<PAGE>
PROSPECTUS
DATED APRIL 15, 1997
$20,000,000
CONSUMER PORTFOLIO SERVICES, INC.
10.50% PARTICIPATING EQUITY NOTES-SM- DUE 2004
"PENS"-SM-
----------------
The 10.50% Participating Equity Notes-SM- ("PENs-SM-") due April 15, 2004 (the
"Notes") being offered hereby (the "Offering") will be unsecured general
obligations of Consumer Portfolio Services, Inc., a California corporation (the
"Company"). Interest on the Notes will be payable on the 15th day of each month
(each, an "Interest Payment Date"), commencing May 15, 1997. The Notes will be
subordinated to all existing and future Senior Indebtedness (as defined herein)
of the Company. As of December 31, 1996, there was approximately $13.3 million
of Senior Indebtedness outstanding.
The Notes are not redeemable at the option of the Company prior to April 15,
2000. The Company may at its option elect to redeem the Notes from the
registered holders of the Notes ("Holders"), in whole but not in part, at any
time on or after April 15, 2000 at 100% of their principal amount, subject to
limited conversion rights, plus accrued interest to and including the date of
redemption. At maturity or upon the exercise by the Company of an optional
redemption each Holder will have the right to convert into common stock of the
Company ("Common Stock") 25% of the aggregate principal amount of the Notes held
by such Holder and if a Special Redemption Event occurs, Holders who require the
redemption of their Notes will have the right to convert up to 25% of the
principal amount thereof into Common Stock, in each case, at the conversion
price of $10.15 per share of Common Stock (equivalent to approximately 24.63
shares of Common Stock for each $250 portion of each $1,000 principal amount of
Notes) as adjusted as described herein. The Company will be required, at the
option of the Holder and at a redemption price of 100% of the principal amount
plus accrued interest to and including the redemption date, to redeem Notes
properly tendered following a Special Redemption Event. A Special Redemption
Event is limited to certain events or transactions that result in a change of
control of the Company. The Common Stock trades on the Nasdaq National Market
under the symbol "CPSS." On April 15, 1997, the last reported sale price of the
Common Stock was $8.125 per share. See "Description of the Notes."
The Notes will be issued initially only in fully registered book-entry form. The
minimum principal amount of Notes which may be purchased is $1,000. The Notes
have been approved for listing on the New York Stock Exchange, Inc., subject to
official notice of issuance. Although the Underwriters have each indicated an
intention to make a market in the Notes, none of the Underwriters is obligated
to make a market in the Notes and any market making may be discontinued at any
time at the sole discretion of such Underwriter. See "Underwriting."
SEE "RISK FACTORS" BEGINNING ON PAGE 10 FOR CERTAIN INFORMATION THAT SHOULD BE
CONSIDERED BY PROSPECTIVE PURCHASERS OF THE NOTES OFFERED HEREBY.
---------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
PRICE TO UNDERWRITING PROCEEDS TO
PUBLIC DISCOUNT(1) COMPANY(2)
<S> <C> <C> <C>
Per Note....................................... 100% 4.0% 96.0%
Total(3)....................................... $20,000,000 $800,000 $19,200,000
</TABLE>
(1) The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act of 1933, as
amended (the "Securities Act"). See "Underwriting."
(2) Before deducting offering expenses payable by the Company estimated to be
$270,000.
(3) The Company has granted the Underwriters a 30-day option to purchase up to
an aggregate principal amount of $3,000,000 of additional Notes on the same
terms and conditions shown above, solely to cover over-allotments, if any.
If the Underwriters exercise such option in full, the total Price to Public,
Underwriting Discount and Proceeds to Company will be $23,000,000, $920,000
and $22,080,000, respectively. See "Underwriting."
--------------------------
The Notes are offered by the several Underwriters subject to prior sale when, as
and if delivered to and accepted by the Underwriters and subject to their right
to reject orders in whole or in part. It is expected that delivery of the Notes
will be made at the offices of Piper Jaffray Inc. in Minneapolis, Minnesota on
or about April 18, 1997. The Notes will be issued initially as book-entry notes
in the form of one fully registered global security deposited with or on behalf
of the The Depository Trust Company or its nominees ("DTC"). The Notes will not
initially be issuable in definitive certificated form to any person other than
DTC.
PIPER JAFFRAY INC.
LEGG MASON WOOD WALKER
INCORPORATED
DAIN BOSWORTH
INCORPORATED
<PAGE>
Appearing on the inside front cover of the Prospectus is a map of the United
States. Of such states, Alaska, Arkansas, Massachusetts, New Hampshire, Rhode
Island, Vermont, and Wisconsin are white and all other states are shaded. Stars
are placed on the map in southern California and southeastern Virginia, with
captions reading, respectively, "Irvine Headquarters" and "Chesapeake Collection
Center." Appearing immediately below the map is a shaded square, captioned
"Active Dealers."
THE ABOVE MAP HIGHLIGHTS THE STATES IN WHICH THE COMPANY CURRENTLY PURCHASES
RETAIL AUTOMOBILE INSTALLMENT CONTRACTS.
The Company will make available, without charge, a copy of its Annual Report to
Shareholders to each person who requests a copy of such report. Such requests
should be directed to Corporate Secretary, Consumer Portfolio Services, Inc., 2
Ada, Irvine, CA 92618.
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT
STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE NOTES, INCLUDING
PURCHASES OF THE NOTES TO STABILIZE THEIR MARKET PRICE, PURCHASES OF THE NOTES
TO COVER SOME OR ALL OF A SHORT POSITION IN THE NOTES MAINTAINED BY THE
UNDERWRITERS AND THE IMPOSITION OF PENALTY BIDS. FOR A DESCRIPTION OF THESE
ACTIVITIES, SEE "UNDERWRITING."
2
<PAGE>
PROSPECTUS SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED
INFORMATION AND CONSOLIDATED AND CONDENSED CONSOLIDATED FINANCIAL STATEMENTS,
AND THE RELATED NOTES THERETO, INCLUDED ELSEWHERE IN THIS PROSPECTUS. EXCEPT AS
OTHERWISE INDICATED, ALL INFORMATION IN THIS PROSPECTUS ASSUMES THAT THE
UNDERWRITERS' OVER-ALLOTMENT OPTION WILL NOT BE EXERCISED. THE COMPANY IN 1995
CHANGED ITS FISCAL YEAR END FROM MARCH 31 TO DECEMBER 31. UNLESS THE CONTEXT
OTHERWISE REQUIRES, "FISCAL 1993," "FISCAL 1994" AND "FISCAL 1995" REFER TO THE
COMPANY'S FISCAL YEARS ENDED MARCH 31, 1993, 1994 AND 1995, RESPECTIVELY, THE
"NINE-MONTH TRANSITION PERIOD" REFERS TO THE NINE-MONTH PERIOD ENDED DECEMBER
31, 1995, AND "FISCAL 1996" REFERS TO THE YEAR ENDED DECEMBER 31, 1996.
EFFECTIVE MARCH 7, 1996, THE COMPANY SPLIT ITS OUTSTANDING SHARES OF COMMON
STOCK TWO-FOR-ONE. REFERENCES HEREIN TO NUMBERS OF SHARES HAVE BEEN ADJUSTED TO
REFLECT THAT SPLIT. UNLESS THE CONTEXT INDICATES OTHERWISE, ALL REFERENCES
HEREIN TO THE "COMPANY" REFER TO CONSUMER PORTFOLIO SERVICES, INC., AND ITS
SUBSIDIARIES. EACH PROSPECTIVE INVESTOR IS URGED TO READ THIS PROSPECTUS IN ITS
ENTIRETY.
THE COMPANY
Consumer Portfolio Services, Inc. (the "Company") 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.
Since its founding in March 1991, the Company has experienced significant
growth. Its "Servicing Portfolio" (the aggregate principal amount of Contracts
for which the Company performs collection services) increased from $288.9
million at December 31, 1995 to $505.9 million at December 31, 1996. Total
revenue increased from $24.3 million for the nine-month period ended December
31, 1995 to $51.2 million for the year ended December 31, 1996. The Company uses
a combination of employee and independent Dealer marketing representatives to
solicit Dealers to submit Contracts to the Company for purchase. In the year
ended December 31, 1996, the Company increased its number of Dealer marketing
representatives from 40 to 48 and the number of Dealers with which it has its
standard form dealer agreements ("Dealer Agreements") from 1,009 in 33 states to
2,182 in 41 states. Approximately 93.2% of these Dealers operate franchised car
dealerships. In the year ended December 31, 1996, the Company purchased
Contracts at an average rate of approximately $29.3 million per month.
Historically, the Company has charged Dealers a fixed acquisition fee,
generally $200, and a percentage discount from the amount financed under the
Contract ranging from 0% to 10%, depending on the perceived credit risk of the
Contract. In the year ended December 31, 1996, the average original principal
amount financed under Contracts purchased by the Company was approximately
$12,606 and the Contracts were purchased at an average discount of approximately
2.8%. 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 acquisition fees instituted
in January 1997 are larger, on average, than the acquisition fees previously
charged in conjunction with percentage discounts, resulting in a similar net
purchase price on a typical Contract. The fees vary based on the perceived
credit risk and, in some cases, the interest rate on the Contract. Approximately
11.5% of the automobiles securing Contracts purchased during the year ended
December 31, 1996, were new. In the aggregate, the average age of the
automobiles securing the Contracts purchased in the year ended December 31, 1996
was 3.4 years. The average original term and Annual Percentage Rate ("APR") on
Contracts purchased during the year ended December 31, 1996, were approximately
54.0 months and 20.4%, respectively. Based on information contained in borrower
applications, for Contracts purchased during the year ended December 31, 1996,
the Company's average borrower at the time of purchase was
3
<PAGE>
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.
The Company generates earnings primarily from 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. For the nine-month
transition period ended December 31, 1995, such earnings 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 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 at par to institutional investors
("Investors"). In transactions since June 1995, the trust has issued a senior
("A Piece") and subordinated ("B Piece") series of asset-backed securities. At
the closing of each sale or securitization, the Company removes from its balance
sheet the Contracts held for sale, and adds to its balance sheet (i) the cash
received by the Company, (ii) the cash deposited by the Company into the Spread
Account (as defined herein) to provide a credit enhancement for the Investors,
and (iii) excess servicing receivables. The excess of the assets added by the
Company upon sale over the carrying value of the Contracts sold equals the gain
on sale recorded by the Company.
Over the life of the Contracts sold to trusts, the Company is eligible to
receive excess cash flow distributions from the trust, if any, in accordance
with the terms of the related Spread Account, resulting from the difference
between the interest received from the obligors on the Contracts and the
interest paid to Investors in the asset-backed securities, net of losses and
expenses. Interest yields to Investors on the Company's securitizations range
from 6.3% to 8.8% and averaged 7.2% at December 31, 1996. The average annual
percentage rate of the Contracts included in the Company's securitization pools
range from 20.0% to 20.7%, and averaged 20.4% as of December 31, 1996.
As of December 31, 1996, the Company had sold $570.3 million of Contracts to
Investors through the issuance of asset-backed securities, and had also sold an
aggregate of $142.7 million of Contracts to General Electric Capital Corporation
("GECC") and Sun Life Insurance Company of America ("Sun Life") pursuant to
purchase commitments. Subsequent to December 31, 1996, the Company sold an
additional $102.3 million of Contracts to Investors through the issuance of
asset-backed securities. Since June 1996, the Company has sold its asset-backed
securities in registered public offerings. The Company services all Contracts
that it purchases and sells, for which it also receives monthly servicing fees.
The Company occasionally purchases portfolios of Contracts in bulk ("Bulk
Purchases") from other financial institutions. As of December 31, 1996,
Contracts that were acquired in Bulk Purchases and not yet sold account for 0.2%
of the Servicing Portfolio.
The Company currently operates from a centralized office in Irvine,
California, and utilizes highly sophisticated, automated data processing and
collection systems. To better accommodate increased servicing and collections
demand relating to increases in its Servicing Portfolio, in March 1997 the
Company opened a satellite collections facility in Chesapeake, Virginia.
The Company attributes its growth to its: (i) consistent and thorough
underwriting practices; (ii) ability to pay Dealers competitive purchase prices
for Contracts; (iii) reliability as a funding source and the timely
communication of credit decisions to Dealers; and (iv) control of losses through
an aggressive monitoring and collection program. The Company's high penetration
autodialer telephone system and its interface to the Contract servicing
computers provide portfolio performance monitoring capabilities and efficiency
in contacting delinquent borrowers. At December 31, 1996, the aggregate amount
of contractual delinquencies (greater than 30 days) as a percentage of the
month-end gross Servicing Portfolio balance
4
<PAGE>
was 6.8%. Net charge-offs for the year ended December 31, 1996 (excluding
uninsured casualty losses) as a percentage of the average Servicing Portfolio
were 5.1%. Uninsured casualty losses as a percentage of the average Servicing
Portfolio for the same period were 0.4%.
The Company's senior management, including those with responsibility for
underwriting, collections, Dealer marketing, systems and financial accounting,
have an average of approximately 13 years of experience in the consumer finance
industry and nine years of experience in Sub-Prime automobile finance.
The structures under which the Company sells its Contracts generally require
that the Company establish and maintain certain credit enhancements on a
pool-specific basis for the benefit of Investors in the asset-backed securities.
Generally, the Company makes an initial cash deposit to an account (a "Spread
Account") which is controlled by a trustee and which is pledged to support the
asset-backed securities backed by the related Contracts. During the term of each
securitization, cash flows in excess of those necessary to pay investor
principal and interest and the expenses of the trust are deposited in the Spread
Account related to that trust until such time as the Spread Account balance
reaches a predetermined percentage of the outstanding related Contracts. 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. To date, transfers between Spread Accounts
to cover deficiencies have been insignificant. As of December 31, 1996, Spread
Account balances related to the Company's September 1996 and December 1996
securitizations had not yet attained their required levels. For those two pools,
the aggregate amount necessary to meet the required Spread Account level was
approximately $8.8 million. The Spread Accounts related to all of the Company's
other securitizations were at their required levels and, for the year ended
December 31, 1996, the Spread Accounts collectively received initial deposits of
$12.3 million, received deposits from excess servicing of $18.8 million, and
released excess cash to the Company of $17.9 million. In each securitization
transaction since June 1995, the Company has issued a subordinated class of
securities (a "B Piece") representing 5.0% of the principal balance of the
Contracts in each securitization pool. Cash flows payable on the B Piece are
subordinate to those payable on the senior class of asset-backed securities,
which represent 95% of the principal balance of the securitization pool. The
aggregate of the cash held in the Spread Accounts and the one retained B Piece
(issued in the June 1995 securitization and not designed for sale) are recorded
by the Company on its balance sheet as investments in credit enhancements, which
equaled approximately 9.0% of the servicing portfolio subject to recourse at
December 31, 1996. Structures for future securitization transactions may require
higher or lower levels of credit enhancement than past structures.
The principal components of the Company's strategy are to (i) maintain
consistent underwriting standards and portfolio performance; (ii) continue to
expand the volume of Contracts purchased and serviced by increasing the number
of Dealers, states and geographic areas the Company services; (iii) control
and/or reduce its cost of funds; and (iv) maintain and strengthen its
relationship with its Dealers through the development of other products and
services for its Dealers.
The Company was incorporated as a California corporation in March 1991. The
Company's offices are located at 2 Ada, Irvine, CA 92618, and its telephone
number is (714) 753-6800.
5
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Notes offered..................... $20,000,000 aggregate principal amount of 10.50%
Participating Equity Notes-SM-, ("PENs-SM-"),* due April
15, 2004, (the "Notes"), plus an Underwriters'
over-allotment option to purchase up to an additional
$3,000,000 aggregate principal amount of Notes. See
"Description of the Notes" for a more detailed
description of the Notes offered hereby.
Denomination...................... $1,000 and any integral multiple thereof.
Maturity date..................... April 15, 2004.
Interest.......................... Interest at the rate of 10.50% per annum is payable
monthly on the 15th day of each month, commencing May
15, 1997. The first interest payment will represent
interest from the date of original issuance to but
excluding May 15, 1997.
Conversion........................ At maturity or in connection with a redemption of the
Notes at the option of the Company or a redemption
following a Special Redemption Event, 25% of the
principal amount of each Note (which, in the case of a
redemption following a Special Redemption Event,
includes only those Notes which the Holder has elected
to require the Company to redeem) is convertible, at the
option of the Holder, into Common Stock at the rate of
$10.15 per share, subject to adjustment under certain
circumstances. See "Description of the Notes--Conversion
Rights".
Redemption at option of
the Company..................... The Notes may not be redeemed at the Company's option
prior to April 15, 2000. Thereafter, the Company may, at
its option, elect to redeem the Notes, in whole but not
in part, at any time, upon not less than 30 days' notice
to the Holder. The redemption price will be 100% of the
principal amount of any redeemed Notes, in each case
plus accrued interest to and including the redemption
date. See "Description of the Notes-- Redemption at
Option of the Company."
Special Redemption................ In the event of a Special Redemption Event, each Holder
will have the right, at the Holder's option, to require
the Company to redeem the Holder's Notes, in whole but
not in part, at 100% of the principal amount plus
accrued interest to and including the date of
redemption. The term Special Redemption Event is limited
to certain events or transactions that result in a
change of control of the Company. See "Description of
the Notes-- Holders' Right to Redemption After Special
Redemption Event."
Subordination..................... The Notes are unsecured and subordinated in right of
payment to all existing and future Senior Indebtedness
of the Company, including amounts outstanding under the
Company's existing Warehouse Line of Credit (as defined
herein). With respect to
</TABLE>
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* "Participating Equity Notes" and "PENs" are service marks of Piper Jaffray
Inc.
6
<PAGE>
<TABLE>
<S> <C>
any distributions that the Company might receive from
its subsidiaries, the Notes are also effectively
subordinated to the claims of the creditors of such
subsidiaries. As of December 31, 1996, there was
approximately $13.3 million of Senior Indebtedness
outstanding. See "Description of the Notes--
Subordination."
Other subordinated debt........... The Notes rank equally with $20 million of previously
issued subordinated debt of the Company ("1995
Subordinated Debt"), all of which remains outstanding.
See "Description of the Notes--1995 Subordinated Debt."
Rating............................ The Notes are rated "B+" by Duff & Phelps Credit Rating
Co. ("Duff & Phelps"), which is below investment grade.
Ratings are not a recommendation to purchase, hold or
sell the Notes, as ratings do not comment as to market
price or suitability for a particular investor. The
ratings are based on current information furnished to
Duff & Phelps by the Company and obtained from other
sources. The ratings may be changed, suspended or
withdrawn at any time as a result of changes in, or
unavailability of, such information.
Listing........................... The Notes have been approved for listing on the New York
Stock Exchange, Inc., subject to official notice of
issuance.
Certain covenants of the
Company......................... In the Indenture (as defined herein), the Company agrees
to certain limitations on dividends and additional
indebtedness and to certain restrictions on
consolidation, merger or transfer of all or
substantially all of its assets. See "Description of the
Notes-- Limitations on Additional Indebtedness,"
"--Limitation on Restricted Payments" and
"--Consolidation, Merger or Transfer."
Registration...................... The Notes will be initially issued only in fully
registered book-entry form. The Notes will not initially
be issuable in definitive certificated form to any
person other than The Depository Trust Company or its
nominees. See "Description of the Notes-- Book-Entry
System." References herein to Holders or registered
Holders shall be to the Depository Trust Company or its
nominees or successors for so long as the Notes are in
book-entry form.
Use of proceeds................... Proceeds from the sale of the Notes will be used to
increase the amount of Contracts that the Company can
acquire and hold for sale in securitization
transactions, to fund credit enhancements for such
transactions, for other working capital needs and for
general corporate purposes. See "Use of Proceeds."
Trustee........................... Bankers Trust Company, New York, New York.
</TABLE>
7
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SUMMARY CONSOLIDATED FINANCIAL INFORMATION
<TABLE>
<CAPTION>
NINE-MONTH
TRANSITION
YEAR ENDED PERIOD FISCAL YEAR ENDED MARCH 31
DECEMBER 31 ENDED -------------------------------
1996 12/31/95 1995 1994(1) 1993
----------- ---------- -------- ---------- -------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
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.......................................... 27,502 11,597 11,358 11,712(1) 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)
Fully diluted net income (loss) per common share............ $ .93 $ .52 $ .56 $ (.21) $ (.24)
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 of period(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)(11)....................... 9.2% 7.9% 4.7% 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 -- --
Pro forma ratio of earnings to fixed charges(8)(12)......... 3.8x n/a n/a n/a n/a
Cash flows used in operating activities..................... $ (9,661) $(18,533) $ (6,115) $ (2,816) $(6,718)
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1996
--------------------------
PRO FORMA
ACTUAL AS ADJUSTED(10)
--------- ---------------
(IN THOUSANDS)
<S> <C> <C>
BALANCE SHEET DATA:
Cash................................................................................... $ 154 $ 5,819
Investments in credit enhancements..................................................... 43,597 43,597
Contracts held for sale................................................................ 21,657 21,657
Excess servicing receivables........................................................... 23,654 23,654
Total assets........................................................................... 101,946 108,681
Total liabilities...................................................................... 44,989 48,724
Total shareholders' equity............................................................. 56,957 59,957
</TABLE>
- ------------------------------
(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
8
<PAGE>
for fiscal 1994 would have been $4,672,000, $.46 and $.44, respectively. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Fiscal Year Ended March 31, 1995 Compared to Fiscal Year Ended
March 31, 1994-- Expenses."
(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 Contracts serviced for third parties but not
purchased by the Company. As of December 31, 1994, the Company had ceased
servicing Contracts 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. 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
Contracts 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-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) Adjusted to reflect (i) the conversion into 480,000 shares of Common Stock
of an outstanding $3 million convertible subordinated note, which conversion
was effected on January 17, 1997, and (ii) the sale of the Notes offered
hereby (assuming no exercise of the Underwriters' over-allotment option) and
the application of the estimated net proceeds therefrom, including a paydown
of a line of credit on which $13,265,000 was owed at December 31, 1996. See
"Use of Proceeds" and "Capitalization."
(11) Amount in repossession represents financed vehicles which have been
repossessed but not yet liquidated.
(12) Adjusted to reflect (i) the conversion into 480,000 shares of Common Stock
of an outstanding $3 million convertible subordinated note, which conversion
was effected on January 17, 1997, and (ii) the sale of the Notes offered
hereby (assuming no exercise of the Underwriters' over-allotment option).
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RISK FACTORS
THE NOTES OFFERED HEREBY ARE SPECULATIVE AND INVOLVE A HIGH DEGREE OF RISK,
INCLUDING, BUT NOT NECESSARILY LIMITED TO, THE RISK FACTORS DESCRIBED BELOW.
EACH PROSPECTIVE INVESTOR SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS
INHERENT IN AND AFFECTING THE BUSINESS OF THE COMPANY AND THE OFFERING BEFORE
MAKING AN INVESTMENT DECISION. WHEN USED IN THIS PROSPECTUS, THE WORDS "MAY,"
"WILL," "EXPECT," "ANTICIPATE," "CONTINUE," "ESTIMATE," "PROJECT," "INTEND" AND
SIMILAR EXPRESSIONS ARE INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS WITHIN
THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE
SECURITIES EXCHANGE ACT OF 1934 REGARDING EVENTS, CONDITIONS AND FINANCIAL
TRENDS THAT MAY AFFECT THE COMPANY'S FUTURE PLANS OF OPERATIONS, BUSINESS
STRATEGY, OPERATING RESULTS AND FINANCIAL POSITION. PROSPECTIVE INVESTORS ARE
CAUTIONED THAT ANY FORWARD-LOOKING STATEMENTS ARE NOT GUARANTEES OF FUTURE
PERFORMANCE AND ARE SUBJECT TO RISKS AND UNCERTAINTIES AND THAT ACTUAL RESULTS
MAY DIFFER MATERIALLY FROM THOSE INCLUDED WITHIN THE FORWARD-LOOKING STATEMENTS
AS A RESULT OF VARIOUS FACTORS. SUCH FACTORS ARE DESCRIBED UNDER THE HEADINGS
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS", AND "THE COMPANY" AND IN THE RISK FACTORS SET FORTH BELOW.
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. See "Use of
Proceeds" and "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity and Capital Resources."
CASH REQUIREMENTS ASSOCIATED WITH SECURITIZATION TRUSTS. Under the
financial structures the Company has used to date in its sixteen
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.
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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. See "Business--Purchase and Sale of Contracts--Securitization
and Sale of Contracts to Institutional Investors."
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
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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. See "Business--Purchase
and Sale of Contracts--Contract Purchase Criteria" and "Business--Servicing of
Contracts."
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. See "Business--Servicing of Contracts" and
"Business--Government Regulation."
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. See "Business--Purchase and Sale of Contracts--Dealer Contract
Purchase Program."
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. See
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"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
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. See
"Business-- Servicing of Contracts." 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. See
"Business--Competition."
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. See generally "Business."
SUBORDINATION OF THE NOTES AND ENCUMBRANCES ON THE COMPANY'S ASSETS
The Notes are unsecured and subordinated in right of payment to all existing
and future Senior Indebtedness of the Company, including indebtedness under the
Warehouse Line of Credit, and indebtedness that may be incurred under the
standby line of credit associated with the Warehouse Line of Credit. The standby
line is secured by substantially all of the Company's assets. Therefore, in the
event of the
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liquidation, dissolution, or reorganization of or any similar proceedings
regarding the Company, the assets of the Company will be available to pay
obligations on the Notes (and any other obligations ranking PARI PASSU with the
Notes, including, without limitation, the presently existing subordinated debt)
only after all Senior Indebtedness has been paid in full, and there may not be
sufficient assets to pay any or all amounts due on the Notes. If the Company
becomes insolvent or is liquidated, or if payment under the Warehouse Line of
Credit or the associated standby line of credit is accelerated, the lenders
under the lines of credit, as the holders of security interests in substantially
all of the Company's assets, would be entitled to exercise the remedies
available to a secured lender under applicable law and pursuant to these lines
of credit. See "Description of the Notes." Any right of the Company to receive
assets of any of its subsidiaries upon the latter's liquidation or
reorganization (and the consequent right of the holders of the Notes to
participate in those assets) will be effectively subordinated to the claims of
creditors of such subsidiaries, including claims of warehouse lenders, FSA and
any other credit enhancement providers, and holders of asset-backed securities
that may be secured by Spread Accounts before such assets may be available for
distribution to the Company. As a result, there can be no assurance that in such
event there will be resources available to repay the holders of the Notes in
whole or in part.
RESTRICTIONS IMPOSED BY THE TERMS OF THE COMPANY'S INDEBTEDNESS
The Warehouse Line of Credit and the indentures governing the Notes
("Indenture") and the 1995 Subordinated Debt ("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. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations--Liquidity and Capital
Resources."
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 sale of the
Notes will increase the Company's outstanding subordinated indebtedness from
$20.0 million to $40.0 million (assuming no exercise of the Underwriters'
over-allotment option). 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. See "Description of 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
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
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able to obtain such financing, and, if obtained, the terms of any such financing
may be less favorable than the terms of the Notes. See "Description of the
Notes."
LIMITED COVENANTS IN THE INDENTURE
The Indenture contains financial and operating covenants including, among
others, limitations on the Company's ability to pay dividends, to incur
additional indebtedness and to engage in certain transactions, including
consolidations, mergers or transfers of all or substantially all of its assets.
The covenants in the Indenture are limited and are not designed to protect
holders of the Notes in the event of a material adverse change in the Company's
financial condition or results of operations. See "Description 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.
See "Business--Government Regulation."
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. See "Business--Purchase and Sale of Contracts--Dealer Contract
Purchase Program."
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. See "Business--Purchase and Sale of
Contracts--Sale of Contracts to Institutional Investors."
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
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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.
See "Business-- Government Regulation."
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. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Results of Operations."
LIMITED MARKET
Prior to the Offering, there has been no market for the Notes. Although the
Notes have been approved for listing, subject to official notice of issuance, on
the New York Stock Exchange, no assurance can be given that an active trading
market in the Notes will develop or that Holders will be able to sell their
Notes at or above par. The Company has been advised that the Underwriters
currently intend to make a market in the Notes, but they are under no obligation
to do so and may discontinue such market making activities at any time.
Accordingly, in deciding whether or not to invest in the Notes, investors should
take into account the possible illiquid and long-term nature of an investment in
the Notes.
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. See "Management."
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
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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. See "Principal Shareholders."
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USE OF PROCEEDS
The net proceeds from the sale of the Notes (after deducting underwriting
discounts and Offering expenses) are expected to be approximately $18.9 million
(approximately $21.8 million if the Underwriters' over-allotment option is
exercised in full). The primary purpose of the Offering is to provide the
Company with additional capital to fund its growth, including increasing the
amount of Contracts that the Company can acquire and hold for pooling and sale
in the asset-backed securities market, to support securitization transactions,
for other working capital needs and for general corporate purposes. Pending
their ultimate application, the net proceeds will be used to reduce temporarily
the Company's balances under its existing Warehouse Line of Credit. As of
December 31, 1996, amounts outstanding under the Warehouse Line of Credit bore
interest at an effective rate of 6.99% per annum.
PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY
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.
<TABLE>
<CAPTION>
HIGH LOW
--------- ---------
<S> <C> <C>
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
January 1--March 31, 1997............................................... 13.625 7.250
April 1--April 15, 1997................................................. 8.125 7.125
</TABLE>
On April 15, 1997 the last reported sale price for the Common Stock on the
Nasdaq National Market was as reported on the cover page of this Prospectus. 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
<PAGE>
CAPITALIZATION
The following table sets forth the capitalization of the Company as of
December 31, 1996 and as adjusted to give effect to (i) the conversion into
480,000 shares of Common Stock at $6.25 per share of the 9.5% Convertible
Subordinated Note due November 16, 1998, which was effected on January 17, 1997,
and (ii) the sale of the Notes offered hereby (assuming no exercise of the
Underwriters' over-allotment option) and the application of the estimated net
proceeds therefrom as described in "Use of Proceeds." The table should be read
in conjunction with the Company's Consolidated Financial Statements and the
related Notes thereto included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1996
-----------------------
PRO FORMA
ACTUAL AS ADJUSTED
---------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
LIABILITIES:
Warehouse Line of Credit............................................................... $ 13,265 $ --
Subordinated Notes due 2006............................................................ 20,000 20,000
9.5% Convertible Subordinated Note due November 16, 1998............................... 3,000 --
Other liabilities...................................................................... 8,724 8,724
10.50% Participating Equity Notes-SM- due 2004......................................... -- 20,000
---------- -----------
Total liabilities.................................................................... $ 44,989 $ 48,724
---------- -----------
SHAREHOLDERS' EQUITY:
Preferred Stock, $1.00 par value, 5,000,000 shares authorized, none issued............. $ -- $ --
Common Stock, no par value, 30,000,000 shares authorized, 13,779,242 shares issued and
outstanding and 14,259,242 shares pro forma as adjusted(1)........................... 34,644 37,644
Retained earnings...................................................................... 22,313 22,313
---------- -----------
Total shareholders' equity........................................................... 56,957 59,957
---------- -----------
Total capitalization................................................................. $ 101,946 $ 108,681
---------- -----------
---------- -----------
</TABLE>
- ------------------------
(1) Does not include: (i) 14,000 shares of Common Stock reserved for issuance
upon exercise of warrants issued in connection with the Company's 1992
initial public offering of Common Stock; (ii) 2,094,200 shares of Common
Stock reserved for issuance upon exercise of stock options outstanding under
the Company's 1991 Stock Option Plan, of which options to purchase 1,319,420
shares were exercisable at December 31, 1996; (iii) 97,000 shares of Common
Stock reserved for issuance upon exercise of stock options available for
future grant under the Company's 1991 Stock Option Plan; and (iv) 60,000
shares of Common Stock reserved for issuance upon the exercise of stock
options granted to certain directors of the Company. See "Certain
Transactions" and "Principal Shareholders."
19
<PAGE>
SELECTED CONSOLIDATED 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.
<TABLE>
<CAPTION>
NINE-MONTH
TRANSITION
YEAR ENDED PERIOD FISCAL YEAR ENDED MARCH 31,
DECEMBER 31, ENDED -------------------------------
1996 12/31/95 1995 1994(1) 1993
------------ ----------- --------- --------- ---------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
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 of period(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 -- --
Pro forma ratio of earnings to fixed charges
(8)(11)........................................... 3.8x n/a n/a n/a n/a
Cash flows provided by (used in) operating
activities........................................ $ (9,661) $ (18,533) $ (6,115) $ (2,816) $ (6,718)
</TABLE>
20
<PAGE>
<TABLE>
<CAPTION>
AS OF MARCH 31, 1993
AS OF DECEMBER 31, AS OF DECEMBER 31, -------------------------------
1996 1995 1995 1994 1993
------------------ ------------------- --------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
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
</TABLE>
- ------------------------------
(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-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.
(11) Adjusted to reflect (i) the conversion into 480,000 shares of common stock
of an outstanding $3 million convertible subordinated note, which conversion
was effected on January 17, 1997, and (ii) the sale of the Notes offered
hereby (assuming no exercise of the Underwriters' over-allotment option).
21
<PAGE>
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 Prospectus.
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. Transfers between
Spread Accounts to cover deficiencies have been insignificant from inception
through December 31, 1996. 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
22
<PAGE>
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
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 $151.0 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
23
<PAGE>
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 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
24
<PAGE>
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, 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).
25
<PAGE>
Upon consummation of the Company's initial public offering which became
effective on October 22, 1992, the Company's 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.
<TABLE>
<CAPTION>
12 MONTHS ENDED DECEMBER 31,
------------------------------------------
1996 1995 1994(1) 1994(2)
--------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
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
</TABLE>
- ------------------------
(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.
26
<PAGE>
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 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 do 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.
27
<PAGE>
The table below documents the Company's history of Contract securitizations,
comprising sales to 17 securitization trusts.
STRUCTURED CONTRACT SECURITIZATIONS
<TABLE>
<CAPTION>
PERIOD FUNDED RATINGS(1) RATING AGENCY POOL NAME
- ------------------ SECURITIZED ----------- ---------------- -------------------------------------
DOLLAR AMOUNT
--------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
April 1993 $ 4,990 A Duff & Phelps Alton Grantor Trust 1993-1
May 1993 3,933 A Duff & Phelps Alton Grantor Trust 1993-1
June 1993 3,467 A Duff & Phelps Alton Grantor Trust 1993-1
July 1993 5,575 A Duff & Phelps Alton Grantor Trust 1993-2
August 1993 3,336 A Duff & Phelps Alton Grantor Trust 1993-2
September 1993 3,578 A Duff & Phelps Alton Grantor Trust 1993-2
October 1993 1,921 A Duff & Phelps Alton Grantor Trust 1993-2
November 1993 1,816 A Duff & Phelps Alton Grantor Trust 1993-3
December 1993 6,694 A Duff & Phelps Alton Grantor Trust 1993-3
January 1994 1,998 A Duff & Phelps Alton Grantor Trust 1993-3
March 1994 20,787 A Duff & Phelps Alton Grantor Trust 1993-4
June 1994 24,592 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1994-1
September 1994 28,916 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1994-2
October 1994 13,136 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1994-3
December 1994 28,893 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1994-4
February 1995 20,084 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1995-1
June 1995 49,290 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1995-2
September 1995 45,009 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1995-3
September 1995 2,369 BB S&P CPS Auto Grantor Trust 1995-3
December 1995 53,634 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1995-4
December 1995 2,823 BB S&P CPS Auto Grantor Trust 1995-4
March 1996 63,747 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1996-1
March 1996 3,355 BB S&P CPS Auto Grantor Trust 1996-1
June 1996 (2) 84,456 Aaa/AAA Moody's/S&P Fasco Auto Grantor Trust 1996-1
June 1996 4,445 BB S&P Fasco Auto Grantor Trust 1996-1
September 1996 87,523 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1996-2
September 1996 4,606 BB S&P CPS Auto Grantor Trust 1996-2
December 1996 88,215 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1996-3
December 1996 4,643 BB S&P CPS Auto Grantor Trust 1996-3
March 1997 97,211 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1997-1
March 1997 5,116 BB S&P CPS Auto Grantor Trust 1997-1
--------------
$ 770,158
--------------
--------------
</TABLE>
- ------------------------
(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."
28
<PAGE>
(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 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. 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 Prospectus 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").
The Company anticipates that the proceeds from this offering, 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.
29
<PAGE>
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.
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.
30
<PAGE>
BUSINESS
GENERAL
The Company is a consumer finance company specializing in the business of
purchasing, selling and servicing Contracts originated by Dealers in the sale of
new and used automobiles, light trucks and passenger vans. Through its
purchases, the Company provides indirect financing to 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 GECC. To date, the Company has sold $42.6 million
in Contracts to GECC and an additional $100.1 million to Sun Life. Since June
1994, the Company has issued an additional $545.4 million of "AAA"-rated and
$22.2 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
31
<PAGE>
is a demand by automobile dealers for Sub-Prime Borrower financing that has not
been effectively served by traditional automobile financing sources.
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 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
32
<PAGE>
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 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. See
"Certain Transactions".
PURCHASE AND SALE OF CONTRACTS
DEALER CONTRACT PURCHASE PROGRAM. As of December 31, 1996, the Company was
a party to 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
33
<PAGE>
as stated on the Company's records) during each of the years ended December 31,
1996 and December 31, 1995.
<TABLE>
<CAPTION>
CONTRACTS PURCHASED DURING YEAR ENDED
--------------------------------------------------
DECEMBER 31, 1996 DECEMBER 31, 1995
------------------------ ------------------------
NUMBER PERCENT NUMBER PERCENT
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
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
----------- -----------
----------- -----------
</TABLE>
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.
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<PAGE>
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 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 and
assumed the servicing thereon in bulk from other companies that had previously
purchased the Contracts from Dealers. 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 its 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
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<PAGE>
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 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.
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<PAGE>
SECURITIZATION AND SALE OF CONTRACTS TO INSTITUTIONAL INVESTORS. The
Company purchases Contracts with the intention of reselling them to 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
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
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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 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 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
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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 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
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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.
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
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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.
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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:
DELINQUENCY EXPERIENCE(1)
<TABLE>
<CAPTION>
DECEMBER 31, 1996 DECEMBER 31, 1995 MARCH 31, 1995
----------------------- ----------------------- -----------------------
NUMBER OF NUMBER OF NUMBER OF
LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT
----------- ---------- ----------- ---------- ----------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
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%
</TABLE>
- ------------------------
(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.
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NET CHARGE-OFF EXPERIENCE(1)
<TABLE>
<CAPTION>
TRANSITION PERIOD FISCAL YEAR
YEAR ENDED ENDED ENDED MARCH
DECEMBER 31, 1996 DECEMBER 31, 1995(2) 31, 1995
----------------- -------------------- --------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
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%
</TABLE>
- ------------------------
(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.
(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 were $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 System-TM-, 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
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<PAGE>
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
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
44
<PAGE>
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.
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
45
<PAGE>
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.
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.
46
<PAGE>
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.
EMPLOYEES
As of December 31, 1996, the Company had 330 employees (including 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.
LEGAL PROCEEDINGS
As of the date of this Prospectus, 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.
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<PAGE>
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The current directors and executive officers of the Company are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ------------------------------------ --- ---------------------------------------------------------------------
<S> <C> <C>
Charles E. Bradley, Sr.............. 67 Chairman of the Board of Directors
Charles E. Bradley, Jr.............. 37 President, Chief Executive Officer, and Director
William B. Roberts.................. 59 Director
John G. Poole....................... 54 Vice Chairman of the Board of Directors
Robert A. Simms..................... 58 Director
Thomas L. Chrystie.................. 63 Director
Jeffrey P. Fritz.................... 37 Senior Vice President--Chief Financial Officer and Secretary
William L. Brummund, Jr............. 44 Senior Vice President--Systems Administration
Nicholas P. Brockman................ 52 Senior Vice President--Asset Recovery & Liquidation
Richard P. Trotter.................. 53 Senior Vice President--Contract Origination
Curtis K. Powell.................... 40 Senior Vice President--Marketing
Mark A. Creatura.................... 37 Senior Vice President--General Counsel
</TABLE>
CHARLES E. BRADLEY, SR. has been the Chairman of the Board of the Company
since its formation in March 1991. Mr. Bradley is one of the founders of
Stanwich Partners, Inc. ("Stanwich"), a Connecticut investment firm which
acquires controlling interests in companies in conjunction with the existing
operating management of such companies, and has been President, a director and a
shareholder of that company since its formation in 1982. He is also President
and director of Reunion Industries, Inc., a publicly held company which
manufactures precision plastic products and provides engineered plastics
services. Mr. Bradley also served as President and a director of CPS Holdings,
Inc., the Company's former parent corporation, from August 1989 until its merger
into the Company in December 1995. He currently is a director of
DeVlieg-Bullard, Inc., Chatwins Group, Inc., Texon Energy Corp., General
Housewares Corp., NAB Asset Corporation (38% of whose outstanding shares of
voting stock are held by the Company), Zydeco Exploration, Inc., Sanitas, Inc.
and Audits and Surveys Worldwide, all of which are publicly-held corporations or
are required to file periodic reports under Section 13 or 15(d) of the
Securities Exchange Act of 1934. Mr. Bradley is the father of Charles E.
Bradley, Jr.
CHARLES E. BRADLEY, JR. 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.
WILLIAM B. ROBERTS has been a director of the Company since its formation in
March 1991. Since 1981, he has been the President of Monmouth Capital Corp., an
investment firm which specializes in management buyouts. Mr. Roberts serves on
the board of directors of Atlantic City Racing Association, a publicly-held
corporation, which owns and operates a race track.
JOHN G. POOLE has been a director of the Company since November 1993 and its
Vice Chairman since January 1996. He was a co-founder of Stanwich in 1982 and
has been a director, vice president and shareholder of that company since its
formation. Mr. Poole is a director of Reunion Industries, Inc.,
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<PAGE>
Sanitas, Inc., Chatwins Group, Inc., and DeVlieg-Bullard, Inc. Mr. Poole served
as a director and Vice President of CPS Holdings, Inc. from 1993 to 1995.
ROBERT A. SIMMS has been a director of the Company since April 1995. He has
been the Chairman and Chief Executive Officer of Simms Capital Management, Inc.
since 1984. He is also a director of New York Bancorp, Arrhythmia Research
Technology, Inc. and the National Football Foundation and Hall of Fame. Mr.
Simms also serves on the Board of Overseers of Rutgers University and was
formerly a partner in Bear Stearns & Co.
THOMAS L. CHRYSTIE has been a director of the Company since April 1995. He
has been self-employed as an investor since 1988. His previous experience
includes 33 years at Merrill Lynch & Co. in various capacities including heading
Merrill Lynch's investment banking, capital markets and merchant banking
activities. In addition, he served as Merrill Lynch & Co.'s Chief Financial
Officer. He is also a director of Titanium Industries, Eonyx Corporation and
Wyoming Properties.
JEFFREY P. FRITZ 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. 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 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 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.
CURTIS K. POWELL 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 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.
The Board of Directors has established an Audit Committee and Compensation
and Stock Option Committee. The members of the Audit Committee are Robert A.
Simms, Thomas L. Chrystie and William B. Roberts. The Audit Committee is
empowered by the Board of Directors to review the financial books and records of
the Company in consultation with the Company's accounting and auditing staff and
its independent auditors and to review with the accounting staff and independent
auditors any questions raised with respect to accounting and auditing policy and
procedure.
49
<PAGE>
The members of the Compensation and Stock Option Committee are Robert A.
Simms, Thomas L. Chrystie and William B. Roberts. This Committee makes
recommendations to the Board of Directors as to general levels of compensation
for all employees of the Company, the annual salary of each of the executive
officers of the Company, authorizes the grants options to employees under the
Company's 1991 Stock Option Plan, and reviews and approves compensation and
benefit plans of the Company.
CERTAIN TRANSACTIONS
From January 1, 1992 through December 31, 1995 the Company retained Stanwich
(a corporation of which Charles E. Bradley, Sr. and John G. Poole are principal
shareholders) to provide consulting services for compensation at the rate of
$350,000 per year. Effective January 1, 1996, upon expiration of the prior
agreement, the Company and Stanwich agreed to continue the consulting
arrangement for an additional three-year period, at a reduced rate of
compensation of $75,000 per year. The current rate was arrived at by negotiation
between Stanwich and the independent directors of the Company. Such negotiations
took into account the prior rate of compensation, the services performed by
Stanwich in the past, and the expectation that a reduced level of consulting
service would be required as the Company matured. Under both the current and
prior agreements, Stanwich agreed to provide such level of consulting services
relating to strategic business and tax planning and investment analysis as the
Company reasonably may request. No fixed, minimum or maximum number of hours of
service is or was specified.
In January 1997, the Company acquired 80% of the outstanding shares of the
capital stock of Stanwich Leasing, Inc. ("SLI") for an aggregate purchase price
of $100,000. SLI's selling shareholders included Charles E. Bradley, Sr. and
John G. Poole, each of whom is an officer, director and shareholder of the
Company and who received, respectively, $45,000 and $15,000 of the purchase
price. Messrs. Bradley, Sr. and Poole, the founders of SLI, purchased their SLI
shares in 1996 for $450 and $150, respectively. SLI and its 80% owned
subsidiary, PIC Leasing Corp. ("PIC"), are in the business of leasing equipment
and containers to others. At December 31, 1996, SLI and PIC together had
approximately $2.0 million of assets under lease, and a book value of
approximately $37,000. Approximately 6% of the assets under lease were leased to
corporate lessees with which Messrs. Bradley, Sr. and Poole are affiliated. SLI
is indebted in the amount of $500,000 to a company of which Messrs. Bradley, Sr.
and Poole are the indirect majority owners. This debt constitutes the purchase
price for SLI's acquisition of PIC in 1996. The purchase price for SLI was
determined by negotiation between the Company and SLI's selling shareholders.
The transaction was approved by the Company's disinterested directors,
consisting of Messrs. Chrystie, Roberts and Simms. The remaining 20% of SLI not
acquired by the Company is held by Charles E. Bradley, Jr., who is the President
and a director of the Company.
The agreements and arrangements described above were not entered into
between parties negotiating or dealing on an arm's length basis, but were
entered into by the Company with the parties who personally benefited from such
transactions and who had a control or fiduciary relationship with the Company.
50
<PAGE>
PRINCIPAL SHAREHOLDERS
The following table sets forth the number and percentage of shares of Common
Stock owned beneficially as of March 31, 1997: (i) by each person known to the
Company to own more than 5% of the outstanding Common Stock, (ii) by each
director and executive officer of the Company, and (iii) by all directors and
officers of the Company as a group.
Except as otherwise indicated, and subject to applicable community property
and similar laws, each of the persons named has sole voting and investment power
with respect to the shares shown as beneficially owned by such persons. The
address of Messrs. Bradley, Jr., Brockman, Fritz, Brummund, Trotter, Powell and
Creatura is c/o Consumer Portfolio Services, Inc., 2 Ada, Irvine, CA 92618.
<TABLE>
<CAPTION>
AMOUNT &
NATURE OF
NAME & ADDRESS OF BENEFICIAL PERCENT OF
BENEFICIAL OWNER OWNERSHIP(1) CLASS
- ---------------------------------------------------------------------------------------- ------------ -------------
<S> <C> <C>
Charles E. Bradley, Sr. ................................................................ 2,895,137(2) 19.5%
c/o Stanwich Partners, Inc., 62 Southfield Avenue,
Stamford, CT 06902
William B. Roberts ..................................................................... 1,233,982 8.5%
Monmouth Capital Corp., 126 East 56th Street, 12th Floor
New York, NY 10022
John G. Poole .......................................................................... 276,360(3) 2.0%
c/o Stanwich Partners, Inc., 62 Southfield Avenue,
Stamford, CT 06902
Thomas L. Chrystie, .................................................................... 100,000(4) *
P.O. Box 640,
Wilson, WY 83014
Robert A. Simms, ....................................................................... 227,144(5) 1.6%
55 Railroad Ave., Plaza Suite
Greenwich, CT 06830
Charles E. Bradley, Jr.................................................................. 1,572,920(6) 10.8%
Nicholas P. Brockman.................................................................... 90,600 *
Jeffrey P. Fritz........................................................................ 90,600 *
William L. Brummund, Jr................................................................. 89,600 *
Richard P. Trotter...................................................................... 54,086 *
Curtis K. Powell........................................................................ 19,300 *
Mark A. Creatura........................................................................ 8,000 *
All officers and directors as a group (sixteen persons)................................. 6,128,969(7) 39.1%
Sun Life Insurance Company of America .................................................. 1,013,332 7.1%
One Sun America Center, Los Angeles, CA 90067
Robert T. Gilhuly and Kimball J. Bradley, Trustees ..................................... 1,058,818(8) 7.4%
c/o Cummings & Lockwood
Two Greenwich Plaza, Box 2505, Greenwich, CT 06830
</TABLE>
- ------------------------
* Less than 1%
51
<PAGE>
(1) Includes the following shares which are not currently outstanding but which
the named individuals have the right to acquire currently or within 60 days
of March 31, 1997 upon exercise of options: Charles E. Bradley, Sr.--600,000
shares; William B. Roberts--200,000 shares; Thomas L. Chrystie-- 30,000
shares; Robert A. Simms--30,000 shares; Charles E. Bradley, Jr.--267,640
shares; Jeffrey P. Fritz--50,600 shares; William L. Brummund, Jr.--49,600
shares; Richard P. Trotter--53,686 shares; Nicholas P. Brockman--36,600
shares; Curtis K. Powell--19,300 shares; Mark A. Creatura--8,000 shares; and
all directors and officers as a group (16 persons)--1,406,666 shares. The
shares described in this note are deemed to be outstanding for the purpose
of computing the percentage of outstanding Common Stock owned by such
persons individually and by the group, but are not deemed to be outstanding
for the purpose of computing the percentage of ownership of any other
person.
(2) Includes 207,490 shares owned by the named person's spouse as to which he
has no voting or investment power; and 600,000 shares that Mr. Bradley, Jr.,
has the presently exercisable right to acquire from Mr. Bradley, Sr.
(3) Includes 2,000 shares held by Mr. Poole as custodian for his children.
(4) Includes 70,000 shares held by the Thomas L. Chrystie Living Trust.
(5) Includes 16,944 shares owned by Mr. Simms' spouse as to which he has no
voting or investment power.
(6) Includes 211,738 shares held by a trust of which Mr. Bradley is the
beneficiary, as to which he has no voting or investment power. Also
includes, in addition to the 267,640 shares referred to in footnote 1,
600,000 shares that Mr. Bradley, Jr. has the presently exercisable right to
acquire from Mr. Bradley, Sr.
(7) Includes an aggregate of 1,406,666 shares which are not currently
outstanding, but which may be acquired by officers and directors of the
company within 60 days of March 31, 1997.
(8) These shares are held in trusts of which the beneficiaries are Charles E.
Bradley, Sr.'s adult children, including, among others, Charles E. Bradley,
Jr., (as to 211,738 shares) and Kimball J. Bradley (as to 211,802 shares).
52
<PAGE>
DESCRIPTION OF THE NOTES
THE NOTES WILL BE ISSUED UNDER AN INDENTURE BETWEEN THE COMPANY AND BANKERS
TRUST COMPANY, AS TRUSTEE (THE "TRUSTEE"), THE FORM OF WHICH HAS BEEN FILED AS
AN EXHIBIT TO THE REGISTRATION STATEMENT OF WHICH THIS PROSPECTUS IS A PART. THE
INDENTURE IS SUBJECT TO AND IS GOVERNED BY THE TRUST INDENTURE ACT OF 1939, AS
AMENDED (THE "TRUST INDENTURE ACT"). ALTHOUGH THEY INCLUDE A DISCUSSION OF THE
MATERIAL PROVISIONS OF THE INDENTURE, THE FOLLOWING SUMMARIES OF CERTAIN
PROVISIONS OF THE INDENTURE, ARE SUBJECT TO, AND ARE QUALIFIED IN THEIR ENTIRETY
BY REFERENCE TO, THE FULL TEXT OF THE INDENTURE, INCLUDING THE DEFINITIONS OF
CERTAIN TERMS IN THE INDENTURE AND THOSE TERMS MADE A PART OF THE INDENTURE BY
THE TRUST INDENTURE ACT. WHEREVER PARTICULAR PROVISIONS AND DEFINITIONS
CONTAINED IN THE INDENTURE ARE REFERRED TO, SUCH PROVISIONS AND DEFINITIONS ARE
INCORPORATED BY REFERENCE AS PART OF THE STATEMENTS MADE, AND THE STATEMENTS ARE
QUALIFIED IN THEIR ENTIRETY BY THOSE REFERENCES. ARTICLE AND SECTION REFERENCES
ARE TO ARTICLES AND SECTIONS OF THE INDENTURE. UNLESS OTHERWISE DEFINED HEREIN,
CAPITALIZED TERMS HAVE THE SAME MEANINGS AS DEFINED IN THE INDENTURE. FOR
DEFINITIONS OF CERTAIN TERMS USED IN THIS SECTION, SEE "--CERTAIN DEFINITIONS"
BELOW.
GENERAL
The Notes will be general, unsecured obligations of the Company and will be
limited to $20,000,000 aggregate principal amount, plus up to an additional
$3,000,000 aggregate principal amount if the Underwriters' over-allotment option
is exercised in full. The Notes will be subordinated to all existing and future
Senior Indebtedness of the Company as described under "--Subordination" below.
At December 31, 1996, there was approximately $13.3 million of Senior
Indebtedness outstanding. The Notes will mature on April 15, 2004, unless
redeemed earlier (i) at the option of the Company or (ii) at the option of
Holders following the occurrence of a Special Redemption Event. See
"--Redemption at Option of the Company" and "--Holders' Right to Redemption
After Special Redemption Event."
Interest on the Notes will be payable on the 15th day of each month
commencing May 15, 1997 (each an "Interest Payment Date") to the person who is
the Holder as of the close of business on the first day of the calendar month
(whether or not a Business Day) in which the related Interest Payment Date
occurs. Interest will accrue, at the rate per annum stated on the cover page of
this Prospectus, from and including each Interest Payment Date (or, in the case
of the first Interest Payment Date, from the date of issuance) to but excluding
the next Interest Payment Date. In the event an Interest Payment Date falls on a
day other than a Business Day, interest will be paid on the next succeeding
Business Day and no interest on such payment shall accrue for the period from
and after such Interest Payment Date to such next succeeding Business Day. The
amount of interest payable on each Interest Payment Date will be computed on the
basis of a 360-day year consisting of twelve 30-day months. (Sections 301, 307,
308, 310 and Supplement Sections 1.4 and 1.5) Principal and interest will be
payable at an office or agency to be maintained by the Company in New York, New
York. (Sections 301, 307, 1002 and Supplement Section 1.3)
The Company will issue the Notes in denominations of $1,000 and integral
multiples thereof. (Section 302) The Notes will be initially issued only in
fully registered book-entry form with The Depository Trust Company, as the
book-entry depositary (the "Depositary"). Except as described in this Prospectus
or in the Indenture, the Notes will not be issuable in definitive certificated
form to any person other than the Depositary or its nominees (Article 2 and
Supplement 1.3). Book-entry beneficial owners of the Notes will not be entitled
to have such book-entry beneficial ownership registered in their names on the
Security Register, will not receive or be entitled to receive physicial delivery
of the Notes beneficially owned by book-entry registration, and will not be
deemed to be the registered holders (the "Holders") of the Notes under the
Indenture. Accordingly, such person holding a book-entry beneficial interest in
the Notes must rely upon the procedures of the Depositary and, if such person is
not a Participant (as defined below) in the Depositary's book-entry system, on
the procedures of the Participant through which such person owns its interest,
to exercise any rights of a Holder of the Notes under the Indenture. See
"--Book-Entry System."
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The Company will furnish to Holders annual reports containing financial
statements of the Company audited by independent certified public accountants.
(Section 704)
CONVERSION RIGHTS
At maturity or upon the exercise by the Company of an optional redemption,
each Holder of Notes will have the right to convert into Common Stock 25% of the
aggregate principal amount of the Notes held by such Holder and if a Special
Redemption Event occurs, each Holder who elects to require the redemption of its
Notes will have the right to convert into Common Stock 25% of the principal
amount of its Notes. The conversion price shall be $10.15 per share (equivalent
to approximately 24.63 shares of Common Stock for each $250 portion of each
$1,000 principal amount of Notes) provided that such price may be adjusted from
time to time as provided in the Indenture. To be effective, any notice that a
Holder is exercising its right to convert 25% of its Notes to Common Stock, must
be received by the Trustee from the Holder not later than the close of business
on the third Business Day prior to the Effective Date. The "Effective Date"
refers to (i) if the conversion occurs on the Stated Maturity of the Notes, the
Stated Maturity date, (ii) if the conversion occurs as a result of the
redemption of the Notes at the option of the Company, the Redemption Date, and
(iii) if the conversion occurs because of the occurrence of a Special Redemption
Event and the Holder's election to require redemption of such Holder's Notes,
the Repayment Date. The documentation and information which is to be delivered
by the Holder to the Trustee or the Company to effect any such conversion is
described in the Indenture; however, so long as the Notes are in book-entry only
form, the sole registered Holder of the Notes will be the Depositary or its
nominee or successor. Accordingly, any person holding a book-entry beneficial
owner interest in the Notes must rely upon the procedures of the Depositary in
order to effect a conversion and, if such beneficial owner is not a Participant,
on the procedures of the Participant through which such person owns its
interest. See "-- Book-Entry System." (Supplement Sections 1.9 and 1.10)
The conversion price will be subject to adjustment in certain events,
including (i) dividends (and other distributions) payable in Common Stock on any
class of capital stock of the Company, (ii) the issuance to all holders of
Common Stock of rights, options or warrants entitling them to subscribe for or
purchase Common Stock (or securities convertible into Common Stock) at less than
the then-current market price (as determined in accordance with the Indenture)
unless holders of Notes are entitled to receive the same upon conversion, (iii)
subdivisions, combinations and reclassifications of Common Stock and (iv)
distributions to all holders of Common Stock of evidences of indebtedness of the
Company or assets (including securities, but excluding those rights, options,
warrants, dividends and distributions referred to above, and excluding dividends
and distributions paid in cash out of the retained earnings of the Company). In
addition to the foregoing adjustments, in case the Company shall subdivide its
outstanding shares of Common Stock into a greater number of shares, the
Conversion Price in effect immediately prior to such subdivision shall be
proportionately reduced, and, in case the outstanding shares of Common Stock of
the Company shall be combined into a smaller number of shares, the conversion
price in effect immediately prior to such combination shall be proportionately
increased. In addition, if any capital reorganization or reclassification of the
capital stock of the Company, or consolidation or merger of the Company with
another corporation, or the sale of all or substantially all of its assets to
another corporation shall result in the holders of Common Stock being entitled
to receive stock, securities or assets with respect to or in exchange for Common
Stock, then provision is to be made whereby the Holders shall have the right to
purchase and receive such shares of stock, securities or assets as may be issued
or payable with respect to or in exchange for such Common Stock. Adjustments in
the conversion price of less than $0.25 per share will not be required, but any
adjustment that would otherwise be required to be made will be taken into
account in the computation of any subsequent adjustment. Fractional shares of
Common Stock are not to be issued or delivered upon conversion, but, in lieu
thereof, a cash adjustment will be paid based upon the then-current market price
of Common Stock. (Supplement Sections 1.11 and 1.12)
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Subject to the foregoing, no payments or adjustments will be made upon
conversion on account of accrued interest on the Notes or for any dividends or
distributions on any shares of Common Stock delivered upon such conversion.
Conversion price adjustments or omissions in making such adjustments may,
under certain circumstances, be deemed to be distributions that could be taxable
as dividends under the Code to holders of Notes or of Common Stock.
In the event that the Company should merge with another company, become a
party to a consolidation or sell or transfer all or substantially all of its
assets to another company, each Note then outstanding would, without the consent
of any Holder of Notes, become convertible only into the kind and amount of
securities, cash and other property receivable upon the merger, consolidation or
transfer by a holder of the number of shares of Common Stock into which such
Note might have been converted immediately prior to such merger, consolidation
or transfer. Such a transaction, or the securities, cash or other property
received in such a transaction, could result in United States federal taxes
being imposed on the Holder of a Note at a time or in a manner not anticipated
at the time such Note was purchased by such Holder.
REDEMPTION AT OPTION OF THE COMPANY
The Notes may not be redeemed at the Company's option prior to April 15,
2000. The Notes are subject to redemption at the option of the Company, in whole
but not in part, at any time, upon not less than 30 nor more than 60 days'
notice mailed to the person in whose name the Note is registered, commencing on
April 15, 2000 at the redemption price of 100% of the principal amount of the
Notes. The redemption price will be paid with interest accrued to and including
the date fixed for redemption. After the redemption date, interest will cease to
accrue on the Notes. (Article 11 and Supplement Section 1.6)
HOLDERS' RIGHT TO REDEMPTION AFTER SPECIAL REDEMPTION EVENT
In the event of any Special Redemption Event, each Holder will have the
right, at such Holder's option and subject to the terms and conditions, of the
Indenture, to require the Company to redeem such Holder's Notes, in whole, but
not in part, on the date that is 75 days after the occurrence of the Special
Redemption Event at a price equal to 100% of the principal amount thereof, plus
interest accrued to and including the date of redemption. Neither the Board of
Directors of the Company nor the Trustee will have the ability to waive the
Company's obligation to redeem a Holder's Notes upon request in the event of a
Special Redemption Event. (Section 1303 and Supplement Section 1.7)
If a Special Redemption Event occurs, the Company is obligated to provide
promptly, but in any event within three Business Days after expiration of a
40-day period following the occurrence of such event, notice to the Trustee, who
shall promptly (within five days after receipt of notice from the Company)
notify all Holders of the Special Redemption Event, which notice shall state
among other things, (i) the occurrence of such Special Redemption Event, (ii)
the date on or before which a Holder must notify the Trustee of such Holder's
intention to exercise the redemption option (which date shall be three Business
Days prior to the date of redemption) , (iii) the procedure such Holder must
follow to exercise such right and (iv) that, if the Holder elects to exercise
such right, the Holder may convert 25% of the principal amount of such Notes
into Common Stock. To exercise such right, the Holder must deliver to the
Trustee on or before the close of business on the third Business Day prior to
the date of redemption, written notice of such Holder's redemption election and
the Note(s) to be redeemed free of liens or encumbrances. (Section 1303)
The definition of "Special Redemption Event" is set forth herein under the
caption "Description of the Notes--Certain Definitions."
Although there is a developing body of case law interpreting the phrase
"substantially all," there is no precise established definition of the phrase
under applicable law. Accordingly, the ability of a Holder to
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require the Company to redeem such Notes as a result of a conveyance, transfer
or lease of less than all of the assets of the Company to another person may be
uncertain.
Except as described above with respect to a Special Redemption Event, the
Indenture does not contain any other provisions that permit the Holders to
require that the Company redeem the Notes in the event of a takeover or similar
transaction. Moreover, a recapitalization of the Company or a transaction
entered into by the Company with management or their affiliates would not
necessarily be included within the definition of a "Special Redemption Event."
Accordingly, while such definition covers a wide variety of arrangements which
have traditionally been used to effect highly leveraged transactions, the
Indenture does not afford the Holders protection in all circumstances from
highly leveraged transactions, reorganizations, restructurings, mergers or
similar transactions involving the Company that may adversely affect Holders.
The Special Redemption Event redemption feature of the Notes may, in certain
circumstances, make more difficult or discourage a takeover of the Company and
thus removal of incumbent management. The Special Redemption Event redemption
feature, however, is not the result of management's knowledge of any specific
effort to obtain control of the Company or part of a plan by management to adopt
a series of antitakeover provisions. Rather, the terms of the Special Redemption
Event redemption feature are a result of negotiations between the Company and
the Underwriters.
The Company will comply with the provisions of Rule 13e-4 and any other
tender offer rules under the Exchange Act which may then be applicable and will
file a Schedule 13E-4 or any other schedule required thereunder in connection
with any offer by the Company to purchase Notes at the option of Holders thereof
upon a Special Redemption Event.
SUBORDINATION
The Notes will be subordinated, in the manner and to the extent set forth in
the Indenture, to the prior payment in full of all Senior Indebtedness of the
Company. (Article Fourteen)
From and after the receipt by the Trustee of a written notice (a "Default
Notice") from the holder or holders of not less than 51% in principal amount of
the outstanding Senior Indebtedness specifying that any payment default under
any Senior Indebtedness has occurred (a "Senior Event of Default"), the Company
may not make any principal payments to the holders of the Notes and neither the
Trustee nor the holders of not less than 25% in principal amount of the
outstanding Notes may accelerate the maturity of the Notes until (i) such Senior
Event of Default is cured, (ii) such Senior Event of Default is waived by the
holders of such Senior Indebtedness, or (iii) the expiration of 180 days after
the date the Default Notice is received by the Trustee, if the maturity of such
Senior Indebtedness has not been accelerated at such time.
Upon payment in full of the Senior Indebtness, payment of principal may be
made to the holders of the Notes.
If there has been and is continuing a payment default on the Senior
Indebtedness, interest will not be paid on the Notes.
Upon a distribution of assets, dissolution, winding up, liquidation or
reorganization of the Company, upon an assignment for the benefit of creditors,
or if the principal of the Notes has been declared due and payable and such
declaration has not been rescinded or annulled, then in any such instance all
Senior Indebtedness must be repaid in full before any payment of principal or
interest on the Notes can be made. Any subordination will not prevent the
occurrence of an Event of Default under the Indenture. See "--Events of Default;
Notice and Waiver."
As stated above, by reason of the subordination of the Notes, in the event
of liquidation of the Company, the Holders of the Notes will not receive payment
until the holders of Senior Indebtedness have
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been satisfied. Also, by reason of the subordination provisions, the Holders of
the Notes may receive payments less ratably than other creditors of the Company.
As of December 31, 1996, the Company had $13.3 million of outstanding Senior
Indebtedness. Substantial additional Senior Indebtedness may be issued or
incurred in the future, subject only to certain limitations on Indebtedness for
Money Borrowed. See "--Limitations on Additional Indebtedness."
LIMITATIONS ON ADDITIONAL INDEBTEDNESS
The Indenture provides that the Company will not, nor will it permit any
Subsidiary to, create, incur, assume, guarantee or be liable with respect to any
Indebtedness for Money Borrowed (other than Subordinated Indebtedness) if,
immediately after giving effect thereto (including the retirement of any
existing indebtedness from the proceeds of such additional Indebtedness for
Money Borrowed), the aggregate amount of Indebtedness for Money Borrowed
outstanding would exceed six times the sum of the Company's Consolidated Net
Worth plus Subordinated Indebtedness. For purposes of the limitation on
additional indebtedness set forth in this paragraph, Indebtedness for Money
Borrowed shall not include the "Warehouse Indebtedness," and in calculating the
Consolidated Net Worth, the Warehouse Indebtedness shall not be included as a
liability. (Sections 101 and 1008) At December 31, 1996, the Company's
Consolidated Net Worth was $57.0 million and Indebtedness for Money Borrowed
other than Subordinated Indebtedness was $13.3 million and $23.0 million of
Subordinated Indebtedness was outstanding.
The Indenture provides that the Company will not, nor will it permit any
Subsidiary to, create, incur, assume, guarantee or be liable with respect to any
Subordinated Indebtedness, if immediately after giving effect thereto (including
the retirement of any existing indebtedness from the proceeds of such
Subordinated Indebtedness), the aggregate amount of Subordinated Indebtedness
outstanding would exceed the Company's Consolidated Net Worth. (Section 1009)
LIMITATION ON RANKING OF FUTURE INDEBTEDNESS
The Indenture provides that the Company may not, directly or indirectly,
incur, create, assume or guarantee any Indebtedness for Money Borrowed which is
not Senior Indebtedness (other than Subordinated Indebtedness that is PARI PASSU
or subordinate in right of payment to the Notes). (Section 1014)
LIMITATION ON RESTRICTED PAYMENTS
The Indenture provides that the Company shall not (i) declare or pay any
dividend, either in cash or property, on any shares of its capital stock (except
dividends or other distributions payable solely in shares of capital stock of
the Company or warrants, options or other rights solely to acquire capital stock
of the Company) or (ii) purchase, redeem or retire any shares of its capital
stock or any warrants, rights or options to purchase or acquire any shares of
its capital stock (except from employees in connection with the termination of
their employment) or (iii) make any other payment or distribution, either
directly or indirectly through any Subsidiary, in respect of its capital stock
(such dividends, purchases, redemptions, retirements, payments and distributions
being herein collectively called "Restricted Payments") if, after giving effect
thereto,
(1) an Event of Default would have occurred; or
(2) (A) the sum of (i) such Restricted Payment plus (ii) the aggregate
amount of all Restricted Payments made during the period after December 31, 1996
would exceed (B) the sum of (i) $7.5 million plus (ii) 50% of Consolidated Net
Income for the period commencing December 31, 1996 and ending on the date of
payment of such Restricted Payment, treated as one accounting period plus (iii)
100% of the cumulative cash and non-cash proceeds received by the Company from
contributions to capital or the issuance or sale after December 31, 1996 of
capital stock of the Company or of any warrants, rights or other options to
purchase or acquire its capital stock.
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Notwithstanding the foregoing, the Company may make a previously declared
Restricted Payment if at the date of the declaration, such Restricted Payment
would have been permitted under this covenant. For purposes of this covenant,
the amount of any Restricted Payment payable in property shall be deemed to be
the fair market value of such property as determined by the Board of Directors
of the Company. (Section 1007)
RESTRICTIONS ON SUBSIDIARIES
The Indenture provides that the Company will not organize and own directly
or indirectly the Voting Stock of any Person that directly or indirectly owns or
holds finance receivables (with an aggregate principal amount in excess of $1.0
million) originated by the Company or any Subsidiary unless (i) the net income
and net worth of such Person is accounted for as a consolidated subsidiary of
the Company in accordance with generally accepted accounting principles, (ii)
the Company owns directly or indirectly at least 80% of the outstanding Voting
Stock of such Person and (iii) the Company owns directly or indirectly stock or
equity interests in such Person having a value equal to at least 80% of the
total value of the stock or equity interests in such Person. For purposes of
clause (iii), "stock" or "equity interests" shall not include preferred stock or
any similar equity interest which (A) is not entitled to vote except as required
by law, (B) is limited and preferred as to dividends or distributions and does
not participate in the economic growth of the Person to any significant extent,
(C) has, to the extent provided for, redemption rights and liquidation rights
which do not exceed the issue price of such stock or equity interests (except
for a reasonable redemption or liquidation premium), and (D) is not convertible
into another class of stock or equity interest. (Section 1015)
LIMITATIONS ON TRANSACTIONS WITH AFFILIATES
The Indenture provides that the Company shall not, and shall not permit any
of its Subsidiaries to, enter into or permit to exist any transaction (or series
of related transactions), including, without limitation, any loan, advance,
guarantee or capital contribution to, or for the benefit of, or any sale,
purchase, lease, exchange or other disposition of any property or the rendering
of any service, or any other direct or indirect payment, transfer or other
disposition (a "Transaction"), involving payments, with any Affiliate of the
Company, on terms and conditions less favorable to the Company or such
Subsidiary, as the case may be, than would be available at such time in a
comparable Transaction in arm's-length dealings with an unrelated Person as
determined by the Board of Directors, such approval to be evidenced by a Board
Resolution.
The provisions of the immediately preceding paragraph will not apply to:
(i) Restricted Payments otherwise permitted pursuant to the Indenture;
or
(ii) fees and compensation (including amounts paid pursuant to employee
benefit plans) paid to, and indemnity provided on behalf of, officers,
directors, employees or consultants of the Company or any Subsidiary, as
determined by the Board of Directors or the senior management thereof in the
exercise of their reasonable business judgment; or
(iii) payments for goods and services purchased in the ordinary course of
business on an arm's-length basis; or
(iv) Transactions which do not exceed $200,000; or
(v) Transactions between or among any of the Company and its wholly
owned subsidiaries. (Section 1016)
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CONSOLIDATION, MERGER OR TRANSFER
The Indenture provides that except in connection with a sale, financing or
securitization of receivables or transfers made in the ordinary course of
business, the Company may not consolidate with, merge with or transfer all or
substantially all of its assets to another entity (other than a wholly owned
subsidiary) unless such other entity assumes the Company's obligations under the
Indenture and unless, after giving effect thereto, no event shall have occurred
and be continuing which, after notice or lapse of time, would become an Event of
Default. (Section 801)
BOOK-ENTRY SYSTEM
Upon issuance of the Notes to the Depositary, the Depositary will credit on
its book-entry registration and transfer system to the accounts of institutions
that have accounts with the Depositary or the Depositary's nominee (the
"Participants") the aggregate principal amounts of such Notes beneficially owned
by such Participants. The accounts to be credited initially shall be designated
by the Underwriters. Beneficial ownership of the Notes issued to the Depositary
will be limited to the Participants or persons holding interests through the
Participants. The Participants' beneficial ownership of the Notes will be shown
on, and the transfer of such ownership interest will be effected only through,
records maintained by the Depositary or its nominee. Beneficial ownership of the
Notes by persons who hold through the Participants will be shown on, and the
transfer of such ownership interest will be effected only through, records
maintained by such Participant. The laws of some jurisdictions require that
certain purchasers of securities take physical delivery of such securities in
definitive form. Such laws and limits may impair a Holder's ability to transfer
beneficial ownership in the Notes.
Except as set forth below, book-entry beneficial owners of the Notes will
not be entitled to have such book-entry beneficial ownership registered in their
names on the Security Register, will not receive or be entitled to receive
physical delivery of the Notes beneficially owned by book-entry registration,
and will not be deemed to be the registered holders of the Notes under the
Indenture.
Accordingly, such person holding a book-entry beneficial interest in the
Notes must rely upon the procedures of the Depositary and, if such person is not
a Participant, on the procedures of the Participant through which such person
owns its interest, to exercise any rights of a Holder of the Notes under the
Indenture. The Indenture provides that the Depositary may grant proxies or
otherwise authorize Participants to take any action which a registered holder of
a Note under the Indenture is entitled to take. (Section 104) The Company
understands that under existing industry practice, in the event that the Company
requests any action of registered holders of the Notes under the Indenture or a
book-entry beneficial owner of such Notes desires to take any action which a
registered holder of a Note under the Indenture would be entitled to take, the
Depositary would authorize the Participants to take any such action and the
Participants would authorize the book-entry beneficial owners holding the Notes
through such Participants to take such action or would otherwise act upon the
instructions of the book-entry beneficial owners holding the Notes through them.
The total amount of any principal and/or interest due to book-entry
beneficial owners with regard to the Notes on any Interest Payment Date,
redemption date or upon maturity will be made available by the Company to the
Paying Agent on such date. As soon as practicable thereafter, the Paying Agent
will make such payments available to the Depositary in accordance with
arrangements between the Paying Agent and the Depositary. The Company expects
that the Depositary upon receipt of any payment of interest or principal in
respect of the Notes will credit immediately the Participants' book-entry
accounts in amounts proportionate to their respective book-entry beneficial
interests in the Notes as reflected on the records of the Depositary. The
Company also expects that payments by the Participants to the book-entry owners
of beneficial interests in the Notes will be governed by standing instructions
and customary practices, as is the case with any securities held for the
accounts of customers in bearer form or registered in "street name." Neither the
Company, the Paying Agent, the Trustee nor any agent of the Company, Paying
Agent or
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Trustee will have any responsibility or liability for any aspect of such
payments to the book-entry accounts by the Depositary or the Participants or for
maintaining, supervising or reviewing any records relating to book-entry
beneficial interests in the Notes.
Pursuant to the policies of the Depositary, the Notes held by the Depositary
may not be transferred except as a whole by the Depositary to a nominee of such
Depositary or by a nominee of such Depositary to such Depositary or another
nominee of such Depositary or by the Depositary or such nominee to a successor
depositary or its nominees. Book-entry beneficial interests in the Notes are
exchangeable for Notes in denominations of $1,000 and integral multiples thereof
and fully registered in such names as the Depositary directs if: (i) the
Depositary holding the Notes notifies the Company that the Depositary is
unwilling, unable or ineligible to continue as Depositary for the Notes and a
successor depositary is not appointed by the Company within 60 days; (ii) the
Company executes and delivers to the Trustee a Company Order that such
book-entry beneficial interests in the Notes be exchangeable for fully
registered Notes; or (iii) an Event of Default occurs and shall be continuing as
to the Notes. Subject to the foregoing, the book-entry beneficial interests in
the Notes shall not otherwise be exchangeable for fully registered Notes.
(Section 305)
EVENTS OF DEFAULT, NOTICE AND WAIVER
An Event of Default under the Indenture includes: (i) failure to pay the
principal on the Notes when due at Maturity, upon redemption or upon repayment,
as provided in the Indenture, or, with respect to any Securities issued under
the Indenture which provides for sinking fund payments, failure to deposit a
sinking fund payment and, in each case, which default continues for five days;
(ii) failure to pay any interest on the Notes when due, which default continues
for ten days; (iii) failure to perform any other covenant set forth in the
Indenture for 30 days after receipt of written notice from the Trustee or
Holders of at least 25% in principal amount of the outstanding Securities under
the Indenture specifying the default and requiring the Company to remedy such
default; (iv) default in the payment at stated maturity of any Indebtedness for
Money Borrowed of the Company or a Significant Subsidiary having an outstanding
principal amount greater than $1,000,000 and such default having continued for a
period of 30 days beyond any applicable grace period; (v) an event of default as
defined in any mortgage, indenture or instrument of the Company or any
Significant Subsidiary shall have happened and resulted in indebtedness in a
principal amount in excess of $1,000,000 being accelerated, and such
acceleration having continued for a period of 30 days after notice has been
given to the Company by the Trustee or Holders of at least 25% in principal
amount of the outstanding Securities under the Indenture requesting such
acceleration be rescinded or annulled; (vi) certain events of insolvency,
receivership, or reorganization of the Company or any Significant Subsidiary,
and (vii) entry of a final judgment, decree or order against the Company or any
Significant Subsidiary for the payment of money in excess of $5,000,000 in
certain circumstances. (Section 501)
If an Event of Default shall occur and be continuing, the Trustee, in its
discretion may, and, at the written request of Holders of at least 25% in
aggregate principal amount of the outstanding Notes and upon being indemnified
to its satisfaction shall, proceed to protect and enforce its rights and the
rights of the Holders. If an Event of Default shall occur and be continuing,
subject to the subordination provisions of the Indenture, either the Trustee or
the Holders of at least 25% in aggregate principal amount of outstanding Notes
may accelerate the maturity of all such outstanding Notes. Prior to any judgment
or decree for the payment of money being obtained, the Holders of a majority in
aggregate principal amount outstanding Notes may waive an Event of Default
resulting in acceleration of such Notes but only if all Events of Default have
been remedied and all payments due, other than those due as a result of
acceleration, have been made. (Sections 502, 503, 512 and 513)
The Company must furnish annually to the Trustee an Officers' Certificate
stating whether, to the best of the knowledge of the officers executing such
certificate, the Company is in default under any of the
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provisions of the Indenture, and specifying all such defaults, and the nature
thereof, of which they have knowledge. (Section 1012)
A Holder will not have any right to institute any proceeding with respect to
the Indenture or for any remedy thereunder, unless (i) such Holder shall have
previously given to the Trustee written notice of a continuing Event of Default,
(ii) the Holders of at least 25% in aggregate principal amount of the
outstanding Notes shall have made a written request, and offered reasonable
indemnity, to the Trustee to institute such proceedings, (iii) the Trustee shall
have failed to institute such proceeding within 60 days and (iv) the Trustee
shall not have received from the Holders of a majority in aggregate principal
amount of the outstanding Notes a direction inconsistent with such request.
(Section 507) However, the Holder of any Note will have an absolute right to
receive payment of the principal of and interest on such Note on or after the
respective due dates and to institute suit for the enforcement of any such
payments. (Section 508)
MODIFICATION AND WAIVER
With certain limited exceptions which permit modification of the Indenture
by the Company and Trustee only and without the consent of any holders of the
Securities, the Indenture may be modified by the Company with the consent of
Holders of not less than a majority in aggregate principal amount of outstanding
Notes, if the Notes are affected thereby; provided, however, that no such
changes shall without the consent of the Holder of each Note affected thereby
(i) change the Maturity of the principal of, or the due date of any installment
of principal or interest on, any Note, (ii) reduce the principal of, or the rate
of interest on any Note, (iii) change the coin or currency in which any portion
of the principal of, or interest on, any Note is payable, (iv) impair the right
to institute suit for the enforcement of any such payment, (v) reduce the
above-stated percentage of Holders of the outstanding Notes necessary to modify
the Indenture, (vi) modify the foregoing requirements or reduce the percentage
of outstanding Notes necessary to waive any past default, (vii) impair the
Special Redemption Event or any optional right to redemption or repayment
provided the Holders, or (viii) adversely affect a Holder's rights to convert
25% of the principal amount of its Notes into Common Stock. (Sections 513, 901
and 902)
The Holders of a majority in aggregate principal amount of outstanding Notes
may waive compliance by the Company with certain restrictive provisions of the
Indenture. (Section 1013)
SATISFACTION AND DISCHARGE OF INDENTURE; DEFEASANCE
The Indenture provides that the Company may terminate its obligations under
the Indenture with respect to all Notes which have become due and payable, will
become due and payable at their Stated Maturity within one year or are
redeemable at the option of the Company within one year, by delivering to the
Trustee, in trust for such purpose, money and/or Government Obligations which,
through the payment of interest and principal in respect thereof in accordance
with their terms, will provide on the due dates of any payment of principal and
interest with respect thereto, or a combination thereof, money in an amount
sufficient to discharge the entire indebtedness on such Notes. Defeasance of the
Notes is subject to delivery to the Trustee of an opinion of independent counsel
that Holders of the outstanding Notes will not recognize income, gain or loss
for Federal income tax purposes as a result of such deposit and termination and
certain other conditions. (Sections 401 and 402)
1995 SUBORDINATED DEBT
On December 20, 1995, the Company issued the 1995 Subordinated Debt,
consisting of $20.0 million in rising interest subordinated redeemable
securities due January 1, 2006, represented by promissory notes ("1995 Notes").
The 1995 Notes are unsecured general obligations of the Company. Interest on the
1995 Notes is payable on the first day of each month, since February 1, 1996,
initially 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
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<PAGE>
last year. The 1995 Notes are subordinated to certain existing and future
indebtedness of the Company to the same extent as the Notes offered by this
Prospectus are subordinated. The Company is required to redeem, subject to
certain adjustments, $1.0 million of the aggregate principal amount of the 1995
Notes through the operation of the sinking fund on each of January 1, 2000,
2001, 2002, 2003, 2004 and 2005. The 1995 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 1995 Notes from the registered holders of the 1995 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.
CERTAIN DEFINITIONS
"Affiliate" of any specified Person means any other Person directly or
indirectly controlling or controlled by or under direct or indirect common
control with such specified Person. For the purposes of this definition,
"control", when used with respect to any specified Person, means the power to
direct the management and policies of such Person, directly or indirectly,
whether through the ownership of voting securities, by contract or otherwise;
and the terms "controlling" and "controlled" have the meanings correlative to
the foregoing.
"Capitalized Lease Obligations" means, as to any Person, the obligations of
such Person to pay rent or other amounts under a lease of (or other agreement
conveying the right to use) real or personal property which obligations are
required to be classified and accounted for as capital lease obligations on a
balance sheet of such Person under generally accepted accounting principles and,
for purposes of the Indenture, the amount of such obligations at any date shall
be the capitalized amount thereof at such date, determined in accordance with
generally accepted accounting principles.
"Consolidated Net Income" means the amount of net income (loss) of the
Company and its Subsidiaries determined in accordance with generally accepted
accounting principles; provided, however, that there shall not be included in
Consolidated Net Income any net income (loss) of any Person acquired or disposed
of in a pooling of interests transaction for any period prior to the acquisition
thereof or subsequent to the disposition thereof.
"Consolidated Net Worth" means the excess, as determined in accordance with
generally accepted accounting principles, after making appropriate deductions
for any minority interest in the net worth of Subsidiaries of (i) the assets of
the Company and its Subsidiaries over (ii) the liabilities of the Company and
its Subsidiaries; provided, however, that any write-up in the book value of any
assets owned subsequent to the date of the Indenture, other than as required for
and at the time of assets acquired in connection with the purchase of a Person
or business, shall not be taken into account.
"Indebtedness for Money Borrowed" means any of the following obligations of
the Company or any Subsidiary which by its terms matures at or is extendable or
renewable at the sole option of the obligor without requiring the consent of the
obligee to a date more than twelve months after the date of the creation or
incurrence of such obligation: (i) any obligations, contingent or otherwise, for
borrowed money or for the deferred purchase price of property, assets,
securities, or services (including, without limitation, any interest accruing
subsequent to an Event of Default), (ii) all obligations (including the Notes)
evidenced by bonds, notes, debentures, letters of credit, or other similar
instruments, (iii) all indebtedness created or arising under any conditional
sale or other title retention agreement with respect to property acquired (even
though the rights and remedies of the seller or lender under such agreement in
the event of default are limited to repossession or sale of such property),
except any such obligation that constitutes a trade payable and an accrued
liability arising in the ordinary course of business, if and to the extent any
of the foregoing indebtedness would appear as a liability on a balance sheet
prepared in accordance with generally accepted accounting principles, (iv) all
Capitalized Lease Obligations, (v) all indebtedness of the
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<PAGE>
type referred to in clause (i), (ii), (iii) or (iv) above secured by (or for
which the holder of such indebtedness has an existing right, contingent or
otherwise, to be secured by) any lien upon or in property of the Company
(including, without limitation, accounts and contract rights), even though the
Company has not assumed or become liable for the payment of such indebtedness,
and (vi) any guaranty or endorsement (other than for collection or deposit in
the ordinary course of business) or discount with recourse of, or other
agreement, contingent or otherwise, to purchase, repurchase, or otherwise
acquire, to supply or advance funds, or become liable with respect to, any
indebtedness or any obligation of the type referred to in any of the foregoing
clauses (i) through (v), regardless of whether such obligation would appear on a
balance sheet; provided, however, that Indebtedness for Money Borrowed shall not
include (x) Interest Rate Swap Obligations with respect to any obligations
included in the foregoing clauses (i) through (vi), or any guarantees of any
such Interest Rate Swap Obligations or (y) amounts due under or represented by
asset-backed securities or other interest-bearing certificates issued by trusts
formed by Subsidiaries in connection with the securitization of automobile
installment sale contracts or other receivables.
"Interest Rate Swap Obligations" means the obligation of the Company or any
Subsidiary pursuant to any interest rate swap agreement, interest rate collar
agreement, forward rate agreement, interest rate cap insurance, option or
futures contract or other similar agreement or arrangement, and any renewal or
extension thereof, designed to protect the Company or any of its Subsidiaries
against interest rate risk.
"Senior Indebtedness" means the principal amount of, premium, if any, and
interest on (i) any Indebtedness for Money Borrowed whether outstanding as of
the date of the Indenture or thereafter created, incurred, assumed or
guaranteed, unless in the instrument creating or evidencing such Indebtedness
for Money Borrowed or pursuant to which such Indebtedness for Money Borrowed is
outstanding it is provided that such Indebtedness for Money Borrowed is
subordinate in right of payment or in rights upon liquidation to any other
Indebtedness for Money Borrowed of the Company and (ii) refundings, renewals,
extensions, modifications, restatements, and increases of any such indebtedness.
"Significant Subsidiary" means any Subsidiary which accounted for more than
10% of the Company's Consolidated Net Worth or more than 10% of the Company's
consolidated revenue, in each case, as of the end of the Company's most recent
fiscal year.
"Special Redemption Event" means the occurrence of any one or more of the
following: (i) (x) the Company shall consolidate with or merge into another
Person, (y) the Company shall convey, transfer or lease all or substantially all
of its assets to any Person or (z) any Person shall consolidate with or merge
into the Company pursuant to a transaction in which the outstanding common stock
of the Company is reclassified, changed or exchanged; provided that the
following shall be excluded from the operation of this clause (i): a transaction
which is part of a sale, financing or securitization of receivables, entered
into in the ordinary course of business; a transaction between the Company and
one or more of its wholly-owned Subsidiaries; or a transaction of the type
described in clause (i) (x) or (i) (z) above unless immediately after giving
effect to such transaction, a Person or "group" (as such term is used for
purposes of Section 13(d) and 14(d) of the Exchange Act), other than any Person
who is a director of the Company or a "related Person" on the date of the
Indenture, is or becomes the "beneficial owner," directly or indirectly, of more
than 50% of the total voting power in the aggregate normally entitled to vote in
the election of directors; and (ii) any Person or "group" (as such term is used
for purposes of Section 13(d) or 14(d) of the Exchange Act) other than any
Person who is a director of the Company or a "related Person" on the date of the
Indenture, shall purchase or otherwise acquire in one or more transactions or
series of transactions beneficial ownership of 50% or more of the outstanding
common stock of the Company on the date immediately prior to the last such
purchase or other acquisition. For purposes of this definition, "related Person"
means, in addition to such director, (a) any relative or spouse of such
director, or any relative of such spouse, (b) any trust or estate in which such
Person or any of the Persons specified in clause (a) collectively own 50% or
more of the total beneficial interest or (c) any corporation or other
63
<PAGE>
organization (other than the Company) in which such director or any of the
Persons specified in clause (a) or (b) are the beneficial owners collectively of
50% or more the voting power.
"Subordinated Indebtedness" means any Indebtedness for Money Borrowed that
is not Senior Indebtedness.
"Subsidiary" means any corporation of which at that time of determination
the Company or one or more Subsidiaries owns or controls directly or indirectly
more than 50% of the shares of Voting Stock.
"Voting Stock" means stock of a corporation of the class or classes having
general voting power under ordinary circumstances to elect at least a majority
of the board of directors, managers, or trustees of such corporation, provided
that, for the purposes hereof, stock which carries only the right to vote
conditionally on the happening of an event shall not be considered Voting Stock
whether or not such event shall have happened.
"Warehouse Indebtedness" means Indebtedness for Money Borrowed under the
Warehouse Line of Credit and any replacement or additional facility under which
the Company borrows money against Contracts held for sale, pending their sale in
securitization transactions.
RATING
The Notes are rated "B+" by Duff & Phelps Credit Rating Co. ("Duff &
Phelps"), which is below investment grade. Ratings are not a recommendation to
purchase, hold or sell the Notes, as ratings do not comment as to market price
or suitability for a particular investor. The ratings are based on current
information furnished to Duff & Phelps by the Company and obtained from other
sources. The ratings may be changed, suspended or withdrawn at any time as a
result of changes in, or unavailability of, such information.
THE TRUSTEE
Bankers Trust Company is the Trustee under the Indenture. Its principal
corporate trust office is located at Four Albany Street, New York, New York.
DESCRIPTION OF COMMON STOCK
The holders of Common Stock are entitled to one vote for each share held of
record on all matters submitted to a vote of shareholders, except that holders
of Common Stock are entitled to cumulate their votes in the election of
directors if they comply with the provisions of the Company's Bylaws as to
cumulative voting. In cumulative voting, each holder is permitted to cast such
number of votes in the aggregate as equals the number of shares of stock held
multiplied by the number of directors to be elected. The holders may cast the
whole number of such votes for one nominee for director or distribute the votes
among two or more nominees as the holder sees fit.
Holders of Common Stock are entitled to such dividends as the Company's
Board of Directors, in its discretion, may declare out of funds available
therefore, subject to the terms of any outstanding shares of preferred stock and
other restrictions. In the event of liquidation of the Company, holders of the
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 any preferred stock then outstanding. No shares of preferred stock
are presently outstanding. 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. All of the
outstanding shares of Common Stock are, and the shares of Common Stock issuable
upon conversion of the Notes offered hereby will be, validly issued, fully paid
and nonassessable.
64
<PAGE>
UNDERWRITING
Subject to the terms and conditions set forth in the Purchase Agreement
between the Company and the Underwriters named below, the Underwriters have
severally agreed to purchase from the Company the respective principal amounts
of the Notes set forth opposite their names below.
<TABLE>
<CAPTION>
PRINCIPAL
UNDERWRITERS AMOUNT OF NOTES
- ----------------------------------------------------------------------------- ---------------
<S> <C>
Piper Jaffray Inc............................................................ $ 6,666,667
Legg Mason Wood Walker Incorporated.......................................... $ 6,666,666
Dain Bosworth Incorporated................................................... $ 6,666,667
---------------
Total...................................................................... $ 20,000,000
---------------
---------------
</TABLE>
The Purchase Agreement provides that the obligations of the several
Underwriters are subject to certain conditions precedent set forth therein and
that the Underwriters must purchase all of the Notes if they purchase any Notes.
The Underwriters have advised the Company that they propose initially to
offer the Notes to the public at the Price to Public and to selected dealers at
such price less a concession of not more than 2.0% of the principal amount of
the Notes. The Underwriters may allow, and such dealers may reallow, concessions
not in excess of 1.75% of the principal amount of the Notes to certain other
brokers and dealers. After the initial distribution of the Notes has been
completed, the Price to Public and other selling terms may be changed by the
Underwriters.
The Offering of the Notes is made for delivery when, as and if accepted by
the Underwriters and subject to prior sale and to withdrawal, cancellation or
modification of the offer without notice. The Underwriters reserve the right to
reject any order for the purchase of the Notes.
The Company has granted the Underwriters an option, exercisable within 30
days from the date of this Prospectus, to purchase up to an additional
$3,000,000 in aggregate principal amount of Notes at the Price to Public less
the Underwriting Discount. The Underwriters may exercise such option solely for
the purpose of covering over-allotments, if any, incurred in the sale of the
Notes offered hereby. To the extent that the Underwriters exercise this option,
each Underwriter will be obligated, subject to certain conditions, to purchase a
principal amount of Notes approximately proportionate to that Underwriter's
initial commitment, and the Company will be obligated, pursuant to the option,
to sell such Notes to the Underwriters.
The Notes have been approved for listing on the New York Stock Exchange,
subject to official notice of issuance. The Underwriters have indicated an
intention to make a market in the Notes as permitted by applicable laws and
regulations. No Underwriter, however, is obligated to make a market in the
Notes, and any such market making may be discontinued at any time at the sole
discretion of such Underwriter. There can be no assurance that an active trading
market for the Notes will develop. If the Notes are traded after their initial
issuance, they may trade at a discount from their principal amount.
In connection with this Offering, certain Underwriters and selling group
members and their respective affiliates may engage in transactions that
stabilize, maintain or otherwise affect the market price of the Notes. Such
transactions may include stabilization transactions effected in accordance with
Rule 104 under the Securities Exchange Act of 1934 (the "Exchange Act"),
pursuant to which such person may bid for or purchase Notes for the purpose of
stabilizing its market price. The Underwriters also may create a short position
for the account of the Underwriters by selling more Notes in connection with the
Offering than they are committed to purchase from the Company, and in such case
may purchase Notes in the open market following completion of the Offering to
cover all or a portion of such short position. The Underwriters may also cover
all or a portion of such short position, up to $3,000,000 in aggregate principal
65
<PAGE>
amount, by exercising the over-allotment option referred to above. In addition,
Piper Jaffray Inc. may impose "penalty bids" under contractual arrangements
among the Underwriters whereby there may be reclaimed from an Underwriter (or
dealer participating in the Offering) for the account of other Underwriters, the
selling concession with respect to Notes that are distributed in the Offering
but subsequently purchased for the account of the Underwriters in the open
market. Underwriters and prospective underwriters intend to engage in passive
market making in accordance with Rule 103 under the Exchange Act, which, in
general, permits entities which are Nasdaq market makers to continue to maintain
bids for the Notes so long as certain price and daily quantity limits are
observed. Any of the transactions described in this paragraph may result in the
maintenance of the price of the Notes at a level above that which might
otherwise prevail in the open market in the absence of such transactions. None
of the transactions described in this paragraph is required, and, if they are
undertaken, they may be discontinued at any time.
The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act, or to contribute to
payments which the Underwriters may be required to make in respect thereof.
Piper Jaffray Inc. has provided certain investment banking services to the
Company from time to time and has received compensation customary for such
services.
LEGAL MATTERS
The legality of the Notes offered hereby is being passed upon for the
Company by Troy & Gould Professional Corporation, Los Angeles, California.
Certain legal matters in connection with the sale of the Notes offered hereby
will be passed upon for the Underwriters by Orrick, Herrington & Sutcliffe LLP,
Washington, D.C.
EXPERTS
The consolidated financial statements of Consumer Portfolio Services, Inc.
and subsidiaries as of December 31, 1996 and 1995, and for the year ended
December 31, 1996, the nine-month period ended December 31, 1995 and for the
year ended March 31, 1995 have been included herein and in the Registration
Statement in reliance upon the report of KPMG Peat Marwick LLP, independent
certified public accountants, appearing elsewhere herein, and upon the authority
of said firm as experts in accounting and auditing.
INCORPORATION OF CERTAIN INFORMATION BY REFERENCE
There are hereby incorporated by reference herein (i) the Company's Annual
Report on Form 10-K for the year ended December 31, 1996, (ii) the Company's
current report on Form 8-K dated March 14, 1997, (iii) the Company's current
report on Form 8-K dated March 17, 1997, and (iv) the description of the Common
Stock contained in the Company's registration statement on Form 8-A filed
September 4, 1992, as amended on October 21, 1992, and December 6, 1995.
The Company will provide, without charge, to each person to whom a copy of
this Prospectus is delivered, on the written or oral request of such person, a
copy of any or all of the documents incorporated herein by reference (other than
exhibits thereto, unless such exhibits are specifically incorporated by
reference into the information that this Prospectus incorporates). Written or
telephone requests for such copies should be directed to the Company's principal
office: Consumer Portfolio Services, Inc., 2 Ada, Suite 100, Irvine, California
92618, Attention: Corporate Secretary, (714) 753-6800.
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<PAGE>
ADDITIONAL INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"SEC") a registration statement (as amended, the "Registration Statement") under
the Securities Act with respect to the securities offered by this Prospectus.
This Prospectus, which constitutes a part of the Registration Statement, does
not contain all the information set forth in the Registration Statement. For
further information with respect to the Company and the securities offered
hereby, reference is made to the Registration Statement and to the exhibits
filed therewith, which may be inspected without charge at the principal office
of the SEC, 450 Fifth Street, N.W., Washington, D.C. 20549, and copies of the
material contained therein may be obtained from the SEC upon payment of
applicable copying charges. Statements contained in this Prospectus as to the
contents of any contract or other document referred to are not necessarily
complete, and in each instance reference is made to the copy of such contract or
other document filed as an exhibit to the Registration Statement.
The Company is subject to the reporting and other informational requirements
of the Exchange Act and, in accordance therewith, files reports and other
information with the SEC. Such reports, proxy statements and other information
filed by the Company can be inspected and copied at the public reference
facilities maintained by the SEC at the offices of the SEC at Room 1024,
Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and at the
SEC's regional offices at Northwestern Atrium Center, 500 West Madison Street,
Suite 1400, Chicago, Illinois 60661-2511 and 7 World Trade Center, New York, New
York 10048. The SEC also maintains a Web site on the Internet that contains
reports, proxy and information statements and other information regarding
issuers, including the Company, that file electronically with the SEC. The
address of such site is http://www.sec.gov. Copies of such materials can also be
obtained by written request to the Public Reference Section of the SEC at
Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed
rates.
67
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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
REFERENCE
-------------
<S> <C>
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
</TABLE>
68
<PAGE>
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
<PAGE>
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1995
-------------- -------------
<S> <C> <C>
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
-------------- -------------
-------------- -------------
</TABLE>
See accompanying notes to consolidated financial statements
F-2
<PAGE>
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, MARCH 31,
1996 1995 1995
------------- ------------- -------------
<S> <C> <C> <C>
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
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
See accompanying notes to consolidated financial statements
F-3
<PAGE>
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
SERIES A RETAINED
PREFERRED STOCK COMMON STOCK EARNINGS
-------------------------- --------------------------- (ACCUMULATED
SHARES AMOUNT SHARES AMOUNT DEFICIT) TOTAL
----------- ------------- ------------ ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
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
----------- ------------- ------------ ------------- ------------- -------------
----------- ------------- ------------ ------------- ------------- -------------
</TABLE>
See accompanying notes to consolidated financial statements
F-4
<PAGE>
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, DECEMBER 31, YEAR ENDED
1996 1995 MARCH 31, 1995
-------------- -------------- --------------
<S> <C> <C> <C>
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 $ --
</TABLE>
See accompanying notes to consolidated financial statements
F-5
<PAGE>
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
<PAGE>
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
<PAGE>
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
<PAGE>
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
<PAGE>
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
<PAGE>
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:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1995
------------- -------------
<S> <C> <C>
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
------------- -------------
------------- -------------
</TABLE>
F-11
<PAGE>
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:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1995
------------- ------------
<S> <C> <C>
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
------------- ------------
------------- ------------
</TABLE>
(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
<PAGE>
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:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1995
------------- -------------
<S> <C> <C>
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
------------- -------------
------------- -------------
</TABLE>
Activity in the allowance for credit losses consisted of the following:
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, MARCH 31,
1996 1995 1995
------------- ------------- -----------
<S> <C> <C> <C>
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
------------- ------------- -----------
------------- ------------- -----------
</TABLE>
F-13
<PAGE>
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:
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, MARCH 31,
1996 1995 1995
------------- ------------- -------------
<S> <C> <C> <C>
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
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
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:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------
1996 1995 MARCH 31, 1995
-------------- -------------- --------------
<S> <C> <C> <C>
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
-------------- -------------- --------------
-------------- -------------- --------------
</TABLE>
F-14
<PAGE>
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:
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, MARCH 31,
1996 1995 1995
------------- ------------- -------------
<S> <C> <C> <C>
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
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
ESR balances were made up of the following components:
<TABLE>
<CAPTION>
DECEMBER 31, 1996
------------------------------
1996 1995 MARCH 31, 1995
-------------- -------------- --------------
<S> <C> <C> <C>
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%
-------------- -------------- --------------
-------------- -------------- --------------
</TABLE>
Net gain on sale on Contracts was made up of the following components:
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, MARCH 31,
1996 1995 1995
------------- ------------- -------------
<S> <C> <C> <C>
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
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
(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
<PAGE>
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
<PAGE>
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:
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS
DECEMBER 31, ENDED DECEMBER
1996 31, 1995
--------------- ---------------
<S> <C> <C>
Expected life (years)...................................................... 5.86 6.33
Risk-free interest rate.................................................... 6.23% 6.80%
Volatility................................................................. 46.20% 46.20%
Expected dividend yield.................................................... -- --
</TABLE>
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.
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, DECEMBER 31,
1996 1995
------------- ------------
<S> <C> <C>
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
</TABLE>
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
<PAGE>
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:
<TABLE>
<CAPTION>
NUMBER OF WEIGHTED-AVERAGE
SHARES EXERCISE PRICE
---------- ----------------
<S> <C> <C>
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
---------- ----------------
---------- ----------------
</TABLE>
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:
<TABLE>
<CAPTION>
WEIGHTED- WEIGHTED WEIGHTED-
AVERAGE AVERAGE AVERAGE
NUMBER REMAINING EXERCISE NUMBER EXERCISE
RANGE OF EXERCISE PRICES OUTSTANDING TERM PRICE EXERCISABLE PRICE
- ---------------------------------------------------- ----------- ------------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
$ 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
</TABLE>
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
<PAGE>
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:
<TABLE>
<S> <C>
1997.................................................................... $ 989,333
1998.................................................................... 874,539
1999.................................................................... 794,019
2000.................................................................... 670,497
2001.................................................................... 87,433
---------
$3,415,821
---------
---------
</TABLE>
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
<PAGE>
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:
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, MARCH 31,
1996 1995 1995
------------ ------------ ------------
<S> <C> <C> <C>
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
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
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:
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, MARCH 31,
1996 1995 1995
------------ ------------ ------------
<S> <C> <C> <C>
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
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
F-20
<PAGE>
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:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1995
------------ ------------
<S> <C> <C>
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
------------ ------------
------------ ------------
</TABLE>
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
<PAGE>
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
<PAGE>
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:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------------------
1996 1995
---------------------------- ----------------------------
CARRYING FAIR CARRYING FAIR
FINANCIAL INSTRUMENT VALUE VALUE VALUE VALUE
- ---------------------------------------------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
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
</TABLE>
CASH
The carrying value equals fair value.
F-23
<PAGE>
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
<PAGE>
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 $20
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)
<TABLE>
<CAPTION>
QUARTER ENDED QUARTER ENDED QUARTER ENDED QUARTER ENDED
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
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
</TABLE>
F-25
<PAGE>
No dealer, salesperson or any other person has been authorized to give any
information or to make any representation not contained in this Prospectus and,
if given or made, such information or representation must not be relied upon as
having been authorized by the Company or any Underwriter. This Prospectus does
not constitute an offer to sell any securities other than the registered
securities to which it relates, or an offer to sell, or a solicitation of an
offer to buy, to any person in any jurisdiction where such offer or solicitation
would be unlawful. Neither the delivery of this Prospectus nor any sale made
hereunder shall, under any circumstances, create any implication that the
information contained herein is correct as of any time subsequent to the date of
this Prospectus.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
---
<S> <C>
Prospectus Summary............................... 3
Risk Factors..................................... 10
Use of Proceeds.................................. 18
Price Range of Common Stock and Dividend
Policy.......................................... 18
Capitalization................................... 19
Selected Consolidated Financial Data............. 20
Management's Discussion and Analysis of Financial
Condition and Results of Operations............. 22
Business......................................... 31
Management....................................... 48
Certain Transactions............................. 50
Principal Shareholders........................... 51
Description of the Notes......................... 53
Description of Common Stock...................... 64
Underwriting..................................... 65
Legal Matters.................................... 66
Experts.......................................... 66
Incorporation of Certain Information by
Reference....................................... 66
Additional Information........................... 67
Index to Consolidated Financial Statements....... 68
</TABLE>
$20,000,000
CONSUMER PORTFOLIO
SERVICES, INC.
10.50% PARTICIPATING EQUITY NOTES-SM-
DUE 2004
"PENS-SM-"
--------------------
P R O S P E C T U S
--------------------
PIPER JAFFRAY INC.
LEGG MASON WOOD WALKER
INCORPORATED
DAIN BOSWORTH
INCORPORATED
April 15, 1997
