trust debt:
Beginning balance ..................................... $ 71,630 $ -- $ --
Assumption in connection with MFN & TFC Merger ....... 115,597 156,923 --
Issuances .......................................... 154,375 -- --
Payments ............................................ (96,484) (85,293) --
---------- ---------- ----------
Ending balance ........................................ $ 245,118 $ 71,630 $ --
========== ========== ==========
Senior secured debt:
Beginning balance ..................................... $ 50,072 $ 26,000 $ 38,000
Issuances .......................................... 25,000 46,242 --
Payments ........................................... (25,107) (22,170) (12,000)
---------- ---------- ----------
Ending balance ........................................ $ 49,965 $ 50,072 $ 26,000
========== ========== ==========
Subordinated debt:
Beginning balance ..................................... $ 36,000 $ 36,989 $ 37,699
Assumption in connection with MFN & TFC Merger ..... -- 22,500 --
Payments ........................................... (1,000) (23,489) (710)
---------- ---------- ----------
Ending balance ........................................ $ 35,000 $ 36,000 $ 36,989
========== ========== ==========
Related party debt:
Beginning balance ..................................... $ 17,500 $ 17,500 $ 21,500
Issuances ......................................... -- -- --
Payments .......................................... -- -- (4,000)
---------- ---------- ----------
Ending balance ........................................ $ 17,500 $ 17,500 $ 17,500
========== ========== ==========
Increase (decrease) of Common Stock and equivalents ... $ 23 $ 2,074 $ (757)
========== ========== ==========
The assumption of debt related to the TFC Merger is included in the 2003
activity in the table above. The assumption of debt related to the MFN Merger is
included in the 2002 activity in the table above.
During the first quarter of 2001, the Company purchased a total of $8,000,000 of
outstanding indebtedness held by Levine Leichtman Capital Partners II, L.P.
("LLCP") and Stanwich Financial Services Corp. ("SFSC"). The Company purchased
and retired $4,000,000 of subordinated debt held by SFSC in exchange for payment
of $3,920,000, and purchased and retired $4,000,000 of senior secured debt held
by LLCP in exchange for payment of $4,200,000. The LLCP debt by its terms called
for a prepayment penalty of 3% (or $120,000); the additional 2% (or $80,000)
paid in connection with its February 2001 prepayment was absorbed by SFSC.
In March 2002, the Company and LLCP entered into an additional series of
agreements under which LLCP provided additional funding to enable the Company to
acquire MFN Financial Corporation. Under the March 2002 agreements, the Company
borrowed $35 million from LLCP as a Bridge Note (Bridge Note) and approximately
$8.5 million ("Term C") on a deemed principal amount of approximately $11.2
million. The Bridge Note requires principal payments of $2.0 million a month,
which began in June 2002, with a final balloon payment in the amount of $17.0
million, which was made pursuant to the terms of the Bridge Note in February
2003. The Term C Note repayment schedule is based on the performance of a
certain securitized pool. As the subordinated Note of the pool is repaid from
the Trust, principal payments are due on the Term C Note. The maturity date of
the Term C Note is March 2008. Interest is due monthly on the Bridge Note at a
rate of 13.5% per annum and on the Term C Note at a rate of 12.0% per annum. In
connection with the March 2002 agreements and the acquisition of MFN, the
Company paid LLCP a structuring fee of $1.75 million and an investment banking
fee of $1.0 million, and paid LLCP's out-of-pocket expenses of approximately
35
$315,000. In addition, the Company paid LLCP certain other fees and interest
amounting to $426,181. Approximately $1.4 million of the fees and other amounts
paid to LLCP were deferred as financing costs and are being amortized over the
life of the related debt. The remaining fees and other costs were included in
the purchase price of MFN. At December 31, 2003, there was $5.1 million
principal outstanding on the Term C.
At the time of the MFN Merger, MFN had outstanding $22.5 million in principal
amount of senior subordinated debt, which was due and repaid in full on March
23, 2002. Such debt bore interest at the rate of 11.00% per annum, payable
quarterly in arrears. At the time of the TFC Merger, TFC had outstanding $6.3
million in principal amount of subordinated debt, which the Company assumed as
part of the TFC Merger. Such debt bears interest at the rate of 13.25% per annum
payable monthly in arrears, requires monthly amortization and is due in June
2005.
On February 3, 2003, the Company borrowed $25.0 million from LLCP, net of fees
and expenses of $1.05 million. The indebtedness, represented by the "Term D
Note," was originally due in April 2003, with Company options to extend the
maturity to May 2003 and January 2004, upon payment of successive extension fees
of $125,000. The Company has paid the fees to extend the maturity to January
2004. Interest on the Term D Note is payable monthly at rates that averaged
4.79% per annum through June 30, 2003, and 12.0% per annum thereafter. In a
separate transaction, the Bridge Note issued to LLCP in connection with the
acquisition of MFN, in an original principal amount of $35.0 million, was due on
February 28, 2003. The outstanding principal balance of $17.0 million was paid
in February 2003. In addition, the maturity of the Term B Note was extended in
October 2003 from November 2003 to January 2004. As of December 31, 2003, the
outstanding principal balances of the Term B Note and the Term C Note were $19.8
million and $5.3 million, respectively. The Company repaid in full the Term C
Note on January 29, 2004 and repaid $10.0 million of the Term D Note on January
15, 2004. In addition, on January 29, 2004 the maturities of the Term B Note and
the Term D Note were extended to December 15, 2005 and the coupons on both notes
were decreased to 11.75% per annum. The Company paid LLCP fees equal to $921,000
for these amendments, which will be amortized over the remaining life of the
notes.
LLCP holds approximately 22.1% of the Company's outstanding common shares. SFSC
is an affiliate of Charles E. Bradley, Sr., the Company's former Chairman and
Father of the Company's current Chairman and Chief Executive Officer, and SFSC
and Mr. Bradley, Sr. together hold in excess of 5.0% of the Company's
outstanding common shares.
The Company must comply with certain affirmative and negative covenants related
to debt facilities, which require, among other things, that the Company maintain
certain financial ratios related to liquidity, net worth, capitalization,
investments, acquisitions, restricted payments and certain dividend
restrictions. The Company was in compliance with all of its debt covenants with
respect to non-securitization related debt as of December 31, 2003. The Company
was in violation of four covenants related to securitization debt as of December
31, 2003, including maximum leverage, minimum equity, maximum financial loss and
interest coverage. As of December 31, 2003, the Company had received a waiver of
such non-compliance from the controlling party. In March 2004, each of these
financial covenants was amended with the controlling party such that all
breaches have been cured.
In July 2000, the Board of Directors authorized the purchase of up to $5,000,000
of outstanding debt and equity securities of the Company, inclusive of the
mandatory annual purchase or redemption of $1,000,000 of the Company's
outstanding "RISRS" subordinated debt securities, due 2006. In October 2002, the
Board of Directors authorized the purchase of an additional $5,000,000 of
outstanding debt or equity securities. As of December 31, 2003, the Company had
purchased $4.0 million in principal amount of the RISRS, and $3.9 million of its
common stock, representing 2,141,037 shares.
36
FORWARD-LOOKING STATEMENTS
This report on Form 10-K includes certain "forward-looking statements,"
including, without limitation, the statements or implications to the effect that
prepayments as a percentage of original balances will approximate 18.1% to 22.1%
cumulatively over the lives of the related Contracts, that charge-offs as a
percentage of original balances will approximate 15.9% to 23.1% cumulatively
over the lives of the related Contracts, with recovery rates approximating 2.2%
to 5.3% of original principal balances. Other forward-looking statements may be
identified by the use of words such as "anticipates," "expects," "plans,"
"estimates," or words of like meaning. As to the specifically identified
forward-looking statements, factors that could affect charge-offs and recovery
rates include changes in the general economic climate, which could affect the
willingness or ability of obligors to pay pursuant to the terms of Contracts,
changes in laws respecting consumer finance, which could affect the ability of
the Company to enforce rights under Contracts, and changes in the market for
used vehicles, which could affect the levels of recoveries upon sale of
repossessed vehicles. Factors that could affect the Company's revenues in the
current year include the levels of cash releases from existing pools of
Contracts, which would affect the Company's ability to purchase Contracts, the
terms on which the Company is able to finance such purchases, the willingness of
Dealers to sell Contracts to the Company on the terms that it offers, and the
terms on which the Company is able to complete term securitizations once
Contracts are acquired. Factors that could affect the Company's expenses in the
current year include competitive conditions in the market for qualified
personnel, and interest rates (which affect the rates that the Company pays on
Notes issued in its securitizations). The statements concerning the Company
structuring future securitization transactions as secured financings and the
effects of such structures on financial items and on the Company's future
profitability also are forward-looking statements. Any change to the structure
of the Company's securitization transaction could cause such forward-looking
statements not to be accurate. Both the amount of the effect of the change in
structure on the Company's profitability and the duration of the period in which
the Company's profitability would be affected by the change in securitization
structure are estimates. The accuracy of such estimates will be affected by the
rate at which the Company purchases and sells Contracts, any changes in that
rate, the credit performance of such Contracts, the financial terms of future
securitizations, any changes in such terms over time, and other factors that
generally affect the Company's profitability.
Additional risk factors, any of which could have a material effect on the
Company's performance, are set forth below:
DEPENDENCE ON WAREHOUSE FINANCING. The Company's primary source of day-to-day
liquidity is continuous securitization of Contracts, under which it sells or
pledges Contracts, as often as once a week, to one special-purpose affiliated
entity in the case of CPS, or a different special-purpose affiliated entity in
the case of TFC. Such transactions function as a "warehouse," in which Contracts
are held. The Company expects to continue to effect similar transactions (or to
obtain replacement or additional financing) as current arrangements expire or
become fully utilized; however, there can be no assurance that such financing
will be obtainable on favorable terms. To the extent that the Company is unable
to maintain its existing structure or is unable to arrange new warehouse
facilities, the Company may have to curtail Contract purchasing activities,
which could have a material adverse effect on the Company's financial condition
and results of operations. In addition, the Company is currently in breach of a
covenant under one of its warehouse facilities to maintain $75 million in
additional minimum warehouse borrowing capacity. The Company has until June 20,
2004 to cure such breach prior to it becoming an event of default under one
warehouse facility and four term securitizations. While the Company is currently
in discussions with several parties about a replacement facility and believes
that it will be successful in replacing the facility within the required time
frame, there can be no assurances that it will do so. If the Company is
unsuccessful in these efforts, the Note Insurer will have the right to declare
an event of default. Remedies available to the Note Insurer in such event
include, among other things, transferring the servicing rights to the portfolio
that it insures to another servicer and trapping excess cash releases to the
Company from its warehouse facility and four term securitizations that it
insures. To the extent that the Note Insurer were to pursue either of these
remedies, it would have a material adverse effect on the liquidity and
operations of the Company.
37
DEPENDENCE ON SECURITIZATION PROGRAM. The Company is dependent upon its ability
to continue to finance pools of Contracts in term securitizations in order to
generate cash proceeds for new purchases. Adverse changes in the market for
securitized Contract pools, or a substantial lengthening of the warehousing
period, would burden the Company's financing capabilities, could require the
Company to curtail its purchase of Contracts, and could have a material adverse
effect on the Company. In addition, as a means of reducing the percentage of
cash collateral that the Company would otherwise be required to deposit and
maintain in Spread Accounts and overcollateralization, all of the Company's
securitizations since June 1994 have utilized credit enhancement in the form of
financial guaranty insurance policies issued by monoline financial guaranty
insurers. The Company believes that financial guaranty insurance policies reduce
the costs of securitizations relative to alternative forms of credit
enhancements available to the Company. No insurer is required to insure
Company-sponsored securitizations and there can be no assurance that any will
continue to do so. Similarly, there can be no assurance that any securitization
transaction will be available on terms acceptable to the Company, or at all. The
timing of any securitization transaction is affected by a number of factors
beyond the Company's control, any of which could cause substantial delays,
including, without limitation, market conditions and the approval by all parties
of the terms of the securitization.
RISK OF GENERAL ECONOMIC DOWNTURN. The Company's business is directly related to
sales of new and used automobiles, which are affected by employment rates,
prevailing interest rates and other domestic economic conditions. Delinquencies,
repossessions and losses generally increase during economic slowdowns or
recessions. Because of the Company's focus on Sub-Prime Customers, the actual
rates of delinquencies, repossessions and losses on such Contracts could be
higher under adverse economic conditions than those experienced in the
automobile finance industry in general. Any sustained period of economic
slowdown or recession could adversely affect the Company's ability to sell or
securitize pools of Contracts. The timing of any economic changes is uncertain,
and sluggish sales of automobiles and weakness in the economy could have an
adverse effect on the Company's business and that of the Dealers from which it
purchases Contracts.
DEPENDENCE ON PERFORMANCE OF SECURITIZED CONTRACTS. Under the financial
structures the Company has used to date in its term securitizations, certain
excess cash flows generated by the Contracts sold in the term securitizations
are used to increase overcollateralization or retained in a Spread Account
within the securitization trusts to provide liquidity and credit enhancement.
While the specific terms and mechanics of each Spread Account vary among
transactions, the Company's Securitization Agreements generally provide that the
Company will receive excess cash flows only if the amount of Credit Enhancement
has reached specified levels and/or the delinquency, defaults or net losses
related to the Contracts in the pool are below certain predetermined levels. In
the event delinquencies, defaults or net losses on the Contracts exceed such
levels, the terms of the securitization: (i) may require increased Credit
Enhancement to be accumulated for the particular pool; (ii) may restrict the
distribution to the Company of excess cash flows associated with other pools; or
(iii) in certain circumstances, may permit the insurers to require the transfer
of servicing on some or all of the Contracts to another servicer. Any of these
conditions could materially adversely affect the Company's liquidity and
financial condition.
CREDITWORTHINESS OF CONSUMERS. The Company specializes in the purchase, sale and
servicing of Contracts to finance automobile purchases by Sub-Prime Customers,
which entail a higher risk of non-performance, higher delinquencies and higher
losses than Contracts with more creditworthy customers. While the Company
believes that the underwriting criteria and collection methods it employs enable
it to control the higher risks inherent in Contracts with Sub-Prime Customers,
no assurance can be given that such criteria and methods will afford adequate
protection against such risks. The Company has experienced fluctuations in the
delinquency and charge-off performance of its Contracts. In the event that
portfolios of Contracts securitized and serviced by the Company experience
greater defaults, higher delinquencies or higher net losses than anticipated,
the Company's income could be negatively affected. A larger number of defaults
than anticipated could also result in adverse changes in the structure of the
Company's future securitization transactions, such as a requirement of increased
cash collateral or other Credit Enhancement in such transactions.
PROBABLE INCREASE IN COST OF FUNDS. The Company's profitability is determined
by, among other things, the difference between the rate of interest charged on
the Contracts purchased by the Company and the rate of interest payable to
purchasers of Notes issued in securitizations. The Contracts purchased by the
Company generally bear finance charges close to or at the maximum permitted by
applicable state law. The interest rates payable on such Notes are fixed, based
on interest rates prevailing in the market at the time of sale. Consequently,
increases in market interest rates tend to reduce the "spread" or margin between
38
Contract finance charges and the interest rates required by investors and, thus,
the potential operating profits to the Company from the purchase, securitization
and servicing of Contracts. Operating profits expected to be earned by the
Company on portfolios of Contracts previously securitized are insulated from the
adverse effects of increasing interest rates because the interest rates on the
related Notes were fixed at the time the Contracts were sold. With interest
rates near historical lows as of the date of this report, it is probable that
interest rates will increase in the near to intermediate term. Any future
increases in interest rates would likely increase the interest rates on Notes
issued in future term securitizations and could have a material adverse effect
on the Company's results of operations.
PREPAYMENTS AND CREDIT LOSSES. Gains from the sale of Contracts in the Company's
past securitization transactions structured as sales for financial accounting
purposes have constituted a significant portion of the revenue of the Company. A
portion of the gains is based in part on management's estimates of future
prepayments and credit losses and other considerations in light of then-current
conditions. If actual prepayments with respect to Contracts occur more quickly
than was projected at the time such Contracts were sold, as can occur when
interest rates decline, or if credit losses are greater than projected at the
time such Contracts were sold, a charge to income may be required and would be
taken in the period of adjustment. If actual prepayments occur more slowly or if
net losses are lower than estimated with respect to Contracts sold, total
revenue would exceed previously estimated amounts. Provisions for credit losses
are recorded in connection with the origination and throughout the life of
Contracts that are held on the Company's Consolidated Balance Sheet. Such
provisions are based on management's estimates of future credit losses in light
of then-current conditions. If actual credit losses in a given period exceed the
allowance for credit losses, a bad debt expense during the period would be
required.
COMPETITION. The automobile financing business is highly competitive. The
Company competes with a number of national, local and regional finance
companies. 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 and Ford Motor Credit 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 relative to that of 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' purchases of automobiles from
manufacturers, which is not offered by the Company. There can be no assurance
that the Company will be able to continue to compete successfully.
LITIGATION. Because of 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 class-action 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. Although the Company is not involved in
any such material consumer protection litigation, a significant judgment against
the Company or within the industry in connection with any such litigation, or an
adverse outcome in the litigation identified under the caption "Legal
Proceedings" in this report could have a material adverse effect on the
Company's financial condition and results of operations.
DEPENDENCE ON DEALERS. The Company is dependent upon establishing and
maintaining relationships with unaffiliated Dealers to supply it with Contracts.
During the year ended December 31, 2003, no Dealer accounted for more than 1.0%
of the Contracts purchased by the Company. The Dealer Agreements do not require
Dealers to submit a minimum number of Contracts for purchase by the Company. The
failure of Dealers to submit Contracts that meet the Company's underwriting
criteria would have a material adverse effect on the Company's financial
condition and results of operations.
39
GOVERNMENT REGULATIONS. The Company's business is subject to numerous federal
and state consumer protection laws and regulations, which, among other things:
(i) require the Company to obtain and maintain certain licenses and
qualifications; (ii) limit the interest rates, fees and other charges the
Company is allowed to charge; (iii) limit or prescribe certain other terms of
its Contracts; (iv) require the Company to provide specified disclosures; and
(v) regulate certain servicing and collection practices and define its rights to
repossess and sell collateral. An adverse change in existing laws or
regulations, or in the interpretation thereof, the promulgation of any
additional laws or regulations, or the failure to comply with such laws and
regulations could have a material adverse effect on the Company's financial
condition and results of operations.
NEW ACCOUNTING PRONOUNCEMENTS
The Company 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.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
The Company is subject to interest rate risk during the period between when
Contracts are purchased from Dealers and when such Contracts become part of a
term securitization. Specifically, the interest rates on the warehouse
facilities are adjustable while the interest rates on the Contracts are fixed.
Historically, the Company's term securitization facilities have had fixed rates
of interest. To mitigate some of this risk, the Company has in the past, and
intends to continue to, structure certain of its securitization transactions to
include pre-funding structures, whereby the amount of Notes issued exceeds the
amount of Contracts initially sold to the Trusts. In pre-funding, 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 Contracts 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 Notes outstanding, the amount as to which there can be no assurance.
The Company is subject to market risks due to fluctuations in interest rates
primarily through its outstanding indebtedness and to a lesser extent its
outstanding interest earning assets, and commitments to enter into new
Contracts. The table below outlines the carrying values and estimated fair
values of such financial instruments:
DECEMBER 31,
------------------------------------------
2003 2002
-------------------- --------------------
CARRYING FAIR CARRYING FAIR
FINANCIAL INSTRUMENT VALUE VALUE VALUE VALUE
-------------------- --------- --------- --------- ---------
(IN THOUSANDS)
Finance receivables, net ... $266,189 $266,189 $ 84,592 $ 84,592
Notes payable .............. 3,330 3,330 673 673
Securitization trust debt .. 245,118 245,118 71,630 71,630
Senior secured debt ........ 49,965 49,965 50,072 50,072
Subordinated debt .......... 35,000 35,506 36,000 32,800
Related party debt ......... 17,500 17,763 17,500 15,400
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 markets do
not exist. Therefore, considerable judgments were required in estimating fair
value for certain items. The subjective factors include, among other things, the
40
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 the dates shown in the table, the amounts that will actually be
realized or paid at settlement or maturity of the instruments could be
significantly different.
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.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
ITEM 9A. CONTROLS AND PROCEDURES
QUARTERLY EVALUATION OF THE COMPANY'S DISCLOSURE CONTROLS AND INTERNAL CONTROLS
The Company maintains a system of internal controls and procedures designed to
provide reasonable assurance as to the reliability of its published financial
statements and other disclosures included in this report. As of the end of the
period covered by this report, The Company evaluated the effectiveness of the
design and operation of such disclosure controls and procedures. Based upon that
evaluation, the principal executive officer (Charles E. Bradley, Jr.) and the
principal financial officer (Robert E. Riedl) concluded that the disclosure
controls and procedures are effective in recording, processing, summarizing and
reporting, on a timely basis, material information relating to the Company that
is required to be included in its reports filed under the Securities Exchange
Act of 1934. There have been no significant changes in our internal controls
over financial reporting during our most recently completed fiscal quarter that
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.
CEO AND CFO CERTIFICATIONS
Immediately following the Signatures section of this Annual Report, there are
two separate forms of "Certifications" of the CEO and the CFO. The first form of
Certification (the Rule 13a-14 Certification) is required in accord with Rule
13a-14 of the Securities Exchange Act of 1934 (the "Exchange Act"). This
Controls and Procedures section of the Annual Report includes the information
concerning the Controls Evaluation referred to in the Rule 13a-14 Certifications
and it should be read in conjunction with the Rule 13a-14 Certifications for a
more complete understanding of the topics presented.
DISCLOSURE CONTROLS AND INTERNAL CONTROLS
Disclosure Controls are procedures designed to ensure that information required
to be disclosed in our reports filed under the Exchange Act, such as this Annual
Report, is recorded, processed, summarized and reported within the time periods
specified in the U.S. Securities and Exchange Commission's (the "SEC") rules and
forms. Disclosure Controls are also designed to ensure that such information is
accumulated and communicated to our management, including the CEO and CFO, as
appropriate to allow timely decisions regarding required disclosure. Internal
Controls are procedures designed to provide reasonable assurance that (1) our
transactions are properly authorized; (2) our assets are safeguarded against
unauthorized or improper use; and (3) our transactions are properly recorded and
reported, all to permit the preparation of our Consolidated Financial Statements
in conformity with accounting principles generally accepted in the United States
of America.
41
LIMITATIONS ON THE EFFECTIVENESS OF CONTROLS
The Company's management, including the CEO and CFO, does not expect that our
Disclosure Controls or our Internal Controls will prevent all error and all
fraud. A control system, no matter how well designed and operated, can provide
only reasonable, not absolute, assurance that the control system's objectives
will be met. Further, the design of a control system must reflect the fact that
there are resource constraints, and the benefits of controls must be considered
relative to their costs. Because of the inherent limitations in all control
systems, no evaluation of controls can provide absolute assurance that all
control issues and instances of fraud, if any, within the Company have been
detected. These inherent limitations include the realities that judgments in
decision-making can be faulty, and that breakdowns can occur because of simple
error or mistake. Controls can also be circumvented by the individual acts of
some persons, by collusion of two or more people, or by management override of
the controls. The design of any system of controls is based in part upon certain
assumptions about the likelihood of future events, and there can be no assurance
that any design will succeed in achieving its stated goals under all potential
future conditions. Over time, controls may become inadequate because of changes
in conditions or deterioration in the degree of compliance with its policies or
procedures. Because of the inherent limitations in a cost-effective control
system, misstatements due to error or fraud may occur and not be detected.
SCOPE OF THE CONTROLS EVALUATION
The evaluation of our Disclosure Controls and our Internal Controls included a
review of the controls' objectives and design, the Company's implementation of
the controls and the effect of the controls on the information generated for use
in this Annual Report. In the course of the Controls Evaluation, we sought to
identify data errors, controls problems or acts of fraud and confirm that
appropriate corrective actions, including process improvements, were being
undertaken. This type of evaluation is performed on a quarterly basis so that
the conclusions of management, including the CEO and CFO, concerning controls
effectiveness can be reported in our Quarterly Reports on Form 10-Q and Annual
Report on Form 10-K. Our Internal Controls are also evaluated by other personnel
in our organization, as well as independent interested third parties such as
financial guaranty insurers or their designees. The overall goals of these
various evaluation activities are to monitor our Disclosure Controls and our
Internal Controls, and to modify them as necessary; our intent is to maintain
the Disclosure Controls and the Internal Controls as dynamic systems that change
as conditions warrant.
Among other matters, we sought in our evaluation to determine whether there were
any "significant deficiencies" or "material weaknesses" in the Company's
Internal Controls, and whether the Company had identified any acts of fraud
involving personnel with a significant role in the Company's Internal Controls.
This information was important both for the Controls Evaluation generally, and
because items 5 and 6 in the Rule 13a-14 Certifications of the CEO and CFO
require that the CEO and CFO disclose that information to our Board's Audit
Committee and our independent auditors, and report on related matters in this
section of the Annual Report. In professional auditing literature, "significant
deficiencies" are referred to as "reportable conditions," which are control
issues that could have a significant adverse effect on the ability to record,
process, summarize and report financial data in the Consolidated Financial
Statements. Auditing literature defines "material weakness" as a particularly
serious reportable condition where the internal control does not reduce to a
relatively low level the risk that misstatements caused by error or fraud may
occur in amounts that would be material in relation to the Consolidated
Financial Statements and the risk that such misstatements would not be detected
within a timely period by employees in the normal course of performing their
assigned functions. We also sought to deal with other controls matters in the
Controls Evaluation, and in each case if a problem was identified, we considered
what revision, improvement and/or correction to make in accordance with our
ongoing procedures.
From the date of the Controls Evaluation to the date of this Annual Report,
there have been no significant changes in Internal Controls or in other factors
that could significantly affect Internal Controls, including any corrective
actions with regard to significant deficiencies and material weaknesses.
42
CONCLUSIONS
Based upon the Controls Evaluation, our CEO and CFO have concluded that, subject
to the limitations noted above, our Disclosure Controls are effective to ensure
that material information relating to Consumer Portfolio Services, Inc. and its
consolidated subsidiaries is made known to management, including the CEO and
CFO, particularly during the period when our periodic reports are being
prepared, and that our Internal Controls are effective to provide reasonable
assurance that our Consolidated Financial Statements are fairly presented in
conformity with accounting principles generally accepted in the United States of
America.
43
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 2004 (the "2004 Proxy Statement"). The 2004 Proxy
Statement will be filed not later than April 29, 2004. 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 2004 Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated by reference to the 2004 Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference to the 2004 Proxy Statement.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Incorporated by reference to the 2004 Proxy Statement.
44
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8K
(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 exhibits listed below are filed as part of this report, whether filed
herewith or incorporated by reference to an exhibit filed with the report
identified in the parentheses following the description of such exhibit. Unless
otherwise indicated, each such identified report was filed by or with respect to
the registrant.
EXHIBIT
NUMBER DESCRIPTION
------ -----------
2.1 Agreement and Plan of Merger, dated as of November 18, 2001, by
and among the Registrant, CPS Mergersub, Inc. and MFN Financial
Corporation. (Form 8-K filed on November 19, 2001 by MFN Financial
Corporation).
3.1 Restated Articles of Incorporation (Form 10-KSB dated December 31,
1995)
3.2 Amended and Restated Bylaws (Form 10-K dated December 31, 1997)
4.1 Indenture re Rising Interest Subordinated Redeemable Securities
("RISRS") (Form 8-K filed December 26, 1995)
4.2 First Supplemental Indenture re RISRS (Form 8-K filed December 26,
1995)
4.3 Form of Indenture re 10.50% Participating Equity Notes ("PENs")
(Form S-3, no. 333-21289)
4.4 Form of First Supplemental Indenture re PENs (Form S-3, no.
333-21289)
4.5 Third Amended and Restated Securities Purchase Agreement, dated as
of January 29, 2004, by and between Levine Leichtman Capital
Partners II, L.P. and the Registrant. (Schedule 13D/A filed on
February 3, 2004).
4.6 Secured Senior Note due February 28, 2003 issued by the Registrant
to Levine Leichtman Capital Partners II, L.P. (Form 8-K filed on
March 25, 2002).
4.7 Second Amended and Restated Secured Senior Note due November 30,
2003 issued by the Registrant to Levine Leichtman Capital Partners
II, L.P. (Form 8-K filed on March 25, 2002).
4.8 12.00% Secured Senior Note due 2008 issued by the Registrant to
Levine Leichtman Capital Partners II, L.P. (Form 8-K filed on
March 25, 2002).
4.9 Sale and Servicing Agreement, dated as of March 1, 2002, among the
Registrant, CPS Auto Receivables Trust 2002-A, CPS Receivables
Corp., Systems & Services Technologies, Inc. and Bank One Trust
Company, N.A. (Form 8-K filed on March 25, 2002).
4.10 Indenture, dated as of March 1, 2002, between CPS Auto Receivables
Trust 2002-A and Bank One Trust Company, N.A. (Form 8-K filed on
March 25, 2002).
45
10.1 1991 Stock Option Plan & forms of Option Agreements thereunder
(Form 10-KSB dated March 31, 1994)
10.2 1997 Long-Term Incentive Stock Plan (filed as Appendix A to the
Company's definitive proxy statement filed May 13, 2003.)
10.3 Lease Agreement re Chesapeake Collection Facility (Form 10-K dated
December 31, 1996)
10.4 Lease of Headquarters Building (Form 10-Q dated September 30,
1997)
10.5 Partially Convertible Subordinated Note (Form 10-Q dated September
30, 1997)
10.13 FSA Warrant Agreement dated November 30, 1998 (Form 10-K dated
December 31, 1998)
10.29 Warrant to Purchase 1,335,000 Shares of Common Stock (Schedule 13D
filed on April 21, 1999)
10.31 Agreement dated May 29, 1999 for Sale of Contracts on a Flow Basis
(Form 10-Q dated June 30, 1999)
10.32 Amendment to Master Spread Account Agreement (Form 10-K dated
December 31, 1999)
23.1 Consent of independent auditors (filed herewith)
(b) Reports on Form 8-K
The Company did not file any reports on Form 8-K during the fourth quarter of
the year ended December 31, 2002.
SIGNATURES AND CERTIFICATIONS OF THE CHIEF EXECUTIVE OFFICER AND THE CHIEF
FINANCIAL OFFICER
The following pages include the Signatures page for this Form 10-K, and two
separate Certifications of the Chief Executive Officer ("CEO") and the Chief
Financial Officer ("CFO") of the company.
The first form of Certification is required by Rule 13a-14 (the Rule 13a-14
Certification) under the Securities Exchange Act of 1934 (the "Exchange Act").
The Rule 13a-14 Certification includes references to an evaluation of the
effectiveness of the design and operation of the company's "disclosure controls
and procedures" and its "internal controls and procedures for financial
reporting." Item 14 of Part III of this Annual Report presents the conclusions
of the CEO and the CFO about the effectiveness of such controls based on and as
of the date of such evaluation (relating to Item 4 of the Rule 13a-14
Certification), and contains additional information concerning disclosures to
the company's Audit Committee and independent auditors with regard to
deficiencies in internal controls and fraud (Item 5 of the Rule 13a-14
Certification) and related matters (Item 6 of the Rule 13a-14 Certification).
The second form of Certification is required by section 1350 of chapter 63 of
title 18 of the United States Code.
46
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. (REGISTRANT)
March 22, 2004 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.
March 22, 2004 /s/ Charles E. Bradley, Jr.
-------------------------------------------
Charles E. Bradley, Jr., DIRECTOR,
PRESIDENT AND CHIEF EXECUTIVE OFFICER
(PRINCIPAL EXECUTIVE OFFICER)
March 22, 2004 /s/ Thomas L. Chrystie
-------------------------------------------
Thomas L. Chrystie, DIRECTOR
March 22, 2004 /s/ E. Bruce Fredrikson
-------------------------------------------
E. Bruce Fredrikson, DIRECTOR
March 22, 2004 /s/ John E. McConnaughy, Jr.
-------------------------------------------
John E. McConnaughy, Jr., DIRECTOR
March 22, 2004 /s/ John G. Poole
-------------------------------------------
John G. Poole, DIRECTOR
March 22, 2004 /s/ William B. Roberts
-------------------------------------------
William B. Roberts, DIRECTOR
March 22, 2004 /s/ John C. Warner
--------------------------------------------
John C. Warner, DIRECTOR
March 22, 2004 /s/ Daniel S. Wood
-------------------------------------------
Daniel S. Wood, DIRECTOR
March 22, 2004 /s/ Robert E. Riedl
-------------------------------------------
Robert E. Riedl, CHIEF FINANCIAL OFFICER
(PRINCIPAL FINANCIAL OFFICER)
47
CERTIFICATION
I, Charles E. Bradley, Jr., certify that:
1. I have reviewed this annual report on Form 10-K of Consumer Portfolio
Services, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
March 22, 2004 By: /s/ Charles E. Bradley, Jr.
-------------------------------------
Charles E. Bradley, Jr.
PRESIDENT AND CHIEF EXECUTIVE OFFICER
48
CERTIFICATION
I, Robert E. Riedl, certify that:
1. I have reviewed this annual report on Form 10-K of Consumer Portfolio
Services, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
March 22, 2004 By: /s/ Robert E. Riedl
----------------------------------------
Robert E. Riedl, CHIEF FINANCIAL OFFICER
49
CERTIFICATION
Each of the undersigned hereby certifies, for the purposes of section 1350 of
chapter 63 of title 18 of the United States Code, in his capacity as an officer
of Consumer Portfolio Services, Inc., that, to his knowledge, the Annual Report
of Consumer Portfolio Services, Inc. on Form 10-K for the period ended December
31, 2003, fully complies with the requirements of Section 13(a) of the
Securities Exchange Act of 1934 and that the information contained in such
report fairly presents, in all material respects, the financial condition and
results of operations of Consumer Portfolio Services, Inc.
March 22, 2004 By: /s/ Charles E. Bradley, Jr.
----------------------------------------
Charles E. Bradley, Jr.
PRESIDENT AND CHIEF EXECUTIVE OFFICER
March 22, 2004 By: /s/ Robert E. Riedl
----------------------------------------
Robert E. Riedl, CHIEF FINANCIAL OFFICER
50
INDEX TO FINANCIAL STATEMENTS
PAGE
REFERENCE
---------
Independent Auditors' Report........................................... F-2
Consolidated Balance Sheets as of December 31, 2003 and 2002........... F-3
Consolidated Statements of Operations for the years ended
December 31, 2003, 2002, and 2001.................................. F-4
Consolidated Statements of Comprehensive Income (Loss)
for the years ended December 31, 2003, 2002, and 2001.............. F-5
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 2003, 2002, and 2001.................................. F-6
Consolidated Statements of Cash Flows for the years ended December
31, 2003, 2002, and 2001........................................... F-7
Notes to Consolidated Financial Statements for the years ended
December 31, 2003, 2002, and 2001.................................. F-9
F-1
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 (the "Company") as of December 31,
2003 and 2002, and the related consolidated statements of operations,
comprehensive income (loss), shareholders' equity, and cash flows for each of
the years in the three-year period ended December 31, 2003. 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 auditing standards generally accepted
in the United States of America. 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, 2003 and 2002, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2003, in conformity with accounting
principles generally accepted in the United States of America.
/s/ KPMG LLP
Orange County, California
March 15, 2004
F-2
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
DECEMBER 31, DECEMBER 31,
2003 2002
---------- ----------
ASSETS
Cash ........................................................... $ 33,209 $ 32,947
Restricted cash ................................................ 67,277 18,912
Finance receivables ............................................ 302,078 110,420
Less: Allowance for finance credit losses ...................... (35,889) (25,828)
---------- ----------
Finance receivables, net ....................................... 266,189 84,592
Servicing fees receivable ...................................... 3,942 3,407
Residual interest in securitizations ........................... 111,702 127,170
Furniture and equipment, net ................................... 826 1,612
Deferred financing costs ....................................... 1,529 1,671
Deferred interest expense ...................................... -- 2,695
Other assets ................................................... 7,796 12,442
---------- ----------
$ 492,470 $ 285,448
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Accounts payable & accrued expenses ............................ $ 22,920 $ 18,132
Warehouse lines of credit ...................................... 33,709 --
Tax liabilities, net ........................................... 2,768 8,800
Capital lease obligation ....................................... -- 67
Notes payable .................................................. 3,330 673
Securitization trust debt ...................................... 245,118 71,630
Senior secured debt ............................................ 49,965 50,072
Subordinated debt .............................................. 35,000 36,000
Related party debt ............................................. 17,500 17,500
---------- ----------
410,310 202,874
---------- ----------
Shareholders' Equity
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;
20,588,924 and 20,528,270 shares issued and outstanding
at December 31, 2003 and December 31, 2002, respectively .... 64,397 63,929
Retained earnings .............................................. 20,992 20,597
Comprehensive loss - minimum pension benefit obligation, net ... (2,426) (1,594)
Deferred compensation .......................................... (803) (358)
---------- ----------
82,160 82,574
---------- ----------
$ 492,470 $ 285,448
========== ==========
See accompanying Notes to Consolidated Financial Statements.
F-3
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31,
------------------------------------
2003 2002 2001
---------- ---------- ----------
Revenues:
Gain on sale of contracts, net ....................... $ 6,369 $ 16,444 $ 32,765
Interest income ...................................... 58,164 48,644 17,205
Servicing fees ....................................... 17,058 14,621 10,666
Other income ......................................... 19,343 13,605 1,940
---------- ---------- ----------
100,934 93,314 62,576
---------- ---------- ----------
Expenses:
Employee costs ....................................... 37,141 37,778 23,994
General and administrative ........................... 21,271 20,131 12,645
Interest ............................................. 23,861 23,925 14,335
Provision for credit losses .......................... 11,390 -- --
Marketing ............................................ 5,380 6,253 7,096
Occupancy ............................................ 3,930 4,027 3,167
Depreciation and amortization ........................ 1,000 1,138 1,019
---------- ---------- ----------
103,973 93,252 62,256
---------- ---------- ----------
Income (loss) before income taxes (benefit) .......... (3,039) 62 320
Income tax expense (benefit) ......................... (3,434) (2,934) --
---------- ---------- ----------
Income before extraordinary item ..................... 395 2,996 320
Extraordinary item, unallocated negative goodwill .... -- 17,412 --
---------- ---------- ----------
Net income ........................................... $ 395 $ 20,408 $ 320
========== ========== ==========
Earnings per share before extraordinary item:
Basic .............................................. $ 0.02 $ 0.15 $ 0.02
Diluted ............................................ 0.02 0.14 0.02
Earnings per share, extraordinary item:
Basic .............................................. $ -- $ 0.87 $ --
Diluted ............................................ -- 0.83 --
Earnings per share after extraordinary item:
Basic .............................................. $ 0.02 $ 1.03 $ 0.02
Diluted ............................................ 0.02 0.97 0.02
Number of shares used in computing earnings per share:
Basic .............................................. 20,263 19,902 19,480
Diluted ............................................ 21,578 20,987 21,018
See accompanying Notes to Consolidated Financial Statements.
F-4
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
---------------------------------
2003 2002 2001
--------- --------- ---------
Net income ................................. $ 395 $ 20,408 $ 320
Other comprehensive loss:
Minimum pension liability, net of tax ...... (832) (1,594) --
--------- --------- ---------
Comprehensive income (loss) ................ $ (437) $ 18,814 $ 320
========= ========= =========
See accompanying Notes to Consolidated Financial Statements.
F-5
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS)
PREFERRED STOCK SERIES A PREFERRED STOCK COMMON STOCK
--------------------- --------------------- ---------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
--------- --------- --------- --------- --------- ---------
Balance at December 31, 2000 .......... -- $ -- -- $ -- 19,646 $ 62,987
Common stock issued upon exercise
of options, including tax benefit .. -- -- -- -- 498 312
Purchase of common stock .............. -- -- -- -- (863) (1,348)
Increase in deferred compensation
on stock options ................... -- -- -- -- -- (77)
Amortization of stock compensation .... -- -- -- -- -- --
Net income ............................ -- -- -- -- -- --
--------- --------- --------- --------- --------- ---------
Balance at December 31, 2001 .......... -- -- -- -- 19,281 61,874
Common stock issued upon exercise
of options, including tax benefit .. -- -- -- -- 1,255 893
Purchase of common stock .............. -- -- -- -- (8) (15)
Pension benefit obligation ............ -- -- -- -- -- --
Increase in deferred compensation
on stock options ................... -- -- -- -- -- 1,177
Amortization of stock compensation .... -- -- -- -- -- --
Net income ............................ -- -- -- -- -- --
--------- --------- --------- --------- --------- ---------
Balance at December 31, 2002 .......... -- -- -- -- 20,528 63,929
Common stock issued upon exercise
of options, including tax benefit .. -- -- -- -- 609 974
Purchase of common stock .............. -- -- -- -- (548) (1,195)
Pension benefit obligation ............ -- -- -- -- -- --
Repurchase of warrants issued ......... -- -- -- -- -- (896)
Increase in deferred compensation
on stock options ................... -- -- -- -- -- 1,585
Amortization of stock compensation .... -- -- -- -- -- --
Net income ............................ -- -- -- -- -- --
--------- --------- --------- --------- --------- ---------
Balance at December 31, 2003 .......... -- $ -- -- $ -- 20,589 $ 64,397
========= ========= ========= ========= ========= =========
PENSION RETAINED
BENEFIT DEFERRED EARNINGS
OBLIGATION COMPENSATION (DEFICIT) TOTAL
--------- --------- --------- ---------
Balance at December 31, 2000 .......... $ -- $ (734) $ (131) $ 62,122
Common stock issued upon exercise
of options, including tax benefit .. -- -- -- 312
Purchase of common stock .............. -- -- -- (1,348)
Increase in deferred compensation
on stock options ................... -- 77 -- --
Amortization of stock compensation .... -- 280 -- 280
Net income ............................ -- -- 320 320
--------- --------- --------- ---------
Balance at December 31, 2001 .......... -- (377) 189 61,686
Common stock issued upon exercise
of options, including tax benefit .. -- -- -- 893
Purchase of common stock .............. -- -- -- (15)
Pension benefit obligation ............ (1,594) -- -- (1,594)
Increase in deferred compensation
on stock options ................... -- (1,177) -- --
Amortization of stock compensation .... -- 1,196 -- 1,196
Net income ............................ -- -- 20,408 20,408
--------- --------- --------- ---------
Balance at December 31, 2002 .......... (1,594) (358) 20,597 82,574
Common stock issued upon exercise
of options, including tax benefit .. -- -- -- 974
Purchase of common stock .............. -- -- -- (1,195)
Pension benefit obligation ............ (832) -- -- (832)
Repurchase of warrants issued ......... -- -- -- (896)
Increase in deferred compensation
on stock options ................... -- (1,585) -- --
Amortization of stock compensation .... -- 1,140 -- 1,140
Net income ............................ -- -- 395 395
--------- --------- --------- ---------
Balance at December 31, 2003 .......... $ (2,426) $ (803) $ 20,992 $ 82,160
========= ========= ========= =========
See accompanying Notes to Consolidated Financial Statements.
F-6
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
------------------------------------
2003 2002 2001
---------- ---------- ----------
Cash flows from operating activities:
Net income .................................................... $ 395 $ 20,408 $ 320
Adjustments to reconcile net income to net cash
provided by operating activities:
Extraordinary gain, excess of assets acquired
over purchase price .................................... -- (17,412) --
Depreciation and amortization ............................... 1,000 1,138 1,019
Amortization of deferred financing costs .................... 2,695 4,547 890
Provision for (recovery of) credit losses ................... 11,916 2,639 (5,695)
NIR gains recognized ........................................ (4,381) (16,873) (9,211)
Write off of related party receivables ...................... -- 669 --
Loss on sale of furniture and equipment ..................... -- 5 --
Deferred compensation ....................................... 1,140 1,196 280
Releases of cash from Trusts to Company ..................... 25,934 60,393 43,652
Initial deposits to Trusts .................................. (18,736) (16,749) (2,477)
Net deposits to Trusts to increase Credit Enhancement ....... (20,867) (24,236) (24,581)
(Increase) decrease in receivables from Trusts and
investment in subordinated certificates ................... 33,518 8,884 (14,287)
Changes in assets and liabilities:
Restricted cash ........................................... (30,641) 17,940 (6,090)
Purchases of Contracts held for sale ...................... (182,045) (463,253) (672,281)
Amortization and liquidation of Contracts held for sale ... 283,423 566,124 693,258
Other assets .............................................. 6,936 5,016 5,164
Accounts payable and accrued expenses ..................... (3,363) (16,113) (3,995)
Tax asset/liability ....................................... (7,162) 12,570 (240)
---------- ---------- ----------
Net cash provided by operating activities .............. 99,762 146,893 5,726
---------- ---------- ----------
Cash flows from investing activities:
Net related party receivables ................................. -- -- 230
Purchase of Contracts held for investment ..................... (175,275) -- --
Amortization of Contracts held for investment ................. 5,741 -- --
Purchase of furniture and equipment ........................... (93) (285) (766)
Purchase of subsidiary, net of cash acquired .................. (10,181) (29,467) --
---------- ---------- ----------
Net cash used in investing activities .................. (179,808) (29,752) (536)
---------- ---------- ----------
Cash flows from financing activities:
Proceeds from issuance of senior secured debt ................ 25,000 46,242 --
Proceeds from issuance of securitization trust debt ........... 154,375 -- --
Net proceeds from warehouse lines of credit ................... 31,332 -- (2,003)
Repayment of securitization trust debt ........................ (96,484) (85,293) --
Repayment of senior secured debt .............................. (25,107) (22,170) (12,000)
Repayment of subordinated debt ................................ (1,000) (23,489) (710)
Repayment of capital lease obligations ........................ (84) (409) (522)
Repayment of notes payable .................................... (3,664) (917) (824)
Repayment of related party debt ............................... -- -- (4,000)
Payment of financing costs .................................... (2,553) (1,037) (576)
Purchase of common stock ...................................... (1,195) (15) (1,348)
Repurchase of warrants issued ................................. (896) -- --
Exercise of options and warrants .............................. 584 324 312
---------- ---------- ----------
Net cash provided by (used in) financing activities .... 80,308 (86,764) (21,671)
---------- ---------- ----------
Increase (decrease) in cash ...................................... 262 30,377 (16,481)
Cash at beginning of period ...................................... 32,947 2,570 19,051
---------- ---------- ----------
Cash at end of period ............................................ $ 33,209 $ 32,947 $ 2,570
========== ========== ==========
See accompanying Notes to Consolidated Financial Statements.
F-7
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
--------------------------------
2003 2002 2001
--------- --------- ---------
Supplemental disclosure of cash flow information:
Cash paid (received) during the period for:
Interest ...................................................... $ 18,677 $ 19,255 $ 10,780
Income taxes .................................................. 3,728 (15,565) 22
Supplemental disclosure of non-cash investing and financing activities:
Stock compensation .............................................. 1,140 1,196 280
Pension benefit obligation, net ................................. 832 1,594 --
Deferred income taxes ........................................... 944 1,632 --
Purchase of common stock with notes ............................. -- 479 --
See accompanying Notes to Consolidated Financial Statements.
F-8
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") specialize
in purchasing, selling and servicing retail automobile installment sale
contracts ("Contracts") originated by licensed motor vehicle dealers ("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.
ACQUISITIONS
On March 8, 2002, the Company acquired MFN Financial Corporation and its
subsidiaries in a merger (the "MFN Merger"). On May 20, 2003, the Company
acquired TFC Enterprises, Inc. and its subsidiaries in a second merger (the "TFC
Merger"). Each merger was accounted for as a purchase. MFN Financial Corporation
and its subsidiaries ("MFN") and TFC Enterprises, Inc. and its subsidiaries
("TFC") were engaged in businesses similar to that of the Company: buying
Contracts from Dealers, repackaging those Contracts in securitization
transactions, and servicing those Contracts. MFN ceased acquiring Contracts in
March 2002; TFC continues to acquire Contracts under its "TFC Programs."
RECENT DEVELOPMENTS
In July 2003, the Company agreed with the other parties to its continuous or
"warehouse" securitization facilities to amend the terms of such facilities. The
effect of the amendments was to cause use of those facilities to be treated for
financial accounting purposes as borrowings secured by pledged Contracts, rather
than as sales of such Contracts.
In addition, the Company announced in August 2003 that it would structure its
future term securitization transactions so that they will be treated for
financial accounting purposes as borrowings secured by receivables, rather than
as sales of receivables. The new structure for the warehouse facilities
described in the preceding paragraph and the intended future structure of the
Company's term securitizations has affected and will affect the way in which the
transactions are reported. The major effects are these: (i) the finance
receivables will be shown as assets of the Company on its balance sheet; (ii)
the debt issued in the transactions will be shown as indebtedness of the
Company; (iii) cash posted to enhance the credit of the securitization
transactions will be shown as "restricted cash" on the Company's balance sheet;
(iv) the servicing fee that the Company receives in connection with such
receivables will be recorded as a portion of the interest earned on such
receivables; (v) the Company will initially and periodically record as expense a
provision for estimated credit losses on the receivables; and (vi) the portion
of scheduled payments on the receivables representing interest will be recorded
as revenue as accrued.
These changes collectively represent a deferral of revenue and acceleration of
expenses, and thus a more conservative approach to accounting for the Company's
operations. The changes initially will result in the Company's reporting lower
earnings than it would report if it were to continue to structure its
securitizations to require recognition of gain on sale.
PRINCIPLES OF CONSOLIDATION
The Consolidated Financial Statements include the accounts of Consumer Portfolio
Services, Inc. and its wholly-owned subsidiaries, certain of which are Special
Purpose Subsidiaries ("SPS"), formed to accommodate the structures under which
the Company purchases and securitizes its Contracts. The Consolidated Financial
Statements also include the accounts of CPS Leasing, Inc., an 80% owned
subsidiary. All significant intercompany balances and transactions have been
eliminated in consolidation.
F-9
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
CASH AND CASH EQUIVALENTS
For purposes of the statements of cash flows, the Company considers all highly
liquid debt instruments with original maturities of three months or less to be
cash equivalents. Cash equivalents consist of cash on hand and due from banks
and money market accounts.
FINANCE RECEIVABLES, NET OF UNEARNED INCOME
Finance receivables are presented at cost. Finance receivable Contracts include
automobile installment sales contracts on which interest is pre-computed and
added to the amount financed. The interest on such Contracts is included in
unearned finance charges. Unearned finance charges are amortized using the
interest method over the remaining period to contractual maturity. Generally,
payments received on finance receivables are restricted to certain securitized
pools, and the related Contracts cannot be resold. Finance receivables are
charged off pursuant to the controlling documents of certain securitized pools,
generally before they become contractually delinquent five payments. Contracts
that are deemed uncollectible prior to the maximum charge off period are charged
off immediately. Management may authorize a temporary extension of payment terms
if collection appears likely during the next calendar month.
The method selected to measure impairment is made on a loan-by-loan basis,
unless repossession of the collateral has occurred, in which case the net
realizable value is used.
ALLOWANCE FOR FINANCE CREDIT LOSSES
In order to estimate an appropriate allowance for losses to be incurred on
finance receivables, the Company uses a loss allowance methodology commonly
referred to as "static pooling," which stratifies its finance receivable
portfolio into separately identified pools. Using analytical and formula driven
techniques, the Company estimates an allowance for finance credit losses, which
management believes is adequate for known and inherent losses in its portfolio
of finance receivable Contracts. Provision for loss is charged to the Company's
Consolidated Statement of Operations. Net losses incurred on finance receivables
are charged to the allowance. Management evaluates the adequacy of the allowance
by examining current delinquencies, the characteristics of the portfolio and the
value of the underlying collateral. As conditions change, the Company's level of
provisioning and/or allowance may change as well.
CONTRACT ACQUISITION FEES
Upon purchase of a Contract from a Dealer, the Company generally charges or
advances the Dealer an acquisition fee. For Contracts securitized in pools which
were structured as sales for financial accounting purposes, the acquisition fees
associated with Contract purchases were deferred until the Contracts were
securitized, at which time the deferred acquisition fees were recognized as a
component of the gain on sale. For Contracts securitized in pools which are
structured as secured financings for financial accounting purposes, the
acquisition fees associated with Contract purchases are deferred and revenue is
recognized over the life of the Contracts using a method that approximates a
level yield. The Company also charged the purchaser an origination fee for those
Contracts that were sold on a flow basis. Those fees were recognized at the time
the Contracts were sold and were also a component of the gain on sale.
FLOW PURCHASE PROGRAM
Through May 2002, the Company purchased Contracts for immediate and outright
resale to non-affiliated third parties. The Company sold such Contracts for a
mark-up above what the Company paid the Dealer. In such sales, the Company made
certain representations and warranties to the purchasers, normal in the
industry, which related primarily to the legality of the sale of the underlying
motor vehicle and to the validity of the security interest being conveyed to the
purchaser. Those representations and warranties were generally similar to the
representations and warranties given by the originating Dealer to the Company.
In the event of a breach of such representations or warranties, the Company may
F-10
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
incur liabilities in favor of the purchaser(s) of the Contracts and there can be
no assurance that the Company would be able to recover, in turn, against the
originating Dealer(s).
TREATMENT OF SECURITIZATIONS
Gain on sale may be recognized on the disposition of Contracts either outright
or in securitization transactions. In those securitization transactions that
were treated as sales for financial accounting purposes, the Company, or a
wholly-owned, consolidated subsidiary of the Company, retains a residual
interest in the Contracts that were sold to a wholly-owned, unconsolidated
special purpose subsidiary. The Company's securitization transactions include
"term" securitizations (the purchaser holds the Contracts for substantially
their entire term) and "continuous" or "warehouse" securitizations (which
finance the acquisition of the Contracts for future sale into term
securitizations).
As of December 31, 2002 the line item "residual interest in securitizations" on
the Company's Consolidated Balance Sheet includes residual interests in both
term and warehouse securitizations. As of December 31, 2003 the line item
"residual interest in securitizations" on the Company's Consolidated Balance
Sheet represents the residual interests in certain term securitizations but no
residual interest in warehouse securitizations, because the Company's warehouse
securitizations were restructured in July 2003 as secured financings. Subsequent
term securitizations in September and December 2003 were also structured as
secured financings. The warehouse securitizations are accordingly reflected in
the line items "Finance receivables" and "Warehouse lines of credit" on the
Company's Consolidated Balance Sheet, and the term securitizations are reflected
in the line items "Finance receivables" and "Securitization trust debt." The
"residual interest in securitizations" represents the discounted sum of expected
future releases from securitization trusts. Accordingly, the valuation of the
residual is heavily dependent on estimates of future performance.
The Company's securitization structure has generally been as follows:
The Company sells Contracts it acquires to a wholly-owned Special Purpose
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 another entity, typically a statutory trust ("Trust"). The Trust issues
interest-bearing asset-backed securities (the "Notes"); generally in a principal
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 Notes issued by the Trust; the proceeds from the sale of
the Notes are then used to purchase the Contracts from the Company. The Company
may retain subordinated Notes issued by the Trust. The Company purchases a
financial guaranty insurance policy, guaranteeing timely payment of principal
and interest on the senior Notes, from an insurance company (a "Note Insurer").
In addition, the Company provides "Credit Enhancement" for the benefit of the
Note Insurer and the investors in the form of an initial cash deposit to an
account ("Spread Account") held by the Trust, in the form of
overcollateralization of the Notes, where the principal balance of the Notes
issued is less than the principal balance of the Contracts, in the form of
subordinated Notes, or some combination of such Credit Enhancements. The
agreements governing the securitization transactions (collectively referred to
as the "Securitization Agreements") require that the initial level of Credit
Enhancement be supplemented by a portion of collections from the Contracts until
the level of Credit Enhancement reaches 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 Contracts. The specified
levels at which the Credit Enhancement is to be maintained will vary depending
on the performance of the pools of Contracts held by the Trusts and on other
conditions, and may also be varied by agreement among the Company, the SPS, the
Note Insurers and the trustee. Such levels have increased and decreased from
time to time based on performance of the various pools, and have also varied by
Securitization Agreement. The Securitization Agreements generally grant the
Company the option to repurchase the sold Contracts from the Trust when the
aggregate outstanding balance of the Contracts has amortized to a specified
percentage of the initial aggregate balance.
F-11
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The prior securitizations that are treated as sales for financial accounting
purposes differ from secured financings in that the Trust to which the SPS sells
the Contracts meets the definition of a "qualified special purpose entity" under
Statement of Financial Accounting Standards No. 140 ("SFAS 140"). As a result,
assets and liabilities of the Trust are not consolidated into the Company's
Consolidated Balance Sheet.
The Company's warehouse securitization structures are similar to the above,
except that (i) the SPS that purchases the Contracts pledges the Contracts to
secure promissory notes which it issues, (ii) the promissory notes are in an
aggregate principal amount of not more than 71.6% to 73% of the aggregate
principal balance of the Contracts (that is, up to 28.4% overcollateralization),
and (iii) no increase in the required amount of Credit Enhancement is
contemplated unless certain portfolio performance tests are breached. During the
quarter ended September 30, 2003 the warehouse securitizations related to the
CPS programs were amended to cause the transactions to be treated as secured
financings for financial accounting purposes. The Contracts held by the
warehouse SPSs and the promissory notes that they issue are therefore included
in the Company's Consolidated Financial Statements as of December 31, 2003 as
assets and liabilities, respectively.
Upon each sale of Contracts in a securitization structured as a secured
financing, whether a term securitization or a warehouse securitization, the
Company retains on its Consolidated Balance Sheet the Contracts securitized as
assets and records the Notes issued in the transaction as indebtedness of the
Company.
Under the prior securitizations structured as sales for financial accounting
purposes, the Company removed from its Consolidated Balance Sheet the Contracts
sold and added to its Consolidated Balance Sheet (i) the cash received, if any,
and (ii) the estimated fair value of the ownership interest that the Company
retains in Contracts sold in the securitization. That retained or residual
interest (the "Residual") consists of (a) the cash held in the Spread Account,
if any, (b) overcollateralization, if any, (c) subordinated Notes retained, if
any, and (d) receivables from Trust, which include 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 Notes, 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. Until the maturity of these transactions, the Company's Consolidated
Balance Sheet will reflect both securitization transactions structured as sales
and others structured as secured financings.
With respect to securitizations structured as sales for financial accounting
purposes, the Company allocates its basis in the Contracts between the Notes
sold 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. The Company is not aware of an active market
for the purchase or sale of interests such as the Residuals; accordingly, the
Company determines the estimated fair value of the Residuals by discounting the
amount and timing of anticipated cash flows that it estimates will be released
to the Company in the future (the cash out method), using a discount rate that
the Company believes is appropriate for the risks involved. The anticipated cash
flows include collections from both current and charged off receivables. The
Company has used an effective pre-tax 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 Trusts that represent collections on the Contracts in excess of
the amounts required to pay principal and interest on the Notes, the base
servicing fees, and certain other fees (such as trustee and custodial fees).
Required principal payments are generally defined as the payments sufficient to
keep the principal balance of the Notes equal to the aggregate principal balance
of the related Contracts (excluding those Contracts that have been charged off),
or a pre-determined percentage of such balance. Where that percentage is less
than 100%, the related Securitization Agreements require accelerated payment of
principal until the principal balance of the Notes is reduced to the specified
percentage. Such accelerated principal payment is said to create
"overcollateralization" of the Notes.
F-12
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
If the amount of cash required for payment of fees, interest and principal
exceeds the amount collected during the collection period, the shortfall is
withdrawn from the Spread Account, if any. 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 or other form of Credit Enhancement, the
excess is released to the Company, or in certain cases is transferred to other
Spread Accounts that may be below their required levels. If the total Credit
Enhancement amount is not at the required level, then the excess cash collected
is retained in the Trust until the specified level is achieved. Although Spread
Account balances are held by the Trusts on behalf of the Company's SPS as the
owner of the Residuals (in the case of securitization transactions structured as
sales for financial accounting purposes) or the Trusts (in the case of
securitization transactions structured as secured financings for financial
accounting purposes), 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 Securitization
Agreements. The interest rate payable on the Contracts is significantly greater
than the interest rate on the Notes. As a result, the Residuals described above
are a significant asset of the Company. In determining the value of the
Residuals, the Company must estimate the future rates of prepayments,
delinquencies, defaults and default loss severity, and recovery rates, as all of
these factors affect the amount and timing of the estimated cash flows. The
Company estimates prepayments by evaluating historical prepayment performance of
comparable Contracts. The Company has used prepayment estimates of approximately
18.1% to 22.1% cumulatively over the lives of the related Contracts. 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. The Company estimates recovery rates of previously
charged off receivables using available historical recovery data and projected
future recovery levels. In valuing the Residuals, the Company estimates that
charge-offs as a percentage of the original principal balance will approximate
15.9% to 23.1% cumulatively over the lives of the related Contracts, with
recovery rates approximating 2.2% to 5.3% of the original principal balance.
Following a securitization that is structured as a sale for financial accounting
purposes, interest income is recognized on the balance of the Residuals at the
same rate as used for calculating the present value of the NIRs, which is 14%
per annum. In addition, the Company will recognize additional revenue from the
Residuals if the actual performance of the Contracts is better than the original
estimate. If the actual performance of the Contracts were worse than the
original estimate, then a downward adjustment to the carrying value of the
Residuals and a related expense would be required. In a securitization that is
structured as a secured financing for financial accounting purposes, interest
income is recognized when accrued under the terms of the related Contracts and,
therefore, presents less potential for fluctuations in performance when compared
to the approach used in a transaction structured as a sale for financial
accounting purposes.
In all the Company's term securitizations, whether treated as secured financings
or as sales, the Company has transferred the receivables (through a subsidiary)
to the securitization Trust. The difference between the two structures is that
in securitizations that are treated as secured financings the Company reports
the assets and liabilities of the securitization Trust on its Consolidated
Balance Sheet. Under both structures the Noteholders and the related
securitization Trusts have no recourse to the Company for failure of the
Contract obligors to make payments on a timely basis. The Company's Residuals,
however, are subordinate to the Notes until the Noteholders are fully paid, and
the Company is therefore at risk to that extent.
SERVICING
The Company considers the servicing fee received on its managed portfolio held
by non-consolidated subsidiaries to approximate adequate compensation. As a
result, no servicing asset or liability has been recognized. Servicing fees
received on its managed portfolio held by non-consolidated subsidiaries are
reported as income when earned. Servicing fees received on its managed portfolio
held by consolidated subsidiaries are included in interest 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.
F-13
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
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.
IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF
The Company accounts for long-lived assets in accordance with the provisions of
SFAS No. 144, "Accounting for the Impairment of Long-Lived Assets." This
Statement requires that long-lived assets and certain identifiable intangibles
be reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying amount of
an asset to future net cash flows expected to be generated by the asset. If such
assets are considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount of the assets exceeds the
fair value of the assets. Assets to be disposed of are reported at the lower of
carrying amount or fair value less costs to sell.
OTHER INCOME
Other Income consists primarily of recoveries on previously charged off MFN
contracts. These recoveries totaled $12.2 million and $10.5 million for the
years ended December 31, 2003 and 2002, respectively. There were no such
recoveries for the year ended December 31, 2001.
EARNINGS PER SHARE
The following table illustrates the computation of basic and diluted earnings
per share:
YEAR ENDED DECEMBER 31,
----------------------------
2003 2002 2001
-------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Numerator:
Numerator for basic and diluted earnings
per share before extraordinary item .................. $ 395 $ 2,996 $ 320
======== ======== ========
Denominator:
Denominator for basic earnings per share
before extraordinary item-- weighted average
number of common shares outstanding during the
year .................................................. 20,263 19,902 19,480
Incremental common shares attributable to
exercise of outstanding options and warrants ........... 1,315 1,085 1,538
-------- -------- --------
Denominator for diluted earnings
before extraordinary item per share ................... 21,578 20,987 21,018
======== ======== ========
Basic earnings per share before extraordinary item ....... $ 0.02 $ 0.15 $ 0.02
======== ======== ========
Diluted earnings per share before extraordinary item ..... $ 0.02 $ 0.14 $ 0.02
======== ======== ========
Incremental shares of 1.1 million related to the conversion of subordinated debt
have been excluded from the calculation for the years ended December 31, 2003,
2002 and 2001, because the impact of assumed conversion of such subordinated
debt is anti-dilutive.
Incremental shares of 908,000, 595,000 and 1.5 million shares related to stock
options have been excluded from the calculation for the years ended December 31,
2003, 2002, and 2001, respectively, because the impact of assumed exercise is
anti-dilutive. In addition, incremental shares of 2.5 million related to
warrants have been excluded from the calculation for the years ended December
31, 2002 and 2001, because the impact of assumed exercise is anti-dilutive.
DEFERRAL AND AMORTIZATION OF DEBT ISSUANCE COSTS
Costs related to the issuance of debt are amortized on a straight-line basis
over the shorter of the actual or expected term of the related debt.
F-14
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
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 the differences between the
financial statement values 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. The Company has estimated a valuation
allowance against that portion of the deferred tax asset whose utilization in
future periods is not more than likely.
In determining the possible realization of deferred tax assets, future taxable
income from the following sources are considered: (a) the reversal of taxable
temporary differences, (b) future operations exclusive of reversing temporary
differences, and (c) tax planning strategies that, if necessary, would be
implemented to accelerate taxable income into periods in which operating losses
might otherwise expire.
PURCHASES OF COMPANY STOCK
The Company records purchases of its own common stock at cost.
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, whereby stock options are recorded at intrinsic value equal to
the excess of the share price over the exercise price at the date of grant. The
Company provides the pro forma net income (loss), pro forma earnings per share,
and stock based compensation plan disclosure requirements set forth in SFAS No.
123. The Company accounts for repriced options as variable awards.
The per share weighted-average fair value of stock options granted during the
years ended December 31, 2003, 2002 and 2001, was $2.09, $1.39, and $1.79,
respectively, at the date of grant. That fair value was computed using the
Black-Scholes option-pricing model with the following weighted average
assumptions:
YEAR ENDED DECEMBER 31,
-------------------------
2003 2002 2001
------- ------- -------
Expected life (years)....................... 7.63 8.21 6.50
Risk-free interest rate..................... 4.16% 4.19% 4.70%
Volatility.................................. 100.82% 107.56% 128.56%
Expected dividend yield..................... -- -- --
Compensation cost has been recognized for certain stock options in the
Consolidated Financial Statements in accordance with APB Opinion No. 25. 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
("SFAS 123"), "Accounting for Stock Based Compensation," the Company's net
income and earnings per share would have been reduced to the pro forma amounts
indicated below.
F-15
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
YEAR ENDED DECEMBER 31,
-------------------------------
2003 2002 2001
-------- ---------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net income (loss)
As reported ...................... $ 395 $ 20,408 $ 320
Pro forma ........................ 175 20,109 (1,040)
Earnings (loss) per share-- basic
As reported ...................... $ 0.02 $ 1.03 $ 0.02
Pro forma ........................ 0.01 1.01 (0.05)
Earnings (loss) per share-- diluted
As reported ...................... $ 0.02 $ 0.97 $ 0.02
Pro forma ........................ 0.01 0.96 (0.05)
Pro forma net income (loss) and earnings (loss) per share reflect only options
granted in the years ended December 31, 1996 to 2003. Therefore, the full effect
of calculating compensation cost for stock options under SFAS No. 123 is not
reflected in the pro forma amounts presented above, because compensation cost is
reflected over the options' vesting period and compensation cost for options
granted prior to 1996 is not considered.
SEGMENT REPORTING
Operations are managed and financial performance is evaluated on a Company-wide
basis by a chief decision maker. Accordingly, all of the Company's operations
are aggregated in one reportable operating segment.
NEW ACCOUNTING PRONOUNCEMENTS
The FASB issued Statement of Financial Accounting Standards No. 148 "Accounting
for Stock-Based Compensation--Transition and Disclosure" amends FASB Statement
No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") in December
2002. SFAS 148 is designed to provide alternative methods of transition for
enterprises that elect to change to the SFAS 123 fair value method of accounting
for stock-based employee compensation. SFAS 148 will permit two additional
transition methods for entities that adopt the preferable SFAS 123 fair value
method of accounting for stock-based employee compensation. Both of those
methods avoid the ramp-up effect arising from prospective application of the
fair value method under the existing transition provisions of SFAS 123. In
addition, under the provisions of SFAS 148, the original Statement 123
prospective method of transition for changes to the fair value method will no
longer be permitted in fiscal periods beginning after December 15, 2003.
SFAS 148 will also amend the disclosure requirements of SFAS 123 to require
prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. The provisions of SFAS 148 are effective for
fiscal years ended after December 15, 2002. The adoption of SFAS No. 148 did not
have a material effect on the Company.
In December 2003, the FASB issued FASB Interpretation No. 46 (revised December
2003, FIN 46R), CONSOLIDATION OF VARIABLE INTEREST ENTITIES, which addresses how
a business enterprise should evaluate whether it has a controlling financial
interest in an entity through means other than voting rights and accordingly
should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46,
CONSOLIDATION OF VARIABLE INTEREST ENTITIES, which was issued in January 2003.
The Company will be required to apply FIN 46R to variable interests in VIEs
created after December 31, 2003. For variable interests in VIEs created before
January 1, 2004, the Interpretation will be applied beginning on January 1,
2005. For any VIEs that must be consolidated under FIN 46R that were created
before January 1, 2004, the assets, liabilities and noncontrolling interests of
the VIE initially would be measured at their carrying amounts with any
difference between the net amount added to the balance sheet and any previously
recognized interest being recognized as the cumulative effect of an accounting
change. If determining the carrying amounts is not practicable, fair value at
the date FIN 46R first applies may be used. Certain of the Company's
subsidiaries are qualifying special purpose entities formed in connection with
F-16
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
off-balance sheet securitizations and are not subject to the requirements of FIN
46R. The Company's subsidiaries that are considered variable interest entities
subject to the requirements of FIN 46R, Trusts related to the Company's
on-balance sheet securitizations, are currently being consolidated and are
included in the Company's consolidated financial statements. The adoption of FIN
46R is not expected to have a material effect on the Company.
On April 30, 2003, the FASB issued statement of Financial Accounting Standards
No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities" ("SFAS 149"). The purpose of SFAS 149 is to amend and clarify
financial accounting and reporting for derivative instruments and hedging
activities under SFAS No.133. These amendments clarify the definition of a
derivative, expand the nature of exemptions from SFAS No.133, clarify the
application of hedge accounting when using certain instruments, clarify the
application of paragraph 13 of SFAS No.133 to embedded derivative instruments in
which the underlying is an interest rate, and modify the cash flow presentation
of derivative instruments that contain financing elements. SFAS 149 is effective
for derivative transactions and hedging relationships entered into or modified
after June 30, 2003. The adoption of SFAS 149 did not have a material impact on
the Company's financial statements.
FASB Statement No. 150, "Accounting for Certain Financial Instruments with
Characteristics of Both Liabilities and Equity" ("SFAS 150"), was issued in May
2003. This Statement establishes standards for the classification and
measurement of certain financial instruments with characteristics of both
liabilities and equity. The Statement also includes required disclosures for
financial instruments within its scope. For the Company, the Statement was
effective for instruments entered into or modified after May 31, 2003 and
otherwise will be effective as of January 1, 2004, except for mandatorily
redeemable financial instruments. For certain mandatorily redeemable financial
instruments, the Statement will be effective for the Company on January 1, 2005.
The effective date has been deferred indefinitely for certain other types of
mandatorily redeemable financial instruments. The Company adopted the provisions
of SFAS 150 on July 1, 2003. The adoption of SFAS 150 did not have a material
impact on the Company's consolidated financial statements.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America 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 finance credit losses, valuing the Residuals and computing the
related gain on sale on the transactions that created the Residuals, and
deferred tax asset valuation allowance. 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.
(2) ACQUISITIONS
ACQUISITION OF MFN FINANCIAL CORPORATION
On March 8, 2002, CPS acquired 100% of MFN Financial Corporation, a Delaware
corporation ("MFN") and its subsidiaries, by the merger (the "MFN Merger") of a
direct wholly-owned subsidiary of CPS with and into MFN. MFN thus became a
wholly-owned subsidiary of CPS, and CPS thus acquired the assets of MFN, which
consisted principally of interests in automobile installment sales finance
Contracts and the facilities for originating and servicing such Contracts. The
MFN Merger was accounted for as a purchase.
F-17
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
MFN, through its primary operating subsidiary, Mercury Finance Company LLC, was
in the business of purchasing automobile installment sales finance Contracts
from Dealers, and securitizing and servicing such Contracts. CPS continues to
use the assets acquired in the MFN Merger in the automobile finance business,
but has disposed of a portion of such assets. MFN has ceased to purchase
automobile installment sales finance Contracts, and does not anticipate
recommencing such purchasing. In connection with the termination of MFN
origination activities and the integration and consolidation of certain
activities, the Company has recognized certain liabilities related to the costs
to exit these activities and terminate the affected employees of MFN. These
activities include service departments such as accounting, finance, human
resources, information technology, administration, payroll and executive
management. These costs include the following:
DECEMBER 31, DECEMBER 31, MARCH 8,
2003 (2) ACTIVITY 2002 ACTIVITY 2002
--------- --------- --------- --------- ---------
(IN THOUSANDS)
Severance payments and consulting
contracts ...................................... $ -- $ 571 $ 571 $ 2,644 $ 3,215
Facilities closures (1) ........................ 1,889 106 1,995 157 2,152
Termination of contracts, leases,
services and other obligations ................. -- 323 323 274 597
Acquisition expenses accrued but
unpaid ......................................... -- 51 51 199 250
--------- --------- --------- --------- ---------
Total liabilities assumed....................... $ 1,889 $ 1,051 $ 2,940 $ 3,274 $ 6,214
========= ========= ========= ========= =========
____________
(1) For the period from March 8, 2002 to December 31, 2002 the activity
resulting in a net charge of $157,000, includes charges against liability of
$1.4 million, and the "reclassification" of an existing accrual for offices
closed prior to the Merger Date of approximately $1.2 million.
(2) Approximately $1.9 million of remaining accrual is recorded in the
Consolidated Balance Sheet of the Company at December 31, 2003. The Company
believes that this amount provides adequately for anticipated remaining costs
related to exiting certain activities of MFN, and that amounts indicated above
are reasonably allocated.
The Company's Consolidated Balance Sheet and Consolidated Statement of
Operations as of and for the years ended December 31, 2003 and 2002, include the
balance sheet accounts of MFN Financial Corporation as of December 31, 2003 and
2002 and the results of operations subsequent to March 8, 2002, the merger date.
The following table summarizes the estimated fair value of the assets acquired
and liabilities assumed at the date of acquisition.
MARCH 8, 2002
--------------
(IN THOUSANDS)
Cash ........................................................ $ 93,782
Restricted cash ............................................. 25,499
Finance Contracts, net ...................................... 186,554
Residual interest in securitizations ........................ 32,485
Other assets ................................................ 12,006
--------------
Total assets acquired ............................... 350,326
--------------
Securitization trust debt ................................... 156,923
Subordinated debt ........................................... 22,500
Accounts payable and other liabilities ...................... 30,242
--------------
Total liabilities assumed ........................... 209,665
--------------
Net assets acquired ................................. 140,661
Less: purchase price ................................ 123,249
--------------
Excess of net assets acquired over purchase price ... $ 17,412
==============
F-18
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
ACQUISITION OF TFC ENTERPRISES, INC.
On May 20, 2003, CPS acquired TFC Enterprises, Inc., a Delaware corporation
("TFC") and its subsidiaries, by the merger (the "TFC Merger") of a direct,
wholly-owned subsidiary of CPS, with and into TFC. In the TFC Merger, TFC became
a wholly-owned subsidiary of CPS. CPS thus acquired the assets of TFC and its
subsidiaries, which consisted principally of interests in motor vehicle
installment sales, finance Contracts, interests in securitized pools of such
Contracts, and the facilities for originating and servicing such Contracts. The
merger was accounted for as a purchase.
TFC, through its primary operating subsidiary, "The Finance Company," purchases
motor vehicle installment sales finance Contracts from automobile Dealers, and
securitizes and services such Contracts. CPS intends to continue to use the
assets acquired in the TFC Merger in the automobile finance business.
In connection with the integration and consolidation of certain activities
between CPS and TFC, the Company has recognized certain liabilities related to
the costs to integrate certain activities and terminate the affected employees
of TFC. These activities include service departments such as accounting,
finance, human resources, information technology, administration, payroll and
executive management. The total of these liabilities recognized by the Company
at the time of the merger were $4.5 million. These costs include the following:
DECEMBER 31, MAY 20,
2003 (1) ACTIVITY 2003
--------- --------- ---------
(IN THOUSANDS)
Severance payments and consulting contracts ... $ 2,326 $ 357 $ 2,683
Facilities closures ........................... 1,231 190 1,421
Other obligations ............................. 234 206 440
--------- --------- ---------
Total liabilities assumed ................ $ 3,791 $ 753 $ 4,544
========= ========= =========
____________
(1) The Company believes that this amount provides adequately for anticipated
remaining costs related to exiting certain activities of TFC, and that amounts
indicated above are reasonably allocated.
At the closing of the TFC Merger, each outstanding share of common stock of TFC
became a right to receive $1.87 per share in cash. The total merger
consideration payable to stockholders of TFC was approximately $21.6 million.
The recipients of the total merger consideration had no material relationship
with CPS, its directors, its officers or any associates of such directors or
officers, to the best of CPS's knowledge. The merger consideration was paid with
existing cash of CPS. The aggregate purchase price, including expenses related
to the transaction, was approximately $23.7 million.
The Company's Consolidated Balance Sheet and Consolidated Statement of
Operations as of and for the year ended December 31, 2003, include the balance
sheet accounts of TFC Enterprises, Inc. as of December 31, 2003 and the results
of operations subsequent to May 20, 2003, the merger date. The Company has
recorded certain purchase accounting adjustments on its Consolidated Balance
Sheet, which are estimates based on available information.
The following table summarizes the recorded amounts of the assets acquired and
liabilities assumed at the date of acquisition.
F-19
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
MAY 20, 2003
--------------
(IN THOUSANDS)
Cash ......................................................... $ 13,545
Restricted cash .............................................. 17,723
Finance Contracts, net ....................................... 125,108
Other assets ................................................. 502
--------------
Total assets acquired ................................ 156,878
--------------
Securitization trust debt .................................... 115,597
Notes Payable ................................................ 6,321
Capital lease obligations .................................... 17
Accounts payable and other liabilities ....................... 11,217
--------------
Total liabilities assumed ............................ 133,152
--------------
Purchase price ....................................... $ 23,726
==============
PRO FORMA RESULTS OF OPERATIONS
Selected unaudited pro forma combined results of operations for the years ended
December, 2003 and 2002, assuming the MFN Merger and TFC Merger occurred on
January 1, 2003 and 2002, are as follows:
PRO FORMA PRESENTATION (UNAUDITED) YEAR ENDED
DECEMBER 31,
--------------------------
2003 2002
------------ ------------
(IN THOUSANDS)
Total revenue ........................................... $ 107,598 $ 130,212
Net income (loss) before Merger-related expenses and
extraordinary item ................................... 824 (1,695)
Net income (loss) ....................................... 824 (1,695)
Basic net income (loss) per share before Merger-related
expenses and extraordinary item ...................... $ 0.04 $ (0.09)
Extraordinary item (loss) ............................... -- --
------------ ------------
Basic net income per share .............................. $ 0.04 $ (0.09)
============ ============
Diluted net income (loss) per share before Merger-related
expenses and extraordinary item ...................... $ 0.04 $ (0.08)
------------ ------------
Extraordinary item ...................................... -- --
Diluted net income (loss) per share ..................... $ 0.04 $ (0.08)
============ ============
(3) RESTRICTED CASH
Restricted cash comprised the following components:
DECEMBER 31,
----------------------
2003 2002
-------- --------
(IN THOUSANDS)
Securitization trust accounts ................ $60,550 $11,881
Litigation reserve ........................... 5,503 5,503
Note purchase facility reserve ... ........... 1,074 968
Other ........................................ 150 560
-------- --------
Total restricted cash ........................ $67,277 $18,912
======== ========
Certain of the Company's operating agreements require that the Company establish
cash reserves for the benefit of the other parties to the agreements, in case
those parties are subject to any claims or exposure. In addition, certain of
these agreements require that the Company establish amounts in reserve related
to outstanding litigation.
F-20
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(4) FINANCE RECEIVABLES
The following table presents the components of Finance Receivables, net of
unearned interest:
DECEMBER 31, DECEMBER 31,
2003 2002
---------- ------------
(IN THOUSANDS)
Finance Receivables
Automobile
Simple interest ........................................... $ 178,679 $ 31,372
Pre-compute or "Rule of 78's", net of unearned interest ... 133,339 79,094
---------- ------------
Finance Receivables, net of unearned interest ............. 312,018 110,466
Less: Unearned acquisition fees and discounts ............. (9,940) (46)
---------- ------------
Finance Receivables ....................................... $ 302,078 $ 110,420
========== ============
The following table presents the contractual maturities of Finance Receivables,
net of unearned income, as of December 31, 2003:
AMOUNT %
---------- ------------
(DOLLARS IN THOUSANDS)
Due within one year ............................................. $ 23,329 7.48%
Due within two years ............................................ 38,876 12.46%
Due within three years .......................................... 38,990 12.49%
Due within four years ........................................... 46,319 14.84%
Due within five years ........................................... 128,880 41.31%
Due after five years ............................................ 35,624 11.42%
---------- ------------
Total ....................................................... $ 312,018 100.00%
========== ============
The following table presents a summary of the activity for the allowance for
credit losses, for the years ended December 31, 2003 and 2002:
DECEMBER 31,
-----------------------
2003 2002
---------- ----------
(IN THOUSANDS)
Balance at beginning of year ....................................... $ 25,828 $ --
Addition to allowance for credit losses due to acquisition of TFC... 24,271 --
Addition to allowance for credit losses due to acquisition of MFN... -- 59,261
Provision for credit losses ........................................ 11,667 2,639
Net charge offs .................................................... (25,950) (35,732)
Net amount transferred from allowance for repossessed assets ....... 73 (340)
---------- ----------
Balance at end of year ............................................. $ 35,889 $ 25,828
========== ==========
(5) RESIDUAL INTEREST IN SECURITIZATIONS
The following table presents the components of the residual interest in
securitizations:
DECEMBER 31,
-----------------------
2003 2002
---------- ----------
(IN THOUSANDS)
Cash, commercial paper, United States government securities
and other qualifying investments (Spread Account) ............... $ 35,693 $ 27,218
Receivable from Trusts ............................................. 20,959 33,214
Overcollateralization .............................................. 38,548 59,366
Investment in subordinated certificates ............................ 16,502 7,372
---------- ----------
Residual interest in securitizations ............................... $ 111,702 $ 127,170
========== ==========
F-21
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
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 managed portfolio held by non-consolidated subsidiaries subject to
recourse provisions:
DECEMBER 31,
---------------------------------
2003 2002 2001
--------- --------- ---------
(IN THOUSANDS)
Undiscounted estimated credit losses ...... $ 47,935 $ 54,363 $ 16,210
Managed portfolio held by non-consolidated
subsidiaries .............................. 425,534 478,136 281,493
========= ========= =========
Undiscounted estimated credit losses as
percentage of managed portfolio held by non
consolidated subsidiaries ................. 11.3% 11.4% 5.8%
========= ========= =========
The key economic assumptions used in measuring all residual interest in
securitizations as of December 31, 2003 and 2002 are included in the table
below. The pre-tax discount rate remained constant at 14%.
2003 2002
------------- -------------
Prepayment speed (Cumulative)....... 18.1% - 22.1% 19.8% - 22.9%
Credit losses (Cumulative).......... 11.8% - 18.0% 10.0% - 15.4%
Static pool losses are calculated by summing the actual and projected future
credit losses and dividing them by the original balance of each pool of assets.
Key economic assumptions and the sensitivity of the current fair value of
residual cash flows to immediate 10% and 20% adverse changes in those
assumptions are as follows:
DECEMBER 31,
2003
-------------
(DOLLARS IN
THOUSANDS)
Carrying amount/fair value of residual interest
in securitizations ............................................ $111,702
Weighted average life in years ................................... 3.74
Prepayment Speed Assumption (Cumulative) ......................... 18.1% - 22.1%
Estimated fair value assuming 10% adverse change ................. $110,938
Estimated fair value assuming 20% adverse change ................. 110,116
Expected Credit Losses (Cumulative) .............................. 11.8% -18.0%
Estimated fair value assuming 10% adverse change ................. $100,907
Estimated fair value assuming 20% adverse change ................. 90,312
Residual Cash Flows Discount Rate (Annual) ....................... 14.0%
Estimated fair value assuming 10% adverse change ................. $109,594
Estimated fair value assuming 20% adverse change ................. 107,477
These sensitivities are hypothetical and should be used with caution. As the
figures indicate, changes in fair value based on 10% and 20% percent variation
in assumptions generally cannot be extrapolated because the relationship of the
change in assumption to the change in fair value may not be linear. Also, in
this table, the effect of a variation in a particular assumption on the fair
value of the retained interest is calculated without changing any other
assumption; in reality, changes in one factor may result in changes in another
(for example, increases in market rates may result in lower prepayments and
increased credit losses), which could magnify or counteract the sensitivities.
The following table summarizes the cash flows received from (paid to)
securitization Trusts:
F-22
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
FOR THE YEAR ENDED DECEMBER 31,
---------------------------------
2003 2002 2001
--------- --------- ---------
(IN THOUSANDS)
Releases of cash from Spread Accounts ......... $ 25,934 $ 60,393 $ 43,652
Servicing fees received ....................... 17,039 13,761 10,208
Net deposits to increase Credit Enhancement ... (20,867) (24,236) (24,581)
Initial funding of Credit Enhancement ......... (18,736) (16,749) (2,477)
Purchase of delinquent or foreclosed assets ... (45,747) (34,365) (37,620)
Repurchase of trust assets .................... -- (97,946) (2,936)
The following table presents the historical loss and delinquency amounts for the
serviced portfolio:
TOTAL PRINCIPAL
AMOUNT OF PRINCIPAL AMOUNT OF
OF CONTRACTS 60 DAYS NET CREDIT LOSSES
CONTRACTS OR MORE PAST DUE FOR THE YEAR ENDED
-------------------- -------------------- --------------------
AT DECEMBER 31, DECEMBER 31,
------------------------------------------ --------------------
2003 2002 2003 2002 2003 2002
--------- --------- --------- --------- --------- ---------
(IN THOUSANDS)
Contracts held by non-consolidated
subsidiaries ..................... $425,534 $478,136 $ 13,969 $ 14,835 $ 40,096 $ 15,605
Contracts held by
consolidated subsidiaries ........ 315,598 117,075 16,176 6,017 4,210 29,566
--------- --------- --------- --------- --------- ---------
Total managed portfolio .......... $741,132 $595,211 $ 30,145 $ 20,852 $ 44,306 $ 45,171
========= ========= ========= ========= ========= =========
(6) FURNITURE AND EQUIPMENT
The following table presents the components of furniture and equipment:
DECEMBER 31,
-------------------
2003 2002
-------- --------
(IN THOUSANDS)
Furniture and fixtures ........................... $ 2,994 $ 2,994
Computer equipment ............................... 4,034 3,980
Leasing assets ................................... 673 729
Leasehold improvements ........................... 637 637
Other fixed assets ............................... 50 17
-------- --------
8,388 8,357
Less: accumulated depreciation and amortization (7,562) (6,745)
-------- --------
$ 826 $ 1,612
======== ========
Depreciation expense totaled $878,000, $1.0 million and $1.0 million for the
years ended December 31, 2003, 2002 and 2001, respectively.
(7) SECURITIZATION TRUST DEBT
The Company's MFN and TFC subsidiaries have completed a number of securitization
transactions that are treated as secured borrowings for financial accounting
purposes, rather than as sales. In addition, CPS completed two such term
securitization transactions in 2003. The debt issued in these transactions is
shown on the Company's balance sheet as "Securitization Trust Debt," and the
components of such debt are summarized in the following table:
F-23
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
OUTSTANDING OUTSTANDING
PRINCIPAL AT PRINCIPAL AT
INITIAL DECEMBER DECEMBER 31, INTEREST RATE
SERIES: ISSUE DATE PRINCIPAL 31, 2003 2002 RANGE
--------- ------------ ------------ -------------
(DOLLARS IN THOUSANDS)
CPS2003-D December 16, 2003 $ 71,250 $ 71,250 $ -- 1.76 - 3.56 %
CPS2003-C September 30, 2003 83,125 77,928 -- 1.55 - 3.99 %
TFC2003-1 May 20, 2003 52,365 37,114 -- 2.69 %
TFC2002-2 October 9, 2002 62,589 25,436 -- 2.95 %
TFC2002-1 March 19, 2002 64,552 12,403 -- 4.23 %
MFN2001-A June 28, 2001 301,000 20,987 71,630 4.05 - 5.07 %
--------- ------------ ------------
$634,881 $ 245,118 $ 71,630
========== ============ ===========
All of the securitization trust debt was sold in private placement transactions
to qualified institutional buyers. The debt was issued through wholly-owned,
bankruptcy remote subsidiaries of CPS, TFC or MFN, and is secured by the assets
of such subsidiaries, but not by other assets of the Company. Principal and
interest payments are guaranteed by financial guaranty insurance policies.
The terms of the various Securitization Agreements related to the issuance of
the securitization trust debt require that certain delinquency and credit loss
criteria be met with respect to the collateral pool, and require that the
Company maintain a minimum net worth, and meet other financial tests. As of
December 31, 2003, the Company was in default of four financial covenants,
including maximum leverage, minimum equity, maximum financial loss and interest
coverage. As of December 31, 2003, the Company had received a waiver on these
covenant breaches from the controlling party. On March 15, 2004, each of these
financial covenants was amended with the controlling party such that all
breaches have been cured.
The Company is responsible for the administration and collection of the
Contracts. The Securitization Agreements also require certain funds be held in
restricted cash accounts to provide additional collateral for the borrowings or
to be applied to make payments on the securitization trust debt. As of December
31, 2003, restricted cash under the various agreements totaled approximately
$60.6 million. Interest expense on the securitization trust debt is composed of
the stated rate of interest plus amortization of additional costs of borrowing.
Additional costs of borrowing include facility fees, insurance and amortization
of deferred financing costs. Deferred financing costs related to the
securitization trust debt are amortized in proportion to the principal
distributed to the noteholders. Accordingly, the effective cost of borrowing of
the securitization trust debt is greater than the stated rate of interest.
The wholly-owned, bankruptcy remote subsidiaries of CPS, MFN and TFC were formed
to facilitate the above asset-backed financing transactions. Similar bankruptcy
remote subsidiaries issue the debt outstanding under the Company's warehouse
lines of credit. Bankruptcy remote refers to a legal structure in which it is
expected that the applicable entity would not be included in any bankruptcy
filing by its parent or affiliates. All of the assets of these subsidiaries have
been pledged as collateral for the related debt. All such transactions, treated
as secured financings for accounting and tax purposes, are treated as sales for
all other purposes, including legal and bankruptcy purposes. None of the assets
of these subsidiaries are available to pay other creditors of the Company or its
affiliates.
On March 15, 2004 a wholly-owned, bankruptcy remote consolidated subsidiary of
the Company issued $44 million of asset-backed notes secured by its retained
interest in eight term securitization transactions. The notes, which have an
interest rate of 10% per annum and a final maturity in October 2009, are
required to be repaid from the distributions on the underlying retained
interests. In connection with the issuance of the notes, the Company incurred
and capitalized issuance costs of $1.2 million.
F-24
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(8) DEBT
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 Notes are subordinated to certain existing and future
indebtedness of the Company as defined in the indenture agreement. The Company
is required to redeem on an annual basis, subject to certain adjustments, $1.0
million of the aggregate principal amount of the Notes through the operation of
a sinking fund on or before of January 1, 2000, 2001, 2002, 2003, 2004 and 2005.
The Company may at its option elect to redeem the Notes from the registered
holders of the Notes, in whole or in part at 100% of their principal amount,
plus accrued interest to and including the date of redemption. During each of
the years 1999 through 2003, the Company redeemed $1.0 million of principal
amount of the notes in conjunction with the requirements of the related sinking
fund agreement. The balance outstanding of the Notes at December 31, 2003 and
2002, was $15.0 million and $16.0 million, respectively.
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.
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., Levine Leichtman Capital Partners II, L.P. ("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 13). 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 related party loan in favor of LLCP (See Note 13.).
In April 1999, the Company issued an additional $5.0 million of subordinated
promissory notes due April 30, 2004, to the same affiliate of LLCP as noted
above, and received proceeds (net of $312,000 of capitalized issuance costs) of
$4.7 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, exercisable through April
2009. The debt bears interest at 14.5% per annum, and may be prepaid without
penalty at anytime. As part of the purchase agreement, the interest rate on the
previously issued LLCP notes was increased to 14.5% per annum, and the warrant
to purchase 3,450,000 shares of the Company's common stock at $3.00 per share
was exchanged for a warrant to purchase 3,115,000 shares at a price of $0.01 per
share.
F-25
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
In March 2000, the Company issued $16.0 million of senior secured debt to LLCP
("Term B"). The proceeds from the issuance were used to repay in full all
amounts owed under the Senior Secured Line. As part of the agreement, all of
LLCP's existing debt of $30.0 million was restructured as senior secured debt,
making the Company's aggregate principal indebtedness to LLCP equal to $46.0
million. The $16.0 million bears interest at 12.5% per annum and the interest
rate on the $30.0 million is unchanged at 14.5% per annum. As part of the
agreement, all prior defaults were either waived or cured. As of December 31,
2000, the amount outstanding of the $16.0 million portion of senior secured debt
was $8.0 million. The outstanding balance on the $16.0 million LLCP debt was
repaid during the first quarter of 2001. In addition, during the first quarter
of 2001, the Company made a $4.0 million principal prepayment on the remaining
outstanding LLCP debt, incurring $200,000 in prepayment penalties and waiver
fees. The outstanding balance of Term B debt at December 31, 2003 was $19.8
million.
In March 2002, the Company and LLCP entered into an additional series of
agreements under which LLCP provided additional funding to enable the Company to
acquire MFN Financial Corporation. Under the March 2002 agreements, the Company
borrowed $35 million from LLCP as a Bridge Note (Bridge Note) and approximately
$8.5 million ("Term C") on a deemed principal amount of approximately $11.2
million. The Bridge Note requires principal payments of $2.0 million a month,
which began in June 2002, with a final balloon payment in the amount of $17.0
million, which was made pursuant to the terms of the Bridge Note in February
2003. The Term C Note repayment schedule is based on the performance of a
certain securitized pool. As the subordinated Note of the pool is repaid from
the Trust, principal payments are due on the Term C Note. The maturity date of
the Term C Note is March 2008. Interest is due monthly on the Bridge Note at a
rate of 13.5% per annum and on the Term C Note at a rate of 12.0% per annum. In
connection with the March 2002 agreements and the acquisition of MFN, the
Company paid LLCP a structuring fee of $1.75 million and an investment banking
fee of $1.0 million, and paid LLCP's out-of-pocket expenses of approximately
$315,000. In addition, the Company paid LLCP certain other fees and interest
amounting to $426,181. Approximately $1.4 million of the fees and other amounts
paid to LLCP were deferred as financing costs and are being amortized over the
life of the related debt. The remaining fees and other costs were included in
the purchase price of MFN. At December 31, 2003, there was $5.1 million
principal outstanding on the Term C note.
On February 3, 2003, the Company borrowed $25.0 million from LLCP, net of fees
and expenses of $1.05 million. The indebtedness, represented by the "Term D
Note," was originally due in April 2003, with Company options to extend the
maturity to May 2003 and January 2004, upon payment of successive extension fees
of $125,000. The Company has paid the fees to extend the maturity to January
2004. Interest on the Term D Note is payable monthly at rates that averaged
4.79% per annum through June 30, 2003, and 12.0% per annum thereafter. In a
separate transaction, the Bridge Note issued to LLCP in connection with the
acquisition of MFN, in an original principal amount of $35.0 million, was due on
February 28, 2003. The outstanding principal balance of $17.0 million was paid
in February 2003. In addition, the maturity of the Term B Note was extended in
October 2003 from November 2003 to January 2004. As of December 31, 2003, the
outstanding principal balances of the Term B Note and the Term C Note were $19.8
million and $5.3 million, respectively. The Company repaid in full the Term C
Note on January 29, 2004 and repaid $10.0 million of the Term D Note on January
15, 2004. In addition, on January 29, 2004 the maturities of the Term B Note and
the Term D Note were extended to December 15, 2005 and the coupons on both notes
were decreased to 11.75% per annum. The Company paid LLCP fees equal to $921,000
for these amendments, which will be amortized over the remaining life of the
notes.
During the year ended December 31, 1997 the Company acquired CPS Leasing, Inc.
At December 31, 2003 and 2002, CPS Leasing, Inc., had borrowings to banks of
$74,000 and $673,000, respectively.
F-26
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
At the time of the MFN Merger, MFN had outstanding $22.5 million in principal
amount of senior subordinated debt, which was due and repaid in full on March
23, 2002. Such debt bore interest at the rate of 11.00% per annum, payable
quarterly in arrears. At the time of the TFC Merger, TFC had outstanding $6.3
million in principal amount of subordinated debt, which the Company assumed as
part of the TFC Merger. Such debt bears interest at the rate of 13.25% per annum
payable monthly in arrears, requires monthly amortization and is due in June
2005.
The Company must comply with certain affirmative and negative covenants related
to debt facilities, which require, among other things, that the Company maintain
certain financial ratios related to liquidity, net worth, capitalization,
investments, acquisitions, restricted payments and certain dividend
restrictions. The Company was in compliance with all of its debt covenants with
respect to non-securitization related debt as of December 31, 2003. The Company
was in violation of four covenants related to securitization debt as of December
31, 2003, including maximum leverage, minimum equity, maximum financial loss and
interest coverage. The Company has received a waiver of such non-compliance from
the controlling party. On March 15, 2004, each of these financial covenants was
amended with the controlling party such that all breaches have been cured.
The following table summarizes the amount of senior secured, subordinated and
related party debt maturing over the next 5 years and thereafter as of December
31, 2003:
PRINCIPAL
AMOUNT
---------
(IN THOUSANDS)
2004 ............................................ $ 83,328
2005 ............................................ --
2006 ............................................ 14,000
2007 ............................................ --
2008 ............................................ 5,137
Thereafter ...................................... --
---------
Total .................................... $102,465
=========
(9) SHAREHOLDERS' EQUITY
COMMON STOCK
Holders of 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, senior debt,
subordinated debt, and related party debt. The covenants restrict the payment of
certain distributions, including dividends (See Note 8.).
Included in common stock at December 31, 2003 and 2002, is additional paid in
capital of $1,585,000 and $1,770,000 related to the valuation of certain stock
options as required by Financial Interpretation No. 44 ("FIN 44") or the
valuation of conditionally granted options as required under Accounting
Principals Board Opinion No. 25 ("APB 25"). Included in compensation expense for
December 31, 2003 and 2002, is $1,141,000 and $1,196,000 related to the
amortization of deferred compensation expense and valuation of stock options.
STOCK PURCHASES
During 2000, the Company's Board of Directors authorized the Company to purchase
up to $5 million of Company securities. In October 2002, the Board of Directors
authorized the purchase of an additional $5 million of outstanding debt or
equity securities. As of December 31, 2003, the Company had purchased $4.0
million in principal amount of the Notes, and $3.9 million of its common stock,
representing 2,141,037 shares.
F-27
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
OPTIONS AND WARRANTS
In 1991, the Company adopted and its sole shareholder approved 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. The Plan terminated in December 2001, without
affecting the validity of the outstanding options.
In July 1997, the Company adopted and its shareholders approved 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. In 2001, the shareholders of the Company approved an
amendment to the 1997 Plan providing that an aggregate maximum of 3,400,000
shares of the Company's common shares may be subject to awards under the 1997
Plan. In 2003, the shareholders of the Company approved an amendment to the 1997
Plan to further increase the aggregate maximum number of shares that may be
granted within the Plan to 4,900,000 shares.
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 per share, were repriced to $3.25 per share. In conjunction
with the repricing, a one-year period of non-exercisability was placed on all
repriced options, which period ended on October 21, 1999.
In October 1999, 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 29, 1999, with an option price
greater than $0.625 per share, were repriced to $0.625 per share. In conjunction
with the repricing, a six-month period of non-exercisability was placed on all
repriced options, which period ended on April 29, 2000.
At December 31, 2003, there were a total of 146,631 additional shares available
for grant under the 1997 Plan and the 1991 Plan. Of the options outstanding at
December 31, 2003, 2002 and 2001, 1,168,042, 920,101, and 1,715,767,
respectively, were then exercisable, with weighted-average exercise prices of
$1.71, $1.30, and $0.84, respectively.
Stock option activity during the periods indicated is as follows:
F-28
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
WEIGHTED
AVERAGE
NUMBER OF EXERCISE
SHARES PRICE
------ ------
(IN THOUSANDS,
EXCEPT PER SHARE DATA)
Balance at December 31, 2000 ............... 3,501 $0.86
Granted ............................... 1,097 2.53
Exercised ............................. 501 0.63
Canceled .............................. 275 1.05
------ ------
Balance at December 31, 2001 ............... 3,822 1.35
Granted ............................... 1,804 1.55
Exercised ............................. 1,254 0.64
Canceled .............................. 340 1.63
------ ------
Balance at December 31, 2002 ............... 4,032 1.64
Granted ............................... 1,013 2.46
Exercised ............................. 609 0.93
Canceled .............................. 564 1.69
------ ------
Balance at December 31, 2003 ............... 3,872 $1.96
====== ======
During 2002, the Company's Board of Directors approved a program whereby
officers of the Company would be loaned amounts sufficient to enable them to
exercise certain of their outstanding options. See Note 13.
At December 31, 2003, 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:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- -------------------------------------------------------------------------------- ----------------------------
WEIGHTED
WEIGHTED WEIGHTED AVERAGE
AVERAGE EXERCISE EXERCISE
RANGE OF EXERCISE PRICES NUMBER REMAINING PRICE PER NUMBER PRICE PER
(PER SHARE) OUTSTANDING TERM (YEARS) SHARE EXERCISABLE SHARE
------------------------- ----------- ------------ ---------- ----------- -----
(IN THOUSANDS, EXCEPT TERM AND PER SHARE DATA)
$ 0.63 - $ 0.63................ 301 4.44 $ 0.63 168 $ 0.63
$ 0.69 - $ 1.50................ 1,245 8.45 $ 1.49 322 $ 1.47
$ 1.54 - $ 2.39................ 1,175 7.79 $ 1.80 502 $ 1.77
$ 2.50 - $ 3.28................ 929 8.93 $ 2.69 131 $ 2.59
$ 4.25 - $ 4.25................ 222 7.05 $ 4.25 45 $ 4.25
On November 17, 1998, in conjunction with the issuance of a $25.0 million
subordinated promissory note to an affiliate of LLCP, the Company issued
warrants to purchase up to 3,450,000 shares of common stock at $3.00 per share,
exercisable through November 30, 2005. In April 1999, in conjunction with the
issuance of $5.0 million of an additional subordinated promissory note to an
affiliate of LLCP, the Company issued additional warrants to purchase 1,335,000
shares of the Company's common stock at $0.01 per share to LLCP. As part of the
purchase agreement, the existing warrants to purchase 3,450,000 shares at $3.00
per share were exchanged for warrants to purchase 3,115,000 shares at a price of
$0.01 per share. The aggregate value of the warrants, $12.9 million, which is
comprised of $3.0 million from the original warrants issued in November 1998 and
$9.9 million from the repricing and additional warrants issued in April 1999, is
reported as deferred interest expense to be amortized over the expected life of
the related debt, five years. As of December 31, 2003, 1,000 warrants remained
unexercised. Such warrants, and the 4,449,000 shares of common stock have, upon
the exercise of such warrants, not been registered for public sale. However, the
holder has the right to require the Company register the warrants and common
stock for public sale in the future.
F-29
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Also in November 1998, the Company entered into an agreement with the Note
Insurer of its asset-backed securities. The agreement committed the Note 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, subject to anti-dilution adjustments. The
warrants were fully exercisable on the date of grant and expired in December
2003. In November 2003, the Company purchased the warrants from the Note Insurer
for $896,415.
(10) GAIN ON SALE OF CONTRACTS
The following table presents the components of the net gain on sale of
Contracts:
YEAR ENDED DECEMBER 31,
---------------------------------
2003 2002 2001
--------- --------- ---------
(IN THOUSANDS)
Gain on sale of Contracts ............................. $ 4,381 $ 17,480 $ 25,803
Deferred acquisition fees and discounts ............... 4,590 5,285 2,816
Expenses related to sales ............................. (2,076) (3,682) (1,549)
(Provision for) recovery of credit losses ............. (526) (2,639) 5,695
--------- --------- ---------
Net gain on sale of Contracts ......................... $ 6,369 $ 16,444 $ 32,765
========= ========= =========
(11) INTEREST INCOME
The following table presents the components of interest income:
YEAR ENDED DECEMBER 31,
---------------------------------
2003 2002 2001
--------- --------- ---------
(IN THOUSANDS)
Interest on Finance Receivables ....................... $ 40,380 $ 32,851 $ 2,249
Residual interest income .............................. 16,178 15,392 14,648
Other interest income ................................. 1,606 401 308
--------- --------- ---------
Net interest income ................................... $ 58,164 $ 48,644 $ 17,205
========= ========= =========
(12) INCOME TAXES
Income taxes consist of the following:
YEAR ENDED DECEMBER 31,
---------------------------------
2003 2002 2001
--------- --------- ---------
(IN THOUSANDS)
Federal ............................................. $ 2,781 $(11,295) $ 366
State ............................................... 356 (715) (126)
--------- --------- ---------
3,137 (12,010) 240
Deferred:
Federal ............................................. (25,345) 10,867 (277)
State ............................................... (4,141) 1,428 485
Change in valuation allowance ....................... 22,915 (3,219) (448)
--------- --------- ---------
(6,571) 9,076 (240)
--------- --------- ---------
Income tax benefit .............................. $ (3,434) $ (2,934) $ --
========= ========= =========
The Company's effective tax expense benefit for the years ended December 31,
2003, 2002 and 2001, differs from the amount determined by applying the
statutory federal rate of 35% to income (loss) before income taxes as follows:
YEAR ENDED DECEMBER 31,
---------------------------------
2003 2002 2001
--------- --------- ---------
(IN THOUSANDS)
Expense (benefit) at federal tax rate ................. $ (1,064) $ 6,116 $ 112
California franchise tax, net of federal income
tax benefit ........................................ (2,460) 459 233
Other ................................................. 92 (196) 103
Negative Goodwill ..................................... -- (6,094) --
Debt Forgiveness ...................................... (22,917) -- --
Valuation allowance ................................... 22,915 (3,219) (448)
--------- --------- ---------
$ (3,434) $ (2,934) $ --
========= ========= =========
F-30
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The tax effected cumulative temporary differences that give rise to deferred tax
assets and liabilities as of December 31, 2003 and 2002, are as follows:
DECEMBER 31,
-----------------------
2003 2002
--------- ---------
(IN THOUSANDS)
Deferred Tax Assets:
Accrued liabilities ........................ $ 11,185 $ 2,760
Furniture and equipment .................... 1,465 2,335
Equity investment .......................... 82 82
NOL carryforwards and BILs ................. 31,397 36,979
Minimum tax credit ......................... 481 334
Provision for loan loss .................... (2,125) 1,383
Pension Accrual ............................ 1,617 1,063
Other ...................................... 461 110
--------- ---------
Total deferred tax assets .............. 44,563 45,046
Valuation allowance ........................ (37,363) (8,563)
--------- ---------
7,200 36,483
Deferred Tax Liabilities:
NIRs ....................................... (6,789) (13,568)
Debt Forgiveness ........................... -- (29,629)
--------- ---------
Total deferred tax liabilities ......... (6,789) (43,197)
--------- ---------
Net deferred tax asset (liability) ..... $ 411 $ (6,714)
========= =========
As part of the MFN Merger, CPS acquired certain net operating losses, debt
forgiveness, as discussed below, and built in loss assets. Moreover, MFN has
undergone an ownership change for purposes of Internal Revenue Code ("IRC")
section 382. In general, IRC section 382 imposes an annual limitation on the
ability of a loss corporation (i.e., a corporation with a net operating loss
("NOL") carryforward, credit carryforward, or certain built-in losses ("BILs"))
to utilize its pre-change NOL carryforwards or BILs to offset taxable income
arising after an ownership change. During 1999, MFN recorded an extraordinary
gain from the discharge of indebtedness related to the emergence from
Bankruptcy. This gain was not taxable under IRC section 108. In accordance with
the rules under IRC section 108, MFN has reduced certain tax attributes
including unused net operating losses and tax basis in certain MFN assets.
Deferred taxes have been provided for the estimated tax effect of the future
reversing timing differences related to the discharge of indebtedness gain as
reduced by the tax attributes. Additionally, the Company has established a
valuation allowance of $8.6 million against MFN's deferred tax assets, as it is
not more than likely that these amounts will be realized in the future. In
determining the possible future realization of deferred tax assets, future
taxable income from the following sources are taken into account: (a) reversal
of taxable temporary differences, (b) future operations exclusive of reversing
temporary differences, and (c) tax planning strategies that, if necessary, would
be implemented to accelerate taxable income into years in which net operating
losses might otherwise expire.
As part of the TFC Merger, CPS acquired certain built in loss assets. Moreover,
TFC has undergone an ownership change for purposes of Internal Revenue Code
("IRC") section 382. In general, IRC section 382 imposes an annual limitation on
the ability of a loss corporation (i.e., a corporation with a net operating loss
("NOL") carryforward, credit carryforward, or certain built-in losses ("BILs"))
to utilize its pre-change NOL carryforwards or BILs to offset taxable income
arising after an ownership change. Additionally, the Company has established a
valuation allowance of $5.9 million against TFC's deferred tax assets, as it is
not more than likely that these amounts will be realized in the future. In
determining the possible future realization of deferred tax assets, future
taxable income from the following sources are taken into account: (a) reversal
of taxable temporary differences, (b) future operations exclusive of reversing
temporary differences, and (c) tax planning strategies that, if necessary, would
be implemented to accelerate taxable income into years in which net operating
losses might otherwise expire.
F-31
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
As of December 31, 2003, the Company has net operating loss carryforwards for
federal and state income tax purposes of $29 million and $8 million,
respectively, which are available to offset future taxable income, if any,
subject to IRC section 382 limitations, through 2021 and 2013, respectively. In
addition, the Company has an alternative minimum tax credit carry forward of
approximately $481,000, which is available to reduce future federal regular
income taxes, if any, over an indefinite period.
The Company's tax returns are open for audits by various tax authorities.
Therefore, from time-to-time there may be differences in opinions with respect
to the tax treatment accorded to certain transactions. When, and if, such
differences occur and become probable and estimatable, such amounts will be
recognized. The Company filed its tax returns on a fiscal year ending March 31
through March 31, 2002. It changed its tax fiscal year to a calendar year
effective December 31, 2002.
(13) RELATED PARTY TRANSACTIONS
RELATED PARTY RECEIVABLES
As of December 31, 2001, the Company had a receivable from CARSUSA, Inc.
("CARSUSA"), which owned and operated a Mitsubishi automobile dealership in
Southern California, and is owned by Charles E. Bradley, Sr. and Charles E.
Bradley, Jr. During 2002, CARUSA became insolvent, sold its assets to an
unaffiliated party, partially paid its secured creditors, and would up its
business. The Company determined that the receivable was uncollectible, and
wrote down its value to zero. The writedown-related expense of $669,000 is
reflected in the Company's Consolidated Statement of Operations for the year
ended December 31, 2002 in general and administrative expenses. The Company
purchased seven and 16 Contracts from CARSUSA, with an aggregate principal
balance of approximately $99,996 and $233,431, respectively, in 2002 and 2001.
The Company did not purchase any contracts from CARSUSA in 2003.
CPS LEASING, INC. RELATED PARTY DIRECT LEASE RECEIVABLES
Included in other assets recorded in the Company's Consolidated Balance Sheet
are direct lease receivables due to CPS Leasing, Inc. from related parties,
primarily companies affiliated with the Company's former Chairman of the Board
of Directors. Such related party direct lease receivables totaled approximately
$1.9 million and $2.2 million at December 31, 2003 and 2002, respectively.
RELATED PARTY DEBT
In June 1997 the Company borrowed $15.0 million on an unsecured and subordinated
basis from Stanwich Financial Services Corp. ("SFSC"), an affiliate of Charles
E. Bradley, Sr., the former Chairman of the Company's Board of Directors. This
loan ("RPL") is due 2004, and has a fixed rate of interest of 9% per 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, 2003 and 2002, was $15.0 million.
During 1998, the Company borrowed an additional $4 million on an unsecured basis
from SFSC. This loan ("RPL2") is due 2004, and has a fixed rate of interest of
12.5% per annum payable monthly beginning December 1998. The Company had the
right to pre-pay the RPL2, without penalty, at any time after June 12, 2000. At
maturity or repayment of the RPL2, the holder thereof would 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 per share. The balance
of the RPL2 was repaid during the first quarter of 2001.
F-32
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
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 the RPL2. The balance of the RPL3 at December 31, 2003 and 2002 was $1.0
million.
During 1999, the Company borrowed $1.5 million on an unsecured basis from SFSC.
This loan ("RPL4") is due 2004, has a fixed rate of interest of 14.5% per annum
payable monthly beginning October 1999. In conjunction with the issuance of the
RPL4, the Company issued warrants to purchase 103,500 shares of the Company's
common stock at a price of $0.01 per share. The balance of the RPL4 at December
31, 2003 and 2002 was $1.5 million.
LOANS TO OFFICERS TO EXERCISE CERTAIN STOCK OPTIONS
During 2002, the Company's Board of Directors approved a program under which
officers of the Company would be advanced amounts sufficient to enable them to
exercise certain of their outstanding options. Such loans were available for a
limited period of time, and available only to exercise previously repriced
options. The loans bear interest at a rate of 5.50% per annum, and are due in
2007. At December 31, 2003, there was $458,531 outstanding related to these
loans. Such amounts have been recorded as contra-equity in the Shareholders'
Equity section of the Company's Consolidated Balance Sheet.
(14) COMMITMENTS AND CONTINGENCIES
LEASES
The Company leases its facilities and certain computer equipment under
non-cancelable operating leases, which expire through 2008. Future minimum lease
payments at December 31, 2003, under these leases are as follows:
OPERATING
----------
(IN THOUSANDS)
2004..................................................... $ 4,511
2005..................................................... 4,370
2006..................................................... 3,524
2007..................................................... 2,795
2008..................................................... 1,748
Thereafter............................................... --
----------
Total minimum lease payments............................. $ 16,948
==========
Rent expense for the years ended December 31, 2003, 2002 and 2001, was $3.9
million, $4.0 million, and $2.6 million, 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.
During 2003, 2002 and 2001, the Company received $169,777, $140,537 and
$270,486, respectively, of sublease income, which is included in occupancy
expense. Future minimum sublease payments totaled $587,854 at December 31, 2003.
LITIGATION
STANWICH LITIGATION. CPS is currently a defendant in a class action (the
"Stanwich Case") pending in the California Superior Court, Los Angeles County.
The plaintiffs in that case are persons entitled to receive regular payments
(the "Settlement Payments") under out-of-court settlements reached with third
party defendants. Stanwich Financial Services Corp. ("Stanwich"), an affiliate
of the former Chairman of the Board of Directors of CPS, is the entity that is
obligated to pay the Settlement Payments. Stanwich has defaulted on its payment
obligations to the plaintiffs and in June 2001 filed for reorganization under
the Bankruptcy Code, in the federal Bankruptcy Court of Connecticut. CPS is also
a defendant in certain cross-claims brought by other defendants in the case,
which assert claims of equitable and/or contractual indemnity against CPS.
F-33
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
In November 2001, one of the defendants in the Stanwich Case, Jonathan Pardee,
asserted claims for indemnity against CPS in a separate action, which is now
pending in federal district court in Rhode Island. CPS has filed counterclaims
in the Rhode Island federal court against Mr. Pardee. CPS is defending this
matter and pursuing its counterclaims vigorously.
In February 2002, CPS entered into a term sheet with Stanwich, the plaintiffs in
the Stanwich Case and others, which provides for CPS's release upon its
repayment of the amounts concededly owed to Stanwich, all of which amounts have
been recorded in CPS's financial statements as indebtedness.
The California court in December 2003 preliminarily approved a settlement of the
Stanwich Case. That settlement will result in CPS being released from all claims
pending in the California court, other than an alleged contractual indemnity in
favor of one of the financial institution co-defendants. As to that institution,
CPS has an agreement in principle to settle its cross-claim. The court-approved
settlement requires of CPS only that it repay the amounts it concededly owes to
Stanwich, all of which amounts have been recorded in CPS's financial statements
as indebtedness.
Investors should consider that any adverse judgment against CPS in the Stanwich
Case (or the related case in Rhode Island) for indemnification, in an amount
materially in excess of any liability already recorded in respect thereof, could
have a material adverse effect on the ability of CPS to perform its servicing
and indemnification obligations.
OTHER LITIGATION. On November 15, 2000, Denice and Gary Lang filed a lawsuit
against CPS in South Carolina Common Pleas Court, Beaufort County, alleging that
they, and a purported nationwide class, were harmed by an alleged failure to
refer, in the notice given after repossession of their vehicle, to the right to
purchase the vehicle by tender of the full amount owed under the retail
installment contract. They sought damages in an unspecified amount. CPS filed a
counterclaim to recover any delinquent amounts owed by the members of the
putative class in the event that the class were to be certified. In February
2004, CPS reached an agreement to settle that case on a class basis for payment
of attorneys' fees and other immaterial consideration.
On September 26, 2001, Maggie Chandler, Bobbie Mike and Mary Ann Benford each
commenced a lawsuit against subsidiaries of MFN (now subsidiaries of CPS) in
three different state courts in Mississippi. A similar case was filed in
December 2002 in a fourth Mississippi court. Plaintiffs in all four cases
alleged deceptive practices related to various loans and the related purchase
and sale of insurance, and sought unspecified damages. In September 2003, the
defendant subsidiaries reached an agreement in principle to settle all such
cases, and any similar cases that might be brought by other clients of the same
plaintiff law firms.
(15) EMPLOYEE BENEFITS
The Company sponsors a pretax savings and profit sharing plan (the "401(k)
Plan") qualified 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, may, at its discretion, match 100% of employees'
contributions up to $1,000 per employee per calendar year. The Company's
contributions to the 401(k) Plan were $213,045 for the year ended December 31,
2000. The Company did not make a matching contribution in 2003, 2002 or 2001,
other than to employees eligible for the MFN Financial Corporation Retirement
Savings Plan. Such contribution amounted to $250,682 for the period from the
Merger Date through December 31, 2002. The MFN Financial Corporation Retirement
Savings Plan was merged into the Company's 401(k) Plan in February 2003.
The Company also sponsors the MFN Financial Corporation Pension Plan ("the
Plan"). The Plan benefits were frozen June 30, 2001. The following table sets
forth the plan's benefit obligations, fair value of plan assets, and funded
status at December 31, 2003 and 2002:
F-34
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
DECEMBER 31,
----------------------
2003 2002
--------- ---------
(DOLLARS IN THOUSANDS)
CHANGE IN PROJECTED BENEFIT OBLIGATION
Projected benefit obligation, beginning of year ....... $ 13,743 $ 12,223
Service cost .......................................... -- --
Interest cost ......................................... 902 853
Settlements ........................................... 0 (826)
Actuarial gain ........................................ 1,578 2,964
Benefits paid ......................................... (1,200) (1,471)
--------- ---------
Projected benefit obligation, end of year .......... $ 15,023 $ 13,743
========= =========
The accumulated benefit obligation for the pension plan was $15.0 million and
$13.7 million at December 31, 2003 and 2002, respectively.
CHANGE IN PLAN ASSETS
Fair value of plan assets, beginning of year .......... $ 9,906 $ 12,013
Return on assets ...................................... 1,001 (636)
Employer contribution ................................. 1,546 --
Benefits paid ......................................... (1,200) (1,471)
--------- ---------
Fair value of plan assets, end of year ............. $ 11,253 $ 9,906
RECONCILIATION OF ACCRUED PENSION COST AND TOTAL AMOUNT RECOGNIZED
Funded status of the plan ............................. $ (3,770) $ (3,836)
Unrecognized loss ..................................... 4,136 2,771
Unrecognized transition asset ......................... (80) (115)
Unrecognized prior service cost ....................... -- --
--------- ---------
Accrued pension cost ............................... $ 286 $ (1,180)
========= =========
Weighted average assumptions used to determine benefit obligations at December
31, 2003 and 2002 were as follows:
WEIGHTED AVERAGE ASSUMPTIONS AS OF DECEMBER 31, 2002
Discount rate ......................................... 6.25% 6.50%
Expected return on plan assets ........................ 9.00% 9.00%
Rate of compensation increase ......................... N/A N/A
The Company's overall expected long-term rate of return on assets is 9.00% per
annum. The expected long-term rate of return is based on the weighted average of
historical returns on individual asset categories, which are described in more
detail below
AMOUNTS RECOGNIZED IN CONSOLIDATED BALANCE SHEET
Prepaid benefit cost .................................. $ 286 $ --
Accrued minimum pension obligation .................... (4,055) (3,836)
Intangible asset ...................................... -- --
Accumulated other comprehensive income, pretax ........ 4,055 2,656
--------- ---------
Net amount recognized .............................. $ 286 $ (1,180)
TOTAL COST
Service cost .......................................... $ -- $ --
Interest cost ......................................... 902 853
Expected return on assets ............................. (872) (1,052)
Amortization of unrecognized loss ..................... 98 --
Amortization of transition obligation ................. (35) (25)
Amortization of prior service cost .................... -- --
--------- ---------
Net periodic pension income ........................... 93 (224)
Loss due to settlement ................................ -- 224
--------- ---------
Total benefit income ................................ $ 93 $ --
========= =========
F-35
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
ACCUMULATED BENEFIT OBLIGATION AND FAIR VALUE OF ASSETS
Projected Benefit Obligation .......................... $(15,023) $(13,743)
Accumulated Benefit Obligation ........................ (15,023) (13,743)
Fair Value of Assets .................................. 11,253 9,906
--------- ---------
Unfunded Accumulated Benefit Obligation ............... $ (3,770) $ (3,837)
========= =========
The weighted average asset allocation of the Company's pension
benefits at December 31, 2003 and 2002 were as follows:
PLAN ASSETS AT
PLAN ASSETS DECEMBER 31,
------------------
Asset Category 2003 2002
------- -------
Equity securities.......................................... 61.73% --
Fixed income securities.................................... 29.14% --
CPS stock.................................................. 9.07% 5.27%
Cash....................................................... 0.06% 94.73%
------- -------
Total................................................... 100.00% 100.00%
======= =======
The Company's investment policies and strategies for the pension benefits plan
utilize a target allocation of 70% equity securities and 30% fixed income
securities. The Company's investment goals are to maximize returns subject to
specific risk management policies. The Company addresses risk management and
diversification by the use of a professional investment advisor and several
sub-advisors which invest in domestic and international equity securities and
domestic fixed income securities. Each sub-advisor focuses its investments
within a specific sector of the equity or fixed income market. For the
sub-advisors focused on the equity markets, the sectors are differentiated by
the market capitalization and the relative valuation of the underlying issuer.
For the sub-advisors focused on the fixed income markets, the sectors are
differentiated by the credit quality and the maturity of the underlying fixed
income investment. The investments made by the sub-advisors are readily
marketable and can be sold to fund benefit payment obligations as they become
payable.
(16) 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 markets 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, 2003 and 2002, 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, 2003 and 2002, were as follows:
F-36
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
DECEMBER 31,
------------------------------------------------------
2003 2002
------------------------ --------------------------
CARRYING CARRYING
VALUE OR VALUE OR
NOTIONAL FAIR NOTIONAL FAIR
FINANCIAL INSTRUMENT AMOUNT VALUE AMOUNT VALUE
-------------------- ---------- ---------- ---------- ------------
(IN THOUSANDS)
Cash...................................... $ 33,209 $ 33,209 $ 32,947 $ 32,947
Restricted cash........................... 67,277 67,277 18,912 18,912
Finance receivables, net.................. 266,189 266,189 84,592 84,592
Residual interest in securitizations ..... 111,702 111,702 127,170 127,170
Notes payable............................. 3,330 3,330 673 673
Securitization trust debt................. 245,118 245,118 71,630 71,630
Senior secured debt....................... 49,965 49,965 50,072 50,072
Subordinated debt......................... 35,000 35,506 36,000 32,800
Related party debt........................ 17,500 17,763 17,500 15,400
CASH AND RESTRICTED CASH
The carrying value equals fair value.
FINANCE RECEIVABLES, NET
The carrying value approximates fair value because the related interest rates
are estimated to reflect current market conditions for similar types of
instruments.
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.
COMMITMENTS
The fair value of commitments to purchase contracts from Dealers is determined
by purchase commitments from investors and prevailing market rates.
NOTES PAYABLE, SECURITIZATION TRUST DEBT AND SENIOR SECURED DEBT
The carrying value approximates fair value because the related interest rates
are estimated to reflect current market conditions for similar types of secured
instruments.
SUBORDINATED DEBT
The fair value is based on a market quote.
RELATED PARTY DEBT
The fair value is based on the fair value of subordinated debt, as the terms and
structure are similar.
(17) LIQUIDITY
The Company's business requires substantial cash to support its purchases of
Contracts and other operating activities. The Company's primary sources of cash
have been cash flows from operating activities, including proceeds from sales of
Contracts, amounts borrowed under various revolving credit facilities (also
sometimes known as warehouse credit facilities), servicing fees on portfolios of
F-37
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Contracts previously sold in securitization transactions, customer payments of
principal and interest on finance receivables, fees for origination of
Contracts, and releases of cash from securitized pools of Contracts in which the
Company has retained a residual ownership interest, and from the Spread Accounts
associated with such pools. The Company's primary uses of cash have been the
purchases of Contracts, repayment of amounts borrowed under lines of credit and
otherwise, operating expenses such as employee, interest, occupancy expenses and
other general and administrative expenses, the establishment of Spread Accounts
and initial overcollateralization, if any, and the increase of Credit
Enhancement to required levels in securitization transactions, and income taxes.
There can be no assurance that internally generated cash will be sufficient to
meet the Company's cash demands. The sufficiency of internally generated cash
will depend on the performance of securitized pools (which determines the level
of releases from those pools and their related Spread Accounts), the rate of
expansion or contraction in the Company's managed portfolio, and the terms upon
which the Company is able to acquire, sell, and borrow against Contracts.
Contracts are purchased from Dealers for a cash price approximating their
principal amount, and generate cash flow over a period of years. As a result,
the Company has been dependent on warehouse credit facilities to purchase
Contracts, and on the availability of cash from outside sources in order to
finance its continuing operations, as well as to fund the portion of Contract
purchase prices not financed under revolving warehouse credit facilities. As of
December 31, 2003, the Company had $225 million in warehouse credit capacity, in
the form of a $125 million facility, a $75 million facility and a $25 million
facility. The first two warehouse facilities provide funding for Contracts
purchased under CPS' programs while the third facility provides funding for
Contracts purchased under TFC's programs. On February 21, 2004, the $75 million
facility expired and, as a result, the Company's current warehouse credit
capacity is $150 million. These facilities are independent of each other and
provide funding equal to 71-73% of the principal balance of the Contracts
pledged, subject to collateral tests and certain other conditions and covenants.
On February 21, 2004 the CPS Funding LLC $75 million revolving warehouse credit
facility expired. One of the covenants within the Company's $125 million
warehouse credit facility and four of the six term securitizations insured by
one Note Insurer requires that the Company maintain additional warehouse
facilities with minimum borrowing capacity of $75.0 million. With the expiration
of the CPS Funding LLC facility described above, the Company is in breach of
such covenant. The Company has until June 20, 2004 to cure such breach prior to
it becoming an event of default under this warehouse facility and four term
securitizations. While the Company is currently in discussions with several
parties about a replacement facility and believes that it will be successful in
replacing the facility within the required time frame, there can be no
assurances that it will do so. If the Company is unsuccessful in these efforts,
the Note Insurer will have the right to declare an event of default. Remedies
available to the Note Insurer in such event include, among other things,
transferring the servicing rights to the portfolio that it insures to another
servicer and trapping excess cash releases to the Company from its warehouse
facility and four term securitizations that it insures. To the extent that the
Note Insurer was to follow either of these remedies, it would have a material
adverse effect on the liquidity and the operations of the Company.
Through May 2002, the Company's Contract purchasing program consisted of both
(i) flow purchases for immediate resale to non-affiliates and (ii) purchases for
the Company's own account made on other than a flow basis, funded primarily by
advances under a revolving warehouse credit facility. Flow purchases allowed the
Company to purchase Contracts with minimal demands on liquidity. The Company's
revenues from the resale of flow purchase Contracts, however, were materially
less than those that may be received by holding Contracts to maturity or by
selling Contracts in securitization transactions. During the year ended December
31, 2003 the Company purchased $357.3 million of Contracts for its own account,
compared to $282.2 million for its own account and $181.1 million of Contracts
on a flow basis in 2002. For the year ended December 31, 2001, the Company
purchased $134.4 million of Contracts for its own account and $537.9 million on
a flow basis. The Company's flow purchase program ended in May 2002.
The $125 million warehouse facility is structured to allow CPS to fund a portion
of the purchase price of Contracts by drawing against a floating rate variable
funding note issued by CPS Warehouse Trust. This facility was established on
March 7, 2002, in the maximum amount of $100 million. Such maximum amount was
increased to $125 million in November 2002. Approximately 73% of the principal
balance of Contracts may be advanced to the Company under this facility, subject
to collateral tests and certain other conditions and covenants. Notes under this
facility accrue interest at a rate of one-month commercial paper plus 1.18% per
annum. This facility expires on April 4, 2004. The Company is currently in
discussions with the related parties to renew such facility.
The $75 million warehouse facility which expired on February 21, 2004, was
similarly structured to allow CPS to fund a portion of the purchase price of
Contracts by drawing against a floating rate variable funding note issued by CPS
Funding LLC. Approximately 72.5% of the principal balance of Contracts could be
advanced to the Company under this facility, subject to collateral tests and
certain other conditions and covenants. Notes under this facility accrued
interest at a rate of one-month LIBOR plus 0.75% per annum. This facility
expired on February 21, 2004. The Company is currently in discussions with
several parties regarding a replacement facility.
F-38
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The $25 million warehouse facility is similarly structured to allow TFC to fund
a portion of the purchase price of Contracts by drawing against a floating rate
variable funding note issued by TFC Warehouse I LLC. Approximately 71% of the
principal balance of Contracts may be advanced to TFC under this facility,
subject to collateral tests and certain other conditions and covenants. Notes
under this facility accrue interest at a rate of one-month LIBOR plus 1.75% per
annum. This facility was entered into as part of the TFC Merger on May 20, 2003
and has a 364-day term. The Company is currently in discussions with the related
parties to renew such facility.
These facilities are independent of each other. Two different financial
institutions purchase the notes issued by these facilities, and three different
insurers insure the notes. Up through June 30, 2003, sales of Contracts to the
special purpose subsidiaries ("SPS") related to the first two facilities had
been treated as sales for financial accounting purposes. The Company, therefore,
removed these securitized Contracts and related debt from its Consolidated
Balance Sheet and recognized a gain on sale in the Company's Consolidated
Statement of Operations. Indebtedness related to Contracts funded by the third
facility, however, were on the Company's Consolidated Balance Sheet and no gain
on sale has ever been recognized in the Company's Consolidated Statement of
Operations. During July 2003, each of the first two facilities was amended, with
the effect that subsequent use of such facilities is treated for financial
accounting purposes as borrowing secured by such receivables, rather than as a
sale of receivables. The effects of that amendment are similar to those
discussed above with respect to the change in securitization structure.
The Company's primary means of ensuring that its cash demands do not exceed its
cash resources is to match its levels of Contract purchases to its availability
of cash. The Company's ability to adjust the quantity of Contracts that it
purchases and securitizes will be subject to general competitive conditions and
the continued availability of warehouse credit facilities. There can be no
assurance that the desired level of Contract acquisition can be maintained or
increased. Obtaining releases of cash from the Trusts and their related Spread
Accounts is dependent on collections from the related Trusts generating
sufficient cash to maintain the Spread Accounts and other Credit Enhancement in
excess of their respective requisite levels. There can be no assurance that
collections from the related Trusts will continue to generate sufficient cash.
Certain of the Company's securitization transactions and the warehouse credit
facilities contain various financial covenants requiring certain minimum
financial ratios and results. The Company was in violation of four of these
covenants as of December 31, 2003, including maximum leverage, minimum equity,
maximum financial loss and interest coverage. As of December 31, 2003 the
Company had received a waiver of such non-compliance from the controlling party.
On March 15, 2004, each of these financial covenants was amended with the
controlling party such that all breaches have been cured.
The Servicing Agreements of the Company's securitization transactions and
warehouse credit facilities are terminable by the insurers of certain of the
Trust's obligations ("Note Insurers") in the event of certain defaults by the
Company and under certain other circumstances. Were a Note Insurer in the future
to exercise its option to terminate the Servicing Agreements, such a termination
would have a material adverse effect on the Company's liquidity and results of
operations. The Company continues to receive Servicer extensions on a monthly
and/or quarterly basis, pursuant to the Servicing Agreements.
F-39
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)
2003
Revenues ............................ $ 22,547 $ 23,715 $ 26,487 $ 28,184
Income (loss) before income taxes ... 2,354 3,132 (2,852) (5,674)
Net income (loss) ................... 6,278 2,642 (2,852) (5,674)
Income (loss) per share:
Basic ............................. $ 0.31 $ 0.13 $ (0.14) $ (0.28)
Diluted ........................... 0.29 0.12 (0.14) (0.28)
2002
Revenues ............................ $ 13,136 $ 27,216 $ 26,040 $ 25,560
Income (loss) before income taxes
and extraordinary item ........... (6,775) 1,279 2,240 3,318
Extraordinary item .................. 17,412 -- -- --
Net income .......................... 16,431 739 1,300 1,938
Income (loss) per share
before extraordinary item:
Basic ............................. $ (0.05) $ 0.04 $ 0.07 $ 0.09
Diluted ........................... (0.05) 0.04 0.06 0.09
Extraordinary item per share:
Basic ............................. $ 0.90 $ -- $ -- $ --
Diluted ........................... 0.90 -- -- --
Income per share:
Basic ............................. $ 0.85 $ 0.04 $ 0.07 $ 0.09
Diluted ........................... 0.85 0.04 0.06 0.09
2001
Revenues ............................ $ 17,325 $ 16,320 $ 14,271 $ 14,089
Income (loss) before income taxes ... 306 241 253 (480)
Net income (loss) ................... 186 241 253 (360)
Income (loss) per share:
Basic ............................. $ 0.01 $ 0.01 $ 0.01 $ (0.01)
Diluted ........................... 0.01 0.01 0.01 (0.01)
F-40