SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K/A [ x ] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the fiscal year ended December 31, 1996 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission file number: 1-14116 CONSUMER PORTFOLIO SERVICES, INC. (Exact name of registrant as specified in its charter) California 33-0459135 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 2 Ada, Irvine, California 92618 (Address of principal executive (Zip Code) offices) Registrant's telephone number, including area code: (714) 753-6800 Securities registered pursuant to section 12(b) of the Act: Title of each class: Rising Interest Subordinated Redeemable Securities due 2006 Name of each exchange on which registered: New York Stock Exchange Securities registered pursuant to section 12(g) of the Act: Common stock, no par value Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes / x / No / / Indicate by check mark if there is no disclosure of delinquent filers pursuant to Item 405 of Regulation S-K contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. / / The aggregate market value on March 31, 1996 (based on the $8.00 average of closing bid and asked prices on Nasdaq Stock Market on that date) of the voting stock beneficially held by non-affiliates of the registrant was $76,457,112. The number of shares of the registrant's Common Stock outstanding on March 31, 1997 was 14,279,442 DOCUMENTS INCORPORATED BY REFERENCE: The registrant's proxy statement for its 1997 annual meeting of shareholders is incorporated by reference into Part III of this report. PART I ITEM 1. BUSINESS GENERAL Consumer Portfolio Services, Inc. (the "Company" or the "registrant") is a consumer finance company specializing in the business of purchasing, selling and servicing retail automobile installment contracts ("Contracts") originated by dealers ("Dealers") in the sale of new and used automobiles, light trucks and passenger vans. Through its purchases, the Company provides indirect financing to borrowers with limited credit histories, low incomes or past credit problems ("Sub-Prime Borrowers"). The Company serves as an alternative source of financing for Dealers, allowing sales to customers who otherwise might not be able to obtain financing from more traditional sources of automobile financing such as banks, credit unions or finance companies affiliated with major automobile manufacturers. HISTORY The Company was incorporated in March 1991 as a wholly owned subsidiary of CPS Holdings, Inc. ("Holdings") (formerly known as FWB Acceptance Corp.). Holdings was formed in April 1990 by Charles E. Bradley, Sr., the Chairman of the Board of the Company, in order to enter into the automobile financing business. Mr. Bradley believed that the Sub-Prime Borrower segment of this business had the potential for growth and profit due in part to the withdrawal from such business by many savings and loan associations and other financial institutions. In December 1995, Holdings was merged with and into the Company. The period from March 8, 1991 (the Company's inception) through May 1991 was devoted to the start-up of the Company's operations. On May 31, 1991, the Company first acquired certain third-party loan servicing contracts and in June 1991 began earning servicing fee income. The Company thereafter added to its third-party loan servicing portfolio and, in October 1991, began acquiring Contracts and selling them to General Electric Capital Corporation ("GECC"). To date, the Company has sold $42.6 million in Contracts to GECC and an additional $100.1 million to Sun Life Insurance Company of America ("Sun Life"). Since June 1994, the Company has issued an additional $642.6 million of "AAA"-rated and $27.3 million of "BB"-rated certificates backed by Contracts to various institutional investors. Since June 1996, all sales of "AAA"-rated certificates have been made in public offerings pursuant to registration statements filed with the Securities and Exchange Commission. See "Servicing of Contracts-- Third-Party Loan Servicing" and "Purchase and Sale of Contracts--Securitization and Sale of Contracts to Institutional Investors." AUTOMOBILE FINANCING INDUSTRY Automobile financing is the largest category, by dollar amount, of consumer installment debt in the United States. Most traditional sources of automobile financing, such as commercial banks, credit unions and captive finance companies affiliated with major automobile manufacturers, generally provide automobile financing for the most creditworthy, or so-called "prime" borrowers. The Company believes that the strong credit performance and large size of the market have led to intense price competition in the financing market for prime borrowers, and, in turn, low profit margins, effectively limiting this market to only the largest participants. In addition, special low-rate financing programs offered by automobile manufacturers' captive finance companies to promote the sale of specific automobiles have added to the competition within the prime borrower market. Although prime borrowers represent the largest segment of the automobile financing market, there are many potential purchasers of automobiles who do not qualify as prime borrowers. Purchasers considered by the Company to be Sub- Prime Borrowers have limited credit histories, low incomes or past credit problems and, therefore, are unable to obtain credit from traditional sources of automobile financing, such as commercial banks, credit unions or captive finance companies affiliated with major automobile manufacturers. (The terms "prime" and "sub-prime" reflect the Company's categorization of borrowers and bear no relationship to the prime rate of interest or persons who are able to borrow at that rate.) The Company believes that, because these potential purchasers represent a substantial market, there is a demand by automobile dealers for Sub- Prime Borrower financing that has not been effectively served by traditional automobile financing sources. 1 According to the Board of Governors of the Federal Reserve System, as of March 1996, there was approximately $359 billion in automobile-related installment credit outstanding. The Company is unaware of any authoritative estimates of the size of the "non-prime" portion of this market, although various sources have estimated that the potential loan base in this portion of the market is between $50 billion and $70 billion. Based on these figures, the Company's "Servicing Portfolio" (the aggregate principal amount of Contracts for which the Company performs collection services) represents less than one percent of the market. BUSINESS STRATEGY The Company's primary objective is to increase revenue and earnings through the expansion of its sales and servicing of Contracts purchased from Dealers. The Company has substantial operational and administrative capacity to expand its business. The Company's strategy is to: - - Maintain consistent underwriting standards and portfolio performance. - - Increase the number of Contracts it purchases from its existing Dealers. - - Expand its Dealer network, in part by entry into other geographic areas. During the year ended December 31, 1996, 52.1% of the Contracts acquired by the Company related to borrowers who resided in California, Florida, Pennsylvania and Texas (see "Purchase and Sale of Contracts--Dealer Contract Purchase Program"). - - Control and/or reduce its cost of funds by proper structuring of its securitization offerings and by obtaining the necessary ratings from nationally recognized credit rating agencies. - - Evaluate opportunities to provide additional products and services, such as automobile insurance, credit cards and extended maintenance contracts. EXPANSION AND DIVERSIFICATION In March 1996, the Company formed Samco Acceptance Corp. ("Samco"), an 80 percent-owned subsidiary based in Dallas, Texas. Samco's business plan is to provide the Company's sub-prime auto finance products to rural areas through independently owned finance companies. The Company believes that many rural areas are not adequately served by other industry participants due to their distance from large metropolitan areas where a Dealer marketing representative is most likely to be based. Samco employees call on independent finance companies ("IFCs"), primarily in the southeastern United States and present them with financing programs that are essentially identical to those which the Company markets directly to Dealers through its marketing representatives. The Company believes that a typical rural IFC has relationships with many local automobile purchasers as well as Dealers who, because of their financial resources or capital structure are generally unable to provide 36, 48 or 60 month financing for an automobile. IFCs may offer Samco's financing programs to borrowers directly or to local Dealers. Upon submission of applications to Samco, credit personnel who have been trained by the Company use the Company's proprietary systems to evaluate the borrower and the proposed Contract terms. Samco purchases Contracts from the IFCs after its credit personnel have performed all of the underwriting and verification procedures that the Company performs for Contracts it purchases from Dealers. Servicing and collection procedures on Samco Contracts are performed by the Company at its headquarters in Irvine, California. However, Samco may solicit aid from the IFC in collecting accounts that are seriously past due. As of December 31, 1996, Samco had purchased 399 Contracts with original balances aggregating $4.7 million. In May 1996, the Company formed LINC Acceptance Corp. ("LINC"), an 80 percent-owned subsidiary based in Norwalk, Connecticut. LINC's business plan is to provide the Company's sub-prime auto finance products to credit unions, banks and savings and loans ("Deposit Institutions"). The Company believes that credit unions, banks and savings and loans do not generally make loans to sub- prime borrowers, even though they may have relationships with Dealers and have sub-prime borrowers as deposit customers. LINC proposes to have certain of its employees call on various Deposit Institutions and present them with a financing program that is similar to those which the Company markets directly to Dealers through its 2 marketing representatives. The LINC program is intended to result in a slightly more creditworthy borrower than the Company's regular programs by requiring slightly higher income and lower debt-to-income ratios. LINC's customers may offer its financing program to borrowers directly or to local Dealers. Unlike Samco, which has employees who evaluate applications and make decisions to purchase Contracts, LINC applications will be submitted by the Deposit Institution directly to the Company, where the approval, underwriting and purchase procedures will be performed by Company staff who will work with LINC as well as with the Company's Dealers. Servicing and collection procedures on LINC Contracts will be performed entirely by the Company using its personnel. As of December 31, 1996, LINC had purchased seven Contracts with original balances aggregating $81,000. In June 1996, the Company acquired 38% of the outstanding shares of NAB Asset Corporation ("NAB") for $4.3 million. At the time of the acquisition, NAB had approximately $3.5 million in cash and no significant operations. Subsequent to the Company's investment in NAB, NAB purchased Mortgage Portfolio Services, Inc. ("MPS") from the Company for $300,000. MPS is a Dallas, Texas- based mortgage broker-dealer which the Company formed in April 1996. MPS specializes in the origination and sale of sub-prime residential mortgages. In July 1996, NAB formed CARSUSA, Inc., which subsequently purchased a Mitsubishi dealership in Riverside, California. The Company provides CARSUSA with an $800,000 line of credit for financing its vehicle inventory. In November 1996, NAB purchased Mack Financial Ltd, a small appliance "rent to own" company based in Dallas, Texas. In January 1997, the Company purchased 80% of the outstanding shares of an equipment financing company, Stanwich Leasing, Inc. ("SLI"), from its shareholders, who included two directors of the Company, Charles E. Bradley, Sr. and John G. Poole. The purchase price was $100,000 in cash. As of December 31, 1996, SLI owned and serviced an outstanding equipment lease portfolio of approximately $2.0 million, and had a book value of approximately $37,000. PURCHASE AND SALE OF CONTRACTS DEALER CONTRACT PURCHASE PROGRAM. As of December 31, 1996, the Company was a party to its standard form dealer agreements ("Dealer Agreements") with 2,182 Dealers. Approximately 93.2% 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, 1996, approximately 88.5% of the Contracts purchased by the Company consisted of financing for used cars and the remaining 11.5% for new cars. Most of these Dealers regularly submit Contracts to the Company for purchase, although such Dealers are under no obligation to submit any Contracts to the Company, nor is the Company obligated to purchase any Contracts. During the year ended December 31, 1996, no Dealer accounted for more than 2.3% of the total number of Contracts purchased by the Company. In addition, the Company continues to diversify geographically, and has reduced its concentration of Contract purchases in California from 35.0% for the year ended December 31, 1995, to 25.8% for the year ended December 31, 1996. The following table sets forth the geographical sources of the Contracts purchased by the Company (based on the addresses of the borrowers as stated on the Company's records) during each of the years ended December 31, 1996 and December 31, 1995. 3 CONTRACTS PURCHASED DURING YEAR ENDED --------------------------------------------------------------- DECEMBER 31, 1996 DECEMBER 31, 1995 --------------------------- ----------------------------- NUMBER PERCENT NUMBER PERCENT --------- ----------- ----------- ----------- California 7,296 25.8% 5,157 35.0% Pennsylvania 2,730 9.6% 1,432 9.7% Florida 2,638 9.3% 1,555 10.6% Texas 2,073 7.3% 1,046 7.1% Illinois 1,385 4.9% 963 6.5% Tennessee 1,225 4.3% 221 1.5% New York 1,201 4.2% 384 2.6% Louisiana 1,184 4.2% 271 1.8% Ohio 1,180 4.2% 119 0.8% Nevada 1,060 3.7% 750 5.1% Maryland 920 3.3% 106 0.7% Alabama 906 3.2% 93 0.6% Michigan 788 2.8% 598 4.1% New Jersey 625 2.2% 308 2.1% Hawaii 507 1.8% 452 3.1% Other states 2,587 9.1% 1,283 8.7% --------- ----------- Total 28,305 14,738 --------- ----------- --------- ----------- When a retail automobile buyer elects to obtain financing from a Dealer, an application is taken for submission by the Dealer to its financing sources. Typically, a Dealer will submit the buyer's application to more than one financing source for review. The Company believes the Dealer's decision to finance the automobile purchase with the Company, rather than other financing sources, is based primarily upon an analysis of the discounted purchase price offered for the Contract, the timeliness, consistency and predictability of response, the cash resources of the financing source, and any conditions to purchase. Upon receipt of an application from a Dealer, the Company's administrative personnel order a report containing information from the three major national credit bureaus on the applicant to document the buyer's credit history. If, upon review by a Company loan officer, it is determined that the application meets the Company's underwriting criteria, or would meet such criteria with modification, the Company requests and reviews further information and supporting documentation and, ultimately, decides whether to purchase the Contract. When presented with an application, the Company attempts to notify the Dealer within four hours as to whether it intends to purchase such Contract. The Company buys Contracts directly from Dealers and does not make loans directly to purchasers of automobiles. The Company has historically purchased Contracts from Dealers at discounts ranging from 0% to 10% of the total amount financed under the Contracts, depending on the perceived credit risk of the Contract, plus a flat acquisition fee, generally $200, for each Contract purchased. Discounts averaged 4.1% and 2.8% for the years ended December 31, 1995 and 1996, respectively. The Company believes that the level of discounts and fees are a significant factor in the Dealer's decision to submit a Contract to the Company for purchase, and will continue to play such a role in the future. Effective January 10, 1997, the Company began purchasing all Contracts without a percentage discount, charging Dealers only an acquisition fee ranging from zero to $1,195 for each Contract purchased. The fees vary based on the perceived credit risk and, in some cases, the interest rate on the Contract. The acquisition fees instituted in January 1997 are larger, on average, than the acquisition fees previously charged in conjunction with percentage discounts, so as to result in a similar net purchase price on a typical Contract. The Company attempts to control Dealer misrepresentation by carefully screening the Contracts it purchases, by establishing and maintaining professional business relationships with Dealers, and by including certain representations and warranties by the Dealer in the Dealer Agreement. Pursuant to the Dealer 4 Agreement, the Company may require the Dealer to repurchase any Contract in the event that the Dealer breaches its representations or warranties or if a borrower fails, for any reason, to make timely payment of the first installment due under a Contract. There can be no assurance, however, that any Dealer will have the financial resources to satisfy its repurchase obligations to the Company. BULK PURCHASES. The Company has purchased portfolios of Contracts in bulk ("Bulk Purchases") from other companies that had previously purchased the Contracts from Dealers, and assumed the servicing thereon. To date, the Company has made four such Bulk Purchases aggregating approximately $22.9 million. In considering Bulk Purchases, the Company carefully evaluates the credit profile and payment history of each portfolio and negotiates the purchase price accordingly. The credit profiles of the Contracts in each of the portfolios purchased are similar to those in the underwriting standards used by the Company in its normal course of business. The Bulk Purchases were made at purchase prices ranging from 93.0% to 100.0% of the aggregate principal balance of the Contracts. The Company may consider the purchase of additional portfolios from third parties, but has not made any such purchases since August 1995. As of December 31, 1996, Contracts that were acquired in Bulk Purchases and not yet sold account for 0.2% of the Servicing Portfolio. CONTRACT PURCHASE CRITERIA. To be eligible for purchase by the Company, a Contract must have been originated by a Dealer that has entered into a Dealer Agreement to sell Contracts to the Company. The Contracts must be secured by a first priority lien on a new or used automobile, light truck or passenger van and must meet the Company's underwriting criteria. In addition, each Contract requires the borrower to maintain physical damage insurance covering the financed vehicle and naming the Company as a loss payee. The Company or any purchaser of the Contract from the Company may, nonetheless, suffer a loss upon theft or physical damage of any financed vehicle if the borrower fails to maintain insurance as required by the Contract and is unable to pay for repairs to or replacement of the vehicle or is otherwise unable to fulfill its obligations under the Contract. The Company believes that its objective underwriting criteria enable it to evaluate effectively the creditworthiness of Sub-Prime Borrowers and the adequacy of the financed vehicle as security for a Contract. These criteria include standards for price; term; amount of down payment, installment payment and add-on interest rate; mileage, age and type of vehicle; amount of the Contract in relation to the value of the vehicle; borrower's income level, job and residence stability, credit history and debt serviceability; and other factors. Specifically, the Company's guidelines limit the maximum principal amount of a purchased Contract to 115% of wholesale book value in the case of used vehicles or to 110% of the manufacturer's invoice in the case of new vehicles, plus, in each case, sales tax, licensing and, when the customer purchases such additional items, a service contract or a credit life or disability policy. The Company does not finance vehicles that are more than eight model years old or have in excess of 85,000 miles. The maximum term of a purchased Contract is 60 months; a shorter maximum term may be applied based on the year and mileage of the vehicle. These criteria are subject to change from time to time as circumstances may warrant. Upon receiving this information with the borrower's application, the Company's underwriters will verify the borrower's employment, residency, insurance and credit information provided by the borrower by contacting various parties noted on the borrower's application, credit information bureaus and other sources. The Company typically completes its credit review and responds to the Dealer within four hours. CREDIT SCORING. From inception through December 31, 1996, the Company has purchased $729.1 million in Contracts and, as of that date, had an outstanding Servicing Portfolio of $505.9 million. The Company's management information systems are structured to include a variety of credit and demographic data for each Contract as well as maintaining data which indicate each Contract's past or current performance characteristics. Furthermore, the Company's technical staff have the ability to interrogate the database to compare performing and non-performing Contracts and to ascertain which demographic and credit related data elements may be predictors of credit performance. In November 1996, the Company implemented a scoring model which assigns each Contract a numeric value (a "credit score") at the time the application is received from the Dealer and the borrower's credit information is retrieved from the credit reporting agencies. The credit score is based on a variety of parameters such as the borrower's job and residence stability, the amount of the down payment, and the age and mileage of the vehicle. The Company has developed the credit score as a means of improving its productivity by 5 identifying Contracts where the characteristics are so strong (or alternatively, so weak), that the initial notification to the Dealer can be given without the more extensive analysis that a Company loan officer would give to a more average scoring Contract. Regardless of the credit score a Contract originally receives, the Company's underwriters perform the same extensive review and verification procedures on all Contracts. In addition to productivity improvements, the credit score is used to identify Contracts for which review by a supervisor or manager prior to approval and purchase may be appropriate. Once an application is approved, financing documents are generated by the Dealer and the Company obtains a certificate of title for the vehicle when a lien is recorded, and various other documents pertaining to the borrower's credit application. After the documents are signed by the Dealer and the borrower, the Dealer sells the Contract to the Company. The borrower then receives monthly billing statements. All of the Contracts purchased by the Company are fully amortizing and provide for level payments over the term of the Contract. The average original principal amount financed under Contracts purchased in the year ended December 31, 1996 was approximately $12,606, with an average original term of approximately 54.0 months and an average down payment of 15.3%. Based on information contained in borrower applications, for this twelve-month period, the retail purchase price of the related automobiles averaged $12,855 (which excludes tax and license fees, and any additional costs such as a maintenance contract), the average age of the vehicle at the time the Contract was purchased was 3 years, and the Company's average borrower at the time of purchase was approximately 37.0 years old, with approximately $32,007 in average household income and an average of 4.6 years' history with his or her current employer. All Contracts may be prepaid at any time without penalty. In the event a borrower elects to prepay a Contract in full, the payoff amount is calculated by deducting the unearned interest (as determined by the "Rule of 78s" method, where applicable) from the Contract balance. When a partial prepayment is made on a Contract originated in California, at the option of the borrower, the future monthly payments may be reduced pro rata by the aggregate amount of the prepayment, payment of the next succeeding regular monthly payments may be suspended, or the borrower may continue to make the regular monthly payments and thereby pay the Contract in full prior to its scheduled amortization. With respect to Contracts originated outside of California, the portion of each payment on the Contracts allocated to principal and interest and the payoff amount in the event of a full prepayment would be determined by the Rule of 78s method or such other interest amortization method as is permitted by applicable state law. Each Contract purchased by the Company prohibits the sale or transfer of the financed vehicle without the Company's consent and allows for the acceleration of the maturity of a Contract upon a sale or transfer without such consent. In most circumstances, the Company will not consent to a sale or transfer of a financed vehicle unless the related Contract is prepaid in full. The Company believes that the most important requirements to succeed in the sub-prime automobile financing market are the ability to control borrower and Dealer misrepresentation at the point of origination; the development and consistent implementation of objective underwriting criteria specifically designed to evaluate the creditworthiness of Sub-Prime Borrowers; and the maintenance of an active program to monitor performance and collect payments. SECURITIZATION AND SALE OF CONTRACTS TO INSTITUTIONAL INVESTORS. The Company purchases Contracts with the intention of reselling them to institutional investors ("Investors") either as bulk sales or as asset-backed securities. Asset-backed securities are generally structured as follows: First, the Company sells a portfolio of Contracts to a wholly-owned subsidiary which has been established for the limited purpose of buying and reselling the Company's Contracts. The subsidiary then sells the same Contracts to a grantor trust, and the grantor trust in turn issues interest-bearing asset-backed securities in an amount equal to the aggregate principal balance of the Contracts. One or more Investors purchase these asset-backed securities, the proceeds of which are used by the grantor trust to purchase the Contracts from the subsidiary, which uses such proceeds to purchase the Contracts from the Company. In addition, the Company provides a credit enhancement for the benefit of investors in the form of an initial cash deposit to a specific trust account ("Spread Account") and a deposit of certain excess servicing cash flows. Since its September 1995 securitization, and, it is expected, on an ongoing basis in the future, the Company altered the credit enhancement mechanism used in its securitizations to create and sell a subordinated security ("B Piece") in order to reduce the size of the required 6 initial deposit to the Spread Account. The B Piece provides an additional credit enhancement to the senior security holders because distributions of interest on the B Piece are subordinated in priority of payment to interest due on the senior certificates and distributions of principal on the B Piece are subordinated in priority of payment to interest and principal due on the senior certificates. This revised structure may, if the Company is able to continue to sell the B Piece, reduce the amount of cash effectively used in securitizations. The Company continues to hold the B Piece associated with the June 1995 securitization but has sold all subsequent B Pieces. The Company believes it will be able to continue to sell the B Pieces created in its future securitizations. Purchasers of the asset-backed securities receive a particular coupon rate (the "Pass-Through Rate") established at the time of the sale. The Company receives periodic base servicing fees for its duties relating to the accounting for and collection of the Contracts. In addition, the Company is entitled to certain excess servicing fees that represent collections on the Contracts in excess of the amounts required to pay investor principal and interest, the base servicing fees and certain other fees such as trustee and custodial fees. Generally, the Company sells the Contracts at face value and without recourse except that the representations and warranties provided by the Dealer to the Company are similarly provided by the Company to the investor. At the end of the month, the aggregate cash collections are allocated first to the base servicing fees and certain other fees such as trustee and custodial fees for the period, then to the asset-backed securities certificateholder in an amount equal to the interest accrued at the Pass-Through Rate on the portfolio plus the amount by which the portfolio balance decreased (due to payments, payoffs or charge-offs) during the period. If the amount of cash required for the above allocations exceeds the amount collected during the monthly period, the shortfall is drawn from the Spread Account. If the cash collected during the period exceeds the amount necessary for the above allocations, and there is no shortfall in the related Spread Account, the excess is returned to the Company or one of its subsidiaries. The excess cash flows are considered by the Company to be excess servicing fees, part of which the Company recognizes as a gain on sale based on an estimate of the discounted present value of the excess cash flows. Each sale of asset-backed securities results in an increase in the Excess Servicing Receivables account on the Company's Consolidated Balance Sheet and the recognition of a "Net Gain on Sale of Contracts" on the Company's Consolidated Statement of Operations for the period in which the sale was made. The Excess Servicing Receivables account is increased by a portion of the gain recognized on each securitization which represents principally the net present value of estimated future cash flows relating to the Contracts which were sold, calculated as follows: (i) the present value of all future interest and principal payments expected to be received by the Company over the remaining life of the Contracts; less (ii) the Contracts' principal payments which are required to be passed through to the investors in the period in which they were received plus interest payments required to be made to investors at the Pass-Through Rate established at the time of securitization, and certain other fees and expenses associated with the securitization transaction, including the base servicing fee paid to the Company in respect of its obligations to service the borrowers' Contracts. Because the annual percentage rate ("APR") on the Contracts received by the Company is relatively high in comparison to the Pass-Through Rate paid to investors, the net present value described above can be significant. In calculating the net gain on sale described above, the Company must estimate the future rates of prepayments, delinquencies, defaults and default loss severity as they impact the amount and timing of the cash flows in the net present value calculation. The cash flows received by the Company are then discounted at an interest rate that the Company believes a third-party purchaser would require as a rate of return. Expected losses are discounted using a rate equivalent to the risk free rate for securities with a duration similar to that estimated for the underlying Contracts. In future periods, the Company will recognize additional revenue in the Servicing Fees account if the actual performance of the Contracts is better than the original discounted estimate. Although the Company has never recognized a writedown against the Excess Servicing Receivables account, if the actual performance of the Contracts is worse than the original discounted estimate, then such a writedown would be required. The 7 Company's actual excess servicing cash flows, however, historically have exceeded the Company's original discounted estimates. The Company's first significant sales consisted of an aggregate of $17.6 million of Contracts sold from October 1, 1991 through January 31, 1993 to GECC pursuant to an agreement that expired on December 31, 1992. On March 16, 1995, the Company sold an additional $25.0 million in Contracts to GECC for an aggregate total of $42.6 million sold to GECC. On April 7, 1993, the Company began selling Contracts to Sun Life pursuant to various agreements. As of December 31, 1996, the Company had sold approximately $100.1 million in Contracts to Sun Life, $42.1 million of which was sold in the form of "Aaa/AAA" rated securities, as discussed below. As of December 31, 1996, the unpaid balance of the Contracts sold to Sun Life was approximately $25.0 million and the unpaid balance of Contracts sold to GECC was approximately $11.2 million. Contract sales to GECC were in the form of whole loan sales. All of the Contracts sold to Sun Life have been in the form of asset-backed securities issued by grantor trusts to which a wholly-owned subsidiary of the Company has sold the Contracts. The first $58.1 million of the certificates sold to Sun Life were rated "A" by Duff & Phelps Credit Rating Co. The principal and interest due on the remaining $42.0 million of the certificates sold to Sun Life are guaranteed by Financial Security Assurance Inc. ("FSA"), and, as a result, such certificates were rated "Aaa" by Moody's Investors Service and "AAA" by Standard & Poor's Corporation. On June 23, 1994, the Company began using various investment banking firms to place its asset-backed securities issues. The certificates have been issued by grantor trusts to which a wholly owned subsidiary of the Company has sold the related Contracts. Through December 31, 1996, the Company had delivered approximately $612.3 million principal amount of Contracts (of which approximately $461.7 million was outstanding at December 31, 1996) to twelve grantor trusts pursuant to these arrangements. Subsequent to December 31, 1996, the Company delivered an additional $102.3 million of Contracts to a thirteenth grantor trust. The principal and interest due on the certificates issued pursuant to these arrangements are guaranteed by FSA and, as a result, such certificates are rated "Aaa" by Moody's Investors Services and "AAA" by Standard & Poor's Corporation. Since June 1996, the Company has sold such "AAA"-rated certificates in public offerings pursuant to registration statements filed with the Securities and Exchange Commission. In connection with the sale of the Contracts, the Company is required to make certain representations and warranties, which generally duplicate the substance of the representations and warranties made by Dealers in connection with the Company's purchase of the Contracts. If the Company breaches any of its representations or warranties to a purchaser of the Contracts, the Company will be obligated to repurchase the Contract from such purchaser at a price equal to such purchaser's purchase price less the related cash securitization reserve and any payments received by such purchaser on the Contract. In most cases, the Company would then be entitled under the terms of its Dealer Agreement to require the selling Dealer to repurchase the Contract at a price equal to the Company's purchase price, less any payments made by the borrower. Subject to any recourse against Dealers, the Company will bear the risk of loss on repossession and resale of vehicles under Contracts repurchased by it. TERMS OF SERVICING AGREEMENTS. The Company currently services all Contracts sold and expects to service all Contracts that it purchases and sells in the future, whether structured as whole loan sales or sales of asset-backed securities. Pursuant to the Company's usual form of servicing agreement (the Company's servicing agreements are collectively referred to as the "Servicing Agreements"), the Company is obligated to service all Contracts sold to the investors or trusts in accordance with the Company's standard procedures. The Servicing Agreements generally provide that the Company will bear all costs and expenses incurred in connection with the management, administration and collection of the Contracts serviced. The Servicing Agreements also provide that the Company will take all actions necessary or reasonably requested by the investor to maintain perfection and priority of the investor's or the trust's security interest in the financed vehicles. Upon the sale of a portfolio of Contracts to an investor or a trust, the Company mails to borrowers monthly billing statements directing them to mail payments on the Contracts to a lock-box account. The Company engages an independent lock-box processing agent to retrieve and process payments received in the lock-box account. This results in a daily deposit to the investor's or the trust's bank account of the entire amount of each day's lock-box receipts and the simultaneous electronic data transfer to the Company of borrower payment data 8 for posting to the Company's computerized records. Pursuant to the Servicing Agreements, the Company is required to deliver monthly reports to the investor or the trust reflecting all transaction activity with respect to the Contracts. The reports contain, among other information, a reconciliation of the change in the aggregate principal balance of the Contracts in the portfolio to the amounts deposited into the investor's or the trust's bank account as reflected in the daily reports of the lock-box processing agent. The Company is entitled under most of the Servicing Agreements to receive a base monthly servicing fee of 2.0% per annum computed as a percentage of the declining outstanding principal balance of each Contract in the portfolio that is not in default as of the beginning of the month. Each month, after payment of the Company's base monthly servicing fee and certain other fees, the investor receives the paid principal reduction of the Contracts in its portfolios and interest thereon at the Pass-Through Rate. If, in any month, collections on the Contracts are insufficient to pay such amounts and any principal reduction due to charge-offs, the shortfall is satisfied from the Spread Account established in connection with the sale of the portfolio. (If the Spread Account is not sufficient to satisfy a shortfall, then the investor or trust may suffer a loss to the extent that the shortfall exceeds the Spread Account.) If collections on the Contracts exceed such amounts, the excess is utilized, first, to build up or replenish the Spread Account to the extent required, next, to cover deficiencies in Spread Accounts for other portfolios, and the balance, if any, constitutes excess servicing fees, which are distributed to the Company. If, in any month, the Spread Account balance is in excess of that required under the commitment or the Servicing Agreements, the Company is entitled to receive such excess. The Servicing Agreements also provide that the Company is entitled to receive certain late fees collected from borrowers. Pursuant to the Servicing Agreements, the Company is generally required to charge off the balance of any Contract by the earlier of the end of the month in which the Contract becomes five scheduled installments past due or, in the case of repossessions, the month that the proceeds from the liquidation of the financed vehicle are received by the Company. In the case of a repossession, the amount of the charge-off is the difference between the outstanding principal balance of the defaulted Contract and the repossession sale proceeds. In the event collections on the Contracts are not sufficient to pay to the investor the entire principal balance of any Contracts charged off during the month, the Spread Account established in connection with the sale of the Contracts is reduced by the unpaid principal amount of such Contracts. Such amount would then have to be restored to the Spread Account from future collections on the Contracts remaining in the portfolio before the Company would again be entitled to excess servicing fees. In addition, the Company would not be entitled to receive any further base monthly servicing fees with respect to the defaulted Contracts. Subject to any recourse against the Company in the event of a breach of the Company's representations and warranties with respect to any Contracts and after any recourse to any FSA guarantees backing the certificates, the investor bears the risk of all charge-offs on the Contracts in excess of the Spread Account. However, the Company would experience a reduction of excess servicing fees in the event of greater than anticipated charge-offs or prepayments on Contracts sold and serviced by the Company. The Servicing Agreements are terminable by the investor in the event of certain defaults by the Company and under certain other circumstances. SERVICING OF CONTRACTS GENERAL. The Company's servicing activities, both with respect to portfolios of Contracts sold by it and with respect to loans owned or originated by third parties, consist of collecting, accounting for and posting of all payments received; responding to borrower inquiries; taking all necessary action to maintain the security interest granted in the financed vehicle or other collateral; investigating delinquencies; communicating with the borrower to obtain timely payments; repossessing and reselling the collateral when necessary; and generally monitoring each Contract and any related collateral. 9 COLLECTION PROCEDURES. The Company believes that its ability to monitor performance and collect payments owed from Sub-Prime Borrowers is primarily a function of its collection approach and support systems. The Company believes that if payment problems are identified early and the Company's collection staff works closely with borrowers to address these problems, it is possible to correct many of them before they deteriorate further. To this end, the Company utilizes pro-active collection procedures, which include making early and frequent contact with delinquent borrowers; educating borrowers as to the importance of maintaining good credit; and employing a consultative and customer service approach to assist the borrower in meeting his or her obligations, which includes attempting to identify the underlying causes of delinquency and cure them whenever possible. In support of its collection activities, the Company maintains a computerized collection system specifically designed to service automobile installment sale contracts with Sub-Prime Borrowers and similar consumer loan contracts. See "Business -- Management Information Systems." With the aid of its high penetration auto dialer, the Company typically attempts to make telephonic contact with delinquent borrowers on the sixth day after their monthly payment due date. Using coded instructions from a collection supervisor, the automatic dialer will attempt to contact borrowers 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 borrower's record and moves on to the next call. If a live voice answers the automatic dialer's call, the call is transferred to a waiting collector at the same time that the borrower's pertinent information is simultaneously displayed on the collector's workstation. The collector then inquires of the borrower the reason for the delinquency and when the Company can expect to receive the payment. The collector will attempt to get the borrower 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 borrower makes such a promise, the account is routed to a pending queue and is not contacted until the outcome of the promise is known. If the payment is made by the promise date and the account is no longer delinquent, the account is routed out of the collection system. If the payment is not made, or if the payment is made, but the account remains delinquent, the account is returned to the automatic dialing queue for subsequent contacts. If a borrower fails to make or keep promises for payments, or if the borrower 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 borrower's payment due date, but could occur sooner or later, depending on the specific circumstances. If a decision to repossess is made by a supervisor, such assignment is given to one of many licensed, bonded repossession agents used by the Company. When the vehicle is recovered, the repossession agent delivers it to a wholesale auto auction where it is kept until it is liquidated, usually within 30 days of the repossession. Liquidation proceeds are applied to the borrower's outstanding obligation under the Contract and the borrower is advised of his obligation to pay any deficiency balance that remains. The Company uses all practical means available to collect deficiency balances, including filing for judgments against borrowers where applicable. A repossession in the event of default generally does not yield proceeds sufficient to pay all amounts owing under a Contract. The actual cash value of the vehicle may be less than the amount financed at inception of the Contract, and also thereafter, because the amount financed may be as much as 115% of the wholesale book value in the case of used vehicles or 110% of manufacturer's invoice in the case of new vehicles, plus sales tax, licensing fees, and any service contract or credit life or disability policy purchased by the borrower, less the borrower's down payment and/or trade-in allowance (generally not less than 10% of the vehicle sales price). In addition, the proceeds available upon resale are reduced by statutory liens, such as those for repairs, storage, unpaid taxes and unpaid parking fines, and by the costs incurred in the repossession and resale. Unless the Contract is sufficiently seasoned that the borrower has substantial equity in the vehicle, the proceeds of sale are generally insufficient to pay all amounts owing. For that reason, the Company's collection policies aim to avoid repossession to the extent possible. In order to do so the Company may extend the payment due date of a Contract within limits specified in the Servicing Agreements. Included in the Servicing Portfolio at December 31, 1996 are 5,680 Contracts for which the purchaser of the underlying vehicle had been granted at least a one month payment extension. Of such extended Contracts, 4,814 were current based on the modified payment terms. 10 The Company's excess servicing fees are impacted by the relative performance of the portfolios of Contracts it has sold to institutional investors. The tables below document the delinquency, repossession and net credit loss experience of all Contracts originated by the Company since its inception: - -------------- (1) All amounts and percentages are based on the full amount remaining to be repaid on each Contract, including, for Rule of 78s Contracts, any unearned finance charges. The information in the table represents the principal amount of all Contracts purchased by the Company, including Contracts subsequently sold by the Company which it continues to service. (2) The Company considers a Contract delinquent when an obligor fails to make at least 90% of a contractually due payment by the following due date, which date may have been extended within limits specified in the Servicing Agreements, as discussed above. The period of delinquency is based on the number of days payments are contractually past due. Contracts less than 31 days delinquent are not included. (3) Amount in repossession represents financed vehicles which have been repossessed but not yet liquidated. Net Charge-Off Experience(1)
Delinquency Experience(1) December 31, 1996 December 31, 1995 March 31, 1995 ----------------- ----------------- -------------- Number Number Number of Loans Amount of Loans Amount of Loans Amount -------- ------ -------- ------ -------- ------ (Dollars in thousands) Gross Servicing Portfolio . . . . 47,187 $604,092 27,129 $356,114 18,104 $248,550 Period of delinquency (2) 31-60 days . . . . . . . . . . 1,801 22,099 910 11,525 299 3,878 61-90 days . . . . . . . . . . 724 9,068 203 2,654 70 948 91+ days . . . . . . . . . . . 768 9,906 273 3,912 101 1,487 ------- -------- ------- --------- ------- -------- Total delinquencies(2) . . . . . 3,293 41,073 1,386 18,091 470 6,313 Amount in repossession (3) 1,168 14,563 836 10,179 367 5,271 ------- -------- ------- --------- ------- -------- Total delinquencies and amount in repossession (2) 4,461 55,636 2,222 28,270 837 11,584 ------- -------- ------- --------- ------- -------- ------- -------- ------- --------- ------- -------- Delinquencies as a percent of gross Servicing Portfolio 7.0% 6.8% 5.1% 5.1% 2.6% 2.5% Total delinquencies and amount in repossession as a percent of gross Servicing Portfolio . . . . . . . 9.5% 9.2% 8.2% 7.9% 4.6% 4.7% - -------------- (1) All amounts and percentages are based on the principal amount scheduled to be paid on each Contract. The information in the table represents all Contracts purchased by the Company including Contracts subsequently sold by the Company which it continues to service. 11
Transition Period Fiscal Year Year Ended Ended Ended December 31, 1996 December 31, 1995 March 31, 1995 ----------------- ----------------- -------------- (Dollars in thousands) Average Servicing Portfolio outstanding . . . . . . . . . . . . . $397,430 $240,864 $128,004 Net charge-offs as a percent of average Servicing Portfolio(3 . . . . 5.1% 4.9% 4.0% (2) The percentages set forth for the nine-month transition period ended December 31, 1995, are computed using annualized operating data which do not necessarily represent comparable data for a full twelve-month period. (3) 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). For periods prior to the year ended December 31, 1996, post liquidation amounts received on previously charged off Contracts were applied to the period in which the related Contract was originally charged off. These prior period allocations were made only for the purpose of calculating this ratio. For financial statement purposes, post liquidation amounts are recognized in the period received. Effective January 1, 1996, post liquidation amounts received on previously charged off Contracts are applied in the period in which they are received, both for this ratio and financial statement purposes. Excludes uninsured casualty losses which for the year ended December 31, 1996, the nine-month transition period ended December 31, 1995, and the year ended March 31, 1995 was $1.7 million, $604,000 and $205,000, respectively. MANAGEMENT INFORMATION SYSTEMS The Company maintains sophisticated data processing support and management information systems. To support its collection efforts, the Company utilizes Digital Systems International's Intelligent Dialing SystemJ, a high-penetration automatic dialer, in conjunction with the American Management Systems' Computer Assisted Collection System software, which has been customized by the Company, and numerous accounting software programs. All systems are operated at the Company's offices on an Advance System IBM AS/400 computer. The Company's high-penetration automatic dialer controls multiple telephone lines and automatically dials numbers from file records in accordance with programmed instructions established by management. If the dialer receives a busy signal or no answer, it will generally route the number for a subsequent re-call. The dialer has the ability to distinguish a pre-recorded voice and will leave the appropriate digitized human voice message on the borrower's answering machine. Generally, the dialer transfers the call to a collector only after it has determined that there is a live voice on the line. In most instances, this is accomplished so rapidly that the individual receiving the call is unaware that an automatic dialer has been used. The efficiency of the auto dialer allows the Company to place as many as 5,000 telephone calls per day. The high-penetration automatic dialer also monitors telephone activity and activates more telephone lines when connect rates are low or shuts down lines when connect rates are high. Once a live call is passed to a collector, all relevant account information, including one of 99 account status codes, automatically appears on the collector's video screen. The Company believes the capabilities of the automatic dialer reduce the likelihood that an account will remain delinquent for a prolonged period without appropriate follow-up. The Company's automation allows it to electronically sort and prioritize each collector's workload as well as to implement specific collection strategies. Moreover, the Company has adopted certain procedural controls designed to ensure that certain important decisions, such as ordering a repossession, initiating legal action or materially modifying an account, are automatically routed to a supervisor for review and approval. The Company believes that the capacity of its existing data processing support and management information systems is sufficient to allow the Company to substantially expand its business without significant additional capital expenditures. COMPETITION The automobile financing business is highly competitive. The Company competes with a number of national, local and regional finance companies with operations similar to those of the Company. In addition, competitors or potential competitors include other types of financial services companies, such as commercial banks, savings and loan associations, leasing companies, credit unions providing retail loan financing and lease financing for new and used vehicles, and captive finance companies affiliated with major automobile manufacturers such as General Motors Acceptance Corporation, Ford Motor Credit Corporation, Chrysler Credit Corporation and Nissan Motors Acceptance Corporation. Many of the Company's competitors and potential competitors possess substantially greater financial, marketing, technical, personnel and other 12 resources than the Company. Moreover, the Company's future profitability will be directly related to the availability and cost of its capital in relation to the availability and cost of capital to its competitors. The Company's competitors and potential competitors include far larger, more established companies that have access to capital markets for unsecured commercial paper and investment grade-rated debt instruments and to other funding sources which may be unavailable to the Company. Many of these companies also have long-standing relationships with Dealers and may provide other financing to dealers, including floor plan financing for the Dealers' purchase of automobiles from manufacturers, which is not offered by the Company. The Company believes that the principal competitive factors affecting a Dealer's decision to offer Contracts for sale to a particular financing source are the purchase price offered for the Contracts, the reasonableness of the financing source's underwriting guidelines and documentation requests, the predictability and timeliness of purchases and the financial stability of the funding source. The Company believes that it can obtain from Dealers sufficient Contracts for purchase at attractive prices by consistently applying reasonable underwriting criteria and making timely purchases of qualifying Contracts. The Company believes that it can compete effectively for the interest of institutional investors in purchasing Contracts acquired by the Company based upon the historical performance of portfolios of Contracts sold and serviced by it and its willingness to establish substantial Spread Accounts for the benefit of investors and to derive a portion of its revenues from excess servicing fees paid on a monthly basis rather than up-front fees paid at the time of sale of the Contracts. MARKETING The Company establishes relationships with Dealers through Company representatives that contact a prospective Dealer to explain the Company's Contract purchases and thereafter provide Dealer training and support services. As of December 31, 1996, the Company had 48 representatives, 31 of whom are employees and 17 of whom are independent. The independent representatives are contractually obligated to represent the Company's financing program exclusively. The Company's representatives present the Dealer with a marketing package, which includes the Company's promotional material containing the current discount rate offered by the Company for the purchase of Contracts, a copy of the Company's standard-form Dealer Agreement, examples of monthly reports and required documentation relating to Contracts, but they have no authority relating to the decision to purchase Contracts from Dealers. The Company's acceptance of a Dealer is subject to its analysis of, among other things, the Dealer's operating history. The Company has not actively advertised its automobile financing or third-party loan servicing businesses, although it may do so selectively in the future. GOVERNMENT REGULATION The Company intends to obtain and maintain all licenses necessary to the lawful conduct of its business and operations. The Company is not licensed to make loans directly to borrowers. Several federal and state consumer protection laws, including the Federal Truth-In-Lending Act, the Federal Equal Credit Opportunity Act, the Federal Fair Debt Collection Practices Act and the Federal Trade Commission Act, regulate the extension of credit in consumer credit transactions. These laws mandate certain disclosures with respect to finance charges on Contracts and impose certain other restrictions on Dealers. In addition, laws in a number of states impose limitations on the amount of finance charges that may be charged by Dealers on credit sales. The so-called Lemon Laws enacted by the federal government and various states provide certain rights to purchasers with respect to motor vehicles that fail to satisfy express warranties. The application of Lemon Laws or violation of such other federal and state laws may give rise to a claim or defense of a borrower against a Dealer and its assignees, including the Company and purchasers of Contracts from the Company. The Dealer Agreement contains representations by the Dealer that, as of the date of assignment of Contracts, no such claims or defenses have been asserted or threatened with respect to the Contracts and that all requirements of such federal and state laws have been complied with in all material respects. Although a Dealer would be obligated to repurchase Contracts that involve a breach of such warranty, there can be no assurance that the Dealer will have the financial resources to satisfy its repurchase obligations to the Company. Certain of these laws also regulate the Company's servicing activities, including its methods of collection. 13 Although the Company believes that it is currently in compliance with applicable statutes and regulations, there can be no assurance that the Company will be able to maintain such compliance. The failure to comply with such statutes and regulations could have a material adverse effect upon the Company. Furthermore, the adoption of additional statutes and regulations, changes in the interpretation and enforcement of current statutes and regulations or the expansion of the Company's business into jurisdictions that have adopted more stringent regulatory requirements than those in which the Company currently conducts business could have a material adverse effect upon the Company. In addition, due to the consumer-oriented nature of the industry in which the Company operates and the application of certain laws and regulations, industry participants are regularly named as defendants in litigation involving alleged violations of federal and state laws and regulations and consumer law torts, including fraud. Many of these actions involve alleged violations of consumer protection laws. Although the Company is not involved in any material litigation, a significant judgment against the Company or within the industry in connection with any such litigation could have a material adverse effect on the Company's financial condition and results of operations. Upon the purchase of Contracts by the Company, the original Contracts and related title documents for the financed vehicles are delivered by the selling Dealers to the Company. Upon the sale of each portfolio of Contracts by the Company, a financing statement is filed under the Uniform Commercial Code as adopted in the applicable state (the "UCC") to perfect and give notice of the purchaser's security interest in the Contracts. The Dealer Agreement and related assignment contain representations and warranties by the Dealer that an application for state registration of each financed vehicle, naming the Company as secured party with respect to the vehicle, was effected at the time of sale of the related Contract to the Company, and that all necessary steps have been taken to obtain a perfected first priority security interest in each financed vehicle in favor of the Company under the laws of the state in which the financed vehicle is registered. If a Dealer or the Company, because of clerical error or otherwise, has failed to take such action in a timely manner, or to maintain such interest with respect to a financed vehicle, neither the Company nor any purchaser of the related Contract from the Company would have a perfected security interest in the financed vehicle and its security interest may be subordinate to the interest of, among others, subsequent purchasers of the financed vehicle, holders of perfected security interests and a trustee in bankruptcy of the borrower. The security interest of the Company or the purchaser of a Contract may also be subordinate to the interests of third parties if the interest is not perfected due to administrative error by state recording officials. Moreover, fraud or forgery by the borrower could render a Contract unenforceable against third parties. In such events, the Company could be required by the purchaser to repurchase the Contract. In the event the Company is required to repurchase a Contract, it will generally have recourse against the Dealer from which it purchased the Contract. This recourse will be unsecured except for a lien on the vehicle covered by the Contract, and there can be no assurance that any Dealer will have the financial resources to satisfy its repurchase obligations to the Company. Subject to any recourse against Dealers, the Company will bear any loss on repossession and resale of vehicles financed under Contracts repurchased by it from investors. Under the laws of many states, liens for storage and repairs performed on a vehicle and for unpaid taxes take priority over a perfected security interest in the vehicle. Pursuant to its securitization purchase commitments, the Company generally warrants that, to the best of the Company's knowledge, no such liens or claims are pending or threatened with respect to a financed vehicle, which may be or become prior to or equal with the lien of the related Contracts. In the event that any of the Company's representations or warranties proves to be incorrect, the trust or the investor would be entitled to require the Company to repurchase the Contract relating to such financed vehicle. The Company, on behalf of purchasers of Contracts, may take action to enforce the security interest in financed vehicles with respect to any related Contracts in default by repossession and resale of the financed vehicles. The UCC and other state laws regulate repossession sales by requiring that the secured party provide the borrower with reasonable notice of the date, time and place of any public sale of the collateral, the date after which any private sale of the collateral may be held and of the borrower's right to redeem the financed vehicle prior to any such sale and by providing that any such sale be conducted in a commercially reasonable manner. Financed vehicles repossessed generally are resold by the Company through unaffiliated wholesale automobile networks or auctions, which are attended principally by used car dealers. 14 In the event of a repossession and resale of a financed vehicle, after payment of outstanding liens for storage, repairs and unpaid taxes, to the extent those liens take priority over the Company's security interest, and after payment of the reasonable costs of retaking, holding and selling the vehicle, the secured party would be entitled to be paid the full outstanding balance of the Contract out of the sale proceeds before payments are made to the holders of junior security interests in the financed vehicles, to unsecured creditors of the borrower, or, thereafter, to the borrower. Under the UCC and other laws applicable in most states (including California), a creditor is entitled to obtain a deficiency judgment from a borrower for any deficiency on repossession and resale of the motor vehicle securing the unpaid balance of such borrower's Contract. However, some states impose prohibitions or limitations on deficiency judgments. If a deficiency judgment were granted, the judgment would be a personal judgment against the borrower for the shortfall, and a defaulting borrower may often have very little capital or few sources of income available following repossession. Therefore, in many cases, it may not be useful to seek a deficiency judgment against a borrower or, if one is obtained, it may be settled at a significant discount. EMPLOYEES As of December 31, 1996, the Company had 325 full-time and 5 part-time employees, of whom 10 are management personnel, 102 are collections personnel, 119 are Contract origination personnel, 37 are marketing representatives, 53 are operations personnel, and 9 are accounting personnel. The Company believes that its relations with its employees are good. The Company is not a party to any collective bargaining agreement. 15 ITEM 2. PROPERTY The Company's headquarters are located in Irvine, California, where it leases approximately 51,400 square feet of general office space from an unaffiliated lessor. The annual rent is $524,596 through the year 2000, the final year of the lease. In addition, the Company pays the property taxes, maintenance and other common area expenses of the premises, currently at the approximate annual rate of $98,000. All such amounts are payable monthly. The Company has an option to extend the lease for an additional five years upon terms substantially similar to those of the existing lease. The Company in March 1997 established a branch facility in Chesapeake, Virginia. The Company leases approximately 18,600 square feet of general office space in Chesapeake at an initial annual rent of $260,666, increasing to $333,652 over a ten-year term. In addition, the Company is in discussions with its current landlord in California regarding a lease of a larger headquarters location or of additional space. Although the terms of any such lease have not been fixed as yet, the Company believes that adequate facilities are available. ITEM 3. LEGAL PROCEEDINGS As of the date of this report, the Company was not involved in any material litigation in which it is the defendant. The Company regularly initiates legal proceedings as a plaintiff in connection with its routine collection activities. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. EXECUTIVE OFFICERS OF THE REGISTRANT Information regarding the Company's executive officers follows: CHARLES E. BRADLEY, JR., 37, has been the President and a director of the Company since its formation in March 1991. In January 1992, Mr. Bradley was appointed Chief Executive Officer of the Company. From March 1991 until December 1995 he served as Vice President and a director of CPS Holdings, Inc. From April 1989 to November 1990, he served as Chief Operating Officer of Barnard and Company, a private investment firm. From September 1987 to March 1989, Mr. Bradley, Jr. was an associate of The Harding Group, a private investment banking firm. Mr. Bradley, Jr. is currently serving as a director of NAB Asset Corporation, Chatwins Group, Inc., Texon Energy Corporation, Thomas Nix Distributor, Inc., and CARS USA. Charles E. Bradley, Sr. is his father. JEFFREY P. FRITZ, 37, has been Senior Vice President - Chief Financial Officer and Secretary of the Company since March 1991. From December 1988 to March 1991, Mr. Fritz was Vice President and Chief Financial Officer of Far Western Bank. From 1985 to December 1988, Mr. Fritz was a management consultant for Price Waterhouse in St. Louis, Missouri. WILLIAM L. BRUMMUND, JR., 44, has been Senior Vice President - Systems Administration since March 1991. From 1986 to March 1991, Mr. Brummund was Vice President and Systems Administrator for Far Western Bank. NICHOLAS P. BROCKMAN, 52, has been Senior Vice President - Asset Recovery & Liquidation since January 1996. He was Senior Vice President of Contract Originations from April 1991 to January 1996. From 1986 to March 1991, Mr. Brockman served as a Vice President and Branch Manager of Far Western Bank. RICHARD P. TROTTER, 53, has been Senior Vice President-Contract Origination since January 1995. He was Senior Vice President of Administration from April 1995 to December 1995. From January 1994 to April 1995 he was Senior Vice President-Marketing of the Company. From December 1992 to January 1994, Mr. Trotter was Executive Vice President of Lange Financial Corporation, Newport Beach, California. From May 1992 to December 1992, he was Executive Director of Fabozzi, Prenovost & Normandin, Santa Ana, California. From December 1990 to May 1992 he was Executive Vice President/Chief Operating Officer of R. Thomas Ashley, Newport Beach, California. From April 1984 to December 1990, he was President/Chief Executive Officer of Far Western Bank, Tustin, California. 16 CURTIS K. POWELL, 40, has been Senior Vice President - Marketing of the Company since April 1995. He joined the Company in January 1993 as an independent marketing representative until being appointed Regional Vice President of Marketing for Southern California in November 1994. From June 1985 through January 1993, Mr. Powell was in the retail automobile sales and leasing business. MARK A. CREATURA, 37, 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. 17 PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock is traded on the Nasdaq National Market, under the symbol "CPSS." The following table sets forth the high and low bid prices quoted for the Common Stock for the periods indicated. Such quotations reflect inter- dealer prices, without retail mark-up, mark-down or commission, and may not necessarily represent actual transactions. High Low ---- ----- January 1-March 31, 1995................. $ 8.375 $ 6.625 April 1-June 30, 1995.................... 9.313 7.000 July 1-September 30, 1995................ 12.875 9.250 October 1-December 31, 1995............... 11.625 8.500 January 1-March 31, 1996................. 10.438 7.375 April 1-June 30, 1996.................... 10.250 8.250 July 1-September 30, 1996................ 12.750 7.500 October 1-December 31, 1996.............. 14.375 10.625 As of March 26, 1997, there were 84 holders of record of the Company's Common Stock. To date, the Company has not declared or paid any dividends on its Common Stock. The payment of future dividends, if any, on the Company's Common Stock is within the discretion of the Board of Directors and will depend upon the Company's earnings, its capital requirements and financial condition, and other relevant factors. The Company does not intend to declare any dividends on its Common Stock in the foreseeable future, but instead intends to retain any earnings for use in the Company's operations. See "Description of Common Stock." 18 ITEM 6. SELECTED FINANCIAL DATA The following table presents certain summary consolidated financial information for the year ended December 31, 1996, the nine-month transition period ended December 31, 1995, and the fiscal years ended March 31, 1995, 1994 and 1993, which has been derived from the Company's Consolidated Financial Statements audited by KPMG Peat Marwick LLP, independent certified public accountants, certain of which have been included elsewhere herein. The following information should be read in conjunction with the Consolidated Financial Statements and related Notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere herein. 19
NINE-MONTH TRANSITION YEAR ENDED PERIOD DECEMBER 31, ENDED FISCAL YEAR ENDED MARCH 31, ----------- ----------- --------------------------- 1996 12/31/95 1995 1994(1) 1993 ------- -------- ---- ------ ---- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENT OF OPERATIONS DATA: Net gain on sale of Contracts.$ 23,321 $ 11,549 $ 9,455 $ 5,425 $ 523 Servicing fees................ 16,169 6,475 7,201 3,556 1,538 Interest income............... 11,704 6,230 5,849 1,443 400 ------------ ----------- ------------- ------- -------- Total revenue................. 51,194 24,254 22,505 10,424 2,461 Operating expenses (1)........ 27,502 11,597 11,358 11,712 3,963 Income taxes.................. 9,595 5,082 4,481 490 0 ------------ ---------- ------------- -------- -------- ------------ ---------- ------------- -------- -------- Net income (loss)............ $ 14,097 7,575 $ 6,666 $(1,778) $(1,502) ------------ ---------- ------------- -------- -------- ------------ ---------- ------------- -------- -------- Primary net income (loss) per common share........... $ .95 $ .53 $ .60 $ (.21) $ (.24) ------------ ----------- ------------- -------- -------- ------------ ---------- ------------- -------- -------- Weighted average common and common equivalent shares.... 14,849,609 14,323,592 11,143,268 8,520,548 6,378,082 Fully diluted net income (loss) per common share..... $ .93 $ .52 $ .56 $ (.21) $ (.24) ------------ ----------- ------------- -------- -------- Fully diluted weighted average common and common equivalent shares........... 15,410,044 14,803,592 12,538,352 8,520,548 6,378,082 OTHER DATA: Principal amount of Contracts purchased during period (excluding Bulk Purchases).. $ 351,350 $ 150,943 $ 150,573 $ 53,103 $ 19,484 Principal amount of Contracts sold during period......... 340,990 155,719 140,617 58,095 14,103 Outstanding Servicing Portfolio at end of period(2)........ 505,934 288,927 192,800 63,208 20,436 Net charge-offs(3)........... 20,328 8,331 4,349 964 276 Servicing fees as a percentage of average principal balance of Contracts being serviced (4)......................... 4.1% 3.6% 5.3% 7.5% 4.7% Delinquencies as a percentage of gross Servicing Portfolio at end ofperiod(5)(6)....... 6.8% 5.1% 2.5% 1.3% 1.0% Delinquencies and amount in repossession as a percent of gross Servicing Portfolio(5) (6)(10)..................... 9.2% 7.9% 4.4% 2.0% 2.0% Net charge-offs as a percentage of average Servicing Portfolio (3)(6)...................... 5.1% 4.9% 4.0% 2.5% 2.2% Operating expenses (before interest and provisions for credit losses) as a percentage of average Servicing Portfolio (2)(4)...................... 4.8% 4.4% 5.4% 28.9% 31.5% Servicing subject to recourse provisions(6)............... 483,106 268,163 169,331 62,464 14,736 Discounted allowance for credit losses as a percentage of servicing subject to recourse provisions(7)............... 9.7% 8.7% 8.5% 8.1% 10.2% Ratio of earnings to fixed charges(8)(9)............... 5.0x 5.5x 4.2x - - Cash flows provided by (used in) operating activities.... $ (9,661) $ (18,533) $ (6,115) $(2,816) $ (6,718) - ----------------- (1) In October 1992, as a condition to the initial public offering of Common Stock of the Company, the then majority shareholder of the Company deposited 1,200,000 shares of Common Stock (the "Escrow Shares") in escrow. The escrow agreement provided that part or all of the Escrow Shares would be released if the Company's net income after taxes (as defined in the escrow agreement) or the average market price of the Common Stock for specified periods exceeded specified levels. The Company's net income (as defined in the escrow agreement) for fiscal 1994 (prior to the accounting effect of the release of the Escrow Shares) exceeded the specified level and, accordingly, all 1,200,000 Escrow Shares were released. The release of the Escrow Shares was deemed compensatory for accounting purposes, resulting in a one-time, non-cash charge of $6,450,000 against earnings for fiscal 1994. Without that charge, net income, primary net income per share and fully diluted net income per share for fiscal 1994 would have been $4,672,000, $.46 and $44, respectively. (2) Includes the outstanding principal amount of all Contracts purchased by the Company, including Contracts subsequently sold by the Company which it continues to service. Excludes loans serviced for third parties but not purchased by the Company. As of December 31, 1994, the Company had ceased servicing loans for third parties. (3) 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). For periods prior to the year ended December 31, 1996, post liquidation amounts received on previously charged off Contracts were applied to the period in which the related Contract was originally charged off. These prior period allocations were made only for the purpose of calculating this ratio. For financial statement purposes, post liquidation amounts are recognized in the period received. Effective January 1, 1996, post liquidation amounts received on previously charged off Contracts are applied in the period in which they are received, both for this ratio and financial statement purposes. This ratio excludes uninsured casualty losses, which, for the year ended December 31, 1996, the nine-month transition period ended December 31, 1995, and the years ended March 31, 1995, 1994 and 1993 were $1.7 million, $604,000, $205,000, $111,000 and $15,000, respectively. (4) The percentages set forth for the nine-month transition period ended December 31, 1995, are computed using annualized operating data, which do not necessarily represent comparable data for a full twelve-month period. (5) The Company considers a Contract delinquent when an obligor fails to make at least 90% of a contractually due payment by the following due date and the vehicle securing the Contract has not been repossessed. All amounts and percentages are based on the full amount remaining to be repaid on each Contract, including, for Rule of 78s Contracts, any unearned finance charges. (6) Includes the outstanding principal amount of all Contracts purchased and subsequently sold by the Company which it continues to service. Excludes loans serviced for third parties and Contracts purchased but not yet sold by the Company. (7) Discounted allowance for credit losses represents the discounted present value calculated at a risk free rate, of future estimated credit losses as determined by the Company in conjunction with the recognition of its gains on sale of Contracts. (8) The ratio of earnings to fixed charges has been computed by dividing income before taxes and fixed charges by fixed charges. Fixed charges include interest expense and the portion of rent expense that is representative of the interest factor (deemed by the Company to be one-third). (9) The Company incurred losses in fiscal 1994 and fiscal 1993. Earnings were inadequate to cover fixed charges by $1.3 million and $1.5 million for fiscal 1994 and fiscal 1993, respectively. Adjusted to eliminate the one-time non- 20
DECEMBER 31, DECEMBER 31, MARCH 31, 1996 1995 1995 1994 1993 ---- ---- ---- ---- ---- (IN THOUSANDS) BALANCE SHEET DATA: Cash................................. $ 154 $ 10,895 $ 5,767 $ 2,089 $ 245 Investments in credit enhancements... 43,597 30,478 23,201 10,497 0 Contracts held for sale.............. 21,657 19,549 21,896 647 5,054 Excess servicing receivables......... 23,654 11,108 5,154 2,294 503 Total assets......................... 101,946 77,878 57,975 16,538 6,922 Total liabilities.................... 44,989 36,397 30,981 6,337 2,833 Total shareholders' equity........... 56,957 41,481 26,994 10,201 4,089 cash charge of $6,450,000 referred to in footnote (1) above, the ratio of earnings to fixed charges for fiscal 1994 would have been 10.1x. (10) Amount in repossession represents financed vehicles which have been repossessed but not yet liquidated 21 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following analysis of the financial condition of the Company should be read in conjunction with "Selected Financial Data" and the Company's Consolidated and Condensed Consolidated Financial Statements and the Notes thereto and the other financial data included elsewhere in this report. OVERVIEW The Company specializes in the business of purchasing, selling and servicing retail automobile installment sales Contracts originated by Dealers in the sale of new and used automobiles, light trucks and passenger vans and has done so since its inception on March 8, 1991. Through its purchases, the Company provides indirect financing to borrowers with limited credit histories, low incomes or past credit problems. The Company generates earnings primarily from the gains recognized on the sale or securitization of its Contracts, servicing fees earned on Contracts sold, and interest earned on Contracts held for sale. Earnings from gains on sale, servicing fees and interest for the year ended December 31, 1996, were $23.3 million, $16.2 million, and $11.7 million, respectively. Such earnings for the nine-month transition period ended December 31, 1995, were $11.5 million, $6.5 million, and $6.2 million, respectively. For the fiscal year ended March 31, 1995, such earnings were $9.5 million, $7.2 million and $5.8 million, respectively. The Company's income is affected by losses incurred on Contracts, whether such Contracts are held for sale or have been sold in securitizations. The Company's cash requirements have been and will continue to be significant. Net cash used in operating activities for the year ended December 31, 1996, the nine-month transition period ended December 31, 1995 and the year ended March 31, 1995 were $9.7 million, $18.5 million and $6.1 million, respectively. In each securitization, the Company sells Contracts to a trust which, in turn, sells asset-backed securities to Investors. The terms of the securitization transactions generally provide for the Company to earn a base servicing fee computed as a percentage of the outstanding balance of the Contracts as compensation for its duties as servicer. In addition, the Company is entitled to certain excess servicing fees which represent collections on the Contracts in excess of the amounts necessary to pay principal and interest to Investors and the expenses of the trust, including, primarily, base servicing fees. Excess servicing fees are first deposited into a Spread Account in order to meet the predetermined credit enhancement levels of the securitization trusts. To the extent cash in excess of the predetermined level is generated, such cash is either transferred to cover deficiencies, if any, in Spread Accounts for other pools, or is released to the Company. For the year ended December 31, 1996, initial deposits to Spread Accounts, excess servicing deposited to Spread Accounts and cash released from Spread Accounts was $12.3 million, $18.8 million, and $17.9 million, respectively. For the nine-month transition period ended December 31, 1995, initial deposits to Spread Accounts, excess servicing deposited to Spread Accounts and cash released from Spread Accounts was $4.9 million, $7.6 million, and $7.7 million, respectively. For the year ended March 31, 1995, initial deposits to Spread Accounts, excess servicing deposited to Spread Accounts and cash released from Spread Accounts was $13.2 million, $5.4 million, and $5.9 million, respectively. The Company also recognizes gains on its sales of Contracts. Gains are determined based upon the difference between the sales proceeds for the portion of Contracts sold and the Company's recorded investment in the Contracts sold. The Company allocates the recorded investment in the Contracts between the portion of the Contracts sold and the portion retained based on the relative fair values of those portions on the date of the sale. In addition, the Company recognizes gains attributable to its estimates of excess servicing receivables for each pool of Contracts it securitizes. Excess servicing receivables are determined by computing the difference between the weighted average yield of the Contracts sold and the yield to the purchaser, adjusted for the normal servicing fee based on the agreements between the Company and the purchaser. The resulting differential is recorded as a gain at the time of sale equal to the present value of the estimated cash flows, net of any portion of the excess that may be due to the purchaser and adjusted for anticipated prepayments, repossessions, liquidations and other losses. To the extent that the actual future performance of the Contracts results in less excess cash flows than the Company estimated, the Company's excess servicing receivables will be adjusted at least quarterly, with corresponding charges recorded against income in the period in which the 22 adjustment is made. To the extent that the actual cash flows exceed the Company's discounted estimates, the Company will record additional servicing fees in the periods in which the excess cash is received. RESULTS OF OPERATIONS THE YEAR ENDED DECEMBER 31, 1996 COMPARED TO THE NINE-MONTH TRANSITION PERIOD ENDED DECEMBER 31, 1995 The Company changed its fiscal year-end from March 31 to December 31, effective with the nine-month transition period ended December 31, 1995. Accordingly, readers should take into account that the following discussion compares figures for a full twelve month year to a nine-month period. The discussion below does not attempt to explain, for each item discussed, the extent to which the differing length of these periods has affected the figures. REVENUE. During the year ended December 31, 1996, revenue increased $26.9 million, or 111.1%, compared to the nine-month transition period ended December 31, 1995. Net gain on sale of Contracts includes (i) the excess of the amount realized on the sale of Contracts over the Company's net cost, (ii) the net present value of estimated excess servicing fees on sold contracts, and (iii) the recognition of deferred acquisition fees paid by Dealers net of related acquisition costs. Net gain on sale of Contracts increased by $11.8 million, or 101.9%, and represented 45.6% of total revenue for the year ended December 31, 1996. The increase in gain on sale is largely due to the volume of Contracts which were sold in the period. During the year ended December 31, 1996, the Company sold $341.0 million in Contracts, compared to $155.7 million in the nine-month transition period ended December 31, 1995. Servicing fees increased by $9.7 million, or 149.7%, and represented 31.6% of total revenue. The increase in servicing fees is due to the Company's continued expansion of its Contract purchase, sale and servicing activities. As of December 31, 1996, the Company was earning servicing fees on 45,363 Contracts approximating $483.1 million compared to 25,398 Contracts approximating $268.2 million as of December 31, 1995. In addition to the $483.1 million in sold Contracts on which servicing fees were earned, the Company was holding for sale and servicing an additional $22.8 million in Contracts for an aggregate servicing portfolio of $505.9 million. Amortization of excess servicing increased by $4.1 million and represented 27.5% of gross loan servicing fees for the year ended December 31, 1996 versus 23.8% for the nine-month transition period ended December 31, 1995. The increase is primarily due to the increase in the average age of the Contracts making up the Company's Servicing Portfolio and consequently the increase in charge-offs and corresponding reduction of servicing fees. The Company expects these increases in the ratio of amortization of excess servicing to gross loan servicing fees to continue until the size and average age of the Servicing Portfolio stabilizes. Interest income on Contracts held for sale increased by $5.5 million, or 87.9%, representing 22.9% of total revenues for the year ended December 31, 1996. The increase is due to the increase in the volume of contracts purchased and held for sale. During the year ended December 31, 1996, the Company purchased $351.4 million in Contracts from Dealers, compared to $160.1 million in the nine-month transition period ended December 31, 1995. EXPENSES. During the year ended December 31, 1996, operating expenses increased $15.9 million, or 137.1%, compared to the nine-month transition period ended December 31, 1995. Employee costs increased by $5.6 million, or 169.6%, and represented 32.4% of total operating expenses. The increase is due to the addition of staff necessary to accommodate the Company's growth and certain increases in salaries of existing staff. General and administrative expenses increased by $4.4 million, or 158.9% and represented 26.4% of total operating expenses. Increases in general and administrative expenses included increases in telecommunications, stationery, credit reports and other related items as a result of increases in the volume of purchasing and servicing of Contracts. Additionally, general and administrative expenses increased by $595,000 as a result of including the company's share of losses incurred by NAB Asset Corporation, in which the Company made a 38% equity investment on June 6, 1996. Marketing expenses increased by $448,000, or 36.4%, and represented 6.1% of total expenses. The increase is primarily due to the increase in the volume of contracts purchased as marketing representatives are compensated directly in proportion to the number of Contracts the Company purchases from Dealers serviced 23 by the marketing representative. Additional increases in marketing expense relate to other marketing expenses such as travel, promotion and convention expenses. Interest expense increased $3.1 million, or 112.2%, and represented 21.0% of total operating expenses. The increase is primarily due to the interest paid on the $20.0 million in subordinated debt securities issued on December 20, 1995. Interest expense was also impacted by the volume of Contracts held for sale as well as by the Company's cost of borrowed funds. During the year ended December 31, 1996, the provision for losses on Contracts held for sale increased by $1.9 million, or 232.6%, and represented 10.0% of total operating expenses. The increase in the provision reflects somewhat higher charge-off rates and a larger volume of Contracts held prior to sale when compared to the nine-month transition period ended December 31, 1995. The results for the year ended December 31, 1996 include net operating losses of $491,000 from the Company's subsidiary Samco Acceptance Corp. ("Samco"). Samco was formed in March 1996 and provides the Company's products and services to Dealers and independent finance companies primarily in rural areas of the southeastern portion of the United States. The results for the year ended December 31, 1996 also include net operating losses of $324,000 from the Company's subsidiary LINC Acceptance LLC ("LINC"). LINC was formed in May 1996 and provides the Company's products and services to credit unions and other depository institutions. NINE-MONTH TRANSITION PERIOD ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED MARCH 31, 1995 The Company changed its fiscal year-end from March 31 to December 31, effective with the nine-month transition period ended December 31, 1995. Accordingly, readers should take into account that the following discussion compares figures for a nine-month period to a full twelve-month year. The discussion below does not attempt to explain, for each item discussed, the extent to which the differing length of these periods has affected the figures. REVENUES. During the nine months ended December 31, 1995, revenues increased $1.7 million, or 7.8%, compared to the year ended March 31, 1995. Net gain on sale of Contracts, which includes (i) the excess of the amount realized on the sale of Contracts over the Company's net cost, (ii) the net present value of estimated excess servicing fees on sold Contracts, and (iii) the recognition of acquisition fees paid by Dealers and deferred by the Company, increased by $2.1 million, or 22.2%, and represented 47.6% of total revenues for the nine months ended December 31, 1995. The increase in gain on sale is largely due to the volume of Contracts which were sold in the period. During the nine months ended December 31, 1995, the Company sold $155.7 million in Contracts, compared to $140.6 million in the year ended March 31, 1995. Servicing fees decreased by $726,000, or 10.1%, and represented 26.7% of total revenues. Servicing fees consist primarily of base and excess monthly servicing fees earned on Contracts sold and serviced by the Company, as well as servicing fees for certain third-party originated portfolios for which it has been engaged as servicer. Servicing fees have been impacted by the Company's continued expansion of its Contract purchase, sale and servicing activities. As of December 31, 1995, the Company was earning servicing fees on 25,398 Contracts and loans approximating $268.2 million compared to 16,077 Contracts and loans approximating $169.3 million as of March 31, 1995. In addition to the $268.2 million in sold Contracts and loans on which servicing fees were earned, the Company was holding for sale and servicing an additional $20.8 million in Contracts for an aggregate total servicing portfolio of $288.9 million at December 31, 1995. Amortization of excess servicing increased by $819,000 and represented 23.8% of gross loan servicing fees for the nine-month transition period ended December 31, 1995 versus 14.3% for the year ended March 31, 1995. The increase is primarily due to the increase in the average age of the Contracts making up the Company's securitized portfolio and consequently the increase in charge-offs and corresponding reduction of servicing fees. Interest income on Contracts warehoused for sale increased by $381,000, or 6.5%, representing 25.7% of total revenues for the nine months ended December 31, 1995. Interest income is closely related to the volume of Contracts purchased and the length of time they are held by the Company prior to their sale. During the nine months ended December 31, 1995, the Company purchased $151.0 million in Contracts from Dealers, 24 compared to $150.6 million in the year ended March 31, 1995. In addition to Contracts purchased from Dealers, the Company made two bulk purchases of portfolios of Contracts having an aggregate principal balance of $9.2 million during the nine months ended December 31, 1995. EXPENSES. During the nine months ended December 31, 1995, operating expenses increased $239,131, or 2.1%, compared to the year ended March 31, 1995. Employee costs increased by $318,886 or 10.7%, and represented 28.5% of total operating expenses. The increase is due to the addition of staff necessary to accommodate the Company's growth in its business as well as certain increases in salaries of existing staff. General and administrative expenses increased by $894,444, or 46.9% and represented 24.1% of total operating expenses. Increases in general and administrative expenses included increases in telephone, stationery, credit bureaus and other related items as a result of increases in the volume of purchases and servicing of Contracts. Marketing expenses decreased by $533,011 or 30.2%, and represented 10.6% of total expenses. The Company uses a combination of independent contractor and employee marketing representatives all of whom are compensated directly in proportion to the number of Contracts the Company purchases from Dealers serviced by the marketing representative. Marketing expense is further impacted by the Company's estimates for direct expenses made in accordance with deferring contract origination costs. Interest expense decreased by $683,195, or 20.0%, and represented 23.5% of total operating expenses. During the nine-month period ended December 31, 1995, the Company's interest expense was affected by improved pricing on the Line, a more favorable interest rate environment, and less reliance on other short term financing, in part, as a result of the proceeds from the Company's issuance of two million shares of common stock in March 1995. During the nine months ended December 31, 1995, the provision for losses on Contracts held for sale increased by $295,511 or 55.4% and represented 7.1% of total operating expenses. The increase in the provision reflects a larger volume of Contracts held for a longer period of time prior to sale when compared to the year ended March 31, 1995, and certain losses associated with Bulk Purchases in the nine months ended December 31, 1995. CHANGE OF FISCAL YEAR; 1994 RELEASE OF ESCROW SHARES In 1995, the Company changed its fiscal year-end from March 31 to December 31. For that reason, much of the information contained herein compares a fiscal year ended March 31, 1995 with a nine-month transition period ended December 31, 1995, and then with a full fiscal year ended December 31, 1996. The table below presents certain information on a calendar-year basis, for the calendar years 1994, 1995 and 1996. In that table, two columns present information regarding the year ended December 31, 1994, one column including and one column excluding the effect of a charge for release of Escrow Shares (as described below). Upon consummation of the Company's initial public offering which became effective on October 22, 1992, the Company's then controlling shareholder, Holdings, deposited 1,200,000 shares of Common Stock (the "Escrow Shares") in escrow, subject to release upon attainment of certain net income goals or stock price levels. As of March 31, 1994, the Company exceeded the requisite levels. The release of the Escrow Shares was deemed compensatory and resulted in a one-time, non-cash charge for fiscal 1994 of $6.5 million which was equal to the market value of the Escrow Shares at the time of their release. This one-time, non-cash charge was offset by an identical increase in common stock and was not tax deductible. Consequently, there was no impact on total shareholders' equity on the Company's financial statements as a result of the release of the Escrow Shares and the corresponding charge. The following table presents three-year comparative information. 25 12 Months Ended December 31, ------------------------------------------- 1996 1995 1994 (1) 1994 (2) (In thousands, except per share data) REVENUES: Net gain on sale of contracts $ 23,321 $ 13,719 $ 9,980 $ 9,980 Servicing fees 16,169 9,019 6,175 6,175 Interest 11,704 7,869 4,403 4,403 ------------------------------------------- 51,194 30,607 20,558 20,558 EXPENSES: Charge from release of escrow shares -- -- 6,450 -- Selling, general and administrative 9,694 5,276 3,651 3,651 Employee costs 8,921 3,888 3,253 3,253 Interest 5,781 3,842 2,520 2,520 Provision for losses 2,756 1,008 384 384 Depreciation 275 209 169 169 Related party consulting fees 75 350 350 350 ------------------------------------------- 27,502 14,573 16,777 10,327 ------------------------------------------- Income before taxes 23,692 16,034 3,781 10,231 Income taxes 9,595 6,440 3,613 3,613 ------------------------------------------- Net income $ 14,097 $ 9,594 $ 168 $ 6,618 ------------------------------------------- Primary income per share $0.95 $0.71 $0.02 $0.61 Weighted average primary shares 14,850 13,431 10,932 10,932 Fully diluted income per share $0.93 $0.70 $0.02 $0.57 Fully diluted weighted average shares 15,410 13,911 12,182 12,182 - ---------------- (1) Results include the non-cash one time charge from the release of Escrow Shares. (2) Results exclude the non-cash one time charge from the release of Escrow Shares. LIQUIDITY AND CAPITAL RESOURCES The Company's primary sources of cash from operating activities include base and excess servicing fees it earns on portfolios of Contracts it has previously sold, proceeds on the sales of Contracts in excess of its recorded investment of the Contracts, amortization and release of investments in credit enhancement balances pledged in conjunction with the securitization of its Contracts, borrower payments on Contracts held for sale, and interest earned on Contracts held for sale. The Company's primary uses of cash include its normal operating expenses, the establishment and build-up of Spread Accounts used for credit enhancement to their maintenance levels, and income taxes. Net cash used in operating activities was $9.7 million during the year ended December 31, 1996 compared to net cash used of $18.5 million during the nine month transition period ended December 31, 1995. Cash used for purchasing Contracts was $351.4 million, an increase of $191.2 million, or 119.4%, over cash used for purchasing Contracts in the nine month transition period ended December 31, 1995. Cash provided from the liquidation of Contracts was $346.5 million, an increase of $189.6 million, or 120.8%, over cash provided from liquidation of Contracts in the nine month transition period ended December 31, 1995. During the year ended December 31, 1996, cash used for initial deposits to Spread Accounts was $12.3 million, an increase of $7.3 million, or 149.0%, from the amount of cash used for initial deposits to Spread Accounts in the nine month transition period ended December 31, 1995. Cash from excess servicing deposited to Spread Accounts for the year ended December 31, 1996, was $18.8 million, an increase of $11.2 million, or 148.8%, over cash from excess servicing deposited to Spread Accounts in the nine month transition period 26 ended December 31, 1995. Cash released from Spread Accounts for the year ended December 31, 1996, was $17.9 million, an increase of $10.2 million, or 133.2%, over cash released from Spread Accounts in the nine month transition period ended December 31, 1995. Changes in deposits to and releases from Spread Accounts are impacted by the relative size, seasoning and performance of the various pools of sold Contracts that make up the Company's Servicing Portfolio. Delinquencies as a percent of the gross Servicing Portfolio increased from 5.1% at December 31, 1995 to 6.8% at December 31, 1996. Increases in delinquency can be attributed to the continued aging of the Company's Servicing Portfolio, and to the fact that during 1996 the Company often allowed a borrower more time to resolve a delinquency prior to ordering repossession than it had allowed in prior periods. To accommodate the resulting higher levels of delinquency, the Company restructured certain aspects of its agreements with FSA in November 1996. Under the restructured agreements, the levels of delinquency that trigger increased Spread Account requirements have been raised, so that the higher delinquency levels currently experienced by the Company would not result in increased Spread Account requirements. The Company cannot predict with assurance whether delinquency and loss rates will continue to increase, but a further increase in average delinquency and in losses should be expected if the average age of the Servicing Portfolio continues to rise. Whether the average age of the Servicing Portfolio increases will depend in part on the rate of the Company's continued growth (rapid growth in originations decreases the average age of the Servicing Portfolio), as to which there can be no assurance. During the year ended December 31, 1996, the Company purchased 38% of the outstanding common stock of NAB Asset Corporation for approximately $4.3 million. See "Business--Expansion and Diversification". The Company's cash requirements have been and will continue to be significant. The agreements under which the Company has securitized and sold its Contracts required the Company to make a significant initial cash deposit, for purposes of credit enhancement, to a Spread Account which is pledged to support the related asset-backed securities, and is invested in high quality liquid securities. Excess cash flows from the securitized Contracts are deposited into the Spread Accounts until such time as the Spread Account balance reaches a specified percent of the outstanding balance of the related asset-backed securities. Since its June 1995 securitization, and, it is expected, on an ongoing basis, the Company altered the credit enhancement mechanism used in its securitizations to create a subordinated class of asset-backed securities (a "B Piece") in order to reduce the size of the required initial deposit to the Spread Accounts. This revised structure may, if the Company is able to continue to sell the B Piece, reduce the amount of cash that the Company must invest or set aside in Spread Accounts in future securitizations. The Company continues to hold the B Piece associated with its June 1995 transaction, but has sold and believes it will be able to continue to sell the B Pieces created in subsequent securitizations. The aggregate balances of the Spread Accounts associated with each securitization of Contracts, together with the one B Piece held by the Company, are reflected as "Investments in credit enhancements" on the Company's consolidated balance sheet. The table below documents the Company's history of Contract securitizations, comprising sales to 17 securitization trusts. STRUCTURED CONTRACT SECURITIZATIONS 27
PERIOD SECURITIZED RATING FUNDED DOLLAR AMOUNT RATINGS(1) AGENCY POOL NAME - ---------- ------------- ---------- -------------- --------------------------- (IN THOUSANDS) April 1993 $ 4,990 A Duff & Phelps Alton Grantor Trust 1993-1 May 1993 3,933 A Duff & Phelps Alton Grantor Trust 1993-1 June 1993 3,467 A Duff & Phelps Alton Grantor Trust 1993-1 July 1993 5,575 A Duff & Phelps Alton Grantor Trust 1993-2 August 1993 3,336 A Duff & Phelps Alton Grantor Trust 1993-2 September 1993 3,578 A Duff & Phelps Alton Grantor Trust 1993-2 October 1993 1,921 A Duff & Phelps Alton Grantor Trust 1993-2 - ------------------ (1) Commencing with the securitization completed on June 28, 1994, the principal and interest due on the asset-backed securities issued by the various grantor trusts are guaranteed by Financial Security Assurance Inc. ("FSA"), enabling the issuer to obtain Aaa/AAA ratings for the asset-backed securities issued in such transactions. See "Business -- Purchase and Sale of Contracts -- Securitization and Sale of Contracts to Institutional Investors." (2) Commencing with the securitization completed on June 27, 1996, asset-backed securities with Aaa/AAA ratings have been sold through public offerings pursuant to registration statements filed with the Securities and Exchange Commission. Cash flows are impacted by the use of the "Warehouse Line of Credit" (as defined below) which is in turn impacted by the amount of Contracts the Company holds for sale. At December 31, 1996, the Warehouse Line of Credit had an outstanding balance of $13.3 million compared to $7.5 million at December 31, 1995. Borrowings under the Warehouse Line of Credit rise during each fiscal quarter and then are substantially repaid when the Company completes a Contract securitization, which has occurred near the end of each quarter during the past two fiscal years. The maximum amount outstanding under the Warehouse Line of Credit during 1996 was $92.1 million and the average was $41.2 million. In June 1995 the Company entered into two new agreements which restructured the Warehouse Line of Credit and increased the maximum available amount to $100.0 million. The primary agreement provides for loans by Redwood Receivables Corporation ("Redwood") to the Company, to be funded by commercial paper issued by Redwood and secured by Contracts pledged periodically by the Company. The Redwood facility provides for a maximum of $100.0 million of advances to the Company, with interest at a variable rate tied to prevailing commercial paper rates. 28
PERIOD SECURITIZED RATING FUNDED DOLLAR AMOUNT RATINGS(1) AGENCY POOL NAME - ---------- ------------- ---------- -------------- --------------------------- (IN THOUSANDS) November 1993 1,816 A Duff & Phelps Alton Grantor Trust 1993-3 December 1993 6,694 A Duff & Phelps Alton Grantor Trust 1993-3 January 1994 1,998 A Duff & Phelps Alton Grantor Trust 1993-3 March 1994 20,787 A Duff & Phelps Alton Grantor Trust 1993-4 June 1994 24,592 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1994-1 September 1994 28,916 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1994-2 October 1994 13,136 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1994-3 December 1994 28,893 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1994-4 February 1995 20,084 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1995-1 June 1995 49,290 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1995-2 September 1995 45,009 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1995-3 September 1995 2,369 BB S&P CPS Auto Grantor Trust 1995-3 December 1995 53,634 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1995-4 December 1995 2,823 BB S&P CPS Auto Grantor Trust 1995-4 March 1996 63,747 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1996-1 March 1996 3,355 BB S&P CPS Auto Grantor Trust 1996-1 June 1996 (2) 84,456 Aaa/AAA Moody's/S&P Fasco Auto Grantor Trust 1996-1 June 1996 4,445 BB S&P Fasco Auto Grantor Trust 1996-1 September 1996 87,523 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1996-2 September 1996 4,606 BB S&P CPS Auto Grantor Trust 1996-2 December 1996 88,215 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1996-3 December 1996 4,643 BB S&P CPS Auto Grantor Trust 1996-3 March 1997 97,211 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1997-1 March 1997 5,116 BB S&P CPS Auto Grantor Trust 1997-1 --------- $ 770,158 --------- --------- When the Company wishes to securitize these Contracts, a substantial part of the proceeds received from Investors is paid to Redwood, which simultaneously releases the pledged Contracts for transfer to a pass-through securitization trust. The second agreement is a standby line of credit with GECC, also with a $100.0 million maximum, which the Company may use only if and to the extent that Redwood does not provide funding as described above. The GECC line is secured by Contracts and substantially all the other assets of the Company. Both agreements extend through November 30, 1998. The two agreements are viewed as a single short-term warehouse line of credit, with advances varying according to the amount of pledged Contracts. All references in this report to the Warehouse Line of Credit refer, since June 1995, to the Redwood facility and, unless the context indicates otherwise, the standby line of credit with GECC. Prior to October 29, 1992, the Company was dependent on capital contributions and loans by Holdings (which was then the sole shareholder of the Company) to satisfy its cash requirements. On October 29, 1992, the Company raised approximately $4.9 million (net of offering expenses) in an initial public offering. On March 12, 1993, the Company borrowed $2.0 million from Sun Life through the issuance of a convertible note in conjunction with an agreement by that investor to purchase up to $50.0 million of the Company's Contracts. On July 5, 1995, Sun Life converted this note into 533,334 shares of the Company's Common Stock. On November 16, 1993, the Company borrowed an additional $3.0 million from Sun Life through the issuance of a convertible note in conjunction with that investor's commitment to purchase an additional $50.0 million in Contracts. On January 17, 1997, Sun Life converted this note into 480,000 shares of Common Stock. On November 23, 1993, the Company issued and sold 333,334 shares of Common Stock in a private transaction at a price of $4.50 per share ($1.5 million in the aggregate). In May and October, 1994, the Company borrowed an aggregate of $5.0 million pursuant to three short term notes, all of which were repaid in March 1995 with proceeds from the March 7, 1995 public offering of 2.0 million shares of the Company's stock at a price of $7.38 per share. In December 1995, the Company issued $20 million of debt in the form of Rising Interest Subordinated Redeemable Securities ("RISRS"). In the month of April 1997 the Company plans to issue additional debt securities (partially convertible into common stock) in a registered public offering. The Company anticipates that the proceeds from the intended April 1997 offering of debt securities, the funds available under the Warehouse Line of Credit, proceeds from the sale of Contracts, and cash from operations will be sufficient to satisfy the Company's estimated cash requirements for at least the next 12 months, assuming that the Company continues to have a means by which to sell its warehoused Contracts. If for any reason the Company is unable to sell its Contracts, or if the Company's available cash otherwise proves to be insufficient to fund operations (because of future changes in the industry, general economic conditions, unanticipated increases in expenses, or other factors), the Company may be required to seek additional financing. On November 1, 1996, the Company began to rent an additional 7,000 square feet of contiguous office space in accordance with the Company's lease agreement. In addition, the Company recently acquired an additional, and significantly upgraded, IBM AS/400 computer. This hardware serves as the primary platform on which the Company processes its Contracts. The Company anticipates that it will incur certain limited capital expenditures during the next twelve months as its business continues to grow. The Company expects to incur occupancy expenses of approximately $50,000 per month in connection with its Chesapeake, Virginia satellite facility, which were not incurred in fiscal 1996. Personnel and other expenses may also increase, depending on the extent of any continuing growth in the Company's business (as to which there can be no assurance) and the availability of personnel. FORWARD-LOOKING STATEMENTS The descriptions of the Company's business and activities set forth in this report and in other past and future reports and announcements by the Company may contain forward-looking statements and assumptions regarding the future activities and results of operations of the Company. Actual results may be adversely affected by various factors including the following: increases in unemployment or other changes in domestic economic conditions which adversely affect the sales of new and used automobiles and may result in increased delinquencies, foreclosures and losses on Contracts; adverse economic conditions in geographic areas in which the Company's business is concentrated; changes in interest rates, adverse changes in the market for securitized receivables pools, or a substantial lengthening of the Company's warehousing period, each of which could restrict the Company's ability to obtain cash for new Contract originations and purchases; increases in the amounts required to be set aside in Spread Accounts or to be expended for other forms of credit enhancement to support future securitizations; the reduction or unavailability or warehouse lines of credit which the Company uses to accumulate Contracts for securitization transactions; increased competition from other automobile finance sources; reduction in the number and amount of acceptable Contracts submitted to the Company by its automobile dealer network; changes in government regulations affecting consumer credit; and other economic, financial and regulatory factors beyond the Company's control. A further discussion of factors that may cause actual results to differ, or may otherwise have an adverse effect on the Company's financial condition or results of operations, is contained in the exhibit to this report titled "risk factors," incorporated herein by this reference. NEW ACCOUNTING PRONOUNCEMENTS In June 1996, the Financial Accounting Standards board issued SFAS No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. SFAS No. 125 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996 and is to be applied prospectively. This Statement provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities based on consistent application of a financial-components approach that focuses on control. It distinguishes transfers of financial assets that are sales from transfers that are secured borrowings. Management of the Company does not expect that adoption of SFAS No. 125 will have a material impact on the Company's financial position, results of operations or liquidity. 29 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA This report includes Consolidated Financial Statements, Notes thereto and an Independent Auditors' Report, at the pages indicated below. Certain subsequent events and quarterly financial information (not audited) are included in the Notes to Consolidated Financial Statements, as Notes 14 and 15. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. 30
INDEX TO FINANCIAL STATEMENTS PAGE REFERENCE Independent Auditors' Report............................................................... F-1 Consolidated Balance Sheets as of December 31, 1996 and 1995............................. F-2 Consolidated Statements of Operations for the year ended December 31, 1996, the nine-month period ended December 31, 1995, and the year ended March 31, 1995........ F-3 Consolidated Statements of Shareholders' Equity for the year ended December 31, 1996, the nine-month period ended December 31, 1995, and the year ended March 31, 1995.. F-4 Consolidated Statements of Cash Flows for the year ended December 31, 1996, the nine-month period ended December 31, 1995, and the year ended March 31, 1995........ F-5 Notes to Consolidated Financial Statements for the year ended December 31, 1996, the nine-month period ended December 31, 1995 and the year ended March 31, 1995......... F-6 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS Information regarding directors of the registrant is incorporated by reference to the registrant's definitive proxy statement for its annual meeting of shareholders to be held in 1997 (the "1997 Proxy Statement"). The 1997 Proxy Statement will be filed not later than April 30, 1997. Information regarding executive officers of the registrant appears in Part I of this report, and is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION Incorporated by reference to the 1997 Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Incorporated by reference to the 1997 Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Incorporated by reference to the 1997 Proxy Statement. PART IV ITEM 14. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits - ------------ The following exhibits are filed as part of this report: Exhibit No. Exhibit 3.1....Restated Articles of Incorporation of the Company, as amended on December 13, 1993, and March 7, 1996. (A) Exhibit 3.2....Amended and Restated By-Laws of the Company, adopted November 30, 1993. (B) Exhibit 4.1....The Indenture dated December 15, 1995, between Consumer Portfolio Services, Inc., and Harris Trust and Savings Bank. (C) Exhibit 4.2....First Supplemental Indenture dated December 15, 1995, between Consumer Portfolio Services, Inc., and Harris Trust and Savings Bank. (C) Exhibit 10.1...1991 Stock Option Plan as amended on April 27, 1994, and forms of Stock Option Agreement. (B) Exhibit 10.2...Lease Agreement dated February 14, 1991 between Holdings and Irvine Technology Partners ("ITP"), First Amendment to Lease dated as of June 26, 1992 by and among ITP, Holdings and the Company and Assignment and Assumption of Lease dated April 1, 1992 by and between Holdings and the Company. (D) Exhibit 10.3...Amendment #2, dated January 17, 1995, between ITP and Consumer Portfolio Services, Inc., to Lease Agreement dated February 14, 1991, between Holdings and Irvine Technology Partners ("ITP"), First Amendment to Lease dated as of June 26, 1992, by and among ITP, Holdings and the Company and Assignment and Assumption of Lease dated April 1, 1992, by and between Holdings and the Company. (E) Exhibit 10.4...Form of Automobile Dealer Agreement between the Company and its Dealers and the related Assignment. (D) Exhibit 10.5...Consulting Agreement dated February 14, 1996, by and between the Company and Stanwich Partners, Inc. (A) Exhibit 10.6...The Receivables Funding and Servicing Agreement, dated June 1, 1995, between Consumer Portfolio Services, Inc., CPS Funding Corp., Redwood Receivables Corporation and General Electric Capital Corporation. (A) 31 Exhibit 10.7...Amended and Restated Motor Vehicle Installment Contract Loan and Security Agreement, dated June 1, 1995, between Consumer Portfolio Services, Inc., and General Electric Capital Corporation. (A) Exhibit 10.8...Agreement and Plan of Merger, dated August 30, 1995, between Consumer Portfolio Services, Inc., and CPS Holdings, Inc. (F) Exhibit 10.9...Promissory Note, dated September 27, 1995, made by the Company in favor of Charles E. Bradley, Sr., in the aggregate principal amount of $2,000,000.(A) Exhibit 10.10..Promissory Note, dated July 6, 1995, made by the Company in favor of SunAmerica, Inc., in the aggregate principal amount of $2,000,000. (A) Exhibit 10.11..Lease Agreement dated December 9, 1996 between the Company and The Prudential Insurance Company of America, relating to the Company's branch facility in Chesapeake, Virginia. (G) Exhibit 11.0...Statement re Computation of Per Share Earnings. Exhibit 12.....Statement re Computation of Ratios. (H) Exhibit 21.1...Subsidiaries of the Company. (G) Exhibit 23.1...Consent of independent auditors. Exhibit 24.1...Powers of Attorney. (G) Exhibit 27.....Financial Data Schedule. (G) Exhibit 99.....Risk Factors - ----------------- A. Previously filed as an exhibit to the Company's Form 10-KSB for the transition period ended December 31, 1995, and incorporated herein by reference. B. Previously filed as an exhibit to the Company's Form 10-KSB for the fiscal year ended March 31, 1994, and incorporated herein by reference. C. Previously filed as an exhibit to the Company's Form 8-K, filed on December 26, 1995, and incorporated herein by reference. D. Previously filed as an exhibit to the Company's Registration Statement on Form S-1, No. 33-49770, as amended, and incorporated herein by reference. E. Previously filed as an exhibit to the Company's Form 10-KSB for the fiscal year ended March 31, 1995, and incorporated herein by reference. F. Previously filed as an exhibit to the Company's Proxy Statement for the September 26, 1995, Annual Meeting, and incorporated herein by reference. G. Previously filed as an exhibit to this report, on March 31, 1997. H. Previously filed as an exhibit to the Company's Registration Statement on Form S-3, No. 333-21289, as amended on March 4, 1997, and incorporated herein by reference. (b) REPORTS ON FORM 8-K During the last quarter of the fiscal ended December 1996, two reports on Form 8-K were filed by the Company. Each of such two reports included responses to Items 5 and 7 of Form 8-K relating to "Other Information," and "Financial Statement and Exhibits," respectively. No financial statements were filed with either of such reports on Form 8-K. Each of such two reports related to the Company's December 1996 sale of Contracts in a securitization transaction. The first of the two reports, dated December 19, 1996 and filed December 23, 1996, filed the forms of Underwriting Agreement, Pooling and Servicing Agreement and Receivables Purchase Agreement relating to that transaction, and the second, dated December 11, 1996 and filed December 19, 1996, filed computational materials relating to the securitization transaction. 32 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this amendment to Form 10-K report to be signed on its behalf by the undersigned, thereunto duly authorized. CONSUMER PORTFOLIO SERVICES, INC. (Registrant) /s/ Jeffrey P. Fritz Date: April 14, 1997 - --------------------------- Jeffrey P. Fritz Senior Vice President and Chief Financial Officer S-1 INDEPENDENT AUDITORS' REPORT The Board of Directors Consumer Portfolio Services, Inc. We have audited the accompanying consolidated balance sheets of Consumer Portfolio Services, Inc. and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations, shareholders' equity and cash flows for the year ended December 31, 1996, for the nine-month period ended December 31, 1995, and for the year ended March 31, 1995. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Consumer Portfolio Services, Inc. and subsidiaries as of December 31, 1996 and 1995, and the results of their operations and their cash flows for the year ended December 31, 1996, for the nine-month period ended December 31, 1995, and for the year ended March 31, 1995, in conformity with generally accepted accounting principles. KPMG PEAT MARWICK LLP Orange County, California February 14, 1997 F-1 CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS See accompanying notes to consolidated financial statements F-2
DECEMBER 31, DECEMBER 31, 1996 1995 -------------- ------------- ASSETS (note 11) Cash.............................................................................. $ 153,958 $ 10,895,157 Contracts held for sale (notes 5 and 11).......................................... 21,656,773 19,548,842 Servicing fees receivable......................................................... 3,086,194 1,454,707 Investment in subordinated certificates........................................... -- 2,174,666 Investments in credit enhancements (note 2)....................................... 43,597,472 30,477,793 Excess servicing receivables (note 7)............................................. 23,654,461 11,108,251 Furniture and equipment, net (note 3)............................................. 629,774 548,535 Taxes receivable.................................................................. 610,913 -- Deferred financing costs (note 11)................................................ 943,222 1,100,430 Investment in unconsolidated affiliate (note 4)................................... 2,263,768 -- Other assets (note 4)............................................................. 5,349,885 569,944 -------------- ------------- $ 101,946,420 $ 77,878,325 -------------- ------------- -------------- ------------- LIABILITIES AND SHAREHOLDERS' EQUITY LIABILITIES Accounts payable & accrued expenses............................................... $ 1,697,051 $ 1,341,905 Warehouse line of credit (note 11)................................................ 13,264,585 7,500,000 Taxes payable..................................................................... -- 2,912,084 Deferred tax liability (note 10).................................................. 7,027,251 1,643,254 Notes payable (note 11)........................................................... 20,000,000 20,000,000 Convertible subordinated debt (note 11)........................................... 3,000,000 3,000,000 -------------- ------------- 44,988,887 36,397,243 SHAREHOLDERS' EQUITY (notes 8 and 11) 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; 13,779,242 and 13,298,642 shares issued and outstanding at December 31, 1996 and 1995, respectively.................................................................... 34,644,314 33,265,239 Retained earnings................................................................. 22,313,219 8,215,843 -------------- ------------- 56,957,533 41,481,082 Commitments and contingencies (notes 4, 5, 6, 8, 9 and 12) Subsequent events (notes 9, 11 and 14) -------------- ------------- $ 101,946,420 $ 77,878,325 -------------- ------------- -------------- ------------- CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS See accompanying notes to consolidated financial statements F-3
NINE MONTHS YEAR ENDED ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, MARCH 31, 1996 1995 1995 ------------- ------------- ------------- REVENUES: Net gain on sale of contracts (note 7).............................. $ 23,321,015 $ 11,549,413 $ 9,454,620 Servicing fees (note 6)............................................. 16,168,867 6,475,405 7,201,062 Interest............................................................ 11,703,921 6,229,895 5,849,154 ------------- ------------- ------------- 51,193,803 24,254,713 22,504,836 ------------- ------------- ------------- EXPENSES: Employee costs...................................................... 8,920,521 3,309,139 2,990,253 General and administrative.......................................... 7,247,011 2,799,599 1,905,155 Interest............................................................ 5,780,529 2,724,403 3,407,598 Provision for credit losses (note 5)................................ 2,755,803 828,458 532,947 Marketing........................................................... 1,678,674 1,231,110 1,764,121 Occupancy........................................................... 768,521 267,641 254,845 Depreciation and amortization....................................... 275,348 174,555 153,355 Related party consulting fees (note 4).............................. 75,000 262,500 350,000 ------------- ------------- ------------- 27,501,407 11,597,405 11,358,274 ------------- ------------- ------------- Income before income taxes.......................................... 23,692,396 12,657,308 11,146,562 Income taxes (note 10).............................................. 9,595,020 5,082,186 4,480,932 ------------- ------------- ------------- Net income.......................................................... $ 14,097,376 $ 7,575,122 $ 6,665,630 ------------- ------------- ------------- ------------- ------------- ------------- Net income per common and common equivalent share................... $ 0.95 $ 0.53 $ 0.60 ------------- ------------- ------------- ------------- ------------- ------------- Weighted average number of common and common equivalent shares...... 14,849,609 14,323,592 11,143,268 ------------- ------------- ------------- ------------- ------------- ------------- Fully diluted net income per common and common equivalent share..... $ 0.93 $ 0.52 $ 0.56 ------------- ------------- ------------- ------------- ------------- ------------- Fully diluted weighted average number of common and common equivalent shares.................................................. 15,410,044 14,803,592 12,538,352 ------------- ------------- ------------- ------------- ------------- ------------- CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY See accompanying notes to consolidated financial statements F-4
SERIES A RETAINED PREFERRED STOCK COMMON STOCK EARNINGS -------------------------- --------------------------- (ACCUMULATED SHARES AMOUNT SHARES AMOUNT DEFICIT) TOTAL ----------- ------------- ------------ ------------- ------------- ------------- Balance at March 31, 1994.......... 3,415,000 $ 3,415,000 8,733,334 $ 12,810,689 $ (6,024,909) $ 10,200,780 Common stock issued upon exercise of warrants....................... -- -- 39,466 118,398 -- 118,398 Common stock issued upon exercise of options........................ -- -- 48,000 120,000 -- 120,000 Common stock issuance, net (note 8)................................ -- -- 2,000,000 13,304,550 -- 13,304,550 Redemption of Preferred Stock (note 8)................................ (3,415,000) (3,415,000) -- -- -- (3,415,000) Net income......................... -- -- -- -- 6,665,630 6,665,630 ----------- ------------- ------------ ------------- ------------- ------------- Balance at March 31, 1995.......... -- $ -- 10,820,800 $ 26,353,637 $ 640,721 $ 26,994,358 Common stock issued upon exercise of warrants....................... -- -- 100,534 301,602 -- 301,602 Common stock issued upon exercise of options........................ -- -- 1,843,974 4,610,000 -- 4,610,000 Common stock issued upon conversion of debt (note 11)................. -- -- 533,334 2,000,000 -- 2,000,000 Net income......................... -- -- -- -- 7,575,122 7,575,122 ----------- ------------- ------------ ------------- ------------- ------------- Balance at December 31, 1995....... -- $ -- 13,298,642 $ 33,265,239 $ 8,215,843 $ 41,481,082 Common stock issued upon exercise of warrants....................... -- -- 86,000 258,000 -- 258,000 Common stock issued upon exercise of options........................ -- -- 394,600 1,121,075 -- 1,121,075 Net income......................... -- -- -- -- 14,097,376 14,097,376 ----------- ------------- ------------ ------------- ------------- ------------- Balance at December 31, 1996....... -- $ -- 13,779,242 $ 34,644,314 $ 22,313,219 $ 56,957,533 ----------- ------------- ------------ ------------- ------------- ------------- ----------- ------------- ------------ ------------- ------------- ------------- CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS See accompanying notes to consolidated financial statements F-5
NINE MONTHS YEAR ENDED ENDED DECEMBER 31, DECEMBER 31, YEAR ENDED 1996 1995 MARCH 31, 1995 -------------- -------------- -------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income........................................................ $ 14,097,376 $ 7,575,122 $ 6,665,630 Adjustments to reconcile net income to net cash used in operating activities: Depreciation and amortization................................... 275,348 174,555 153,355 Amortization of purchased and excess servicing receivables...... 6,119,219 2,023,938 1,210,120 Amortization of deferred financing costs........................ 157,208 5,265 -- Provision for credit losses..................................... 2,755,803 828,458 532,947 Gain on sale of contracts from excess servicing receivables..... (18,665,429) (7,977,828) (4,065,899) Loss on investment in unconsolidated affiliate.................. 595,352 -- -- Changes in operating assets and liabilities: Purchases of contracts held for sale.......................... (351,350,070) (160,150,781) (164,263,577) Liquidation of contracts held for sale........................ 346,486,336 156,890,700 142,472,028 Servicing fees receivable..................................... (1,631,487) (658,385) (615,063) Prepaid related party expenses................................ -- -- 233,333 Initial deposits to credit enhancement accounts............... (12,270,168) (4,931,325) (13,237,454) Excess servicing deposited to credit enhancement accounts..... (18,790,430) (7,553,086) (5,390,422) Release of cash from credit enhancement accounts.............. 17,940,919 7,693,839 5,923,201 Deferred taxes................................................ 5,383,997 2,199,068 (381,616) Other assets.................................................. (3,361,654) (425,695) 3,810 Accounts payable and accrued expenses......................... 355,146 (131,382) 528,256 Warehouse line of credit...................................... 5,764,585 (12,230,389) 19,730,389 Taxes payable/receivable...................................... (3,522,997) (1,865,464) 4,385,724 -------------- -------------- -------------- Net cash used in operating activities....................... (9,660,946) (18,533,390) (6,115,238) CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sale of subordinated certificates 2,022,220 -- -- Investment in unconsolidated affiliate.......................... (4,277,407) -- -- Purchases of furniture and equipment............................ (356,587) (263,496) (334,458) Payments received on subordinated certificates.................. 152,446 118,764 -- -------------- -------------- -------------- Net cash used in investing activities....................... (2,459,328) (144,732) (334,458) CASH FLOWS FROM FINANCING ACTIVITIES: Issuance of promissory notes.................................... -- 2,000,000 5,000,000 Issuance of note to related party............................... -- 2,000,000 -- Issuance of long term notes..................................... -- 20,000,000 -- Payment of financing costs...................................... -- (1,105,695) -- Repayment of promissory notes................................... -- (2,000,000) (5,000,000) Repayment of note to related party.............................. -- (2,000,000) -- Issuance of common stock........................................ -- -- 13,304,550 Redemption of preferred stock................................... -- -- (3,415,000) Exercise of options and warrants................................ 1,379,075 4,911,602 238,398 -------------- -------------- -------------- Net cash provided by financing activities................... 1,379,075 23,805,907 10,127,948 -------------- -------------- -------------- Increase (decrease) in cash....................................... (10,741,199) 5,127,785 3,678,252 Cash at beginning of period....................................... 10,895,157 5,767,372 2,089,120 -------------- -------------- -------------- Cash at end of period............................................. $ 153,958 $ 10,895,157 $ 5,767,372 -------------- -------------- -------------- -------------- -------------- -------------- Supplemental disclosure of cash flow information: Cash paid during the period Interest...................................................... $ 5,213,912 $ 2,542,718 $ 3,288,848 Income taxes.................................................. $ 6,679,000 $ 4,759,050 $ 523,000 Supplemental disclosure of non-cash investing and financing activities: Issuance of common stock upon conversion of debt................ $ -- $ 2,000,000 $ -- Investments in subordinated certificates........................ $ -- $ 4,779,166 $ -- CONSUMER PORTFOLIO SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 1996, NINE MONTHS ENDED DECEMBER 31, 1995 AND YEAR ENDED MARCH 31, 1995 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES DESCRIPTION OF BUSINESS Consumer Portfolio Services, Inc. ("the Company") was incorporated in California on March 8, 1991. The Company and its subsidiaries engage primarily in the business of purchasing, selling and servicing retail automobile installment sale contracts ("Contracts") originated by dealers located throughout the United States. The Company specializes in Contracts with borrowers who generally would not be expected to qualify for traditional financing such as that provided by commercial banks or automobile manufacturers' captive finance companies. The Company's operations are centralized in Irvine, California and it has purchased Contracts from Dealers in California since its inception. During the year ended December 31, 1996, Contract purchases relating to borrowers who resided in California totaled 25.8% of all contract purchases. Moreover, at December 31, 1996, borrowers who resided in California made up 33.3% of the Servicing Portfolio. A significant adverse change in the economic climate in California could result in fewer Contracts available for sale and potentially less gain on sale and servicing fee revenue. The automobile financing business is highly competitive. The Company competes with a number of national, local and regional finance companies with operations similar to those of the Company. In addition, competitors or potential competitors include other types of financial services companies, such as commercial banks, savings and loan associations, leasing companies, credit unions providing retail loan financing and lease financing for new and used vehicles, and captive finance companies affiliated with major automobile manufacturers such as General Motors Acceptance Corporation, Ford Motor Credit Corporation, Chrysler Credit Corporation and Nissan Motors Acceptance Corporation. Many of the Company's competitors and potential competitors possess substantially greater financial, marketing, technical, personnel and other resources than the Company. Moreover, the Company's future profitability will be directly related to the availability and cost of its capital in relation to the availability and cost of capital to its competitors. The Company's competitors and potential competitors include far larger, more established companies that have access to capital markets for unsecured commercial paper and investment grade-rated debt instruments and to other funding sources which may be unavailable to the Company. Many of these companies also have long-standing relationships with dealers and may provide other financing to dealers, including floor plan financing for the dealers' purchase of automobiles from manufacturers, which is not offered by the Company. The Company purchases Contracts with the intent to re-sell them to institutional investors either as bulk sales or in the form of securities backed by the Contracts. Purchasers of the Contracts receive a pass through rate of interest set at the time of the sale and the Company receives a base servicing fee for its duties relating to the accounting for and collection of the Contracts. In addition, the Company is entitled to certain excess servicing fees which represent collections on the Contracts in excess of those required to pay investor principal and interest, base servicing fees and any other expenses of the trust. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of Consumer Portfolio Services, Inc. and its wholly-owned subsidiaries, Alton Receivables Corp. ("Alton") , CPS Receivables Corp. ("CPSRC") and CPS Funding Corp. ("CPSFC"). Alton, CPSRC and CPSFC are limited purpose corporations formed to accommodate the structures under which the Company sells its Contracts. The consolidated financial statements also include the accounts of SAMCO Acceptance Corp. and LINC Acceptance Company, LLC, F-6 CONSUMER PORTFOLIO SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEAR ENDED DECEMBER 31, 1996, NINE MONTHS ENDED DECEMBER 31, 1995 AND YEAR ENDED MARCH 31, 1995 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) both of which are 80% owned subsidiaries formed by the Company in fiscal 1996. All significant intercompany balances and transactions have been eliminated in consolidation. Investments in unconsolidated affiliates which are not majority owned are reported using the equity method. The excess of the cost of the stock over the Company's share of the net assets at the acquisition date ("goodwill") is being amortized over fifteen years. CONTRACTS HELD FOR SALE The Contracts which the Company purchases from dealers provide for finance charges of approximately 20% per annum, in most cases. Each Contract provides for full amortization, equal monthly payments and can be fully prepaid by the borrower at any time without penalty. The Company typically purchases the Contracts from dealers at a discount from the amount financed under the Contract with such discounts deferred and recognized as revenue upon sale of the related Contracts. Effective January 10, 1997, the Company began purchasing all Contracts without a percentage discount, charging dealers only a flat acquisition fee for each Contract purchased based on the perceived credit risk and, in some cases, the interest rate on the Contract. Contracts are generally sold to institutional investors at par. In the case of whole loan sales, the investor withholds a portion of the purchase price as an initial credit enhancement. In the case of Contracts sold in the form of asset backed securities, the Company pledges certain cash balances as an initial credit enhancement. Contracts are generally sold by the Company within one to three months of their purchase, although they may be held longer. Contracts held for sale are stated at the lower of cost or market value. Market value is determined by purchase commitments from investors and prevailing market prices. Gains and losses are recorded as appropriate when Contracts are sold. ALLOWANCE FOR CREDIT LOSSES The Company provides an allowance for credit losses which management believes provides adequately for current and possible future losses that may develop in the Contracts held for sale. Management evaluates the adequacy of the allowance by examining current delinquencies, the characteristics of the portfolio, the value of underlying collateral, and general economic conditions and trends. CONTRACT ACQUISITION FEES AND COSTS The Company generally receives an acquisition fee from the dealer for each Contract purchased. Fee proceeds are used to offset the direct expenses associated with the purchase of the Contracts, with any excess amount deferred until the Contracts are sold at which time the deferred portions are recognized as a component of the gain on sale. INVESTMENTS The Company determines the appropriate classification of its investments in debt securities at the time of purchase or creation. Debt securities for which the Company does not have the intent or ability to hold to maturity are classified as available for sale. Securities available for sale are carried at fair value, with unrealized gains and losses, net of tax, reported in a separate component of shareholders' equity. F-7 CONSUMER PORTFOLIO SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEAR ENDED DECEMBER 31, 1996, NINE MONTHS ENDED DECEMBER 31, 1995 AND YEAR ENDED MARCH 31, 1995 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) The amortized cost of debt securities classified as available for sale is adjusted for amortization of premiums and accretion of discounts, over the estimated life of the security. Such amortization and interest earned on the debt securities are included in interest income. GAIN ON SALE OF CONTRACTS Gains or losses are determined based upon the difference between the sales proceeds for the portion of Contracts sold and the Company's recorded investment in the Contracts sold. The Company allocates the recorded investment in the Contracts between the portion of the Contracts sold and the portion retained based on the relative fair values of those portions on the date of sale. EXCESS SERVICING RECEIVABLES Excess servicing receivables ("ESR") result from the sale of Contracts on which the Company retains servicing rights and all, or a portion of, the excess cash flows. ESRs are determined by computing the difference between the weighted average yield of the Contracts sold and the yield to the purchaser, adjusted for the normal servicing fee based on the agreements between the Company and the purchaser. The resulting differential is recorded as a gain at the time of the sale equal to the present value of the estimated cash flows, net of any portion of the excess that may be due to the purchaser and adjusted for anticipated prepayments, repossessions, liquidations and other losses. The excess servicing cash flows over the estimated remaining life of the Contracts have been calculated for all applicable periods using estimates for prepayments, losses (charge-offs) and weighted average discount rates, which the Company expects market participants would use for similar instruments. Losses are discounted at an assumed risk free rate. The ESRs are amortized using the interest method and are offset against servicing fees. To the extent that the actual future performance of the Contracts results in less excess cash flows than the Company estimated, the Company's ESRs will be adjusted at least quarterly, with corresponding charges recorded against income in the period in which the adjustment is made. To the extent that the actual cash flows exceed the Company's estimates the Company will record additional servicing fees. Excess servicing receivables are evaluated quarterly for impairment by reassessing the discounted future estimated excess servicing fees, on individual securitized pools, which consist predominantly of pools of Contracts purchased in the quarter of each securitization. If the carrying value of the ESR is greater than the future estimated ESR, a charge to earnings is made through a valuation allowance. FURNITURE AND EQUIPMENT Furniture and equipment are stated at cost net of accumulated depreciation which is calculated using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized over the lesser of the estimated useful lives of the assets or the related lease term. SERVICING Servicing fees are reported as income when earned, net of related amortization of purchased and excess servicing. Servicing costs are charged to expense as incurred. F-8 CONSUMER PORTFOLIO SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEAR ENDED DECEMBER 31, 1996, NINE MONTHS ENDED DECEMBER 31, 1995 AND YEAR ENDED MARCH 31, 1995 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) NET INCOME PER SHARE The computation of net income per common and common equivalent share is based upon the Treasury Stock Method using the weighted average number of common shares outstanding during the period plus (in periods in which they have a dilutive effect) the effect of common shares contingently issuable, primarily from stock options and warrants. The fully diluted net income per share computation reflects the effect of common shares contingently issuable upon the conversion of convertible debt in which such conversion would cause dilution. Fully diluted net income per common share also reflects additional dilution related to stock options and warrants due to the use of the market price at the end of the period, when higher than the average price for the period. INCOME TAXES The Company and its subsidiaries file a consolidated Federal income and combined state franchise tax return on a fiscal year basis. The Company utilizes the asset and liability method of accounting for income taxes under which deferred income taxes are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. The Company has accounted for income taxes in this manner since its inception. STOCK SPLIT On February 16, 1996, the Board of Directors authorized a two-for-one stock split to be distributed on or about March 14, 1996, to shareholders of record on March 7, 1996. All references in the consolidated financial statements to number of shares, per share amounts and market prices of the Company's common stock have been retroactively restated to reflect the increased number of common shares outstanding. STOCK OPTION PLAN Prior to January 1, 1996, the Company accounted for its stock option plan in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. On January 1, 1996, the Company adopted SFAS No. 123, Accounting for Stock-Based Compensation, which permits entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively, SFAS No. 123 also allows entities to continue to apply the provisions of APB Opinion No. 25 and provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants made in 1995 and future years as if the fair-value-based methods defined in SFAS No. 123 had been applied. The Company has elected to continue to apply the provisions of APB Opinion No. 25 and to provide the pro forma disclosure provisions of SFAS No. 123. F-9 CONSUMER PORTFOLIO SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEAR ENDED DECEMBER 31, 1996, NINE MONTHS ENDED DECEMBER 31, 1995 AND YEAR ENDED MARCH 31, 1995 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF The Company adopted the provisions of SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, on January 1, 1996. 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 exceed the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. Adoption of this Statement did not have a material impact on the Company's financial position, results of operations or liquidity. NEW ACCOUNTING PRONOUNCEMENTS In June 1996, the Financial Accounting Standards Board issued SFAS No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. SFAS No. 125 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996 and is to be applied prospectively. This Statement provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities based on consistent application of a financial-components approach that focuses on control. It distinguishes transfers of financial assets that are sales from transfers that are secured borrowings. Management of the Company does not expect that adoption of SFAS No. 125 will have a material impact on the Company's financial position, results of operations or liquidity. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements, as well as the reported amounts of income and expenses during the reported periods. Specifically, a number of estimates were made in connection with the recording of the allowance for credit losses and excess servicing receivables and the related gain. Actual results could differ from those estimates. RECLASSIFICATION Certain amounts for the prior periods have been reclassified to conform to the current presentation. (2) INVESTMENTS The Company is a party to various agreements with institutional investors and investment banks for the sale of the Company's Contracts. The agreements call for the Company to sell Contracts to one of its special purpose corporation subsidiaries, either Alton or CPSRC (the "SPCs"), which subsequently transfer the Contracts to various grantor trusts (the "Trusts") which then issue interest bearing certificates which are purchased by institutional investors. The terms of the agreements provide that simultaneous with F-10 CONSUMER PORTFOLIO SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEAR ENDED DECEMBER 31, 1996, NINE MONTHS ENDED DECEMBER 31, 1995 AND YEAR ENDED MARCH 31, 1995 (2) INVESTMENTS (CONTINUED) each purchase of certificates by the investor, the Company is required to provide a credit enhancement in the form of a cash capital contribution to the SPC equal to a specified percentage of the amount of the certificates purchased by the investor. The SPC then deposits the initial cash, and subsequent excess servicing cash flows as required by the terms of the various agreements, to an account held by a trustee (the "Spread Account") and pledges the cash to the Trust, which in turn invests the cash in high quality liquid investment securities as defined by the various agreements. In the securitizations since June 1995, the Company altered the credit enhancement mechanism to create a subordinated class of asset-backed securities ("B Piece") in order to reduce the size of the required initial deposit to the Spread Account. All of the B Pieces through December 31, 1996, had an initial principal balance equal to 5% of the aggregate principal balance of the asset-backed securities. As of December 31, 1996, all of the B Pieces have been sold except the B Piece related to the June 1995 securitization. In the event that the cash flows generated by the Contracts transferred to the Trust are insufficient to pay obligations of the Trust, including principal or interest due to certificateholders or expenses of the Trust, the trustee will draw an amount necessary from the Spread Accounts to pay the obligations of the Trust. The agreements provide that the Spread Accounts shall be maintained at a specified percent of the principal balance of the certificates, which can be increased in the event delinquencies and/or losses exceed certain specified levels. In the event delinquencies and/or losses on the Contracts serviced exceed specified levels defined in certain of the Company's securitization agreements, the terms of those securitizations may require the transfer of servicing to another servicer. Consequently, as principal payments are made to the certificateholders, and if the Spread Accounts are in excess of the specified percent of the principal balance of the certificates, the trustee shall release to the SPC the portion of the pledged cash that is in excess of the amount necessary to meet the specified percent of the principal balance of the certificates. To the extent cash in excess of the predetermined level is generated, such cash is either transferred to cover deficiencies, if any, in Spread Accounts for other pools, or is released to the Company. Except for releases in this manner, the cash in the Spread Accounts is restricted from use by the SPC or the Company. Investments in credit enhancements were made up of the following components: F-11
DECEMBER 31, DECEMBER 31, 1996 1995 ------------- ------------- Funds held by investor.............................................. $ 1,263,660 $ 2,211,363 Investment in subordinated certificates............................. 1,530,950 2,137,333 US government securities............................................ 40,802,862 26,129,097 ------------- ------------- $ 43,597,472 $ 30,477,793 ------------- ------------- ------------- ------------- CONSUMER PORTFOLIO SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEAR ENDED DECEMBER 31, 1996, NINE MONTHS ENDED DECEMBER 31, 1995 AND YEAR ENDED MARCH 31, 1995 (3) FURNITURE AND EQUIPMENT Furniture and equipment consists of the following: (4) RELATED PARTY TRANSACTIONS Prior to December 11, 1995, the Company was a majority-owned subsidiary of CPS Holdings, Inc., a Delaware corporation ("Holdings"). In September 1995, the shareholders of the Company approved the merger of Holdings into the Company. The merger was completed on December 11, 1995, and had no effect on the Company's consolidated financial statements. Prior to the merger, Charles E. Bradley, Sr., the Company's Chairman of the Board, was the principal shareholder of Holdings. The Company is a party to a consulting agreement with Stanwich Partners, Inc. ("SPI") that call for monthly payments of $6,250 through December 31, 1998. Included in the accompanying consolidated statements of operations for the year ended December 31, 1996, for the nine months ended December 31, 1995, and for the year ended March 31, 1995, is $75,000, $262,500 and $350,000, respectively, of consulting expense related to this consulting agreement. The Chairman of the Board of Directors of the Company is a principal shareholder of SPI. During the year ended March 31, 1995, the Company advanced to Holdings $714,494, pursuant to various notes which were to mature on or before July 1, 1995. As of March 31, 1995, all principal and interest under the notes had been paid in full. On September 27, 1995, the Company borrowed $2 million through a promissory note to Charles E. Bradley, Sr., Chairman of the Board of Directors. Interest accrued at 11.5% and was payable on the maturity date, December 31, 1995, or upon the exercise of an option by Holdings for the purchase of 1,800,000 shares of the Company's common stock at $2.50 per share, whichever was earlier. On December 6, 1995, Holdings exercised its option and the note was repaid in full. Included in other assets at December 31, 1996, is a receivable for approximately $100,000 from SPI related to investment banking services performed by the Company in connection with the Company's January 2, 1997 acquisition of Stanwich Leasing, Inc. ("SLI") (see note 14). Investment in unconsolidated affiliate consists of a 38% interest in NAB Asset Corporation ("NAB") that was acquired by the Company on June 6, 1996, for approximately $4,300,000. At the time of the acquisition, NAB had approximately $3.5 million in cash and no significant operations. The Company's investment in NAB exceeded the Company's share of the net assets of NAB at the acquisition date by approximately $1,418,000. This amount, which is included in other assets in the accompanying balance F-12
DECEMBER 31, DECEMBER 31, 1996 1995 ------------- ------------ Furniture and fixtures.............................................. $ 759,783 $ 629,613 Computer equipment.................................................. 875,870 682,541 Leasehold improvements.............................................. 91,700 65,103 ------------- ------------ 1,727,353 1,377,257 Less accumulated depreciation and amortization.................. (1,097,579) (828,722) ------------- ------------ $ 629,774 $ 548,535 ------------- ------------ ------------- ------------ CONSUMER PORTFOLIO SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEAR ENDED DECEMBER 31, 1996, NINE MONTHS ENDED DECEMBER 31, 1995 AND YEAR ENDED MARCH 31, 1995 (4) RELATED PARTY TRANSACTIONS (CONTINUED) sheet, has been recorded by the Company as goodwill. Based on the closing price on the Nasdaq, the market value of the investment in NAB was approximately $7.5 million at December 31, 1996. Charles E. Bradley, Sr., Chairman of the Company's Board of Directors and principal shareholder and Charles E. Bradley, Jr., President, Chief Executive Officer and a member of the Company's Board of Directors are both on the Board of Directors of NAB. Subsequent to the Company's investment in NAB, NAB purchased Mortgage Portfolio Services, Inc. ("MPS") from the Company for $300,000. MPS, formed by the Company in April, 1996, is a mortgage broker-dealer based in Texas specializing in "B" and "C" mortgages. In July 1996, NAB formed CARSUSA, Inc. ("CARSUSA"), which purchased, and now owns and operates, a Mitsubishi automobile dealership in Southern California. Included in general and administrative expenses for the year ended December 31, 1996, is $595,352, which represents the Company's share of NAB's loss since June 6, 1996. Included in other assets at December 31, 1996, are amounts due from NAB amounting to $1,098,000. Of this amount, $800,000 relates to a flooring line of credit provided to CARSUSA and the remainder relates to fees owed by MPS and CARSUSA for services rendered by the Company in fiscal 1996. During fiscal 1996, the Company sold 69 automobiles to CARSUSA and received proceeds of $458,650. Additionally, the Company purchased 39 contracts from CARSUSA. The aggregate principal balance of the Contracts purchased was $517,264. (5) CONTRACTS HELD FOR SALE The balance of Contracts held for sale was made up of the following components: Activity in the allowance for credit losses consisted of the following:
DECEMBER 31, DECEMBER 31, 1996 1995 ------------- ------------- Gross receivable balance............................................ $ 28,095,461 $ 24,584,472 Unearned finance charges............................................ (5,268,107) (3,820,267) Dealer discounts.................................................... (509,266) (944,284) Deferred loan origination costs (net of related fees)............... 61,774 59,077 Allowance for credit losses......................................... (723,089) (330,156) ------------- ------------- Net contracts held for sale..................................... $ 21,656,773 $ 19,548,842 ------------- ------------- ------------- ------------- F-13
NINE MONTHS YEAR ENDED ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, MARCH 31, 1996 1995 1995 ------------- ------------- ----------- Balance, beginning of period............................ $ 330,156 $ 323,631 $ 50,169 Provisions.............................................. 2,755,803 828,458 532,947 Charge-offs............................................. (2,755,303) (1,076,982) (386,408) Recoveries.............................................. 392,433 255,049 126,923 ------------- ------------- ----------- Balance, end of period.............................. $ 723,089 $ 330,156 $ 323,631 ------------- ------------- ----------- ------------- ------------- ----------- CONSUMER PORTFOLIO SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEAR ENDED DECEMBER 31, 1996, NINE MONTHS ENDED DECEMBER 31, 1995 AND YEAR ENDED MARCH 31, 1995 The Company is required to represent and warrant certain matters with respect to the Contracts sold to the investors, which generally duplicate the substance of the representations and warranties made by the dealers in connection with the Company's purchase of the Contracts. In the event of a breach by the Company of any representation or warranty, the Company is obligated to repurchase the Contracts from the investors at a price equal to the investors' purchase price less the related credit enhancement and any principal payments received from the borrower. In most cases, the Company would then be entitled under the terms of its agreements with its dealers to require the selling dealer to repurchase the Contracts at the Company's purchase price less any principal payments received from the borrower. As of December 31, 1996, December 31, 1995, and March 31, 1995, the Company had commitments to purchase $1,109,595, $910,325, and $706,720, respectively of Contracts from Dealers in the ordinary course of business. (6) SERVICING Servicing fees are reported as income when earned, net of related amortization of purchased and excess servicing. Servicing costs are charged to expense as incurred. Servicing fees included the following components: The Company services Contracts and loans to borrowers residing in approximately 49 states, with the largest concentrations of loans in California, Florida, Pennsylvania and Texas. Servicing balances were made up of the following components:
NINE MONTHS YEAR ENDED ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, MARCH 31, 1996 1995 1995 ------------- ------------- ------------- Gross loan servicing fees............................. $ 22,288,086 $ 8,499,343 $ 8,411,182 Amortization of purchased servicing................... -- -- (4,849) Amortization of excess servicing...................... (6,119,219) (2,023,938) (1,205,271) ------------- ------------- ------------- Net Servicing fees................................ $ 16,168,867 $ 6,475,405 $ 7,201,062 ------------- ------------- ------------- ------------- ------------- ------------- F-14
DECEMBER 31, ------------------------------ 1996 1995 MARCH 31, 1995 -------------- -------------- -------------- Contracts held for sale.......................... $ 22,827,354 $ 20,764,205 $ 23,469,223 Servicing subject to recourse provisions: Whole loan portfolios........................ 11,212,010 21,213,050 29,754,103 Alton Receivables Corp....................... 10,240,973 22,732,021 35,324,463 CPS Receivables Corp......................... 461,653,273 224,218,079 104,252,042 -------------- -------------- -------------- $ 505,933,610 $ 288,927,355 $ 192,799,831 -------------- -------------- -------------- -------------- -------------- -------------- CONSUMER PORTFOLIO SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEAR ENDED DECEMBER 31, 1996, NINE MONTHS ENDED DECEMBER 31, 1995 AND YEAR ENDED MARCH 31, 1995 (7) EXCESS SERVICING RECEIVABLES The following table summarizes ESR activity: ESR balances were made up of the following components:
NINE MONTHS YEAR ENDED ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, MARCH 31, 1996 1995 1995 ------------- ------------- ------------- Balance, beginning of period.......................... $ 11,108,251 $ 5,154,361 $ 2,293,733 ESR gains recognized.................................. 18,665,429 7,977,828 4,065,899 Amortization of ESR................................... (6,119,219) (2,023,938) (1,205,271) ------------- ------------- ------------- Balance, end of period............................ $ 23,654,461 $ 11,108,251 $ 5,154,361 ------------- ------------- ------------- ------------- ------------- ------------- Net gain on sale on Contracts was made up of the following components:
DECEMBER 31, 1996 ------------------------------ 1996 1995 MARCH 31, 1995 -------------- -------------- -------------- Present value of future cash flows............... $ 70,339,711 $ 34,538,442 $ 19,551,370 Discounted allowance for credit losses........... (46,685,250) (23,430,191) (14,397,009) -------------- -------------- -------------- Net ESR balance.............................. $ 23,654,461 $ 11,108,251 $ 5,154,361 -------------- -------------- -------------- -------------- -------------- -------------- Servicing subject to recourse provisions..... $ 483,106,256 $ 268,163,150 $ 169,330,608 -------------- -------------- -------------- -------------- -------------- -------------- Discounted allowance as percentage of servicing subject to recourse provisions............... 9.66% 8.74% 8.50% -------------- -------------- -------------- -------------- -------------- -------------- (8) SHAREHOLDERS' EQUITY PREFERRED STOCK The holders of the Series A Preferred Stock were entitled to receive non-cumulative annual dividends equal to 6% of par value, payable quarterly in cash (or, at the option of the Company, in-kind in additional shares of Series A Preferred Stock), when and as declared by the Board of Directors, after the Company's cumulative net income from the date of the Company's initial public offering reached $5,000,000. No dividends or other distributions may be made with respect to the common stock until accrued dividends F-15
NINE MONTHS YEAR ENDED ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, MARCH 31, 1996 1995 1995 ------------- ------------- ------------- Dealer discount...................................... $ 8,271,777 $ 5,573,371 $ 6,750,955 ESR gains recognized................................. 18,665,429 7,977,828 4,065,899 Deferred acquisition fees (expenses)................. (1,381,436) (528,870) 647,766 Expenses related to sales............................ (2,234,755) (1,472,916) (2,010,000) ------------- ------------- ------------- $ 23,321,015 $ 11,549,413 $ 9,454,620 ------------- ------------- ------------- ------------- ------------- ------------- CONSUMER PORTFOLIO SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEAR ENDED DECEMBER 31, 1996, NINE MONTHS ENDED DECEMBER 31, 1995 AND YEAR ENDED MARCH 31, 1995 (8) SHAREHOLDERS' EQUITY (CONTINUED) have been declared and paid (or reserved for payment) on the Series A Preferred Stock. Upon liquidation, the Series A Preferred Stock is entitled to receive, in preference to any payment on the common stock, an amount equal to par value plus any accrued and unpaid dividends. After March 31, 1994, the Series A Preferred Stock was subject to redemption at the option of the Company at a price of $1.00 per share plus accrued and unpaid dividends. On March 15, 1995, the Company redeemed, for an aggregate price of $3.4 million, all of the outstanding Series A Preferred Stock with proceeds from the March 7, 1995, public offering of 2,000,000 shares of its common stock. COMMON STOCK On March 7, 1995, the Company completed a second public offering of 2,000,000 shares of its common stock. Net of related offering expenses of $1,445,450, the Company raised $13,304,550 in this offering. Holders of the common stock are entitled to such dividends as the Company's Board of Directors, in its discretion, may declare out of funds available, subject to the terms of any outstanding shares of preferred stock and other restrictions. In the event of liquidation of the Company, holders of common stock are entitled to receive, pro rata, all of the assets of the Company available for distribution, after payment of any liquidation preference to the holders of outstanding shares of preferred stock. Holders of the shares of common stock have no conversion or preemptive or other subscription rights and there are no redemption or sinking fund provisions applicable to the common stock. OPTIONS AND WARRANTS In 1991, the Company adopted and gained sole shareholder approval of the 1991 Stock Option Plan (the "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 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. At December 31, 1996, there were 97,000 additional shares available for grant under the Plan. Of the options outstanding at December 31, 1996 and 1995 and March 31, 1995, 1,319,420, 1,296,786 and 1,191,872 were exercisable with weighted-average exercise prices of $4.02, $2.71 and $2.62, respectively. The per share weighted-average fair value of stock options granted during the year ended December 31, F-16 CONSUMER PORTFOLIO SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEAR ENDED DECEMBER 31, 1996, NINE MONTHS ENDED DECEMBER 31, 1995 AND YEAR ENDED MARCH 31, 1995 (8) SHAREHOLDERS' EQUITY (CONTINUED) 1996 and the nine months ended December 31, 1995 was $4.99 and $4.17 at the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions: The Company applies APB Opinion No. 25 in accounting for its plans and, accordingly, no compensation cost has been recognized for its stock options in the consolidated financial statements. Had the Company determined compensation cost based on the fair value at the grant date for its stock options under Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation", the Company's net income and net income per share would have been reduced to the pro forma amounts indicted below.
YEAR ENDED NINE MONTHS DECEMBER 31, ENDED DECEMBER 1996 31, 1995 --------------- --------------- Expected life (years)................................................. 5.86 6.33 Risk-free interest rate............................................... 6.23% 6.80% Volatility............................................................ 46.20% 46.20% Expected dividend yield............................................... -- -- Pro forma net income and net income per share reflects only options granted in the year ended December 31, 1996 and the nine months ended December 31, 1995. Therefore, the full impact of calculating compensation cost for stock options under SFAS No. 123 is not reflected in the pro forma net income amounts presented above because compensation cost is reflected over the options' vesting period and compensation cost for options granted prior to January 1, 1995 is not considered. F-17
NINE MONTHS YEAR ENDED ENDED DECEMBER 31, DECEMBER 31, 1996 1995 ------------- ------------ Net income As reported...................................................... $ 14,097,376 $7,575,122 Pro forma........................................................ 13,550,000 7,505,000 Net income per share As reported...................................................... $ 0.95 $ 0.53 Pro forma........................................................ $ 0.92 $ 0.53 Net income per fully-diluted share As reported...................................................... $ 0.93 $ 0.52 Pro forma........................................................ $ 0.90 $ 0.52 CONSUMER PORTFOLIO SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEAR ENDED DECEMBER 31, 1996, NINE MONTHS ENDED DECEMBER 31, 1995 AND YEAR ENDED MARCH 31, 1995 (8) SHAREHOLDERS' EQUITY (CONTINUED) Stock options activity during the periods indicated is as follows: At December 31, 1996, 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:
NUMBER OF WEIGHTED-AVERAGE SHARES EXERCISE PRICE ---------- ---------------- Balance at March 31, 1994........................................... 1,677,840 $ 2.63 Granted......................................................... 415,200 5.54 Exercised....................................................... 48,000 2.50 Canceled........................................................ -- -- ---------- ---------------- Balance at March 31, 1995........................................... 2,045,040 3.23 Granted......................................................... 159,360 7.61 Exercised....................................................... 44,000 2.50 Canceled........................................................ -- -- ---------- ---------------- Balance at December 31, 1995........................................ 2,160,400 3.56 Granted......................................................... 513,400 9.60 Exercised....................................................... 394,600 2.82 Canceled........................................................ 124,800 5.23 ---------- ---------------- Balance at December 31, 1996........................................ 2,154,400 $ 5.04 ---------- ---------------- ---------- ---------------- In connection with the Company's initial public offering, the Company sold to the underwriter of the offering, for an aggregate price of $120, warrants to purchase up to 240,000 shares of the Company's common stock at an exercise price of $3.00 per share. The warrants are exercisable during the four year period commencing one year from the date of the offering. The shares represented by the warrants have been registered for public sale. During the year ended December 31, 1996, the nine months ended F-18
WEIGHTED- WEIGHTED WEIGHTED- AVERAGE AVERAGE AVERAGE NUMBER REMAINING EXERCISE NUMBER EXERCISE RANGE OF EXERCISE PRICES OUTSTANDING TERM PRICE EXERCISABLE PRICE - ---------------------------------------------------- ----------- ------------- ----------- ----------- ----------- $ 2.50--$ 2.50...................................... 874,920 1.80 $ 2.50 874,920 $ 2.50 $ 2.69--$ 2.69...................................... 228,920 4.96 $ 2.89 91,840 $ 2.69 $ 4.38--$ 4.38...................................... 70,000 7.25 $ 4.38 34,000 $ 4.38 $ 5.38--$ 5.38...................................... 301,200 7.25 $ 5.38 27,200 $ 5.38 $ 6.78--$ 8.38...................................... 201,760 8.09 $ 7.42 57,700 $ 7.41 $ 8.63--$ 8.63...................................... 15,000 9.53 $ 8.63 3,000 $ 8.63 $ 8.88--$ 8.88...................................... 326,400 9.25 $ 8.88 205,760 $ 8.88 $11.00--$11.00...................................... 15,200 7.83 $ 11.00 -- -- $12.00--$12.00...................................... 119,000 9.82 $ 12.00 23,800 $ 12.00 $12.13--$12.13...................................... 2,000 9.83 $ 12.13 400 $ 12.13 CONSUMER PORTFOLIO SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEAR ENDED DECEMBER 31, 1996, NINE MONTHS ENDED DECEMBER 31, 1995 AND YEAR ENDED MARCH 31, 1995 (8) SHAREHOLDERS' EQUITY (CONTINUED) December 31, 1995, and the year ended March 31, 1995, the underwriter exercised 86,000, 100,534, and 39,466 warrants, respectively, leaving a balance of 14,000 at December 31, 1996. (9) COMMITMENTS AND CONTINGENCIES LEASES The Company leases its facilities and certain computer equipment under non-cancelable operating leases which expire through 2007. Future minimum lease payments at December 31, 1996, under these leases are as follows: Subsequent to December 31, 1996, the Company entered into a building lease for a new collection facility in Chesapeake, Virginia. The lease calls for 126 monthly payments of $21,722 for total minimum lease payments of $2,736,993. Rent expense for the year ended December 31, 1996, the nine months ended December 31, 1995, and the year ended March 31, 1995, was $463,592, $186,483 and $219,835, 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. LITIGATION The Company is subject to lawsuits which arise in the ordinary course of its business. Management is of the opinion, based in part upon consultation with its counsel, that the liability of the Company, if any, arising from existing and threatened lawsuits would not have a material adverse effect on the Company's financial position and results of operations. F-19
1997.................................................................... $ 989,333 1998.................................................................... 874,539 1999.................................................................... 794,019 2000.................................................................... 670,497 2001.................................................................... 87,433 --------- $3,415,821 --------- --------- CONSUMER PORTFOLIO SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEAR ENDED DECEMBER 31, 1996, NINE MONTHS ENDED DECEMBER 31, 1995 AND YEAR ENDED MARCH 31, 1995 (10) INCOME TAXES Income taxes are comprised of the following: The Company's effective tax expense differs from the amount determined by applying the statutory Federal rate of 35% for the year ended December 31, 1996, and for the nine months ended December 31, 1995, and the year ended March 31, 1995, to income before income taxes as follows:
NINE MONTHS YEAR ENDED ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, MARCH 31, 1996 1995 1995 ------------ ------------ ------------ Current Federal.................................................... $3,060,164 $2,156,799 $ 3,718,390 State...................................................... 1,150,859 726,319 1,144,158 ------------ ------------ ------------ 4,211,023 2,883,118 4,862,548 Deferred Federal.................................................... 4,565,383 1,683,960 (353,739) State...................................................... 818,614 515,108 (27,877) ------------ ------------ ------------ 5,383,997 2,199,068 (381,616) ------------ ------------ ------------ Total tax expense........................................ $9,595,020 $5,082,186 $ 4,480,932 ------------ ------------ ------------ ------------ ------------ ------------ F-20
NINE MONTHS YEAR ENDED ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, MARCH 31, 1996 1995 1995 ------------ ------------ ------------ Expense at Federal tax rate.................................. $8,292,338 $4,430,058 $ 3,901,297 California franchise tax, net of............................. 1,280,157 Federal income tax benefit................................... 737,192 727,267 Other........................................................ 22,525 (85,064) (147,632) ------------ ------------ ------------ $9,595,020 $5,082,186 $ 4,480,932 ------------ ------------ ------------ ------------ ------------ ------------ CONSUMER PORTFOLIO SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEAR ENDED DECEMBER 31, 1996, NINE MONTHS ENDED DECEMBER 31, 1995 AND YEAR ENDED MARCH 31, 1995 (10) INCOME TAXES (CONTINUED) The tax effected cumulative temporary differences that give rise to deferred tax assets and liabilities as of December 31, 1996, and December 31, 1995, are as follows: In determining the possible future realization of deferred tax assets, future taxable income from the following sources are taken into account: (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 years in which net operating losses might otherwise expire. The Company believes that the deferred tax asset will more likely than not be realized due to the reversal of the deferred tax liability and expected future taxable income. (11) DEBT In June 1995, the Company entered into two warehouse line of credit agreements (collectively the "Line"). The Line provides the Company with an interim financing facility to hold Contracts for sale in greater numbers and for longer periods of time prior to their sale to other institutional investors. The primary agreement provides for loans by Redwood Receivables Corporation ("Redwood") to the Company, to be funded by commercial paper issued by Redwood and secured by Contracts pledged periodically by the Company. The Redwood facility provides for a maximum of $100.0 million of advances to the Company, with interest at a variable rate tied to prevailing commercial paper rates (6.99% at December 31, 1996). When the Company wishes to securitize these Contracts, a substantial part of the proceeds received from investors is paid to Redwood, which simultaneously releases the pledged Contracts for transfer to a pass-through securitization trust. The second agreement is a standby line of credit with General Electric Capital Corporation ("GECC"), also with a $100.0 million maximum, which the Company may use only if and to the extent that Redwood does not provide funding as described above. The GECC line is secured by Contracts and substantially all the other assets of the Company. Both agreements extend through November 30, 1998. F-21
DECEMBER 31, DECEMBER 31, 1996 1995 ------------ ------------ Deferred Tax Assets: Accrued Liabilities...................................................... $ 13,670 $ 77,716 Furniture and equipment.................................................. 23,095 52,938 Provision for credit losses.............................................. 301,357 33,727 State taxes.............................................................. 508,219 489,856 ------------ ------------ 846,341 654,237 Valuation allowance........................................................ -- -- ------------ ------------ 846,341 654,237 Deferred Tax Liabilities-- Excess servicing receivables............................................. 7,873,592 2,297,491 ------------ ------------ Net deferred tax liability............................................. $7,027,251 $1,643,254 ------------ ------------ ------------ ------------ CONSUMER PORTFOLIO SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEAR ENDED DECEMBER 31, 1996, NINE MONTHS ENDED DECEMBER 31, 1995 AND YEAR ENDED MARCH 31, 1995 (11) DEBT (CONTINUED) The two agreements are viewed as a single short-term warehouse line of credit, with advances varying according to the amount of pledged Contracts. The Company is charged a non-utilization fee of .25% per annum on the unused portion of the Line. In December 1996, the Company entered into a overdraft financing facility with, a bank that provides for maximum borrowings of $2.0 million. Interest is charged on the outstanding balance at the bank's reference rate (8.25% at December 31, 1996) plus 1.75%. There were no borrowings outstanding under this facility at December 31, 1996. The facility expires on June 1, 1998. Both the Line and the overdraft financing facility contain various restrictive and financial covenants that the Company was in compliance with at December 31, 1996. On December 20, 1995, the Company issued $20.0 million in rising interest subordinated redeemable securities due January 1, 2006 (the "Notes"). The Notes are unsecured general obligations of the Company. Interest on the Notes is payable on the first day of each month, commencing February 1, 1996, at an interest rate of 10.0% per annum. The interest rate increases 0.25% on each January 1 for the first nine years and 0.50% in the last year. In connection with the issuance of the Notes, the Company incurred and capitalized issuance costs of $1,105,695. The Company recognizes interest and amortization expense related to the Notes using a method which approximates the effective interest method over the expected redemption period. The Notes are subordinated to certain existing and future indebtedness of the Company as defined in the indenture agreement. The Company is required to redeem, subject to certain adjustments, $1.0 million of the aggregate principal amount of the Notes through the operation of a sinking fund on each of January 1, 2000, 2001, 2002, 2003, 2004 and 2005. The Notes are not redeemable at the option of the Company prior to January 1, 1998. The Company may at its option elect to redeem the Notes from the registered holders of the Notes, in whole or in part, at any time, on or after January 1, 1998, and prior to January 1, 1999, at 102% of their principal amount, on or after January 1, 1999, and prior to January 1, 2000, at 101% of their principal amount, and on or after January 1, 2000, at 100% of their principal amount, in each case plus accrued interest to and including the date of redemption. On March 12, 1993, the Company issued a $2 million five year convertible subordinated note ("Note 1") to an institutional investor in conjunction with an agreement by that investor to commit to purchase up to $50 million of the Company's Contracts. Interest accrued at 11% and was payable semi-annually. On July 5, 1995, the holder converted Note 1 to 533,334 shares of the Company's common stock. On November 16, 1993, the Company issued a $3 million five year convertible subordinated note ("Note 2") to the same institutional investor in conjunction with an agreement by that investor to commit to purchase an additional $50 million of the Company's Contracts. Interest accrued at 9.5% and was payable semi-annually. On January 17, 1997, the holder converted Note 2 into 480,000 shares of the Company's common stock. On May 15, 1994, the Company issued a promissory note in the amount of $2.0 million to the same institutional investor who held Note 2. On October 25, 1994, the Company borrowed an additional $3.0 million under two new promissory notes from two different institutional investors. These promissory notes bore interest at 400 basis points over the Citibank Base Rate and matured on February 28, 1995, with provisions for extensions to April 30, 1995, at the option of the Company. The Company repaid each of these notes with the proceeds from its March 7, 1995, public common stock offering. F-22 CONSUMER PORTFOLIO SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEAR ENDED DECEMBER 31, 1996, NINE MONTHS ENDED DECEMBER 31, 1995 AND YEAR ENDED MARCH 31, 1995 (11) DEBT (CONTINUED) On July 6, 1995, the Company issued a promissory note in the amount of $2.0 million to the same institutional investor who held Note 2. The note bore interest at 200 basis points over the Citibank Base Rate and matured on December 31, 1995. On December 6, 1995, this note was repaid in full. (12) EMPLOYEE BENEFITS The Company sponsors a pretax savings and profit sharing plan (the "401(K) Plan") under section 401(k) of the Internal Revenue Code. Under the 401(K) Plan, eligible employees are able to contribute up to 15% of their compensation (subject to stricter limitation in the case of highly compensated employees). The Company matches 40% of employees' contributions up to $500 per employee per calendar year. The Company's contribution to the 401(K) Plan was $63,801, $13,811, and $16,245 for the year ended December 31, 1996, for the nine months ended December 31, 1995, and for the year ended March 31, 1995, respectively. (13) FAIR VALUE OF FINANCIAL INSTRUMENTS The following summary presents a description of the methodologies and assumptions used to estimate the fair value of the Company's financial instruments. Much of the information used to determine fair value is highly subjective. When applicable, readily available market information has been utilized. However, for a significant portion of the Company's financial instruments, active market values do not exist. Therefore, considerable judgments were required in estimating fair value for certain items. The subjective factors include, among other things, the estimated timing and amount of cash flows, risk characteristics, credit quality and interest rates, all of which are subject to change. Since the fair value is estimated as of December 31, 1996, 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, 1996, were as follows: CASH The carrying value equals fair value. F-23
DECEMBER 31, ---------------------------------------------------------- 1996 1995 ---------------------------- ---------------------------- CARRYING FAIR CARRYING FAIR FINANCIAL INSTRUMENT VALUE VALUE VALUE VALUE - ---------------------------------------------------- ------------- ------------- ------------- ------------- Cash................................................ $ 153,958 $ 153,958 $ 10,895,157 $ 10,895,157 Contracts held for sale............................. 21,656,773 22,800,000 19,548,842 20,700,000 Investment in subordinated certificates............. -- -- 2,174,666 2,174,666 Investment in credit enhancements................... 43,597,472 43,597,472 30,477,793 30,477,793 Excess servicing receivable......................... 23,654,461 23,654,461 11,108,251 11,108,251 Warehouse line of credit............................ 13,264,585 13,264,585 7,500,000 7,500,000 Notes payable....................................... 20,000,000 20,000,000 20,000,000 20,000,000 Convertible subordinated debt....................... $ 3,000,000 $ 3,000,000 $ 3,000,000 $ 3,000,000 CONSUMER PORTFOLIO SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEAR ENDED DECEMBER 31, 1996, NINE MONTHS ENDED DECEMBER 31, 1995 AND YEAR ENDED MARCH 31, 1995 (13) FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED) CONTRACTS HELD FOR SALE The fair value of the Company's contracts held for sale is determined in the aggregate based upon current investor yield requirements and by discounting the future cash flows using the current credit and discount rates that the Company believes reflect the estimated credit, interest rate and prepayment risks associated with similar types of instruments. INVESTMENTS IN SUBORDINATED CERTIFICATES 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. INVESTMENTS IN CREDIT ENHANCEMENTS 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. EXCESS SERVICING RECEIVABLES 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. WAREHOUSE LINE OF CREDIT The carrying value approximates fair value because the warehouse line of credit is short-term in nature and the related interest rates are estimated to reflect current market conditions for similar types of instruments. NOTES PAYABLE The fair value is estimated based on quoted market prices and on current rates for similar debt with similar remaining maturities. CONVERTIBLE SUBORDINATED DEBT The carrying value approximates fair value because the related interest rates are estimated to reflect current market conditions for similar types of instruments. (14) SUBSEQUENT EVENTS (UNAUDITED) In January 1997, the Company purchased 80% of the outstanding stock of SLI from Charles E. Bradley, Sr., Chairman of the Board of Directors and principal shareholder, and John G. Poole, a director of the Company, for a purchase price of $100,000. The transaction was considered and approved by the independent members of the Board of Directors of the Company. F-24 CONSUMER PORTFOLIO SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEAR ENDED DECEMBER 31, 1996, NINE MONTHS ENDED DECEMBER 31, 1995 AND YEAR ENDED MARCH 31, 1995 (14) SUBSEQUENT EVENTS (UNAUDITED, CONTINUED) The Company has filed a Form S-3 Registration Statement with the Securities and Exchange Commission pursuant to which it plans to sell approximately $22 million in unsecured Participating Equity Notes due in 2004. Twenty-five percent of each note is convertible into common stock of the Company at maturity or in connection with redemption. The notes will be subordinate to all existing and future senior indebtedness. There can be no assurance that all or any of such notes will be sold. (15) SELECTED QUARTERLY DATA (UNAUDITED) F-25
QUARTER ENDED QUARTER ENDED QUARTER ENDED QUARTER ENDED MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, -------------- -------------- -------------- -------------- 1996 Revenues........................................ $ 9,907,581 $ 12,485,185 $ 13,758,526 $ 15,042,511 Income before income taxes...................... 5,101,297 5,517,249 6,451,297 6,622,553 Net income...................................... 3,051,297 3,271,229 3,834,297 3,940,553 Net income per common and common equivalent share......................................... 0.21 0.22 0.26 0.26 Fully diluted net income per common and common equivalent share.............................. 0.20 0.22 0.25 0.26 1995 Revenues........................................ $ 6,518,853 $ 8,089,304 $ 7,852,191 $ 8,313,218 Income before income taxes...................... 3,376,694 4,075,286 4,175,663 4,406,359 Net income...................................... 2,019,189 2,342,207 2,532,645 2,700,270 Net income per common and common equivalent share......................................... 0.18 0.18 0.18 0.18 Fully diluted net income per common and common equivalent share.............................. 0.18 0.16 0.18 0.18 EXHIBIT INDEX Exhibit 3.1....Restated Articles of Incorporation of the Company, as amended on December 13, 1993, and March 7, 1996. (A) Exhibit 3.2....Amended and Restated By-Laws of the Company, adopted November 30, 1993. (B) Exhibit 4.1....The Indenture dated December 15, 1995, between Consumer Portfolio Services, Inc., and Harris Trust and Savings Bank. (C) Exhibit 4.2....First Supplemental Indenture dated December 15, 1995, between Consumer Portfolio Services, Inc., and Harris Trust and Savings Bank. (C) Exhibit 10.1...1991 Stock Option Plan as amended on April 27, 1994, and forms of Stock Option Agreement. (B) Exhibit 10.2...Lease Agreement dated February 14, 1991 between Holdings and Irvine Technology Partners ("ITP"), First Amendment to Lease dated as of June 26, 1992 by and among ITP, Holdings and the Company and Assignment and Assumption of Lease dated April 1, 1992 by and between Holdings and the Company. (D) Exhibit 10.3...Amendment #2, dated January 17, 1995, between ITP and Consumer Portfolio Services, Inc., to Lease Agreement dated February 14, 1991, between Holdings and Irvine Technology Partners ("ITP"), First Amendment to Lease dated as of June 26, 1992, by and among ITP, Holdings and the Company and Assignment and Assumption of Lease dated April 1, 1992, by and between Holdings and the Company. (E) Exhibit 10.4...Form of Automobile Dealer Agreement between the Company and its Dealers and the related Assignment. (D) Exhibit 10.5...Consulting Agreement dated February 14, 1996, by and between the Company and Stanwich Partners, Inc. (A) Exhibit 10.6...The Receivables Funding and Servicing Agreement, dated June 1, 1995, between Consumer Portfolio Services, Inc., CPS Funding Corp., Redwood Receivables Corporation and General Electric Capital Corporation. (A) Exhibit 10.7...Amended and Restated Motor Vehicle Installment Contract Loan and Security Agreement, dated June 1, 1995, between Consumer Portfolio Services, Inc., and General Electric Capital Corporation. (A) Exhibit 10.8...Agreement and Plan of Merger, dated August 30, 1995, between Consumer Portfolio Services, Inc., and CPS Holdings, Inc. (F) Exhibit 10.9...Promissory Note, dated September 27, 1995, made by the Company in favor of Charles E. Bradley, Sr., in the aggregate principal amount of $2,000,000.(A) Exhibit 10.10..Promissory Note, dated July 6, 1995, made by the Company in favor of SunAmerica, Inc., in the aggregate principal amount of $2,000,000. (A) Exhibit 10.11..Lease Agreement dated December 9, 1996 between the Company and The Prudential Insurance Company of America, relating to the Company's branch facility in Chesapeake, Virginia. (G) Exhibit 11.0...Statement re Computation of Per Share Earnings. Exhibit 12.....Statement re Computation of Ratios. (H) Exhibit 21.1...Subsidiaries of the Company. (G) Exhibit 23.1...Consent of independent auditors. Exhibit 24.1...Powers of Attorney. (G) Exhibit 27.....Financial Data Schedule. (G) Exhibit 99.....Risk Factors - ----------------- A. Previously filed as an exhibit to the Company's Form 10-KSB for the transition period ended December 31, 1995, and incorporated herein by reference. B. Previously filed as an exhibit to the Company's Form 10-KSB for the fiscal year ended March 31, 1994, and incorporated herein by reference. C. Previously filed as an exhibit to the Company's Form 8-K, filed on December 26, 1995, and incorporated herein by reference. D. Previously filed as an exhibit to the Company's Registration Statement on Form S-1, No. 33-49770, as amended, and incorporated herein by reference. E. Previously filed as an exhibit to the Company's Form 10-KSB for the fiscal year ended March 31, 1995, and incorporated herein by reference. F. Previously filed as an exhibit to the Company's Proxy Statement for the September 26, 1995, Annual Meeting, and incorporated herein by reference. G. Previously filed as an exhibit to this report, on March 31, 1997. H. Previously filed as an exhibit to the Company's Registration Statement on Form S-3, No. 333-21289, as amended on March 4, 1997, and incorporated herein by reference.
Consumer Portfolio Services, Inc. Statement Regarding Computation of Per Share Earnings (Loss) Exhibit 11
Nine month transition Primary earnings (loss) per share Year ended period ended December 31, December 31, Year ended March 31, ------------------- --------------------- ------------------------------------- 1996 1995 1995 1994 1993 ---- ---- ---- ---- ---- Computation for Statement of Operations; Net earnings (loss) per statement of operations used in primary earnings (loss) per share computation Net earnings (loss) $ 14,097,376 $ 7,575,122 $6,665,630 $(1,778,069) $(1,502,272) Interest on borrowings, net of tax effect, on application of assumed proceeds from exercise of warrants and options in excess of 20% limitations - - - - - ------------------- --------------------- ---------- ----------- ------------ Net earnings (loss) as adjusted $ 14,097,376 $ 7,575,122 $6,665,630 $(1,778,069) $(1,502,272) ------------------- --------------------- ---------- ----------- ------------ ------------------- --------------------- ---------- ----------- ------------ Weighted average number of shares outstanding 13,489,247 11,582,625 8,903,596 8,520,548 6,378,082 Net shares issuable from assumed exercise of warrants and options, as determined by the application of the Treasury Stock Method 1,360,362 2,740,967 2,240,172 - - Weighted average number of -------------------- --------------------- ---------- ----------- ------------ shares outstanding 14,849,609 14,323,592 11,143,268 8,520,548 6,378,582 -------------------- --------------------- ---------- ----------- ------------ -------------------- --------------------- ---------- ----------- ------------ Primary earnings (loss) per -------------------- --------------------- ---------- ----------- ------------ share, as adjusted $ 0.95 $ 0.53 $ 0.60 $ (.21) $ (0.24) -------------------- --------------------- ---------- ----------- ------------ -------------------- --------------------- ---------- ----------- ------------ Consumer Portfolio Services, Inc. Statement Regarding Computation of Per Share Earnings (Loss) - (continued) Exhibit 11
Nine month transition Fully diluted earnings (loss) per share Year ended period ended December 31, December 31, Year ended March 31, -------------- -------------- ------------------------------------------- Computation for Statement of Operations: 1996 1995 1995 1994 1993 ---- ---- ---- ---- ---- Net earnings (loss) per statement of operations used in fully diluted earnings (loss) per share computation Net earnings (loss) $ 14,097,376 $ 7,575,122 $ 6,665,630 $ (1,778,069) $ (1,502,272) Interest on borrowings, net of tax effect, on application of assumed proceeds from exercise of warrants and options in excess of 20% limitations - - - - - Interest on borrowings, net of tax effect on conversion of convertible subordinated debt 169,575 127,823 301,990 - - --------------- -------------- -------------- --------------- --------------- Net earnings (loss) as adjusted $ 14,266,951 $ 7,702,945 $ 6,967,620 $ (1,778,069) $ (1,502,272) --------------- -------------- -------------- --------------- --------------- --------------- -------------- -------------- --------------- --------------- Weighted average number of shares outstanding 13,489,247 11,582,625 8,903,096 8,520,548 6,378,082 Net shares issuable from assumed exercise of warrants and options, as determined by the application of the Treasury Stock Method 1,440,797 2,740,967 2,621,922 - - Shares issuable from assumed conversion 480,000 480,000 1,013,334 - - of subordinated debt Weighted average number of --------------- -------------- -------------- --------------- --------------- shares outstanding 15,410,044 14,803,592 12,538,352 8,520,548 6,378,082 --------------- -------------- -------------- --------------- --------------- --------------- -------------- -------------- --------------- --------------- Fully diluted earnings (loss) per --------------- -------------- -------------- --------------- --------------- share, as adjusted $ 0.93 $ 0.52 $ 0.56 $ (0.21) $ (0.24) --------------- -------------- -------------- --------------- --------------- --------------- -------------- -------------- --------------- ---------------
Exhibit 23.1 INDEPENDENT AUDITORS' CONSENT The Board of Directors Consumer Portfolio Services, Inc.: We consent to incorporation by reference in the registration statements (Nos. 33-77314, 33-82778, 333-00880, 333-00736 and 333-21289) on Form S-3 and (Nos. 33-78680 and 33-80327) on Form S-8 of Consumer Portfolio Services, Inc. of our report dated February 14, 1997, relating to the consolidated balance sheets of Consumer Portfolio Services, Inc. and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations, shareholders' equity and cash flows for the year ended December 31, 1996, for the nine-month period ended December 31, 1995, and for the year ended March 31, 1995, which report appears in the December 31, 1996 annual report on Form 10-K/A of Consumer Portfolio Services, Inc. KPMG PEAT MARWICK LLP Orange County, California April 14, 1997
EXHIBIT 99 RISK FACTORS LIQUIDITY AND CAPITAL RESOURCES LIQUIDITY. The Company requires significant operating cash to purchase Contracts. As a result of the Company's expansion since inception and its program of securitizing and selling Contracts, the Company's cash requirements have in the past exceeded cash generated from operations. The Company's primary operating cash requirements include the funding of (a) purchases of Contracts pending their pooling and sale, (b) Spread Accounts in connection with sales or securitizations of Contracts, (c) fees and expenses incurred in connection with its sales and securitizations of Contracts, (d) tax payments and (e) ongoing administrative and other operating expenses. Net cash used in operating activities during fiscal 1995, the nine-month transition period ended December 31, 1995, and the year ended December 31, 1996 was $6.1 million, $18.5 million, and $9.7 million, respectively. The Company has obtained these funds in three ways: (a) loans and warehouse financing arrangements, pursuant to which Contracts are financed on a temporary basis; (b) securitizations or sales of Contracts, pursuant to which Contracts are sold; and (c) external financing. At December 31, 1996 the Company had cash of approximately $154,000. CASH REQUIREMENTS ASSOCIATED WITH SECURITIZATION TRUSTS. Under the financial structures the Company has used to date in its seventeen securitizations, certain excess servicing cash flows generated by the Contracts are retained in a Spread Account within the securitization trusts to provide liquidity and credit enhancement. While the specific terms and mechanics of the Spread Account vary slightly among transactions, the Company's agreements with Financial Security Assurance, Inc. ("FSA"), the financial guaranty insurer that has provided credit enhancements in connection with the Company's securitizations since June 1994, generally provide that the Company is not entitled to receive any excess servicing cash flows unless certain Spread Account balances have been attained and/or the delinquency or losses related to the Contracts in the pool are below certain predetermined levels. In the event delinquencies and losses on the Contracts exceed such levels, the terms of the securitization may require increased Spread Account balances to be accumulated for the particular pool; may restrict the distribution to the Company of excess cash flows associated with other pools in which asset-backed securities are insured by FSA; or, in certain circumstances, may require the transfer of servicing on some or all of the Contracts in FSA-insured pools to another servicer. The imposition by FSA of any of these conditions could materially adversely affect the Company's liquidity and financial condition. In the past, delinquency and loss levels on ten of the FSA-insured pools have attained levels which temporarily resulted in increased Spread Account requirements for those pools. As of December 31, 1996, all FSA-insured pools were performing within the guidelines required by their related insurance policies and therefore were not subject to increased Spread Account requirements. DEPENDENCE ON WAREHOUSE FINANCING. One of the Company's primary sources of financing is its $100.0 million warehouse line of credit (the "Warehouse Line of Credit"), under which the Company borrows against Contracts held for sale, pending their sale in securitization transactions. The Warehouse Line of Credit expires in 1998. The Company expects to be able to maintain existing warehouse arrangements (or to obtain replacement or additional financing) as current arrangements expire or become fully utilized; however, there can be no assurance that such financing will be obtainable on favorable terms. To the extent that the Company is unable to maintain its existing Warehouse Line of Credit or is unable to arrange new warehouse lines of credit, the Company may have to curtail Contract purchasing activities, which could have a material adverse effect on the Company's financial condition and results of operations. DEPENDENCE ON SECURITIZATION PROGRAM. The Company is dependent upon its ability to continue to pool and sell Contracts in order to generate cash proceeds for new purchases. Adverse changes in the market for securitized Contract pools, or a substantial lengthening of the warehousing period, would burden the Company's financing capabilities, could require the Company to curtail its purchase of Contracts, and could have a material adverse effect on the Company. In addition, as a means of reducing the percentage of cash collateral that the Company would otherwise be required to deposit and maintain in Spread Accounts, all of the Company's securitizations since June 1994 have utilized credit enhancement in the form of financial guaranty insurance policies issued by FSA to achieve "AAA/Aaa" ratings for the asset-backed securities that have been sold to investors. The Company believes that financial guaranty insurance policies reduce the costs of securitizations relative to alternative forms of credit enhancements available to the Company. FSA is not required to insure Company-sponsored securitizations and there can be no assurance that it will continue to do so or that future securitizations will be similarly rated. Similarly, there can be no assurance that any securitization transaction will be available on terms acceptable to the Company, or at all. The timing of any securitization transaction is affected by a number of factors beyond the Company's control, any of which could cause substantial delays, including, without limitation, market conditions and the approval by all parties of the terms of the securitization. Any delay in the sale of a pool of Contracts beyond a quarter-end could reduce the gain on sale recognized in such quarter and could result in decreased earnings or possible losses for such quarter being reported by the Company. ECONOMIC CONSIDERATIONS RISK OF GENERAL ECONOMIC DOWNTURN. The Company's business is directly related to sales of new and used automobiles, which are affected by employment rates, prevailing interest rates and other domestic economic conditions. Delinquencies, foreclosures and losses generally increase during economic slowdowns or recessions. Because of the Company's focus on Sub-Prime Borrowers, the actual rates of delinquencies, repossessions and losses on such Contracts could be higher under adverse economic conditions than those currently experienced in the automobile finance industry in general. Any sustained period of economic slowdown or recession could adversely affect the Company's ability to sell or securitize pools of Contracts. The timing of any economic changes is uncertain, and sluggish sales of automobiles and weakness in the economy could have an adverse effect on the Company's business and that of the Dealers from which it purchases Contracts. CREDITWORTHINESS OF BORROWERS. The Company specializes in the purchase, sale and servicing of Contracts to finance automobile purchases by Sub-Prime Borrowers, which entail a higher risk of non-performance, higher delinquencies and higher losses than Contracts with more creditworthy borrowers. While the Company believes that the underwriting criteria and collection methods it employs enable it to control the higher risks inherent in Contracts with Sub-Prime Borrowers, no assurance can be given that such criteria and methods will afford adequate protection against such risks. Since inception, the Company has expanded its operations significantly and has rapidly increased its Servicing Portfolio. Because there is limited performance data available with respect to that portion of the Company's Servicing Portfolio purchased most recently, historical delinquency and loss statistics are not necessarily indicative of future performance. The Company has experienced fluctuations in the delinquency and charge-off performance of its Contracts, including an upward trend for each. The Company believes, however, that such fluctuations are normal and that the upward trend is the result of the seasoning of the Servicing Portfolio. In the event that portfolios of Contracts sold and serviced by the Company experience greater defaults, higher delinquencies or higher losses than anticipated, the Company's earnings could be negatively impacted. In addition, the Company bears the entire risk of loss on Contracts it holds for sale. A larger number of defaults than anticipated could also result in adverse changes in the structure of the Company's future securitization transactions, such as increased interest rates on the asset-backed securities issued in those transactions. CONTRACTS MAY BE ONLY PARTIALLY SECURED. Although the Contracts are each secured by a lien on the purchased vehicle, a repossession in the event of default generally does not yield proceeds sufficient to pay all amounts owing under a Contract. The actual cash value of the vehicle may be less than the amount financed at inception of the Contract, and also thereafter, because the amount financed may be as much as 115% of the wholesale book value in the case of used vehicles or 110% of manufacturer's invoice in the case of new vehicles, plus sales tax, licensing fees, and any service contract or credit life or disability policy purchased by the borrower, less the borrower's down payment and/or trade-in allowance (generally not less than 10% of the vehicle sales price). In addition, the proceeds available upon resale are reduced by statutory liens, such as those for repairs, storage, unpaid taxes and unpaid parking fines, and by the costs incurred in the repossession and resale. Unless the Contract is sufficiently seasoned that the borrower has substantial equity in the vehicle, the proceeds of sale are generally insufficient to pay all amounts owing. For that reason, the Company's collection policies aim to avoid repossession to the extent possible. GEOGRAPHIC CONCENTRATION OF BUSINESS. For the year ended December 31, 1996, the Company purchased 25.8% of its Contracts from Dealers located in California, and its prospects are dependent, in part, upon economic conditions prevailing in this state. Such geographic concentration increases the potential impact of collection disruptions and casualty losses on the financed vehicles which could result from regional economic or catastrophic events. Although the percentage of the Servicing Portfolio purchased from Dealers in California has been declining as the Company's volume of Contract purchases has increased, at December 31, 1996, 33.3% of the Servicing Portfolio represents obligations of automobile purchasers in California. Accordingly, an economic slowdown in California could result in a decline in the availability of Contracts for purchase by the Company as well as an increase in delinquencies and repossessions. Such conditions could have a material adverse effect on the Company's revenue and results of operations. POSSIBLE INCREASE IN COST OF FUNDS. The Company's profitability is determined by, among other things, the difference between the rate of interest charged on the Contracts purchased by the Company and the pass-through rate of interest (the "Pass-Through Rate") payable to investors on portfolios of Contracts sold by the Company. The Contracts purchased by the Company generally bear the maximum finance charges permitted by applicable state law. The fixed Pass-Through Rates payable to investors on portfolios of Contracts sold by the Company are based on interest rates prevailing in the market at the time of sale. Consequently, increases in market interest rates tend to reduce the "spread" or margin between Contract finance charges and the Pass-Through Rates required by investors and, thus, the potential operating profits to the Company from the purchase, sale and servicing of Contracts. Operating profits expected to be earned by the Company on portfolios of Contracts previously sold are insulated from the adverse effects of increasing interest rates because the Pass-Through Rates on such portfolios were fixed at the time the Contracts were sold. Any future increases in interest rates would likely increase the Pass-Through Rates for future portfolios sold and could have a material adverse effect on the Company's results of operations. PREPAYMENT AND DEFAULT RISK. Gains from the sale of Contracts in the Company's seventeen securitization transactions have constituted a significant portion of the net earnings of the Company and are likely to continue to represent a significant portion of the Company's net earnings. A portion of the gains are based in part on management's estimates of future prepayment and default rates and other considerations in light of then-current conditions. If actual prepayments with respect to Contracts occur more quickly than was projected at the time such Contracts were sold, as can occur when interest rates decline, or if default rates are greater than projected at the time such Contracts were sold, a charge to earnings may be required and would be taken in the period of adjustment. If actual prepayments occur more slowly or if default rates are lower than estimated with respect to Contracts sold, total revenue would exceed previously estimated amounts. Actual default and prepayment performance, both in the aggregate and as to each securitization trust, has been materially consistent with management's estimates. No material charges to earnings have occurred as a result of default and prepayment performance. However, there can be no assurance that charges to earnings will not occur in the future as a result of actual default and prepayment performance exceeding management's estimates. COMPETITION The automobile financing business is highly competitive. The Company competes with a number of national, local and regional finance companies. In addition, competitors or potential competitors include other types of financial services companies, such as commercial banks, savings and loan associations, leasing companies, credit unions providing retail loan financing and lease financing for new and used vehicles and captive finance companies affiliated with major automobile manufacturers such as General Motors Acceptance Corporation, Ford Motor Credit Corporation, Chrysler Credit Corporation and Nissan Motors Acceptance Corporation. Many of the Company's competitors and potential competitors possess substantially greater financial, marketing, technical, personnel and other resources than the Company. Moreover, the Company's future profitability will be directly related to the availability and cost of its capital relative to that of its competitors. The Company's competitors and potential competitors include far larger, more established companies that have access to capital markets for unsecured commercial paper and investment grade rated debt instruments, and to other funding sources which may be unavailable to the Company. Many of these companies also have long-standing relationships with Dealers and may provide other financing to Dealers, including floor plan financing for the Dealers' purchases of automobiles from manufacturers, which is not offered by the Company. There can be no assurance that the Company will be able to continue to compete successfully. MANAGEMENT OF RAPID GROWTH The Company has experienced rapid growth and expansion of its business. The Company's ability to support and manage continued growth is dependent upon, among other things, its ability to hire, train, supervise and manage the increased personnel. Furthermore, the Company's ability to manage portfolio delinquency and loss rates is dependent upon the maintenance of efficient collection procedures, adequate collection staffing, internal controls, and automated systems. There can be no assurance that the Company's personnel, procedures, staff, internal controls, or systems will be adequate to support such growth. RESTRICTIONS IMPOSED BY THE TERMS OF THE COMPANY'S INDEBTEDNESS The Warehouse Line of Credit and the indentures governing the notes ("Notes") that the Company proposes to issue in April 1997("Indenture") and the notes ("1995 Notes") that the Company issued in December 1995("1995 Indenture") contain covenants limiting, among other things, the nature and amount of additional indebtedness that the Company may incur. These covenants could limit the Company's ability to withstand competitive pressures or adverse economic conditions, make acquisitions or take advantage of business opportunities that may arise. Failure to comply with these covenants could, as provided in the Warehouse Line of Credit, permit the lender under the Warehouse Line of Credit to accelerate payment of the amounts borrowed under the facility or, as provided in the 1995 Indenture, permit the indenture trustee thereunder to accelerate payment of the 1995 Subordinated Debt. POTENTIAL FOR ADDITIONAL SENIOR INDEBTEDNESS Under the Indenture and the 1995 Indenture, the Company will be permitted to incur substantial additional senior indebtedness. Based on the Company's consolidated stockholders' equity as of December 31, 1996, the Company would be permitted to borrow approximately $328 million in Senior Indebtedness. Effective January 17, 1997, an outstanding $3 million convertible subordinated note was converted into 480,000 shares of the Company's Common Stock. The anticipated sale of the Notes, as to which there can be no assurance, would increase the Company's outstanding subordinated indebtedness. The interest expense associated with the Notes and the potential interest expense associated with the maximum permitted Senior Indebtedness could substantially increase the Company's fixed charge obligations and could potentially limit the Company's ability to meet its obligations under the Notes. ABILITY TO REPAY NOTES UPON ACCELERATED REDEMPTION Upon the occurrence of a Special Redemption Event (certain events or transactions that result in a change in control of the Company), each holder of the Notes or the 1995 Notes will have the right to require that the Company purchase the holder's notes at 100% of the principal amount plus accrued interest. If a Special Redemption Event should occur, there can be no assurance that the Company will have available funds sufficient to pay that purchase price for all of the notes that might be delivered by holders seeking to exercise such rights. In the event the Company is required to purchase outstanding notes pursuant to a Special Redemption Event, the Company expects that it would seek third party financing to the extent it does not have available funds to meet its purchase obligations. However, there can be no assurance that the Company would be able to obtain such financing, and, if obtained, the terms of any such financing may be less favorable than the terms of the notes. LITIGATION Because of the consumer-oriented nature of the industry in which the Company operates and the application of certain laws and regulations, industry participants are regularly named as defendants in class-action litigation involving alleged violations of federal and state laws and regulations and consumer law torts, including fraud. Many of these actions involve alleged violations of consumer protection laws. Although the Company is not involved in any material litigation, a significant judgment against the Company or within the industry in connection with any such litigation could have a material adverse effect on the Company's financial condition and results of operations. DEPENDENCE ON DEALERS The Company is dependent upon establishing and maintaining relationships with unaffiliated Dealers to supply it with Contracts. As of December 31, 1996 the Company was a party to Dealer Agreements with 2,182 Dealers. During the year ended December 31, 1996, no Dealer accounted for more than 2.3% of the Contracts purchased by the Company. The Dealer Agreements do not require Dealers to submit a minimum number of Contracts for purchase by the Company. The failure of Dealers to submit Contracts that meet the Company's underwriting criteria would have a material adverse effect on the Company's financial condition and results of operations. CONTRACTUAL RECOURSE BY PURCHASERS OF CONTRACTS Purchasers of Contracts have recourse against the Company in the event of the Company's breach of its representations and warranties to the purchaser (relating to the enforceability and validity of the Contracts) or certain defaults with respect to the Contracts. In such cases, recourse is limited to requiring the Company to repurchase the Contracts in question. In the event the Company is required to repurchase a Contract, the Company will generally have similar recourse against the Dealer from which it purchased the Contract; however, there can be no assurance that any Dealer will have the financial resources to satisfy its repurchase obligations to the Company. Subject to any recourse against Dealers, the Company will bear any loss on repossession and resale of vehicles financed under Contracts repurchased by it from investors, which could have a material adverse effect on the financial condition and results of operations of the Company. At December 31, 1996, the Servicing Portfolio subject to recourse was $483.1 million. To date, the Company has never been required to repurchase a Contract due to a breach of its representations and warranties to the trust. However, the Company has voluntarily repurchased Contracts from the trusts when the collateral suffers an uninsured casualty loss. In the event of a repurchase, the Company is not obligated to replace the Contract repurchased. For the year ended December 31, 1996, aggregate repurchases of Contracts with uninsured casualty losses, and the amount of losses thereon, were approximately $1.7 million. The Company may or may not continue its practice of voluntarily repurchasing Contracts from the trusts. GOVERNMENT REGULATION The Company's business is subject to numerous federal and state consumer protection laws and regulations, which, among other things: (i) require the Company to obtain and maintain certain licenses and qualifications; (ii) limit the interest rates, fees and other charges the Company is allowed to charge; (iii) limit or prescribe certain other terms of its Contracts; (iv) require the Company to provide specified disclosures; and (v) regulate certain servicing and collection practices and define its rights to repossess and sell collateral. An adverse change in existing laws or regulations, or in the interpretation thereof, the promulgation of any additional laws or regulations, the failure to comply with such laws and regulations or the expansion of the Company's business into jurisdictions with more stringent requirements could have a material adverse effect on the Company's financial condition and results of operations. OPERATING LOSSES IN PRIOR YEARS The Company incurred net losses for each of fiscal 1993 and 1994 of $1.5 million, and $1.8 million, respectively. Losses incurred through the end of fiscal 1993 were attributable primarily to the Company's relatively high degree of fixed operating costs as compared to its revenue in those years. The net loss for fiscal 1994 was attributable entirely to a one-time, non-cash accounting charge reflecting the release of the Escrow Shares. Although the Company generated net income of $6.7 million for fiscal 1995, $7.6 million for the nine-month transition period ended December 31, 1995, and $14.1 million for the year ended December 31, 1996, there can be no assurance that the Company will not sustain losses in the future. DEPENDENCE ON KEY PERSONNEL The Company's success is largely dependent on the efforts of Charles E. Bradley, Jr., its President, Jeffrey P. Fritz, its Senior Vice President--Chief Financial Officer, and on Nicholas P. Brockman, William J. Brummund, Jr., Richard P. Trotter, Curtis K. Powell, and Mark A. Creatura, each of whom is a Senior Vice President responsible for a different aspect of the Company's operations. The Company has not entered into employment agreements with any of these individuals and the loss of the services of any of these individuals could have a material adverse effect on the Company. The Company has obtained "key man" life insurance on Messrs. Bradley and Fritz in the amount of $1.0 million each. CONTROL OF THE COMPANY As of December 31, 1996, Charles E. Bradley, Jr., his father, Charles Bradley, Sr., and other members of his family beneficially owned 3,847,497 shares of outstanding Common Stock, and held options or other rights to acquire an additional 867,640 shares. Such shares represent approximately 27.0% of the outstanding Common Stock of the Company (or 31.2%, upon assumed exercise of all such options). As a result of their ownership of Common Stock, they and the other directors of the Company collectively are able, as a practical matter, to elect a majority of the Company's Board of Directors, to cause an increase in the authorized capital or the dissolution, merger or sale of the assets of the Company, and generally to direct the affairs of the Company.