Back to GetFilings.com
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________.
COMMISSION FILE NUMBER: 1-11416
CONSUMER PORTFOLIO SERVICES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
California 33-0459135
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
16355 Laguna Canyon Road, Irvine, California 92618
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER: (949) 753-6800
FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED SINCE LAST
REPORT: N/A
Indicate by check mark whether the registrant (1) filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined by Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of November 9, 2004 the registrant had 21,418,689 common shares outstanding.
================================================================================
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
INDEX TO FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Unaudited Condensed Consolidated Balance Sheets as of September 30, 2004 and December 31,
2003............................................................................................3
Unaudited Condensed Consolidated Statements of Operations for the three-month and
nine-month periods ended September 30, 2004 and 2003 ...........................................4
Unaudited Condensed Consolidated Statements of Cash Flows for the nine-month periods ended
September 30, 2004 and 2003.....................................................................5
Notes to Unaudited Condensed Consolidated Financial Statements..................................6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...........21
Item 3. Quantitative and Qualitative Disclosures About Market Risk......................................36
Item 4. Controls and Procedures.........................................................................37
PART II. OTHER INFORMATION
Item 1. Legal Proceedings...............................................................................38
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities................38
Item 6. Exhibits and Reports on Form 8-K................................................................38
Signatures.................................................................................................39
Certifications.............................................................................................40
2
ITEM 1. FINANCIAL STATEMENTS
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
SEPTEMBER 30, DECEMBER 31,
2004 2003
-------------- --------------
ASSETS
Cash $ 10,952 $ 33,209
Restricted cash 113,816 67,277
Finance receivables 524,950 302,078
Less: Allowance for finance credit losses (39,028) (35,889)
-------------- --------------
Finance receivables, net 485,922 266,189
Servicing fees receivable 3,441 3,942
Residual interest in securitizations 68,714 111,702
Furniture and equipment, net 1,650 826
Deferred financing costs 5,996 1,529
Other assets 15,335 7,796
-------------- --------------
$ 705,826 $ 492,470
============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Accounts payable and accrued expenses $ 24,081 $ 22,920
Warehouse lines of credit 16,521 33,709
Tax liabilities, net 2,949 2,768
Capital lease obligation 391 --
Notes payable 1,593 3,330
Residual interest financing 27,311 --
Securitization trust debt 477,891 245,118
Senior secured debt 59,829 49,965
Subordinated debt 15,000 35,000
Related party debt -- 17,500
-------------- --------------
625,566 410,310
SHAREHOLDERS' EQUITY
Preferred stock, $1 par value;
authorized 5,000,000 shares; none issued -- --
Series A preferred stock, $1 par value;
authorized 5,000,000 shares;
3,415,000 shares issued; none outstanding -- --
Common stock, no par value; authorized
30,000,000 shares; 21,403,409 and 20,588,924
shares issued and outstanding at September 30, 2004 and
December 31, 2003, respectively 65,894 64,397
Retained earnings 17,350 20,992
Comprehensive loss - minimum pension benefit obligation, net (2,426) (2,426)
Deferred compensation (558) (803)
-------------- --------------
80,260 82,160
-------------- --------------
$ 705,826 $ 492,470
============== ==============
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
3
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
2004 2003 2004 2003
--------- --------- --------- ---------
REVENUES:
Gain on sale of contracts, net $ -- $ -- $ -- $ 8,664
Interest income 25,314 15,835 71,458 36,605
Servicing fees 3,031 4,295 9,864 13,361
Other income 3,918 5,911 11,151 14,674
--------- --------- --------- ---------
32,263 26,041 92,473 73,304
--------- --------- --------- ---------
EXPENSES:
Employee costs 9,905 9,491 29,352 27,380
General and administrative 4,785 6,050 15,220 14,131
Interest 8,388 6,427 21,800 17,044
Provision for credit losses 7,560 4,190 20,610 4,190
Marketing 2,585 1,400 5,901 4,129
Occupancy 900 1,112 2,651 3,096
Depreciation and amortization 201 223 581 700
--------- --------- --------- ---------
34,324 28,893 96,115 70,670
--------- --------- --------- ---------
Income (loss) before income tax benefit (2,061) (2,852) (3,642) 2,634
Income tax benefit -- -- -- (3,434)
--------- --------- --------- ---------
Net income (loss) $ (2,061) $ (2,852) $ (3,642) $ 6,068
========= ========= ========= =========
Earnings (loss) per share:
Basic $ (0.10) $ (0.14) $ (0.17) $ 0.30
Diluted (0.10) (0.14) (0.17) 0.28
Number of shares used in computing
earnings (loss) per share:
Basic 21,345 20,200 21,001 20,226
Diluted 21,345 20,200 21,001 21,711
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
4
CONSUMER PORTFOLIO SERVICES, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------
2004 2003
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (3,642) $ 6,068
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization 581 700
Amortization of deferred financing costs 1,871 2,015
Provision for credit losses 20,610 4,716
NIR (gains) losses recognized 2,650 (6,676)
Loss on sale of furniture and equipment 8 --
Stock-based compensation expense 210 772
Releases of cash from Trusts to Company 17,175 20,227
Initial deposits to Trusts -- (18,736)
Net deposits to Trusts to increase Credit Enhancement (2,106) (19,575)
Decrease in receivables from Trusts and investment in subordinated certificates 25,269 32,690
Changes in assets and liabilities:
Restricted cash (46,539) (24,077)
Purchases of contracts held for sale -- (182,045)
Amortization and liquidation of contracts held for sale -- 249,660
Servicing fees receivable and other assets (7,133) 7,786
Accounts payable and accrued expenses 1,161 (2,568)
Tax liabilities, net 181 (6,802)
---------- ----------
Net cash provided by operating activities 10,296 64,155
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of finance receivables held for investment (374,717) (92,389)
Amortization of finance receivables held for investment 134,374 1,683
Purchase of furniture and equipment (838) (68)
Purchase of subsidiary, net of cash acquired -- (10,181)
---------- ----------
Net cash used in investing activities (241,181) (100,955)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of residual financing debt 44,000 --
Proceeds from issuance of securitization trust debt 363,300 83,125
Proceeds from issuance of senior secured debt 25,000 25,000
Net proceeds from warehouse lines of credit (17,188) 21,877
Repayment of residual interest financing debt (16,689) --
Repayment of securitization trust debt (130,527) (68,256)
Repayment of senior secured debt (15,136) (24,935)
Repayment of subordinated debt (20,000) (34)
Repayment of capital lease obligations (89) (80)
Repayment of notes payable (1,737) (2,994)
Repayment of related party debt (16,500) --
Payment of financing costs (6,338) (1,833)
Repurchase of common stock (25) (1,195)
Exercise of options and warrants 557 271
---------- ----------
Net cash provided by financing activities 208,628 30,946
---------- ----------
Decrease in cash (22,257) (5,854)
Cash at beginning of period 33,209 32,947
---------- ----------
Cash at end of period $ 10,952 $ 27,093
========== ==========
Supplemental disclosure of cash flow information:
Cash paid (received) during the period for:
Interest $ 19,534 $ 12,997
Income taxes (181) 3,369
Supplemental disclosure of non-cash investing and financing activities:
Stock-based compensation $ 35 $ 772
Conversion of related party debt to common stock 1,000 --
Furniture and equipment acquired through capital leases 480 --
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
5
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Consumer Portfolio Services, Inc. ("CPS") was incorporated in California on
March 8, 1991. CPS and its subsidiaries (collectively, the "Company") specialize
primarily in purchasing, selling and servicing retail automobile installment
sale contracts ("Contracts" or "finance receivables") originated by licensed
motor vehicle dealers ("Dealers") located throughout the United States. The
Company purchases Contracts with obligors who generally would not be expected to
qualify for traditional financing, such as that provided by commercial banks or
automobile manufacturers' captive finance companies.
ACQUISITION OF MFN FINANCIAL CORPORATION
On March 8, 2002, CPS acquired 100% of MFN Financial Corporation, a Delaware
corporation ("MFN") and its subsidiaries, by the merger (the "MFN Merger") of a
direct wholly-owned subsidiary of CPS with and into MFN. MFN thus became a
wholly-owned subsidiary of CPS, and CPS thus acquired the assets of MFN, which
consisted principally of interests in automobile installment sales finance
Contracts and the facilities for originating and servicing such Contracts. The
MFN Merger was accounted for as a purchase.
MFN, through its primary operating subsidiary, Mercury Finance Company LLC, was
in the business of purchasing automobile installment sales finance Contracts
from Dealers, and securitizing and servicing such Contracts. CPS continues to
use the assets acquired in the MFN Merger in the automobile finance business,
but has disposed of a portion of such assets. MFN has ceased to purchase
automobile installment sales finance Contracts, and does not anticipate
recommencing such purchasing. In connection with the termination of MFN
origination activities and the integration and consolidation of certain
activities, the Company has recognized certain liabilities related to the costs
to exit these activities and terminate the affected employees of MFN. These
activities include service departments such as accounting, finance, human
resources, information technology, administration, payroll and executive
management. These costs include the following:
SEPTEMBER 30, DECEMBER 31, MARCH 8,
2004(1) ACTIVITY 2003 ACTIVITY 2002
--------------- --------------- --------------- --------------- ---------------
(IN THOUSANDS)
Severance payments and
consulting contracts ........... $ -- $ -- $ -- $ 3,215 $ 3,215
Facilities closures .............. 1,358 531 1,889 263 2,152
Termination of contracts,
leases, services and other
obligations .................... -- -- -- 597 597
Acquisition expenses
accrued but unpaid ............. -- -- -- 250 250
--------------- --------------- --------------- --------------- ---------------
Total liabilities assumed..... $ 1,358 $ 531 $ 1,889 $ 4,325 $ 6,214
=============== =============== =============== =============== ===============
- -----------
(1) The initial accrual amount recorded was $6.2 million on March 8, 2002 and
the remaining accrual recorded in the Unaudited Condensed Consolidated Balance
Sheet of the Company is approximately $1.4 million and $1.9 million as of
September 30, 2004 and December 31, 2003, respectively. The Company believes
that this amount provides adequately for anticipated remaining costs related to
exiting certain activities of MFN, and that amounts indicated above are
reasonably allocated.
ACQUISITION OF TFC ENTERPRISES, INC.
On May 20, 2003, CPS acquired TFC Enterprises, Inc., a Delaware corporation
("TFC") and its subsidiaries, by the merger (the "TFC Merger") of a direct,
wholly-owned subsidiary of CPS, with and into TFC. In the TFC Merger, TFC became
a wholly-owned subsidiary of CPS. CPS thus acquired the assets of TFC and its
subsidiaries, which consisted principally of interests in motor vehicle
installment sales finance Contracts, interests in securitized pools of such
Contracts, and the facilities for originating and servicing such Contracts. The
TFC Merger was accounted for as a purchase.
6
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
TFC, through its primary operating subsidiary, "The Finance Company," purchases
motor vehicle installment sales finance Contracts from automobile Dealers, and
securitizes and services such Contracts. CPS has continued to use the assets
acquired in the TFC Merger in the automobile finance business.
In connection with the integration and consolidation of certain activities
between CPS and TFC, the Company has recognized certain liabilities related to
the costs to integrate certain activities and terminate the affected employees
of TFC. These activities include service departments such as accounting,
finance, human resources, information technology, administration, payroll and
executive management. The total of these liabilities recognized by the Company
at the time of the merger was $4.5 million. These costs include the following:
SEPTEMBER 30, DECEMBER 31,
2004(1) ACTIVITY 2003
------------- ------------- -------------
(IN THOUSANDS)
Severance payments and consulting contracts..... $ 1,782 $ 544 $ 2,326
Facilities closures ............................ 890 341 1,231
Other obligations .............................. 49 185 234
------------- ------------- -------------
Total liabilities assumed .................. $ 2,721 $ 1,070 $ 3,791
============= ============= =============
- ------------
(1) The initial accrual amount recorded was $4.5 million on May 20, 2003 and the
remaining accrual recorded in the Unaudited Condensed Consolidated Balance Sheet
of the Company is approximately $2.7 million and $3.8 million as of September
30, 2004 and December 31, 2003, respectively. The Company believes that this
amount provides adequately for anticipated remaining costs related to exiting
certain activities of TFC, and that amounts indicated above are reasonably
allocated.
At the closing of the TFC Merger, each outstanding share of common stock of TFC
became a right to receive $1.87 per share in cash. The total merger
consideration paid to stockholders of TFC was approximately $21.6 million. The
recipients of the total merger consideration had no material relationship with
CPS, its directors, its officers or any associates of such directors or
officers, to the best of CPS's knowledge. The merger consideration was paid with
existing cash of CPS. The aggregate purchase price, including expenses related
to the transaction, was approximately $23.7 million.
The Company's Unaudited Condensed Consolidated Balance Sheet and Unaudited
Condensed Consolidated Statements of Operations as of and for the three and nine
months ended September 30, 2004, include the balance sheet accounts of TFC as of
September 30, 2004 and the results of its operations subsequent to May 20, 2003,
the merger date. The Company has recorded certain purchase accounting
adjustments on its Unaudited Condensed Consolidated Balance Sheet, which are
estimates based on available information.
The following table summarizes the recorded amounts of the assets acquired and
liabilities assumed at the date of acquisition.
7
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MAY 20, 2003
----------------
(IN THOUSANDS)
Cash .................................................. $ 13,545
Restricted cash ....................................... 17,723
Finance receivables, net .............................. 125,108
Other assets .......................................... 502
----------------
Total assets acquired ........................... 56,878
----------------
Securitization trust debt ............................. 15,597
Subordinated debt ..................................... 6,321
Capital lease obligations ............................. 17
Accounts payable and other liabilities ................ 11,217
----------------
Total liabilities assumed ....................... 33,152
----------------
Purchase price .................................. $ 23,726
================
PRO FORMA RESULTS OF OPERATIONS
Selected unaudited pro forma combined results of operations for the three- and
nine-month periods ended September 30, 2003, assuming the TFC Merger occurred on
January 1, 2003, are as follows:
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------- -------------
2003 2003
------------- -------------
(IN THOUSANDS)
Total revenue ............................... $ 25,487 $ 78,413
Net earnings (loss) ......................... $ (2,852) $ 6,497
Basic net earnings (loss) per share ......... $ (0.14) $ 0.32
Diluted net earnings (loss) per share ....... $ (0.14) $ 0.30
ACQUISITION OF RECEIVABLES AND OTHER ASSETS FROM SEAWEST FINANCIAL CORPORATION
The Company on April 2, 2004 acquired automotive finance receivables and other
assets (the "SeaWest Asset Acquisition") of SeaWest Financial Corporation
("SeaWest"). The aggregate purchase price was approximately $63.2 million, which
was funded with the proceeds of an acquisition financing facility and existing
cash. The receivables were purchased at a discount to par and such discount has
been accounted for as a non-accretable discount. The other assets included a
$2.8 million note to an affiliate of SeaWest and certain furniture and
equipment. In addition, the Company has been appointed the successor servicer on
three separate term securitization transactions originally sponsored by SeaWest
(the "SeaWest Third Party Portfolio").
BASIS OF PRESENTATION
The unaudited Condensed Consolidated Financial Statements of the Company have
been prepared in conformity with accounting principles generally accepted in the
United States of America, with the instructions to Form 10-Q and with Article 10
of Regulation S-X of the Securities and Exchange Commission, and include all
adjustments that are, in the opinion of management, necessary for a fair
presentation of the results for the interim periods presented. All such
adjustments are, in the opinion of management, of a normal recurring nature. In
addition, certain items in prior period financial statements have been
reclassified for comparability to current period presentation. Results for the
three- and nine-month periods ended September 30, 2004 are not necessarily
indicative of the operating results to be expected for the full year.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted from these
Unaudited Condensed Consolidated Financial Statements. These Unaudited Condensed
Consolidated Financial Statements should be read in conjunction with the
Consolidated Financial Statements and Notes to Consolidated Financial Statements
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2003.
8
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
RECENT DEVELOPMENTS
In July 2003, the Company agreed with the other parties to its continuous or
"warehouse" securitization facilities to amend the terms of such facilities. The
effect of the amendments was to cause use of those facilities to be treated for
financial accounting purposes as borrowings secured by pledged Contracts, rather
than as sales of such Contracts.
In addition, the Company announced in August 2003 that it would structure its
future term securitization transactions so that they would be treated for
financial accounting purposes as borrowings secured by receivables, rather than
as sales of receivables. The new structure for the warehouse facilities
described in the preceding paragraph and the change in structure of the
Company's term securitizations has affected and will affect the way in which the
transactions are reported. The major effects are these: (i) the finance
receivables are shown as assets of the Company on its balance sheet; (ii) the
debt issued in the transactions is shown as indebtedness of the Company on its
balance sheet; (iii) cash deposited to enhance the credit of the securitization
transactions is shown as "restricted cash" on the Company's balance sheet; (iv)
cash collected from borrowers and other sources related to the receivables prior
to making the required payments under the Securitization Agreements is also
shown as "Restricted cash" on the Company's balance sheet; (v) the servicing fee
that the Company receives in connection with such receivables is recorded as a
portion of the interest earned on such receivables in the Company's statements
of operations; (vi) the Company has initially and periodically recorded as
expense a provision for credit losses on the receivables in the Company's
statements of operations; and (vii) the portion of scheduled payments on the
receivables representing interest is recorded as revenue as earned in the
Company's statements of operations.
These changes collectively represent a deferral of revenue and acceleration of
expenses, and thus a more conservative approach to accounting for the Company's
operations. The changes initially have resulted in the Company reporting lower
earnings than it would have reported if it had continued structuring its
securitizations to require recognition of gain on sale.
TREATMENT OF SECURITIZATIONS
Gain on sale may be recognized on the disposition of Contracts either outright
or in securitization transactions. In those securitization transactions that
were sales for financial accounting purposes, the Company, or a wholly-owned
consolidated subsidiary of the Company, retained a residual interest in the
Contracts that were sold to a wholly-owned unconsolidated special purpose
subsidiary. The Company's securitization transactions include "term"
securitizations (the purchaser holds the Contracts for substantially their
entire term) and "continuous" or "warehouse" securitizations (which finance the
acquisition of the Contracts for future sale into term securitizations).
As of September 30, 2004 and December 31, 2003, the line item "Residual interest
in securitizations" on the Company's Unaudited Condensed Consolidated Balance
Sheet represents the residual interests in certain term securitizations but no
residual interest in warehouse securitizations, because the Company's warehouse
securitizations were restructured in July 2003 as secured financings. Term
securitizations of receivables purchased under the CPS programs subsequent to
July 2003 were also structured as secured financings. The warehouse
securitizations are accordingly reflected in the line items "Finance
receivables" and "Warehouse lines of credit" on the Company's Unaudited
Condensed Consolidated Balance Sheet, and the term securitizations are reflected
in the line items "Finance receivables" and "Securitization trust debt." The
line item "Residual interest in securitizations" represents the discounted sum
of expected future releases from securitization trusts that were structured as
sales prior to July 2003. Accordingly, the valuation of the residual is heavily
dependent on estimates of future performance.
9
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The Company's securitization structure is generally as follows:
The Company sells Contracts it acquires to a wholly-owned Special Purpose
Subsidiary ("SPS"), which has been established for the limited purpose of buying
and reselling the Company's Contracts. The SPS then transfers the same Contracts
to another entity, typically a statutory trust ("Trust"). The Trust issues
interest-bearing asset-backed securities (the "Notes"), generally in a principal
amount equal to the aggregate principal balance of the Contracts. The Company
typically sells these Contracts to the Trust at face value and without recourse,
except that representations and warranties similar to those provided by the
Dealers to the Company are provided by the Company to the Trust. One or more
investors purchase the Notes issued by the Trust; the proceeds from the sale of
the Notes are then used to purchase the Contracts from the Company. The Company
may retain or sell subordinated Notes issued by the Trust. The Company purchases
a financial guaranty insurance policy, guaranteeing timely payment of principal
and interest on the senior Notes, from an insurance company (a "Note Insurer").
In addition, the Company provides "Credit Enhancement" for the benefit of the
Note Insurer and the investors in the form of an initial cash deposit to a bank
account (a "Spread Account") held by the Trust; in the form of
overcollateralization of the Notes, where the principal balance of the Notes
issued is less than the principal balance of the Contracts; in the form of
subordinated Notes; or some combination of such Credit Enhancements. The
agreements governing the securitization transactions (collectively referred to
as the "Securitization Agreements") require that the initial level of Credit
Enhancement be supplemented by a portion of collections from the Contracts until
the level of Credit Enhancement reaches specified levels, and then maintained at
those levels. The specified levels are generally computed as a percentage of the
remaining unpaid principal amount under the related Contracts. The specified
levels at which the Credit Enhancements are to be maintained will vary depending
on the performance of the portfolios of Contracts held by the Trusts and on
other conditions, and may also be varied by agreement among the Company, the
SPS, the Note Insurers and the trustee. Such levels have increased and decreased
from time to time based on performance of the portfolios, and have also varied
by Securitization Agreement. The Securitization Agreements generally grant the
Company the option to repurchase the sold Contracts from the Trust when the
aggregate outstanding balance has amortized to a specified percentage of the
initial aggregate balance.
The prior securitizations that were treated as sales for financial accounting
purposes differ from secured financings in that the Trust to which the SPS sold
the Contracts in those prior securitizations met the definition of a qualified
special purpose entity under Statement of Financial Accounting Standards No. 140
("SFAS 140"). As a result, assets and liabilities of the Trust in those prior
securitizations are not consolidated into the Company's Unaudited Condensed
Consolidated Balance Sheet.
The Company's warehouse securitization structures are similar to the above,
except that (i) the SPS that purchases the Contracts pledges the Contracts to
secure promissory notes that it issues, (ii) the promissory notes are in an
aggregate principal amount of not more than 73.0% to 73.5% of the aggregate
principal balance of the Contracts (that is, at least 26.5%
overcollateralization), and (iii) no increase in the required amount of Credit
Enhancement is contemplated unless certain portfolio performance tests are
breached. During the quarter ended September 30, 2003, the warehouse
securitizations related to the CPS programs were amended to provide for the
transactions to be reflected as secured financings for financial accounting
purposes. The Contracts held by the warehouse SPS and the promissory notes that
it issues are therefore included in the Company's Unaudited Condensed
Consolidated Financial Statements as of September 30, 2004 and December 31, 2003
as assets and liabilities, respectively.
Upon each sale of Contracts in a securitization structured as a secured
financing, whether a term securitization or a continuous securitization, the
Company retains on its Unaudited Condensed Consolidated Balance Sheet the
Contracts securitized as assets and records the Notes issued in the transaction
as indebtedness of the Company.
Under the prior securitizations structured as sales for financial accounting
purposes, the Company removed from its Unaudited Condensed Consolidated Balance
Sheet the Contracts sold and added to its Unaudited Condensed Consolidated
Balance Sheet (i) the cash received and (ii) the estimated fair value of the
10
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
ownership interest that the Company retains in Contracts sold in the
securitization. That retained or residual interest (the "Residual") consists of
(a) the cash held in the Spread Account, if any, (b) overcollateralization, if
any, (c) subordinated Notes retained, if any, and (d) receivables from Trust,
which include the net interest receivables ("NIRs"). NIRs represent the
estimated discounted cash flows to be received from the Trust in the future, net
of principal and interest payable with respect to the Notes, and certain
expenses. The excess of the cash received and the assets retained by the Company
over the carrying value of the Contracts sold, less transaction costs, equals
the net gain on sale of Contracts recorded by the Company. Until the maturity of
these transactions, the Company's Unaudited Condensed Consolidated Balance Sheet
will reflect securitization transactions structured both as sales and as secured
financings.
With respect to the prior securitizations structured as sales for financial
accounting purposes, the Company allocated its basis in the Contracts between
the Notes sold and the Residuals retained based on the relative fair values of
those portions on the date of the sale. The Company recognizes gains or losses
attributable to the change in the fair value of the Residuals, which are
recorded at estimated fair value. The Company is not aware of an active market
for the purchase or sale of interests such as the Residuals; accordingly, the
Company determines the estimated fair value of the Residuals by discounting the
amount and timing of anticipated cash flows that it estimates will be released
to the Company in the future (the cash out method), using a discount rate that
the Company believes is appropriate for the risks involved. The anticipated cash
flows include collections from both current and charged off receivables. The
Company has used an effective pre-tax discount rate of approximately 14% per
annum except for certain collections from charged off receivables related to the
Company's securitizations in 2001 and later for which the Company has used a
discount rate of approximately 25%.
The Company receives periodic base servicing fees for the servicing and
collection of the Contracts. In addition, the Company is entitled to the cash
flows from the Residuals that represent collections on the Contracts in excess
of the amounts required to pay principal and interest on the Notes, the base
servicing fees, and certain other fees (such as trustee and custodial fees).
Required principal payments are generally defined as the payments sufficient to
keep the principal balance of the Notes equal to the aggregate principal balance
of the related Contracts (excluding those Contracts that have been charged off),
or a pre-determined percentage of such balance. Where that percentage is less
than 100%, the related Securitization Agreements require accelerated payment of
principal until the principal balance of the Notes is reduced to the specified
percentage.
If the amount of cash required for payment of fees, interest on the Notes and
principal of the Notes exceeds the amount collected during the collection
period, the shortfall is withdrawn from the Spread Account, if any. If the cash
collected during the period exceeds the amount necessary for the above
allocations, and there is no shortfall in the related Spread Account, the excess
is released to the Company, or in certain cases is transferred to other Spread
Accounts that may be below their required levels. If the Spread Account balance
is not at the required credit enhancement level, then the excess cash collected
is retained in the Spread Account until the specified level is achieved.
Although Spread Account balances are held by the Trusts on behalf of the
Company's SPS as the owner of the Residuals (in the case of securitization
transactions structured as sales for financial accounting purposes) or as the
owner of the Trusts (in the case of securitization transactions structured as
secured financings for financial accounting purposes), the cash in the Spread
Accounts is restricted from use by the Company. Cash held in the various Spread
Accounts is invested in high quality, liquid investment securities, as specified
in the Securitization Agreements. The interest rate payable on the Contracts is
significantly greater than the interest rate on the Notes. As a result, the
Residuals described above are a significant asset of the Company. In determining
the value of the Residuals, the Company must estimate the future rates of
prepayments, delinquencies, defaults, default loss severity, and recovery rates,
as all of these factors affect the amount and timing of the estimated cash
flows. The Company estimates prepayments by evaluating historical prepayment
performance of comparable Contracts. As of September 30, 2004, the Company has
used prepayment estimates of approximately 19.4% to 24.6% cumulatively over the
11
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
lives of the related Contracts. The Company estimates defaults and default loss
severity using available historical loss data for comparable Contracts and the
specific characteristics of the Contracts purchased by the Company. The Company
estimates recovery rates of previously charged off receivables using available
historical recovery data and projected future recovery levels. In valuing the
Residuals as of September 30, 2004, the Company estimates that charge-offs as a
percentage of the original principal balance will approximate 15.1% to 24.0%
cumulatively over the lives of the related Contracts, with recovery rates
approximating 2.6% to 5.6% of the original principal balance.
Following a securitization that is structured as a sale for financial accounting
purposes, interest income is generally recognized on the balance of the
Residuals at the same rate as used for calculating the present value of the
NIRs, which is equal to 14% per annum. In addition, the Company will recognize
additional revenue from the Residuals if the actual performance of the Contracts
is better than the original estimate. If the actual performance of the Contracts
were worse than the original estimate, then an impairment loss would be required
to reduce the carrying value of the Residuals. In the quarter ended September
30, 2004, the Company recorded an impairment loss of $2.6 million related to the
Company's analysis and estimate of the expected ultimate performance of the
company's previously securitized pools that are held by non-consolidated
subsidiaries. In a securitization structured as a secured financing for
financial accounting purposes, interest income is recognized when accrued under
the terms of the related Contracts and, therefore, presents less potential for
fluctuations in performance when compared to the approach used in a transaction
structured as a sale for financial accounting purposes.
In all the Company's term securitizations, whether treated as secured financings
or as sales, the Company has transferred the receivables (through a subsidiary)
to the securitization Trust. The difference between the two structures is that
in securitizations that are treated as secured financings the Company reports
the assets and liabilities of the securitization Trust on its Unaudited
Condensed Consolidated Balance Sheet. Under both structures the Noteholders and
the related securitization Trusts have no recourse to the Company for failure of
the Contract obligors to make payments on a timely basis. The Company's
Residuals, however, are subordinate to the Notes until the Noteholders are fully
paid, and the Company is therefore at risk to that extent.
OTHER INCOME
Other income consists primarily of recoveries on certain previously charged off
Contracts and state sales tax refunds relating to previously charged-off loans.
STOCK BASED COMPENSATION
As permitted by Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation" ("SFAS No. 123"), the Company accounts for
stock-based employee compensation plans in accordance with Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related
interpretations, whereby stock options are recorded at intrinsic value equal to
the excess of the share price over the exercise price at the measurement date.
The Company provides the pro forma net income (loss), pro forma earnings (loss)
per share, and stock based compensation plan disclosure requirements as set
forth in SFAS No. 123. The Company accounts for re-priced options as variable
awards.
Compensation cost has been recognized for certain stock options in the
Consolidated Financial Statements in accordance with APB Opinion No. 25. Had the
Company determined compensation cost based on the fair value at the grant date
for its stock options under Statement of Financial Accounting Standards No. 123
("SFAS 123"), "Accounting for Stock Based Compensation," the Company's net
income (loss) and earnings (loss) per share would have been reduced to the pro
forma amounts indicated below.
12
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net income (loss), as reported ................ $ (2,061) $ (2,852) $ (3,642) $ 6,068
Stock-based employee compensation expense,
fair value method, net of tax ............... (231) (214) (626) (639)
Previously recorded stock-based employee
compensation expense, intrinsic value method,
net of tax .................................. 36 189 122 448
---------- ---------- ---------- ----------
Pro forma net income (loss) ................... $ (2,256) $ (2,877) $ (4,146) $ 5,877
========== ========== ========== ==========
Net income (loss) per share
Basic, as reported ............................ $ (0.10) $ (0.14) $ (0.17) $ 0.30
Diluted, as reported (1) ...................... $ (0.10) $ (0.14) $ (0.17) $ 0.28
Pro forma Basic ............................... $ (0.11) $ (0.14) $ (0.20) $ 0.29
Pro forma Diluted (1) ......................... $ (0.11) $ (0.14) $ (0.20) $ 0.27
- ----------
(1) The assumed conversion of certain subordinated debt during the nine-month
periods ended September 30, 2003, resulted in an increase to income for purposes
of the diluted earnings per share calculation of $54,979.
Pro forma net income (loss) and income (loss) per share reflect only options
granted in the years ended December 31, 1996 to September 30, 2004. Therefore,
the full effect of calculating compensation cost for stock options under SFAS
No. 123 is not reflected in the pro forma amounts presented above, as
compensation expense for options granted prior to 1996 is not considered.
PURCHASES OF COMPANY STOCK
During the nine-month periods ended September 30, 2004 and 2003, the Company
purchased 6,738 and 548,426 shares, respectively, of its common stock at an
average price of $3.75 and $2.18, respectively.
NEW ACCOUNTING PRONOUNCEMENTS
In December 2003, the FASB issued FASB Interpretation No. 46 (revised December
2003, FIN 46R), CONSOLIDATION OF VARIABLE INTEREST ENTITIES, which addresses how
a business enterprise should evaluate whether it has a controlling financial
interest in an entity through means other than voting rights and accordingly
should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46,
CONSOLIDATION OF VARIABLE INTEREST ENTITIES, which was issued in January 2003.
The Company is required to apply FIN 46R to variable interests in Variable
Interest Entities ("VIEs") created after December 31, 2003. For variable
interests in VIEs created before January 1, 2004, the Interpretation will be
applied beginning on January 1, 2005. For any VIEs that must be consolidated
under FIN 46R that were created before January 1, 2004, the assets, liabilities
and noncontrolling interests of the VIE initially is measured at their carrying
amounts with any difference between the net amount added to the balance sheet
and any previously recognized interest being recognized as the cumulative effect
of an accounting change. If determining the carrying amounts is not practicable,
fair value at the date FIN 46R first applies may be used. Certain of the
Company's subsidiaries are qualifying special purpose entities formed in
connection with off-balance sheet securitizations and are not subject to the
requirements of FIN 46R. The Company's subsidiaries that are considered VIEs
subject to the requirements of FIN 46R consist of Trusts related to the
Company's on-balance sheet securitizations, which are consolidated and in the
Company's consolidated financial statements. The adoption of FIN 46R did not
have a material effect on the Company.
13
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(2) FINANCE RECEIVABLES
The following table presents the components of Finance Receivables, net of
unearned interest:
SEPTEMBER 30, DECEMBER 31,
2004 2003
-------------- --------------
Finance Receivables (IN THOUSANDS)
Automobile
Simple Interest ............................................ $ 449,729 $ 178,679
Pre-compute or "Rule of 78's", net of unearned interest..... 97,412 133,339
-------------- --------------
Finance Receivables, net of unearned interest .............. 547,141 312,018
Less: Unearned acquisition fees and discounts .............. (22,191) (9,940)
-------------- --------------
Finance Receivables ........................................ $ 524,950 $ 302,078
============== ==============
The following table presents the contractual maturities of Finance Receivables,
net of unearned income as of September 30, 2004:
AMOUNT %
------------- ------------
(DOLLARS IN THOUSANDS)
Due in 2004 ....................... $ 2,283 0.42%
Due in 2005 ....................... 18,791 3.43%
Due in 2006 ....................... 36,286 6.63%
Due in 2007 ....................... 53,029 9.69%
Due in 2008 ....................... 136,087 24.87%
Due thereafter .................... 300,665 54.95%
------------- ------------
Total ........................... $ 547,141 100.00%
============= ============
The following table presents a summary of the activity for the allowance for
finance credit losses for the nine-month periods ended September 30, 2004 and
2003:
SEPTEMBER 30, SEPTEMBER 30,
2004 2003
------------- -------------
(IN THOUSANDS)
Balance at beginning of period ............................... $ 35,889 $ 25,828
Addition to allowance for credit losses from acquisitions..... -- 24,271
Provision for credit losses .................................. 20,610 4,716
Net charge offs .............................................. (17,471) (16,798)
------------- -------------
Balance at end of period ..................................... $ 39,028 $ 38,017
============= =============
14
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(3) RESIDUAL INTEREST IN SECURITIZATIONS
The following table presents the components of the residual interest in
securitizations:
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------- ------------
(IN THOUSANDS)
Cash, commercial paper, United States government securities
and other qualifying investments (Spread Accounts)............ $ 26,394 $ 35,693
Receivables from Trusts (NIRs) ................................. 15,500 20,959
Overcollateralization .......................................... 22,795 38,548
Investment in subordinated certificates ........................ 4,025 16,502
------------- ------------
Residual interest in securitizations ........................... $ 68,714 $ 111,702
============= ============
The following table presents estimated remaining undiscounted credit losses
included in the estimated fair value of the residual interest in securitizations
as a percentage of the Company's non-consolidated servicing portfolio subject to
recourse provisions:
SEPTEMBER 30, DECEMBER 31,
2004 2003
--------------- ------------
(DOLLARS IN THOUSANDS)
Undiscounted estimated credit losses ............................. $ 22,372 $ 47,935
Managed portfolio held by non-consolidated subsidiaries .......... 276,202 425,534
Undiscounted estimated credit losses as percentage of managed
portfolio held by non-consolidated subsidiary .................... 8.1% 11.3%
(4) RESIDUAL INTEREST FINANCING
On March 16, 2004, a special-purpose subsidiary of CPS issued $44 million of
asset-backed 10% notes. The notes, issued by CPS Auto Receivables Trust 2004-R,
are rated BBB by Standard & Poor's and have a final maturity date of October 16,
2009. The notes are secured by the Company's residual interest in four
securitizations sponsored by CPS, two securitizations sponsored by MFN, and two
securitization transactions sponsored by TFC. The notes are non-recourse
obligations of the Company and will be repaid solely from the cash distributions
on the retained interests securing the notes.
(5) SECURITIZATION TRUST DEBT
The Company has completed a number of securitization transactions that are
structured as secured borrowings for financial accounting purposes. The debt
issued in these transactions is shown on the Company's unaudited condensed
consolidated balance sheets as "Securitization Trust Debt," and the components
of such debt are summarized in the following table:
15
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Outstanding Outstanding Weighted Average
Initial Principal at Principal at Coupon as of
Series Issue Date Principal September 30, 2004 December 31, 2003 September 30, 2004
------ ---------- --------- ------------------ ----------------- ------------------
(DOLLARS IN THOUSANDS)
CPS 2004-C September 30, 2004 $ 91,000 $ 91,000 $ N/A 2.74%
CPS 2004-B August 2, 2004 96,370 90,949 N/A 3.08%
PCR 2004-1 June 24, 2004 76,257 63,174 N/A 3.11%
CPS 2004-A May 5, 2004 76,347 72,353 N/A 3.19%
CPS 2003-D December 16, 2003 71,250 56,695 71,250 2.91%
CPS 2003-C September 30, 2003 83,125 60,172 77,928 2.85%
TFC 2003-1 May 20, 2003 52,365 21,715 37,114 2.69%
TFC 2002-2 October 9, 2002 62,589 11,995 25,436 2.95%
TFC 2002-1 March 19, 2002 64,552 4,090 12,403 4.23%
MFN 2001-A June 28, 2001 301,000 5,748 20,987 5.07%
------------ ----------------- ----------------
$ 974,855 $ 477,891 $ 245,118
============ ================= ================
All of the securitization trust debt was sold in private placement transactions
to qualified institutional buyers. The debt was issued through wholly-owned
bankruptcy remote subsidiaries of CPS, TFC or MFN, and is secured by the assets
of such subsidiaries, but not by other assets of the Company.
The terms of the various Securitization Agreements related to the issuance of
the securitization trust debt require that certain delinquency and credit loss
criteria be met with respect to the collateral pool, and require that the
Company maintain a minimum net worth and meet other financial tests. As of
September 30, 2004, the Company was not in default of any provisions of the
agreements as amended, except one related to the minimum cash balance on the
closing date of a term securitization transaction. The controlling party has
waived this covenant breach. The Company is responsible for the administration
and collection of the Contracts. The Securitization Agreements also require
certain funds be held in restricted cash accounts to provide additional
collateral for the borrowings or to be applied to make payments on the
securitization trust debt. As of September 30, 2004, restricted cash under the
various agreements totaled approximately $108.0 million. Interest expense on the
securitization trust debt is composed of the stated rate of interest plus
amortization of additional costs of borrowing. Additional costs of borrowing
include facility fees, insurance and deferred financing costs. Deferred
financing costs related to the securitization trust debt are amortized in
proportion to the principal distributed to the noteholders. Accordingly, the
effective cost of borrowing of the securitization trust debt is greater than the
weighted average coupon appearing in the table above.
The wholly-owned bankruptcy remote subsidiaries of CPS, MFN and TFC were formed
to facilitate the above asset-backed financing transactions. Similar bankruptcy
remote subsidiaries issue the debt outstanding under the Company's warehouse
lines of credit. "Bankruptcy remote" refers to a legal structure in which it is
expected that the applicable entity would not be included in any bankruptcy
filing by its parent or affiliates. All of the assets of these subsidiaries have
been pledged as collateral for the related debt. All such transactions, treated
as secured financings for accounting and tax purposes, are treated as sales for
all other purposes, including legal and bankruptcy purposes. None of the assets
of these subsidiaries are available to pay other creditors of the Company or its
affiliates.
(6) SENIOR SECURED DEBT
On February 3, 2003, the Company borrowed $25.0 million from Levine Leichtman
Capital Partners II, L.P. ("LLCP"), net of fees and expenses of $1.05 million.
The indebtedness, represented by the "Term D Note," was originally due in April
2003, with Company options to extend the maturity to May 2003 and January 2004,
upon payment of successive extension fees of $125,000. The Company paid the fees
to extend the maturity to January 2004.
16
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The Company had previously borrowed other amounts from LLCP in the form of the
"Term B Note" and the "Term C Note." The Company repaid in full the Term C Note
on January 29, 2004 and repaid $10.0 million of the Term D Note on January 15,
2004. In addition, on January 29, 2004 the maturities of the Term B Note and the
remaining $15.0 million of the Term D Note were extended to December 15, 2005,
and the interest rates applicable to both notes were decreased to 11.75% per
annum, from 14.50% and 12.00%, respectively. The Company paid LLCP fees equal to
$921,000 for these amendments, which were deferred and are amortized over the
remaining life of the notes. As of September 30, 2004, the outstanding principal
balances of the Term B Note and the Term D Note were $19.8 million and $15.0
million, respectively.
On May 28, 2004 and June 25, 2004, the Company borrowed $15 million and $10
million, respectively, from LLCP. The indebtedness, represented by the "Term E
Note," and the "Term F Note," respectively, bears interest at 11.75% per annum.
Both the Term E Note and the Term F Note mature two years from their respective
funding dates. As of September 30, 2004, the outstanding principal balances of
the Term E Note and the Term F Note were $15.0 million and $10.0 million,
respectively.
The Senior Secured Debt is secured by all of the assets of the Company.
(7) NET GAIN ON SALE OF CONTRACTS
The following table presents components of net gain on sale of Contracts:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- ------------------------
2004 2003 2004 2003
----- ------ -------- --------
(IN THOUSANDS)
Gain (loss) recognized on sale .......................... $ -- $ -- $ -- $ 6,676
Deferred acquisition fees and discounts ................. -- -- -- 4,590
Expenses related to sales ............................... -- -- -- (2,076)
Provision for credit losses ............................. -- -- -- (526)
----- ------ -------- --------
Net gain on sale of Contracts ........................... $ -- $ -- $ -- $ 8,664
===== ====== ======== ========
No gain on sale was recorded in the three-month periods ended September 30, 2004
and 2003 and the nine-month period ended September 30, 2004, due to the July
2003 decision to structure future securitizations as secured financings, rather
than as sales.
(8) INTEREST INCOME
The following table presents the components of interest income:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- -------------------
2004 2003 2004 2003
-------- -------- -------- --------
(IN THOUSANDS)
Interest on finance receivables..... 27,695 11,731 68,405 23,841
Residual interest income (expense),
net of impairment loss ........... (2,650) 3,682 1,984 12,070
Other interest income .............. 269 422 1,069 694
-------- -------- -------- --------
Net interest income ................ 25,314 15,835 71,458 36,605
======== ======== ======== ========
17
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(9) EARNINGS (LOSS) PER SHARE
Diluted earnings (loss) per share for the three-month and nine-month periods
ended September 30, 2004 and 2003 were calculated using the weighted average
number of shares outstanding for the related period. The following table
reconciles the number of shares used in the computations of basic and diluted
earnings (loss) per share for the three-month and nine-month periods ended
September 30, 2004 and 2003:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ ------------------
2004 2003 2004 2003
------- ------- ------- -------
(IN THOUSANDS)
Weighted average number of common shares outstanding during
the period used to compute basic earnings (loss) per share..... 21,345 20,200 21,001 20,226
Incremental common shares attributable to exercise of
outstanding options and warrants .............................. -- -- -- 1,152
Incremental common shares attributable to convertible debt ....... -- -- -- 333
------- ------- ------- -------
Weighted average number of common shares used to compute
diluted earnings per share .................................... 21,345 20,200 21,001 21,711
======= ======= ======= =======
The assumed conversion of certain subordinated debt during the nine-month period
ended September 30, 2003, resulted in an increase to income for purposes of the
diluted earnings per share calculation of $55,000, representing interest
attributable to convertible debt that would not have been incurred if the
convertible debt had been converted. Diluted net earnings for purposes of the
diluted earnings per share calculation totaled $6.1 million for the nine months
ended September 30, 2003.
If the anti-dilutive effects of common stock equivalents were considered,
additional shares included in the diluted earnings (loss) per share calculation
for the three-month and nine-month periods ended September 30, 2004 would have
included an additional 1.9 million and 1.8 million shares, respectively,
attributable to the exercise of outstanding options and warrants. Similarly,
additional shares included in the diluted earnings per share calculation for the
three-month and nine-month periods ended September 30, 2003 would have included
an additional 2.8 million and 746,000 shares, respectively, attributable to the
conversion of certain subordinated debt and the exercise of outstanding options
and warrants.
(10) INCOME TAXES
As of December 31, 2003, the Company had a net deferred tax asset of $411,000,
which included a valuation allowance of $37.4 million against certain deferred
tax assets of $44.6 million. Tax liabilities, net, at September 30, 2004 and
December 31, 2003 were $2.9 million and $2.8 million, respectively. The Company
increased its valuation allowance by the income tax benefit for the period to
result in no net income tax provision for the three- and nine-month periods
ended September 30, 2004. The tax benefit for the nine months ended September
30, 2003 is primarily the result of the resolution of certain Internal Revenue
Service examinations of previously filed MFN tax returns, resulting in a tax
benefit of $4.9 million, and other state tax matters. The Company has evaluated
its deferred tax assets and believes that it is more likely than not that
certain deferred tax assets will not be realized due to limitations imposed by
the Internal Revenue Code and expected future taxable income.
18
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(11) LIQUIDITY
The Company's business requires substantial cash to support its purchases of
Contracts and other operating activities. The Company's primary sources of cash
have been cash flows from operating activities, including proceeds from sales of
Contracts, amounts borrowed under various revolving credit facilities (also
sometimes known as warehouse credit facilities), servicing fees on portfolios of
Contracts previously sold in securitization transactions or serviced for third
parties, customer payments of principal and interest on finance receivables, and
releases of cash from securitized pools of Contracts in which the Company has
retained a residual ownership interest and from the Spread Accounts associated
with such pools. The Company's primary uses of cash have been the purchases of
Contracts, repayment of amounts borrowed under lines of credit and otherwise,
operating expenses such as employee, interest, occupancy expenses and other
general and administrative expenses, the establishment of Spread Accounts and
initial over collateralization, if any, and the increase of Credit Enhancement
to required levels in securitization transactions, and income taxes. There can
be no assurance that internally generated cash will be sufficient to meet the
Company's cash demands. The sufficiency of internally generated cash will depend
on the performance of securitized pools (which determines the level of releases
from those pools and their related Spread Accounts), the rate of expansion or
contraction in the Company's managed portfolio, and the terms upon which the
Company is able to acquire, sell, and borrow against Contracts.
Contracts are purchased from Dealers for a cash price generally approximating
their principal amount, and generate cash flow over a period of years. As a
result, the Company has been dependent on warehouse credit facilities to
purchase Contracts, and on the availability of cash from outside sources in
order to finance its continuing operations, as well as to fund the portion of
Contract purchase prices not financed under warehouse credit facilities. As of
September 30, 2004, the Company had $225 million in warehouse credit capacity,
in the form of a $125 million facility and a $100 million facility. Both
warehouse facilities provide funding for Contracts purchased under the CPS
Programs. A third facility in the amount of $75 million, which the Company also
utilized to fund Contracts under the CPS Programs, expired on February 21, 2004.
A fourth facility in the amount of $25 million, which the Company utilized to
fund Contracts under the TFC Programs, expired on June 24, 2004.
The Company's primary means of ensuring that its cash demands do not exceed its
cash resources is to match its levels of Contract purchases to its availability
of cash. The Company's ability to adjust the quantity of Contracts that it
purchases and securitizes will be subject to general competitive conditions and
the continued availability of warehouse credit facilities. There can be no
assurance that the desired level of Contract acquisition can be maintained or
increased. Obtaining releases of cash from the Trusts and their related Spread
Accounts is dependent on collections from the related Trusts generating
sufficient cash to maintain the Spread Accounts in excess of their respective
requisite levels. There can be no assurance that collections from the related
Trusts will continue to generate sufficient cash.
Certain of the Company's securitization transactions and the warehouse credit
facilities contain various covenants requiring certain minimum financial ratios
and results. As a result of amendments to the related Securitization Agreements
executed during the first nine months of 2004, the Company was in compliance
with all of these covenants as of September 30, 2004, except one related to the
minimum cash balance on the closing date of a term securitization transaction.
The controlling party has waived this covenant breach.
(12) LEGAL PROCEEDINGS
The information provided under the caption "Legal Proceedings" in the Company's
Annual Report of Form 10-K for the year ended December 31, 2003 is incorporated
herein by reference. In addition, the reader should be aware of the following:
19
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
On June 2, 2004, Delmar Coleman filed a lawsuit in the circuit court of
Tuscaloosa, Alabama, making allegations similar to those that were asserted in
the LANG case, and seeking damages in an unspecified amount, on behalf of a
purported nationwide class. (The LANG case has been settled on the terms
disclosed in the Annual Report, and related to alleged defects in the notices
given with respect to repossessed vehicles.) CPS believes that it has one or
more defenses to each of the claims made in this lawsuit, and intends to defend
the matter vigorously.
On June 15, 2004, Keywana Booker filed a lawsuit in the federal district court
of Atlanta, Georgia, alleging violations of the Fair Debt Collection Practices
Act, and seeking damages in an unspecified amount on behalf of a purported class
of Georgia residents. The Company has reached an agreement in principle to
settle the BOOKER lawsuit payment of an immaterial amount.
On July 14, 2004, Jeremy Henry filed a lawsuit in the superior court of San
Diego, California, alleging that he, and a purported California class, were
harmed by alleged defects in post-repossession notices. The notice in question
is a form that was used by TFC prior to TFC's having been acquired by CPS, and
for a short time thereafter. CPS believes that it has one or more defenses to
each of the claims made in the lawsuit, and intends to defend this matter
vigorously.
The Company is routinely involved in various legal proceedings resulting from
its consumer finance activities and practices, both continuing and discontinued.
The Company believes that there are substantive legal defenses to such claims,
and intends to defend them vigorously. There can be no assurance, however, as to
the outcome.
20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
Consumer Portfolio Services, Inc. ("CPS," and together with its subsidiaries,
the ("Company") is a consumer finance company specializing in purchasing,
selling and servicing retail automobile installment purchase contracts
("Contracts") originated by licensed motor vehicle dealers ("Dealers") in the
sale of new and used automobiles, light trucks and passenger vans. Through its
purchases, the Company provides indirect financing to Dealer customers with
limited credit histories, low incomes or past credit problems ("Sub-Prime
Customers"). The Company serves as an alternative source of financing for
Dealers, allowing sales to customers who otherwise might not be able to obtain
financing. The Company does not lend money directly to consumers. Rather, it
purchases installment Contracts from Dealers.
CPS was incorporated and began its operations in 1991. In March 2002, CPS
acquired by merger (the "MFN Merger") MFN Financial Corp. and its subsidiaries.
In May 2003, CPS acquired by merger (the "TFC Merger") TFC Enterprises Inc. and
its subsidiaries. Both MFN Financial Corp and TFC Enterprises Inc., through
their respective subsidiaries, were engaged in businesses substantially similar
to that of CPS, and in each merger CPS acquired a portfolio of receivables that
had been held by the acquired company. Each merger was accounted for as a
purchase. The indirect financing programs of subsidiaries of TFC Enterprises,
Inc. were directed principally to members of the United States armed forces. The
Company has continued to offer such financing programs (the "TFC Programs")
subsequent to the TFC merger, in addition to its other financing programs (the
"CPS Programs").
On April 2, 2004, the Company purchased a portfolio of Contracts and certain
other assets (the "SeaWest Asset Acquisition") from SeaWest Financial
Corporation ("SeaWest"). In addition, the Company was named the successor
servicer for three term securitization transactions originally sponsored by
SeaWest (the "SeaWest Third Party Portfolio"). The Company does not intend to
offer financing programs similar to those previously offered by SeaWest.
SECURITIZATION
GENERALLY
Throughout the periods for which information is presented in this report, the
Company has purchased Contracts with the intention of repackaging them in
securitizations. All such securitizations have involved identification of
specific Contracts, sale of those Contracts (and associated rights) to a special
purpose subsidiary of the Company, and issuance of asset-backed securities to
fund the transactions. Depending on the structure of the securitization, the
transaction may be properly accounted for as a sale of the Contracts, or as a
secured financing.
When the transaction is structured as a secured financing, the subsidiary is
consolidated with the Company. Accordingly, the sold Contracts and the related
securitization trust debt appear as assets and liabilities, respectively, of the
Company on its Unaudited Condensed Consolidated Balance Sheet. The Company then
periodically (i) recognizes interest and fee income on the receivables (ii)
recognizes interest expense on the securities issued in the securitization, and
(iii) records as expense a provision for credit losses on the receivables.
When structured as a sale, the subsidiary is not consolidated with the Company.
Accordingly, the securitization removes the sold Contracts from the Company's
Unaudited Condensed Consolidated Balance Sheet, the asset-backed securities
(debt of the non-consolidated subsidiary) do not appear as debt of the Company,
and the Company shows as an asset a retained residual interest in the sold
Contracts. The residual interest represents the discounted value of what the
Company expects will be the excess of future collections on the Contracts over
principal and interest due on the asset-backed securities. That residual
interest appears on the Company's balance sheet as "Residual interest in
securitizations," and the determination of its value is dependent on estimates
of the future performance of the sold Contracts.
21
CHANGE IN POLICY
In August 2003, the Company announced that it would structure its future
securitization transactions as secured financings for financial accounting
purposes. Its five subsequent term securitizations of finance receivables have
been so structured. Prior to August 2003, the Company had structured its term
securitization transactions related to the CPS Programs as sales for financial
accounting purposes. In the MFN Merger and in the TFC Merger the Company
acquired finance receivables that had been previously securitized in term
securitization transactions that were reflected as secured financings. As of
September 30, 2004, the Company's Unaudited Condensed Consolidated Balance Sheet
included net finance receivables of approximately $61.0 million and
securitization trust debt of $81.5 million related to finance receivables
acquired in the two mergers and the SeaWest Asset Acquisition, out of totals of
net finance receivables of approximately $485.9 million and securitization trust
debt of approximately $477.9 million.
CREDIT RISK RETAINED
Whether a securitization is treated as a secured financing or as a sale for
financial accounting purposes, the related special purpose subsidiary may be
unable to release excess cash to the Company if the credit performance of the
securitized Contracts falls short of pre-determined standards. Such releases
represent a material portion of the cash that the Company uses to fund its
operations. An unexpected deterioration in the performance of securitized
Contracts could therefore have a material adverse effect on both the Company's
liquidity and its results of operations, regardless of whether such Contracts
are treated as having been sold or as having been financed. For estimation of
the magnitude of such risk, it may be appropriate to look to the size of the
Company's "managed portfolio," which represents both financed and sold Contracts
as to which such credit risk is retained. The Company's managed portfolio as of
September 30, 2004 was approximately $898.3 million (this amount includes $68.2
million related to the SeaWest Third Party Portfolio on which the Company earns
only servicing fees and has no credit risk).
RESULTS OF OPERATIONS
ACQUISITION
The Company's Unaudited Condensed Consolidated Balance Sheet and Unaudited
Condensed Consolidated Statements of Operations as of and for the three and nine
months ended September 30, 2004 and 2003, include the results of operations of
TFC Enterprises, Inc. for the period subsequent to May 20, 2003, which is the
date on which the Company acquired that corporation and its subsidiaries in the
TFC Merger. See Note 1 of Notes to Unaudited Condensed Consolidated Financial
Statements, Acquisition of TFC Enterprises, Inc.
EFFECTS OF CHANGE IN SECURITIZATION STRUCTURE
The Company's decision to structure securitization transactions as borrowings
secured by receivables for financial accounting purposes, rather than as sales
of receivables, has affected and will affect the way in which the transactions
are reported. The major effects are these: (i) the finance receivables are shown
as assets of the Company on its balance sheet; (ii) the debt issued in the
transactions is shown as indebtedness of the Company; (iii) cash deposited to
enhance the credit of the securitization transactions ("Spread Accounts") is
shown as "Restricted cash" on the Company's balance sheet; (iv) cash collected
from borrowers and other sources related to the receivables prior to making the
required payments under the Securitization Agreements is also shown as
"Restricted cash" on the Company's balance sheet; (v) the servicing fee that the
Company receives in connection with such receivables is recorded as a portion of
the interest earned on such receivables in the Company's statements of
operations; (vi) the Company has initially and periodically recorded as expense
22
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
a provision for credit losses on the receivables in the Company's statements of
operations; and (vii) the portion of scheduled payments on the receivables
representing interest is recorded as revenue as earned in the Company's
statements of operations.
These changes collectively represent a deferral of revenue and acceleration of
expenses, and thus a more conservative approach to accounting for the Company's
operations. The changes initially have resulted, and may continue to result, in
the Company's reporting lower earnings than it would have reported if it had
continued structuring its securitizations to require recognition of gain on
sale. It should also be noted that growth in the Company's portfolio of
receivables in excess of current expectations would result in an increase in
expenses in the form of provision for credit losses, and would have a negative
effect on net earnings. The Company's cash availability and cash requirements
have been unaffected by the change in structure.
The Company's first five term securitizations of Contracts originated under the
CPS Programs structured as secured financings closed in September 2003, December
2003, May 2004, August 2004 and September 2004. In March 2004, the Company
completed a securitization of its retained interest in eight securitization
transactions previously sponsored by the Company and its affiliates, which was
also structured as a secured financing. In addition, in June 2004, the Company
completed a term securitization of Contracts purchased in the SeaWest Asset
Acquisition and under the TFC Programs, which was structured as a secured
financing. The Company's MFN and TFC subsidiaries completed term securitizations
structured as secured financings prior to their becoming subsidiaries of the
Company. The structures of the Company's two warehouse securitization
transactions that related to the CPS Programs were amended in July 2003 to be
treated as secured financings for financial accounting purposes. The Company's
third warehouse securitization credit facility available to the Company at the
time, which related to the TFC Programs, was structured as a secured financing
for financial accounting purposes since the date of the TFC Merger. Such third
warehouse facility expired on June 24, 2004.
THE THREE-MONTH PERIOD ENDED SEPTEMBER 30, 2004 COMPARED TO THE THREE-MONTH
PERIOD ENDED SEPTEMBER 30, 2003
REVENUES. During the three months ended September 30, 2004, revenues were $32.3
million, an increase of $6.2 million, or 23.9%, from the prior year period
revenue amount of $26.0 million. The primary reason for the increase in revenues
is an increase in interest income. Interest income for the three-month period
ended September 30, 2004 increased $9.5 million, or 59.9%, to $25.3 million in
2004 from $15.8 million for the same period in 2003. The primary reasons for the
increase in interest income are the change in securitization structure
implemented during the third quarter of 2003 as described above and the interest
income earned on the portfolios of Contracts acquired in the SeaWest Asset
Acquisition. Those increases were partially offset by the decline in the balance
of the portfolio of Contracts acquired in the MFN Merger and the TFC Merger, and
an impairment loss of $2.6 million related to the Company's analysis and
estimate of the expected ultimate performance of the Company's previously
securitized pools which are held by non-consolidated subsidiaries.
The interest income is additionally offset in part by a decrease in servicing
fees. Servicing fees of $3.0 million in the three months ended September 30,
2004 decreased $1.3 million, or 29.4%, from $4.3 million in the same period a
year earlier. The decrease in servicing fees is the result of the change in
securitization structure and the consequent decline in the Company's managed
portfolio held by non-consolidated subsidiaries. The decrease was partially
offset by the servicing fees earned on the SeaWest Third Party Portfolio. The
Contracts in the Company's managed portfolio held by non-consolidated
subsidiaries were securitized in structures treated as sales for financial
accounting purposes and, therefore, do not appear on the Company's Unaudited
Condensed Consolidated Balance Sheet. As a result of the decision to structure
future securitizations as secured financings, the Company's managed portfolio
held by non-consolidated subsidiaries will continue to decline in future
periods, and servicing fee revenue is anticipated to continue to decline
proportionately. As of September 30, 2004 and 2003, the Company's managed
portfolio owned by consolidated vs. non-consolidated subsidiaries and other
third parties was as follows:
23
SEPTEMBER 30, 2004 SEPTEMBER 30, 2003
------------------- -------------------
AMOUNT % AMOUNT %
--------- ------ --------- ------
Total Managed Portfolio (DOLLARS IN MILLIONS)
Owned by Consolidated Subsidiaries ........ $ 553.9 61.6% $ 275.1 36.6%
Owned by Non-Consolidated Subsidiaries..... 276.2 30.8% 477.2 63.4%
SeaWest Third Party Portfolio ............. 68.2 7.6% -- 0.0%
--------- ------ --------- ------
Total ..................................... $ 898.3 100.0% $ 752.3 100.0%
========= ====== ========= ======
At September 30, 2004, the Company was generating income and fees on a managed
portfolio with an outstanding principal balance approximating $898.3 million
(this amount includes $68.2 million related to the SeaWest Third Party Portfolio
on which the Company earns only servicing fees), compared to a managed portfolio
with an outstanding principal balance approximating $752.3 million as of
September 30, 2003. As the portfolio of Contracts acquired in the MFN Merger and
the TFC Merger decreases, the portfolio of Contracts originated under the CPS
Programs continues to expand. At September 30, 2004 and 2003, the managed
portfolio composition was as follows:
SEPTEMBER 30, 2004 SEPTEMBER 30, 2003
------------------- ------------------
AMOUNT % AMOUNT %
--------- ------ --------- -----
Originating Entity (Dollars in millions)
CPS ................................. $ 660.5 73.6% $ 517.8 68.8%
TFC ................................. 93.2 10.3% 137.9 18.3%
MFN ................................. 26.7 3.0% 96.6 12.9%
SeaWest ............................. 49.7 5.5% -- --
SeaWest Third Party Portfolio ....... 68.2 7.6% -- --
--------- ------ --------- ------
Total ............................... $ 898.3 100.0% $ 752.3 100.0%
========= ====== ========= ======
Other income decreased $2.0 million, or 33.7%, to $3.9 million during the
quarter ended September 30, 2004 from $5.9 million during the same 2003 period.
The period over period decrease resulted primarily from a sales tax refund of
$2.0 million received in the 2003 period.
EXPENSES. The Company's operating expenses consist primarily of personnel costs
and other operating expenses, which are incurred as applications and Contracts
are received, processed and serviced. Factors that affect margins and net
earnings include changes in the automobile and automobile finance market
environments and macroeconomic factors such as interest rates and the
unemployment level.
Personnel costs include base salaries, commissions and bonuses paid to
employees, and certain expenses related to the accounting treatment of
outstanding warrants and stock options, and are one of the Company's most
significant operating expenses. These costs (other than those relating to stock
options) generally fluctuate with the level of applications and Contracts
processed and serviced.
Other operating expenses include interest expense, provision for credit losses,
facilities expenses, telephone and other communication services, credit
services, computer services (including personnel costs associated with
information technology support), professional services, marketing and
advertising expenses, and depreciation and amortization.
Total operating expenses were $34.3 million for the third quarter of 2004,
compared to $28.9 million for the third quarter of 2003. The increase is
primarily due to the $3.4 million increase in the provision for credit losses to
$7.6 million during the 2004 period as compared to $4.2 million in the 2003
period. Increased interest expense also contributed. These increases were
partially offset by reduced general and administrative expenses.
24
Personnel costs increased slightly to $9.9 million during the three months ended
September 30, 2004, representing 28.9% of total operating expenses, from $9.5
million for the comparable 2003 period, or 32.8% of total operating expenses.
The decrease as a percentage of total operating expenses reflects the higher
operating expenses incurred in the current period, primarily a result of the
increased provision for credit losses and interest expense.
General and administrative expenses decreased to $4.8 million, or 13.9% of total
operating expenses, in the third quarter of 2004, as compared to $6.1 million,
or 20.9% of total operating expenses, in the third quarter of 2003. The decrease
is due primarily to reduced corporate legal expenses as compared to the 2003
period.
Interest expense for the three-month period ended September 30, 2004, increased
$2.0 million, or 30.5%, to $8.4 million, compared to $6.4 million in the
comparable period in 2003. The increase is primarily the result of changes in
the amount and composition of securitization trust debt carried on the Company's
Unaudited Condensed Consolidated Balance Sheet. Such debt increased as a result
of the SeaWest Asset Acquisition and the change in securitization structure
implemented beginning in July 2003, partially offset by the decrease in the
balance of the securitization trust debt acquired in the MFN Merger and the TFC
Merger. As the Company continues to structure future securitization transactions
as secured financings, securitization trust debt and the related interest
expense are expected to increase.
Marketing expense for the three-month period ended September 30, 2004, increased
$1.2 million, or 84.6%, to $2.6 million, compared to $1.4 million in the
comparable period in 2003. The increase is primarily the result of subscription
fees associated with dealer application software initially implemented in the
first quarter of 2004.
The Company increased its valuation allowance against the net deferred tax asset
by the income tax benefit for the 2004 period. The result is a net income tax
provision of zero for the three-month period ended September 30, 2004. No income
tax expense was recorded during the 2003 period.
THE NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2004 COMPARED TO THE NINE-MONTH PERIOD
ENDED SEPTEMBER 30, 2003
REVENUES. During the nine months ended September 30, 2004, revenues were $92.5
million, an increase of $19.2 million, or 26.2%, from the prior year period
revenue amount of $73.3 million. The primary reason for the increase in revenues
is an increase in interest income. Interest income for the nine-month period
ended September 30, 2004 increased $34.9 million, or 95.2%, to $71.5 million in
2004 from $36.6 million in 2003. The primary reasons for the increase in
interest income are the change in securitization structure implemented during
the third quarter of 2003 as described above and the interest income earned on
the portfolios of Contracts acquired in the TFC Merger and the SeaWest Asset
Acquisition. This increase was partially offset by the decline in the balance of
the portfolio of Contracts acquired in the MFN Merger and a decrease in residual
interest income, including an impairment loss of $2.6 million related to the
Company's analysis and estimate of the expected ultimate performance of the
Company's previously securitized pools that are held by non-consolidated
subsidiaries.
The increase in interest income is offset in part by the elimination of net gain
on sale of Contracts revenue and a decrease in servicing fees. As a result of
the change in securitization structure, zero net gain on sale of Contracts was
recorded in the current period, compared to $8.7 million net gain on sale in the
year earlier period. The 2003 gain on sale of Contracts amount is net of a
negative fair value adjustment of $1.8 million related to the Company's analysis
and estimate of the expected ultimate performance of the Company's previously
securitized pools that are held by non-consolidated subsidiaries.
25
Servicing fees of $9.9 million in the nine months ended September 30, 2004
decreased $3.5 million, or 26.2%, from $13.4 million in the same period a year
earlier. The decrease in servicing fees is the result of the change in
securitization structure and the consequent decline in the Company's managed
portfolio held by non-consolidated subsidiaries. The decrease was partially
offset by the servicing fees earned on the SeaWest Third Party Portfolio.
Other income decreased $3.5 million, or 24.0%, to $11.2 million during the nine
months ended September 30, 2004 from $14.7 million during the 2003 period. The
period over period decrease resulted primarily from a sales tax refund of $2.0
received in the 2003 period and decreased recoveries on previously charged off
MFN Contracts. Such recoveries were $6.4 million for the nine months ended
September 30, 2004, compared to $9.6 million for the same period in 2003.
EXPENSES. The Company's operating expenses consist primarily of personnel costs
and other operating expenses, which are incurred as applications and Contracts
are received, processed and serviced. Factors that affect margins and net
earnings include changes in the automobile and automobile finance market
environments and macroeconomic factors such as interest rates and the
unemployment level.
Personnel costs include base salaries, commissions and bonuses paid to
employees, and certain expenses related to the accounting treatment of
outstanding warrants and stock options, and are one of the Company's most
significant operating expenses. These costs (other than those relating to stock
options) generally fluctuate with the level of applications and Contracts
processed and serviced.
Other operating expenses include interest expense, provision for credit losses,
facilities expenses, telephone and other communication services, credit
services, computer services (including personnel costs associated with
information technology support), professional services, marketing and
advertising expenses, and depreciation and amortization.
Total operating expenses were $96.1 million for the first nine months of 2004,
compared to $70.7 million for the first nine months of 2003. The increase is
primarily due to a $16.4 million increase in the provision for credit losses to
$20.6 million during the 2004 period as compared to $4.2 million in the 2003
period. Increased interest expense and personnel costs were also significant.
Personnel costs increased to $29.4 million during the nine months ended
September 30, 2004, representing 30.5% of total operating expenses, from $27.4
million for the comparable 2003 period, or 38.7% of total operating expenses.
The increase is primarily the result of staff additions related to the TFC
Merger in May 2003 and the SeaWest Asset Acquisition in April 2004. This
increase was partially offset by staff reductions since the MFN Merger in 2002
related to the integration and consolidation of certain service and
administrative activities and the decline in the balance of the portfolio of
Contracts acquired in the MFN Merger. The decrease as a percentage of total
operating expenses reflects the higher operating expenses, primarily a result of
the increased provision for credit losses and interest expense.
General and administrative expenses increased to $15.2 million, or 15.8% of
total operating expenses, in the first nine months of 2004, as compared to $14.1
million, or 20.0% of total operating expenses, in the first nine months of 2003.
The increase is due primarily to increased legal expenses and incremental
corporate expenses associated with the TFC Merger, which closed in May 2003. The
decrease as a percentage of total operating expenses reflects the higher
operating expenses primarily a result of the provision for credit losses and
interest expense.
Interest expense for the nine-month period ended September 30, 2004, increased
$4.8 million, or 27.9%, to $21.8 million, compared to $17.0 million in the
comparable period in 2003. The increase is primarily the result of changes in
the amount and composition of securitization trust debt carried on the Company's
Unaudited Condensed Consolidated Balance Sheet. Such debt increased as a result
of the TFC Merger and the SeaWest Asset Acquisition and the change in
securitization structure implemented beginning in July 2003, partially offset by
the decrease in the balance of the securitization trust debt acquired in the MFN
Merger.
26
Marketing expense for the nine-month period ended September 30, 2004, increased
$1.8 million, or 42.9%, to $5.9 million, compared to $4.1 million in the
comparable period in 2003. The increase is primarily the result of subscription
fees associated with dealer application software initially implemented in the
first quarter of 2004.
The Company increased its valuation allowance against the net deferred tax
asset by the income tax benefit for the 2004 periods presented. The result is a
net income tax provision of zero for the three- and nine-month periods ended
September 30, 2004. In the 2003 period, an income tax benefit of $3.4 million
was recorded. The income tax benefit in the prior period was primarily the
result of the resolution of certain IRS examinations of tax returns filed by MFN
prior to the MFN Merger. The resulting tax benefit of $4.9 million was offset in
part by an income tax provision of $1.5 million.
LIQUIDITY AND CAPITAL RESOURCES
The Company's business requires substantial cash to support its purchases of
Contracts and other operating activities. The Company's primary sources of cash
have been cash flows from operating activities, including proceeds from sales of
Contracts, amounts borrowed under various revolving credit facilities (also
sometimes known as warehouse credit facilities), servicing fees on portfolios of
Contracts previously sold in securitization transactions or serviced for third
parties, customer payments of principal and interest on finance receivables, and
releases of cash from securitized pools of Contracts in which the Company has
retained a residual ownership interest and from the Spread Accounts associated
with such pools. The Company's primary uses of cash have been the purchases of
Contracts, repayment of amounts borrowed under lines of credit and otherwise,
operating expenses such as employee, interest, occupancy expenses and other
general and administrative expenses, the establishment of Spread Accounts and
initial overcollateralization, if any, and the increase of Credit Enhancement to
required levels in securitization transactions, and income taxes. There can be
no assurance that internally generated cash will be sufficient to meet the
Company's cash demands. The sufficiency of internally generated cash will depend
on the performance of securitized pools (which determines the level of releases
from those pools and their related Spread Accounts), the rate of expansion or
contraction in the Company's managed portfolio, and the terms upon which the
Company is able to acquire, sell, and borrow against Contracts.
Net cash provided by operating activities for the nine-month periods ended
September 30, 2004 and 2003 was $10.3 million and $64.2 million, respectively.
Cash from operating activities is generally provided by the net releases from
the Company's securitization Trusts.
Net cash used in investing activities for the nine-month periods ended September
30, 2004 and 2003 was $241.2 million and $101.0 million, respectively. Cash used
in investing activities has generally related to purchases of Contracts, the
cost of acquiring TFC and the purchase of furniture and equipment.
Net cash provided by financing activities for the nine months ended September
30, 2004, was $208.6 million compared with net cash used in financing activities
of $30.9 million for the nine months ended September 30, 2003. Cash used or
provided by financing activities is primarily attributable to the repayment or
issuance of debt.
The primary reason for the significant increase in cash used in investing
activities and cash provided by financing activities period over period is the
change in the securitization structure implemented in the third quarter of 2003.
Contracts are purchased from Dealers for a cash price generally approximating
their principal amount, and generate cash flow over a period of years. As a
result, the Company has been dependent on warehouse credit facilities to
purchase Contracts, and on the availability of cash from outside sources in
order to finance its continuing operations, as well as to fund the portion of
Contract purchase prices not financed under warehouse credit facilities. As of
September 30, 2004 the Company had $225 million in warehouse credit capacity, in
the form of a $125 million facility and a $100 million facility. Both warehouse
facilities provide funding for Contracts purchased under the CPS Programs. A
third facility in the amount of $75 million, which the Company utilized to fund
Contracts under the CPS Programs, expired on February 21, 2004. A fourth
facility in the amount of $25 million, which the Company utilized to fund
Contracts under the TFC Programs, expired on June 24, 2004.
27
The $125 million warehouse facility is structured to allow the Company to fund a
portion of the purchase price of Contracts by drawing against a floating rate
variable funding note issued by CPS Warehouse Trust. This facility was
established on March 7, 2002, in the maximum amount of $100 million. Such
maximum amount was increased to $125 million in November 2002. Approximately 73%
of the principal balance of Contracts may be advanced to the Company under this
facility, subject to collateral tests and certain other conditions and
covenants. Notes under this facility bear interest at a rate of one-month
commercial paper plus 1.18% per annum. This facility was renewed in April 2004
and expires on April 3, 2005.
The $100 million warehouse facility is similarly structured to allow CPS to fund
a portion of the purchase price of Contracts by drawing against a floating rate
variable funding note issued by Page Funding LLC. Approximately 73.5% of the
principal balance of Contracts may be advanced to the Company under this
facility, subject to collateral tests and certain other conditions and
covenants. Notes under this facility accrue interest at a rate of one-month
LIBOR plus 1.50% per annum. This facility was entered into on June 30, 2004 and
expires on June 30, 2007. The lender has annual termination options.
The $75 million warehouse facility was similarly structured to allow CPS to fund
a portion of the purchase price of Contracts by drawing against a floating rate
variable funding note issued by CPS Funding LLC. Approximately 72.5% of the
principal balance of Contracts could be advanced to the Company under this
facility, subject to collateral tests and certain other conditions and
covenants. Notes under this facility accrued interest at a rate of one-month
LIBOR plus 0.75% per annum. This facility expired on February 21, 2004.
The $25 million warehouse facility was similarly structured to allow TFC to fund
a portion of the purchase price of Contracts by drawing against a floating rate
variable funding note issued by TFC Warehouse I LLC. Approximately 71% of the
principal balance of Contracts could be advanced to TFC under this facility,
subject to collateral tests and certain other conditions and covenants. Notes
under this facility accrued interest at a rate of one-month LIBOR plus 1.75% per
annum. This facility was entered into as part of the TFC Merger on May 20, 2003
and expired on June 24, 2004. The Company is currently in discussions with
several parties regarding a replacement facility.
These facilities are independent of each other. With the two currently existing
facilities, two different financial institutions purchase the notes issued by
these facilities, and two different insurers insure the notes (each a "Note
Insurer"). The Note Insurer on the $125 million facility is the controlling
party whereas the lender on the $100 million facility is the controlling party.
Up through June 30, 2003, sales of Contracts to the special purpose subsidiaries
("SPS") related to two of the three then existing facilities had been treated as
sales for financial accounting purposes. The Company, therefore, removed these
securitized Contracts and related debt from its Unaudited Condensed Consolidated
Balance Sheet and recognized a gain on sale in the Company's Unaudited Condensed
Consolidated Statement of Operations related to Contracts financed through this
facility. Indebtedness related to Contracts f