As filed with the Securities and Exchange Commission on June 27, 2006
Registration No. 333-______
--------------------------------------------------------------------------------
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM S-3 REGISTRATION STATEMENT
UNDER THE SECURITIES ACT OF 1933
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 IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
16355 Laguna Canyon Road, Irvine, California 92618
(Address, including zip code, and telephone number,
including area code, of registrant's principal executive offices)
Charles E. Bradley, Jr.
CONSUMER PORTFOLIO SERVICES, INC.
16355 Laguna Canyon Road
Irvine, California 92618
Telephone: (949) 753-6800
Fax: (949) 753-6897
(Name, address, including zip code, and telephone number,
including area code, of agents for service)
Copies to:
Patrick C. Sargent, Esq. Thomas J. Poletti, Esq. Mitchell S. Cohen, Esq.
Mark W. Harris, Esq. Shoshannah D. Katz, Esq. IRELL & MANELLA, LLP
ANDREWS KURTH LLP KIRKPATRICK & LOCKHART NICHOLSON GRAHAM LLP 1800 Avenue of the Stars
1717 Main Street, Suite 3700 10100 Santa Monica Boulevard, 7th Floor Suite 900
Dallas, Texas 75201 Los Angeles, California 90067 Los Angeles, California 90067
Telephone: (214) 659-4400 Telephone: (310) 552-5000 Telephone: (310) 277-1010
Fax: (214) 659-4401 Fax: (310) 552-5001 Fax: (310) 203-7199
Approximate date of commencement of proposed sale to the public: As soon as
practicable after this Registration Statement becomes effective.
If the only securities being registered on this form are being offered pursuant
to dividend or interest reinvestment plans, please check the following box. [ ]
If any of the securities being registered on this form are to be offered on a
delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, other than securities offered only in connection with dividend or interest
reinvestment plans, check the following box. [ ]
If this form is filed to register additional securities for an offering pursuant
to Rule 462(b) under the Securities Act, check the following box and list the
Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
If this form is a post-effective amendment filed pursuant to Rule 462(c) under
the Securities Act, please check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If this form is a registration statement pursuant to General Instruction I.D. or
a post-effective amendment thereto that shall become effective upon filing with
the Commission pursuant to Rule 462(e) under the Securities Act, check the
following box. [ ]
If this form is a post-effective amendment to a registration statement filed
pursuant to General Instruction I.D. filed to register additional securities or
additional classes of securities pursuant to Rule 413(b) under the Securities
Act, check the following box. [ ]
CALCULATION OF REGISTRATION FEE
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Title of Each Class of Proposed Maximum Proposed Maximum
Securities to Be Amount to be Offering Price Per Aggregate Offering Amount of
Registered Registered Unit (1) Price (1) Registration Fee
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Common Stock, no par value 4,600,000 shares $6.73 $30,958,000 $3,313
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(1) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457(c) under the Securities Act, based on the average of high
and low prices reported for the registrant's Common Stock by the Nasdaq National
Market on June 20, 2006.
The registrant hereby amends this registration statement on such date or dates
as may be necessary to delay its effective date until it shall file a further
amendment which specifically states that this registration statement shall
become effective in accordance with Section 8(a) of the Securities Act of 1933
or until the registration statement shall become effective on such date as the
Commission, acting pursuant to Section 8(a), may determine.
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THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE HAVE
FILED A REGISTRATION STATEMENT WITH THE SECURITIES AND EXCHANGE COMMISSION
RELATING TO THE COMMON STOCK. THE COMMON STOCK MAY NOT BE SOLD NOR MAY OFFERS TO
BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES EFFECTIVE.
THIS PROSPECTUS IS NOT AN OFFER TO SELL THE COMMON STOCK, AND NEITHER WE NOR THE
SELLING SHAREHOLDER ARE SOLICITING OFFERS TO BUY THESE SECURITIES IN ANY
JURISDICTION WHERE THE OFFER OR SALE IS NOT PERMITTED.
Subject to Completion dated June ____, 2006
PRELIMINARY PROSPECTUS
CONSUMER PORTFOLIO SERVICES, INC.
4,000,000 SHARES
COMMON STOCK
We are a specialty finance company engaged in sub-prime automobile finance,
which includes the purchase and servicing of automobile contracts originated
primarily by franchised automobile dealers. We indirectly provide financing to
vehicle purchasers who typically have limited or impaired credit histories that
restrict their ability to obtain financing through traditional lending sources.
We are offering 500,000 shares of our common stock and a selling shareholder,
Levine Leichtman Capital Partners II, L.P., is offering 3,500,000 shares of our
common stock. We will not receive any of the proceeds from the sale of shares of
common stock by the selling shareholder. The selling shareholder, one of our
principal shareholders, beneficially owned approximately 18.3% of our common
stock as of June 20, 2006, and also holds $40.0 million of our outstanding
secured senior indebtedness.
Our common stock is traded on the Nasdaq National Market under the symbol
"CPSS." On June 23, 2006, the last reported sale price of our common stock on
the Nasdaq National Market was $7.04 per share.
INVESTING IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK.
SEE RISK FACTORS BEGINNING ON PAGE 8.
PER SHARE TOTAL
Public offering price $ $
Underwriting discounts and commissions $ $
Proceeds, before expenses, to us (1) $ $
Proceeds, before expenses, to the selling shareholder (2) $ $
(1) We estimate that we will incur approximately $170,000 in offering expenses
in connection with this offering.
(2) We will pay all offering expenses related to the offering and sale of
shares of our common stock in this offering by the selling shareholder
(other than the underwriting discounts and commissions of the selling
shareholder).
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION OR REGULATORY AUTHORITY HAS APPROVED OR DISAPPROVED OF THESE
SECURITIES OR PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
We and the selling shareholder have granted the underwriter a 30-day option to
purchase up to an additional 600,000 shares of our common stock to cover
over-allotments, if any, at the public offering price per share, less discounts
and commissions.
The underwriter expects that the shares of our common stock will be ready for
delivery to purchasers on or about ______________.
JMP SECURITIES
The date of this prospectus is ________,2006
YOU SHOULD RELY ONLY UPON THE INFORMATION CONTAINED IN, OR INCORPORATED INTO,
THIS PROSPECTUS. WE HAVE NOT AUTHORIZED ANY OTHER PERSON TO PROVIDE YOU WITH
DIFFERENT INFORMATION. WE HAVE SUPPLIED ALL INFORMATION CONTAINED OR
INCORPORATED BY REFERENCE RELATING TO CONSUMER PORTFOLIO SERVICES, INC. AND OUR
SUBSIDIARIES. THE SELLING SHAREHOLDER HAS SUPPLIED CERTAIN INFORMATION CONTAINED
IN THE DOCUMENT RELATING TO THE SELLING SHAREHOLDER. IF ANYONE PROVIDES YOU WITH
DIFFERENT OR INCONSISTENT INFORMATION, YOU SHOULD NOT RELY ON IT. NEITHER WE NOR
THE SELLING SHAREHOLDER ARE MAKING AN OFFER TO SELL OUR COMMON STOCK IN ANY
JURISDICTION WHERE THE OFFER OR SALE IS NOT PERMITTED. YOU SHOULD ASSUME THE
INFORMATION APPEARING IN THIS DOCUMENT IS ACCURATE ONLY AS OF THE DATE ON THE
FRONT COVER OF THIS PROSPECTUS. OUR BUSINESS, FINANCIAL CONDITION, RESULTS OF
OPERATIONS AND PROSPECTS MAY HAVE CHANGED SINCE THAT DATE.
TABLE OF CONTENTS
Page
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Prospectus Summary 3
Risk Factors 8
Forward-Looking Statements 17
Use of Proceeds 17
Price Range of Common Stock 18
Dividend Policy 19
Capitalization 20
Selected Consolidated Financial Data 22
Management's Discussion and Analysis of Financial
Condition and Results of Operations 40
Our Company 50
Management 52
Certain Transactions 54
Principal Shareholders 55
Description of Capital Stock 56
Selling Shareholder 56
Underwriting 56
Legal Matters 58
Experts 58
Where You Can Find More Information 58
Documents Incorporated by Reference 59
Index to Consolidated Financial Statements F-1
Independent Registered Public Accounting Firm Reports F-2
2
PROSPECTUS SUMMARY
THIS SUMMARY PROVIDES A BRIEF OVERVIEW OF CERTAIN INFORMATION FOUND IN GREATER
DETAIL ELSEWHERE IN THIS PROSPECTUS. IT DOES NOT CONTAIN ALL THE INFORMATION
THAT MAY BE IMPORTANT TO YOU IN MAKING A DECISION TO PURCHASE OUR COMMON STOCK.
WE URGE YOU TO READ THE ENTIRE PROSPECTUS CAREFULLY, INCLUDING "RISK FACTORS"
AND OUR CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES, BEFORE DECIDING TO
INVEST IN OUR COMMON STOCK. FOR MORE COMPLETE INFORMATION, YOU SHOULD CAREFULLY
READ THIS PROSPECTUS AND THE DOCUMENTS REFERRED TO IN "WHERE YOU CAN FIND MORE
INFORMATION" AND "DOCUMENTS INCORPORATED BY REFERENCE." UNLESS WE INDICATE
OTHERWISE, ALL INFORMATION IN THIS PROSPECTUS ASSUMES THE UNDERWRITER WILL NOT
EXERCISE ITS OVER-ALLOTMENT OPTION. UNLESS OTHERWISE INDICATED, ALL REFERENCES
TO "WE," "US" AND SIMILAR TERMS MEAN CONSUMER PORTFOLIO SERVICES, INC. AND ITS
SUBSIDIARIES.
OUR COMPANY
We are a specialty finance company engaged in purchasing and servicing new and
used retail automobile contracts originated primarily by franchised automobile
dealerships and, to a lesser extent, by select independent dealers of used
automobiles in the United States. We serve as an alternative source of financing
for dealers, facilitating sales to sub-prime customers, who have limited credit
history, low income or past credit problems and who otherwise might not be able
to obtain financing from traditional lending sources. We do not currently lend
money directly to consumers but, rather, purchase automobile contracts from
dealers under several different financing programs. We are headquartered in
Irvine, California and have three additional strategically located servicing
branches in Virginia, Florida and Illinois.
We began our operations in October 1991. From our inception through March 31,
2006, we have purchased, in aggregate, approximately $6.3 billion of automobile
contracts from dealers. In addition, we obtained a total of approximately $605.0
million of automobile contracts in three acquisitions in 2002, 2003 and 2004. We
establish our relationships with dealers through our marketing representatives.
As of March 31, 2006, we had 85 marketing representatives and we had active
contract relationships with over 7,300 dealers in 47 states. Approximately 92%
of these dealers are franchised new car dealers that sell both new and used cars
and the remainder are independent used car dealers. For the year ended December
31, 2005, approximately 81% of the automobile contracts purchased under our
programs consisted of financing for used cars and 19% consisted of financing for
new cars.
We purchase automobile contracts with the intention of financing them on a
long-term basis through securitizations. Depending on the structure of the
securitization, the transaction may be treated as a sale of the contracts or as
a secured financing for financial accounting purposes. Since the third quarter
of 2003, we have structured our securitization transactions to be treated as
secured financings for financial accounting purposes, which means the contracts
and the asset-backed notes issued remain on our balance sheet, and the interest
income from the contracts and the related financing costs of the asset-backed
notes are recognized over the life of the underlying pool of contracts. As of
March 31, 2006, we had a total managed automobile contract portfolio of
approximately $1,240.0 million, which included $1,144.3 million of automobile
contracts held by subsidiaries that are consolidated on our balance sheet and
$95.6 million of automobile contracts held by subsidiaries that are not
consolidated on our balance sheet.
Our net income was $1.8 million, or $0.07 per diluted share, for the three
months ended March 31, 2006, and $3.4 million, or $0.14 per diluted share, for
the year ended December 31, 2005. As of March 31, 2006, we had $75.6 million in
shareholders' equity and $1,354.2 million in total assets, of which $1,050.8
million were net automobile receivables. During the three months ended March 31,
2006 and the year ended December 31, 2005, we purchased a total of $255.6
million and $691.3 million, respectively, of automobile contracts.
OUR BUSINESS STRATEGY
Our business objective is to maximize long-term profitability by efficiently
purchasing and servicing sub-prime automobile contracts that generate strong and
consistent risk-adjusted returns. We achieve this objective by employing our
business strategy, which includes the following key elements:
3
DISCIPLINED GROWTH IN AUTOMOBILE CONTRACT PURCHASES AND TOTAL MANAGED PORTFOLIO.
We have focused on steady origination growth by expanding our network of
marketing representatives. Since 2003, we have grown the number of marketing
representatives from 42 as of December 31, 2003 to 85 as of March 31, 2006. We
intend to continue to grow originations by further expansion of our marketing
representative network, through increased dealer penetration (that is,
increasing automobile contract purchases from our current dealer base), and by
developing new dealer relationships. We intend to increase dealer penetration
through our recent initiatives to improve dealer service levels by decreasing
our application "turnaround" and funding times. Our annual automobile finance
contract purchases have grown from $357.3 million in fiscal year 2003, to $447.2
million in fiscal year 2004, to $691.3 million in fiscal year 2005 and to $801.5
million for the twelve months ended March 31, 2006, representing a compounded
annual growth rate of 43.2%. Additionally, our managed portfolio increased from
$743.5 million as of December 31, 2003 to $906.9 million as of December 31,
2004, to $1,121.7 million as of December 31, 2005, and to $1,240.0 million as of
March 31, 2006, representing a compounded annual growth rate of 25.5%.
CENTRALIZED CREDIT UNDERWRITING PLATFORM FOCUSED ON DISCIPLINED CREDIT
MANAGEMENT. We underwrite all of our automobile contract purchases through a
centralized process at our corporate headquarters in Irvine, California. We
believe that a centralized underwriting approach enables us to maintain close
control over the credit quality of our managed portfolio. During our
underwriting process, we utilize a proprietary automated decisioning system that
we have developed and continually enhanced over the last seven years. A major
component of our automated system is a scorecard that we developed using the
historical credit performance of our managed receivables portfolio. We also
rely, to a lesser extent, on the judgment of our trained credit analysts to make
risk-based credit and pricing decisions. Our high level of automation enhances
our ability to make consistent credit decisions in a growth environment. Our
credit performance has shown significant improvement with net charge-offs as a
percentage of our average managed receivables portfolio equal to 6.8% for the
year ended December 31, 2003, 7.8% for the year ended December 31, 2004, 5.3%
for the year ended December 31, 2005, and 4.8% for the three months ended March
31, 2006.
GEOGRAPHICALLY FOCUSED SERVICING CENTERS ALLOW OPERATING FLEXIBILITY AND DRIVE
PORTFOLIO PERFORMANCE. We maintain four strategically located servicing centers
across the country in California, Virginia, Florida, and Illinois. All four
servicing centers are linked on-line with our automated collections system and
accounts can be allocated between the different facilities as needed to optimize
resource allocation. This strategy affords us solid time zone coverage, the
ability to leverage the employee base in our four servicing locations and
provides back-up capabilities for disaster scenarios. We have used performance
benchmarking of the centers and internal disclosure of comparative performance
data to encourage competition among our centers and to improve processes. We
believe these techniques have contributed to improved delinquencies and
charge-offs for the total managed portfolio.
SECURITIZATION FUNDING STRATEGY AND HIGH-QUALITY EARNINGS. We purchase
automobile contracts with the intention of financing them on a long-term basis
through asset-backed term securitizations. We have been a regular issuer of
asset-backed securities since 1994, completing 40 asset-backed term
securitizations totaling over $4.3 billion through March 31, 2006. Our
securitization funding strategy provides us with an attractive cost of matched
funding and allows us to mitigate interest rate risk by locking in a fixed
interest rate spread at the time of securitization, since the interest received
on automobile contracts and interest paid for securitization notes payable are
both fixed rate obligations. Additionally, since the third quarter of 2003, we
have structured our securitizations to be treated for financial accounting
purposes as secured financings, rather than as sales of automobile contracts.
Generally, we expect that our revenues will grow proportionately to the size of
our on-balance sheet portfolio of automobile contracts, thereby generating a
recurring stream of interest income. We believe this securitization structure
reduces the potential earnings volatility associated with accounting for
securitizations as sales of automobile contracts, and as a result, has improved
the quality of our earnings.
IMPROVED OPERATING EFFICIENCY GAINS THROUGH ECONOMIES OF SCALE AND INVESTMENTS
IN TECHNOLOGY. We believe that the use of technology in both our contract
origination and servicing platforms has enabled us to achieve economies of scale
as we have continued to grow our managed receivables portfolio. With our
existing infrastructure, we expect to continue to be positioned to support
future portfolio growth with slower increases in core operating expenses (that
is, total expenses excluding provision for credit losses, interest expense and
impairment loss on residual assets). Our core operating expenses as a percentage
of average managed receivables have declined from 10.4% for the fiscal year
2003, to 8.4% for fiscal year 2004, 8.0% for fiscal year 2005 and 6.5%
annualized for the three months ended March 31, 2006.
4
THE SELLING SHAREHOLDER
The selling shareholder, Levine Leichtman Capital Partners II, L.P., is one of
our principal shareholders, and as of June 20, 2006 beneficially owned
approximately 18.3% of the outstanding shares of our common stock. The selling
shareholder also holds $40.0 million of our outstanding secured senior debt
securities. The selling shareholder was formed in 1997 and acquired its shares
of our common stock in connection with a series of purchases of our debt
securities beginning in October 1998. We entered into a registration rights
agreement, as subsequently amended and restated, with the selling shareholder to
provide registration rights covering such shares. For more information, see
"Selling Shareholder--Registration Rights Agreement."
For information regarding the beneficial ownership of our common stock for the
selling shareholder as of May 31, 2006 and as adjusted to reflect the sale of
the common stock in this offering by the selling shareholder, see "Principal
Shareholders."
GENERAL INFORMATION
Our principal executive offices are located at 16355 Laguna Canyon Road, Irvine,
California 92618, and our telephone number is (949) 753-6800. Our website is
www.consumerportfolio.com. None of the information on or hyperlinked from our
website is incorporated by reference into this prospectus.
THE OFFERING
Common stock offered by us: 500,000 shares(1)
Common stock offered by the selling shareholder: 3,500,000 shares(1)
Common stock to be outstanding after the offering: 22,313,041 shares (1) (2)
Use of proceeds: We will receive the net proceeds from the sale
of 500,000 shares of our common stock, and
intend to use such net proceeds for the
purchase of automobile contracts and for
general corporate purposes. We will not
receive any proceeds from the sale of shares
by the selling shareholder.
Nasdaq National Market symbol: CPSS
_________________
(1) Excludes a 30-day option granted to the underwriter by us and by the
selling shareholder to purchase up to 600,000 additional shares of common
stock to cover over-allotments, if any. We granted an option to purchase
up to 112,442 shares and the selling shareholder granted an option for up
to 487,558 shares.
(2) Based on shares outstanding as of June 20, 2006. This share information
does not include (a) 4,532,649 shares of common stock issuable upon the
exercise of stock options outstanding as of June 20, 2006 at a weighted
average exercise price of $3.44 per share, (b) 272,000 shares issuable
upon exercise of a warrant at an exercise price of $4.85 per share, and
(c) 1,627,131 additional shares reserved for future grants or issuances
under our stock option plans. The number of shares issuable is subject to
adjustment upon certain events, such as stock splits.
5
SUMMARY CONSOLIDATED FINANCIAL DATA
The following table presents our summary consolidated financial data and
operating data as of and for the dates indicated. The data under the captions
"Statement of Operations Data" and "Balance Sheet Data" have been derived from
our audited and unaudited consolidated financial statements. The remainder is
derived from other records of ours.
You should read the summary consolidated financial data together with
"Capitalization," "Selected Consolidated Financial Data," "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
our audited and unaudited financial statements and notes thereto that are
included in this prospectus.
AS OF AND FOR THE THREE AS OF AND
MONTHS ENDED MARCH 31, FOR THE YEAR ENDED DECEMBER 31,
------------------------- ---------------------------------------
2006 2005 2005 2004 2003
----------- ---------- ----------- ---------- ----------
(unaudited)
(Dollars in thousands, except per share data)
STATEMENT OF OPERATIONS DATA
Revenues:
Interest income $ 54,527 $ 36,172 $ 171,834 $ 105,818 $ 58,164
Servicing fees 1,005 2,264 6,647 12,480 17,058
Net gain on sale of contracts -- -- -- -- 10,421
Other income 2,492 3,397 15,216 14,394 19,343
----------- ---------- ----------- ----------- ----------
Total revenues 58,024 41,833 193,697 132,692 104,986
Expenses:
Employee costs 9,357 10,450 40,384 38,173 37,141
General and administrative 9,743 8,926 39,285 33,936 31,581
Interest expense 18,035 10,384 51,669 32,147 23,861
Provision for credit losses 19,099 12,312 58,987 32,574 11,390
Impairment loss on residual assets (1) -- -- -- 11,750 4,052
----------- ---------- ----------- ----------- ----------
Total expenses 56,234 42,072 190,325 148,580 108,025
Income (loss) before income tax benefit 1,790 (239) 3,372 (15,888) (3,039)
Income tax benefit -- -- -- -- (3,434)
----------- ---------- ----------- ----------- ----------
Net income (loss) $ 1,790 $ (239) $ 3,372 $ (15,888) $ 395
=========== ========== =========== ============ ==========
Earnings (loss) per share--basic $ 0.08 $ (0.01) $ 0.16 $ (0.75) $ 0.02
Earnings (loss) per share--diluted $ 0.07 $ (0.01) $ 0.14 $ (0.75) $ 0.02
Weighted average shares outstanding--basic 21,732 21,528 21,627 21,111 20,263
Weighted average shares outstanding--diluted 24,188 21,528 23,513 21,111 21,578
BALANCE SHEET DATA
Total assets $ 1,354,223 $ 850,533 $ 1,155,144 $ 766,599 $ 492,470
Cash and cash equivalents 25,504 9,730 17,789 14,366 33,209
Restricted cash and equivalents 212,428 150,059 157,662 125,113 67,277
Finance receivables, net 1,050,825 620,302 913,576 550,191 266,189
Residual interest in securitizations 22,608 44,135 25,220 50,430 111,702
Warehouse lines of credit 75,056 50,535 35,350 34,279 33,709
Residual interest financing 37,728 16,411 43,745 22,204 --
Securitization trust debt 1,100,606 619,430 924,026 542,815 245,118
Long-term debt 46,314 73,829 58,655 74,829 102,465
Shareholders' equity 75,626 69,808 73,589 69,920 82,160
6
AS OF AND FOR THE THREE AS OF AND
MONTHS ENDED MARCH 31, FOR THE YEAR ENDED DECEMBER 31,
------------------------ --------------------------------------
2006 2005 2005 2004 2003
------------ ---------- ------------ ----------- ----------
(unaudited)
(Dollars in thousands, except per share data)
CONTRACT PURCHASES/SECURITIZATIONS
Automobile contract purchases $ 255,586 $ 144,165 $ 691,252 $ 447,232 $ 357,320
Automobile contract acquisitions(2) -- -- -- 74,901 152,143
Automobile contracts securitized--structured as
sales -- -- -- -- 254,436
Automobile contracts securitized--structured as
secured financings 245,000 137,390 698,353 491,269 162,488
MANAGED PORTFOLIO DATA
Contracts held by consolidated subsidiaries $ 1,144,340 $ 691,967 $ 1,000,597 $ 619,794 $ 317,952
Contracts held by non-consolidated subsidiaries 83,162 193,823 103,130 233,621 425,534
SeaWest third party portfolio(3) 12,456 40,501 18,018 53,463 --
------------ ---------- ------------ ----------- ----------
Total managed portfolio 1,239,958 926,291 1,121,745 906,878 743,485
Average managed portfolio 1,191,132 915,547 997,697 861,261 674,523
Weighted average fixed effective interest rate
(total managed portfolio)(4) 18.6% 19.0% 18.6% 19.2% 19.7%
Core operating expense
(% of average managed portfolio) (5) 6.5% 8.5% 8.0% 8.4% 10.4%
Allowance for loan losses $ 63,846 $ 46,284 $ 57,728 $ 42,615 $ 35,889
Allowance for loan losses (% of total contracts
held by consolidated subsidiaries) 5.6% 6.7% 5.8% 6.9% 11.3%
Total delinquencies
(% of total managed portfolio) (6) 1.8% 2.1% 3.8% 4.0% 4.7%
Total delinquencies and repossessions
(% of total managed portfolio) (6) 2.7% 3.2% 5.0% 5.6% 6.2%
Net charge-offs (% of average managed
portfolio)(4)(7) 4.8% 6.6% 5.3% 7.8% 6.8%
(1) The impairment loss was related to our analysis and estimate of the expected
ultimate performance of our previously securitized pools that were held by our
non-consolidated subsidiaries and the residual interest in securitizations. The
impairment loss was a result of the actual net loss and prepayment rates
exceeding our previous estimates for the automobile contracts held by our
non-consolidated subsidiaries.
(2) Represents automobile contracts not purchased directly from dealers, but
acquired as a result of our acquisitions of TFC in 2003 and of certain assets of
SeaWest in 2004.
(3) Receivables related to the SeaWest third party portfolio, on which we earn
only a servicing fee.
(4) Excludes receivables related to the SeaWest third party portfolio.
(5) Total expenses excluding provision for credit losses, interest expense and
impairment loss on residual assets.
(6) For further information regarding delinquencies and the managed portfolio,
see the table captioned "Delinquency Experience," at page 45 of this prospectus
and the notes to that table.
(7) 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) and amounts collected subsequent to the date of the
charge-off. For further information regarding charge-offs, see the table
captioned "Net Charge-Off Experience," at page 46 of this prospectus and the
notes to that table.
7
RISK FACTORS
This offering involves a high degree of risk. You should carefully consider the
risks described below and the other information in this prospectus and the
information incorporated by reference before deciding to invest in our common
stock. Our business, operating results and financial condition could be
adversely affected by any of the following specific risks. The trading price of
our common stock could decline due to any of these risks and other industry
risks, and you could lose all or part of your investment. In addition to the
risks described below, we may encounter risks that are not currently known to us
or that we currently deem immaterial, which may also impair our business
operations and your investment in our common stock.
RISKS RELATED TO OUR BUSINESS
WE REQUIRE A SUBSTANTIAL AMOUNT OF CASH TO SERVICE OUR SUBSTANTIAL DEBT.
To service our existing substantial indebtedness, we require a significant
amount of cash. Our ability to generate cash depends on many factors, including
our successful financial and operating performance. Our financial and
operational performance depends upon a number of factors, many of which are
beyond our control. These factors include, without limitation:
o the economic and competitive conditions in the asset-backed securities
market;
o the performance of our current and future automobile contracts;
o the performance of our residual interests from our securitizations and
warehouse credit facilities;
o any operating difficulties or pricing pressures we may experience;
o our ability to obtain credit enhancement for our securitizations;
o our ability to establish and maintain dealer relationships;
o the passage of laws or regulations that affect us adversely;
o our ability to compete with our competitors; and
o our ability to acquire and finance automobile contracts.
Depending upon the outcome of one or more of these factors, we may not be
able to generate sufficient cash flow from operations or obtain sufficient
funding to satisfy all of our obligations. If we were unable to pay our debts,
we would be required to pursue one or more alternative strategies, such as
selling assets, refinancing or restructuring our indebtedness or selling
additional equity capital. These alternative strategies might not be feasible at
the time, might prove inadequate or could require the prior consent of our
secured and unsecured lenders.
WE NEED SUBSTANTIAL LIQUIDITY TO OPERATE OUR BUSINESS.
We have historically funded our operations principally through internally
generated cash flows, sales of debt and equity securities, including through
securitizations and warehouse credit facilities, borrowings from the selling
shareholder and sales of subordinated notes. However, we may not be able to
obtain sufficient funding for our future operations from such sources. If we
were unable to access the capital markets or obtain other acceptable financing,
our results of operations, financial condition and cash flows would be
materially and adversely affected. We require a substantial amount of cash
liquidity to operate our business. Among other things, we use such cash
liquidity to:
o acquire automobile contracts;
o fund overcollateralization in warehouse credit facilities and
securitizations;
o pay securitization fees and expenses;
o fund spread accounts in connection with securitizations;
o satisfy working capital requirements and pay operating expenses; and
o pay interest expense.
8
Prior to the third quarter of 2003, we reported a gain on the sale of our
automobile contracts upon their securitization. This gain represented a
substantial portion of our revenues prior to the third quarter of 2003. However,
although we reported this gain at the time of sale, we received the monthly cash
payments on those contracts (representing revenue previously recognized) over
the life of the automobile contracts, rather than at the time of sale. As a
result, a substantial portion of our reported revenues prior to the third
quarter of 2003 did not represent immediate cash liquidity.
OUR RESULTS OF OPERATIONS WILL DEPEND ON OUR ABILITY TO SECURE AND MAINTAIN
ADEQUATE CREDIT AND WAREHOUSE FINANCING ON FAVORABLE TERMS.
We depend on warehouse credit facilities to finance our purchases of
automobile contracts. Our business strategy requires that these warehouse credit
facilities continue to be available to us from the time of purchase or
origination of an automobile contract until it is financed through a
securitization.
Our primary sources of day-to-day liquidity are our warehouse credit
facilities, in which we sell and contribute automobile contracts, as often as
twice a week, to affiliated special-purpose entities, where they are
"warehoused" until they are securitized, at which time funds advanced under one
or more warehouse credit facilities are repaid from the proceeds of the
securitizations. The special-purpose entities obtain the funds to purchase these
contracts by pledging the contracts to a trustee for the benefit of warehouse
lenders, who advance funds to our affiliated special-purpose entities based on
the dollar amount of the contracts pledged. We depend substantially on two
warehouse credit facilities: (i) a $150 million warehouse credit facility, which
we established in November 2005 and, unless earlier renewed or terminated upon
the occurrence of certain events will expire in November 2006 and (ii) a $200
million warehouse credit facility, which we established in June 2004 and, unless
renewed or earlier terminated upon the occurrence of certain events, will expire
in June 2007. Each of these facilities may be renewed by mutual agreement
between the lender and us. These warehouse credit facilities will remain
available to us only if, among other things, we comply with certain financial
covenants contained in the documents governing these facilities. These warehouse
credit facilities may not be available to us in the future and we may not be
able to obtain other credit facilities on favorable terms to fund our
operations.
If we were unable to arrange new warehousing or other credit facilities or
renew our existing warehouse credit facilities when they come due, our results
of operations, financial condition and cash flows would be materially and
adversely affected.
OUR RESULTS OF OPERATIONS WILL DEPEND ON OUR ABILITY TO SECURITIZE OUR PORTFOLIO
OF AUTOMOBILE CONTRACTS.
We are dependent upon our ability to continue to finance pools of
automobile contracts in securitizations in order to generate cash proceeds for
new purchases of automobile contracts. We have historically depended on
securitizations of automobile contracts to provide permanent financing of those
contracts. By "permanent financing" we mean financing that extends to cover the
full term during which the underlying contracts are outstanding. By contrast,
our warehouse credit facilities permit us to borrow against the value of such
receivables only for limited periods of time. Our past practice and future plan
has been and is to repay loans made to us under our warehouse credit facilities
with the proceeds of securitizations. There can be no assurance that any
securitization transaction will be available on terms acceptable to us, or at
all. The timing of any securitization transaction is affected by a number of
factors beyond our control, any of which could cause substantial delays,
including, without limitation:
o market conditions;
o the approval by all parties of the terms of the securitization;
o the availability of credit enhancement on acceptable terms; and
o our ability to acquire a sufficient number of automobile contracts for
securitization.
Adverse changes in the market for securitized pools of automobile
contracts may result in our inability to securitize automobile contracts and may
result in a substantial extension of the period during which our automobile
contracts are financed through our warehouse credit facilities, which would
burden our financing capabilities, could require us to curtail our purchase of,
or find an alternative source of financing for, such automobile contracts and
would have a material adverse effect on our results of operations.
9
OUR RESULTS OF OPERATIONS WILL DEPEND ON CASH FLOWS FROM OUR RESIDUAL INTERESTS
IN OUR SECURITIZATION PROGRAM AND OUR WAREHOUSE CREDIT FACILITIES.
When we finance our automobile contracts through securitizations and
warehouse credit facilities, we receive cash and a residual interest in the
assets financed. Those financed assets are owned by the special-purpose
subsidiary that is formed for the related securitization. This residual interest
represents the right to receive the future cash flows to be generated by the
automobile contracts in excess of (i) the interest and principal paid to
investors on the indebtedness issued in connection with the financing (ii) the
costs of servicing the contracts and (iii) certain other costs incurred in
connection with completing and maintaining the securitization or warehouse
credit facility. We sometimes refer to these future cash flows as "excess spread
cash flows."
Under the financial structures we have used to date in our securitizations
and warehouse credit facilities, excess spread cash flows that would otherwise
be paid to the holder of the residual interest are first used to increase
overcollateralization or are retained in a spread account within the
securitization trusts or the warehouse facility to provide liquidity and credit
enhancement for the related securities.
While the specific terms and mechanics vary among transactions, our
securitization and warehousing agreements generally provide that we will receive
excess spread cash flows only if the amount of overcollateralization and spread
account balances have reached specified levels and/or the delinquency, defaults
or net losses related to the contracts in the automobile contract pools are
below certain predetermined levels. In the event delinquencies, defaults or net
losses on contracts exceed these levels, the terms of the securitization or
warehouse credit facility:
o may require increased credit enhancement, including an increase in the
amount required to be on deposit in the spread account, to be
accumulated for the particular pool;
o may restrict the distribution to us of excess spread cash flows
associated with other securitized or warehoused pools; and
o in certain circumstances, may permit affected parties to require the
transfer of servicing on some or all of the securitized or warehoused
contracts from us to an unaffiliated servicer.
We typically retain or sell residual interests or use them as collateral
to borrow cash. In any case, the future excess spread cash flow received in
respect of the residual interests are integral to the financing of our
operations. The amount of cash received from residual interests depends in large
part on how well our portfolio of securitized and warehoused automobile
contracts performs. If our portfolio of securitized and warehoused automobile
contracts has higher delinquency and loss ratios than expected, then the amount
of money realized from our retained residual interests, or the amount of money
we could obtain from the sale or other financing of our residual interests,
would be reduced, which could have an adverse effect on our operations,
financial condition and cash flows.
IF WE ARE UNABLE TO OBTAIN CREDIT ENHANCEMENT FOR OUR SECURITIZATIONS OR OUR
WAREHOUSE CREDIT FACILITIES UPON FAVORABLE TERMS, OUR RESULTS OF OPERATIONS
WOULD BE IMPAIRED.
In our securitizations, we typically utilize credit enhancement in the
form of one or more financial guaranty insurance policies issued by financial
guaranty insurance companies. Each of these policies unconditionally and
irrevocably guarantees certain interest and principal payments on the senior
classes of the securities issued in our securitizations. These guarantees enable
these securities to achieve the highest credit rating available. This form of
credit enhancement reduces the costs of our securitizations relative to
alternative forms of credit enhancement currently available to us. None of such
financial guaranty insurance companies is required to insure future
securitizations. As we pursue future securitizations, we may not be able to
obtain:
o credit enhancement in any form from financial guaranty insurance
companies or any other provider of credit enhancement on terms
acceptable to us, or at all; or
o similar ratings for senior classes of securities to be issued in
future securitizations.
If we were unable to obtain such enhancements or such ratings, we would expect
to incur increased interest expense, which would adversely affect our results of
operations.
10
IF WE ARE UNABLE TO SUCCESSFULLY COMPETE WITH OUR COMPETITORS, OUR RESULTS OF
OPERATIONS MAY BE IMPAIRED.
The automobile financing business is highly competitive. We compete with a
number of national, regional and local 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 our competitors and potential competitors
possess substantially greater financial, marketing, technical, personnel and
other resources than we do, including greater access to capital markets for
unsecured commercial paper and investment grade rated debt instruments, and to
other funding sources which may be unavailable to us. Moreover, our future
profitability will be directly related to the availability and cost of our
capital relative to that of our competitors. Many of these companies also have
long-standing relationships with automobile dealers and may provide other
financing to dealers, including floor plan financing for the dealers' purchases
of automobiles from manufacturers, which we do not offer. There can be no
assurance that we will be able to continue to compete successfully and, as a
result, we may not be able to purchase contracts from dealers at a price
acceptable to us, which could result in reductions in our revenues or the cash
flows available to us.
IF OUR DEALERS DO NOT SUBMIT A SUFFICIENT NUMBER OF SUITABLE AUTOMOBILE
CONTRACTS TO US FOR PURCHASE, OUR RESULTS OF OPERATIONS MAY BE IMPAIRED.
We are dependent upon establishing and maintaining relationships with a
large number of unaffiliated automobile dealers to supply us with automobile
contracts. During the year ended December 31, 2005, no dealer accounted for more
than 1.0% of the contracts we purchased. The agreements we have with dealers to
purchase contracts do not require dealers to submit a minimum number of
contracts for purchase. The failure of dealers to submit contracts that meet our
underwriting criteria could result in reductions in our revenues or the cash
flows available to us, and, therefore, could have an adverse effect on our
results of operations.
IF A SIGNIFICANT NUMBER OF OUR AUTOMOBILE CONTRACTS PREPAY OR EXPERIENCE
DEFAULTS, OUR RESULTS OF OPERATIONS MAY BE IMPAIRED.
We specialize in the purchase and servicing of contracts to finance
automobile purchases by sub-prime customers, those who have limited credit
history, low income, or past credit problems. Such contracts entail a higher
risk of non-performance, higher delinquencies and higher losses than contracts
with more creditworthy customers. While we believe that our pricing of the
automobile contracts and the underwriting criteria and collection methods we
employ enable us to control, to a degree, the higher risks inherent in contracts
with sub-prime customers, no assurance can be given that such pricing, criteria
and methods will afford adequate protection against such risks. We have in the
past experienced fluctuations in the delinquency and charge-off performance of
our contracts.
If automobile contracts that we purchase or service are prepaid or
experience defaults to a greater extent than we have anticipated, this could
materially and adversely affect our results of operations, financial condition,
cash flows and liquidity. Our results of operations, financial condition, cash
flows and liquidity, depend, to a material extent, on the performance of
automobile contracts that we purchase, warehouse and securitize. A portion of
the automobile contracts acquired by us will default or prepay. In the event of
payment default, the collateral value of the vehicle securing an automobile
contract realized by us in a repossession will most likely not cover the
outstanding principal balance on that contract and the related costs of
recovery. We maintain an allowance for credit losses on automobile contracts
held on our balance sheet, which reflects our estimates of probable credit
losses that can be reasonably estimated for securitizations that are accounted
for as financings and warehoused contracts. If the allowance is inadequate, then
we would recognize the losses in excess of the allowance as an expense and our
results of operations could be adversely affected. In addition, under the terms
of our warehouse credit facilities, we are not able to borrow against defaulted
automobile contracts, including contracts that are, at the time of default,
funded under our warehouse credit facilities, which will reduce the
overcollateralization of those warehouse credit facilities and possibly reduce
the amount of cash flows available to us.
11
Our servicing income can also be adversely affected by prepayment of, or
defaults under, automobile contracts in our servicing portfolio. Our contractual
servicing revenue is based on a percentage of the outstanding principal balance
of the automobile contracts in our servicing portfolio. If automobile contracts
are prepaid or charged off, then our servicing revenue will decline, while our
servicing costs may not decline proportionately. In addition unexpected levels
of defaults or losses may trigger changes in the terms applicable to our
securitizations and warehouse credit facilities, which could adversely affect
our cash flows, our revenues, or both.
The value of our residual interest in the securitized assets in each
securitization treated as a sale for financial accounting purposes
(securitizations entered into prior to the beginning of the third quarter of
2003) reflects our estimate of expected future credit losses and prepayments for
the automobile contracts included in that securitization. If actual rates of
credit loss or prepayments, or both, on such automobile contracts exceed our
estimates, the value of our residual interest and the related cash flow would be
impaired, and we would be required to record an impairment charge, which would
reduce our earnings. We periodically review our credit loss and prepayment
assumptions relative to the performance of the securitized automobile contracts
and to market conditions. Our results of operations and liquidity could be
adversely affected if actual credit loss or prepayment levels on securitized
automobile contracts substantially exceed anticipated levels.
Higher credit losses than anticipated could also result in adverse changes
in the structure of future securitization transactions, such as a requirement of
increased cash collateral or other credit enhancement in such transactions.
IF WE LOSE SERVICING RIGHTS ON OUR PORTFOLIO OF AUTOMOBILE CONTRACTS, OUR
RESULTS OF OPERATIONS WILL BE IMPAIRED.
We are entitled to receive servicing fees only while we act as servicer
under the applicable sale and servicing agreements governing our warehouse
facilities and securitizations. Under such agreements, we may be terminated as
servicer upon the occurrence of certain events, including:
o our failure generally to observe and perform covenants and agreements
applicable to us;
o certain bankruptcy events involving us; or
o the occurrence of certain events of default under the documents
governing the facilities.
The loss of our servicing rights could materially and adversely affect our
results of operations, financial condition and cash flows. Our results of
operations, financial condition and cash flows, would be materially and
adversely affected if we were to be terminated as servicer with respect to a
material portion of the automobile contracts for which we are receiving
servicing fees.
IF WE LOSE KEY PERSONNEL, OUR RESULTS OF OPERATIONS MAY BE IMPAIRED.
Our management team averages eleven years of service with us. Charles E.
Bradley, Jr., our President and CEO, has been our President since our formation
in 1991. Our future operating results depend in significant part upon the
continued service of our key senior management personnel, none of whom is bound
by an employment agreement. Our future operating results also depend in part
upon our ability to attract and retain qualified management, technical, sales
and support personnel for our operations. Competition for such personnel is
intense. We cannot assure you that we will be successful in attracting or
retaining such personnel. The loss of any key employee, the failure of any key
employee to perform in his or her current position or our inability to attract
and retain skilled employees, as needed, could materially and adversely affect
our results of operations, financial condition and cash flows.
IF WE FAIL TO COMPLY WITH REGULATIONS, OUR RESULTS OF OPERATIONS MAY BE
IMPAIRED.
Failure to materially comply with all laws and regulations applicable to
us could materially and adversely affect our ability to operate our business.
Our business is subject to numerous federal and state consumer protection laws
and regulations, which, among other things:
12
o require us to obtain and maintain certain licenses and qualifications;
o limit the interest rates, fees and other charges we are allowed to
charge;
o limit or prescribe certain other terms of our automobile contracts;
o require specific disclosures to our customers;
o define our rights to repossess and sell collateral; and
o maintain safeguards designed to protect the security and
confidentiality of customer information.
We believe that we are in compliance in all material respects with all
such laws and regulations, and that such laws and regulations have had no
material adverse effect on our ability to operate our business. However, we may
be materially and adversely affected if we fail to comply with:
o applicable laws and regulations;
o changes in existing laws or regulations;
o changes in the interpretation of existing laws or regulations; or
o any additional laws or regulations that may be enacted in the future.
IF WE EXPERIENCE UNFAVORABLE LITIGATION RESULTS, OUR RESULTS OF OPERATIONS MAY
BE IMPAIRED.
Unfavorable outcomes in any of our current or future litigation
proceedings could materially and adversely affect our results of operations,
financial conditions and cash flows. As a consumer finance company, we are
subject to various consumer claims and litigation seeking damages and statutory
penalties based upon, among other things, disclosure inaccuracies and wrongful
repossession, which could take the form of a plaintiff's class action complaint.
We, as the assignee of finance contracts originated by dealers, may also be
named as a co-defendant in lawsuits filed by consumers principally against
dealers. We are also subject to other litigation common to the automobile
industry and businesses in general. The damages and penalties claimed by
consumers and others in these types of matters can be substantial. The relief
requested by the plaintiffs varies but includes requests for compensatory,
statutory and punitive damages.
While we intend to vigorously defend ourselves against such proceedings,
there is a chance that our results of operations, financial condition and cash
flows could be materially and adversely affected by unfavorable outcomes.
IF WE EXPERIENCE PROBLEMS WITH OUR ORIGINATIONS, ACCOUNTING OR COLLECTION
SYSTEMS, OUR RESULTS OF OPERATIONS MAY BE IMPAIRED.
We are dependent on our receivables originations, accounting and
collection systems to service our portfolio of automobile contracts. Such
systems are vulnerable to damage or interruption from natural disasters, power
loss, telecommunication failures, terrorist attacks, computer viruses and other
events. A significant number of our systems are not redundant, and our disaster
recovery planning is not sufficient for every eventuality. Our systems are also
subject to break-ins, sabotage and intentional acts of vandalism by internal
employees and contractors as well as third parties. Despite any precautions we
may take, such problems could result in interruptions in our services, which
could harm our reputation and financial condition. We do not carry business
interruption insurance sufficient to compensate us for losses that may result
from interruptions in our service as a result of system failures. Such systems
problems could materially and adversely affect our results of operations,
financial conditions and cash flows.
WE MAY BE EXPOSED TO POTENTIAL RISKS IF WE DO NOT HAVE AN EFFECTIVE SYSTEM OF
DISCLOSURE CONTROLS OR INTERNAL CONTROLS OR FAIL TO COMPLY FULLY WITH SECTION
404 OF SARBANES-OXLEY.
We have not yet completed a review of our internal controls over financial
reporting, which we are required to complete under Section 404 of the Sarbanes
Oxley Act of 2002 by the end of 2006. We anticipate devoting significant
management time and resources to documenting and improving our internal controls
over financial reporting. We cannot be certain that we will implement and
maintain adequate controls over our financial reporting in the future. If we
fail to maintain an effective system of disclosure controls or internal control
over financial reporting, including satisfaction of the requirements of Section
404 of the Sarbanes Oxley Act of 2002, we may not be able to accurately or
timely report on our financial results or adequately identify and reduce fraud.
Were that to happen, our financial position could be harmed, current and future
shareholders could lose confidence in our business, our reported financial
information, or both, which could have a negative effect on our trading price;
and we coul d be exposed to litigation or regulatory proceedings, which may be
costly or divert management attention.
WE HAVE SUBSTANTIAL INDEBTEDNESS.
We have and will continue to have a substantial amount of indebtedness. At
March 31, 2006, we had approximately $1,259.9 million of debt outstanding. Such
debt consisted primarily of $1,100.6 million of securitization trust debt and
$75.1 million of warehouse indebtedness, and also included $40.0 million owed to
the selling shareholder, and $6.3 million owed under a subordinated notes
program. We are also currently offering the subordinated notes to the public on
a continuous basis, and such notes have maturities that range from three months
to ten years.
13
Our substantial indebtedness could adversely affect our financial
condition by, among other things:
o increasing our vulnerability to general adverse economic and industry
conditions;
o requiring us to dedicate a substantial portion of our cash flow from
operations payments on our indebtedness, thereby reducing amounts
available for working capital, capital expenditures and other general
corporate purposes;
o limiting our flexibility in planning for, or reacting to, changes in
our business and the industry in which we operate;
o placing us at a competitive disadvantage compared to our competitors
that have less debt; and
o limiting our ability to borrow additional funds.
Although we believe we will generate sufficient free cash flow to service
such debt, there is no assurance that we will be able to do so. If we do not
generate sufficient operating profits, our ability to make required payments on
our debt would be impaired.
BECAUSE WE ARE SUBJECT TO MANY RESTRICTIONS IN OUR EXISTING CREDIT FACILITIES,
OUR ABILITY TO PAY DIVIDENDS OR ENGAGE IN SPECIFIED TRANSACTIONS MAY BE
IMPAIRED.
The terms of our existing credit facilities and our outstanding debt
impose significant operating and financial restrictions on us and our
subsidiaries and require us to meet certain financial tests. These restrictions
may have an adverse effect on our business activities, results of operations and
financial condition. These restrictions may also significantly limit or prohibit
us from engaging in certain transactions, including the following:
o incurring or guaranteeing additional indebtedness;
o making capital expenditures in excess of agreed upon amounts;
o paying dividends or other distributions to our stockholders or
redeeming, repurchasing or retiring our capital stock or subordinated
obligations;
o making investments;
o creating or permitting liens on our assets or the assets of our
subsidiaries;
o issuing or selling capital stock of our subsidiaries;
o transferring or selling our assets;
o engaging in mergers or consolidations;
o permitting a change of control of our company;
o liquidating, winding up or dissolving our company;
o changing our name or the nature of our business, or the names or
nature of the business of our subsidiaries; and
o engaging in transactions with our affiliates outside the normal course
of business.
These restrictions may limit our ability to obtain additional sources of
capital, which may limit our ability to generate earnings. In addition, the
failure to comply with any of the covenants of our existing credit facilities or
to maintain certain indebtedness ratios would cause a default under one or more
of our credit facilities or our other debt agreements that may be outstanding
from time to time. A default, if not waived, could result in acceleration of the
related indebtedness, in which case such debt would become immediately due and
payable. A continuing default or acceleration of one or more of our credit
facilities or any other debt agreement, would likely cause a default under other
debt agreements that otherwise would not be in default, in which case all such
related indebtedness could be accelerated. If this occurs, we may not be able to
repay our debt or borrow sufficient funds to refinance our indebtedness. Even if
any new financing is available, it may not be on terms that are acceptable to us
or it may not be sufficient to refinance all of our indebtedness as it becomes
due.
14
RISKS RELATED TO GENERAL FACTORS
IF THE ECONOMY OF ALL OR CERTAIN REGIONS OF THE UNITED STATES SLOWS OR ENTERS
INTO A RECESSION, OUR RESULTS OF OPERATIONS MAY BE IMPAIRED.
Our business is directly related to sales of new and used automobiles,
which are sensitive to employment rates, prevailing interest rates and other
domestic economic conditions. Delinquencies, repossessions and losses generally
increase during economic slowdowns or recessions. Because of our focus on
sub-prime customers, the actual rates of delinquencies, repossessions and losses
on our automobile contracts could be higher under adverse economic conditions
than those experienced in the automobile finance industry in general,
particularly in the states of Texas, California, Ohio, Florida and Pennsylvania,
states in which our automobile contracts are geographically concentrated. Any
sustained period of economic slowdown or recession could adversely affect our
ability to acquire suitable contracts, or to securitize pools of such contracts.
The timing of any economic changes is uncertain, and weakness in the economy
could have an adverse effect on our business and that of the dealers from which
we purchase contracts and result in reductions in our revenues or the cash flows
available to us.
OUR RESULTS OF OPERATIONS MAY BE IMPAIRED AS A RESULT OF NATURAL DISASTERS.
Our automobile contracts are geographically concentrated in the states of
Texas, California, Ohio, Florida, Pennsylvania, and Louisiana. Several of such
states are particularly susceptible to natural disasters: earthquake in the case
of California, and hurricanes and flooding in the states of Florida, Texas and
Louisiana. Natural disasters, in those states or others, could cause a material
number of our vehicle purchasers to lose their jobs, or could damage or destroy
vehicles that secure our automobile contracts. In either case, such events could
result in our receiving reduced collections on our automobile contracts, and
could thus result in reductions in our revenues or the cash flows available to
us.
IF AN INCREASE IN INTEREST RATES RESULTS IN A DECREASE IN OUR CASH FLOW FROM
EXCESS SPREAD, OUR RESULTS OF OPERATIONS MAY BE IMPAIRED.
Our profitability is largely determined by the difference, or "spread,"
between the effective interest rate received by us on the automobile contracts
that we acquire and the interest rates payable under our warehouse credit
facilities and on the asset-backed securities issued in our securitizations.
Several factors affect our ability to manage interest rate risk.
Specifically, we are subject to interest rate risk during the period between
when automobile contracts are purchased from dealers and when such contracts are
sold and financed in a securitization. Interest rates on our warehouse credit
facilities are adjustable while the interest rates on the automobile contracts
are fixed. Therefore, if interest rates increase, the interest we must pay to
the lenders under our warehouse credit facilities is likely to increase while
the interest realized by us from those warehoused automobile contracts remains
the same, and thus, during the warehousing period, the excess spread cash flow
received by us would likely decrease. Additionally, contracts warehoused and
then securitized during a rising interest rate environment may result in less
excess spread cash flow realized by us under those securitizations as,
historically, our securitization facilities pay interest to securityholders on a
fixed rate basis set at prevailing interest rates at the time of the closing of
the securitization, which may be several months after the securitized contracts
were originated and entered the warehouse, while our customers pay fixed rates
of interest on the contracts, set at the time they purchase the underlying
vehicles. A decrease in excess spread cash flow could adversely affect our
earnings and cash flow.
To mitigate, but not eliminate, the short-term risk relating to interest
rates payable by us under the warehouse facilities, we generally hold automobile
contracts in the warehouse credit facilities for less than four months. To
mitigate, but not eliminate, the long-term risk relating to interest rates
payable by us in securitizations, we have in the past, and intend to continue
to, structure some of our securitization transactions to include pre-funding
structures, whereby the amount of securities issued exceeds the amount of
contracts initially sold into the securitization. In pre-funding, the proceeds
from the pre-funded portion are held in an escrow account until we sell the
additional contracts into the securitization in amounts up to the balance of the
pre-funded escrow account. In pre-funded securitizations, we effectively lock in
our borrowing costs with respect to the contracts we subsequently sell into the
securitization. However, we incur 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 securities issued in the securitization. The amount of such expense may
vary. Despite these mitigation strategies, an increase in prevailing interest
rates would cause us to receive less excess spread cash flows on automobile
contracts, and thus could adversely affect our earnings and cash flows.
15
THE EFFECTS OF TERRORISM AND MILITARY ACTION MAY IMPAIR OUR RESULTS OF
OPERATIONS.
The long-term economic impact of the events of September 11, 2001,
possible future terrorist attacks or other incidents and related military
action, or current or future military action by United States forces in Iraq and
other regions, could have a material adverse effect on general economic
conditions, consumer confidence, and market liquidity in the United States. No
assurance can be given as to the effect of these events on the performance of
our automobile contracts. Any adverse impact resulting from these events could
materially affect our results of operations, financial condition and cash flows.
In addition, activation of a substantial number of U.S. military reservists or
members of the National Guard may significantly increase the proportion of
contracts whose interest rates are reduced by the application of the
Servicemembers' Civil Relief Act, which provides, generally, that an obligor who
is covered by that act may not be charged interest on the related contract in
excess of 6% annually during the period of the obligor's active duty.
RISKS RELATED TO OUR COMMON STOCK
OUR COMMON STOCK IS THINLY-TRADED.
Our stock is thinly-traded, which means investors will have limited
opportunities to sell their shares of common stock in the open market. Limited
trading of our common stock also contributes to more volatile price
fluctuations. Because there historically has been low trading volume in our
common stock, there can be no assurance that our stock price will not decline as
additional shares are sold in the public market. As of June 20, 2006, all of our
directors and executive officers and the selling shareholder beneficially owned
10,181,333 shares of our common stock, or approximately 42.4%. Following this
offering, and assuming the underwriter does not exercise its over-allotment
option, this group will beneficially own 6,681,333 shares of our common stock,
or approximately 27.3%. See "Principal Shareholders."
WE DO NOT INTEND TO PAY DIVIDENDS ON OUR COMMON STOCK.
We have never declared or paid any cash dividends on our common stock. We
currently intend to retain any future earnings and do not expect to pay any
dividends in the foreseeable future. Even if we were to change our intention,
the terms of our secured debt prohibit us from paying any dividends to our
shareholders without the consent of the holder of such secured debt, which may
be withheld in its sole discretion. See "Dividend Policy."
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FORWARD-LOOKING STATEMENTS
Discussions of certain matters contained in this prospectus and incorporated
herein by reference may constitute forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933, as amended (the "Securities Act")
and Section 21E of the Exchange Act, and as such, may involve risks and
uncertainties. These forward-looking statements relate to, among other things,
expectations of the business environment in which we operate, projections of
future performance, perceived opportunities in the market and statements
regarding our mission and vision. You can generally identify forward-looking
statements as statements containing the words "will," "would," "believe," "may,"
"could," "expect," "anticipate," "intend," "estimate," "assume" or other similar
expressions. Our actual results, performance and achievements may differ
materially from the results, performance and achievements expressed or implied
in such forward-looking statements. The discussion under "Risk Factors"
identifies some of the factors that might cause such a difference, including the
following:
o changes in general economic conditions;
o changes in interest rates;
o our ability to generate sufficient operating and financing cash flows;
o competition;
o level of future provisioning for receivables losses; and
o regulatory requirements.
Forward-looking statements are not guarantees of performance. They involve
risks, uncertainties and assumptions. Actual results may differ from
expectations due to many factors beyond our ability to control or predict,
including those described herein, and in documents incorporated by reference in
this prospectus. For these statements, we claim the protection of the safe
harbor for forward-looking statements contained in the Private Securities
Litigation Reform Act of 1995.
We undertake no obligation to publicly update any forward-looking information.
You are advised to consult any additional disclosure we make in our periodic
reports filed with the SEC. See "Where You Can Find More Information" and
"Documents Incorporated by Reference."
USE OF PROCEEDS
We estimate that the net proceeds we will receive from the sale of 500,000
shares of our common stock in this offering will be approximately $3.2 million,
assuming a public offering price of $7.04 per share (based on the last reported
sale price of our common stock on June 23, 2006), after deducting the
underwriting discounts and commissions and estimated offering expenses of
approximately $170,000 payable by us. If the underwriter's over-allotment option
is exercised in full, we estimate that our net proceeds from our sale of 612,442
shares of our common stock will be approximately $3.9 million. We intend to use
the net proceeds we receive from this offering to purchase automobile contracts
and for general corporate purposes. We will not receive any of the proceeds from
the sale of 3,500,000 shares of our common stock by the selling shareholder in
this offering.
17
PRICE RANGE OF COMMON STOCK
Our common stock has been quoted on the Nasdaq National Market under the symbol
"CPSS" since our initial public offering in 1993. The following table shows for
the periods indicated the high and low sale prices per share of our common
stock.
2004 High Low
---------------------------------------------------------------------
First quarter $3.96 $2.94
Second quarter 4.97 3.12
Third quarter 5.21 3.71
Fourth quarter 4.87 3.98
2005
---------------------------------------------------------------------
First quarter $5.50 $4.26
Second quarter 5.38 3.50
Third quarter 5.45 4.14
Fourth quarter 6.50 4.82
2006
---------------------------------------------------------------------
First quarter $8.50 $5.30
Second quarter 8.50 6.50
(through June 23, 2006)
On June 23, 2006 the last reported sale price of our common stock on the Nasdaq
National Market was $7.04 per share. As of June 20, 2006, we had approximately
81 shareholders of record of our common stock.
DIVIDEND POLICY
We have not declared or paid any cash dividends on our common stock since
inception.
We currently anticipate that we will retain all future earnings for use in our
business and do not anticipate that we will pay any cash dividends in the
foreseeable future. The payment of any future dividends will be at the
discretion of our Board of Directors and will depend upon, among other things,
future earnings, operations, capital requirements and our general financial
condition, general business conditions and contractual restrictions on payment
of dividends, if any.
Our agreements relating to the $40.0 million of our debt securities held by the
selling shareholder prohibit us from paying dividends (or other distributions on
and repurchases of our common stock) so long as such debt remains outstanding,
without the consent of the selling shareholder.
18
CAPITALIZATION
The following table sets forth our capitalization, as of March 31, 2006:
o on an actual basis; and
o on an as adjusted basis to give effect to the sale by us of
500,000 shares of common stock in this offering at an assumed
offering price of $7.04 per share, the last reported sale price
of our common stock on June 23, 2006, after deducting
underwriting discounts and commissions and estimated offering
expenses payable by us.
As of March 31, 2006 (1)
---------------------------
Actual As adjusted
------------- -----------
(unaudited)
(in thousands)
Cash and cash equivalents $ 25,504 $ 28,660
============= ===========
Long-term debt:
Senior secured debt, related party $ 40,000 $ 40,000
Subordinated renewable notes (2) 6,314 6,314
------------- -----------
Total long-term debt (2) (3) 46,314 46,314
------------- -----------
Shareholders' equity:
Preferred stock, $1.00 par value; authorized
10,000,000 shares in series; none outstanding -- --
Common stock, no par value; authorized
30,000,000 shares; 21,819,333 shares issued
and outstanding, actual; 22,319,333 shares
issued and outstanding, as adjusted 66,995 70,151
Retained earnings 10,266 10,266
Accumulated other comprehensive loss (2,429) (2,429)
Additional paid-in-capital, warrants 794 794
------------- -----------
Total shareholders' equity 75,626 78,782
------------- -----------
Total capitalization $ 121,940 $ 125,096
============= ===========
(1) Does not include (a) 4,863,654 shares of common stock issuable upon the
exercise of stock options outstanding as of June 20, 2006 at a weighted average
exercise price of $3.38 per share, (b) 272,000 shares issuable upon exercise of
a warrant at an exercise price of $4.85 per share, (c) 1,627,131 additional
shares reserved for future grants or issuances under our stock option plans, and
(d) 112,442 shares that may be issued upon exercise of the underwriter's
overallotment option.
(2) Includes indebtedness outstanding under the renewable subordinated notes
program that is due within twelve months after March 31, 2006.
(3) Does not include (a) securitization trust debt of $1,100.6 million, (b)
indebtedness under warehouse credit facilities of $75.1 million, and (c)
residual interest financing of $37.7 million, all as of March 31, 2006.
19
SELECTED CONSOLIDATED FINANCIAL DATA
The following table presents our selected consolidated financial data and
operating data as of and for the dates indicated. The data under the captions
"Statement of Operations Data" and "Balance Sheet Data" have been derived from
our audited and unaudited consolidated financial statements. The remainder is
derived from other records of ours.
You should read the selected consolidated financial data together with
"Capitalization," "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and our audited and unaudited financial statements
and notes thereto that are included in this prospectus.
AS OF AND FOR THE THREE AS OF AND
MONTHS ENDED MARCH 31, FOR THE YEAR ENDED DECEMBER 31,
------------------------- ---------------------------------------
2006 2005 2005 2004 2003
----------- ---------- ----------- ---------- ----------
(unaudited)
(Dollars in thousands, except per share data)
STATEMENT OF OPERATIONS DATA
Revenues:
Interest income $ 54,527 $ 36,172 $ 171,834 $ 105,818 $ 58,164
Servicing fees 1,005 2,264 6,647 12,480 17,058
Net gain on sale of contracts -- -- -- -- 10,421
Other income 2,492 3,397 15,216 14,394 19,343
----------- ---------- ----------- ----------- ----------
Total revenues 58,024 41,833 193,697 132,692 104,986
Expenses:
Employee costs 9,357 10,450 40,384 38,173 37,141
General and administrative 9,743 8,926 39,285 33,936 31,581
Interest expense 18,035 10,384 51,669 32,147 23,861
Provision for credit losses 19,099 12,312 58,987 32,574 11,390
Impairment loss on residual assets (1) -- -- -- 11,750 4,052
----------- ---------- ----------- ----------- ----------
Total expenses 56,234 42,072 190,325 148,580 108,025
Income (loss) before income tax benefit 1,790 (239) 3,372 (15,888) (3,039)
Income tax benefit -- -- -- -- (3,434)
----------- ---------- ----------- ----------- ----------
Net income (loss) $ 1,790 $ (239) $ 3,372 $ (15,888) $ 395
=========== ========== =========== ============ ==========
Earnings (loss) per share--basic $ 0.08 $ (0.01) $ 0.16 $ (0.75) $ 0.02
Earnings (loss) per share--diluted $ 0.07 $ (0.01) $ 0.14 $ (0.75) $ 0.02
Weighted average shares outstanding--basic 21,732 21,528 21,627 21,111 20,263
Weighted average shares outstanding--diluted 24,188 21,528 23,513 21,111 21,578
BALANCE SHEET DATA
Total assets $ 1,354,223 $ 850,533 $ 1,155,144 $ 766,599 $ 492,470
Cash and cash equivalents 25,504 9,730 17,789 14,366 33,209
Restricted cash and equivalents 212,428 150,059 157,662 125,113 67,277
Finance receivables, net 1,050,825 620,302 913,576 550,191 266,189
Residual interest in securitizations 22,608 44,135 25,220 50,430 111,702
Warehouse lines of credit 75,056 50,535 35,350 34,279 33,709
Residual interest financing 37,728 16,411 43,745 22,204 --
Securitization trust debt 1,100,606 619,430 924,026 542,815 245,118
Long-term debt 46,314 73,829 58,655 74,829 102,465
Shareholders' equity 75,626 69,808 73,589 69,920 82,160
20
AS OF AND FOR THE THREE AS OF AND
MONTHS ENDED MARCH 31, FOR THE YEAR ENDED DECEMBER 31,
------------------------ --------------------------------------
2006 2005 2005 2004 2003
------------ ---------- ------------ ----------- ----------
(unaudited)
(Dollars in thousands, except per share data)
CONTRACT PURCHASES/SECURITIZATIONS
Automobile contract purchases $ 255,586 $ 144,165 $ 691,252 $ 447,232 $ 357,320
Automobile contract acquisitions(2) -- -- -- 74,901 152,143
Automobile contracts securitized--structured
as sales -- -- -- -- 254,436
Automobile contracts securitized--structured
as secured financings 245,000 137,390 698,353 491,269 162,488
MANAGED PORTFOLIO DATA
Contracts held by consolidated subsidiaries $ 1,144,340 $ 691,967 $ 1,000,597 $ 619,794 $ 317,952
Contracts held by non-consolidated subsidiaries 83,162 193,823 103,130 233,621 425,534
SeaWest third party portfolio(3) 12,456 40,501 18,018 53,463 --
------------ ---------- ------------ ----------- ----------
Total managed portfolio 1,239,958 926,291 1,121,745 906,878 743,485
Average managed portfolio 1,191,132 915,547 997,697 861,261 674,523
Weighted average fixed effective interest rate
(total managed portfolio)(4) 18.6% 19.0% 18.6% 19.2% 19.7%
Core operating expense
(% of average managed portfolio) (5) 6.5% 8.5% 8.0% 8.4% 10.4%
Allowance for loan losses $ 63,846 $ 46,284 $ 57,728 $ 42,615 $ 35,889
Allowance for loan losses (% of total contracts
held by consolidated subsidiaries) 5.6% 6.7% 5.8% 6.9% 11.3%
Total delinquencies
(% of total managed portfolio) (6) 1.8% 2.1% 3.8% 4.0% 4.7%
Total delinquencies and repossessions
(% of total managed portfolio) (6) 2.7% 3.2% 5.0% 5.6% 6.2%
Net charge-offs (% of average managed
portfolio)(4)(7) 4.8% 6.6% 5.3% 7.8% 6.8%
(1) The impairment loss was related to our analysis and estimate of the expected
ultimate performance of our previously securitized pools that were held by our
non-consolidated subsidiaries and the residual interest in securitizations. The
impairment loss was a result of the actual net loss and prepayment rates
exceeding our previous estimates for the automobile contracts held by our
non-consolidated subsidiaries.
(2) Represents automobile contracts not purchased directly from dealers, but
acquired as a result of our acquisitions of TFC in 2003 and of certain assets of
SeaWest in 2004.
(3) Receivables related to the SeaWest third party portfolio, on which we earn
only a servicing fee.
(4) Excludes receivables related to the SeaWest third party portfolio.
(5) Total expenses excluding provision for credit losses, interest expense and
impairment loss on residual assets.
(6) For further information regarding delinquencies and the managed portfolio,
see the table captioned "Delinquency Experience," at page 45 of this prospectus
and the notes to that table.
(7) 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) and amounts collected subsequent to the date of the
charge-off. For further information regarding charge-offs, see the table
captioned "Net Charge-Off Experience," at page 46 of this prospectus and the
notes to that table.
21
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion and analysis should be read in conjunction with our
consolidated financial statements and notes thereto and other information
included or incorporated by reference herein.
OVERVIEW
We are a specialty finance company engaged in purchasing and servicing new and
used retail automobile contracts originated primarily by franchised automobile
dealerships and to a lesser extent by select independent dealers of used
automobiles in the United States. We serve as an alternative source of financing
for dealers, facilitating sales to sub-prime customers, who have limited credit
history, low income or past credit problems and who otherwise might not be able
to obtain financing from traditional sources. We do not currently lend money
directly to consumers but, rather, purchase automobile contracts from dealers
under several different financing programs. We are headquartered in Irvine,
California and have three additional strategically located servicing branches in
Virginia, Florida and Illinois.
On March 8, 2002, we acquired MFN Financial Corporation and its subsidiaries in
a merger. On May 20, 2003, we acquired TFC Enterprises, Inc. and its
subsidiaries in a second merger. Each merger was accounted for as a purchase.
MFN Financial Corporation and its subsidiaries and TFC Enterprises, Inc. and its
subsidiaries were engaged in businesses similar to ours: buying automobile
contracts from dealers and servicing those automobile contracts. MFN Financial
Corporation and its subsidiaries ceased acquiring automobile contracts in May
2002; TFC continues to acquire automobile contracts under its "TFC Programs,"
which provide financing for vehicle purchases exclusively by members of the
United States Armed Forces.
On April 2, 2004, we purchased a portfolio of automobile contracts and certain
other assets from SeaWest Financial Corporation and its subsidiaries. In
addition, we were named the successor servicer of three term securitization
transactions originally sponsored by SeaWest. We do not intend to offer
financing programs similar to those previously offered by SeaWest.
From inception through June 2003, we generated revenue primarily from the gains
recognized on the sale or securitization of automobile contracts, servicing fees
earned on automobile contracts sold, interest earned on residuals interests
retained in securitizations, and interest earned on finance receivables. Since
July 2003, we have not recognized any gains from the sale of automobile
contracts. Instead, since July 2003 our revenues have been derived from
servicing fees and interest earned on residual interests in securitizations,
which for automobile contracts purchased since July 2003 are represented as
interest on finance receivables.
SECURITIZATION AND WAREHOUSE CREDIT FACILITIES
GENERALLY
Throughout the periods for which information is presented in this report, we
have purchased automobile contracts with the intention of financing them on a
long-term basis through securitizations, and on an interim basis through our
warehouse credit facilities. All such financings have involved identification of
specific automobile contracts, sale of those automobile contracts (and
associated rights) to one of our special-purpose subsidiaries, and issuance of
asset-backed securities to fund the transactions. Depending on the structure,
these transactions may be accounted for under generally accepted
accounting principles as sales of the automobile contracts or as secured
financings.
When structured to be treated as a secured financing for accounting purposes,
the subsidiary is consolidated with us. Accordingly, the sold automobile
contracts and the related debt appear as assets and liabilities, respectively,
on our consolidated balance sheet. We then periodically (i) recognize interest
and fee income on the contracts, (ii) recognize interest expense on the
securities issued in the transaction and (iii) record as expense a provision for
credit losses on the contracts.
When structured to be treated as a sale for accounting purposes, the assets and
liabilities of the special-purpose subsidiary are not consolidated with us.
Accordingly, the transaction removes the sold automobile contracts from our
consolidated balance sheet, the related debt does not appear as our debt, and
our consolidated balance sheet shows, as an asset, a retained residual interest
in the sold automobile contracts. The residual interest represents the
discounted value of what we expect will be the excess of future collections on
the automobile contracts over principal and interest due on the asset-backed
securities. That residual interest appears on our consolidated balance sheet as
"residual interest in securitizations," and the determination of its value is
dependent on our estimates of the future performance of the sold automobile
contracts.
22
CHANGE IN POLICY
Beginning in the third quarter of 2003, we began to structure our securitization
transactions so that they would be treated for financial accounting purposes as
secured financings, rather than as sales. All subsequent securitizations of
automobile contracts have been so structured. Prior to the third quarter of
2003, we had structured our securitization transactions to be treated as sales
of automobile contracts for financial accounting purposes. In our acquisitions
of MFN and TFC, we acquired automobile contracts that these companies had
previously securitized in securitization transactions that were treated as
secured financings for financial accounting purposes. As of March 31, 2006, our
consolidated balance sheet included net finance receivables of $19.0 million and
securitization trust debt of $4.7 million related to automobile contracts
acquired in the two mergers, out of totals of net finance receivables of
$1,050.8 million and securitization trust debt of $1,100.6 million.
CREDIT RISK RETAINED
Whether a sale of automobile contracts in connection with a securitization or
warehouse credit facility 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 us if the credit performance of the related
automobile contracts falls short of pre-determined standards. Such releases
represent a material portion of the cash that we use to fund our operations. An
unexpected deterioration in the performance of such automobile contracts could
therefore have a material adverse effect on both our liquidity and our results
of operations, regardless of whether such automobile contracts are treated for
financial accounting purposes 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 our "managed portfolio," which represents both financed and sold
automobile contracts as to which such credit risk is retained. Our managed
portfolio as of March 31, 2006 was approximately $1,240.0 million (this amount
includes $12.5 million of automobile contracts securitized by SeaWest, on which
we earn only servicing fees and have no credit risk).
CRITICAL ACCOUNTING POLICIES
We believe that our accounting policies related to (a) Allowance for Finance
Credit Losses, (b) Residual Interest in Securitizations and Gain on Sale of
Automobile Contracts and (c) Income Taxes are considered to be the most critical
to understanding and evaluating our reported financial results. Such policies
are described below.
ALLOWANCE FOR FINANCE CREDIT LOSSES
In order to estimate an appropriate allowance for losses to be incurred on
finance receivables, we use a loss allowance methodology commonly referred to as
"static pooling," which stratifies our finance receivable portfolio into
separately identified pools. Using analytical and formula driven techniques, we
estimate an allowance for finance credit losses, which we believe is adequate
for probable credit losses that can be reasonably estimated in our portfolio of
automobile contracts. Provision for losses is charged to our consolidated
statement of operations. Net losses incurred on finance receivables are charged
to the allowance. We evaluate the adequacy of the allowance by examining current
delinquencies, the characteristics of the portfolio and the value of the
underlying collateral. As conditions change, our level of provisioning and/or
allowance may change as well.
RESIDUAL INTEREST IN SECURITIZATIONS AND GAIN ON SALE OF AUTOMOBILE CONTRACTS
In transactions prior to the third quarter of 2003, we recognized gain on sale
on the disposition of automobile contracts either outright, in securitization
transactions, and in certain of our warehouse credit facilities. In those
securitization transactions and in the warehousing transactions that were
treated as sales for financial accounting purposes, we, or one of our
wholly-owned, consolidated subsidiaries, retain a residual interest in the
automobile contracts that were sold to a wholly-owned, unconsolidated special
purpose subsidiary.
The line item "residual interest in securitizations" on our consolidated balance
sheet represents the residual interests in securitizations completed prior to
the third quarter of 2003. This line represents the discounted sum of expected
future cash flows from these securitization trusts. Accordingly, the valuation
of the residual interest is heavily dependent on estimates of future performance
of the automobile contracts included in the securitizations.
We structured all subsequent securitizations and warehouse credit facilities as
secured financings. The warehouse credit facilities are accordingly reflected in
the line items "Finance receivables" and "Warehouse lines of credit" on our
consolidated balance sheet, and the securitizations are reflected in the line
items "Finance receivables" and "Securitization trust debt."
23
The key economic assumptions used in measuring all residual interests as of
March 31, 2006, December 31, 2005 and December 31, 2004 are included in the
table below. We have used an effective pre-tax discount rate of 14% per annum
except for certain collections from charged off receivables related to our
securitizations executed from 2001 through the second quarter of 2003. With
respect to collections from such charged off receivables, we have used a
discount rate of 25% per annum.
--------------------------------- ----------- ------------- -------------
3/31/2006 12/31/2005 12/31/2004
--------------------------------- ----------- ------------- -------------
Prepayment Speed (Cumulative) ... 22.2%-35.3% 22.2% - 35.8% 20.0% - 30.5%
Net Credit Losses (Cumulative) .. 12.3%-20.0% 11.9% - 20.2% 13.0% - 20.5%
Key economic assumptions and the sensitivity of the fair value of residual cash
flows to immediate 10% and 20% adverse changes in those assumptions as of
December 2005 are as follows:
DECEMBER 31,
----------------------
2005
(DOLLARS IN THOUSANDS)
Carrying amount/fair value of residual interest in
securitizations ...................................... $ 25,220
Weighted average life in years ....................... 2.24
Prepayment Speed Assumption (Cumulative) ............. 22.2% - 35.8%
Estimated Fair value assuming 10% adverse change ..... $ 25,168
Estimated Fair value assuming 20% adverse change ..... 25,119
Expected Net Credit Losses (Cumulative) .............. 11.9% - 20.2%
Estimated Fair value assuming 10% adverse change ..... $ 23,937
Estimated Fair value assuming 20% adverse change ..... 22,656
Residual Cash Flows Discount Rate (Annual) ........... 14.0% - 25.0%
Estimated Fair value assuming 10% adverse change ..... $ 24,636
Estimated Fair value assuming 20% adverse change ..... 24,071
These sensitivities are hypothetical and should be used with caution. As the
figures indicate, changes in fair value based on 10% and 20% 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.
Our term securitization structure has generally been as follows:
We sell automobile contracts we acquire to a wholly-owned special purpose
subsidiary, which has been established for the limited purpose of buying and
reselling our automobile contracts. The special-purpose subsidiary then
transfers the same automobile contracts to another entity, typically a statutory
trust. The trust issues interest-bearing asset-backed securities, in a principal
amount equal to or less than the aggregate principal balance of the automobile
contracts. We typically sell these automobile contracts to the trust at face
value and without recourse, except that representations and warranties similar
to those provided by the dealer to us are provided by us to the trust. One or
more investors purchase the asset-backed securities issued by the trust; the
proceeds from the sale of the asset-backed securities are then used to purchase
the automobile contracts from us. We may retain or sell subordinated
asset-backed securities issued by the trust or by a related entity. We purchase
external credit enhancement in the form of a financial guaranty insurance
policy, guaranteeing timely payment of principal and interest on the senior
asset-backed securities, from an insurance company. In addition, we structure
our securitizations to include internal credit enhancement for the benefit of
the insurance company and the investors (i) in the form of an initial cash
deposit to an account ("spread account") held by the trust, (ii) in the form of
overcollateralization of the senior asset-backed securities, where the principal
balance of the senior asset-backed securities issued is less than the principal
balance of the automobile contracts, (iii) in the form of subordinated
asset-backed securities, or (iv) some combination of such internal credit
enhancements. The agreements governing the securitization transactions require
that the initial level of internal credit enhancement be supplemented by a
portion of collections from the automobile contracts until the level of internal
credit enhancement reaches specified levels, which are then maintained. The
specified levels are generally computed as a percentage of the principal amount
remaining unpaid under the related automobile contracts. The specified levels at
which the internal credit enhancement is to be maintained will vary depending on
the performance of the portfolios of automobile contracts held by the trusts and
on other conditions, and may also be varied by agreement among us, our special
purpose subsidiary, the insurance company and the trustee. Such levels have
increased and decreased from time to time based on performance of the various
portfolios, and have also varied from one transaction to another. The agreements
governing the securitizations generally grant us the option to repurchase the
sold automobile contracts from the trust when the aggregate outstanding balance
of the automobile contracts has amortized to a specified percentage of the
initial aggregate balance.
24
The prior securitizations that were treated as sales for financial accounting
purposes differ from those treated as secured financings in that the trust to
which our special-purpose subsidiaries sold the automobile contracts met 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 those trusts are not consolidated into our consolidated balance sheet.
Our warehouse credit facility structures are similar to the above, except that
(i) our special-purpose subsidiaries that purchase the automobile contracts
pledge the automobile contracts to secure promissory notes that they issue, (ii)
the promissory notes are in an aggregate principal amount of not more than 80.0%
of the aggregate principal balance of the automobile contracts (that is, at
least 20.0% overcollateralization), (iii) no increase in the required amount of
internal credit enhancement is contemplated unless certain portfolio performance
tests are breached, and (iv) we do not purchase financial guaranty insurance.
During the third quarter of 2003, we agreed with our warehouse lenders to amend
the agreements governing our warehouse credit facilities. The effect of these
amendments was to cause the transactions to be treated as secured financings for
financial accounting purposes.
Upon each sale of automobile contracts in a transaction structured as a secured
Financing for financial accounting purposes, whether a term securitization or a
warehouse financing, we retain on our consolidated balance sheet the related
automobile contracts as assets and record the asset-backed notes issued in the
transaction as indebtedness.
Under the prior securitizations and warehouse credit facilities structured as
sales for financial accounting purposes, we removed from our consolidated
balance sheet the automobile contracts sold and added to our consolidated
balance sheet (i) the cash received, if any, and (ii) the estimated fair value
of the ownership interest that we retained in the automobile contracts sold in
the transaction. That retained or residual interest consisted of (a) the cash
held in the spread account, if any, (b) overcollateralization, if any, (c)
subordinated asset-backed securities retained, if any, and (d) receivables from
trust, which include the net interest receivables. Net interest receivables
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
asset-backed notes, and certain expenses. The excess of the cash received and
the assets we retained over the carrying value of the automobile contracts sold,
less transaction costs, equaled the net gain on sale of automobile contracts we
recorded. Until the maturity of these transactions, our consolidated balance
sheet will reflect both securitization transactions structured as sales and
others structured as secured financings.
With respect to transactions structured as sales for financial accounting
purposes, we allocate our basis in the automobile contracts between the
asset-backed securities sold and the residual interests retained based on the
relative fair values of those portions on the date of the sale. We recognize
gains or losses attributable to the change in the fair value of the residual
interests, which are recorded at estimated fair value. We are not aware of an
active market for the purchase or sale of interests such as the residual
interests; accordingly, we determine the estimated fair value of the residual
interests by discounting the amount of anticipated cash flows that we estimate
will be released to us in the future (the cash out method), using a discount
rate that we believe is appropriate for the risks involved. The anticipated cash
flows include collections from both current and charged off receivables. We have
used an effective pre-tax discount rate of 14% per annum except for certain
collections from charged off receivables related to our securitizations executed
from 2001 through the second quarter of 2003. With respect to collections from
such charged off receivables, we have used a discount rate of 25% per annum.
We receive periodic base servicing fees for the servicing and collection of the
automobile contracts. (Under our current securitization structure, such
servicing fees are included in interest income from the automobile contracts).
In addition, we are entitled to the cash flows from the trusts that represent
collections on the automobile contracts in excess of the amounts required to pay
principal and interest on the asset-backed securities, the base servicing fees,
and certain other fees and expenses (such as trustee and custodial fees).
Required principal payments on the notes are generally defined as the payments
sufficient to keep the principal balance of such notes equal to the aggregate
principal balance of the related automobile contracts (excluding those
automobile 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 asset-backed securities is reduced to the specified
percentage. Such accelerated principal payment is said to create
overcollateralization of the asset-backed notes.
25
If the amount of cash required for payment of fees, expenses, 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 the required
overcollateralization level, the excess is released to us, or in certain cases
is transferred to other spread accounts related to transactions that may be
below their required levels. If the spread account and overcollateralization 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 our special-purpose subsidiaries as the
owner of the residual interests (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), we are restricted in use of the cash in the
spread accounts. 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 automobile contracts is
significantly greater than the interest rate on the asset-backed notes. As a
result, the residual interests described above are a significant asset of ours.
In determining the value of the residual interests, we must estimate the future
rates of prepayments, delinquencies, defaults, default loss severity, and
recovery rates, as all of these factors affect the amount and timing of the
estimated cash flows. We estimate prepayments by evaluating historical
prepayment performance of comparable automobile contracts. We estimate recovery
rates of previously charged off receivables using available historical recovery
data. We estimate defaults and default loss severity using available historical
loss data for comparable automobile contracts and the specific characteristics
of the automobile contracts we purchased. In valuing the residuals as of March
31, 2006, we estimate that charge-offs as a percentage of the original principal
balance will approximate 16.5% to 25.9% cumulatively over the lives of the
related automobile contracts, with recovery rates approximating 4.3% to 5.9% of
the original principal balance and prepayment estimates of approximately 22.2%
to 35.3% cumulatively over the lives of the related automobile contracts.
For securitizations that were structured as a sale for financial accounting
purposes, we recognize interest income on the balance of the residual interests.
In addition, we would recognize as gain additional revenue from the residual
interests if the actual performance of the automobile contracts were better than
our estimate of the value of the residual interest. If the actual performance of
the automobile contracts were worse than our estimate, then a downward
adjustment to the carrying value of the residuals and a related impairment
charge would be required. In a securitization structured as a secured financing
for financial accounting purposes, interest income is recognized when accrued
under the terms of the related automobile 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 of our term securitizations and warehouse credit facilities, whether
treated as secured financings or as sales, we have sold the automobile contracts
(through a subsidiary) to the securitization trust. The difference between the
two structures is that in securitizations that are treated as secured financings
we report the assets and liabilities of the securitization trust on our
consolidated balance sheet. Under both structures, recourse to us by holders of
the asset-backed securities and by the trust, for failure of the automobile
contract obligors to make payments on a timely basis, is limited to the
automobile contracts included in the securitizations or warehouse credit
facilities, the spread accounts and our residual interests in the respective
trusts.
INCOME TAXES
We and our subsidiaries file a consolidated federal income tax return and
combined or stand-alone state franchise tax returns for certain states. We
utilize 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. We measure
deferred tax assets and liabilities 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. We have
estimated a valuation allowance against that portion of the deferred tax asset
whose utilization in future periods is not more than likely.
26
In determining the possible realization of deferred tax assets, we consider
future taxable income from the following sources: (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
EFFECTS OF CHANGE IN SECURITIZATION STRUCTURE
Our decision in the third quarter of 2003 to structure securitization
transactions as secured financings for financial accounting purposes, rather
than as sales, has affected and will affect the way in which the transactions
are reported. The major effects are these: (i) the automobile contracts are
shown as assets on our balance sheet; (ii) the debt issued in the transactions
is shown as indebtedness; (iii) cash deposited in the spread accounts to enhance
the credit of the securitization transactions is shown as "Restricted cash" on
our balance sheet; (iv) cash collected from automobile purchasers and other
sources related to the automobile contracts prior to making the required
payments under the securitization agreements is also shown as "Restricted cash"
on our balance sheet; (v) the servicing fee that we receive in connection with
such contracts is recorded as a portion of the interest earned on such contracts
in our statements of operations; (vi) we have initially and periodically
recorded as expense a provision for estimated credit losses on the contracts in
our statements of operations; and (vii) portions of scheduled payments on the
contracts and on the debt issued in the transactions representing interest are
recorded as interest income and expense, respectively, in our statements of
operations.
These changes collectively represent a deferral of revenue and acceleration of
expenses, and thus a more conservative approach to accounting for our operations
compared to the previous securitization transactions, which were accounted for
as sales at the consummation of the transaction. As a result of the changes, we
initially reported lower earnings than we would have reported if we had
continued to structure our transactions to require recognition of gain on sale.
It should also be noted that growth in our portfolio of receivables resulted in
an increase in expenses in the form of provision for credit losses, and
initially had a negative effect on net earnings. Our cash availability and cash
requirements should be unaffected by the change in structure.
Since the third quarter of 2003, we have conducted fifteen term securitizations.
Of these fifteen, eleven were quarterly securitizations of automobile contracts
that we purchased from automobile dealers under our regular programs. In
addition, in March 2004 and November 2005, we completed securitizations of our
retained interests in other securitizations that we and our affiliates
previously sponsored. The debt from the March 2004 transaction was repaid in
August 2005. Also, in June 2004, we completed a securitization of automobile
contracts purchased in the SeaWest asset acquisition and under our TFC programs.
Further, in December 2005, we completed a securitization that included
automobile contracts purchased under the TFC programs, automobile contracts
purchased under the CPS programs and automobile contracts we repurchased upon
termination of prior securitizations of our MFN and TFC subsidiaries. All such
securitizations since the third quarter of 2003 have been structured as secured
financings.
COMPARISON OF OPERATING RESULTS FOR THE THREE MONTHS ENDED MARCH 31, 2006 WITH
THE THREE MONTHS ENDED MARCH 31, 2005
REVENUES. During the three months ended March 31, 2006, revenues were $58.0
million, an increase of $16.2 million, or 38.7%, from the prior year period
revenue of $41.8 million. The primary reason for the increase in revenues is an
increase in interest income. Interest income for the three months ended March
31, 2006 increased $18.4 million, or 50.7%, to $54.5 million from $36.2 million
in the prior year period. The primary reason for the increase in interest income
is the increase in finance receivables held by consolidated subsidiaries
(resulting in an increase of $22.5 million in interest income). This increase
was partially offset by the decline in the balance of the portfolios of
automobile contracts we acquired in the MFN, TFC and SeaWest transactions (in
the aggregate, resulting in a decrease of $3.4 million in interest income), and
a decrease of $723,000 in interest earned on our residual asset.
Servicing fees totaling $1.0 million in the three months ended March 31, 2006
decreased $1.3 million, or 55.6%, from $2.3 million in the same period a year
earlier. The decrease in servicing fees is the result of the change in
securitization structure and the consequent decline in our managed portfolio
held by non-consolidated subsidiaries. As a result of the decision to structure
future securitizations as secured financings, our managed portfolio held by
non-consolidated subsidiaries will continue to decline in future periods, and
servicing fee revenue is anticipated to decline proportionately. As of March 31,
2006 and 2005, our managed portfolio owned by consolidated vs. non-consolidated
subsidiaries and other third parties was as follows:
27
MARCH 31, 2006 MARCH 31, 2005
---------------------- ----------------------
AMOUNT % AMOUNT %
---------- --------- ---------- ---------
Total Managed Portfolio ($ IN MILLIONS)
Owned by Consolidated Subsidiaries ... $ 1,144.3 92.3% $ 692.0 74.7%
Owned by Non-Consolidated Subsidiaries 83.2 6.7% 193.8 20.9%
SeaWest Third Party Portfolio ........ 12.5 1.0% 40.5 4.4%
---------- --------- ---------- ---------
Total ................................ $ 1,240.0 100.0% $ 926.3 100.0%
========== ========= ========== =========
At March 31, 2006, we were generating income and fees on a managed portfolio
with an outstanding principal balance of $1,240.0 million (this amount includes
$12.5 million of automobile contracts securitized by SeaWest, on which we earn
only servicing fees), compared to a managed portfolio with an outstanding
principal balance of $926.3 million as of March 31, 2005. As the portfolios of
automobile contracts acquired in the MFN, TFC Merger and SeaWest transactions
decrease, the portfolio of automobile contracts that we purchased directly from
automobile dealers continues to expand. At March 31, 2006 and 2005, the managed
portfolio composition was as follows:
MARCH 31, 2006 MARCH 31, 2005
---------------------- ----------------------
AMOUNT % AMOUNT %
---------- --------- ---------- ---------
ORIGINATING ENTITY ($ IN MILLIONS)
CPS .................................. $ 1,150.5 92.8% $ 760.1 82.1%
TFC .................................. 64.7 5.2% 83.5 9.0%
MFN .................................. 1.3 0.1% 11.1 1.2%
SeaWest .............................. 11.0 0.9% 31.1 3.4%
SeaWest Third Party Portfolio......... 12.5 1.0% 40.5 4.4%
---------- --------- ---------- ---------
Total ................................ $ 1,240.0 100.0% $ 926.3 100.0%
========== ========= ========== =========
Other income decreased $904,000, or 26.6%, to $2.5 million in the three-month
period ended March 31, 2006 from $3.4 million during the same period a year
earlier. The period over period decrease resulted primarily from decreases in
recoveries on MFN and certain other automobile contracts (a decrease of
$792,000) compared to the same period of the prior year and decreased revenue on
our direct mail services (a decrease of $340,000). These direct mail services
are provided to our dealers and consist of customized solicitations targeted to
prospective vehicle purchasers, in proximity to the dealer, who appear to meet
our credit criteria. Decreases in other income for the period were somewhat
offset by increases in convenience fees charged to obligors for certain
transaction types (an increase of $228,000).
EXPENSES. Our operating expenses consist primarily of provisions for credit
losses, interest expense, employee costs and general and administrative
expenses. Provisions for credit losses and interest expense are significantly
affected by the volume of automobile contracts we purchased during a period and
by the outstanding balance of finance receivables held by consolidated
subsidiaries. Employee costs and general and administrative expenses are
incurred as applications and automobile contracts are received, processed and
serviced. Factors that affect margins and net income include changes in the
automobile and automobile finance market environments, and macroeconomic factors
such as interest rates and the unemployment level.
Employee 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 one of our most significant operating expenses. These
costs (other than those relating to stock options) generally fluctuate with the
level of applications and automobile contracts processed and serviced.
Other operating expenses consist primarily of facilities expenses, telephone and
other communication services, credit services, computer services (including
employee costs associated with information technology support), professional
services, marketing and advertising expenses, and depreciation and amortization.
28
Total operating expenses were $56.2 million for the three months ended March 31,
2006, compared to $42.1 million for the same period a year earlier, an increase
of $14.2 million, or 33.7%. The increase is primarily due to increases in
provision for credit losses and interest expense, which increased by $6.8
million and $7.7 million, or 55.1% and 73.7% respectively. Both interest expense
and provision for credit losses are directly affected by the growth in our
portfolio of automobile contracts held by consolidated affiliates.
Employee costs decreased slightly to $9.4 million during the three months ended
March 31, 2006, representing 16.6 % of total operating expenses, from $10.5
million for the same period a year earlier, or 24.8% of total operating
expenses. During the period ended March 31, 2006, we deferred $946,000 of direct
employee costs associated with the purchase of automobile contracts in the
period, in accordance with Statement of Financial Accounting Standard No. 91,
Accounting for Nonrefundable Fees and Costs Associated with Originating or
Acquiring Loans and Initial Direct Costs of Leases (SFAS 91). Historically, we
have not deferred and amortized such costs as our analyses indicated that the
effect of such deferral and amortization would not have been material. However,
due to continued increases in volumes of automobile contract purchases and
refinements in our methodology to measure direct costs associated with
automobile contract purchases, our estimate of direct costs has increased,
resulting in the need to defer such costs and amortize them over the lives of
the related automobile contracts as an adjustment to the yield in accordance
with SFAS 91. The decrease as a percentage of total operating expenses reflects
the higher total of operating expenses, primarily a result of the increased
provision for credit losses and interest expense.
General and administrative expenses decreased slightly by $27,000 or 0.5% and
represented 9.1% of total operating expenses in the three-month period ending
March 31, 2006, as compared to the prior year period when general and
administrative expenses represented 12.2% of total operating expenses. The
decrease as a percentage of total operating expenses reflects the higher
operating expenses primarily a result of the provision for credit losses and
interest expense.
Interest expense for the three-month period ended March 31, 2006 increased $7.7
million, or 73.7%, to $18.0 million, compared to $10.4 million in the same
period of the previous year. The increase is primarily the result of changes in
the amount and composition of securitization trust debt carried on our
consolidated balance sheet. Such debt increased as a result of the change in
securitization structure implemented in the third quarter of 2003 (resulting in
an increase of $8.9 million in interest expense), partially offset by the
decrease in the balance of the securitization trust debt acquired in the MFN and
TFC transaction (resulting in a decrease of $309,000 in interest expense) and a
decrease in interest expense on certain long-term debt (a decrease of $870,000).
Marketing expenses increased by $737,000, or 26.3%, to $3.5million, compared to
$2.8 million in the same period of the previous year and represented 6.3% of
total operating expenses. The increase is primarily due to the increase in
automobile contracts we purchased during the three months ended March 31, 2006
as compared to the prior year period. During the period ended March 31, 2006, we
purchased 16,953 automobile contracts aggregating $255.6 million, compared to
10,103 automobile contracts aggregating $144.2 million in the same period of the
prior year.
Occupancy expenses increased by $121,000, or 15.5%, to $903,000 compared to
$782,000 in the same period of the previous year and represented 1.6% of total
operating expenses.
Depreciation and amortization expenses decreased by $14,000, or 6.8%, to
$193,000 from $207,000 in the same period of the previous year.
COMPARISON OF OPERATING RESULTS FOR THE YEAR ENDED DECEMBER 31, 2005 WITH THE
YEAR ENDED DECEMBER 31, 2004
REVENUES. During the year ended December 31, 2005, revenues were $193.7 million,
an increase of $61.0 million, or 46.0%, from the prior year revenue of $132.7
million. The primary reason for the increase in revenues is an increase in
interest income. Interest income for the year ended December 31, 2005 increased
$66.0 million, or 62.4%, to $171.8 million in 2005 from $105.8 million in 2004.
The primary reason for the increase in interest income is the growth of the
finance receivables held by consolidated subsidiaries on our balance sheet.
During 2005, we purchased $691.3 million of automobile contracts and increased
our balance of receivables held by consolidated subsidiaries to $1,000.6 million
at December 31, 2005 from $619.8 million at December 31, 2004, an increase of
61.4%. Offsetting the increase in interest income were decreases in the balance
of receivables acquired in the MFN, TFC and SeaWest transactions, which resulted
in decreases in interest income of $1.8 million, $2.0 million and $2.6 million,
respectively.
Servicing fees totaling $6.6 million in the year ended December 31, 2005
decreased $5.8 million, or 46.7%, from $12.5 million in the same period a year
earlier. The decrease in servicing fees is the result of the change in
securitization structure and the consequent decline in our managed portfolio
held by non-consolidated subsidiaries, and the decrease in the balance of
automobile contracts originated by SeaWest for which we receive only servicing
fees. As a result of the decision to structure future securitizations as secured
financings, our managed portfolio held by non-consolidated subsidiaries will
continue to decline in future periods, and servicing fee revenue is anticipated
to decline proportionately. As of December 31, 2005 and 2004, our managed
portfolio owned by consolidated vs. non-consolidated subsidiaries and other
third parties was as follows:
29
DECEMBER 31, 2005 DECEMBER 31, 2004
---------------------- ----------------------
AMOUNT % AMOUNT %
---------- --------- ---------- ---------
Total Managed Portfolio (DOLLARS IN MILLIONS)
Owned by Consolidated Subsidiaries ...... $ 1,000.6 89.2% $ 619.8 68.3%
Owned by Non-Consolidated Subsidiaries .. 103.1 9.2% 233.6 25.8%
SeaWest Third Party Portfolio ........... 18.0 1.6% 53.5 5.9%
---------- --------- ---------- ---------
Total ................................... $ 1,121.7 100.0% $ 906.9 100.0%
========== ========= ========== =========
At December 31, 2005, we were generating income and fees on a managed portfolio
with an outstanding principal balance of $1,121.7 million (this amount includes
$18.0 million of automobile contracts securitized by SeaWest, on which we earn
only servicing fees), compared to a managed portfolio with an outstanding
principal balance of $906.9 million as of December 31, 2004. As the portfolios
of automobile contracts acquired in the MFN, TFC and SeaWest transactions
decrease, the portfolio of automobile contracts that we purchased directly from
automobile dealers continues to expand. At December 31, 2005 and 2004, the
managed portfolio composition was as follows:
DECEMBER 31, 2005 DECEMBER 31, 2004
---------------------- ----------------------
AMOUNT % AMOUNT %
---------- --------- ---------- ---------
ORIGINATING ENTITY (DOLLARS IN MILLIONS)
CPS ............................ $ 1,017.3 90.7% $ 706.8 77.9%
TFC ............................ 68.6 6.1% 89.4 9.9%
MFN ............................ 2.5 0.1% 17.8 2.0%
SeaWest ........................ 15.3 1.4% 39.4 4.3%
SeaWest Third Party Portfolio .. 18.0 1.6% 53.5 5.9%
---------- --------- ---------- ---------
Total .......................... $ 1,121.7 100.0% $ 906.9 100.0%
========== ========= ========== =========
Other income increased $822,000, or 5.7%, to $15.2 million during 2005 from
$14.4 million in 2004. During 2005, other income included $2.4 million from the
sale of charged off receivables acquired in the MFN, TFC, and SeaWest
transactions, compared to no such proceeds in 2004. Recoveries on MFN
receivables decreased by $3.1 million to $4.9 million in 2005, compared to $8.0
million in 2004. Other income associated with direct mail services increased by
$765,000 to $4.5 million in 2005, compared to $3.8 million in 2004. These direct
mail services are provided to our dealers and represent direct mail products
which consist of customized solicitations targeted to prospective vehicle
purchasers, in proximity to the Dealer, who are likely to meet our credit
criteria.
EXPENSES. Total operating expenses were $190.3 million for 2005, compared to
$148.6 million for 2004. The increase is primarily due to a $26.4 million
increase, or 81.1% in the provision for credit losses to $59.0 million during
the 2005 period as compared to $32.6 million in the 2004 period. Interest
expense increased by $19.5 million to $51.7 million from $32.1 million in 2004,
an increase of 60.7%. The increase is primarily the result of the amount of
securitization trust debt carried on our consolidated balance sheet, which
increased along with the growth of our portfolio of finance receivables. The
increase was somewhat offset by the decrease in securitization trust debt
acquired in the MFN and TFC transactions. For 2005, the provision for credit
losses and interest expense represented 31.0% and 27.1%, respectively, of total
operating expenses, compared to 21.9% and 21.6% in 2004.
Employee costs increased to $40.4 million, or 5.8% during 2005, representing
21.2% of total operating expenses, from $38.2 million for 2004, or 25.7% of
total operating expenses. The decrease as a percentage of total operating
expenses reflects the higher total of operating expenses, primarily a result of
the increased provision for credit losses and interest expense.
General and administrative expenses increased slightly to $23.1 million, or
12.1% of total operating expenses, in 2005, as compared to $21.3 million, or
14.3% of total operating expenses, in 2004. The decrease as a percentage of
total operating expenses reflects the higher operating expenses primarily a
result of the increased provision for credit losses and interest expense. During
the year ended December 31, 2005, we recognized what we believe will be a
one-time, non-cash impairment charge of $1.9 million against certain assets
other than finance receivables.
30
In December 2005, the Compensation Committee of the Board of Directors approved
accelerated vesting of all the outstanding stock options we issued. Options to
purchase 2,113,998 shares of our common stock, which would otherwise have vested
from time to time through 2010, became immediately exercisable as a result of
the acceleration of vesting. The decision to accelerate the vesting of the
options was made primarily to reduce non-cash compensation expenses that would
have been recorded in our income statement in future periods upon the adoption
of Financial Accounting Standards Board Statement No. 123R, Share-Based Payment,
in January 2006. We estimate that approximately $3.5 million of future non-cash
compensation expense was eliminated as a result of the acceleration of vesting.
At the time of the acceleration of vesting, we accounted for our stock options
in accordance with Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees. Consequently, the acceleration of vesting resulted in
non-cash compensation charge of $427,000 for the year ended December 31, 2005.
For 2005, we recognized no impairment loss on our residual interest in
securitizations compared to $11.8 million in 2004. In 2004, such impairment loss
related to our analysis and estimate of the expected ultimate performance of our
previously securitized pools that are held by non-consolidated subsidiaries and
the residual interest in securitizations. The impairment loss was a result of
the actual net loss and prepayment rates exceeding our previous estimates for
the automobile contracts held by non-consolidated subsidiaries.
Marketing expenses increased by $3.7 million, or 43.9%, to $12.0 million,
compared to $8.3 million in the same period of the previous year and represented
6.3% of total operating expenses. The increase is primarily due to the increase
in automobile contracts we purchased during the year ended December 31, 2005.
Occupancy expenses decreased by $120,000, or 3.4%, to $3.4 million, compared to
$3.5 million in the same period of the previous year and represented 1.8% of
total operating expenses. The decrease is primarily due to the closure and
sub-leasing during 2005 of certain facilities acquired in the MFN and TFC
transactions.
Depreciation and amortization expenses remained essentially unchanged at
$790,000 for 2005, compared to $785,000 for 2004, and represented 0.4% of total
operating expenses.
We would have recorded income tax expense of $1.4 million for the year ended
December 31, 2005, but the income tax expense was offset primarily by a $1.4
million decrease in the valuation allowance that has been established to offset
our deferred tax assets.
COMPARISON OF OPERATING RESULTS FOR THE YEAR ENDED DECEMBER 31, 2004 WITH THE
YEAR ENDED DECEMBER 31, 2003
REVENUES. During the year ended December 31, 2004, revenues were $132.7 million,
an increase of $27.7 million, or 26.4%, from the prior year revenue of $105.0
million. The primary reason for the increase in revenues is an increase in
interest income. Interest income for the year ended December 31, 2004 increased
$47.7 million, or 81.9%, to $105.8 million in 2004 from $58.2 million in 2003.
The primary reasons for the increase in interest income are the change in
securitization structure implemented during the third quarter of 2003 (an
increase of $56.0 million) and the interest income earned on the portfolios of
automobile contracts acquired in the TFC transaction (an increase of $7.2
million) and the SeaWest asset acquisition (an increase of $6.1 million). This
increase was partially offset by the decline in the balance of the portfolio of
automobile contracts acquired in the MFN transaction (resulting in a decrease of
$10.1 million in interest income) and a decrease in residual interest income (a
decrease of $11.6 million).
The increase in interest income is offset in part by the elimination of net gain
on sale of automobile contracts revenue and a decrease in servicing fees. As a
result of the change in securitization structure, no net gain on sale of
automobile contracts was recorded in 2004, compared to $10.4 million net gain on
sale in the year earlier period.
Servicing fees totaling $12.5 million in the year ended December 31, 2004
decreased $4.6 million, or 26.8%, from $17.1 million in the same period a year
earlier. The decrease in servicing fees is the result of the change in
securitization structure and the consequent decline in our managed portfolio
held by non-consolidated subsidiaries. The decrease was partially offset by the
servicing fees earned on the automobile contracts securitized by SeaWest, on
which we earn only a servicing fee, which totaled $2.0 million. As a result of
the decision to structure future securitizations as secured financings, our
managed portfolio held by non-consolidated subsidiaries will continue to decline
in future periods, and servicing fee revenue is anticipated to decline
proportionately. As of December 31, 2004 and 2003, our managed portfolio owned
by consolidated vs. non-consolidated subsidiaries and other third parties was as
follows:
31
DECEMBER 31, 2004 DECEMBER 31, 2003
---------------------- ----------------------
AMOUNT % AMOUNT %
---------- --------- ---------- ---------
Total Managed Portfolio (DOLLARS IN MILLIONS)
Owned by Consolidated Subsidiaries ...... $ 619.8 68.3% $ 318.0 42.8%
Owned by Non-Consolidated Subsidiaries .. 233.6 25.8% 425.5 57.2%
SeaWest Third Party Portfolio ........... 53.5 5.9% -- 0.0%
---------- --------- ---------- ---------
Total ................................... $ 906.9 100.0% $ 743.5 100.0%
========== ========= ========== =========
At December 31, 2004, we were generating income and fees on a managed portfolio
with an outstanding principal balance of $906.9 million (this amount includes
$53.5 million related to automobile contracts securitized by SeaWest, on which
we earn only a servicing fee), compared to a managed portfolio with an
outstanding principal balance of $743.5 million as of December 31, 2003. As the
portfolios of automobile contracts acquired in the MFN and the TFC transactions
decrease, the portfolio of automobile contracts that we purchased directly from
automobile dealers continues to expand. At December 31, 2004 and 2003, the
managed portfolio composition was as follows:
DECEMBER 31, 2004 DECEMBER 31, 2003
---------------------- ----------------------
AMOUNT % AMOUNT %
---------- --------- ---------- ---------
ORIGINATING ENTITY (DOLLARS IN MILLIONS)
CPS ............................ $ 706.8 77.9% $ 543.8 73.1%
TFC ............................ 89.4 9.9% 126.0 17.0%
MFN ............................ 17.8 2.0% 73.7 9.9%
SeaWest ........................ 39.4 4.3% -- 0.0%
SeaWest Third Party Portfolio... 53.5 5.9% -- 0.0%
---------- --------- ---------- ---------
Total .......................... $ 906.9 100.0% $ 743.5 100.0%
========== ========= ========== =========
Other income decreased $4.9 million, or 25.6%, to $14.4 million during 2004 from
$19.3 million during 2003. The period over period decrease resulted primarily
from a sales tax refund of $3.0 million received in 2003 and decreased
recoveries on previously charged off MFN automobile contracts, which were $8.0
million during 2004, compared to $12.2 million for 2003.
EXPENSES. Total operating expenses were $148.6 million for 2004, compared to
$108.0 million for 2003. The increase is primarily due to a $21.2 million
increase in the provision for credit losses to $32.6 million during the 2004
period as compared to $11.4 million in the 2003 period. Increased interest
expense was also significant.
Employee costs increased to $38.2 million during 2004, representing 25.7% of
total operating expenses, from $37.1 million for 2003, or 34.4% of total
operating expenses. The slight increase is primarily the result of staff
additions related to increased automobile contract purchases in 2004 (an
increase of $3.9 million). This increase was partially offset by staff
reductions since the MFN transaction in 2002 related to the integration and
consolidation of certain service and administrative activities and the decline
in the balance of the portfolio of automobile contracts acquired in the MFN
transaction (a decrease of $3.2 million). The decrease as a percentage of total
operating expenses reflects the higher total of operating expenses, primarily a
result of the increased provision for credit losses and interest expense.
General and administrative expenses remained essentially unchanged at $21.3
million, or 14.3% of total operating expenses, in 2004, as compared to $21.3
million, or 19.7% of total operating expenses, in 2003. The decrease as a
percentage of total operating expenses reflects the higher operating expenses
primarily a result of the provision for credit losses and interest expense.
Interest expense for 2004 increased $8.3 million, or 34.7%, to $32.1 million,
compared to $23.9 million in 2003. The increase is primarily the result of
changes in the amount and composition of securitization trust debt carried on
our consolidated balance sheet. Such debt increased as a result of the change in
securitization structure implemented in the third quarter of 2003, the TFC
acquisition in May 2003 and the SeaWest asset acquisition in April 2004 (a
combined increase in interest expense of approximately $10.3 million), partially
offset by the decrease in the balance of the securitization trust debt acquired
in the MFN transaction (resulting in a decrease of approximately $2.0 million in
interest expense).
32
Impairment loss increased by $7.7 million, or 190.0%, to $11.8 million in 2004
as compared to $4.1 million in 2003. Such impairment loss relates to our
analysis and estimate of the expected ultimate performance of our previously
securitized pools that are held by non-consolidated subsidiaries and the
residual interest in securitizations. The impairment loss is a result of the
actual net loss and prepayment rates exceeding our previous estimates for the
automobile contracts held by non-consolidated subsidiaries.
Marketing expenses increased by $3.0 million, or 55.0%, and represented 5.6% of
total operating expenses. The increase is primarily due to the increase in
automobile contracts we purchased during the year ended December 31, 2004.
Occupancy expenses decreased by $410,000, or 10.4%, and represented 2.4% of
total operating expenses. The decrease is primarily due to the closure and
sub-leasing during 2004 of certain facilities acquired in the MFN and TFC
transactions.
Depreciation and amortization expenses decreased by $215,000, or 21.5%, to
$785,000 from $1.0 million.
No income tax benefit was recorded in 2004 as compared to $3.4 million recorded
in 2003. 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
resulting in a tax provision of $1.5 million. We do not expect any comparable
income tax benefit in future periods.
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY
Our business requires substantial cash to support purchases of automobile
contracts and other operating activities. Our primary sources of cash have been
cash flows from operating activities, including proceeds from sales of
automobile contracts, amounts borrowed under various revolving credit facilities
(also sometimes known as warehouse credit facilities), servicing fees on
portfolios of automobile contracts previously sold in securitization
transactions or serviced for third parties, customer payments of principal and
interest on finance receivables, fees for origination of automobile contracts,
and releases of cash from securitized portfolios of automobile contracts in
which we have retained a residual ownership interest and from the spread
accounts associated with such pools. Our primary uses of cash have been the
purchases of automobile 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 our cash demands. The sufficiency of internally generated
cash will depend on the performance of securitized pools (which determines the
level of releases from those portfolios and their related spread accounts), the
rate of expansion or contraction in our managed portfolio, and the terms upon
which we are able to purchase, sell, and borrow against automobile contracts.
Net cash provided by operating activities for the years ended December 31, 2005,
2004 and 2003 was $36.7 million, $10.0 million and $98.9 million, respectively.
Cash from operating activities is generally provided by the net releases from
our securitization trusts. The increase in 2005 vs. 2004 is due in part to our
increased net earnings before the significant increase in the provision for
credit losses. The decrease in 2004 vs. 2003 is primarily the result of our
decision, in the third quarter of 2003, to treat all of our future
securitizations as secured financings. As a result, 2005 and 2004 include no
activity related to automobile contracts held for sale.
Net cash used in operating activities for the three-month period ended March 31,
2006 was $33.5 million compared to net cash used in operating activities for the
three-month period ended March 31, 2005 of $9.2 million. Cash used in operating
activities is affected by the increase in restricted cash as a result of our
pre-funding structure used in the securitization of our finance receivables. The
pre-funding structure allows us to issue securitization debt approximately one
month prior to purchasing finance receivables that collateralize the debt. In
those cases, certain of the proceeds of the securitization debt are held as
restricted cash until such time as the additional collateral is delivered to the
related trust. Increases in restricted cash are offset somewhat by our increased
net earnings before the significant increase in the provision for credit losses.
Net cash used in investing activities for the years ended December 31, 2005,
2004 and 2003, was $411.7 million, $314.1 million, and $178.9 million,
respectively. Cash used in investing activities has generally related to
purchases of automobile contracts, the cost of the SeaWest asset acquisition and
the acquisition of TFC. Purchase of finance receivables held for investment were
$691.3 million, $506.0 million and $175.3 million in 2005, 2004 and 2003,
respectively. Cash used in the TFC acquisition, net of the cash acquired in the
transaction, totaled $10.2 million for the year ended December 31, 2003.
33
Net cash used in investing activities for the three-month periods ended March
31, 2006 and 2005 was $153.8 million and $79.8 million, respectively. Cash used
in investing activities has generally related to purchases of automobile
contracts.
Net cash provided by financing activities for the year ended December 31, 2005,
was $378.4 million compared with $285.3 million for the year ended December 31,
2004 and $80.3 million for the year ended December 31, 2003. Cash used or
provided by financing activities is primarily attributable to the issuance or
repayment of debt. In connection with the TFC acquisition, we assumed
securitization trust debt related to three securitization transactions held by
consolidated subsidiaries and assumed additional subordinated debt. With the
change in the securitization structure implemented in the third quarter of 2003,
$662.4 million of securitization trust debt was issued in 2005 as compared to
$474.7 million in 2004 and $154.4 million in 2003.
Net cash provided by financing activities for the three months ended March 31,
2006 and 2005, was $195.1 million and $84.4 million respectively. Cash provided
by financing activities is generally related to the issuance of new
securitization trust debt. We issued $281.0 million and $135.9 million of such
debt in the three-month periods ended March 31, 2006 and 2005 respectively. Cash
used in financing activities is includes the repayment of securitization trust
debt of $105.0 million and $59.6 million for the three-month periods ended March
31, 2006 and 2005, respectively.
We purchase automobile contracts from dealers for a cash price approximating
their principal amount, adjusted for an acquisition fee which may either
increase or decrease the automobile contract purchase price. Those automobile
contracts generate cash flow, however, over a period of years. As a result, we
have been dependent on warehouse credit facilities to purchase automobile
contracts, and on the availability of cash from outside sources in order to
finance our continuing operations, as well as to fund the portion of automobile
contract purchase prices not financed under revolving warehouse credit
facilities. As of March 31, 2006, we had $350 million in warehouse credit
capacity, in the form of a $150 million facility and $200 million facility. The
$200 million facility provides funding for automobile contracts purchased under
the TFC Programs while both warehouse facilities provide funding for automobile
contracts purchased under the CPS Programs. On June 29, 2005, we terminated a
third facility in the amount of $125 million, which we had utilized to fund
automobile contracts under the CPS and TFC Programs.
The first of two warehouse facilities mentioned above is structured to allow us
to fund a portion of the purchase price of automobile contracts by drawing
against a floating rate variable funding note issued by our consolidated
subsidiary Page Three Funding, LLC. This facility was established on November
15, 2005, and expires on November 14, 2006, although it is renewable with the
mutual agreement of the parties. Up to 80% of the principal balance of
automobile contracts may be advanced to us 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 2.00% per annum. At
March 31, 2006, $171,000 was outstanding under this facility.
The second of two warehouse facilities is similarly structured to allow us to
fund a portion of the purchase price of automobile contracts by drawing against
a floating rate variable funding note issued by our consolidated subsidiary Page
Funding LLC. This facility was entered into on June 30, 2004. On June 29, 2005
the facility was increased from $100 million to $125 million and further amended
to provide for funding for automobile contracts purchased under the TFC
programs, in addition to our CPS programs. The available credit under the
facility was increased again to $200 million on August 31, 2005. In February
2006, the terms of this facility were amended to allow advances to us of up to
80% of the principal balance of automobile contracts that we purchase under our
CPS programs, and of up to 70% of the principal balance of automobile contracts
that we purchase under our TFC programs, in all events subject to collateral
tests and certain other conditions and covenants. Notes under this facility
accrue interest at a rate of one-month LIBOR plus 2.00% per annum. The lender
has annual termination options at its sole discretion on each June 30 through
2007, at which time the agreement expires. At March 31, 2006, $74.9 million was
outstanding under this facility.
The balance outstanding under these warehouse facilities generally will increase
as we purchase additional automobile contracts, until we effect a securitization
utilizing automobile contracts warehoused in the facilities, at which time the
balance outstanding will decrease.
34
We securitized $202.3 million of automobile contracts in one private placement
transaction during the three months ended March 31, 2006, and $674.4 million of
automobile contracts in five private placement transactions during the year
ended December 31, 2005, as compared to $463.9 million in five private
placements during the year ended December 31, 2004. All of these transactions
were structured as secured financings and, therefore, resulted in no gain on
sale. During the year ended December 31, 2003, we securitized $416.9 million of
automobile contracts in four private placement transactions. The first two such
transactions of 2003 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. In March 2004, one of our
wholly-owned bankruptcy remote consolidated subsidiaries issued $44.0 million of
asset-backed notes secured by its retained interest in eight term securitization
transactions. The notes had an interest rate of 10.0% per annum and a final
maturity in October 2009 and were required to be repaid from the distributions
on the underlying retained interests. In connection with the issuance of the
notes, we incurred and capitalized issuance costs of $1.3 million. We repaid the
notes in full in August 2005. In November 2005, we completed a similar
securitization whereby a wholly-owned bankruptcy remote consolidated subsidiary
of ours issued $45.8 million of asset-backed notes secured by its retained
interest in 10 term securitization transactions. These notes, which bear
interest at a blended interest rate of 8.36% per annum and have a final maturity
in July 2011, are required to be repaid from the distributions on the underlying
residual interests. In connection with the issuance of the notes, we incurred
and capitalized issuance costs of $915,000.
For the portfolio owned by non-consolidated subsidiaries, cash used to increase
credit enhancement amounts to required levels for the years ended December 31,
2005, 2004 and 2003 was zero, $2.9 million, $20.9 million, respectively. Cash
released from trusts and their related spread accounts to us related to the
portfolio owned by consolidated subsidiaries for the years ended December 31,
2005, 2004 and 2003 was $23.1 million, $21.4 million and $25.9 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 automobile contracts securitized that make up our managed
portfolio to which the respective spread accounts are related. During the years
ended December 31, 2005 and December 31, 2004, we made no initial deposits to
spread accounts and funded no initial overcollateralization related to our term
securitization transactions owned by non-consolidated subsidiaries, compared to
$18.7 million in 2003.
For the portfolio owned by consolidated subsidiaries, cash used to establish or
increase spread accounts for the three-month periods ended March 31, 2006 and
2005 was $6.1 million and $3.2 million, respectively. Cash released from trusts
and their related spread accounts to our for the three-month periods ended March
31, 2006 and 2005, was $3.9 million and $8.0 million, respectively
The acquisition of automobile 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 our automobile
contract purchases, the required level of initial credit enhancement in
securitizations, and the extent to which the previously established trusts and
their related spread accounts either release cash to us or capture cash from
collections on securitized automobile contracts. We may be limited in our
ability to purchase automobile contracts due to limits on our capital. As of
December 31, 2005, we had unrestricted cash on hand of $17.8 million and
available capacity from our warehouse credit facilities of $314.6 million. As of
March 31, 2006, we had unrestricted cash on hand of $25.5 million and available
capacity from our warehouse credit facilities of $274.9 million. Warehouse
capacity is subject to the availability of suitable automobile contracts to
serve as collateral and of sufficient cash to fund the portion of such
automobile contracts purchase price not advanced under the warehouse facilities.
Our plans to manage the need for liquidity include the completion of additional
securitizations that would provide additional credit availability from the
warehouse credit facilities, and matching our levels of automobile contract
purchases to our availability of cash. There can be no assurance that we will be
able to complete securitizations on favorable economic terms or that we will be
able to complete securitizations at all. If we are unable to complete such
securitizations, we may be unable to purchase automobile contracts and interest
income and other portfolio related income would decrease.
35
Our primary means of ensuring that our cash demands do not exceed our cash
resources is to match our levels of automobile contract purchases to our
availability of cash. Our ability to adjust the quantity of automobile contracts
that we purchase and securitize 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 automobile contract purchases can
be maintained or increased. While the specific terms and mechanics of each
spread account vary among transactions, our securitization agreements generally
provide that we 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 automobile contracts in the pool are below certain
predetermined levels. In the event delinquencies, defaults or net losses on the
automobile 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 us 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 automobile contracts to
another servicer. There can be no assurance that collections from the related
trusts will continue to generate sufficient cash.
Certain of our securitization transactions and the warehouse credit facilities
contain various financial covenants requiring certain minimum financial ratios
and results. Such covenants include maintaining minimum levels of liquidity and
net worth and not exceeding maximum leverage levels and maximum financial
losses. In addition, certain securitization and non-securitization related debt
contain cross-default provisions that would allow certain creditors to declare a
default if a default occurred under a different facility.
The agreements under which we receive periodic fees for servicing automobile
contracts in securitizations are terminable by the respective note insurers upon
defined events of default, and, in some cases, at the will of the note insurer.
Were a note insurer in the future to exercise its option to terminate such
agreements, such a termination could have a material adverse effect on our
liquidity and results of operations, depending on the number and value of the
terminated agreements. Our note insurers continue to extend our term as servicer
on a monthly and/or quarterly basis, pursuant to the servicing agreements.
CONTRACTUAL OBLIGATIONS
The following table summarizes our material contractual obligations as of
December 31, 2005 (dollars in thousands):
PAYMENT DUE BY PERIOD(1)
-----------------------------------------------------
LESS THAN 1 TO 3 3 TO 5 MORE THAN
TOTAL 1 YEAR YEARS YEARS 5 YEARS
--------- --------- ------- ------- ---------
Long Term Debt (2)(3) $ 58,866 $ 55,854 $ 2,642 $ 279 $ 91
Operating Leases .... $ 11,085 $ 4,353 $ 6,188 $ 545 $ --
(1) Securitization trust debt, in the aggregate amount of $924.0 million as of
December 31, 2005, is omitted from this table because it becomes due as and when
the related receivables balance is reduced. Expected payments, which will depend
on the performance of such receivables, as to which there can be no assurance,
are $328.7 million in 2006, $223.7 million in 2007, $160.5 million in 2008,
$114.6 million in 2009, $75.1 million in 2010, and $21.4 million in 2011.
Residual interest financing, of $43.7 million as of December 31, 2005, is also
omitted from this table because it becomes due as and when the related residual
interest and Spread account balances are reduced. Expected payments, which will
depend on the performance of the related receivables, as to which there can be
no assurance, are $18.0 million in 2006, $14.4 million in 2007, $7.6 million in
2008 and $3.7 million in 2009.
(2) On May 26, 2006, $25.0 million of long-term debt held by the selling
shareholder, which was due in less than one year (on May 27, 2006 and June 24,
2006) was amended to become due on May 31, 2007. The remaining $15.0 million of
long-term debt held by the selling shareholder is due in December 2006. See
"Certain Transactions." An additional $14.0 million of subordinated debt, not
held by the selling shareholder, was paid when due in January 2006.
(3) Long term debt includes senior secured debt, subordinated debt, subordinated
renewable notes and notes payable.
WAREHOUSE CREDIT FACILITIES
The terms on which credit has been available to us for purchase of automobile
contracts have varied over the three years 2004-2006 and through March 31, 2006,
as shown in the following recapitulation of our warehouse credit facilities:
FACILITY IN USE FROM NOVEMBER 2000 TO FEBRUARY 2004. In November 2000, we
(through our subsidiary CPS Funding LLC) entered into a floating rate variable
note purchase facility under which up to $75.8 million of notes could be
outstanding at any time subject to collateral tests and other conditions. We
used funds derived from this facility to purchase automobile contracts under the
CPS Programs, which were pledged to secure the notes. The collateral tests and
other conditions generally allowed us to borrow up to approximately 72.5% of the
principal balance of the automobile contracts. Notes issued under this facility
bore interest at one-month LIBOR plus 0.75% per annum. This facility expired on
February 21, 2004.
36
FACILITY IN USE FROM MARCH 2002 TO JUNE 2005. In March 2002, we (through our
subsidiary CPS Warehouse Trust) entered into a second floating rate variable
note purchase facility, under which up to $125.0 million of notes could be
outstanding at any time, subject to collateral tests and other conditions. We
used funds derived from this facility to purchase automobile contracts under the
CPS Programs and the TFC Programs, which were pledged to secure the notes. The
collateral tests and other conditions generally allowed us to borrow up to
approximately 73% of the principal balance of the automobile contracts purchased
under the CPS Programs. Notes issued under this facility bore interest at
commercial paper plus 1.18% per annum. During November 2004, this facility was
amended to allow us to borrow up to approximately 70% of the principal balance
of automobile contracts purchased under the TFC Programs. This facility was due
to expire on April 11, 2006, but we elected to terminate it on June 29, 2005.
FACILITY IN USE FROM MAY 2003 TO JUNE 2004. In connection with the TFC merger in
May 2003, we (through our subsidiary TFC Warehouse I LLC) entered into a third
floating rate variable note purchase facility, under which up to $25.0 million
of notes could be outstanding at any time, subject to collateral tests and other
conditions. We used funds derived from this facility to purchase automobile
contracts under the TFC Programs, which were pledged to secure the notes. The
collateral tests and other conditions generally allowed us to borrow up to
approximately 71% of the principal balance of the automobile contracts. Notes
issued under this facility bore interest at LIBOR plus 1.75% per annum. This
facility expired on June 24, 2004.
FACILITY IN USE FROM JUNE 2004 TO PRESENT. In June 2004, we (through our
subsidiary Page Funding LLC) entered into a floating rate variable note purchase
facility. Up to $200.0 million of notes may be outstanding under this facility
at any time subject to certain collateral tests and other conditions. We use
funds derived from this facility to purchase automobile contracts under the CPS
Programs and TFC Programs, which are pledged to secure the notes. The collateral
tests and other conditions generally allow us to borrow up to approximately 80%
of the principal balance of automobile contracts that we purchase under our CPS
programs, and of up to 70% of the principal balance of automobile contracts that
we purchase under our TFC programs. Notes issued under this facility bear
interest at one-month LIBOR plus 2.00% per annum. The balance of notes
outstanding related to this facility at December 31, 2005 was $836,000 and at
March 31, 2006 was $74.9 million.
FACILITY IN USE FROM NOVEMBER 2005 TO PRESENT. In November 2005, we (through our
subsidiary Page Three Funding LLC) entered into a floating rate variable note
purchase facility. Up to $150 million of notes may be outstanding under this
facility at any time subject to certain collateral tests and other conditions.
We use funds derived from this facility to purchase automobile contracts under
the CPS Programs, which are pledged to secure the notes. The collateral tests
and other conditions generally allow us to borrow up to approximately 80.0% of
the principal balance of the automobile contracts. Notes issued under this
facility bear interest at one-month LIBOR plus 2.00 % per annum. The balance of
notes outstanding related to this facility at December 31, 2005 was $34.5
million and at March 31, 2006 was $171,000.
CAPITAL RESOURCES
As noted above, approximately $15.0 million of long-term debt matures in
December 2006, and an additional $25.0 million of long-term debt matures in May
2007. We plan to repay our long-term debt from a combination of the following:
(i) additional proceeds from the offering of subordinated renewable notes; (ii)
a possible transaction similar to the financings that we undertook in March 2004
and November 2005, where we issued notes secured by our residual interests in
securitizations; and (iii) possible senior secured financing similar to our
existing outstanding senior secured financing. There can be no assurance that we
will be able to complete these transactions. Securitization trust debt is repaid
from collections on the related receivables, and becomes due in accordance with
its terms as the principal amount of the related receivables is reduced.
Although the securitization trust debt also has alternative maximum maturity
dates, those dates are significantly later than the dates at which repayment of
the related receivables is anticipated, and at no time in our history have any
of our sponsored asset-backed securities reached those alternative maximum
maturities.
The acquisition of automobile contracts for subsequent transfer 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 our automobile contract purchases, the required level
of initial credit enhancement in securitizations, and the extent to which the
trusts and related spread accounts either release cash to us or capture cash
from collections on securitized automobile contracts. We plan to adjust our
levels of automobile contract purchases so as to match anticipated releases of
cash from the trusts and related spread accounts with our capital requirements.
37
CAPITALIZATION
Over the period from January 1, 2003 through March 31, 2006 we have managed our
capitalization by issuing and restructuring debt as summarized in the following
table:
THREE MONTHS
ENDED
MARCH 31, YEAR ENDED DECEMBER 31,
------------- ------------------------------------------
2006 2005 2004 2003
------------- ------------ ------------ ------------
(unaudited) (Dollars in thousands)
RESIDUAL INTEREST FINANCING:
Beginning balance ......................... $ 43,745 $ 22,204 $ -- $ --
Issuances .............................. -- 45,800 44,000 --
Payments ............................... (6,017) (24,259) (21,796) --
------------- ------------ ------------ ------------
Ending balance ............................ $ 37,728 $ 43,745 $ 22,204 $ --
============= ============ ============ ============
SECURITIZATION TRUST DEBT:
Beginning balance ......................... $ 924,026 $ 542,815 $ 245,118 $ 71,630
Assumption in connection with TFC Merger -- -- -- 115,597
Issuances .............................. 280,977 662,350 474,720 154,735
Payments ............................... (104,397) (281,139) (177,023) (96,484)
------------- ------------ ------------ ------------
Ending balance ............................ $ 1,100,606 $ 924,026 $ 542,815 $ 245,118
============= ============ ============ ============
SENIOR SECURED DEBT:
Beginning balance ......................... $ 40,000 $ 59,829 $ 49,965 $ 50,072
Issuances .............................. -- -- 25,000 25,000
Payments ............................... -- (19,829) (15,136) (25,107)
------------- ------------ ------------ ------------
Ending balance ............................ $ 40,000 $ 40,000 $ 59,829 $ 49,965
============= ============ ============ ============
SUBORDINATED DEBT:
Beginning balance ......................... $ 14,000 $ 15,000 $ 35,000 $ 36,000
Payments ............................... (14,000) (1,000) (20,000) (1,000)
------------- ------------ ------------ ------------
Ending balance ............................ $ -- $ 14,000 $ 15,000 $ 35,000
============= ============ ============ ============
SUBORDINATED RENEWABLE NOTES:
Beginning balance ......................... $ 4,655 $ -- $ -- $ --
Issuances .............................. 1,701 4,685 -- --
Payments ............................... (42) (30) -- --
------------- ------------ ------------ ------------
Ending balance ............................ $ 6,314 $ 4,655 $ -- $ --
============= ============ ============ ============
RELATED PARTY DEBT:
Beginning balance ......................... -- $ -- $ 17,500 $ 17,500
Non-cash conversion .................... -- -- (1,000) --
Payments ............................... -- -- (16,500) --
------------- ------------ ------------ ------------
Ending balance ............................ -- $ -- $ -- $ 17,500
============= ============ ============ ============
RESIDUAL INTEREST FINANCING. In March 2004, one of our wholly-owned bankruptcy
remote consolidated subsidiaries issued $44.0 million of asset-backed notes
secured by our retained interests in eight term securitization transactions. We
repaid the notes in full in August 2005. In November 2005, we completed a
similar securitization whereby a wholly-owned bankruptcy remote consolidated
subsidiary of ours issued $45.8 million of asset-backed notes secured by our
retained interests in 10 term securitization transactions. These notes have a
final maturity in July 2011, and are required to be repaid from the
distributions on the underlying retained interests.
SECURITIZATION TRUST DEBT. Since the third quarter of 2003, we have for
financial accounting purposes, treated securitizations of automobile contracts
as secured financings, and the asset-backed securities issued in such
securitizations remain on our balance sheet as securitization trust debt. In
addition, in connection with the MFN merger in March 2002 and the TFC merger in
May 2003 we assumed $156.9 million and $115.6 million, respectively, of
securitization trust debt related to finance receivables that had been
previously securitized in securitization transactions accounted for as secured
financings.
38
SENIOR SECURED DEBT. Since 1998, we have entered into a series of financing
transactions with the selling shareholder to provide us with funding in the form
of issuances of our debt securities to the selling shareholder. For additional
details on our existing senior secured notes, see "Certain Transactions."
SUBORDINATED DEBT. In April 1997, we issued $20.0 million in subordinated
participating equity notes due April 2004, which we retired in the second
quarter of 2004. In 1995, we issued $20.0 million of Rising Interest
Subordinated Redeemable Securities, or RISRS, due 2006. The RISRS included a
sinking fund in their terms, and we repaid in the first quarter of 2006 the
$14.0 million that remained outstanding. In May 2003, in connection with the
acquisition of TFC, we assumed $6.3 million in principal amount of subordinated
debt that TFC had outstanding. We amortized this debt monthly and repaid it in
full in June 2005.
SUBORDINATED RENEWABLE NOTES DEBT. In June 2005, we began issuing registered
subordinated renewable notes. Upon maturity, the notes will be automatically
renewed for the same term as the maturing notes, unless we elect not to have the
notes renewed or unless the investor notifies us within 15 days after the
maturity date for his notes that he wants his notes repaid. Renewed notes will
bear interest at the rate we are offering at that time to other investors with
similar aggregate note portfolios. Based on the terms of the individual notes,
interest payments may be required monthly, quarterly, annually or upon maturity.
RELATED PARTY DEBT. In June 1997, we borrowed $15.0 million unsecured and
subordinated debt from an affiliated corporation. This debt was due in 2004 and
we repaid the $15.0 million of debt in the second quarter of 2004. During 1998,
we borrowed $1.0 million of convertible debt from one of our directors, and in
the second quarter of 2004, the indebtedness to the director was converted, in
accordance with its terms, into common stock at the rate of $3.00 per share.
During 1999, we borrowed $1.5 million of debt from an affiliated corporation and
we repaid this debt in the second quarter of 2004.
We must comply with certain affirmative and negative covenants related to debt
facilities, which require, among other things, that we maintain certain
financial ratios related to liquidity, net worth, capitalization, investments,
acquisitions, restricted payments and certain dividend restrictions. As a result
of waivers and amendments to covenants related to securitization and
non-securitization related debt throughout 2004 and 2005, we were in compliance
with all such covenants as of March 31, 2006. In addition, certain
securitization and non-securitization related debt contain cross-default
provisions that would allow certain creditors to declare default if a default
occurred under a different facility.
39
OUR COMPANY
OVERVIEW
We are a specialty finance company engaged in purchasing and servicing retail
automobile contracts originated primarily by franchised automobile dealers and
to a lesser extent by select independent dealers in the United States in the
sale of new and used automobiles, light trucks and passenger vans. Through our
automobile contract purchases, we provide indirect financing to the customers of
dealers, who have limited credit histories, low incomes or past credit problems,
who we refer to as sub-prime customers. We serve as an alternative source of
financing for dealers, facilitating sales to customers who otherwise might not
be able to obtain financing from traditional sources, such as commercial banks,
credit unions and the captive finance companies affiliated with major automobile
manufacturers. We do not lend money directly to consumers but, rather, purchase
automobile contracts from dealers under several different financing programs. We
are headquartered in Irvine, California, where all credit and underwriting
functions are centralized. We service our automobile contracts from our
California headquarters and from three strategically located servicing branches
in Virginia, Florida and Illinois.
We direct our marketing efforts to dealers, rather than to consumers. We
establish relationships with dealers through marketing representatives who
contact a prospective dealer to explain our automobile contract purchase
programs, and thereafter provide dealer training and support services. The
marketing representatives are obligated to represent our financing program
exclusively. Our marketing representatives present the dealer with a marketing
package, which includes our promotional material containing the terms offered by
us for the purchase of automobile contracts, a copy of our standard-form dealer
agreement, and required documentation relating to automobile contracts. As of
March 31, 2006, we had 85 marketing representatives and we were a party to
dealer agreements with over 7,300 dealers in 47 states. Approximately 92% of
these dealers are franchised new car dealers that sell both new and used cars
and the remainder are independent used car dealers. For the year ended December
31, 2005, approximately 81% of the automobile contracts purchased under our
programs consisted of financing for used cars and 19% consisted of financing for
new cars, as compared to 85% financing for used cars and 15% for new cars in the
year ended December 31, 2004.
We purchase automobile contracts with the intention of financing them on a
long-term basis through securitizations. Securitizations are transactions in
which we sell a specified pool of contracts to a special purpose entity of ours,
which in turn issues asset-backed securities to fund the purchase of the pool of
contracts from us. Depending on the structure of the securitization, the
transaction may, for financial accounting purposes, be treated as a sale of the
contracts or as a secured financing. From inception through the third quarter of
2003, we generated revenue primarily from the gains recognized on the sale or
securitization of automobile contracts, servicing fees earned on automobile
contracts sold, interest earned on residual interests and interest on finance
receivables. However, since the third quarter of 2003, we have structured our
securitizations to be treated as secured financings rather than as sales of
automobile contracts for financial accounting purposes. By accounting for these
securitizations as secured financings, the contracts and asset-backed notes
issued remain on our balance sheet with the interest income of the contracts in
the trust and the related financing costs reflected over the life of the
underlying pool of contracts.
We were incorporated and began our operations in October 1991. From inception
through March 31, 2006, we have purchased a total of approximately $6.3 billion
of automobile contracts from dealers. In addition, we obtained a total of
approximately $605.0 million of automobile contracts in our 2002, 2003 and 2004
acquisitions, as described below. Our total managed portfolio, net of unearned
interest on pre-computed automobile contracts, grew to approximately $1,240.0
million at March 31, 2006 from $1,122.0 million at December 31, 2005, $906.9
million as of December 31, 2004 and $743.5 million as of December 31, 2003.
HISTORICAL ACQUISITIONS
In March 2002, we acquired MFN Financial Corporation and its subsidiaries, or
MFN, in a merger, which we refer to as the MFN merger. In May 2003, we acquired
TFC Enterprises, Inc. and its subsidiaries, or TFC, in a second merger, which we
refer to as the TFC merger. We acquired $381.8 million of automobile contracts
in the MFN merger, and $152.1 million in the TFC merger. MFN and TFC were
engaged in businesses similar to that of ours. MFN ceased acquiring automobile
contracts in March 2002, while TFC continues to acquire automobile contracts
under its TFC programs. Automobile contracts purchased by TFC during the year
ended December 31, 2005 accounted for less than 5% of our total purchases during
the year. In April 2004, we acquired $74.9 million in automobile contracts from
SeaWest Financial Corporation and its subsidiaries. In addition, we were named
servicer of approximately $111.8 million of automobile contracts that SeaWest
had previously securitized.
40
SUB-PRIME AUTO FINANCE INDUSTRY
Automobile financing is the second largest consumer finance market in the United
States. The automobile finance industry can be divided into two principal
segments: a prime credit market and a sub-prime credit market. Traditional
automobile finance companies, such as commercial banks, savings institutions,
credit unions and captive finance companies of automobile manufacturers,
generally lend to the most creditworthy, or so-called prime, borrowers. The
non-prime automobile credit market, in which we operate, provides financing to
borrowers who generally cannot obtain financing from traditional lenders.
Historically, traditional lenders have not serviced the sub-prime market or have
done so only through programs that were not consistently available. Independent
companies specializing in sub-prime automobile financing and subsidiaries of
larger financial services companies currently compete in this segment of the
automobile finance market, which we believe remains highly fragmented, with no
single company having a significant share of the market.
OUR OPERATIONS
Our automobile financing programs are designed to serve sub-prime 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, because they have limited credit
histories, low incomes or past credit problems. Because we serve customers who
are unable to meet the credit standards imposed by most traditional automobile
financing sources, we generally receive interest rates higher than those charged
by traditional automobile financing sources. We also sustain a higher level of
credit losses than traditional automobile financing sources since we provide
financing in a relatively high risk market.
ORIGINATIONS
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. We believe the dealer's decision to choose a financing source is
based primarily on: (i) the monthly payment; (ii) the purchase price offered for
the contract; (iii) timeliness, consistency and predictability of response; (iv)
funding turnaround time; and (v) any conditions to purchase. Dealers can send
credit applications to us via the Internet or fax. For the three months ended
March 31, 2006, we received approximately 80% of all applications through
DealerTrack (the industry leading dealership application aggregator), 10% via
our website and 10% via fax. Our automated application decisioning system gave
an almost instantaneous response to about 90% of those applications.
Upon receipt of information from a dealer, our proprietary automated decisioning
system orders a credit report to document the buyer's credit history. If, upon
review by the automated decisioning systems, or in some cases, one of our credit
analysts, it is determined that the automobile contract meets our underwriting
criteria, or would meet such criteria with modification, we request and review
further information and supporting documentation and, ultimately, decide whether
to approve the automobile contract for purchase. When presented with an
application, we attempt to notify the dealer within one hour as to whether we
would purchase the related automobile contract.
Most of the dealers under a dealer agreement with us regularly submit automobile
contracts for purchase, although they are under no obligation to submit any
automobile contracts to us, nor are we obligated to purchase any automobile
contracts from them. During the year ended December 31, 2005, and the three
month period ended March 31, 2006, no dealer accounted for more than 1% of the
total number of automobile contracts we purchased. Automobile contracts
purchased by TFC after the TFC merger under the TFC programs are purchased with
a dealer marketing strategy that is similar to that of ours as described above
except that the marketing efforts are directed at independent used car dealers
and the target obligors are enlisted personnel of the U.S. Armed Forces. The
following table sets forth the geographical sources of the automobile contracts
purchased by us (based on the addresses of the customers as stated on our
records) during the three months ended March 31, 2006 and the years ended
December 31, 2005 and 2004.
41
CONTRACTS PURCHASED (1) DURING THE
THREE MONTHS ENDED YEAR ENDED
MARCH 31, 2006 DECEMBER 31, 2005 DECEMBER 31, 2004
------------------------------ ------------------- -----------------
Number Percent Number Percent Number Percent
---------------- --------- -------- -------- ------- ---------
Texas 1,665 10.2% 4,734 10.7% 3,422 12.1%
California 1,620 9.9% 3,981 9.0% 2,431 8.6%
Ohio 1,346 8.2% 3,311 7.5% 1,437 5.1%
Florida 1,125 6.9% 3,151 7.1% 1,731 6.1%
Pennsylvania 905 5.5% 2,732 6.2% 1,676 5.9%
Louisiana 806 4.9% 2,268 5.1% 1,949 6.9%
Illinois 793 4.8% 2,188 4.9% 1,312 4.6%
North Carolina 636 3.9% 2,003 4.5% 1,390 4.9%
Maryland 751 4.6% 1,933 4.4% 1,373 4.8%
Kentucky 690 4.2% 1,851 4.2% 1,118 3.9%
Michigan 716 4.4% 1,883 4.2% 1,121 4.0%
New York 580 3.5% 1,617 3.6% 1,102 3.9%
Virginia 499 3.0% 1,379 3.1% 1,043 3.7%
Georgia 338 2.1% 1,277 2.9% 1,263 4.5%
Other States 3,924 23.9% 10,068 22.7% 6,008 21.2%
-------------- -------- ------ -------- ------- --------
Total 16,394 100.0% 44,376 100.0% 28,376 100.0%
============== ======== ====== ======== ======= ========
(1) Automobile 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.
We purchase automobile contracts under our programs from dealers at a price
generally equal to the total amount financed under the automobile contracts,
adjusted for an acquisition fee, which may either increase or decrease the
automobile contract purchase price paid by us. The amount of the acquisition
fee, and whether it results in an increase or decrease to the automobile
contract purchase price, is based on the perceived credit risk and, in some
cases, the interest rate on the automobile contract. For the years ended
December 31, 2005, 2004 and 2003, the average acquisition fee charged per
automobile contract purchased under our programs was $150, $226 and $372,
respectively, or 1.0%, 1.6% and 2.7%, respectively, of the amount financed.
We offer seven different financing programs to our dealership customers, and
price each program according to the relative credit risk. We offer programs
covering a wide band of the credit spectrum. Our upper credit tier products,
which are our Preferred, Super Alpha, Alpha Plus and Alpha programs accounted
for approximately 82% of our new contract originations in 2005 and 80% for the
three months ended March 31, 2006, in each case measured by aggregate amount
financed.
The following table identifies the credit program, sorted from highest to lowest
credit quality, under which we purchased automobile contracts during the three
months ended March 31, 2006 and the years ended December 31, 2005 and 2004.
42
CONTRACTS PURCHASED (1) DURING THE
THREE MONTHS ENDED YEAR ENDED
MARCH 31, 2006 DECEMBER 31, 2005 DECEMBER 31, 2004
------------------------------------------------------------------------
AMOUNT AMOUNT AMOUNT
FINANCED FINANCED FINANCED
(DOLLARS IN (DOLLARS IN (DOLLARS IN
THOUSANDS) PERCENT THOUSANDS) PERCENT THOUSANDS) PERCENT(2)
------------------------------------------------------------------------
Preferred $ 4,567 1.9% $ 13,735 2.1% $ 6,273 1.5%
Super Alpha 30,027 12.2% 78,030 11.8% 34,134 8.3%
Alpha Plus 48,707 19.7% 135,926 20.6% 70,786 17.3%
Alpha 113,423 46.0% 314,444 47.6% 233,521 57.1%
Standard 19,734 8.0% 67,293 10.2% 36,561 8.9%
Mercury/Delta 17,265 7.0% 20,346 3.1% 9,988 2.4%
First Time Buyer 12,947 5.2% 30,329 4.6% 17,655 4.3%
----------- -------- ----------- -------- ----------- --------
246,670 100.0% 660,103 100.0% 408,918 100.0%
=========== ======== =========== ======== =========== ========
(1) Automobile 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.
(2) Percentages may not total to 100.0% due to rounding.
We attempt to control misrepresentation regarding the customer's credit
worthiness by carefully screening the automobile contracts we purchase, 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, we may require the dealer to
repurchase any automobile contract in the event that the dealer breaches our
representations or warranties. There can be no assurance, however, that any
dealer will have the willingness or the financial resources to satisfy our
repurchase obligations to us.
UNDERWRITING
To be eligible for purchase by us, an automobile contract must have been
originated by a dealer that has entered into a dealer agreement to sell
automobile contracts to us. The automobile contract must be secured by a first
priority lien on a new or used automobile, light truck or passenger van and must
meet our underwriting criteria. In addition, each automobile contract requires
the customer to maintain physical damage insurance covering the financed vehicle
and naming us as a loss payee. We 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 automobile 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 automobile contract.
We believe that our underwriting criteria enable us to evaluate effectively the
creditworthiness of sub-prime customers and the adequacy of the financed vehicle
as security for an automobile contract. The underwriting 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
automobile contract in relation to the value of the vehicle; customer income
level, employment and residence stability, credit history and debt service
ability, as well as other factors. Specifically, our underwriting guidelines
generally limit the maximum principal amount of a purchased automobile 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. We generally do not finance
vehicles that are more than eight model years old or have in excess of 85,000
miles. Under most of our programs, the maximum term of a purchased contract is
72 months; a shorter maximum term may be applicable based on the mileage and age
of the vehicle. Automobile contracts with the maximum term of 72 months may be
purchased if the customer is among the more creditworthy of our obligors and the
vehicle is generally not more than two model years old and has less than 35,000
miles. Automobile contract purchase criteria are subject to change from time to
time as circumstances may warrant. Upon receiving the vehicle and customer
information with the customer's application, our underwriters verify the
customer's employment, residency, and credit information by contacting various
parties noted on the customer's application, credit information bureaus and
other sources. In addition, prior to purchasing an automobile contract, we
contact each customer by telephone to confirm that the customer understands and
agrees to the terms of the related automobile contract. During this "welcome
call," we also ask the customer a series of open ended questions about his
application and the contract to uncover any potential misrepresentations.
43
CREDIT SCORING. We use a proprietary scoring model to assign each automobile
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 customer's income, the
monthly payment amount, the loan-to-value ratio and the age and mileage of the
vehicle. We have developed the credit score utilizing statistical risk
management techniques and historical performance data from our managed
portfolio. We believe this improves our allocation of credit evaluation
resources, and more effectively manages the risk inherent in the sub-prime
market.
CHARACTERISTICS OF CONTRACTS. All of the automobile contracts purchased by us
are fully amortizing and provide for level payments over the term of the
automobile contract. All automobile contracts may be prepaid at any time without
penalty. The average original principal amount financed, under the CPS programs
and in the year ended December 31, 2005, was $14,875, with an average original
term of 62 months and an average down payment amount of 13.4%. Based on
information contained in customer applications for this 12-month period, the
retail purchase price of the related automobiles averaged $15,278 (which
excludes tax, license fees and any additional costs such as a maintenance
contract), the average age of the vehicle at the time the automobile contract
was purchased was 3 years, and our customers averaged approximately 38 years of
age, with approximately $39,596 in average annual household income and an
average of 5.0 years history with his or her current employer.
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 us as secured party with respect
to the vehicle, was effected at the time of sale of the related automobile
contract to us, and that all necessary steps have been taken to obtain a
perfected first priority security interest in each financed vehicle in favor of
us under the laws of the state in which the financed vehicle is registered.
SERVICING AND COLLECTION
We currently service all automobile contracts that we own as well as those
automobile contracts included in portfolios that we have sold to off balance
sheet securitization trusts. We organize our servicing activities based on the
tasks performed by our personnel. Our 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; collecting deficiency balances; and generally monitoring each
automobile contract and the related collateral. We are typically entitled to
receive a base monthly servicing fee between 2.5% and 3.5% per annum computed as
a percentage of the declining outstanding principal balance of the
non-charged-off automobile contracts in the securitization pools. The servicing
fee is included in interest income for on balance sheet financings.
COLLECTION PROCEDURES. We believe that our ability to monitor performance and
collect payments owed from sub-prime customers is primarily a function of our
collection approach and support systems. We believe that if payment problems are
identified early and our collection staff works closely with customers to
address these problems, it is possible to correct many of problems before they
deteriorate further. To this end, we utilize 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
our collection activities, we maintain a computerized collection system
specifically designed to service automobile contracts with sub-prime customers
and similar consumer obligations.
With the aid of our automatic dialer, as well as manual efforts made by
collection staff, we typically attempt 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 we 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.
44
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. At the time the
vehicle is repossessed we will stop accruing interest in this automobile
contract, and reclassify the remaining automobile contract balance to other
assets. In addition we will apply a specific reserve to this automobile contract
so that the net balance represents the estimated fair value less costs to sell.
If we elect to repossess the vehicle, we assign 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
automobile auction, where it is kept until sold. Financed vehicles that have
been repossessed are generally resold by us through unaffiliated automobile
auctions, which are attended principally by car dealers. Net liquidation
proceeds are applied to the customer's outstanding obligation under the
automobile contract. Such proceeds usually are insufficient to pay the
customer's obligation in full, resulting in a deficiency. In many cases we will
continue to contact our customers to recover all or a portion of this deficiency
for up to several years after charge-off.
Once a automobile contract becomes greater than 90 days delinquent, we do not
recognize additional interest income until the borrower under the automobile
contract makes sufficient payments to be less than 90 days delinquent. Any
payments received by a borrower that is greater than 90 days delinquent is first
applied to accrued interest and then to principal reduction.
We generally charge off the balance of any contract by the earlier of the end of
the month in which the automobile 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 us or if the vehicle has
been in repossession inventory for more than 90 days. In the case of
repossession, the amount of the charge-off is the difference between the
outstanding principal balance of the defaulted automobile contract and the net
repossession sale proceeds.
CREDIT EXPERIENCE
Our financial results are dependent on the performance of the automobile
contracts in which we retain an ownership interest. The tables below document
the delinquency, repossession and net credit loss experience of all automobile
contracts that we are servicing (excluding contracts from the SeaWest third
party portfolio) as of the respective dates shown. Credit experience for us, MFN
(since the date of the MFN merger), TFC (since the date of the TFC merger) and
SeaWest (since the date of the SeaWest asset acquisition) is shown on a combined
basis in the table below.
45
DELINQUENCY EXPERIENCE (1)
CPS, MFN, TFC AND SEAWEST COMBINED
MARCH 31, 2006 DECEMBER 31, 2005 DECEMBER 31, 2004 DECEMBER 31, 2003
-------------------- ---------------------- --------------------- --------------------
NUMBER OF NUMBER OF NUMBER OF NUMBER OF
CONTRACTS AMOUNT CONTRACTS AMOUNT CONTRACTS AMOUNT CONTRACTS AMOUNT
---------- -------- --------- ---------- --------- -------- --------- --------
DELINQUENCY EXPERIENCE (DOLLARS IN THOUSANDS)
Gross servicing portfolio (1) .. $ 103,828 $1,238,450 $ 95,689 $1,116,534 83,018 $873,880 84,897 $773,899
Period of delinquency (2)
31-60 days ..................... 1,250 12,795 2,367 24,047 2,106 19,010 2,506 17,980
61-90 days ..................... 564 5,215 1,057 10,156 1,069 8,051 1,340 8,943
91+ days ....................... 575 4,066 1,031 7,946 1,176 7,758 1,522 9,453
---------- ----------- ---------- ----------- ---------- --------- ---------- ---------
Total delinquencies (2) ........ 2,389 22,075 4,455 42,149 4,351 34,819 5,368 36,376
Amount in repossession (3) ..... 1,090 11,782 1,335 13,531 1,408 14,090 1,234 12,106
---------- ----------- ---------- ----------- ---------- --------- ---------- ---------
Total delinquencies and
amount in repossession (2) .. $ 3,479 $ 33,857 $ 5,790 $ 55,680 5,759 $ 48,909 6,602 $ 48,482
========== =========== ========== =========== ========== ========= ========== =========
Delinquencies as a percentage
of gross servicing
portfolio ................... 2.3% 1.8% 4.7% 3.8% 5.2% 4.0% 6.3% 4.7%
Total delinquencies and
amount in repossession as a
percentage of gross servicing
portfolio ................... 3.4% 2.7% 6.1% 5.0% 6.9% 5.6% 7.8% 6.2%
EXTENSION EXPERIENCE
Contracts with One Extension (4) $ 9,745 $ 94,375 10,602 $ 95,412 9,661 $ 86,138 10,004 $ 76,617
Contracts with Two or More
Extensions (4) .............. 3,480 26,903 4,575 29,428 4,383 23,659 7,347 34,224
---------- ----------- ---------- ----------- ---------- --------- ---------- ---------
Total Contracts with
Extensions ..................... $ 13,225 $ 121,278 $ 15,177 $ 124,840 14,044 $109,797 17,351 $110,841
========== =========== ========== =========== ========== ========= ========== =========
(1) ALL AMOUNTS AND PERCENTAGES ARE BASED ON THE AMOUNT REMAINING TO BE REPAID
ON EACH AUTOMOBILE CONTRACT, INCLUDING, FOR PRE-COMPUTED AUTOMOBILE CONTRACTS,
ANY UNEARNED INTEREST. THE INFORMATION IN THE TABLE REPRESENTS THE GROSS
PRINCIPAL AMOUNT OF ALL AUTOMOBILE CONTRACTS WE PURCHASED, INCLUDING AUTOMOBILE
CONTRACTS WE SUBSEQUENTLY SOLD IN SECURITIZATION TRANSACTIONS THAT WE CONTINUE
TO SERVICE. THE TABLE DOES NOT INCLUDE AUTOMOBILE CONTRACTS THAT WE SERVICE ON
BEHALF OF SEAWEST SECURITIZATIONS, BUT DO NOT OWN.
(2) WE CONSIDER AN AUTOMOBILE 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. AUTOMOBILE CONTRACTS LESS THAN 31 DAYS DELINQUENT ARE
NOT INCLUDED.
(3) AMOUNT IN REPOSSESSION REPRESENTS THE CONTRACT BALANCE ON FINANCED VEHICLES
THAT HAVE BEEN REPOSSESSED BUT NOT YET LIQUIDATED. THIS AMOUNT IS NOT NETTED
WITH THE SPECIFIC RESERVE TO ARRIVE AT THE ESTIMATED ASSET VALUE LESS COSTS TO
SELL.
(4) THE AGING CATEGORIES SHOWN IN THE TABLES REFLECT THE EFFECT OF EXTENSIONS.
EXTENSIONS
We may offer a customer an extension, under which the customer agrees with us to
move past due payments to the end of the automobile contract term. In such cases
the customer must sign an agreement for the extension, and may pay a fee
representing partial payment of accrued interest. Our policies, and contractual
arrangements for our warehouse and securitization transactions, limit the number
of extensions that may be granted. In general, a customer may arrange for an
extension no more than once every 12 months, not to exceed four extensions over
the life of the contract.
If a customer is granted such an extension, the date next due is advanced.
Subsequent delinquency aging classifications would be based on the future
payment performance of the automobile contract.
46
NET CHARGE-OFF EXPERIENCE (1) Three Months Year Ended
Ended December 31,
March 31, ----------------------------------
2006 2005 2004 2003
------------- ---------- ---------- ----------
(in thousands)
CPS, MFN, TFC and SeaWest combined average
managed portfolio outstanding .................... $ 1,176,879 $ 966,295 $ 796,436 $ 674,523
Net charge-offs as a percentage of average
managed portfolio (2) ............................ 4.8% 5.3% 7.8% 6.8%
(1) ALL AMOUNTS AND PERCENTAGES ARE BASED ON THE PRINCIPAL AMOUNT SCHEDULED TO
BE PAID ON EACH AUTOMOBILE CONTRACT, NET OF UNEARNED INCOME ON PRE-COMPUTED
AUTOMOBILE CONTRACTS. THE INFORMATION IN THE TABLE REPRESENTS ALL AUTOMOBILE
CONTRACTS SERVICED BY US (EXCLUDING AUTOMOBILE CONTRACTS ORIGINATED BY SEAWEST
FOR WHICH WE ARE THE SERVICER BUT HAVE NO EQUITY INTEREST).
(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) AND AMOUNTS COLLECTED SUBSEQUENT TO THE DATE OF
CHARGE-OFF.
SECURITIZATION OF AUTOMOBILE CONTRACTS
We purchase automobile contracts with the intention of financing them on a
long-term basis through securitizations. All such securitizations have involved
identification of specific automobile contracts, sale of those automobile
contracts (and associated rights) to a special purpose subsidiary, and issuance
of asset-backed securities to fund the transactions. Upon the securitization of
a portfolio of automobile contracts, we retain the obligation to service the
contracts, and receive a monthly fee for doing so. We have been a regular issuer
of asset-backed securities since 1994, completing 40 securitizations totaling
over $4.3 billion through March 31, 2006. Depending on the structure of the
securitization, the transaction may be treated as a sale of the automobile
contracts, or as a secured financing for financial accounting purposes. Since
the third quarter of 2003, we have structured our securitizations as secured
financings rather than as sales of contracts.
When structured to be treated as a secured financing, the subsidiary is
consolidated and, accordingly, the automobile contracts and the related
securitization trust debt appear as assets and liabilities, respectively, on our
consolidated balance sheet. We then recognize interest income on the contracts
and interest expense on the securities issued in the securitization and record
as expense a provision for probable credit losses on the contracts.
When structured to be treated as a sale, the subsidiary is not consolidated.
Accordingly, the securitization removes the sold automobile contracts from our
consolidated balance sheet, and the asset-backed securities (debt of the
non-consolidated subsidiary) do not appear as debt on our consolidated balance
sheet, but rather show as an asset, a retained residual interest in the sold
automobile contracts. The residual interest represents the discounted value of
what we expect will be the excess of future collections on the automobile
contracts over principal and interest due on the asset-backed securities and
fees and other expenses. This residual interest appears on our consolidated
balance sheet as "Residual interest in securitizations," and its value is
dependent on estimates of the future performance of the sold automobile
contracts.
Prior to a securitization transaction, we fund our automobile contract purchases
primarily with proceeds from warehouse credit facilities. As of March 31, 2006,
we had $350 million in warehouse credit capacity, in the form of a $200 million
facility and a $150 million facility. Both warehouse credit facilities provide
funding for automobile contracts purchased under the CPS programs, while the
first facility also provides funding for automobile contracts purchased under
the TFC programs. Up to 80% of the principal balance of the automobile contracts
may be advanced to us under these facilities, subject to collateral tests and
certain other conditions and covenants. Long-term financing for the automobile
contract purchases is achieved through securitization transactions and the
proceeds from such securitization transactions are used primarily to repay the
warehouse credit facilities.
In a securitization and in our warehouse credit facilities, we are required to
make certain representations and warranties, which are generally similar to the
representations and warranties made by dealers in connection with our purchase
of the automobile contracts. If we breach any of our representations or
warranties, we will be obligated to repurchase the automobile contract at a
price equal to the principal balance plus accrued and unpaid interest. We may
then be entitled under the terms of our dealer agreement to require the selling
dealer to repurchase the contract at a price equal to our purchase price, less
any principal payments made by the customer. Subject to any recourse against
dealers, we will bear the risk of loss on repossession and resale of vehicles
under automobile contracts that we repurchase.
47
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 us if the credit performance of the securitized
automobile contracts falls short of pre-determined standards. Such releases
represent a material portion of the cash that we use to fund our operations. An
unexpected deterioration in the performance of securitized automobile contracts
could therefore have a material adverse effect on both our liquidity and results
of operations, regardless of whether such automobile 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 our "managed portfolio,"
which represents both financed and sold automobile contracts as to which such
credit risk is retained. Our managed portfolio as of March 31, 2006 was
approximately $1.2 billion (this amount includes $12.5 million related to the
SeaWest third party portfolio on which we earn only servicing fees and have no
credit risk).
COMPETITION
The automobile financing business is highly competitive. We compete with a
number of national, regional and local finance companies with operations similar
to ours. 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 our competitors and potential
competitors possess substantially greater financial, marketing, technical,
personnel and other resources than we do. Moreover, our future profitability
will be directly related to the availability and cost of our capital in relation
to the availability and cost of capital to our competitors. Our 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 us. 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 we
do not offer.
We believe that the principal competitive factors affecting a dealer's decision
to offer automobile contracts for sale to a particular financing source are the
purchase price offered for the automobile 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. While we believe that we can obtain from dealers sufficient
automobile contracts for purchase at attractive prices by consistently applying
reasonable underwriting criteria and making timely purchases of qualifying
automobile contracts, there can be no assurance that we will do so.
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 automobile contracts and impose
certain other restrictions on dealers. In many states, a license is required to
engage in the business of purchasing automobile 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
automobiles 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 us and
purchasers of automobile contracts from us. The dealer agreement contains
representations by the dealer that, as of the date of assignment of automobile
contracts, no such claims or defenses have been asserted or threatened with
respect to the automobile 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 automobile contracts that involve a
breach of such warranty, there can be no assurance that the dealer will have the
financial resources to satisfy our repurchase obligations. Certain of these laws
also regulate our servicing activities, including our methods of collection.
Although we believe that we are currently in material compliance with applicable
statutes and regulations, there can be no assurance that we 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 us.
Furthermore, the adoption of additional statutes and regulations, changes in the
interpretation and enforcement of current statutes and regulations or the
expansion of our business into jurisdictions that have adopted more stringent
regulatory requirements than those in which we currently conduct business could
have a material adverse effect upon us. In addition, due to the
consumer-oriented nature of the industry in which we operate 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 us or within the industry in connection with any such litigation could
have a material adverse effect on our financial condition, results of operations
or liquidity.
48
EMPLOYEES
As of May 31, 2006, we had 715 full-time and five part-time employees. The
breakdown of the employees is as follows: 6 are senior management personnel, 361
are collections personnel, 159 are automobile contract origination personnel,
106 are marketing personnel (85 of whom are marketing representatives), 62 are
operations and systems personnel, and 26 are administrative personnel. We
believe that our relations with our employees are good. We are not a party to
any collective bargaining agreement.
49
MANAGEMENT
The following table sets forth certain information with respect to our executive
officers and directors as of May 31, 2006.
NAME AGE POSITION(S) WITH THE COMPANY
---- --- ----------------------------
DIRECTORS
Charles E. Bradley, Jr. 46 President, Chief Executive Officer, and Chairman of the
Board of Directors
E. Bruce Fredrikson 68 Director
John E. McConnaughy, Jr. 77 Director
John G. Poole 63 Vice Chairman of the Board of Directors
William B. Roberts 68 Director
John C. Warner 58 Director
Daniel S. Wood 47 Director
EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS
Mark A. Creatura 47 Senior Vice President, General Counsel
Jeffrey P. Fritz 46 Senior Vice President, Accounting and Chief Financial
Officer
Curtis K. Powell 49 Senior Vice President, Contract Origination
Robert E. Riedl 42 Senior Vice President, Finance and Chief Investment Officer
Christopher Terry 38 Senior Vice President, Servicing
CHARLES E. BRADLEY, JR. has been our President and a director since our
formation in March 1991, and was elected Chairman of the Board of Directors in
July 2001. In January 1992, Mr. Bradley was appointed Chief Executive Officer.
From April 1989 to November 1990, he served as Chief Operating Officer of
Barnard and Company, a private investment firm. From September 1987 to March
1989, Mr. Bradley, Jr. was an associate of The Harding Group, a private
investment banking firm. Mr. Bradley does not currently serve on the board of
directors of any other publicly-traded companies.
E. BRUCE FREDRIKSON has been a director since March 2003. He is a Professor of
Finance, Emeritus, at Syracuse University's Martin J. Whitman School of
Management, where he taught from 1966 to 2003. Mr. Fredrikson has published
numerous papers on accounting and finance topics. He is also a director of Track
Data Corporation and Colonial Commercial Corp.
JOHN E. MCCONNAUGHY, JR. has been a director since 2001. He is the Chairman and
Chief Executive Officer of JEMC Corporation, which is a personal holding company
he formed in 1985. From 1981 to 1992 he was the Chairman and Chief Executive
Officer of GEO International Corp, a company in the business of nondestructive
testing, screen-printing and oil field services. Mr. McConnaughy was previously
and concurrently Chairman and Chief Executive Officer of Peabody International
Corp., from 1969 to 1986. He currently serves as a director of Levcor
International, Inc., Wave Systems, Inc., Overhill Farms, Inc., Allis Chalmers
Corp. and Arrow Resources Development Ltd. Mr. McConnaughy is also Chairman of
the Board of Trustees of the Strang Clinic and is the Chairman Emeritus of the
Board of the Harlem School of the Arts.
JOHN G. POOLE has been a director since November 1993 and our Vice Chairman
since January 1996. He is now a private investor, having previously been a
director and Vice President of Stanwich Partners, Inc. ("SPI") until July 2001.
SPI, which Mr. Poole co-founded in 1982, acquired controlling interests in
companies in conjunction with their existing management. Mr. Poole is also a
director of Reunion Industries, Inc.
WILLIAM B. ROBERTS has been a director since our formation in March 1991. Since
1981, he has been the President of Monmouth Capital Corp., an investment firm
that specializes in management buyouts.
JOHN C. WARNER has been a director since April 2003. Mr. Warner was chief
executive officer of O'Neill Clothing, a manufacturer and marketer of apparel
and accessories from 1996 until his retirement in May 2005.
50
DANIEL S. WOOD has been a director since July 2001. Mr. Wood is president of
Carclo Technical Plastics, a manufacturer of custom injection moldings.
Previously, from 1988 to September 2000, he was the chief operating officer and
co-owner of Carrera Corporation.
MARK A. CREATURA 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.
JEFFREY P. FRITZ has been Senior Vice President - Chief Financial Officer since
April 2006. He was Senior Vice President - Accounting from August 2004 through
March 2006. He served as a consultant to us from May 2004 to August 2004.
Previously, he was the Chief Financial Officer of SeaWest Financial Corp. from
February 2003 to May 2004, and the Chief Financial Officer of AFCO Auto Finance
from April 2002 to February 2003. He practiced public accounting with Glenn M.
Gelman & Associates from March 2001 to April 2002 and was Chief Financial
Officer of Credit Services Group, Inc. from May 1999 to November 2000. He
previously served as our Chief Financial Officer from its inception through May
1999.
CURTIS K. POWELL has been Senior Vice President - Contract Origination since
June 2001. Previously, he was our Senior Vice President - Marketing, from April
1995. He joined us 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 has been Senior Vice President - Chief Investment Officer since
April 2006. Mr. Riedl was Senior Vice President - Chief Financial Officer from
August 2003 until assuming his current position. Mr. Riedl joined the Company as
Senior Vice President - Risk Management in January 2003. Previously, 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 has been Senior Vice President - Servicing since May 2005, and
prior to that was Senior Vice President - Asset Recovery since January 2003. He
joined us 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 to October 1994.
51
CERTAIN TRANSACTIONS
LEVINE LEICHTMAN. Since 1998, we have entered into a series of financing
transactions with Levine Leichtman Capital Partners II, L.P., the selling
shareholder, to provide us with funding in the form of sales of senior
subordinated and senior secured debt securities.
As of March 31, 2006, we are indebted to the selling shareholder in the
principal amount of $40.0 million, comprising the "Term D Note," the "Term E
Note" and the "Term F Note." Such notes bear interest at 11.75% per annum, and
were at that time due on various dates through December 2006, after having been
previously amended from higher rates and earlier maturities.
On December 13, 2005, we agreed with the selling shareholder to extend the
maturity date of the Term D Note. As of that date, our debt to the selling
shareholder comprised four tranches, with different maturity dates. The
following table sets forth the principal amount of each such tranche as of
December 13, 2005, and the maturity date before and after the December 13, 2005
amendment:
Date due prior to
Term Note Principal amount amendment Date due after amendment
--------- ---------------- --------- ------------------------
Term B Note $19,828,527 December 15, 2005 December 15, 2005
Term D Note 15,000,000 December 15, 2005 December 18, 2006
Term E Note 15,000,000 May 27, 2006 May 27, 2006
Term F Note 10,000,000 June 24, 2006 June 24, 2006
We agreed to pay the selling shareholder a modification fee with respect to
amendments to the Term D Note in the amount of $600,000, payable in two
installments of $150,000 and $450,000; however, if we repaid in full the Term D
Note on or prior to June 14, 2006, then the modification fee would be limited to
the first installment of $150,000 (which installment we paid in December 2005).
The Term D Note was not paid on or prior to June 14, 2006, and the second
installment of the fee of $450,000 is currently due on July 10, 2006. The due
date of the Term B Note was not changed by the December 13, 2005 amendment, and
the Term B Note was paid when due.
On May 26, 2006, we agreed with the selling shareholder to extend the maturity
date of the Term E and Term F Notes, in exchange for a fee of $500,000 (which is
in addition to the $450,000 portion of the fee due from the December 2005 Term D
Note amendment that we have not yet paid). As of May 26, 2006, our debt to the
selling shareholder comprised three tranches, with different maturity dates. The
following table sets forth the principal amount of each such tranche as of that
date, and the maturity date before and after the May 26, 2006 amendment:
Date due prior to
Term Note Principal amount amendment Date due after amendment
--------- ---------------- --------- ------------------------
Term D Note $15,000,000 December 18, 2006 December 18, 2006
Term E Note 15,000,000 May 27, 2006 May 31, 2007
Term F Note 10,000,000 June 24, 2006 May 31, 2007
All of our indebtedness owing to the selling shareholder, as well as the
guaranty obligations of our subsidiaries, is secured by a blanket security
interest in favor of the selling shareholder on substantially all of our assets
and of those of our subsidiaries.
In addition to our debt obligations, the selling shareholder holds a residual
warrant to purchase 1,000 shares of our common stock for nominal consideration
(which is expected to be exercised immediately prior to the sale of shares in
this offering), and has certain rights to require that we register its shares of
our common stock, including those 1,000 shares issuable upon exercise of the
warrant. See "The Selling Shareholder - Registration Rights."
The terms of our transactions with the selling shareholder were determined by
arm's length negotiation.
CPS LEASING. We hold 80% of the outstanding shares of the capital stock of CPS
Leasing, Inc. ("CPSL"). The remaining 20% of CPSL is held by Charles E. Bradley,
Jr., who is our President and a director of the Company. CPSL engaged in the
equipment leasing business, and is currently in the process of liquidation as
its leases come to term. CPSL financed its purchases of the equipment that it
leases to others through either of two lines of credit. Amounts borrowed by CPSL
under one of those two lines of credit have been guaranteed by us. As of
December 31, 2005 both lines of credit have been paid. We have also financed the
operations of CPSL by making operating advances and by advancing to CPSL the
fraction of the purchase prices of its leased equipment that CPSL did not borrow
under its lines of credit. The aggregate amount of advances we made to CPSL as
of March 31, 2006, is approximately $1.1 million. The advances related to
operations bear interest at the rate of 8.5% per annum. The advances related to
the fraction of the purchase price of leased equipment are not interest bearing.
52
EMPLOYEE INDEBTEDNESS. To assist certain officers in exercising stock options,
we lent to such officers the exercise price of options such officers exercised
in May and July 2002. The loans are fully secured by common stock of the
Company, bear interest at 5.50% per annum and are due in 2007. Our chief
executive officer (Mr. Bradley), one other executive officer (Mr. Terry), and
four officers other than executive officers borrowed money on those terms and
still have a balance outstanding. The highest balances of the loans for the
period January 1, 2002 through April 30, 2006, were $350,000 for Mr. Bradley and
$27,375 for one non-executive officer. Pursuant to the Sarbanes-Oxley Act of
2002, we have ceased providing any loans to our executive officers.
The agreements and transactions described above (other than our agreements and
transactions with the selling shareholder) were entered into with parties who
personally benefited from such transactions and who had a control or fiduciary
relationship with us. In each case such agreements and transactions have been
reviewed and approved by the members of our Board of Directors who are
disinterested with respect thereto.
53
PRINCIPAL SHAREHOLDERS
The following table sets forth information regarding beneficial ownership of our
common stock by: (1) each person (including "groups" as that term is used in
Section 13(d)(3) of the Exchange Act) we know to be a "beneficial owner" of more
than five percent of our common stock, (2) each our directors and named
executive officers, and (3) all of our directors and named executive officers as
a group. This information is presented as of June 20, 2006 and as adjusted to
reflect the sale of the common stock in this offering. Other than with respect
to our directors and executive officers, this information is based on reports
filed with the SEC by the persons listed in the table below. If you wish, you
may obtain a copy of these reports from the SEC. Except as otherwise indicated,
and subject to applicable community property and similar laws, each of the
persons named has sole voting and investment power with respect to the shares
shown as beneficially owned by such persons. Except as otherwise noted, the
address of each person named is c/o Consumer Portfolio Services, Inc., 16355
Laguna Canyon Road, Irvine, CA 92618.
"Beneficial ownership" is a technical term broadly defined by the SEC to mean
more than direct ownership. A person has beneficial ownership of a share not
only if he or she owns the share in the usual sense, but also if he or she has
the power to vote, sell or otherwise dispose of the share. In computing the
number of shares of common stock beneficially owned by a person and the
percentage ownership of that person, shares of common stock that are subject to
options or warrants held by that person that are exercisable within 60 days of
June 20, 2006 are deemed outstanding. These shares are not, however, deemed
outstanding for the purpose of computing the percentage ownership of any other
person.
Actual As Adjusted (1)
------------------------------------------------------------------------------------------ --------- -------------------------
Amount and Amount and
Nature of To Be Sold Nature of Percent
Beneficial Percent in This Beneficial of Class
Name and Address of Beneficial Owner Ownership (2) of Class Offering Ownership (2) (1)
---------------------------------------------------------------------------- --------- --------- -------------- ----------
Charles E. Bradley, Jr. 3,226,990 (3) 14.1% 3,226,990 13.8%
E. Bruce Fredrikson 61,000 0.3% 61,000 0.3%
John E. McConnaughy, Jr. 10,000 0.0% 10,000 0.0%
John G. Poole 699,693 3.2% 699,693 3.1%
William B. Roberts 864,107 4.0% 864,107 3.9%
John C. Warner 60,000 0.3% 60,000 0.3%
Daniel S. Wood 80,000 0.4% 80,000 0.4%
Jeffrey P. Fritz 180,000 0.8% 180,000 0.8%
Curtis K. Powell 306,262 1.4% 306,262 1.4%
Robert E. Riedl 237,008 1.1% 237,008 1.1%
Christopher Terry 221,076 1.0% 221,076 1.0%
All directors and executive officers combined (12 persons) 6,193,775 (4) 25.8% 6,193,775 25.2%
Levine Leichtman Capital Partners II, L.P., 335 North Maple
Drive, Suite 240, Beverly Hills, CA 90210 3,987,558 (5) 18.3% 3,500,000 487,558 (6) 2.2%
LC Capital Master Fund, c/o Lampe Conway & Co LLC, 730 Fifth
Avenue Suite 1002, New York NY 10019. 1,126,915 5.2% 1,126,915 5.1%
(1) Reflects the sale of 3,500,000 shares by the selling shareholder and
500,000 shares by us.
54
(2) Includes certain shares that may be acquired from us within 60 days after
June 20, 2006 upon exercise of options, as follows: Mr. Bradley, Jr., 1,136,099
shares; Mr. Fredrikson, 60,000 shares; Mr. McConnaughy, 10,000 shares; Mr.
Poole, 30,000 shares; Mr. Roberts, 30,000 shares; Mr. Warner; 60,000 shares, Mr.
Wood, 40,000 shares; Mr. Fritz, 180,000 shares; Mr. Powell, 125,000 shares; Mr.
Riedl, 235,000 shares; and Mr. Terry, 178,500 shares. The calculation of
beneficial ownership also includes, in the case of the executive officers, an
approximate number of shares each executive officer could be deemed to hold
through contributions made to our Employee 401(k) Plan (the "401(k) Plan"). The
401(k) Plan provides an option for all participating employees to indirectly
purchase our common stock through buying units in a mutual fund. Each "unit" in
the mutual fund represents an interest in our common stock, cash and cash
equivalents.
(3) Includes 271,540 shares held by trusts of which Mr. Bradley is the
co-trustee, and as to which shares Mr. Bradley has shared voting and investment
power. The co-trustee, who has shared voting and investment power as to all such
shares (representing 1.24% of beneficial ownership), is Kimball Bradley, whose
address is 11 Stanwix Street, Pittsburgh, PA 15222.
(4) Includes 2,219,599 shares that may be acquired within 60 days after June
20, 2006, upon exercise of options and conversion of convertible securities.
(5) Comprises 3,986,558 issued shares and 1,000 shares that are issuable upon
exercise of an outstanding warrant.
(6) If the underwriter's overallotment option were exercised in full, the
selling shareholder would sell all of its 3,987,558 shares, and hold no shares
after the offering.
DESCRIPTION OF CAPITAL STOCK
GENERAL
We are authorized to issue 30,000,000 shares of common stock, no par value and
10,000,000 shares of preferred stock, $1.00 par value per share. As of June 20,
2006, there were 21,813,041 shares of our common stock outstanding and no shares
of our preferred stock outstanding.
COMMON STOCK
Holders of our common stock are entitled to one vote per share on all matters to
be voted upon by our shareholders, including the election of directors. Holders
of our common stock are entitled to cumulate their votes in the election of
directors if they comply with the provisions of our Bylaws as to cumulative
voting. In cumulative voting, each holder is permitted to cast such number of
votes in the aggregate as equals the number of shares of stock held multiplied
by the number of directors to be elected. The holders may cast the whole number
of such votes for one nominee for director or distribute the votes among two or
more nominees as the holder sees fit.
Holders of our common stock are entitled to receive such dividends as may be
declared from time to time by our Board of Directors out of funds legally
available therefore, subject to significant contractual restrictions. For more
information, see "Dividend Policy." In the event of our liquidation, dissolution
or winding up, holders of common stock are entitled to share ratably in all
assets remaining after payment of liabilities and after satisfaction of the
liquidation preference of any outstanding preferred stock. Holders of our common
stock have no preemptive, conversion or redemption rights and are not subject to
further assessments by us. All of the currently outstanding shares of our common
stock are fully paid and nonassessable.
The transfer agent and registrar for our common stock is American Stock Transfer
& Trust Company.
PREFERRED STOCK
Our articles of incorporation provide that we are authorized to issue up to
10,000,000 shares of preferred stock, with such designations, rights and
preferences as may be determined from time to time by the Board of Directors.
Accordingly, the Board of Directors is empowered, without shareholder approval,
to issue preferred stock with dividend, liquidation, conversion, voting or other
rights which could adversely affect the voting power or other rights of the
holders of the our common stock. In the event of issuance, the preferred stock
could be utilized, under certain circumstances, as a method of discouraging,
delaying or preventing a change in control of the company. We have no shares of
preferred stock outstanding, and no present intentions to issue any shares of
preferred stock.
55
SELLING SHAREHOLDER
GENERAL
This is an offering of our common stock primarily by the selling shareholder,
one of our principal shareholders. We agreed to register the shares being
offered by the selling shareholder pursuant to a registration rights agreement.
We entered into the registration rights agreement in connection with a series of
purchases by the selling shareholder of our debt securities, which provided us
with debt capital. Certain of these debt securities were issued together with
warrants that allowed the selling shareholder to purchase shares of our common
stock at a nominal consideration. We have agreed with the selling shareholder to
register its shares of our common stock offered by this prospectus through an
underwritten offering. For more information, see "--Registration Rights
Agreement."
REGISTRATION RIGHTS AGREEMENT
We entered into the registration rights agreement with the selling shareholder
in connection with its initial investments in us in 1998. The terms of that
agreement have subsequently been amended and restated.
Under the registration rights agreement, as subsequently amended and restated,
we agreed to register the common stock offered by this prospectus through an
underwritten offering. In addition, if less than all of the selling
shareholder's shares are sold in this offering, we will have an obligation to
register such remaining shares on request of the selling shareholder. We also
agreed that if we propose to register any securities in connection with the
public offering of such securities solely for cash, then we will give the
selling shareholder the ability to participate in the registration. However, we
will not have the obligation to provide such piggy-back registration rights if
the registration we are proposing to undertake is:
o on Form S-4, Form S-8 or any successor form that may be adopted by the
SEC; or
o with respect to an employee benefit plan;
o for an exchange offer solely to our existing shareholders; or
o with respect to a dividend reinvestment plan.
Our obligations under the registration rights agreement will terminate on the
earlier to occur of:
o five years after repayment of all of our indebtedness to the selling
shareholder; or
o the date on which less than five percent of our outstanding shares of
common stock are held by the selling shareholder.
UNDERWRITING
We and the selling shareholder have entered into an underwriting agreement
with the underwriter, JMP Securities LLC, and subject to the terms and
conditions contained in the underwriting agreement, we and the selling
shareholder have agreed to sell to the underwriter, and the underwriter has
agreed to purchase from the us and the selling shareholder 4,000,000 shares of
our common stock.
The underwriting agreement provides that the underwriter's obligation to
pay for and accept delivery of our common stock is subject to approval of
various legal matters by its counsel and to other conditions. The underwriter is
obligated to take and pay for all shares of our common stock offered if any of
the shares are taken, other than those covered by the over-allotment option
described below.
The underwriter proposes to offer shares of our common stock directly to
the public at the public offering price per share listed on the cover page of
this prospectus and to selected dealers at this price less a concession not in
excess of $ per share, of which $ per share may be reallowed to other dealers.
After this offering, the public offering price, concession and reallowance to
dealers may be reduced by the underwriter. No such reduction shall change the
amount of proceeds to be received by us and by the selling shareholder as listed
on the cover page of this prospectus. The common stock is offered by the
underwriter, subject to receipt and acceptance by the underwriter and subject to
the underwriter's right to reject any order in whole or in part.
56
OVER-ALLOTMENT OPTION
We and the selling shareholder have granted the underwriter an option,
exercisable for 30 days after the date of this prospectus, to purchase up to an
additional 600,000 shares of common stock to cover over-allotments, if any, at
the public offering price less the underwriting discounts and commissions listed
on the cover page of this prospectus. If the underwriter exercises the option to
purchase any of the 600,000 additional shares of common stock, they will have a
firm commitment, subject to a number of conditions, to purchase these shares. If
purchased, these additional shares will be sold by the underwriter on the same
terms as those on which the shares offered hereby are being sold. We and the
selling shareholder will be obligated, pursuant to the over-allotment option, to
sell shares to the underwriter to the extent the over-allotment option is
exercised. The underwriter may exercise the over-allotment option only to cover
over-allotments made in connection with the sale of the shares of common stock
offered in this offering.
DISCOUNTS AND COMMISSIONS
The following table shows the per share and total underwriting discount
that we and the selling shareholder will pay to the underwriter. The total
amounts are shown assuming both no exercise and full exercise of the
over-allotment option to purchase 600,000 additional shares of our common stock,
if any.
Total
---------------------------------------
Per No Exercise Full Exercise of
Share of Option Option
----- ----------- ----------------
Underwriting discounts and commissions payable
by us ................................................ $ $ $
Underwriting discounts and commissions payable by the
selling shareholder .................................. $ $ $
We estimate fees and expenses payable by us in connection with this
offering, other than the underwriting discounts and commissions referred to
above, will be approximately $170,000, including fees and expenses paid by us on
behalf of the selling shareholder.
INDEMNITY
We and the selling shareholder have agreed to indemnify the underwriter
against particular liabilities, including certain liabilities under the
Securities Act, or to contribute to payments the underwriter may be required to
make in respect thereof.
LOCK-UP AGREEMENTS
We have agreed with JMP Securities LLC, subject to particular exceptions,
that we will not, without the prior written consent of JMP Securities LLC,
directly or indirectly sell, offer, contract or grant any option to sell,
pledge, transfer, or establish an open "put equivalent position" within the
meaning of Rule 16a-1(h) of the Exchange Act, or otherwise dispose of or enter
into any transaction which may result in the disposition of any shares of our
common stock or securities convertible into, exchangeable or exercisable for any
shares of our common stock for a period of 90 days after the date of this
prospectus.
Each of our executive officers and directors have agreed with JMP
Securities LLC not to directly or indirectly sell, offer, contract, grant or
transfer any option to sell, transfer, or establish an open "put equivalent
position" within the meaning of Rule 16a-1(h) of the Exchange Act, or otherwise
dispose of any shares of our common stock or securities convertible into,
exchangeable or exercisable for any shares of our common stock, or publicly
disclose the intention to make any offer, sale, grant, transfer or disposition
without the prior written consent of JMP Securities LLC for a period of 90 days
after the date of this prospectus.
LISTING
Our common stock is listed on the Nasdaq National Market under the symbol
"CPSS."
STABILIZATION
In connection with this offering, the underwriter is permitted to engage
in certain transactions that stabilize the price of our common stock. These
transactions consist of bids or purchases for the purpose of pegging, fixing or
maintaining the price of our common stock. If the underwriter creates a short
position in our common stock in connection with this offering by selling more
than 600,000 shares of common stock, it may reduce that short position by
purchasing our common stock in the open market. In general, purchases of a
security for the purpose of stabilization or to reduce a short position could
cause the price of the security to be higher than it might be in the absence of
those purchases. Neither we, the selling shareholder, nor the underwriter make
any representation or prediction as to the direction or magnitude of any effect
that the transactions described above may have on the price of our common stock.
In addition, neither we, the selling shareholder, nor the underwriter make any
representation that the underwriter will engage in those transactions or that
those transactions, once commenced, will not be discontinued without notice.
57
ELECTRONIC DISTRIBUTION
A prospectus in electronic format may be made available on the Internet
sites or through other online services maintained by the underwriter and/or
selling group members, if any, participating in the offering, or by their
affiliates. In those cases, prospective investors may view offering terms online
and, depending upon the particular underwriter or selling group member,
prospective investors may be allowed to place orders online. Other than the
prospectus in electronic format, the information on the underwriter's or any
selling group member's website and any information contained in any other
website maintained by the underwriter or any selling group member is not part of
the prospectus or the registration statement of which this prospectus forms a
part, has not been approved and/or endorsed by us or the underwriter or any
selling group member in its capacity as underwriter or selling group member and
should not be relied upon by investors.
OTHER AGREEMENTS
JMP Securities LLC and its affiliates may provide us with investment
banking, financial advisory, or commercial banking services in the future, for
which it may receive customary compensation.
LEGAL MATTERS
The validity of the common stock will be passed upon by Andrews Kurth,
LLP, Dallas, Texas. Legal matters in connection with this offering will be
passed upon for the underwriter by Kirkpatrick & Lockhart Nicholson Graham LLP,
Los Angeles, California.
EXPERTS
The consolidated financial statements of Consumer Portfolio Services, Inc.
as of and for the years ended December 31, 2004 and 2005 have been incorporated
by reference herein in reliance upon the report of McGladrey & Pullen LLP,
independent registered public accountants, incorporated by reference herein, and
upon the authority of said firm as experts in accounting and auditing.
The consolidated financial statements of Consumer Portfolio Services, Inc.
for the year ended December 31, 2003, have been incorporated by reference herein
in reliance upon the report of KPMG LLP, independent registered public
accounting firm, incorporated by reference herein, and upon the authority of
said firm as experts in accounting and auditing.
WHERE YOU CAN FIND MORE INFORMATION
We file annual, quarterly and current reports and proxy statements and
other information with the SEC. You may read and copy any document which we file
at the SEC's public reference room located at 100 F Street, N.E., Washington,
D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the
public reference rooms. Our filings with the SEC are also available to the
public over the Internet at a website maintained by the SEC at
http://www.sec.gov.
We have filed with the SEC a registration statement on Form S-3 under the
Securities Act with respect to the common stock offered hereby. This prospectus
is a part of that registration statement. This prospectus does not contain all
the information set forth in the registration statement or in the exhibits to
the registration statement, certain portions of which have been omitted as
permitted by the rules and regulations of the SEC. For further information with
respect to us and the securities offered hereby, reference is made to the
registration statement and the exhibits and the financial statements, notes and
schedules filed as part thereof or incorporated by reference therein, which may
be inspected as described above. Statements made in this prospectus concerning
the contents of any documents referred to in this prospectus are not necessarily
complete, and in each instance are qualified in all respects by reference to the
copy of the document filed as an exhibit to the registration statement of which
this prospectus is a part.
58
DOCUMENTS INCORPORATED BY REFERENCE
The SEC allows us to "incorporate by reference" information in documents
that we file with it. We have elected to use a similar procedure in connection
with this prospectus, which means that we can disclose important information to
you by referring you to another document filed separately with the SEC. The
information incorporated by reference is considered to be a part of this
prospectus, and information that we file later with the SEC will automatically
update and supersede this information. We incorporate by reference the documents
listed below and, from the date of this prospectus, any future filings made by
us with the SEC which we may make under Sections 13(a), 13(c), 14 or 15(d) of
the Exchange Act (other than information in listed documents and future filings
that is deemed not to be filed):
o Annual Report on Form 10-K for the year ended December 31, 2005;
o Quarterly Report on Form 10-Q for the quarter ended March 31, 2006; and
o Current Reports on Form 8-K filed on January 5, March 7, April 4, April
24, and June 2, 2006.
Any statement contained in this prospectus or in a document incorporated
or deemed to be incorporated by reference herein will be deemed to be modified
or superseded for purposes of this prospectus to the extent that a statement
contained in any subsequently filed document which is or is deemed to be
incorporated by reference herein modifies or supersedes such statement. Any such
statement so modified or superseded will not be deemed, except as so modified or
superseded, to constitute a part of this prospectus.
You may request a copy of these incorporated filings, without charge,
other than exhibits to such documents unless such exhibits are specifically
incorporated by reference in the document that this prospectus incorporates. You
may request copies by writing or telephoning Consumer Portfolio Services, Inc.,
16355 Laguna Canyon Rd., Irvine, California 92618, Attention: Corporate
Secretary, telephone (949) 753-6800. You may also obtain copies of some of these
documents at our website at http://www.consumerportfolio.com. Information
included or referenced to on our website is not part of this prospectus.
59
INDEX TO FINANCIAL STATEMENTS
ANNUAL CONSOLIDATED FINANCIAL STATEMENTS
Page
Reference
Report of Independent Registered Public Accounting Firm - McGladrey & Pullen, LLP F-2
Report of Independent Registered Public Accounting Firm - KPMG LLP F-3
Consolidated Balance Sheets as of December 31, 2005 and 2004 F-4
Consolidated Statements of Operations for the years ended December 31, 2005, 2004, and 2003 F-5
Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2005,
2004, and 2003 F-6
Consolidated Statements of Shareholders' Equity for the years ended December 31, 2005, 2004, and 2003 F-7
Consolidated Statements of Cash Flows for the years ended December 31, 2005, 2004, and 2003 F-8
Notes to Consolidated Financial Statements for the years ended December 31, 2005, 2004, and 2003 F-10
FIRST QUARTER CONDENSED FINANCIAL STATEMENTS
Page
Reference
---------
Condensed Consolidated Statements of Financial Condition as of March 31, 2006 and December 31, 2005 F-37
Condensed Consolidated Statements of Operations for the three month periods ended March 31, 2006
and March 31, 2005 F-38
Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2006 and 2005 F-39
Notes to Condensed Consolidated Financial Statements F-40
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
Consumer Portfolio Services, Inc.:
We have audited the consolidated balance sheets of Consumer Portfolio Services,
Inc. and subsidiaries (the "Company") as of December 31, 2005 and 2004, and the
related consolidated statements of operations, comprehensive income (loss),
shareholders' equity, and cash flows for each of the two years in the period
ended December 31, 2005. 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 the standards of the Public Company
Accounting Oversight Board (United States). 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, 2005 and 2004, and the
results of their operations and their cash flows for each of the two years in
the period ended December 31, 2005, in conformity with U.S. generally accepted
accounting principles.
/s/ McGladrey & Pullen, LLP
Irvine, California
February 24, 2006
F-2
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors
Consumer Portfolio Services, Inc.:
We have audited the accompanying consolidated statements of operations,
comprehensive income (loss), shareholders' equity, and cash flows of Consumer
Portfolio Services, Inc. and subsidiaries (the "Company") for the year 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 audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). 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 audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the results of operations and cash flows of
Consumer Portfolio Services, Inc. and subsidiaries for the year ended December
31, 2003, in conformity with U.S. generally accepted accounting principles.
/s/ KPMG LLP
Orange County, California
March 15, 2004
F-3
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
DECEMBER 31, DECEMBER 31,
2005 2004
------------- -------------
ASSETS
Cash and cash equivalents $ 17,789 $ 14,366
Restricted cash and equivalents 157,662 125,113
Finance receivables 971,304 592,806
Less: Allowance for finance credit losses (57,728) (42,615)
------------- -------------
Finance receivables, net 913,576 550,191
Residual interest in securitizations 25,220 50,430
Furniture and equipment, net 1,079 1,567
Deferred financing costs 8,596 5,096
Deferred tax assets, net 7,532 --
Accrued interest receivable 10,930 6,411
Other assets 12,760 13,425
------------- -------------
$ 1,155,144 $ 766,599
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Accounts payable and accrued expenses $ 19,568 $ 18,153
Warehouse lines of credit 35,350 34,279
Tax liabilities, net -- 2,978
Notes payable 211 1,421
Residual interest financing 43,745 22,204
Securitization trust debt 924,026 542,815
Senior secured debt, related party 40,000 59,829
Subordinated renewable notes 4,655 --
Subordinated debt 14,000 15,000
------------- -------------
1,081,555 696,679
COMMITMENTS AND CONTINGENCIES
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; 21,687,584 and 21,471,478
shares issued and outstanding at December 31, 2005 and
December 31, 2004, respectively 66,748 66,283
Additional paid in capital, warrants 794 --
Retained earnings 8,476 5,104
Accumulated other comprehensive loss (2,429) (1,017)
Deferred compensation -- (450)
------------- -------------
73,589 69,920
------------- -------------
$ 1,155,144 $ 766,599
============= =============
See accompanying Notes to Consolidated Financial Statements.
F-4
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
YEAR ENDED DECEMBER 31,
--------------------------------------
2005 2004 2003
---------- ----------- -----------
REVENUES:
Net gain on sale of contracts $ -- $ -- $ 10,421
Interest income 171,834 105,818 58,164
Servicing fees 6,647 12,480 17,058
Other income 15,216 14,394 19,343
---------- ----------- -----------
193,697 132,692 104,986
---------- ----------- -----------
EXPENSES:
Employee costs 40,384 38,173 37,141
General and administrative 23,095 21,293 21,271
Interest 44,148 25,876 17,867
Interest, related party 7,521 6,271 5,994
Provision for credit losses 58,987 32,574 11,390
Impairment loss on residual asset -- 11,750 4,052
Marketing 12,000 8,338 5,380
Occupancy 3,400 3,520 3,930
Depreciation and amortization 790 785 1,000
---------- ----------- -----------
190,325 148,580 108,025
---------- ----------- -----------
Income (loss) before income tax benefit 3,372 (15,888) (3,039)
Income tax benefit -- -- (3,434)
---------- ----------- -----------
Net income (loss) $ 3,372 $ (15,888) $ 395
========== =========== ===========
Earnings (loss) per share:
Basic $ 0.16 $ (0.75) $ 0.02
Diluted 0.14 (0.75) 0.02
Number of shares used in computing
earnings (loss) per share:
Basic 21,627 21,111 20,263
Diluted 23,513 21,111 21,578
See accompanying Notes to Consolidated Financial Statements.
F-5
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
YEAR ENDED DECEMBER 31,
--------------------------------------
2005 2004 2003
----------- ---------- -----------
Net income (loss) $ 3,372 $ (15,888) $ 395
Other comprehensive income (loss):
Minimum pension liability, net of tax (1,412) 1,409 (832)
----------- ---------- -----------
Comprehensive income (loss) $ 1,960 $ (14,479) $ (437)
=========== ========== ===========
See accompanying Notes to Consolidated Financial Statements.
F-6
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(In thousands)
Additional Accumulated
Paid-in Other
Common Stock Capital, Retained Comprehensive Deferred
Shares Amount Warrants Earnings Loss Compensation Total
--------- --------- ---------- --------- -------------- ------------- ---------
Balance at December 31, 2002 20,528 $ 63,929 $ -- $ 20,597 $ (1,594) $ (358) $ 82,574
Common stock issued upon exercise
of options, including tax benefit 609 974 -- -- -- -- 974
Purchase of common stock (548) (1,195) -- -- -- -- (1,195)
Pension benefit obligation -- -- -- -- (832) -- (832)
Repurchase of warrants issued -- (896) -- -- -- -- (896)
Deferred compensation on
stock options -- 1,585 -- -- -- (1,585) --
Amortization of stock compensation -- -- -- -- -- 1,140 1,140
Net income -- -- -- 395 -- -- 395
--------- --------- ---------- --------- -------------- ------------- ---------
Balance at December 31,2003 20,589 64,397 -- 20,992 (2,426) (803) 82,160
Common stock issued upon exercise
of options, including tax benefit 575 1,079 -- -- -- -- 1,079
Common stock issued upon
conversion of debt 333 1,000 -- -- -- -- 1,000
Purchase of common stock (26) (111) -- -- -- -- (111)
Pension benefit obligation -- -- -- -- 1,409 -- 1,409
Deferred compensation on
stock options -- (82) -- -- -- 82 --
Amortization of stock compensation -- -- -- -- -- 271 271
Net loss -- -- -- (15,888) -- -- (15,888)
--------- --------- ---------- --------- -------------- ------------- ---------
Balance at December 31, 2004 21,471 66,283 -- 5,104 (1,017) (450) 69,920
Common stock issued upon exercise
of options, including tax benefit 415 1,311 -- -- -- -- 1,311
Purchase of common stock (199) (1,040) -- -- -- -- (1,040)
Pension benefit obligation -- -- -- -- (1,412) -- (1,412)
Valuation of warrants issued -- -- 794 -- -- -- 794
Deferred compensation on
stock options -- 194 -- -- -- (194) --
Amortization of stock compensation -- -- -- -- -- 644 644
Net income -- -- -- 3,372 -- -- 3,372
--------- --------- ---------- --------- -------------- ------------- ---------
Balance at December 31, 2005 21,687 $ 66,748 $ 794 $ 8,476 $ (2,429) $ -- $ 73,589
========= ========= ========== ========= ============== ============= =========
F-7
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
---------- ---------- ----------
2005 2004 2003
---------- ---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 3,372 $ (15,888) $ 395
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Reversal of restructuring accrual -- (1,287) --
Impairment loss on residual asset -- 11,750 4,052
Amortization of deferred acquisition fees (10,851) (6,725) (870)
Amortization of discount on Class B Notes 1,486 588 --
Depreciation and amortization 790 785 1,000
Amortization of deferred financing costs 3,296 3,479 2,695
Provision for credit losses 58,987 32,574 11,916
Gain of sale of Contracts, NIR -- -- (4,381)
Deferred compensation 644 271 1,140
Releases of cash from Trusts to Company 23,074 21,357 25,934
Initial deposits to Trusts -- -- (18,736)
Net deposits to Trusts to increase Credit Enhancement -- (2,858) (20,867)
Interest income on residual assets (5,338) (4,633) (16,178)
Cash received from residual interest in securitizations 30,548 54,154 45,644
Impairment charge against non-auto finanace receivable assets 1,882 -- --
Changes in assets and liabilities:
Payments on restructuring accrual (1,425) (1,969) (1,804)
Restricted cash and equivalents (55,623) (76,336) (30,641)
Purchases of contracts held for sale -- -- (182,045)
Proceeds received on Contracts held for sale -- -- 283,423
Other assets (5,578) (5,415) 6,936
Deferred tax assets, net (7,532) -- --
Accounts payable and accrued expenses 1,928 715 (1,559)
Tax liabilities (2,978) (606) (7,162)
---------- ---------- ----------
Net cash provided by operating activities 36,682 9,956 98,892
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of finance receivables held for investment (691,252) (505,977) (175,275)
Purchases of note receivable -- (2,799) --
Proceeds received on finance receivables held for investment 279,730 196,126 6,611
Purchase of furniture and equipment (166) (1,408) (93)
Purchase of subsidiary, net of cash acquired -- -- (10,181)
---------- ---------- ----------
Net cash used in investing activities (411,688) (314,058) (178,938)
---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of residual financing debt 45,800 44,000 --
Proceeds from issuance of securitization trust debt 662,350 474,720 154,375
Proceeds from issuance of senior secured debt, related party -- 25,000 25,000
Proceeds from issuance of subordinated renewable notes 4,685 -- --
Net proceeds from warehouse lines of credit 1,071 570 31,332
Repayment of residual interest financing debt (24,259) (21,796) --
Repayment of securitization trust debt (282,625) (177,611) (96,484)
Repayment of senior secured debt, related party (19,829) (15,137) (25,107)
Repayment of subordinated debt and renewable notes (1,030) (20,000) (1,000)
Repayment of notes payable (1,209) (1,909) (3,748)
Repayment of related party debt -- (16,500) --
Payment of financing costs (6,796) (7,046) (2,553)
Repurchase of common stock (1,040) (111) (1,195)
Repurchase of warrants issued -- -- (896)
Exercise of options and warrants 1,311 1,079 584
---------- ---------- ----------
Net cash provided by financing activities 378,429 285,259 80,308
---------- ---------- ----------
Increase (decrease) in cash and cash equivalents 3,423 (18,843) 262
Cash and cash equivalents at beginning of period 14,366 33,209 32,947
---------- ---------- ----------
Cash and cash equivalents at end of period $ 17,789 $ 14,366 $ 33,209
========== ========== ==========
F-8
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying Notes to Consolidated Financial Statements.
YEAR ENDED DECEMBER 31,
--------- ---------- ---------
2005 2004 2003
--------- ---------- ---------
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 45,929 $ 28,228 $ 18,677
Income taxes 9,377 420 3,728
Supplemental disclosure of non-cash investing and financing activities:
Stock-based compensation $ 644 $ 271 $ 1,140
Conversion of related party debt to common stock -- (1,000) --
Pension benefit obligation, net 1,412 (1,409) 832
Value of warrants issued 794 -- --
See accompanying Notes to Consolidated Financial Statement
F-9
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. Dealers located in Texas, California, Ohio
and Florida represented 10.7%, 9.0%, 7.5% and 7.1%, respectively of Contracts
purchased during 2005 compared with 12.1%, 8.6%, 5.1% and 6.1%, respectively in
2004. No other state had a concentration in excess of 7.0%. The Company
specializes in Contracts with obligors who generally would not be expected to
qualify for traditional financing, such as that provided by commercial banks or
automobile manufacturers' captive finance companies.
The Company is subject to various regulations and laws as they relate to the
extension of credit in consumer credit transactions. Although the Company
believes it is currently in material compliance with these regulation and laws,
there can be no assurance that the Company will be able to maintain such
compliance. Failure to comply with such laws and regulations could have a
material adverse effect on the Company.
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, financing those Contracts through securitization
transactions, and servicing those Contracts. MFN ceased acquiring Contracts in
March 2002; TFC continues to acquire Contracts under its "TFC Programs."
On April 2, 2004, the Company purchased a portfolio of Contracts and certain
other assets (the "SeaWest Asset Acquisition") from SeaWest Financial
Corporation ("SeaWest"). In addition, the Company was named the successor
servicer for three term securitization transactions originally sponsored by
SeaWest (the "SeaWest Third Party Portfolio"). The Company does not intend to
offer financing programs similar to those previously offered by SeaWest.
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.
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. The Company's cash is primarily deposited at three
financial institutions. The Company maintains cash due from banks in excess of
the bank's insured deposit limits. The Company does not believe it is exposed to
any significant credit risk on these deposits. As part of certain financial
covenants related to debt facilities, the Company is required to maintain a
minimum unrestricted cash balance.
FINANCE RECEIVABLES, NET OF UNEARNED INCOME
Finance receivables are presented at cost. All Finance receivable Contracts are
held for investment and 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 contractual term of the
receivables. 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
delinquency period are charged off immediately. Management may authorize an
extension of payment terms if collection appears likely during the next calendar
month.
F-10
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company's portfolio of finance receivables is comprised of smaller-balance
homogeneous Contracts that are collectively evaluated for impairment on a
portfolio basis. The Company reports delinquency on a contractual basis. Once a
Contract becomes greater than 90 days delinquent, the Company does not recognize
additional interest income until the borrower under the Contract makes
sufficient payments to be less than 90 days delinquent. Any payments received by
a borrower that is greater than 90 days delinquent is first applied to accrued
interest and then to principal reduction.
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 probable credit losses that can be
reasonably estimated 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, the value of the underlying collateral and
historical loss trends. As conditions change, the Company's level of
provisioning and/or allowance may change as well.
CHARGE OFF POLICY
Delinquent Contracts for which the related financed vehicle has been repossessed
are generally charged off no later than the month in which the proceeds from the
sale of the financed vehicle were received (see Repossessed and Other Assets
below). The amount charged off is the remaining principal balance of the
Contract, after the application of the net proceeds from the liquidation of the
financed vehicle. With respect to delinquent Contracts for which the related
financed vehicle has not been sold, the remaining principal balance thereof is
generally charged off no later than the end of the month that the Contract
becomes 120 days past due for CPS Program receivables and for non-CPS Program
receivables, no later than the end of the month that the Contract becomes 180
days past due.
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 purchased and securitized in pools which are structured as secured
financings for financial accounting purposes, dealer acquisition fees reduce the
carrying value of finance receivables and are accreted into earnings as an
adjustment to the yield over the life of the loans using the interest method in
accordance with Statement of Financial Accounting Standards No. 91, "Accounting
for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans
and Initial Direct Costs of Leases".
Effective January 1, 2005, the Company adopted the Accounting Standards
Executive Committee's Statement of Position 03-3, "Accounting for Certain Loans
or Debt Securities Acquired in a Transfer" ("SOP 03-3"), for loans acquired
subsequent to December 31, 2004. Under SOP 03-3, dealer acquisition fees on
loans purchased by the Company are not considered credit-related because there
is no deterioration in credit quality between the time the loan originated and
when it is acquired. The adoption of SOP 03-3 had no impact on the financial
statements of the Company.
REPOSSESSED AND OTHER ASSETS
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. At the time the
vehicle is repossessed the Company will stop accruing interest in this Contract,
and reclassify the remaining Contract balance to other assets. In addition the
Company will apply a specific reserve to this Contract so that the net balance
represents the estimated fair value less costs to sell. Included in other assets
in the accompanying balance sheets are repossessed vehicles pending sale, net of
the reserve, of $4.2 million and $2.7 million at December 31, 2005 and 2004,
respectively.
F-11
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Included in Other Assets are non-finance receivable assets totaling $2.4 million
as of December 31, 2005, net of a valuation allowance of $1.9 million. The
valuation allowance was established in 2005 and is included in general and
administrative expenses in the Company's Consolidated Statement of Operations
(See Note 13). Included in the $1.9 million valuation allowance, is $900,000
associated with related party receivables.
TREATMENT OF SECURITIZATIONS
Prior to July 2003, the disposition of Contracts in securitization transactions
were structured as sales for financial accounting purposes, therefore, gain on
sale was recognized on those securitization transactions in which the Company,
or a wholly-owned, consolidated subsidiary of the Company, retained a residual
interest in the Contracts that were sold to a wholly-owned, unconsolidated
special purpose subsidiary. These 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).
The line item "Residual interest in securitizations" on the Company's
Consolidated Balance Sheet represents the residual interests in term
securitizations completed prior to July 2003. This line represents the
discounted sum of expected future cash flows from these securitization trusts.
Accordingly, the valuation of the residual is heavily dependent on estimates of
future performance of the Contracts included in the term securitizations.
All subsequent securitizations were 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 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 ("Notes"), in a principal amount equal
to or less than 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 "Noteholders"); the
proceeds from the sale of the Notes are then used to purchase the Contracts from
the Company. The Company may retain or sell subordinated Notes issued by the
Trust or a related entity. 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
Noteholders in three forms: (1) an initial cash deposit to a bank account (a
"Spread Account") held by the Trust, (2) overcollateralization of the Notes,
where the principal balance of the Notes issued is less than the principal
balance of the Contracts, and (3) in the form of subordinated Notes. 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 which are then
maintained. 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 portfolios 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 portfolios, 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.
Beginning in the third quarter of 2003, the Company began to structure its term
securitization transactions so that they would be treated for financial
accounting purposes as borrowings secured by receivables, rather than as sales
of receivables.
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 compared to the previous term securitization transactions which were
accounted for as sales at the consummation of the transaction. The changes have
resulted in the Company initially reporting lower earnings than it would have
reported if it had continued structuring its securitizations to require
recognition of gain on sale.
F-12
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Securitizations prior to July 2003 that were treated as sales for financial
accounting purposes differ from secured financings in that the Trust to which
the SPS sold the Contracts met 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 77.0% to 80.0% of the aggregate
principal balance of the Contracts (that is, at least 20.0%
overcollateralization), and (iii) no increase in the required amount of Credit
Enhancement is contemplated unless certain portfolio performance tests are
breached. Upon each sale of Contracts in a securitization structured as a
secured financing, 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 allocated 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 securitization transactions structured both as sales
and as secured financings.
With respect to securitizations structured as sales for financial accounting
purposes, the Company allocates its basis in the Contracts between the Contracts
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 estimated fair value of the Residuals. Gains
in fair value are recognized in the income statement with losses being recorded
as an impairment loss in the income statement. 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 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 14% per
annum except for certain collections from charged off receivables related to the
Company's securitizations in 2001 and later where the Company has used a
discount rate of 25%.
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 on the Notes 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 related to transactions insured by the same Note Insurer 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. In
determining the value of the Residuals, the Company must estimate the future
rates of prepayments, delinquencies, defaults, default loss severity, and
recovery rates, as all of these factors affect the amount and timing of the
estimated cash flows. The Company's estimates are based on historical
performance of comparable Contracts.
F-13
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Following a securitization that is structured as a sale for financial accounting
purposes, interest income is recognized on the balance of the Residuals. In
addition, the Company will recognize as a gain additional revenue from the
Residuals if the actual performance of the Contracts is better than the
Company's estimate of the value of the residual. If the actual performance of
the Contracts were worse than the Company's estimate, then a downward adjustment
to the carrying value of the Residuals and a related impairment charge would be
required. In a securitization 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' recourse to the Company for failure of the Contract
obligors to make payments on a timely basis is limited to the Company's Finance
receivables, Spread Accounts and Residuals.
SERVICING
The Company considers the contractual 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, which are included in Other Assets in the
accompanying balance sheets, represent fees earned but not yet remitted to the
Company by the trustee.
FURNITURE AND EQUIPMENT
Furniture and equipment are stated at cost net of accumulated depreciation. The
Company calculates depreciation using the straight-line method over the
estimated useful lives of the assets, which range from three to five years.
Assets held under capital leases and leasehold improvements are amortized over
the lesser of the estimated useful lives of the assets or the related lease
terms. Amortization expense on assets acquired under capital lease is included
with depreciation expense on Company owned assets.
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, fees paid to the Company by Dealers for certain direct mail services
the Company provides, refunds of sales taxes paid by obligors under the
Contracts, and, in 2005 $2.7 million in proceeds from sales of previously
charged off Contracts to independent third parties. The recoveries on previously
charged off MFN Contracts relate to Contracts that were acquired in the MFN
acquisition. These recoveries totaled $4.9 million, $8.0 million and $12.2
million for the years ended December 31, 2005, 2004 and 2003, respectively.
F-14
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
EARNINGS PER SHARE
The following table illustrates the computation of basic and diluted earnings
(loss) per share:
2005 2004 2003
---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Numerator:
Numerator for basic and diluted earnings (loss) per share ..... $ 3,372 $ (15,888) $ 395
========== =========== ==========
Denominator:
Denominator for basic earnings (loss) per share
- weighted average number of common shares
outstanding during the year ................................ 21,627 21,111 20,263
Incremental common shares attributable to exercise
of outstanding options and warrants ........................ 1,886 -- 1,315
---------- ----------- ----------
Denominator for diluted earnings (loss) per
share ...................................................... 23,513 21,111 21,578
========== =========== ==========
Basic earnings (loss) per share ............................... $ 0.16 $ (0.75) $ 0.02
========== =========== ==========
Diluted earnings (loss) per share ............................. $ 0.14 $ (0.75) $ 0.02
========== =========== ==========
Incremental shares of 1.1 million related to the conversion of subordinated debt
have been excluded from the calculation for the year ended December 31, 2003
because the impact of assumed conversion of such subordinated debt is
anti-dilutive. Incremental shares of 1.8 million shares related to stock options
have been excluded from the diluted earnings (loss) per share calculation for
the year ended December 31, 2004 because the impact is anti-dilutive.
In addition, options to purchase 639,000, 305,000 and 908,000 shares of common
stock for the years ended December 31, 2005, 2004 and 2003, respectively, were
excluded from the calculation of diluted earnings (loss) per share because the
option exercise price was greater than the average market price of the shares.
DEFERRAL AND AMORTIZATION OF DEBT ISSUANCE COSTS
Costs related to the issuance of debt are amortized using the interest method
over the contractual or expected term of the related debt.
INCOME TAXES
The Company and its subsidiaries file a consolidated federal income tax return
and combined or stand-alone state franchise tax returns for certain states. 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.
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 (loss) per
share, and stock based compensation plan disclosure requirements set forth in
SFAS No. 123. The Company accounts for repriced options as variable awards.
F-15
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In December 2005, the Compensation Committee of the Board of Directors approved
accelerated vesting of all the outstanding stock options issued by the Company.
Options to purchase 2,113,998 shares of the Company's common stock, which would
otherwise have vested from time to time through 2010, became immediately
exercisable as a result of the acceleration of vesting. The decision to
accelerate the vesting of the options was made primarily to reduce non-cash
compensation expenses that would have been recorded in the Company's income
statement in future periods upon the adoption of Financial Accounting Standards
Board Statement No. 123R in January 2006. The Company estimates that
approximately $3.5 million of future non-cash compensation expense will be
eliminated as a result of the acceleration of vesting.
At the time of the acceleration of vesting, the Company accounted for its stock
options in accordance with Accounting Principals Board Opinion No. 25,
Accounting for Stock Issued to Employees. Consequently, the acceleration of
vesting resulted in non-cash compensation charge of $427,000 for the year ended
December 31, 2005.
The per share weighted-average fair value of stock options granted during the
years ended December 31, 2005, 2004 and 2003, was $3.07, $2.30, and $2.09,
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,
----------------------------------
2005 2004 2003
-------- -------- --------
Expected life (years) .... 6.50 6.50 7.63
Risk-free interest rate .. 4.32% 4.48% 4.16%
Volatility ............... 56.90% 54.65% 100.82%
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 (loss) and earnings (loss) per share would have been adjusted to the pro
forma amounts indicated below.
YEAR ENDED DECEMBER 31,
-------------------------------------
2005 2004 2003
---------- ---------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net income (loss)
As reported ...................... $ 3,372 $ (15,888) $ 395
Pro forma ........................ (648) (16,808) 175
Earnings (loss) per share - basic
As reported ...................... $ 0.16 $ (0.75) $ 0.02
Pro forma ........................ (0.03) (0.80) 0.01
Earnings (loss) per share - diluted
As reported ...................... $ 0.14 $ (0.75) $ 0.02
Pro forma ........................ (0.03) (0.80) 0.01
SEGMENT REPORTING
Operations are managed and financial performance is evaluated on a Company-wide
basis by a chief decision maker. Management has determined that the aggregation
criteria of FASB Statement No. 131 have been met and accordingly, all of the
Company's operations are aggregated in one reportable segment.
NEW ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board ("FASB") issued FASB
Statement No. 123(R) (As Amended), "Share-Based Payment" ("FAS 123(R)" or the
"Statement"). FAS 123 (R) and related interpretations require that the
compensation cost relating to share-based payment transactions, including grants
of employee stock options, be recognized in financial statements. That cost will
be measured based on the fair value of the equity or liability instruments
issued. FAS 123(R) permits entities to use any option-pricing model that meets
the fair value objective in the Statement. Modifications of share-based payments
will be treated as replacement awards with the cost of the incremental value
recorded in the financial statements.
F-16
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Statement is effective at the beginning of 2006 and will therefore be
effective for the Company's first quarter of 2006. As of the effective date, the
Company will apply the Statement using a modified version of prospective
application. Under that transition method, compensation cost is recognized for
(1) all awards granted after the required effective date and to awards modified,
cancelled, or repurchased after that date and (2) the portion of prior awards
for which the requisite service has not yet been rendered, based on the
grant-date fair value of those awards calculated for pro forma disclosures under
SFAS 123. As a result of the acceleration of vesting on all options outstanding
in December 2005 there will be no effect on the Company's adoption of the
statement in 2006 relating to such options currently outstanding.
In February 2006, the FASB issued FASB Statement No. 155, "Accounting for
Certain Hybrid Instruments". This statement amends the guidance in FASB
Statements No. 133, "Accounting for Derivative Instruments and Hedging
Activities", and No. 140, ""Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities". Statement 155 allows financial
instruments that have embedded derivatives to be accounted for as a whole
(eliminating the need to bifurcate the derivative from its host) if the holder
elects to account for the whole instrument on a fair value basis. The Statement
also amends Statement 140 to eliminate the prohibition on a qualifying
special-purpose entity from holding a derivative financial instrument that
pertains to a beneficial interest other than another derivative financial
instrument. Statement 155 is effective for all financial instruments acquired or
issued after January 1, 2007. The Company does not believe the adoption of this
statement will have a material effect on the Company's financial position or
operations.
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, computing the
related gain on sale on the transactions that created the Residuals, and the
recording of the deferred tax asset valuation allowance. These are material
estimates that could be susceptible to changes in the near term and accordingly,
actual results could differ from those estimates.
(2) RESTRICTED CASH
Restricted cash comprised the following components:
DECEMBER 31,
-----------------------
2005 2004
---------- ----------
(IN THOUSANDS)
Securitization trust accounts ..... $ 157,492 $ 118,944
Litigation reserve ................ -- 5,503
Note purchase facility reserve .... 20 516
Other ............................. 150 150
---------- ----------
Total restricted cash ............. $ 157,662 $ 125,113
========== ==========
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.
(3) FINANCE RECEIVABLES
The following table presents the components of Finance Receivables, net of
unearned interest:
F-17
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, DECEMBER 31,
2005 2004
---------------------------
Finance Receivables (IN THOUSANDS)
Automobile
Simple Interest ......................................... $ 933,510 $ 522,346
Pre-compute, net of unearned interest ................... 54,693 86,932
----------- -----------
Finance Receivables, net of unearned interest ........... 988,203 609,278
Less: Unearned acquisition fees and discounts ........... (16,899) (16,472)
----------- -----------
Finance Receivables ..................................... $ 971,304 $ 592,806
=========== ===========
Finance receivables totaling $5.1 million and $5.4 million at December 31, 2005
and 2004, respectively, have been placed on non-accrual status as a result of
their delinquency status.
The following table presents a summary of the activity for the allowance for
credit losses, for the years ended December 31, 2005 and 2004:
DECEMBER 31,
-----------------------------------------
2005 2004 2003
----------- ----------- -----------
(IN THOUSANDS)
Balance at beginning of year .............................. $ 42,615 $ 35,889 $ 25,828
Addition to allowance for credit losses from acquisitions . -- -- 24,271
Provision for credit losses ............................... 58,987 32,574 11,667
Charge-offs ............................................... (55,978) (34,636) (32,117)
Recoveries ................................................ 12,104 8,788 6,240
----------- ----------- -----------
Balance at end of year .................................... $ 57,728 $ 42,615 $ 35,889
=========== =========== ===========
(4) RESIDUAL INTEREST IN SECURITIZATIONS
The following table presents the components of the residual interest in
securitizations and shown at their discounted amounts:
DECEMBER 31,
-------------------------
2005 2004
---------- ----------
(IN THOUSANDS)
Cash, commercial paper, United States government securities
and other qualifying investments (Spread Accounts) ..... $ 12,748 $ 17,776
Receivables from Trusts (NIRs) ............................ 5,798 12,483
Overcollateralization ..................................... 6,674 16,644
Investment in subordinated certificates ................... -- 3,527
---------- ----------
Residual interest in securitizations ...................... $ 25,220 $ 50,430
========== ==========
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,
-----------------------------------------
2005 2004 2003
----------- ----------- -----------
(DOLLARS IN THOUSANDS)
Undiscounted estimated credit losses ...................... $ 5,724 $ 23,588 $ 47,935
Managed portfolio held by non-consolidated subsidiary ..... 103,130 233,621 425,534
Undiscounted estimated credit losses as a percentage of
managed portfolio held by non-consolidated subsidiary ..... 5.55% 10.10% 11.30%
F-18
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The key economic assumptions used in measuring the residual interest in
securitizations at the date of securitization in 2003 are as follows: prepayment
speed of 21.7%, net credit losses of 12.5%, and a discount rate of 14%. There
were no securitizations accounted for as sales for financial accounting purposes
in 2004 and 2005.
The key economic assumptions used in measuring all residual interest in
securitizations as of December 31, 2005 and 2004 are included in the table
below. The pre-tax discount rate remained constant at 14%, except for certain
cash flows from charged off receivables related to the Company's securitizations
from 2001 to 2003 where the Company has used a discount rate of 25%.
2005 2004
------------- -------------
Prepayment speed (Cumulative).............. 22.2% - 35.8% 20.0% - 30.5%
Net credit losses (Cumulative)............. 11.9% - 20.2% 13.0% - 20.5%
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,
----------------------
2005
----------------------
(DOLLARS IN THOUSANDS)
Carrying amount/fair value of residual interest in
securitizations............ $ 25,220
Weighted average life in years.......................... 2.24
Prepayment Speed Assumption (Cumulative)................ 22.2% - 35.8%
Estimated fair value assuming 10% adverse change........ $ 25,168
Estimated fair value assuming 20% adverse change........ 25,119
Expected Net Credit Losses (Cumulative)................. 11.9% - 20.2%
Estimated fair value assuming 10% adverse change........ $ 23,937
Estimated fair value assuming 20% adverse change........ 22,656
Residual Cash Flows Discount Rate (Annual).............. 14.0% - 25.0%
Estimated fair value assuming 10% adverse change........ $ 24,636
Estimated fair value assuming 20% adverse change........ 24,071
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) the
Company's unconsolidated securitization Trusts:
FOR THE YEAR ENDED DECEMBER 31,
-----------------------------------------
2005 2004 2003
----------- ----------- -----------
(IN THOUSANDS)
Releases of cash from Spread Accounts ..................... $ 7,420 $ 17,175 $ 25,934
Servicing Fees received ................................... 4,490 13,631 17,039
Net deposits to increase Credit Enhancement ............... -- (2,106) (20,867)
Initial funding of Credit Enhancement ..................... -- -- (18,736)
Purchase of delinquent or foreclosed assets ............... (22,682) (44,473) (45,747)
Repurchase of trust assets ................................ (9,658) -- --
The following table presents the credit loss and delinquency performance for the
serviced portfolio:
F-19
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
PRINCIPAL AMOUNT OF
TOTAL PRINCIPAL CONTRACTS 60 DAYS NET CREDIT LOSSES (1)
AMOUNT OF CONTRACTS OR MORE PAST DUE FOR THE YEAR ENDED
--------------------------- --------------------------- ---------------------------
AT DECEMBER 31, AT DECEMBER 31, DECEMBER 31,
--------------------------- --------------------------- ---------------------------
2005 2004 2005 2004 2005 2004
------------ ------------ ------------ ------------ ------------ ------------
(IN THOUSANDS)
Contracts held by
consolidated subsidiaries .. $ 1,000,597 $ 619,794 $ 25,864 $ 17,379 $ 36,511 $ 26,418
Contracts held by
non-consolidated subsidiaries 103,130 233,621 4,263 10,037 14,184 36,042
SeaWest Third Party Portfolio 18,018 53,463 1,663 5,065 7,386 18,018
------------ ------------ ------------ ------------ ------------ ------------
Total managed portfolio ...... $ 1,121,745 $ 906,878 $ 31,790 $ 32,481 $ 58,081 $ 80,478
============ ============ ============ ============ ============ ============
(1) Includes recoveries on previously charged off MFN Contracts included in
other income.
(5) FURNITURE AND EQUIPMENT
The following table presents the components of furniture and equipment:
DECEMBER 31,
--------------------------
2005 2004
----------- -----------
(IN THOUSANDS)
Furniture and fixtures .................................... $ 3,780 $ 3,744
Computer equipment ........................................ 4,815 4,700
Leasing assets ............................................ 673 673
Leasehold improvements .................................... 666 651
Other fixed assets ........................................ 17 17
----------- -----------
9,951 9,785
Less: accumulated depreciation and amortization ........... (8,872) (8,218)
----------- -----------
$ 1,079 $ 1,567
=========== ===========
Depreciation expense totaled $654,000, $660,000 and $878,000 for the years ended
December 31, 2005, 2004 and 2003, respectively.
(6) RESTRUCTURING ACCRUALS
MFN MERGER
In connection with the MFN Merger, the Company subsequently terminated the MFN
origination activities and consolidated certain activities of MFN. In connection
therewith, the Company 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. Of these liabilities recognized at the merger date in the amount of
$6.2 million, only the accrual related to facility closures remained outstanding
as of December 31, 2005 and 2004 in the amounts of $545,000 and $1.2 million
respectively.
TFC MERGER
In connection with the TFC Merger, the Company consolidated certain activities
of CPS and TFC. As a result of this consolidation, the Company recognized
certain liabilities related to the costs to integrate and terminate affected
employees of TFC. These activities include service departments such as
accounting, finance, human resources, information technology, administration,
payroll and executive management. The total liabilities recognized by the
Company at the time of the merger were $4.5 million. These costs include the
following:
F-20
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, DECEMBER 31, DECEMBER 31,
2005(2) ACTIVITY 2004 ACTIVITY 2003
------------ ------------ ------------ ------------ ------------
(IN THOUSANDS)
Severance Payments and
consulting contracts (1) .... $ 109 $ 309 $ 418 $ 1,908 $ 2,326
Facilities closures ......... 345 477 822 409 1,231
Other obligations ........... -- -- -- 234 234
------------ ------------ ------------ ------------ ------------
Total liabilities assumed $ 454 $ 786 $ 1,240 $ 2,551 $ 3,791
============ ============ ============ ============ ============
______________
(1) For the period from December 31, 2003 to December 31, 2004 the activity
resulting in a change of $1.9 million, includes charges against the liability of
$621,000 and the reversal of $1.3 million of costs that the Company no longer
expects to incur. The $1.3 was recorded in the statement of income as a
reduction of operating expenses during the year ended December 31, 2004.
(2) 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.
(7) SECURITIZATION TRUST DEBT
The Company has completed a number of securitization transactions that are
structured as secured borrowings for financial accounting purposes. The debt
issued in these transactions is shown on the Company's consolidated balance
sheets as "Securitization trust debt," and the components of such debt are
summarized in the following table:
WEIGHTED
AVERAGE
FINAL RECEIVABLES OUTSTANDING OUTSTANDING INTEREST
SCHEDULED PLEDGED AT PRINCIPAL AT PRINCIPAL AT RATE AT
PAYMENT DECEMBER 31, INITIAL DECEMBER 31, DECEMBER 31, DECEMBER 31,
SERIES DATE (1) 2005 PRINCIPAL 2005 2004 2005
-------------------- ------------- ------------- -------------- -------------- -------------- -------------
MFN 2001-A June 2007 $ -- $ 301,000 $ -- $ 3,382 --
TFC 2002-1 August 2007 -- 64,552 -- 2,574 --
TFC 2002-2 March 2008 -- 62,589 -- 9,152 --
TFC 2003-1 January 2009 7,779 52,365 6,557 17,703 2.69%
CPS 2003-C March 2010 32,063 87,500 30,550 53,456 3.57%
CPS 2003-D October 2010 31,203 75,000 29,688 50,722 3.50%
CPS 2004-A October 2010 40,316 82,094 40,225 66,737 3.62%
PCR 2004-1 March 2010 28,068 76,257 22,873 52,633 3.52%
CPS 2004-B February 2011 53,330 96,369 52,704 84,185 4.17%
CPS 2004-C April 2011 62,360 100,000 61,779 93,071 3.86%
CPS 2004-D December 2011 84,034 120,000 82,801 109,200 4.44%
CPS 2005-A October 2011 109,749 137,500 110,021 N/A 4.93%
CPS 2005-B February 2012 121,440 130,625 113,194 N/A 4.16%
CPS 2005-C May 2012 186,021 183,300 173,509 N/A 4.61%
CPS 2005-TFC July 2012 78,991 72,525 72,525 N/A 5.72%
CPS 2005-D (2) July 2012 86,083 127,600 127,600 N/A 4.98%
------------- -------------- -------------- --------------
$ 921,437 $ 1,769,276 $ 924,026 $ 542,815
============= ============== ============== ==============
____________________
The Final Scheduled Payment Date represents final legal maturity of the
securitization trust debt. Securitization trust debt is expected to become due
and to be paid prior to those dates, based on amortization of the finance
receivables pledged to the Trusts. Expected payments, which will depend on the
performance of such receivables, as to which there can be no assurance, are
$328.7 million in 2006, $223.7 million in 2007, $160.5 million in 2008, $114.6
million in 2009, $75.1 million in 2010, and $21.4 million in 2011.
Receivables Pledged at December 31, 2005 excludes approximately $58.0 million in
Contracts delivered to the Trust in January 2006 pursuant to a pre-funding
structure.
F-21
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All of the securitization trust debt was issued in private placement
transactions to qualified institutional investors. 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 minimum levels of liquidity and net worth and not exceed
maximum leverage levels and maximum financial losses. As a result of waivers and
amendments to these covenants throughout 2004 and 2005, the Company was in
compliance with all such covenants as of December 31, 2005. Without the waivers
and amendments obtained in the first quarter of 2005, the Company would have
been in breach of covenants related to maintaining a minimum level of net worth
and incurring a maximum financial loss as of December 31, 2004.
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, 2005, restricted cash under the various agreements totaled approximately
$157.5 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.
(8) DEBT
The terms of the Company's significant debt outstanding at December 31, 2005 and
2004 are summarized below:
F-22
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31,
--------------------------
2005 2004
----------- -----------
(IN THOUSANDS)
RESIDUAL INTEREST FINANCING
Notes secured by the Company's residual interests in its securitizations. The
notes outstanding at December 31, 2004 were secured by eight securitization
transactions and bore interest at 10.0% per annum. The notes outstanding at
December 31, 2005 are secured by ten securitizations and bear interest at a
blended interest rate of 8.36% per annum. In each period, the securitizations
pledged include both sale transactions and secured financing transactions. The
notes are non-recourse obligations of the Company with interest and principal to
be paid solely from the cash distributions on the retained interests securing
the notes. The notes outstanding at December 31, 2004 were issued in March 2004
with issuance costs of $1.3 million and were repaid in full in August 2005. The
notes outstanding at December 31, 2005 were issued in November 2005 with
issuance costs of $915,000 and have a final maturity of July 2011. $ 43,745 $ 22,204
SENIOR SECURED DEBT, RELATED PARTY
Notes payable to Levine Leichtman Capital Partners II, L.P. ("LLCP"). The notes
consists of separate term notes that each bear interest at 11.75% per annum,
require monthly interest payments and are due on various dates through December
2006, after having been amended from higher rates and earlier maturities. The
Company incurred issuance and amendment fees aggregating $1.3 million in
relation to these notes. The notes are secured by all assets of the Company that
are not pledged to securitization debt, and are the last in a series of
borrowings from LLCP that have taken place since November 1998, which have also
included the issuances to LLCP of warrants to purchase the Company's common
stock. As of December 31, 2005 and 2004, a warrant to purchase 1,000 shares of
common stock at $0.01 per share remained outstanding which expire in April 2009. $ 40,000 $ 59,829
SUBORDINATED DEBT
Notes bearing interest at 12.50% per annum and 12.00% per annum at December 31,
2005 and 2004 respectively. The Company incurred issuance costs of $1.1 million
when the notes were issued in December 1995. The $14.0 million outstanding was
repaid on its maturity date in January 2006. $ 14,000 $ 15,000
RENEWABLE SUBORDINATED NOTES
Notes bearing interest ranging from 5.60% to 11.15%, with a weighted average
rate of 8.53%, and with maturities from January 2006 to November 2015 with a
weighted maturity of January 2008. The Company began issuing the notes in June
2005 and incurred issuance costs of $250,000. Payments may be required monthly,
quarterly, annually or upon maturity based on the terms of the individual notes. $ 4,655 $ --
----------- -----------
$ 102,400 $ 97,033
=========== ===========
F-23
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The costs incurred in conjunction with the above debt are recorded as deferred
financing costs on the accompanying balance sheets and is more fully described
in Note 1.
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 and capitalization.
Further covenants include matters relating to investments, acquisitions,
restricted payments and certain dividend restrictions.
The following table summarizes the contractual maturity amounts of debt as of
December 31, 2005:
RESIDUAL SENIOR RENEWABLE
CONTRACTUAL INTEREST SECURED SUBORDINATED SUBORDINATED
MATURITY DATE FINANCING (1) DEBT DEBT NOTES TOTAL
------------- ------------- ----------- ----------- ------------ ----------
2006 $ 17,986 $ 40,000 $ 14,000 $ 1,643 $ 73,629
2007 14,435 -- -- 909 15,344
2008 7,644 -- -- 1,562 9,206
2009 3,680 -- -- 171 3,851
2010 -- -- -- 279 279
Thereafter -- -- -- 91 91
------------------------------------------------------------------------
$ 43,745 $ 40,000 $ 14,000 $ 4,655 $ 102,400
========================================================================
_________________________
(1) The Contractual maturity date for the Residual interest financing is July
2011. The notes are expected to be paid prior to that date, based on the
amortization of the related securitizations. Since the amortization of the
related securitizations is based on the performance of the underlying finance
receivables, there can be no assurance as to the exact timing of payments.
(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 of credit, senior debt,
and subordinated debt. The covenants restrict the payment of certain
distributions, including dividends (See Note 8.).
Included in common stock at December 31, 2003, is additional paid in capital of
$1.6 million 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 the years ended December 31,
2005, 2004 and 2003, is $644,000, $271,000 and $1.1 million 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. In October 2004, the Board of Directors authorized the
purchase of an additional $5.0 million of outstanding debt or equity securities.
As of December 31, 2005, the Company had purchased $5.0 million in principal
amount of the debt securities, and $5.0 million of its common stock,
representing 2,365,695 shares.
F-24
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 been granted at an exercise price equal to (or greater
than) the stock's fair market value at the date of the grant, with terms of 10
years and vesting generally 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. A further
increase to 6,900,000 shares in the aggregate maximum number of shares that may
be granted was approved by the shareholders in 2004.
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, 2005, there were a total of 165,261 additional shares available
for grant under the 1997 Plan and the 1991 Plan. Of the options outstanding at
December 31, 2005, 2004 and 2003, 4,863,654, 1,611,182, and 1,168,042,
respectively, were then exercisable, with weighted-average exercise prices of
$3.38, $2.25, and $1.71, respectively.
Stock option activity during the periods indicated is as follows:
WEIGHTED
NUMBER OF AVERAGE
SHARES EXERCISE PRICE
-------------- ----------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
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
Granted ......................... 958 3.96
Exercised ....................... 575 1.23
Canceled ........................ 173 2.29
-------------- ----------------
Balance at December 31, 2004 ..... 4,082 2.52
Granted ......................... 1,451 5.39
Exercised ....................... 415 2.08
Canceled ........................ 254 3.17
-------------- ----------------
Balance at December 31, 2005 ..... 4,864 $ 3.38
============== ================
F-25
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The per share weighted average fair value of stock options granted whose
exercise price was equal to the market price of the stock on the grant date
during the years ended December 31, 2005, 2004 and 2003, was $2.77, $2.30, and
$2.09, respectively.
The per share weighted average fair value and exercise price of stock options
granted whose exercise price was above the market price of the stock on the
grant date during the year ended December 31, 2005 was $3.61 and $6.00,
respectively. The Company did not issue any stock options above the market price
of the stock during the year ended December 31, 2004 and 2003.
The Company did not issue any stock options below the market price of the stock
on the grant date.
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, 2005, 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 AVERAGE
RANGE OF EXERCISE PRICES NUMBER REMAINING EXERCISE PRICE NUMBER EXERCISE PRICE
(PER SHARE) OUTSTANDING TERM (YEARS) PER SHARE EXERCISABLE PER SHARE
------------------------- ----------- ------------ -------------- ----------- --------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
$0.63 - $1.50 ........... 858 6.43 $ 1.47 858 $ 1.47
$1.51 - $2.50 ........... 1,092 5.61 1.93 1,092 1.93
$2.51 - $4.00 ........... 1,225 8.00 3.46 1,225 3.46
$4.01 - $5.04 ........... 1,035 8.53 4.74 1,035 4.74
$5.05 - $6.10 ........... 654 9.90 5.99 654 5.99
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, 2005 and 2004, 1,000 warrants
remained unexercised which expire in April 2009. 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.
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.
The Company on August 4, 2005, issued six-year warrants with respect to 272,000
shares of its common stock, in a transaction exempted from the registration
requirements of the Securities Act of 1933 as a transaction not involving a
public offering. The warrants are exercisable at $4.85 per share, and were
issued to the lender's nominee in settlement of a claim against the Company that
arose out of a loan of $500,000 made in September 1998. The Company and the
claimant dispute whether the loan was to the Company or to Stanwich Financial
Services Corp. ("Stanwich"). The Company received in exchange for the warrants
an assignment of the lender's claim in bankruptcy against Stanwich, as well as a
release of all claims against the Company. The Company estimated the value of
the warrants to be $794,000 using a Black-Scholes model, assuming a risk-free
interest rate of 3.41%, a six year life and stock price volatility of 63%. The
Company included the value of the warrant, net of a previously recorded accrual
of $500,000, in general & administrative expense for the year ended December 31,
2005.
F-26
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(10) NET GAIN ON SALE OF CONTRACTS
The following table presents the components of the net gain on sale of
Contracts:
YEAR ENDED
DECEMBER 31,
2003
--------------
(IN THOUSANDS)
Gain recognized on sale of Contracts ......... $ 8,433
Deferred acquisition fees and discounts ..... 4,590
Expenses related to sales .................... (2,076)
Provision for credit losses .................. (526)
--------------
Net gain on sale of Contracts ................ $ 10,421
==============
No gain on sale was recorded in the year ended December 31, 2005 and 2004 due to
the decision in July 2003 to structure future securitizations as secured
financings, rather than as sales.
(11) INTEREST INCOME
The following table presents the components of interest income:
YEAR ENDED DECEMBER 31,
2005 2004 2003
-------- -------- --------
(IN THOUSANDS)
Interest on Finance Receivables ...... $163,552 $ 99,701 $ 40,380
Residual interest income ............. 5,338 4,634 16,178
Other interest income ................ 2,944 1,483 1,606
-------- -------- --------
Net interest income .................. $171,834 $105,818 $ 58,164
======== ======== ========
As a result of the uncertainty of collection of the residual assets, the Company
ceased accruing interest on the residual assets from May 2004 through December
2004. In January 2005, the Company resumed accretion of interest on the residual
assets after it determined that there was no longer any significant uncertainty
as to the collection of the assets.
(12) INCOME TAXES
Income taxes consist of the following:
YEAR ENDED DECEMBER 31,
2005 2004 2003
--------- --------- ---------
(IN THOUSANDS)
Current:
Federal ............................. $ 5,340 $ 712 $ 2,781
State ............................... 1,687 862 356
--------- --------- ---------
7,027 1,574 3,137
Deferred:
Federal ............................. (3,537) (5,859) (25,345)
State ............................... (2,114) (2,282) (4,141)
Change in valuation allowance ....... (1,376) 6,567 22,915
--------- --------- ---------
(7,027) (1,574) (6,571)
--------- --------- ---------
Income tax benefit .............. $ -- $ -- $ (3,434)
========= ========= =========
The Company's effective tax expense/(benefit) for the years ended December 31,
2005, 2004 and 2003, differs from the amount determined by applying the
statutory federal rate of 35% to income (loss) before income taxes as follows:
F-27
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31,
2005 2004 2003
--------- --------- ---------
(IN THOUSANDS)
Expense (benefit) at federal tax rate ...... $ 1,180 $ (5,561) $ (1,064)
State franchise tax, net of federal income
tax benefit .............................. (277) (1,015) (2,460)
Other ...................................... 473 9 92
Debt Forgiveness ........................... -- -- (22,917)
Valuation allowance ........................ (1,376) 6,567 22,915
--------- --------- ---------
$ -- $ -- $ (3,434)
========= ========= =========
The tax affected cumulative temporary differences that give rise to deferred tax
assets and liabilities as of December 31, 2005 and 2004 are as follows:
DECEMBER 31,
----------------------
2005 2004
--------- ---------
(IN THOUSANDS)
DEFERRED TAX ASSETS:
Finance receivables .......................... $ 21,493 $ 18,090
Provision for loan loss ...................... 961 --
Accrued liabilities .......................... 3,141 5,751
Furniture and equipment ...................... 189 1,016
Equity investment ............................ -- 82
NOL carryforwards and BILs ................... 24,137 27,702
Minimum tax credit ........................... -- 697
Pension Accrual .............................. 1,313 801
Other ........................................ 1,830 831
--------- ---------
Total deferred tax assets .................. 53,064 54,970
Valuation allowance .......................... (43,724) (45,100)
--------- ---------
9,340 9,870
--------- ---------
DEFERRED TAX LIABILITIES:
NIRs ......................................... (1,808) (1,407)
Provision for loan loss ...................... -- (8,463)
--------- ---------
Total deferred tax liabilities ............. (1,808) (9,870)
--------- ---------
Net deferred tax asset ..................... $ 7,532 $ --
========= =========
As part of the MFN Merger, CPS acquired certain net operating losses 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 $31.0 million against MFN's deferred tax assets, as it
is not more than likely that these amounts will be realized in the future.
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 $10.0 million against TFC's deferred tax assets, as it is
not more than likely that these amounts will be realized in the future.
F-28
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In determining the possible future realization of deferred tax assets, the
Company considers the taxes paid in the current and prior years that may be
available to recapture as well as future taxable income from the following
sources: (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 of December 31, 2005, the Company has net operating loss carryforwards for
federal and state income tax purposes of $10.2 million (all of which is subject
to IRC 382 limitations) and $4.2 million, respectively, which are available to
offset future taxable income, if any, subject to IRC section 382 limitations,
through 2021 and 2012-2013, respectively.
The statute of limitations on certain of the Company's tax returns are open and
the returns could be audited by the various tax authorities. 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 estimable, such amounts will be recognized.
(13) RELATED PARTY TRANSACTIONS
CPS LEASING, INC. RELATED PARTY DIRECT LEASE RECEIVABLES
Included in other assets 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 net of a valuation
allowance totaled approximately $552,000 and $1.8 million at December 31, 2005
and 2004, respectively.
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, 2005 and 2004, there was $434,000 and $454,000,
respectively outstanding related to these loans. Such amounts have been recorded
as contra-equity within common stock 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 2010. Future minimum lease
payments at December 31, 2005, under these leases are due during the years ended
December 31 as follows:
AMOUNT
--------------
(IN THOUSANDS)
2006 ............................... $ 4,353
2007 ............................... 3,781
2008 ............................... 2,407
2009 ............................... 341
2010 ............................... 203
--------------
Total minimum lease payments ....... $ 11,085
==============
Rent expense for the years ended December 31, 2005, 2004 and 2003, was
$3.4million, $3.5 million, and $3.9 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 2005, 2004 and 2003, the Company received $482,000, $385,000 and
$170,000, respectively, of sublease income, which is included in occupancy
expense. Future minimum sublease payments totaled $507,000 at December 31, 2005.
F-29
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
LITIGATION
STANWICH LITIGATION. CPS was for some time a defendant in a class action (the
"Stanwich Case") brought in the California Superior Court, Los Angeles County.
The original plaintiffs in that case were 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 was 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. At
December 31, 2004, CPS was a defendant only in a cross-claim brought by one of
the other defendants in the case, Bankers Trust Company, which asserted a claim
of contractual indemnity against CPS.
CPS subsequently settled the cross-claim of Bankers Trust by payment of $3.24
million, on or about February 8, 2005. Pursuant to that settlement, the court
has dismissed the cross-claim, with prejudice. The amount paid by the Company
was accrued for and included in Accounts payable and accrued expenses in the
Company's balance sheet as of December 31, 2004.
In November 2001, one of the defendants in the Stanwich Case, Jonathan Pardee,
asserted claims for indemnity against the Company in a separate action, which is
now pending in federal district court in Rhode Island. The Company has filed
counterclaims in the Rhode Island federal court against Mr. Pardee, and has
filed a separate action against Mr. Pardee's Rhode Island attorneys, in the same
court. The action of Mr. Pardee against CPS is stayed, awaiting resolution of an
adversary action brought against Mr. Pardee in the bankruptcy court, which is
hearing the bankruptcy of Stanwich.
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 on the Company's financial position.
OTHER LITIGATION. On June 2, 2004, Delmar Coleman filed a lawsuit in the circuit
court of Tuscaloosa, Alabama, alleging that plaintiff Coleman was harmed by an
alleged failure to refer, in the notice given after repossession of his vehicle,
to the right to purchase the vehicle by tender of the full amount owed under the
retail installment contract. Plaintiff seeks damages in an unspecified amount,
on behalf of a purported nationwide class. CPS removed the case to federal
bankruptcy court, and filed a motion for summary judgment as part of its
adversary proceeding against the plaintiff in the bankruptcy court. The federal
bankruptcy court granted the plaintiff's motion to send the matter back to
Alabama state court. CPS has appealed the ruling. Although CPS believes that it
has one or more defenses to each of the claims made in this lawsuit, no
discovery has yet been conducted and the case is still in its earliest stages.
Accordingly, there can be no assurance as to its outcome.
In June 2004, Plaintiff Jeremy Henry filed a lawsuit against the Company in the
California Superior Court, San Diego County, alleging improper practices related
to the notice given after repossession of a vehicle that he purchased.
Plaintiff's motion for a certification of a class has been denied, and is the
subject of an appeal now before the California Court of Appeal. Irrespective of
the outcome of that appeal, as to which there can be no assurance, the Company
has a number of defenses that may be asserted with respect to the claims of
plaintiff Henry.
In August and September 2005, two plaintiffs represented by the same law firm
filed substantially identical lawsuits in the federal district court for the
northern district of Illinois, each of which purports to be a class action, and
each of which alleges that CPS improperly accessed consumer credit information.
CPS has reached agreements in principle to settle these cases, which await
confirmation by the court.
The Company has recorded a liability as of December 31, 2005 that it believes
represents a sufficient allowance for legal contingencies. Any adverse judgment
against the Company, if in an amount materially in excess of the recorded
liability, could have a material adverse effect on the financial position of the
Company. The Company is involved in various legal matters arising in the normal
course of business. Management believes that any liability as a result of those
matters would not have a material effect on the Company's financial position,
Results of Operations or Cash Flows.
(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 $439,000 and $409,000 for the year ended
December 31, 2005 and 2004, respectively. The Company did not make a matching
contribution in 2003.
F-30
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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, 2005 and 2004:
DECEMBER 31,
-----------------------
2005 2004
--------- ---------
(IN THOUSANDS)
CHANGE IN PROJECTED BENEFIT OBLIGATION
Projected benefit obligation, beginning of year .... $ 13,683 $ 15,023
Service cost ....................................... -- --
Interest cost ...................................... 845 821
Actuarial (gain) loss .............................. 1,867 (1,616)
Benefits paid ...................................... (596) (545)
--------- ---------
Projected benefit obligation, end of year ......... $ 15,799 $ 13,683
========= =========
The accumulated benefit obligation for the plan was $15.8 million and $13.7
million at December 31, 2005 and 2004, respectively.
CHANGE IN PLAN ASSETS
Fair value of plan assets, beginning of year ....... $ 13,287 $ 11,253
Return on assets ................................... 973 1,483
Employer contribution .............................. 207 1,149
Expenses ........................................... (59) (53)
Benefits paid ...................................... (596) (545)
--------- ---------
Fair value of plan assets, end of year ............ $ 13,812 $ 13,287
========= =========
DECEMBER 31,
-----------------------
2005 2004
--------- ---------
(IN THOUSANDS)
RECONCILIATION OF FUNDED STATUS OF THE PLAN AND
NET AMOUNT RECOGNIZED
Funded status of the plan .......................... $ (1,987) $ (396)
Unrecognized loss .................................. 4,071 2,062
Unrecognized transition asset ...................... (11) (46)
Unrecognized prior service cost .................... -- --
--------- ---------
Net amount recognized ............................. $ 2,073 $ 1,620
========= =========
Weighted average assumptions used to determine benefit obligations and cost at
December 31, 2005 and 2004 were as follows:
WEIGHTED AVERAGE ASSUMPTIONS USED TO DETERMINE
BENEFIT OBLIGATIONS
Discount rate ...................................... 5.50% 6.25%
Rate of compensation increase ...................... N/A N/A
WEIGHTED AVERAGE ASSUMPTIONS USED TO DETERMINE NET
PERIODIC BENEFIT COST
Discount rate ...................................... 5.50% 6.25%
Expected return on plan assets ..................... 8.50% 9.00%
Rate of compensation increase ...................... N/A N/A
The Company's overall expected long-term rate of return on assets is 8.50% per
annum as of December 31, 2005. 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.
F-31
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AMOUNTS RECOGNIZED ON CONSOLIDATED BALANCE SHEET
Prepaid benefit cost ............................... $ -- $ --
Accrued benefit liability .......................... (1,987) (396)
Intangible asset ................................... -- --
Accumulated other comprehensive loss, pretax ....... 4,060 2,016
--------- ---------
Net amount recognized ............................. $ 2,073 $ 1,620
========= =========
COMPONENTS OF NET PERIODIC BENEFIT COST
Service cost ....................................... $ -- $ --
Interest Cost ...................................... 845 821
Expected return on assets .......................... (1,104) (1,041)
Amortization of transition (asset)/obligation ...... (35) (35)
Amortization of prior service cost ................. -- --
Recognized net actuarial loss ...................... 48 69
--------- ---------
Net periodic benefit cost ......................... $ (246) $ (186)
========= =========
UNFUNDED ACCUMULATED BENEFIT OBLIGATION AT YEAR-END
Projected Benefit Obligation ....................... $ 15,799 $ 13,683
Accumulated Benefit Obligation ..................... 15,799 13,683
Fair Value of Plan Assets .......................... 13,812 13,288
The weighted average asset allocation of the Company's pension benefits at
December 31, 2005 and 2004 were as follows:
WEIGHTED AVERAGE ASSET ALLOCATION AT YEAR-END
ASSET CATEGORY
Domestic equity funds .............................. 61.9% 60.9%
International equity funds ......................... 13.1% 11.9%
Domestic fixed income funds ........................ 25.0% 27.1%
Other .............................................. 0.0% 0.1%
--------- ---------
Total .............................................. 100.0% 100.0%
========= =========
CASH FLOWS
EXPECTED BENEFIT PAYOUTS
2006 ............................................... $ 476
2007 ............................................... 511
2008 ............................................... 570
2009 ............................................... 574
2010 ............................................... 593
Years 2011 - 2015 .................................. 3,859
Anticipated Contributions in 2006 .................. $ --
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.
F-32
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(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, 2005 and 2004, 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, 2005 and 2004, were as follows:
DECEMBER 31,
-----------------------------------------
2005 2004
-------------------- ------------------
CARRYING FAIR CARRYING FAIR
FINANCIAL INSTRUMENT VALUE VALUE VALUE VALUE
-------------------- -------- -------- -------- --------
(IN THOUSANDS)
Cash and cash equivalents .............. $ 17,789 $ 17,789 $ 14,366 $ 14,366
Restricted cash and cash equivalents ... 157,662 157,662 125,113 125,113
Finance receivables, net ............... 913,576 913,576 550,191 550,191
Residual interest in securitizations ... 25,220 25,220 50,430 50,430
Accrued interest receivable ............ 10,930 10,930 6,411 6,411
Note receivable and accrued interest ... 2,178 2,178 2,800 2,800
Warehouse lines of credit .............. 35,350 35,350 34,279 34,279
Notes payable .......................... 211 211 1,421 1,421
Residual interest financing ............ 43,745 43,745 22,204 22,204
Securitization trust debt .............. 924,026 914,901 542,815 539,749
Senior secured debt .................... 40,000 40,000 59,829 59,829
Subordinated renewable notes ........... 4,655 4,655 -- --
Subordinated debt ...................... 14,000 14,000 15,000 15,113
CASH, CASH EQUIVALENTS 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.
ACCRUED INTEREST RECEIVABLE
The carrying value approximates fair value because the related interest rates
are estimated to reflect current market conditions for similar types of
instruments.
NOTE RECEIVABLE
The fair value is estimated by discounting future cash flows using credit and
discount rates that the Company believes reflect the estimated credit and
interest rate risks associated with similar types of instruments.
WAREHOUSE LINES OF CREDIT, NOTES PAYABLE, RESIDUAL INTEREST FINANCING, AND
SENIOR SECURED DEBT AND SUBORDINATED RENEWABLE NOTES
The carrying value approximates fair value because the related interest rates
are estimated to reflect current market conditions for similar types of secured
instruments.
SECURITIZATION TRUST DEBT
The fair value is estimated by discounting future cash flows using interest
rates that the Company believes reflect the current market rates.
F-33
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SUBORDINATED DEBT
The fair value is based on a market quote.
(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
Contracts previously sold in securitization transactions or serviced for third
parties, customer payments of principal and interest on finance receivables,
fees for origination of Contracts, and releases of cash from securitized
portfolios 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 portfolios 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, 2005,
2004 and 2003 was $36.7 million, $9.9 million and $98.9 million, respectively.
Cash from operating activities is generally provided by the net releases from
the Company's securitization Trusts. The increase in 2005 vs. 2004 is due in
part to the Company's increased net earnings before the significant increase in
the provision for credit losses. The decrease in 2004 vs. 2003 is primarily the
result of the Company's decision, in July 2003, to treat all of its future
securitizations as secured financings. As a result 2005 and 2004 includes no
activity related to Contracts held for sale.
Net cash used in investing activities for the years ended December 31, 2005,
2004 and 2003, was $411.7 million, $314.0 million, and $178.9 million,
respectively. Cash used in investing activities has generally related to
purchases of Contracts, the cost of the SeaWest Asset Acquisition and the
acquisition of TFC. Purchase of finance receivables held for investors were
$691.3, $506.0 and $175.3 in 2005, 2004 and 2003, respectively. 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.
Net cash provided by financing activities for the year ended December 31, 2005,
was $378.4 million compared with $285.3 million in 2004 and $80.3 million for
the year ended December 31, 2003. Cash used or provided by financing activities
is primarily attributable to the issuance or repayment of debt. In connection
with the TFC Merger the Company assumed securitization trust debt related to
three securitization transactions held by consolidated subsidiaries and assumed
additional subordinated debt. With the change in the securitization structure
implemented in the third quarter of 2003, $662.4 million of securitization trust
debt was issued in 2005 as compared to $474.7 million in 2004 and $154.4 million
in 2003.
Contracts are purchased from Dealers for a cash price approximating their
principal amount, adjusted for an acquisition fee which may either increase or
decrease the Contract purchase price, 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, 2005, the Company had $350 million in
warehouse credit capacity, in the form of a $200 million facility and a $150
million facility. The first facility provides funding for Contracts purchased
under the TFC Programs while both warehouse facilities provide funding for
Contracts purchased under the CPS Programs. A third facility in the amount of
$125 million, which the Company utilized to fund Contracts under the CPS and TFC
Programs was terminated by the Company on June 29, 2005
The $150 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 its consolidated subsidiary Page Three Funding, LLC. This
facility was established on November 15, 2005, and expires on November 14, 2006,
although it is renewable with the mutual agreement of the parties. Up to 80% 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
LIBOR plus 2.00% per annum. At December 31, 2005, $34.5 million was outstanding
under this facility.
F-34
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The $200 million warehouse facility is 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 its consolidated subsidiary Page Funding LLC.
This facility was entered into on June 30, 2004. On June 29, 2005 the facility
was increased from $100 million to $125 million and further amended to provide
for funding for Contracts purchased under the TFC Programs. It was increased
again to $200 million on August 31, 2005. Approximately 77.0% 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 LIBOR plus 1.50% per annum. The
lender has annual termination options at its sole discretion on each June 30
through 2007, at which time the agreement expires. At December 31, 2005,
$836,000 was outstanding under this facility, compared to zero at December 31,
2004.
The $125 million warehouse facility was structured to allow the Company to fund
a portion of the purchase price of Contracts by drawing against a floating rate
variable funding note issued by its consolidated subsidiary CPS Warehouse Trust.
This facility was established on March 7, 2002, and the maximum amount was
increased to $125 million in November 2002. Up to 73.0% of the principal balance
of Contracts could have been advanced to the Company under this facility bore
interest at a rate of one-month commercial paper plus 1.50% per annum. This
facility was due to expire on April 11, 2006, but the Company elected to
terminate it on June 29, 2005. At December 31, 2004, $34.3 million was
outstanding under this facility.
The Company securitized $674.4 million of Contracts in five private placement
transactions during the year ended December 31, 2005 compared to $463.9 million
in five private placements during 2004. All of these transactions were
structured as secured financings and, therefore, resulted in no gain on sale. 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 had an interest
rate of 10% per annum and a final maturity in October 2009, were 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 $1.3 million. The Company repaid the notes in full in August
2005. In November 2005, the Company completed similar securitizations whereby a
wholly-owned bankruptcy remote consolidated subsidiary of the Company issued
$45.8 million of asset-backed notes secured by its retained interest in tem term
securitization transactions. These notes, which bear interest at a blended
interest rate of 8.36% per annum and have a final maturity in July 2011, 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 $915,000.
For the portfolio owned by non consolidated subsidiaries, cash used to increase
Credit Enhancement amounts to required levels for the years ended December 31,
2005, 2004 and 2003 was zero, $2.9 million and $20.9 million, respectively. Cash
released from Trusts and their related Spread Accounts to the Company related to
the portfolio owned by consolidated subsidiaries for the years ended December
31, 2005, 2004 and 2003 was $23.1 million, $21.4 million and $25.9 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 years
ended December 31, 2005 and December 31, 2004 the Company made no initial
deposits to Spread Accounts and funded no initial overcollateralization related
to its term securitization transactions owned by non-consolidated subsidiaries,
compared to $18.7 million in the 2003 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 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,
2005, the Company had cash on hand of $17.8 million and available Contract
purchase commitments from its warehouse credit facilities of $314.6 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.
F-35
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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. 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. 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. Such covenants include maintaining minimum levels
of liquidity and net worth and not exceeding maximum leverage levels and maximum
financial losses. In addition, certain securitization and non-securitization
related debt contain cross-default provisions that would allow certain creditors
to declare a default if a default occurred under a different facility.
The Servicing Agreements of the Company's securitization transactions 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.
(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)
2005
Revenues ........................ $ 41,833 $ 47,776 $ 49,374 $ 54,714
Income (loss) before income taxes (239) 545 1,398 1,668
Net income (loss) ............... (239) 545 1,398 1,668
Income (loss) per share:
Basic ......................... $ (0.01) $ 0.03 $ 0.06 $ 0.08
Diluted ....................... (0.01) 0.02 0.06 0.07
2004
Revenues ........................ $ 27,522 $ 32,687 $ 34,913 $ 37,570
Loss before income taxes ........ (1,407) (174) (2,061) (12,246)
Net loss ........................ (1,407) (174) (2,061) (12,246)
Loss per share:
Basic ......................... $ (0.07) $ (0.01) $ (0.10) $ (0.57)
Diluted ....................... (0.07) (0.01) (0.10) (0.57)
F-36
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
MARCH 31, DECEMBER 31,
2006 2005
-------------- --------------
ASSETS
Cash and cash equivalents $ 25,504 $ 17,789
Restricted cash and equivalents 212,428 157,662
Finance receivables 1,114,671 971,304
Less: Allowance for finance credit losses (63,846) (57,728)
-------------- --------------
Finance receivables, net 1,050,825 913,576
Residual interest in securitizations 22,608 25,220
Furniture and equipment, net 1,042 1,079
Deferred financing costs 9,872 8,596
Deferred tax assets, net 8,295 7,532
Accrued interest receivable 10,733 10,930
Other assets 12,916 12,760
-------------- --------------
$ 1,354,223 $ 1,155,144
============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Accounts payable and accrued expenses $ 18,721 $ 19,568
Warehouse lines of credit 75,056 35,350
Notes payable 172 211
Residual interest financing 37,728 43,745
Securitization trust debt 1,100,606 924,026
Senior secured debt, related party 40,000 40,000
Subordinated renewable notes 6,314 4,655
Subordinated debt -- 14,000
-------------- --------------
1,278,597 1,081,555
COMMITMENTS AND CONTINGENCIES
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; 21,819,333 and 21,687,584
shares issued and outstanding at March 31, 2006 and
December 31, 2005, respectively 66,995 66,748
Additional paid in capital, warrants 794 794
Retained earnings 10,266 8,476
Accumulated other comprehensive loss (2,429) (2,429)
-------------- --------------
75,626 73,589
-------------- --------------
$ 1,354,223 $ 1,155,144
============== ==============
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements
F-37
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED
MARCH 31,
-------------------------
2006 2005
---------- -----------
REVENUES:
Interest income $ 54,527 $ 36,172
Servicing fees 1,005 2,265
Other income 2,492 3,396
---------- -----------
58,024 41,833
---------- -----------
EXPENSES:
Employee costs 9,357 10,450
General and administrative 5,111 5,138
Interest 16,781 8,506
Interest, related party 1,254 1,878
Provision for credit losses 19,099 12,312
Marketing 3,536 2,799
Occupancy 903 782
Depreciation and amortization 193 207
---------- -----------
56,234 42,072
---------- -----------
Income (loss) before income tax expense 1,790 (239)
Income tax expense -- --
---------- -----------
Net income (loss) $ 1,790 $ (239)
========== ===========
Earnings (loss) per share:
Basic $ 0.08 $ (0.01)
Diluted 0.07 (0.01)
Number of shares used in computing
earnings (loss) per share:
Basic 21,732 21,528
Diluted 24,188 21,528
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements
F-38
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
THREE MONTHS ENDED
MARCH 31,
-----------------------
2006 2005
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 1,790 $ (239)
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Amortization of deferred acquisition fees (2,620) (2,614)
Amortization of discount on Class B Notes 554 281
Depreciation and amortization 193 207
Amortization of deferred financing costs 1,242 755
Provision for credit losses 19,099 12,312
Deferred compensation -- 56
Releases of cash from Trusts to Company 3,943 8,010
Net deposits to Trusts to increase Spread Accounts (6,070) (3,234)
Interest income on residual assets (961) (1,683)
Cash received from residual interest in securitizations 3,573 7,980
Changes in assets and liabilities:
Payments on restructuring accrual (351) (193)
Restricted cash (52,638) (29,720)
Accrued interest receivable 197 (406)
Other assets (191) 752
Tax assets (763) --
Accounts payable and accrued expenses (496) (1,314)
Tax liabilities -- (155)
---------- ----------
Net cash used in operating activities (33,499) (9,205)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of finance receivables held for investment (255,586) (144,165)
Proceeds received on finance receivables held for investment 101,858 64,355
Purchase of furniture and equipment (121) (22)
---------- ----------
Net cash used in investing activities (153,849) (79,832)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of securitization trust debt 280,977 135,924
Proceeds from issuance of retail notes payable 1,660 --
Net proceeds (repayments) from warehouse lines of credit 39,706 16,256
Repayment of residual interest financing debt (6,018) (5,793)
Repayment of securitization trust debt (104,951) (59,590)
Repayment of subordinated debt (14,000) (1,000)
Repayment of notes payable (40) (560)
Payment of financing costs (2,518) (1,094)
Repurchase of common stock (756) --
Tax benefit from exercise of stock options 337 --
Exercise of options and warrants 666 258
---------- ----------
Net cash provided by financing activities 195,063 84,401
---------- ----------
Increase (decrease) in cash 7,715 (4,636)
Cash at beginning of period 17,789 14,366
---------- ----------
Cash at end of period $ 25,504 $ 9,730
========== ==========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 14,713 $ 9,410
Income taxes $ 312 $ 155
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
F-39
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDTIED CONDENSED 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
primarily in purchasing, selling and servicing retail automobile installment
sale contracts ("Contracts" or "finance receivables") originated by licensed
motor vehicle dealers located throughout the United States ("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 for
borrowers 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 based on its financing
programs (the "CPS Programs").
Basis of Presentation
The Unaudited Condensed Consolidated Financial Statements of the Company have
been prepared in conformity with accounting principles generally accepted in the
United States of America, with the instructions to Form 10-Q and with Article 10
of Regulation S-X of the Securities and Exchange Commission, and include all
adjustments that are, in the opinion of management, necessary for a fair
presentation of the results for the interim periods presented. All such
adjustments are, in the opinion of management, of a normal recurring nature. In
addition, certain items in prior period financial statements may have been
reclassified for comparability to current period presentation. Results for the
three-month period ended March 31, 2006 are not necessarily indicative of the
operating results to be expected for the full year.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted from these
Unaudited Condensed Consolidated Financial Statements. These Unaudited Condensed
Consolidated Financial Statements should be read in conjunction with the
Consolidated Financial Statements and Notes to Consolidated Financial Statements
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2005.
Other Income
Other Income consists primarily of recoveries on previously charged off MFN
contracts and fees paid to the Company by Dealers for certain direct mail
services the Company provides. The recoveries on the charged-off MFN contracts
were $937,000 and $1.6 million for the three months ended March 31, 2006 and
2005, respectively. The direct mail revenues were $897,000 and $1.2 million for
the same periods in 2006 and 2005, respectively.
Stock-based Compensation
Effective January 1, 2006, the Company adopted Statement of Financial Accounting
Standards No. 123(R), "Share-Based Payment, revised 2004" (SFAS 123R"),
prospectively for all option awards granted, modified or settled after January
1, 2006 using the modified prospective method. Under this method, the Company
recognizes compensation costs in the financial statements for all share-based
payments granted subsequent to January 1, 2006 based on the grant date fair
value estimated in accordance with the provisions of SFAS 123(R). Results for
prior periods have not been restated.
For the three months ended March 31, 2006, the Company recorded no stock-based
compensation costs as there were no option awards granted during the three-month
period ended March 31, 2006 and there was no vesting of option awards for
options granted prior to January 1, 2006 since all options outstanding as of
December 31, 2005 were fully vested at that time. As of March 31, 2006, there
are no unrecognized stock-based compensation costs to be recognized over future
periods.
The following represents stock option activity for the three months ended March
31, 2006:
F-40
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDTIED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
WEIGHTED
NUMBER OF WEIGHTED AVERAGE
SHARES AVERAGE REMAINING
(IN THOUSANDS) EXERCISE PRICE CONTRACTUAL TERM
-------------- -------------- ----------------
Options outstanding at the beginning of period ... 4,864 $ 3.38
Granted ......................................... -- --
Exercised ....................................... (251) 2.66
Forefited ....................................... (4) 3.27
-------------- -------------- ----------------
Options outstanding at the end of period ......... 4,609 $ 3.42 7.33 years
============== ============== ================
Options exercisable at the end of period ......... 4,609 $ 3.42 7.33 years
============== ============== ================
At March 31, 2006 the aggregate intrinsic value of options outstanding and
exercisable was $22.0 million. The total intrinsic value of options exercised
was $1.0 million and $399,000 for the three months ended March 31, 2006 and
2005, respectively. New shares were issued for all options exercised during the
three-month periods ended March 31, 2006 and 2005. There were 169,261 shares
available for future stock option grants under existing plans as of March 31,
2006.
Prior to January 1, 2006, as was permitted by Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"),
the Company accounted 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 provided the pro forma net income (loss), pro
forma earnings (loss) per share, and stock based compensation plan disclosure
requirements set forth in SFAS No. 123. The Company accounted for repriced
options as variable awards.
Compensation cost was recognized for certain stock options in the Unaudited
Condensed 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 (loss) and (loss) per share would have been increased to the pro
forma amounts indicated below.
THREE MONTHS ENDED
MARCH 31,
------------------
2005
------------------
(IN THOUSANDS, EXCEPT PER
SHARE DATA)
Net (loss), as reported .............................. $ (239)
Stock-based employee compensation expense,
fair value method, net of tax ........................ (200)
Previously recorded stock-based employee compensation
expense, intrinsic value method, net of tax .......... 32
------------------
Pro forma net (loss) ................................. $ (407)
==================
Net (loss) per share
Basic, as reported ................................... $ (0.01)
Diluted, as reported ................................. $ (0.01)
Pro forma Basic ...................................... $ (0.02)
Pro forma Diluted .................................... $ (0.02)
The Company uses the Black-Scholes-Merton option valuation model to estimate the
fair value of each option on the date of grant using the assumptions noted in
the following table. The Company utilizes assumptions on expected life,
risk-free rate, expected volatility, and dividend yield to determine such
values. The Company did not disclose assumptions for the three months ended
March 31, 2006 because there were no options granted in the period. The expected
term of options granted is derived from historical data on employee exercise and
post-vesting termination behavior. The risk-free rate is based on treasury
instruments in effect at the time of grant whose terms are consistent with the
expected term of the Company's stock options. Expected volatility is based on
historical volatility of the Company's stock. The dividend yield is based on
historical experience and expected future changes.
F-41
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED
MARCH 31,
------------------
2005
------------------
Risk-free interest rate 4.30%
Expected term, in years 6.5
Expected volatility 52.53%
Dividend yield 0%
Purchases of Company Stock
During the three-month periods ended March 31, 2006 and 2005, the Company
purchased 118,751 and zero shares, respectively, of its common stock. The shares
purchased during the three-month period ended March 31, 2006 were purchased at
an average price of $6.37.
New Accounting Pronouncements
In March 2006, the FASB issued FASB Statement No. 156, "Accounting for the
Servicing of Financial Assets an Amendment to FASB Statement No. 140" (FAS 156).
With respect to the accounting for separately recognized servicing assets and
servicing liabilities, this statement: (1) requires an entity to recognize a
servicing asset or servicing liability each time it undertakes an obligation to
service a financial asset by entering into a specific types of servicing
contracts identified in the statement, (2) requires that all separately
recognized servicing assets and servicing liabilities to be initially measured
at fair value, if practicable, (3) permits an entity to choose subsequent
measurement methods for each class of separately recognized servicing assets and
servicing liabilities, (4) permits a one-time reclassification of
available-for-sale securities to trading securities by entities with recognized
servicing rights at the initial adoption of this statement, and (5) requires a
separate presentation of servicing assets and servicing liabilities subsequently
measured at fair value in the statement of financial position and additional
disclosures for all separately recognized servicing assets and servicing
liabilities. FAS 156 will be effective for the Company on January 1, 2007. The
Company is currently in the process of evaluating the effects of this Standard,
but does not believe it will have a significant effect on its financial position
or results of operations.
(2) FINANCE RECEIVABLES
The following table presents the components of Finance Receivables, net of
unearned interest and deferred acquisition fees:
MARCH 31, DECEMBER 31,
2006 2005
------------ -------------
Finance Receivables (IN THOUSANDS)
Automobile
Simple Interest ...................................... $ 1,087,048 $ 933,510
Pre-compute, net of unearned interest ................ 46,882 54,693
------------ -------------
Finance Receivables, net of unearned interest ........ 1,133,930 988,203
Less: Unearned acquisition fees and originations costs (19,259) (16,899)
------------ -------------
Finance Receivables .................................. $ 1,114,671 $ 971,304
============ =============
The following table presents a summary of the activity for the allowance for
credit losses for the three-month periods ended March 31, 2006 and 2005:
MARCH 31, MARCH 31,
2006 2005
------------ -------------
(IN THOUSANDS)
Balance at beginning of period ...................... $ 57,728 $ 42,615
Provision for credit losses on finance
receivables ......................................... 19,099 12,312
Recoveries .......................................... (19,235) (11,436)
Charge offs ......................................... 6,254 2,793
------------ -------------
Balance at end of period ............................ $ 63,846 $ 46,284
============ =============
F-42
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(3) RESIDUAL INTEREST IN SECURITIZATIONS
The residual interest in securitizations represents the discounted sum of
expected future cash flows from securitization trusts. The following table
presents the components of the residual interest in securitizations and are
shown at their discounted amounts:
MARCH 31, DECEMBER 31,
2006 2005
--------- ------------
(IN THOUSANDS)
Cash, commercial paper, United States government securities
and other qualifying investments (Spread Accounts) ........... $ 13,201 $ 12,748
Receivables from Trusts (NIRs) ............................... 3,913 5,798
Overcollateralization ........................................ 5,494 6,674
--------- ------------
Residual interest in securitizations ......................... $ 22,608 $ 25,220
========= ============
The following table presents 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:
MARCH 31, DECEMBER 31,
2006 2005
--------- ------------
(DOLLARS IN THOUSANDS)
Undiscounted estimated credit losses ........................ $ 4,648 $ 5,724
Managed portfolio held by non-consolidated subsidiaries ..... 83,162 103,130
Undiscounted estimated credit losses as percentage of managed
portfolio held by non-consolidated subsidiaries ............. 5.6% 5.6%
The key economic assumptions used in measuring all residual interest in
securitizations as of March 31, 2006 and December 31, 2005 are included in the
table below. The pre-tax discount rate remained constant from previous periods
at 14%, except for certain cash flows from charged off receivables related to
the Company's securitizations from 2001 to 2003 where the Company has used a
discount rate of 25%, which is also consistent with previous periods.
MARCH 31, DECEMBER 31,
2006 2005
--------------- ---------------
Prepayment speed (Cumulative) 22.2% - 35.3% 22.2% - 35.8%
Net credit losses (Cumulative) 12.3% - 20.0% 11.9% - 20.2%
(4) SECURITIZATION TRUST DEBT
The Company has completed a number of securitization transactions that are
structured as secured borrowings for financial accounting purposes. The debt
issued in these transactions is shown on the Company's Unaudited Condensed
Consolidated Balance Sheets as "Securitization Trust Debt," and the components
of such debt are summarized in the following table:
F-43
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
WEIGHTED
FINAL RECEIVABLES OUTSTANDING OUTSTANDING AVERAGE
SCHEDULED PLEDGED AT PRINCIPAL AT PRINCIPAL AT INTEREST RATE AT
PAYMENT MARCH 31, INITIAL MARCH 31, DECEMBER 31, MARCH 31,
SERIES DATE (1) 2006 PRINCIPAL 2006 2005 2006
----------------- ----------------- ------------ ------------ ------------ ------------- ----------------
MFN 2001-A June 2007 $ -- $ 301,000 $ -- $ -- N/A
TFC 2002-1 August 2007 -- 64,552 -- -- N/A
TFC 2002-2 March 2008 -- 62,589 -- -- N/A
TFC 2003-1 January 2009 5,413 52,365 4,741 6,557 2.69%
CPS 2003-C March 2010 26,859 87,500 25,835 30,550 3.57%
CPS 2003-D October 2010 26,481 75,000 25,384 29,688 3.81%
CPS 2004-A October 2010 34,626 82,094 34,695 40,225 3.84%
PCR 2004-1 March 2010 21,361 76,257 17,671 22,873 3.80%
CPS 2004-B February 2011 46,279 96,369 46,394 52,704 4.17%
CPS 2004-C April 2011 54,594 100,000 54,507 61,779 3.95%
CPS 2004-D December 2011 73,473 120,000 72,530 82,801 4.44%
CPS 2005-A October 2011 96,983 137,500 97,113 110,021 5.11%
CPS 2005-B February 2012 109,360 130,625 107,749 113,194 4.56%
CPS 2005-C March 2012 172,025 183,300 169,778 173,509 5.00%
CPS 2005-TFC July 2012 71,941 72,525 62,432 72,525 5.79%
CPS 2005-D July 2012 138,293 145,000 136,777 127,600 5.63%
CPS 2006-A (2) November 2012 142,446 245,000 245,000 -- 5.87%
------------ ------------ ------------ -------------
$ 1,020,134 $ 2,031,676 $ 1,100,606 $ 924,026
============ ============ ============ =============
______________
The Final Scheduled Payment Date represents final legal maturity of the
securitization trust debt. Securitization trust debt is expected to become due
and to be paid prior to those dates, based on amortization of the finance
receivables pledged to the Trusts. Expected payments, which will depend on the
performance of such receivables, as to which there can be no assurance, are
$290.2 million in 2006, $289.8 million in 2007, $211.1 million in 2008, $154.6
million in 2009, $110.6 million in 2010 and $44.4 million in 2012.
Receivables Pledged at March 31, 2006 excludes approximately $100.7 million in
Contracts delivered to this Trust in April 2006 pursuant to a pre-funding
structure.
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 of $1.0
billion, and the related interest payments, are guaranteed by financial guaranty
insurance policies issued by third party financial institutions.
The terms of the various Securitization Agreements related to the issuance of
the securitization trust debt and the warehouse credit facilities require that
certain delinquency and credit loss criteria be met with respect to the
collateral pool, and require that the Company maintain minimum levels of
liquidity and net worth and not exceed maximum leverage levels and maximum
financial losses. In addition, certain securitization and non-securitization
related debt contain cross-default provisions, which would allow certain
creditors to declare a default if a default were declared under a different
facility. As of March 31, 2006, the Company was in compliance with all such
financial covenants.
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 March 31,
2006, restricted cash under the various agreements totaled approximately $212.4
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 using a level yield method. Accordingly,
the effective cost of borrowing of the securitization trust debt is greater than
the stated rate of interest.
F-44
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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.
(5) INTEREST INCOME
The following table presents the components of interest income:
THREE MONTHS ENDED
MARCH 31,
----------------------------
2006 2005
----------- -----------
Interest on Finance Receivables ........ 52,360 33,985
Residual interest income ............... 961 1,683
Other interest income .................. 1,206 504
------------ ------------
Net interest income .................... 54,527 36,172
============ ============
(6) EARNINGS (LOSS) PER SHARE
Earnings (loss) per share for the three-month periods ended March 31, 2006 and
2005 were calculated using the weighted average number of shares outstanding for
the related period. The following table reconciles the number of shares used in
the computations of basic and diluted earnings (loss) per share for the
three-month periods ended March 31, 2006 and 2005:
THREE MONTHS ENDED
MARCH 31,
---------------------
2006 2005
-------- ---------
(IN THOUSANDS)
Weighted average number of common shares outstanding during
the period used to compute basic earnings (loss) per share ...... 21,732 21,528
Incremental common shares attributable to exercise of
outstanding options and warrants ................................ 2,456 --
-------- ---------
Weighted average number of common shares used to compute
diluted earnings (loss) per share ............................... 24,188 21,528
======== =========
If the anti-dilutive effects of common stock equivalents were considered,
additional shares included in the diluted earnings (loss) per share calculation
for the three-month period ended March 31, 2005 would have included an
additional 2.0 million shares attributable to the exercise of outstanding
options and warrants. No such anti-dilution adjustment was applicable to the
three-month period ended March 31, 2006.
(7) INCOME TAXES
As of December 31, 2005, the Company had net deferred tax assets of $7.5
million, which included a valuation allowance of $43.7 million against gross
deferred tax assets of $53.1 million. There were also offsetting gross deferred
tax liabilities of $1.8 million. Net tax assets at March 31, 2006 were $8.3
million compared with net tax assets at December 31, 2005 of $7.5 million. The
Company decreased its valuation allowance by the income tax expense for the
period to result in no net income tax provision for the three-month period ended
March 31, 2006. The Company has evaluated its deferred tax assets and believes
that it is more likely than not that certain deferred tax assets will not be
realized due to limitations imposed by the Internal Revenue Code and expected
future taxable income.
(8) LEGAL PROCEEDINGS
STANWICH LITIGATION. CPS was for some time a defendant in a class action (the
"Stanwich Case") brought in the California Superior Court, Los Angeles County.
The original plaintiffs in that case were 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 was 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. At
December 31, 2004, CPS was a defendant only in a cross-claim brought by one of
the other defendants in the case, Bankers Trust Company, which asserted a claim
of contractual indemnity against CPS.
F-45
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CPS subsequently settled the cross-claim of Bankers Trust by payment of $3.24
million, on or about February 8, 2005. Pursuant to that settlement, the court
has dismissed the cross-claim, with prejudice. The amount paid by the Company
was accrued for and included in Accounts payable and accrued expenses in the
Company's balance sheet as of December 31, 2004.
In November 2001, one of the defendants in the Stanwich Case, Jonathan Pardee,
asserted claims for indemnity against the Company in a separate action, which is
now pending in federal district court in Rhode Island. The Company has filed
counterclaims in the Rhode Island federal court against Mr. Pardee, and has
filed a separate action against Mr. Pardee's Rhode Island attorneys, in the same
court. The action of Mr. Pardee against CPS is stayed, awaiting resolution of an
adversary action brought against Mr. Pardee in the bankruptcy court, which is
hearing the bankruptcy of Stanwich.
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 on the Company's financial position.
OTHER LITIGATION. On June 2, 2004, Delmar Coleman filed a lawsuit in the circuit
court of Tuscaloosa, Alabama, alleging that plaintiff Coleman was harmed by an
alleged failure to refer, in the notice given after repossession of his vehicle,
to the right to purchase the vehicle by tender of the full amount owed under the
retail installment contract. Plaintiff seeks damages in an unspecified amount,
on behalf of a purported nationwide class. CPS removed the case to federal
bankruptcy court, and filed a motion for summary judgment as part of its
adversary proceeding against the plaintiff in the bankruptcy court. The federal
bankruptcy court granted the plaintiff's motion to send the matter back to
Alabama state court. CPS appealed the ruling, and the federal district court, in
which the appeal was heard, has since ordered the bankruptcy court to decide
whether the plaintiff has standing to pursue her claims, and, if standing is
found, to reconsider its remand decision. It is possible that plaintiff may in
turn appeal from the order of the district court. Although CPS believes that it
has one or more defenses to each of the claims made in this lawsuit, no
discovery has yet been conducted and the case remains in its earliest stages.
Accordingly, there can be no assurance as to its outcome.
In June 2004, Plaintiff Jeremy Henry filed a lawsuit against the Company in the
California Superior Court, San Diego County, alleging improper practices related
to the notice given after repossession of a vehicle that he purchased.
Plaintiff's motion for a certification of a class has been denied, and is the
subject of an appeal now before the California Court of Appeal. Irrespective of
the outcome of that appeal, as to which there can be no assurance, the Company
has a number of defenses that may be asserted with respect to the claims of
plaintiff Henry.
In August and September 2005, two plaintiffs represented by the same law firm
filed substantially identical lawsuits in the federal district court for the
northern district of Illinois, each of which purports to be a class action, and
each of which alleges that CPS improperly accessed consumer credit information.
CPS has reached agreements in principle to settle these cases, which await
confirmation by the court.
The Company has recorded a liability as of March 31, 2006 that it believes
represents a sufficient allowance for legal contingencies, including those
described above. Any adverse judgment against the Company, if in an amount
materially in excess of the recorded liability, could have a material adverse
effect on the financial position of the Company.
The Company is routinely involved in various legal proceedings resulting from
its consumer finance activities and practices, both continuing and discontinued.
The Company believes that there are substantive legal defenses to such claims,
and intends to defend them vigorously. There can be no assurance, however, as to
the outcome.
(9) EMPLOYEE BENEFITS
The Company sponsors the MFN Financial Corporation Benefit Plan ("the Plan").
Plan benefits were frozen September 30, 2001. The table below sets forth the
Plan's net periodic benefit cost for the three months ended March 31, 2006 and
2005.
F-46
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED
MARCH 31,
2006 2005
--------- ---------
COMPONENTS OF NET PERIODIC BENEFIT COST
Service cost ................................... $ -- $ -
Interest Cost .................................. 213 211
Expected return on assets ...................... (287) (292)
Amortization of transition (asset)/obligation .. (2) (9)
Amortization of net (gain) / loss .............. 34 12
--------- ---------
Net periodic benefit cost ................... $ (42) $ (78)
========= =========
(10) COMPREHENSIVE INCOME (LOSS)
The components of comprehensive income (loss) are as follows:
THREE MONTHS ENDED
MARCH 31,
2006 2005
-------- ---------
Net income (loss) .............................. $ 1,790 $ (239)
Minimum pension liability, net of tax .......... -- (185)
-------- ---------
Comprehensive income (loss) ................. $ 1,790 $ (424)
======== =========
F-47
[BACK COVER]
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 14. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
Set forth below are expenses (other than the selling agent's commissions and
expenses) expected to be incurred in connection with the issuance and
distribution of the securities registered hereby. With the exception of the
Securities and Exchange Commission registration fee and the NASD filing fee, the
amounts set forth below are estimates and actual expenses may vary considerably
from these estimates depending upon how long the notes are offered and other
factors:
Securities and Exchange Commission registration fee $ 3,313
NASD filing fee 3,700
Accounting fees and expenses 50,000
Blue Sky fees and expenses --
Legal fees and expenses 50,000
Printing expenses 15,000
Selling shareholder's counsel fees and expenses 25,000
Miscellaneous 22,987
--------
TOTAL $170,000
========
ITEM 15. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Under California law, a California corporation may eliminate or limit the
personal liability of a director of the corporation for monetary damages for
breach of the director's duty of care as a director, provided that the breach
does not involve certain enumerated actions, including, among other things,
intentional misconduct or knowing and culpable violation of the law, acts or
omissions which the director believes to be contrary to the best interests of
the corporation or its shareholders or which reflect an absence of good faith on
the director's part, the unlawful purchase or redemption of stock, payment of
unlawful dividends, and receipt of improper personal benefits. The registrant's
Board of Directors believes that such provisions have become commonplace among
major corporations and are beneficial in attracting and retaining qualified
directors, and the registrant's Articles of Incorporation include such
provisions.
The registrant's Articles of Incorporation and Bylaws also impose a mandatory
obligation upon the registrant to indemnify any director or officer to the
fullest extent authorized or permitted by law (as now or hereinafter in effect),
including under circumstances in which indemnification would otherwise be at the
discretion of the registrant.
In the form of underwriting agreement to be filed as Exhibit 1.1 to this
Registration Statement, it is anticipated that the underwriter will agree to
indemnify, under certain conditions, the registrant, its officers and directors,
and persons who control the registrant within the meaning of the Securities Act
of 1933, as amended, against certain liabilities.
II-1
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
Exhibit No. Description
-------------- -------------------------------------------------------------
*1.1 Form of Underwriting Agreement
*5.1 Opinion of Andrews Kurth LLP with respect to legality of the
securities registered
*23.1 Consent of Andrews Kurth LLP (included in Exhibit 5.1)
23.2 Consent of McGladrey & Pullen LLP
23.3 Consent of KPMG LLP
__________________
* To be filed by amendment.
ITEM 17. UNDERTAKINGS
The undersigned registrant hereby undertakes:
(a) That, for purposes of determining any liability under the Securities Act,
the undersigned registrant undertakes that each filing of an annual report of
the undersigned registrant pursuant to section 13(a) or section 15(d) of the
Exchange Act (and, where applicable, each filing of an employee benefit plan's
annual report pursuant to section 15(d) of the Exchange Act) that is
incorporated by reference in this registration statement shall be deemed to be a
new registration statement relating to the securities offered herein, and the
offering of such securities at that time shall be deemed to be the initial bona
fide offering thereof.
(b) Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the provisions described under Item 15 above, or
otherwise, the registrant has been advised that in the opinion of the Securities
and Exchange Commission such indemnification is against public policy as
expressed in the Securities Act of 1933 and is, therefore, unenforceable. In the
event that a claim for indemnification against such liabilities (other than the
payment by the registrant of expenses incurred or paid by a director, officer or
controlling person of the registrant in the successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling person
in connection with the securities being registered, the registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the
Securities Act of 1933 and will be governed by the final adjudication of such
issue.
(c) For purposes of determining any liability under the Securities Act, the
information omitted from the form of Prospectus filed as part of this
Registration Statement in reliance upon Rule 430A and contained in a form of
prospectus filed by us pursuant to Rule 424(b)(1) or (4) or 497(h) under the
Securities Act shall be deemed to be part of this Registration Statement as of
the time it was declared effective; and
II-2
(d) For the purpose of determining any liability under the Securities Act, each
post-effective amendment that contains a form of Prospectus shall be deemed to
be a new Registration Statement relating to the securities offered therein and
the offering of such securities at the time shall be deemed to be the initial
bona fide offering thereof.
II-3
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-3 and has duly caused this Registration
Statement on Form S-3 to be signed on its behalf by the undersigned, thereunto
duly authorized, in Irvine, State of California, on June 26, 2006.
CONSUMER PORTFOLIO SERVICES, INC.
By: /s/ CHARLES E. BRADLEY, JR.
Charles E. Bradley, Jr., President and Chief Executive Officer
POWER OF ATTORNEY
Each person whose signature appears below appoints Charles E. Bradley, Jr. and
Jeffrey P. Fritz, and each of them, with full power to act without the other,
such person's true and lawful attorneys-in-fact and agents, for him and in his
name, place and stead, in any and all capacities, to sign this Registration
Statement, and any and all pre-effective and post-effective amendments thereto
as well as any related registration statements (or amendment thereto) filed
pursuant to Rule 462(b) promulgated by the Securities Act of 1933, as amended,
and to file the same, with exhibits and schedules thereto, and other documents
in connection therewith, with the Securities and Exchange Commission, granting
unto said attorneys-in-fact and agents, and each of them, full power and
authority to do and perform each and every act and thing necessary or desirable
to be done in and about the premises, as fully to all intents and purposes as he
might or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or any of them, or their or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, as amended, this
Registration Statement on Form S-3 has been signed by the following persons in
the capacities and on the dates indicated below.
Signature Title Date
/s/ CHARLES E. BRADLEY, JR.
------------------------------- June 26, 2006
Charles E. Bradley, Jr. Chairman of the Board of Directors, President, and
Chief Executive Officer (Principal Executive Officer)
/s/ JEFFREY P. FRITZ
------------------------------- June 26, 2006
Jeffrey P. Fritz Sr. Vice President (Principal Financial and Accounting
Officer)
/s/ E. BRUCE FREDRIKSON
------------------------------- June 26, 2006
E. Bruce Fredrikson Director
------------------------------- June , 2006
John E. McConnaughy Director
/s/ JOHN G. POOLE
------------------------------- June 26, 2006
John G. Poole Director
/s/ WILLIAM B. ROBERTS
------------------------------- June 26, 2006
William B. Roberts Director
/s/ JOHN C. WARNER
------------------------------- June 26, 2006
John C. Warner Director
/s/ DANIEL S. WOOD
------------------------------- June 26, 2006
Daniel S. Wood Director
EXHIBIT INDEX
Exhibit No. Description
--------------- ---------------------------------------------------
23.2 Consent of McGladrey & Pullen LLP
23.3 Consent of KPMG LLP