================================================================================
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 JUNE 30, 2006
COMMISSION FILE NUMBER: 0-51027
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, INCLUDING AREA CODE: (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 a large accelerated filer or a
non-accelerated filer. See definition of "accelerated filer and large
accelerated filer" in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer [ ] Accelerated Filer [ ] Non-Accelerated Filer [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of August 7, 2006 the registrant had 21,857,177 common shares outstanding.
================================================================================
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
INDEX TO FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2006
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Unaudited Condensed Consolidated Balance Sheets as of
June 30, 2006 and December 31, 2005..................................3
Unaudited Condensed Consolidated Statements of
Operations for the three-month and six-month periods
ended June 30, 2006 and 2005 ........................................4
Unaudited Condensed Consolidated Statements of Cash
Flows for the six-month periods ended June 30, 2006 and 2005.........5
Notes to Unaudited Condensed Consolidated Financial Statements.......6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................15
Item 3. Quantitative and Qualitative Disclosures About Market Risk...........26
Item 4. Controls and Procedures..............................................27
PART II. OTHER INFORMATION
Item 1. Legal Proceedings....................................................27
Item 1A. Risk factors.........................................................27
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds..........27
Item 4 Submission of Matters to a Vote of Security Holders..................28
Item 6. Exhibits.............................................................29
Signatures....................................................................30
Certifications................................................................31
ITEM 1. FINANCIAL STATEMENTS
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
2006 2005
----------- -----------
ASSETS
Cash and cash equivalents $ 11,942 $ 17,789
Restricted cash and equivalents 207,881 157,662
Finance receivables 1,266,534 971,304
Less: Allowance for finance credit losses (74,801) (57,728)
----------- -----------
Finance receivables, net
1,191,733 913,576
Residual interest in securitizations 20,656 25,220
Furniture and equipment, net 993 1,079
Deferred financing costs, net 10,911 8,596
Deferred tax assets, net 13,788 7,532
Accrued interest receivable 12,910 10,930
Other assets 14,510 12,760
----------- -----------
$ 1,485,324 $ 1,155,144
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Accounts payable and accrued expenses $ 20,260 $ 19,568
Warehouse lines of credit 59,346 35,350
Notes payable 145 211
Residual interest financing 30,715 43,745
Securitization trust debt 1,248,332 924,026
Senior secured debt, related party 40,000 40,000
Subordinated renewable notes 8,666 4,655
Subordinated debt - 14,000
----------- -----------
1,407,464 1,081,555
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY
Preferred stock, $1 par value;
authorized 5,000,000 shares; none issued - -
Series A preferred stock, $1 par value;
authorized 5,000,000 shares;
3,415,000 shares issued; none outstanding - -
Common stock, no par value; authorized
30,000,000 shares; 21,799,322 and 21,687,584
shares issued and outstanding at June 30, 2006 and
December 31, 2005, respectively 66,602 66,748
Additional paid in capital, warrants 794 794
Retained earnings 12,893 8,476
Accumulated other comprehensive loss (2,429) (2,429)
----------- -----------
77,860 73,589
----------- -----------
$ 1,485,324 $ 1,155,144
=========== ===========
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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------- ---------------------
2006 2005 2006 2005
-------- -------- -------- --------
REVENUES:
Interest income $ 63,039 $ 40,522 $117,566 $ 76,694
Servicing fees 799 1,795 1,804 4,060
Other income 3,395 5,459 5,887 8,856
-------- -------- -------- --------
67,233 47,776 125,257 89,610
-------- -------- -------- --------
EXPENSES:
Employee costs 9,720 9,701 19,077 20,151
General and administrative 5,678 6,627 10,789 11,766
Interest 21,040 10,051 37,821 18,557
Interest, related party 1,263 1,897 2,517 3,775
Provision for credit losses 22,178 15,224 41,277 27,536
Marketing 3,586 2,679 7,122 5,479
Occupancy 942 850 1,845 1,632
Depreciation and amortization 199 202 392 408
-------- -------- -------- --------
64,606 47,231 120,840 89,304
-------- -------- -------- --------
Income before income tax expense 2,627 545 4,417 306
Income tax expense - - - -
-------- -------- -------- --------
Net income $ 2,627 $ 545 $ 4,417 $ 306
======== ======== ======== ========
Earnings per share:
Basic $ 0.12 $ 0.03 $ 0.20 $ 0.01
Diluted 0.11 0.02 0.18 0.01
Number of shares used in computing
earnings per share:
Basic 21,839 21,623 21,786 21,576
Diluted 24,377 23,399 24,283 23,451
SEE ACCOMPANYING NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
4
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
SIX MONTHS ENDED
JUNE 30,
------------------------
2006 2005
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 4,417 $ 306
Adjustments to reconcile net income to net cash
used in operating activities:
Amortization of deferred acquisition fees (5,625) (5,415)
Amortization of discount on Class B Notes 1,263 681
Depreciation and amortization 392 408
Amortization of deferred financing costs 2,651 1,669
Provision for credit losses 41,277 27,536
Deferred compensation - 92
Releases of cash from Trusts to Company 7,569 13,566
Net deposits to Trusts to increase Spread Accounts (13,985) (5,923)
Interest income on residual assets (2,164) (3,160)
Cash received from residual interest in securitizations 6,728 15,537
Impairment charge against non-auto finance receivable assets - 1,882
Changes in assets and liabilities:
Payments on restructuring accrual (519) (716)
Restricted cash and equivalents (43,802) (22,159)
Accrued interest receivable (1,980) -
Other assets (1,819) (1,243)
Tax assets (6,256) -
Accounts payable and accrued expenses 1,211 (809)
Tax liabilities - (1,182)
--------- ---------
Net cash provided by (used in) operating activities (10,642) 21,070
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of finance receivables held for investment (523,231) (298,095)
Proceeds received on finance receivables held for investment 209,421 132,317
Purchase of furniture and equipment (236) (60)
--------- ---------
Net cash used in investing activities (314,046) (165,838)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of securitization trust debt 538,471 262,743
Proceeds from issuance of subordinated renewable notes 4,011 957
Net proceeds (repayments) from warehouse lines of credit 23,995 11,036
Repayment of residual interest financing debt (13,194) (10,172)
Repayment of securitization trust debt (215,264) (114,219)
Repayment of subordinated debt (14,000) (1,000)
Repayment of notes payable (67) (1,113)
Payment of financing costs (4,966) (2,397)
Repurchase of common stock (1,502) (127)
Tax benefit from exercise of stock options 507 -
Exercise of options and warrants 850 365
--------- ---------
Net cash provided by financing activities 318,841 146,073
--------- ---------
Increase (decrease) in cash (5,847) 1,305
Cash at beginning of period 17,789 14,366
--------- ---------
Cash at end of period $ 11,942 $ 15,671
========= =========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 35,784 $ 20,878
Income taxes $ 5,635 $ 1,182
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 and servicing retail automobile installment sale
contracts ("automobile contracts" or "finance receivables") originated by
licensed motor vehicle dealers located throughout the United States ("Dealers")
in the sale of new and used automobiles, light trucks and passenger vans.
Through its purchases, the Company provides indirect financing to Dealer
customers for borrowers with limited credit histories, low incomes or past
credit problems ("Sub-Prime Customers"). The Company serves as an alternative
source of financing for Dealers, allowing sales to customers who otherwise might
not be able to obtain financing. The Company does not lend money directly to
consumers. Rather, it purchases installment automobile contracts from Dealers
based on its financing programs (the "CPS Programs").
BASIS OF PRESENTATION
The Unaudited Condensed Consolidated Financial Statements of the Company have
been prepared in conformity with accounting principles generally accepted in the
United States of America, with the instructions to Form 10-Q and with Article 10
of Regulation S-X of the Securities and Exchange Commission, and include all
adjustments that are, in the opinion of management, necessary for a fair
presentation of the results for the interim periods presented. All such
adjustments are, in the opinion of management, of a normal recurring nature. In
addition, certain items in prior period financial statements may have been
reclassified for comparability to current period presentation. Results for the
six-month period ended June 30, 2006 are not necessarily indicative of the
operating results to be expected for the full year.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted from these
Unaudited Condensed Consolidated Financial Statements. These Unaudited Condensed
Consolidated Financial Statements should be read in conjunction with the
Consolidated Financial Statements and Notes to Consolidated Financial Statements
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2005.
OTHER INCOME
Other Income consists primarily of recoveries on previously charged off CPS and
MFN contracts and fees paid to the Company by Dealers for certain direct mail
services the Company provides. The recoveries on the charged-off CPS and MFN
contracts were $2.5 million and $2.9 million for the six months ended June 30,
2006 and 2005, respectively. The direct mail revenues were $2.0 million and $2.5
million for the same periods in 2006 and 2005, respectively. Other Income for
the six months ended June 30, 2005 also included proceeds from sales of
deficiency balances to independent third parties in the amount of $2.4 million.
STOCK-BASED COMPENSATION
Effective January 1, 2006, the Company adopted Statement of Financial Accounting
Standards No. 123(R), "Share-Based Payment, revised 2004" ("SFAS 123R"),
prospectively for all option awards granted, modified or settled after January
1, 2006, using the modified prospective method. Under this method, the Company
recognizes compensation costs in the financial statements for all share-based
payments granted subsequent to January 1, 2006 based on the grant date fair
value estimated in accordance with the provisions of SFAS 123(R). Results for
prior periods have not been restated.
For the three and six months ended June 30, 2006, the Company recorded no
stock-based compensation costs as there were no option awards granted during the
three-month and six-month periods ended June 30, 2006 and there was no vesting
of option awards for options granted prior to January 1, 2006 since all options
outstanding as of December 31, 2005 were fully vested at that time. As of June
30, 2006, there are no unrecognized stock-based compensation costs to be
recognized over future periods.
6
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The following represents stock option activity for the six months ended June 30,
2006:
WEIGHTED
NUMBER OF WEIGHTED AVERAGE
SHARES AVERAGE REMAINING
(IN THOUSANDS) EXERCISE PRICE CONTRACTUAL TERM
-------------- -------------- ----------------
Options outstanding at the beginning of period 4,864 $ 3.38 N/A
Granted - - N/A
Exercised (331) 2.48 N/A
Forefited (34) 4.00 N/A
-------------- -------------- ----------------
Options outstanding at the end of period 4,499 $ 3.44 7.10 years
============== ============== ================
Options exercisable at the end of period 4,499 $ 3.44 7.10 years
============== ============== ================
At June 30, 2006 the aggregate intrinsic value of options outstanding and
exercisable was $14.7 million. The total intrinsic value of options exercised
was $1.5 million and $565,000 for the six months ended June 30, 2006 and 2005,
respectively. New shares were issued for all options exercised during the
six-month periods ended June 30, 2006 and 2005. There were 1.7 million shares
available for future stock option grants under existing plans as of June 30,
2006, including 1.5 million shares that are available under the Company's 2006
Long-Term Equity Incentive Plan, which was approved at the Company's annual
meeting of shareholders held on June 15, 2006.
The 2006 Long-Term Equity Incentive Plan permits the grant of the following
awards: nonqualified stock options, incentive stock options, restricted stock,
restricted stock units or stock appreciation rights. Option awards are generally
granted with an exercise price equal to the market price of the Company's stock
at the date of grant. The option awards generally vest over a five year period
of continued employment and expire ten years after grant. In the event of a
Change of Control of the Company, option awards may become fully vested and
immediately exercisable.
Prior to January 1, 2006, as was permitted by Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"),
the Company accounted for stock-based employee compensation plans in accordance
with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" and related interpretations, under which stock options are recorded
at intrinsic value equal to the excess of the share price over the exercise
price at the date of grant. The Company provided the pro forma net income
(loss), pro forma earnings (loss) per share, and stock based compensation plan
disclosure requirements set forth in SFAS No. 123. The Company accounted for
repriced options as variable awards.
Compensation cost was recognized for certain stock options in the Unaudited
Condensed Consolidated Financial Statements in accordance with APB Opinion No.
25. Had the Company determined compensation cost based on the fair value at the
grant date for its stock options under SFAS No 123, the Company's net income and
net income per share would have decreased to the pro forma amounts indicated
below.
7
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ ----------------
2005 2005
------------------ ----------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net income, as reported $ 545 $ 306
Stock-based employee compensation expense,
fair value method, net of tax (379) (579)
Previously recorded stock-based employee compensation
expense, intrinsic value method, net of tax $ 22 $ 54
------------------ ----------------
Pro forma net income (loss) $ 188 $ (219)
================== ================
Net income (loss) per share
Basic, as reported $ 0.03 $ 0.01
Diluted, as reported $ 0.02 $ 0.01
Pro forma Basic $ 0.01 $ (0.01)
Pro forma Diluted $ 0.01 $ (0.01)
The Company uses the Black-Scholes-Merton option valuation model to estimate the
fair value of each option on the date of grant, using the assumptions noted in
the following table. The Company did not disclose assumptions for the six months
ended June 30, 2006 because there were no options granted in the period. The
expected term of options granted is derived from historical data on employee
exercise and post-vesting termination behavior. The risk-free rate is based on
treasury instruments in effect at the time of grant whose terms are consistent
with the expected term of the Company's stock options. Expected volatility is
based on historical volatility of the Company's stock. The dividend yield is
based on historical experience and the lack of any expected future changes.
SIX MONTHS ENDED
JUNE 30,
-----------------
2005
-----------------
Risk-free interest rate............. 4.17%
Expected term, in years............. 6.5
Expected volatility................. 50.70%
Dividend yield...................... 0%
PURCHASES OF COMPANY STOCK
During the six-month periods ended June 30, 2006 and 2005, the Company purchased
219,417 and 29,950 shares, respectively, of its common stock, at average prices
of $6.85 and $4.25, respectively.
NEW ACCOUNTING PRONOUNCEMENTS
In July 2006, the FASB issued FASB Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes" (FIN 48). FIN 48 clarifies the accounting and
reporting for income taxes recognized in accordance with SFAS 109, "Accounting
for Income Taxes". This interpretation prescribes a comprehensive model for the
financial statement recognition, measurement, presentation and disclosure of
uncertain tax positions taken or expected to be taken in income tax returns. The
Company is currently evaluating the impact of FIN 48. The Company will adopt
this Interpretation in the first quarter of 2007.
In March 2006, the FASB issued FASB Statement No. 156, "Accounting for the
Servicing of Financial Assets an Amendment to FASB Statement No. 140" (FAS 156).
With respect to the accounting for separately recognized servicing assets and
servicing liabilities, this statement: (1) requires an entity to recognize a
servicing asset or servicing liability each time it undertakes an obligation to
service a financial asset by entering into a specific types of servicing
contracts identified in the statement, (2) requires that all separately
recognized servicing assets and servicing liabilities be initially measured at
fair value, if practicable, (3) permits an entity to choose subsequent
measurement methods for each class of separately recognized servicing assets and
servicing liabilities, (4) permits a one-time reclassification of
available-for-sale securities to trading securities by entities with recognized
servicing rights at the initial adoption of this statement, and (5) requires a
separate presentation of servicing assets and servicing liabilities subsequently
measured at fair value in the statement of financial position and additional
disclosures for all separately recognized servicing assets and servicing
liabilities. FAS 156 will be effective for the Company on January 1, 2007. The
Company is currently in the process of evaluating the effects of this Standard,
but does not believe it will have a significant effect on its financial position
or results of operations.
8
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 and deferred acquisition fees and originations costs:
JUNE 30, DECEMBER 31,
2006 2005
----------- -----------
Finance Receivables (IN THOUSANDS)
Automobile
Simple Interest $ 1,247,314 $ 933,510
Pre-compute, net of unearned interest 38,500 54,693
----------- -----------
Finance Receivables, net of unearned interest 1,285,814 988,203
Less: Unearned acquisition fees and originations costs (19,280) (16,899)
----------- -----------
Finance Receivables $ 1,266,534 $ 971,304
=========== ===========
The following table presents a summary of the activity for the allowance for
credit losses for the six-month periods ended June 30, 2006 and 2005:
JUNE 30, JUNE 30,
2006 2005
-------- --------
(IN THOUSANDS)
Balance at beginning of period $ 57,728 $ 42,615
Provision for credit losses on finance receivables 41,277 26,654
Charge offs (33,773) (21,549)
Recoveries 9,569 5,583
-------- --------
Balance at end of period $ 74,801 $ 53,303
======== ========
(3) RESIDUAL INTEREST IN SECURITIZATIONS
The residual interest in securitizations represents the discounted sum of
expected future cash flows from securitization trusts held by non-consolidated
subsidiaries. The following table presents the components of the residual
interest in securitizations, which are shown at their discounted amounts:
JUNE 30, DECEMBER 31,
2006 2005
----------- -----------
(IN THOUSANDS)
Cash, commercial paper, United States government securities
and other qualifying investments (Spread Accounts) $ 13,656 $ 12,748
Receivables from Trusts (NIRs) 3,443 5,798
Overcollateralization 3,557 6,674
----------- -----------
Residual interest in securitizations $ 20,656 $ 25,220
=========== ===========
9
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The following table presents estimated remaining undiscounted credit losses
included in the fair value estimate of the Residuals as a percentage of the
Company's managed portfolio held by non-consolidated subsidiaries subject to
recourse provisions:
JUNE 30, DECEMBER 31,
2006 2005
--------- ------------
(DOLLARS IN THOUSANDS)
Undiscounted estimated credit losses $ 2,459 $ 5,724
Managed portfolio held by non-consolidated subsidiaries 67,185 103,130
Undiscounted estimated credit losses as percentage of managed
portfolio held by non-consolidated subsidiaries $ 3.7% 5.6%
The key economic assumptions used in measuring all residual interest in
securitizations as of June 30, 2006 and December 31, 2005 are included in the
table below. The pre-tax discount rate remained constant from previous periods
at 14%, except for certain cash flows from charged off receivables related to
the Company's securitizations from 2001 to 2003, for which the Company has used
a discount rate of 25%, which is also consistent with previous periods.
JUNE 30, DECEMBER 31,
2006 2005
------------- -------------
Prepayment speed (Cumulative) 22.3% - 35.0% 22.2% - 35.8%
Net credit losses (Cumulative) 11.7% - 19.9% 11.9% - 20.2%
(4) SECURITIZATION TRUST DEBT
The Company has completed a number of securitization transactions that are
structured as secured borrowings for financial accounting purposes. The debt
issued in these transactions is shown on the Company's Unaudited Condensed
Consolidated Balance Sheets as "Securitization trust debt," and the components
of such debt are summarized in the following table:
10
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
WEIGHTED
FINAL RECEIVABLES OUTSTANDING OUTSTANDING AVERAGE
SCHEDULED PLEDGED AT PRINCIPAL AT PRINCIPAL AT INTEREST RATE
AT
PAYMENT JUNE 30, INITIAL JUNE 30, DECEMBER 31, JUNE 30,
SERIES DATE (1) 2006 PRINCIPAL 2006 2005 2006
- -----------------------------------------------------------------------------------------------------------------
TFC 2003-1 January 2009 $ 3,885 $ 52,365 $ 3,338 $ 6,557 2.69%
CPS 2003-C March 2010 22,572 87,500 21,861 30,550 3.57%
CPS 2003-D October 2010 22,570 75,000 21,727 29,688 3.91%
CPS 2004-A October 2010 29,724 82,094 29,843 40,225 3.97%
PCR 2004-1 March 2010 17,026 76,257 13,678 22,873 3.97%
CPS 2004-B February 2011 39,826 96,369 39,740 52,704 4.17%
CPS 2004-C April 2011 47,989 100,000 47,633 61,779 4.01%
CPS 2004-D December 2011 63,984 120,000 63,402 82,801 4.44%
CPS 2005-A October 2011 86,192 137,500 84,904 110,021 5.22%
CPS 2005-B February 2012 98,241 130,625 95,138 113,194 4.61%
CPS 2005-C March 2012 156,580 183,300 152,775 173,509 5.04%
CPS 2005-TFC July 2012 64,579 72,525 60,297 72,525 5.75%
CPS 2005-D July 2012 128,145 145,000 125,542 127,600 5.67%
CPS 2006-A November 2012 233,860 245,000 233,979 - 5.23%
CPS 2006-B (2) January 2013 165,938 257,500 254,475 - 6.20%
--------------- --------------- --------------- --------------
$ 1,181,111 $ 1,861,035 $ 1,248,332 $ 924,026
=============== =============== =============== ==============
- ------------------------
(1) THE FINAL SCHEDULED PAYMENT DATE REPRESENTS FINAL LEGAL MATURITY OF THE
SECURITIZATION TRUST DEBT. SECURITIZATION TRUST DEBT IS EXPECTED TO BECOME
DUE AND TO BE PAID PRIOR TO THOSE DATES, BASED ON AMORTIZATION OF THE
FINANCE RECEIVABLES PLEDGED TO THE TRUSTS. EXPECTED PAYMENTS, WHICH WILL
DEPEND ON THE PERFORMANCE OF SUCH RECEIVABLES, AS TO WHICH THERE CAN BE NO
ASSURANCE, ARE $225.5 MILLION IN 2006, $356.4 MILLION IN 2007, $259.3
MILLION IN 2008, $189.9 MILLION IN 2009, $135.3 MILLION IN 2010 AND $81.9
MILLION IN 2011.
(2) RECEIVABLES PLEDGED AT JUNE 30, 2006 EXCLUDES APPROXIMATELY $89.6 MILLION
IN AUTOMOBILE CONTRACTS DELIVERED TO THIS TRUST IN JULY 2006 PURSUANT TO A
PRE-FUNDING STRUCTURE.
All of the securitization trust debt was sold in private placement transactions
to qualified institutional buyers. The debt was issued through wholly-owned
bankruptcy remote subsidiaries of CPS, TFC or MFN, and is secured by the assets
of such subsidiaries, but not by other assets of the Company. Principal of $1.2
billion, and the related interest payments, are guaranteed by financial guaranty
insurance policies issued by third party financial institutions.
The terms of the various Securitization Agreements related to the issuance of
the securitization trust debt and the warehouse credit facilities require that
certain delinquency and credit loss criteria be met with respect to the
collateral pool, and require that the Company maintain minimum levels of
liquidity and net worth and not exceed maximum leverage levels and maximum
financial losses. In addition, certain securitization and non-securitization
related debt contain cross-default provisions, which would allow certain
creditors to declare a default if a default were declared under a different
facility. As of June 30, 2006, the Company was in compliance with all such
financial covenants.
The Company is responsible for the administration and collection of the
automobile contracts. The Securitization Agreements also require certain funds
be held in restricted cash accounts to provide additional collateral for the
borrowings, to purchase retail installment contracts that the securitization
trust has committed to buy, or to be applied to make payments on the
securitization trust debt. As of June 30, 2006, restricted cash under the
various agreements totaled approximately $207.9 million. That figure includes
$89.6 million held by our CPS 2006-B securitization trust which was used to
purchase additional automobile contracts in July 2006. Interest expense on the
securitization trust debt is composed of the stated rate of interest plus
amortization of additional costs of borrowing. Additional costs of borrowing
include facility fees, insurance and amortization of deferred financing costs
and discounts on subordinated notes. Deferred financing costs and discounts on
subordinated notes related to the securitization trust debt are amortized using
a level yield method. Accordingly, the effective cost of borrowing of the
securitization trust debt is greater than the stated rate of interest.
11
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The wholly-owned, bankruptcy remote subsidiaries of CPS and TFC were formed
to facilitate the above asset-backed financing transactions. Similar bankruptcy
remote subsidiaries issue the debt outstanding under the Company's warehouse
lines of credit. Bankruptcy remote refers to a legal structure in which it is
expected that the applicable entity would not be included in any bankruptcy
filing by its parent or affiliates. All of the assets of these subsidiaries have
been pledged as collateral for the related debt. All such transactions, treated
as secured financings for accounting and tax purposes, are treated as sales for
all other purposes, including legal and bankruptcy purposes. None of the assets
of these subsidiaries are available to pay other creditors of the Company or its
affiliates.
(5) INTEREST INCOME
The following table presents the components of interest income:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -------------------
2006 2005 2006 2005
------- ------- -------- --------
Interest on Finance Receivables $60,387 $38,439 $112,747 $ 72,424
Residual interest income 1,203 1,477 2,164 3,160
Other interest income 1,449 606 2,655 1,110
------- ------- -------- --------
Net interest income $63,039 $40,522 $117,566 $ 76,694
======= ======= ======== ========
(6) EARNINGS PER SHARE
Earnings per share for the three-month and six-month periods ended June 30, 2006
and 2005 were calculated using the weighted average number of shares outstanding
for the related period. The following table reconciles the number of shares used
in the computations of basic and diluted earnings per share for the three-month
and six-month periods ended June 30, 2006 and 2005:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -------------------
2006 2005 2006 2005
------- ------- ------- -------
(IN THOUSANDS) (IN THOUSANDS)
Weighted average number of common shares outstanding during
the period used to compute basic earnings per share 21,839 21,623 21,786 21,576
Incremental common shares attributable to exercise of
outstanding options and warrants 2,538 1,776 2,497 1,875
------- ------- ------- -------
Weighted average number of common shares used to compute
diluted earnings per share 24,377 23,399 24,283 23,451
======= ======= ======= =======
(7) INCOME TAXES
As of December 31, 2005, the Company had net deferred tax assets of $7.5
million, which included a valuation allowance of $43.7 million against gross
deferred tax assets of $53.1 million. There were also offsetting gross deferred
tax liabilities of $1.8 million. Net tax assets at June 30, 2006 were $13.8
million. The Company decreased its valuation allowance by the income tax expense
for the period to result in no net income tax provision for the three and
six-month periods ended June 30, 2006. The Company has evaluated its deferred
tax assets and believes that it is more likely than not that certain deferred
tax assets will not be realized due to limitations imposed by the Internal
Revenue Code and expected future taxable income.
12
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(8) LEGAL PROCEEDINGS
STANWICH LITIGATION. CPS was for some time a defendant in a class action (the
"Stanwich Case") brought in the California Superior Court, Los Angeles County.
The original plaintiffs in that case were persons entitled to receive regular
payments (the "Settlement Payments") under out-of-court settlements reached with
third party defendants. Stanwich Financial Services Corp. ("Stanwich"), an
affiliate of the former chairman of the board of directors of CPS, is the entity
that was obligated to pay the Settlement Payments. Stanwich has defaulted on its
payment obligations to the plaintiffs and in June 2001 filed for reorganization
under the Bankruptcy Code, in the federal Bankruptcy Court of Connecticut. At
December 31, 2004, CPS was a defendant only in a cross-claim brought by one of
the other defendants in the case, Bankers Trust Company, which asserted a claim
of contractual indemnity against CPS.
CPS subsequently settled the cross-claim of Bankers Trust by payment of $3.24
million, on or about February 8, 2005. Pursuant to that settlement, the court
has dismissed the cross-claim, with prejudice. The amount paid by the Company
was accrued for and included in Accounts payable and accrued expenses in the
Company's balance sheet as of December 31, 2004.
In November 2001, one of the defendants in the Stanwich Case, Jonathan Pardee,
asserted claims for indemnity against the Company in a separate action, which is
now pending in federal district court in Rhode Island. The Company has filed
counterclaims in the Rhode Island federal court against Mr. Pardee, and has
filed a separate action against Mr. Pardee's Rhode Island attorneys, in the same
court. The action of Mr. Pardee against CPS is stayed, awaiting resolution of an
adversary action brought against Mr. Pardee in the bankruptcy court, which is
hearing the bankruptcy of Stanwich.
The reader should consider that any adverse judgment against CPS in the Stanwich
Case (or the related case in Rhode Island) for indemnification, in an amount
materially in excess of any liability already recorded in respect thereof, could
have a material adverse effect on the Company's financial position.
OTHER LITIGATION. On June 2, 2004, Delmar Coleman filed a lawsuit in the circuit
court of Tuscaloosa, Alabama, alleging that plaintiff Coleman was harmed by an
alleged failure to refer, in the notice given after repossession of her vehicle,
to the right to purchase the vehicle by tender of the full amount owed under the
retail installment contract. Plaintiff seeks damages in an unspecified amount,
on behalf of a purported nationwide class. CPS removed the case to federal
bankruptcy court, and filed a motion for summary judgment as part of its
adversary proceeding against the plaintiff in the bankruptcy court. The federal
bankruptcy court granted the plaintiff's motion to send the matter back to
Alabama state court. CPS appealed the ruling, and the federal district court, in
which the appeal was heard, has since ordered the bankruptcy court to decide
whether the plaintiff has standing to pursue her claims, and, if standing is
found, to reconsider its remand decision. The matter is currently pending before
the bankruptcy court. Although CPS believes that it has one or more defenses to
each of the claims made in this lawsuit, no discovery has yet been conducted and
the case remains in its earliest stages. Accordingly, there can be no assurance
as to its outcome.
In June 2004, Plaintiff Jeremy Henry filed a lawsuit against the Company in the
California Superior Court, San Diego County, alleging improper practices related
to the notice given after repossession of a vehicle that he purchased.
Plaintiff's motion for a certification of a class has been denied, and is the
subject of an appeal now before the California Court of Appeal. Irrespective of
the outcome of that appeal, as to which there can be no assurance, the Company
has a number of defenses that may be asserted with respect to the claims of
plaintiff Henry.
In August and September 2005, two plaintiffs represented by the same law firm
filed substantially identical lawsuits in the federal district court for the
northern district of Illinois, each of which purports to be a class action, and
each of which alleges that CPS improperly accessed consumer credit information.
CPS has reached agreements in principle to settle these cases, which await
confirmation by the court.
The Company has recorded a liability as of June 30, 2006 that it believes
represents a sufficient allowance for legal contingencies, including those
described above. Any adverse judgment against the Company, if in an amount
materially in excess of the recorded liability, could have a material adverse
effect on the financial position of the Company.
13
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The Company is routinely involved in various legal proceedings resulting from
its consumer finance activities and practices, both continuing and discontinued.
The Company believes that there are substantive legal defenses to such claims,
and intends to defend them vigorously. There can be no assurance, however, as to
the outcome.
(9) EMPLOYEE BENEFITS
The Company sponsors the MFN Financial Corporation Benefit Plan ("the Plan").
Plan benefits were frozen September 30, 2001. The table below sets forth the
Plan's net periodic benefit cost for the three-month and six-month periods ended
June 30, 2006 and 2005.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2006 2005 2006 2005
----- ----- ----- -----
COMPONENTS OF NET PERIODIC BENEFIT COST
Service cost $ - $ - $ - $ -
Interest Cost $ 225 209 $ 438 420
Expected return on assets (287) (260) $(574) (552)
Amortization of transition (asset)/obligation (3) (8) $ (5) (17)
Amortization of net (gain) / loss 48 42 $ 82 54
----- ----- ----- -----
Net periodic benefit cost $ (17) $ (17) $ (59) $ (95)
===== ===== ===== =====
The Company made contributions to the Plan in the amounts of $300,000 and
$50,000 for the six months ended June 30, 2006 and 2005, respectively. The
Company previously disclosed in its Financial Statements for the year ended
December 31, 2005 that they did not anticipate making any contributions to the
plan during 2006. The Company presently anticipates that no additional
contributions will be made during the remainder of 2006.
(10) COMPREHENSIVE INCOME
The components of comprehensive income are as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2006 2005 2006 2005
------ ------ ------ ------
Net income $2,627 $ 545 $4,417 $ 306
Minimum pension liability, net of tax -- -- -- (185)
------ ------ ------ ------
Comprehensive income $2,627 $ 545 $4,417 $ 121
====== ====== ====== ======
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
We are a specialty finance company engaged in purchasing and servicing new and
used retail automobile contracts originated primarily by franchised automobile
dealerships and to a lesser extent by select independent dealers of used
automobiles in the United States. We serve as an alternative source of financing
for dealers, facilitating sales to sub-prime customers, who have limited credit
history, low income or past credit problems and who otherwise might not be able
to obtain financing from traditional sources. We do not currently lend money
directly to consumers but, rather, purchase automobile contracts from dealers
under several different financing programs. We are headquartered in Irvine,
California and have three additional strategically located servicing branches in
Virginia, Florida and Illinois.
On March 8, 2002, we acquired MFN Financial Corporation and its subsidiaries in
a merger. On May 20, 2003, we acquired TFC Enterprises, Inc. and its
subsidiaries in a second merger. Each merger was accounted for as a purchase.
MFN Financial Corporation and its subsidiaries and TFC Enterprises, Inc. and its
subsidiaries were engaged in businesses similar to ours: buying automobile
contracts from dealers and servicing those automobile contracts. MFN Financial
Corporation and its subsidiaries ceased acquiring automobile contracts in May
2002; TFC continues to acquire automobile contracts under its "TFC Programs,"
which provide financing for vehicle purchases exclusively by members of the
United States Armed Forces.
On April 2, 2004, we purchased a portfolio of automobile contracts and certain
other assets from SeaWest Financial Corporation and its subsidiaries. In
addition, we were named the successor servicer of three term securitization
transactions originally sponsored by SeaWest. We do not intend to offer
financing programs similar to those previously offered by SeaWest.
>From inception through June 2003, we generated revenue primarily from the gains
recognized on the sale or securitization of automobile contracts, servicing fees
earned on automobile contracts sold, interest earned on residual interests
retained in securitizations, and interest earned on finance receivables. Since
July 2003, we have not recognized any gains from the sale of automobile
contracts. Instead, since July 2003 our revenues have been derived from
servicing fees and interest earned on residual interests in securitizations (for
automobile contracts purchased prior to July 2003) and interest on finance
receivables (for automobile contracts purchased since July 2003).
SECURITIZATION AND WAREHOUSE CREDIT FACILITIES
GENERALLY
Throughout the periods for which information is presented in this report, we
have purchased automobile contracts with the intention of financing them on a
long-term basis through securitizations, and on an interim basis through our
warehouse credit facilities. All such financings have involved identification of
specific automobile contracts, sale of those automobile contracts (and
associated rights) to one of our special-purpose subsidiaries, and issuance of
asset-backed securities to fund the transactions. Depending on the structure,
these transactions may properly be accounted for under generally accepted
accounting principles as sales of the automobile contracts or as secured
financings.
When structured to be treated as a secured financing for accounting purposes,
the subsidiary is consolidated with us. Accordingly, the sold automobile
contracts and the related debt appear as assets and liabilities, respectively,
on our consolidated balance sheet. We then periodically (i) recognize interest
and fee income on the contracts, (ii) recognize interest expense on the
securities issued in the transaction and (iii) record as expense a provision for
credit losses on the contracts.
When structured to be treated as a sale for accounting purposes, the assets and
liabilities of the special-purpose subsidiary are not consolidated with us.
Accordingly, the transaction removes the sold automobile contracts from our
consolidated balance sheet, the related debt does not appear as our debt, and
our consolidated balance sheet shows, as an asset, a retained residual interest
in the sold automobile contracts. The residual interest represents the
discounted value of what we expect will be the excess of future collections on
the automobile contracts over principal and interest due on the asset-backed
securities. That residual interest appears on our consolidated balance sheet as
"residual interest in securitizations," and the determination of its value is
dependent on our estimates of the future performance of the sold automobile
contracts.
15
CHANGE IN POLICY
Beginning in the third quarter of 2003, we began to structure our securitization
transactions so that they would be treated for financial accounting purposes as
secured financings, rather than as sales. All subsequent securitizations of
automobile contracts have been so structured. Prior to the third quarter of
2003, we had structured our securitization transactions to be treated as sales
of automobile contracts for financial accounting purposes. In our acquisitions
of MFN and TFC, we acquired automobile contracts that these companies had
previously securitized in securitization transactions that were treated as
secured financings for financial accounting purposes. As of June 30, 2006, our
consolidated balance sheet included net finance receivables of $4.6 million and
securitization trust debt of $3.3 million related to automobile contracts
acquired in the two mergers, out of totals of net finance receivables of
$1,191.7 million and securitization trust debt of $1,248.3 million.
CREDIT RISK RETAINED
Whether a sale of automobile contracts in connection with a securitization or
warehouse credit facility is treated as a secured financing or as a sale for
financial accounting purposes, the related special-purpose subsidiary may be
unable to release excess cash to us if the credit performance of the related
automobile contracts falls short of pre-determined standards. Such releases
represent a material portion of the cash that we use to fund our operations. An
unexpected deterioration in the performance of such automobile contracts could
therefore have a material adverse effect on both our liquidity and our results
of operations, regardless of whether such automobile contracts are treated for
financial accounting purposes as having been sold or as having been financed.
For estimation of the magnitude of such risk, it may be appropriate to look to
the size of our "managed portfolio," which represents both financed and sold
automobile contracts as to which such credit risk is retained. Our managed
portfolio as of June 30, 2006 was approximately $1,375.3 million (this amount
includes $8.7 million of automobile contracts securitized by SeaWest, on which
we earn only servicing fees and have no credit risk).
RESULTS OF OPERATIONS
EFFECTS OF CHANGE IN SECURITIZATION STRUCTURE
Our decision in the third quarter of 2003 to structure securitization
transactions as secured financings for financial accounting purposes, rather
than as sales, has affected and will affect the way in which the transactions
are reported. The major effects are these: (i) the automobile contracts are
shown as assets on our balance sheet; (ii) the debt issued in the transactions
is shown as indebtedness; (iii) cash deposited in the spread accounts to enhance
the credit of the securitization transactions is shown as "Restricted cash and
equivalents" on our balance sheet; (iv) cash collected from automobile
purchasers and other sources related to the automobile contracts prior to making
the required payments under the securitization agreements is also shown as
"Restricted cash and equivalents" on our balance sheet; (v) the servicing fee
that we receive in connection with such contracts is recorded as a portion of
the interest earned on such contracts in our statements of operations; (vi) we
have initially and periodically recorded as expense a provision for estimated
credit losses on the contracts in our statements of operations; and (vii)
portions of scheduled payments on the contracts and on the debt issued in the
transactions representing interest are recorded as interest income and expense,
respectively, in our statements of operations.
These changes collectively represent a deferral of revenue and acceleration of
expenses, and thus a more conservative approach to accounting for our operations
compared to the previous securitization transactions, which were accounted for
as sales at the consummation of the transaction. As a result of the changes, we
initially reported lower earnings than we would have reported if we had
continued to structure our transactions to require recognition of gain on sale.
It should also be noted that growth in our portfolio of receivables resulted in
an increase in expenses in the form of provision for credit losses, and
initially had a negative effect on net earnings. Our cash availability and cash
requirements should be unaffected by the change in structure.
16
Since the third quarter of 2003, we have conducted 16 term securitizations. Of
these 16, 12 were quarterly securitizations of automobile contracts that we
purchased from automobile dealers under our regular programs. In addition, in
March 2004 and November 2005, we completed securitizations of our retained
interests in other securitizations that we and our affiliates previously
sponsored. We repaid the debt from the March 2004 transaction in August 2005.
Also, in June 2004, we completed a securitization of automobile contracts
purchased in the SeaWest asset acquisition and under our TFC programs. Further,
in December 2005, we completed a securitization that included automobile
contracts purchased under the TFC programs, automobile contracts purchased under
the CPS programs and automobile contracts we repurchased upon termination of
prior securitizations of our MFN and TFC subsidiaries. All such securitizations
since the third quarter of 2003 have been structured as secured financings.
COMPARISON OF OPERATING RESULTS FOR THE THREE MONTHS ENDED JUNE 30, 2006 WITH
THE THREE MONTHS ENDED JUNE 30, 2005
REVENUES. During the three months ended June 30, 2006, revenues were $67.2
million, an increase of $19.5 million, or 40.7%, from the prior year period
revenue of $47.8 million. The primary reason for the increase in revenues is an
increase in interest income. Interest income for the three months ended June 30,
2006 increased $22.5 million, or 55.6%, to $63.0 million from $40.5 million in
the prior year period. The primary reason for the increase in interest income is
the increase in finance receivables held by consolidated subsidiaries (resulting
in an increase of $26.1 million in interest income). This increase was partially
offset by the decline in the balance of the portfolios of automobile contracts
we acquired in the MFN, TFC and SeaWest transactions (in the aggregate,
resulting in a decrease of $3.3 million in interest income) and a decrease of
$274,000 in interest earned on our residual asset.
Servicing fees totaling $799,000 in the three months ended June 30, 2006
decreased $996,000, or 55.5%, from $1.8 million in the same period a year
earlier. The decrease in servicing fees is the result of the change in
securitization structure and the decline in our managed portfolio held by
non-consolidated subsidiaries, and also by the decline in the Seawest Third
Party Portfolio. As a result of the decision to structure future securitizations
as secured financings, our managed portfolio held by non-consolidated
subsidiaries will continue to decline in future periods, and servicing fee
revenue is anticipated to decline proportionately. As of June 30, 2006 and 2005,
our managed portfolio owned by consolidated vs. non-consolidated subsidiaries
and other third parties was as follows:
JUNE 30, 2006 JUNE 30, 2005
------------------------- ------------------------
AMOUNT % AMOUNT %
---------- ---------- --------- ----------
Total Managed Portfolio ($ IN MILLIONS)
Owned by Consolidated Subsidiaries $ 1,299.4 94.5% $ 772.6 80.0%
Owned by Non-Consolidated Subsidiaries 67.2 4.9% 162.3 16.8%
SeaWest Third Party Portfolio 8.7 0.6% 31.3 3.2%
---------- ---------- --------- ----------
Total $ 1,375.3 100.0% $ 966.2 100.0%
========== ========== ========= ==========
At June 30, 2006, we were generating income and fees on a managed portfolio with
an outstanding principal balance of $1,375.3 million (this amount includes $8.7
million of automobile contracts securitized by SeaWest, on which we earn only
servicing fees), compared to a managed portfolio with an outstanding principal
balance of $966.2 million as of June 30, 2005. As the portfolios of automobile
contracts acquired in the MFN, TFC and SeaWest transactions decrease, the
portfolio of automobile contracts that we purchased directly from automobile
dealers continues to expand. At June 30, 2006 and 2005, the managed portfolio
composition was as follows:
17
JUNE 30, 2006 JUNE 30, 2005
------------------------- ---------------------------
AMOUNT % AMOUNT %
---------- ---------- ------------ ----------
ORIGINATING ENTITY ($ IN MILLIONS)
CPS $ 1,295.0 94.2% $ 824.4 85.3%
TFC 62.5 4.5% 78.6 8.1%
MFN 0.7 0.1% 7.0 0.7%
SeaWest 8.4 0.6% 24.9 2.6%
SeaWest Third Party Portfolio 8.7 0.6% 31.3 3.2%
---------- ---------- ------------ ----------
Total $ 1,375.3 100.0% $ 966.2 100.0%
========== ========== ============ ==========
Other income decreased $2.1 million, or 37.8%, to $3.4 million in the
three-month period ended June 30, 2006 from $5.5 million during the same period
a year earlier. The prior year period included proceeds of $2.4 million for the
sale of certain receivables that consisted primarily of charged off receivables
acquired in the MFN, TFC and the SeaWest transactions. The period over period
decrease was also affected by decreased revenue on our direct mail services (a
decrease of $172,000). These direct mail services are provided to our dealers
and consist of customized solicitations targeted to prospective vehicle
purchasers, in proximity to the dealer, who appear to meet our credit criteria.
Decreases in other income for the period were somewhat offset by increases in
convenience fees charged to obligors for certain transaction types (an increase
of $209,000) and increases in recoveries on MFN and certain other automobile
contracts (an increase of $257,000) compared to the same period of the prior
year.
EXPENSES. Our operating expenses consist primarily of provisions for credit
losses, interest expense, employee costs and general and administrative
expenses. Provisions for credit losses and interest expense are significantly
affected by the volume of automobile contracts we purchased during a period and
by the outstanding balance of finance receivables held by consolidated
subsidiaries. Employee costs and general and administrative expenses are
incurred as applications and automobile contracts are received, processed and
serviced. Factors that affect margins and net income include changes in the
automobile and automobile finance market environments, and macroeconomic factors
such as interest rates and the unemployment level.
Employee costs include base salaries, commissions and bonuses paid to employees,
and certain expenses related to the accounting treatment of outstanding warrants
and stock options, and are one of our most significant operating expenses. These
costs (other than those relating to stock options) generally fluctuate with the
level of applications and automobile contracts processed and serviced.
Other operating expenses consist primarily of facilities expenses, telephone and
other communication services, credit services, computer services (including
employee costs associated with information technology support), professional
services, marketing and advertising expenses, and depreciation and amortization.
Total operating expenses were $64.6 million for the three months ended June 30,
2006, compared to $47.2 million for the same period a year earlier, an increase
of $17.4 million, or 36.9%. The increase is primarily due to increases in
provision for credit losses and interest expense, which increased by $7.0
million and $10.4 million, or 45.7% and 86.7% respectively. Both interest
expense and provision for credit losses are directly affected by the growth in
our portfolio of automobile contracts held by consolidated affiliates.
Employee costs for the three months ended June 30, 2006 remained essentially the
same as the prior year period at $9.7 million, representing 15.0% of total
operating expenses in 2006 compared to 20.5% of total operating expenses in the
prior year period. During the period ended June 30, 2006, we deferred $727,000
of direct employee costs associated with the purchase of automobile contracts in
the period, in accordance with Statement of Financial Accounting Standard No.
91, Accounting for Nonrefundable Fees and Costs Associated with Originating or
Acquiring Loans and Initial Direct Costs of Leases ("SFAS 91"). Historically, we
have not deferred and amortized such costs as our analyses indicated that the
effect of such deferral and amortization would not have been material. However,
due to continued increases in volumes of automobile contract purchases and
refinements in our methodology to measure direct costs associated with
automobile contract purchases, our estimate of direct costs has increased,
resulting in the need to defer such costs and amortize them over the lives of
the related automobile contracts as an adjustment to the yield in accordance
with SFAS 91. The decrease as a percentage of total operating expenses reflects
the higher total of operating expenses, primarily a result of the increased
provision for credit losses and interest expense.
18
General and administrative expenses decreased by $949,000, or 14.3%, to $5.7
million and represented 8.8% of total operating expenses in the three-month
period ending June 30, 2006, as compared to $6.6 million in the prior year
period when general and administrative expenses represented 14.0% of total
operating expenses. In the prior year period we recognized what we believe will
be a one-time, non-cash impairment charge of $1.9 million against certain
non-auto finance receivable assets. The decrease as a percentage of total
operating expenses reflects the higher operating expenses primarily a result of
the provision for credit losses and interest expense.
Interest expense for the three-month period ended June 30, 2006 increased $10.4
million, or 86.7%, to $22.3 million, compared to $11.9 million in the same
period of the previous year. The increase is primarily the result of changes in
the amount and composition of securitization trust debt carried on our
consolidated balance sheet. Such debt increased as a result of the change in
securitization structure implemented in the third quarter of 2003 (resulting in
an increase of $11.8 million in interest expense), partially offset by the
decrease in the balance of the securitization trust debt acquired in the MFN and
TFC transactions (resulting in a decrease of $312,000 in interest expense) and a
decrease in interest expense on certain long-term debt (a decrease of $1.1
million).
Marketing expenses increased by $907,000, or 33.9%, to $3.6 million, compared to
$2.7 million in the same period of the previous year and represented 5.6% of
total operating expenses. The increase is primarily due to the increase in
automobile contracts we purchased during the three months ended June 30, 2006 as
compared to the prior year period. During the period ended June 30, 2006, we
purchased 17,399 automobile contracts aggregating $268.8 million, compared to
10,479 automobile contracts aggregating $153.9 million in the same period of the
prior year.
Occupancy expenses increased by $92,000, or 10.8%, to $942,000 compared to
$850,000 in the same period of the previous year and represented 1.5% of total
operating expenses.
Depreciation and amortization expenses decreased by $3,000, or 1.5%, to $199,000
from $202,000 in the same period of the previous year.
COMPARISON OF OPERATING RESULTS FOR THE SIX MONTHS ENDED JUNE 30, 2006 WITH THE
SIX MONTHS ENDED JUNE 30, 2005
REVENUES. During the six months ended June 30, 2006, revenues were $125.3
million, an increase of $35.7 million, or 39.8%, from the prior year period
revenue of $89.6 million. The primary reason for the increase in revenues is an
increase in interest income. Interest income for the six months ended June 30,
2006 increased $40.9 million, or 53.3%, to $117.6 million from $76.7 million in
the prior year period. The primary reason for the increase in interest income is
the increase in finance receivables held by consolidated subsidiaries (resulting
in an increase of $48.6 million in interest income). This increase was partially
offset by the decline in the balance of the portfolios of automobile contracts
we acquired in the MFN, TFC and SeaWest transactions (in the aggregate,
resulting in a decrease of $6.7 million in interest income) and a decrease of
$996,000 in interest earned on our residual asset.
Servicing fees totaling $1.8 million in the six months ended June 30, 2006
decreased $2.3, or 55.6%, from $4.1 million in the same period a year earlier.
The decrease in servicing fees is the result of the change in securitization
structure and the consequent decline in our managed portfolio held by
non-consolidated subsidiaries. As a result of the decision to structure future
securitizations as secured financings, our managed portfolio held by
non-consolidated subsidiaries will continue to decline in future periods, and
servicing fee revenue is anticipated to decline proportionately.
Other income decreased $3.0 million, or 33.5%, to $5.9 million in the six-month
period ended June 30, 2006 from $8.9 million during the same period a year
earlier. The prior year period included proceeds of $2.4 million for the sale of
certain receivables that consisted primarily of charged off receivables acquired
in the MFN,TFC and SeaWest transactions. The period over period decrease was
also affected by decreased revenue on our direct mail services (a decrease of
$512,000). These direct mail services are provided to our dealers and consist of
customized solicitations targeted to prospective vehicle purchasers, in
proximity to the dealer, who appear to meet our credit criteria. Decreases in
other income for the period were also affected by increases in convenience fees
charged to obligors for certain transaction types (an increase of $436,000) and
decreases in recoveries on MFN and certain other automobile contracts (a
decrease of $424,000) compared to the same period of the prior year.
19
EXPENSES. Total operating expenses were $120.8 million for the six months ended
June 30, 2006, compared to $89.3 million for the same period a year earlier, an
increase of $31.5 million, or 35.3%. The increase is primarily due to increases
in provision for credit losses and interest expense, which increased by $13.7
million and $18.0 million, or 49.9% and 80.6% respectively. Both interest
expense and provision for credit losses are directly affected by the growth in
our portfolio of automobile contracts held by consolidated affiliates.
Employee costs for the six months ended June 30, 2006 decreased by $1.1 million,
or 5.3%, to $19.1 million and represented 15.8% of total operating expenses,
compared to $20.2 million representing 22.6% of total operating expenses in the
prior year period. During the period ended June 30, 2006, we deferred $1.8
million of direct employee costs associated with the purchase of automobile
contracts in the period, in accordance with Statement of Financial Accounting
Standard No. 91, Accounting for Nonrefundable Fees and Costs Associated with
Originating or Acquiring Loans and Initial Direct Costs of Leases ("SFAS 91").
Historically, we have not deferred and amortized such costs as our analyses
indicated that the effect of such deferral and amortization would not have been
material. However, due to continued increases in volumes of automobile contract
purchases and refinements in our methodology to measure direct costs associated
with automobile contract purchases, our estimate of direct costs has increased,
resulting in the need to defer such costs and amortize them over the lives of
the related automobile contracts as an adjustment to the yield in accordance
with SFAS 91. The decrease as a percentage of total operating expenses reflects
the higher total of operating expenses, primarily a result of the increased
provision for credit losses and interest expense.
General and administrative expenses decreased by $977,000, or 8.3%, to $10.8
million and represented 8.9% of total operating expenses in the six-month period
ending June 30, 2006, as compared to $11.8 million in the prior year period when
general and administrative expenses represented 13.2% of total operating
expenses. In the prior year period we recognized what we believe will be a
one-time, non-cash impairment charge of $1.9 million against certain non-auto
finance receivable assets. 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 six-month period ended June 30, 2006 increased $18.0
million, or 80.6%, to $40.3 million, compared to $22.3 million in the same
period of the previous year. The increase is primarily the result of changes in
the amount and composition of securitization trust debt carried on our
consolidated balance sheet. Such debt increased as a result of the change in
securitization structure implemented in the third quarter of 2003 (resulting in
an increase of $20.8 million in interest expense), partially offset by the
decrease in the balance of the securitization trust debt acquired in the MFN and
TFC transactions (resulting in a decrease of $556,000 in interest expense) and a
decrease in interest expense on certain long-term debt (a decrease of $2.2
million).
Marketing expenses increased by $1.6 million, or 30.0%, to $7.1 million,
compared to $5.5 million in the same period of the previous year and represented
5.9% of total operating expenses. The increase is primarily due to the increase
in automobile contracts we purchased during the six months ended June 30, 2006
as compared to the prior year period. During the period ended June 30, 2006, we
purchased 34,352 automobile contracts aggregating $523.2 million, compared to
20,591 automobile contracts aggregating $298.1 million in the same period of the
prior year.
Occupancy expenses increased by $213,000, or 13.1%, to $1.8 million compared to
$1.6 million in the same period of the previous year and represented 1.5% of
total operating expenses.
Depreciation and amortization expenses decreased by $16,000, or 3.9%, to
$392,000 from $408,000 in the same period of the previous year.
20
CREDIT EXPERIENCE
Our financial results are dependent on the performance of the automobile
contracts in which we retain an ownership interest. The table below documents
the delinquency, repossession and net credit loss experience of all automobile
contracts that we were servicing (excluding automobile contracts from the
SeaWest Third Party Portfolio) as of the respective dates shown. Credit
experience for CPS, MFN (since the date of the MFN transaction), TFC (since the
date of the TFC transaction) and SeaWest (since the date of the SeaWest
transaction) is shown on a combined basis in the table below. We attribute the
decrease in delinquencies and charge offs during the six-month period ended June
30, 2006 (compared to the 12-month period ended December 31, 2005) to normal
seasonality of our business and also to the increase in the average servicing
portfolio outstanding as of June 30, 2006 compared to December 31, 2005.
DELINQUENCY EXPERIENCE (1)
CPS, MFN, TFC AND SEAWEST COMBINED
JUNE 30, 2006 JUNE 30, 2005 DECEMBER 31, 2005
----------------------- ------------------------ ----------------------
NUMBER OF NUMBER OF NUMBER OF
CONTRACTS AMOUNT CONTRACTS AMOUNT CONTRACTS AMOUNT
---------- ---------- --------- ---------- --------- ----------
DELINQUENCY EXPERIENCE (DOLLARS IN THOUSANDS)
Gross servicing portfolio (1) 112,916 $1,375,562 85,768 $ 957,979 95,942 $1,117,085
Period of delinquency (2)
31-60 days 2,272 24,167 1,757 16,824 2,353 24,050
61-90 days 960 9,451 881 7,658 1,076 10,190
91+ days 588 4,779 673 4,958 1,056 7,985
---------- ---------- --------- ---------- --------- ----------
Total delinquencies (2) 3,820 38,397 3,311 29,440 4,485 42,225
Amount in repossession (3) 1,254 13,902 958 9,489 1,337 13,538
---------- ---------- --------- ---------- --------- ----------
Total delinquencies and amount in repossession (2) 5,074 $ 52,299 4,269 $ 38,929 5,822 $ 55,763
======= ========== ====== ========== ====== ==========
Delinquencies as a percentage of gross servicing portfolio 3.4% 2.8% 3.9% 3.1% 4.7% 3.8%
Total delinquencies and amount in repossession as a
percentage of gross servicing portfolio 4.5% 3.8% 5.0% 4.1% 6.1% 5.0%
(1) ALL AMOUNTS AND PERCENTAGES ARE BASED ON THE AMOUNT REMAINING TO BE REPAID
ON EACH AUTOMOBILE CONTRACT, INCLUDING, FOR PRE-COMPUTED AUTOMOBILE CONTRACTS,
ANY UNEARNED INTEREST. THE INFORMATION IN THE TABLE REPRESENTS THE GROSS
PRINCIPAL AMOUNT OF ALL AUTOMOBILE CONTRACTS PURCHASED BY US, INCLUDING
AUTOMOBILE CONTRACTS SUBSEQUENTLY SOLD BY US IN SECURITIZATION TRANSACTIONS THAT
WE CONTINUE TO SERVICE. THE TABLE DOES NOT INCLUDE AUTOMOBILE CONTRACTS FROM THE
SEAWEST THIRD PARTY PORTFOLIO.
(2) WE CONSIDER A AUTOMOBILE CONTRACT DELINQUENT WHEN AN OBLIGOR FAILS TO MAKE
AT LEAST 90% OF A CONTRACTUALLY DUE PAYMENT BY THE FOLLOWING DUE DATE, WHICH
DATE MAY HAVE BEEN EXTENDED WITHIN LIMITS SPECIFIED IN THE SERVICING AGREEMENTS.
THE PERIOD OF DELINQUENCY IS BASED ON THE NUMBER OF DAYS PAYMENTS ARE
CONTRACTUALLY PAST DUE. AUTOMOBILE CONTRACTS LESS THAN 31 DAYS DELINQUENT ARE
NOT INCLUDED.
(3) AMOUNT IN REPOSSESSION REPRESENTS FINANCED VEHICLES THAT HAVE BEEN
REPOSSESSED BUT NOT YET LIQUIDATED.
21
NET CHARGE-OFF EXPERIENCE (1)
CPS, MFN, TFC AND SEAWEST COMBINED
JUNE 30, JUNE 30, DECEMBER 31,
2006 2005 2005
---------- ------------- -------------
(DOLLARS IN THOUSANDS)
Average servicing portfolio outstanding $1,247,365 $ 894,045 $ 966,295
Annualized net charge-offs as a percentage of
average servicing portfolio (2) 3.7% 5.0% 5.3%
- -------------------------
(1) ALL AMOUNTS AND PERCENTAGES ARE BASED ON THE PRINCIPAL AMOUNT SCHEDULED TO
BE PAID ON EACH AUTOMOBILE CONTRACT, NET OF UNEARNED INCOME ON PRE-COMPUTED
AUTOMOBILE CONTRACTS. THE INFORMATION IN THE TABLE REPRESENTS ALL AUTOMOBILE
CONTRACTS SERVICED BY US (EXCLUDING AUTOMOBILE CONTRACTS FROM THE SEAWEST THIRD
PARTY PORTFOLIO).
(2) NET CHARGE-OFFS INCLUDE THE REMAINING PRINCIPAL BALANCE, AFTER THE
APPLICATION OF THE NET PROCEEDS FROM THE LIQUIDATION OF THE VEHICLE (EXCLUDING
ACCRUED AND UNPAID INTEREST) AND AMOUNTS COLLECTED SUBSEQUENT TO THE DATE OF
CHARGE-OFF. JUNE 30, 2006 AND JUNE 30, 2005 PERCENTAGE REPRESENTS SIX MONTHS
ENDED JUNE 30, 2006 AND JUNE 30, 2005 ANNUALIZED. DECEMBER 31, 2005 REPRESENTS
12 MONTHS ENDED DECEMBER 31, 2005.
LIQUIDITY AND CAPITAL RESOURCES
Our business requires substantial cash to support our purchases of automobile
contracts and other operating activities. Our primary sources of cash have been
cash flows from operating activities, including proceeds from sales of
automobile contracts, amounts borrowed under various revolving credit facilities
(also sometimes known as warehouse credit facilities), servicing fees on
portfolios of automobile contracts previously sold in securitization
transactions or serviced for third parties, customer payments of principal and
interest on finance receivables, and releases of cash from securitized pools of
automobile contracts in which we have retained a residual ownership interest and
from the spread account associated with such pools. Our primary uses of cash
have been the purchases of automobile contracts, repayment of amounts borrowed
under lines of credit and otherwise, operating expenses such as employee,
interest, occupancy expenses and other general and administrative expenses, the
establishment of spread account and initial overcollateralization, if any, and
the increase of credit enhancement to required levels in securitization
transactions, and income taxes. There can be no assurance that internally
generated cash will be sufficient to meet our cash demands. The sufficiency of
internally generated cash will depend on the performance of securitized pools
(which determines the level of releases from those pools and their related
spread account), the rate of expansion or contraction in our managed portfolio,
and the terms upon which we are able to acquire, sell, and borrow against
automobile contracts.
Net cash used in operating activities for the six-month period ended June 30,
2006 was $10.6 million compared to net cash provided by operating activities for
the six-month period ended June 30, 2005 of $21.1 million. Cash used in
operating activities is affected by the increase in restricted cash as a result
of our pre-funding structure used in the securitization of our finance
receivables. The pre-funding structure allows us to issue securitization debt
approximately one month prior to purchasing finance receivables that
collateralize the debt. In those cases, certain of the proceeds of the
securitization debt are held as restricted cash until such time as the
additional collateral is delivered to the related trust. Increases in restricted
cash are offset somewhat by our increased net earnings before the significant
increase in the provision for credit losses.
Net cash used in investing activities for the six-month periods ended June 30,
2006 and 2005 was $314.0 million and $165.8 million, respectively. Cash used in
investing activities has generally related to purchases of automobile contracts.
Net cash provided by financing activities for the six months ended June 30, 2006
and 2005, was $318.8 million and $146.1 million, respectively. Cash provided by
financing activities is generally related to the issuance of new securitization
trust debt. We issued $538.5 million and $262.7 million of such debt in the
six-month periods ended June 30, 2006 and 2005, respectively. Cash used in
financing activities includes the repayment of securitization trust debt of
$215.3 million and $114.2 million for the six-month periods ended June 30, 2006
and 2005, respectively.
22
We purchase automobile contracts from Dealers for a cash price approximating
their principal amount, adjusted for an acquisition fee that may either increase
or decrease the automobile contract purchase price. Those automobile contracts
generate cash flow, however, over a period of years. As a result, we have been
dependent on warehouse credit facilities to purchase automobile contracts, and
on the availability of cash from outside sources in order to finance our
continuing operations, as well as to fund the portion of automobile contract
purchase prices not financed under revolving warehouse credit facilities. As of
June 30, 2006, we had $350 million in warehouse credit capacity, in the form of
separate $200 million and $150 million facilities. The first facility provides
funding for automobile contracts purchased under the TFC Programs while both
warehouse facilities provide funding for automobile contracts purchased under
the CPS Programs.
The $150 million warehouse facility is structured to allow us to fund a portion
of the purchase price of automobile contracts by drawing against a floating rate
variable funding note issued by our consolidated subsidiary Page Three Funding
LLC. This facility was established on November 15, 2005, and expires on November
14, 2006, although it is renewable with the mutual agreement of the parties. Up
to 80% of the principal balance of automobile contracts may be advanced to us
under this facility, subject to collateral tests and certain other conditions
and covenants. Notes under this facility accrue interest at a rate of one-month
LIBOR plus 2.00% per annum. At June 30, 2006, $44.7 million was outstanding
under this facility.
The $200 million warehouse facility is similarly structured to allow us to fund
a portion of the purchase price of automobile contracts by drawing against a
floating rate variable funding note issued by our consolidated subsidiary Page
Funding LLC. This facility was entered into on June 30, 2004. On June 29, 2005
the facility was increased from $100 million to $125 million and further amended
to provide for funding for automobile contracts purchased under the TFC
Programs. It was increased again to $200 million on August 31, 2005. Up to 83.0%
of the principal balance of automobile contracts may be advanced to us under
this facility, subject to collateral tests and certain other conditions and
covenants. Notes under this facility accrue interest at a rate of one-month
LIBOR plus 2.00% per annum. This facility expires on June 30, 2007, although it
is renewable with the mutual agreement of the parties. At June 30, 2006, $14.7
million was outstanding under this facility.
For the portfolio owned by consolidated subsidiaries, cash used to establish or
increase the spread accounts for the six-month periods ended June 30, 2006 and
2005 was $14.0 million and $5.9 million, respectively. Cash released from Trusts
and their related spread account to us for the six-month periods ended June 30,
2006 and 2005, was $7.6 million and $13.6 million, respectively. Changes in the
amount of credit enhancement required for term securitization transactions and
releases from Trusts and their related spread account are affected by the
relative size, seasoning and performance of the various pools of automobile
contracts securitized that make up our managed portfolio to which the respective
spread account is related.
The acquisition of automobile contracts for subsequent sale in securitization
transactions, and the need to fund the spread accounts and initial
overcollateralization, if any, and increase credit enhancement levels when those
transactions take place, results in a continuing need for capital. The amount of
capital required is most heavily dependent on the rate of our automobile
contract purchases, the advance rate on the warehouse facilities, the required
level of initial credit enhancement in securitizations, and the extent to which
the previously established Trusts and their related spread account either
release cash to us or capture cash from collections on securitized automobile
contracts. We are limited in our ability to purchase automobile contracts by our
available cash and the capacity of our warehouse facilities. As of June 30,
2006, we had unrestricted cash on hand of $11.9 million and available capacity
from our warehouse credit facilities of $290.7 million, subject to the
availability of suitable automobile contracts to serve as collateral and of
sufficient cash to fund the portion of such automobile contracts purchase price
not advanced under the warehouse facilities. Our plans to manage our liquidity
include the completion of additional term securitizations that may result in
additional unrestricted cash through repayment of the warehouse facilities, and
matching our levels of automobile contract purchases to our availability of
cash. There can be no assurance that we will be able to complete term
securitizations on favorable economic terms or that we will be able to complete
term securitizations at all. If we are unable to complete such securitizations,
interest income and other portfolio related income would decrease.
23
Our primary means of ensuring that our cash demands do not exceed our cash
resources is to match our levels of automobile contract purchases to our
availability of cash. Our ability to adjust the quantity of automobile contracts
that 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 automobile contract acquisition
can be maintained or increased. While the specific terms and mechanics of each
Spread Account vary among transactions, our Securitization Agreements generally
provide that we will receive excess cash flows only if the amount of credit
enhancement has reached specified levels and/or the delinquency, defaults or net
losses related to the automobile contracts in the pool are below certain
predetermined levels. In the event delinquencies, defaults or net losses on the
automobile contracts exceed such levels, the terms of the securitization: (i)
may require increased credit enhancement to be accumulated for the particular
pool; (ii) may restrict the distribution to us of excess cash flows associated
with other pools; or (iii) in certain circumstances, may permit the Note
Insurers to require the transfer of servicing on some or all of the automobile
contracts to another servicer. There can be no assurance that collections from
the related Trusts will continue to generate sufficient cash.
The terms of the various Securitization Agreements related to the issuance of
the securitization trust debt and the warehouse credit facilities require that
certain delinquency and credit loss criteria be met with respect to the
collateral pool, and require that we maintain minimum levels of liquidity and
net worth and not exceed maximum leverage levels and maximum financial losses.
In addition, certain securitization and non-securitization related debt contain
cross-default provisions, which would allow certain creditors to declare a
default if a default were declared under a different facility. As of June 30,
2006, we were in compliance with all such financial covenants.
The Securitization Agreements of our term securitization transactions are
terminable by the Note Insurers in the event of certain defaults by us and under
certain other circumstances. Similar termination rights are held by the lenders
in the warehouse credit facilities. Were a Note Insurer (or the lenders in such
warehouse facilities) in the future to exercise its option to terminate the
Securitization Agreements, such a termination would have a material adverse
effect on our liquidity and results of operations. We continue to receive
Servicer extensions on a monthly and/or quarterly basis, pursuant to the
Securitization Agreements.
CRITICAL ACCOUNTING POLICIES
(A) ALLOWANCE FOR FINANCE CREDIT LOSSES
In order to estimate an appropriate allowance for losses incurred on finance
receivables held on our Unaudited Condensed Consolidated Balance Sheet, we use a
loss allowance methodology commonly referred to as "static pooling," which
stratifies our finance receivable portfolio into separately identified pools.
Using analytical and formula-driven techniques, we estimate an allowance for
finance credit losses, which management believes is adequate for probable credit
losses that can be reasonably estimated in our portfolio of finance receivable
automobile contracts. Provision for losses is charged to our Unaudited
Consolidated Statement of Operations. Net losses incurred on finance receivables
are charged to the allowance. Management evaluates the adequacy of the allowance
by examining current delinquencies, the characteristics of the portfolio and the
value of the underlying collateral. As conditions change, our level of
provisioning and/or allowance may change as well.
(B) TREATMENT OF SECURITIZATIONS
Gain on sale may be recognized on the disposition of automobile contracts either
outright or in securitization transactions. In those securitization transactions
that were treated as sales for financial accounting purposes, we, or a
wholly-owned, consolidated subsidiary of us, retained a residual interest in the
automobile contracts that were sold to a wholly-owned, unconsolidated special
purpose subsidiary. Our securitization transactions included "term"
securitizations (the purchaser holds the automobile contracts for substantially
their entire term) and "warehouse" securitizations (which financed the
acquisition of the automobile contracts for future sale into term
securitizations).
24
As of June 30, 2006 and December 31, 2005 the line item "Residual interest in
securitizations" on our Unaudited Consolidated Balance Sheet represents the
residual interests in certain term securitizations that were accounted for as
sales. Warehouse securitizations accounted for as secured financings are
accordingly reflected in the line items "Finance receivables" and "Warehouse
lines of credit" on our Unaudited Condensed Consolidated Balance Sheet, and the
term securitizations accounted for as secured financings are reflected in the
line items "Finance receivables" and "Securitization trust debt." The "Residual
interest in securitizations" represents the discounted sum of expected future
releases from securitization trusts held by non-consolidated subsidiaries.
Accordingly, the valuation of the residual is heavily dependent on estimates of
future performance.
(C) INCOME TAXES
We and our subsidiaries file consolidated federal income and combined state
franchise tax returns. We utilize the asset and liability method of accounting
for income taxes, under which deferred income taxes are recognized for the
future tax consequences attributable to the differences between the financial
statement values of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred
taxes of a change in tax rates is recognized in income in the period that
includes the enactment date. We have estimated a valuation allowance against
that portion of the deferred tax asset whose utilization in future periods is
not more than likely.
In determining the possible realization of deferred tax assets, future taxable
income from the following sources are considered: (a) the reversal of taxable
temporary differences; (b) future operations exclusive of reversing temporary
differences; and (c) tax planning strategies that, if necessary, would be
implemented to accelerate taxable income into periods in which net operating
losses might otherwise expire.
(D) STOCK-BASED COMPENSATION
Effective January 1, 2006, we adopted Statement of Financial Accounting
Standards No. 123(R), "Share-Based Payment, revised 2004" ("SFAS 123R"),
prospectively for all option awards granted, modified or settled on or after
January 1, 2006, using the modified prospective method. Under this method, we
recognize compensation costs in the financial statements for all share-based
payments granted subsequent to December 31, 2005 based on the grant date fair
value estimated in accordance with the provisions of SFAS 123(R). Results for
prior periods have not been restated.
In December 2005, the Compensation Committee of the Board of Directors approved
accelerated vesting of all the outstanding stock options issued by us. Options
to purchase 2,113,998 shares of our common stock, which would otherwise have
vested from time to time through 2010, became immediately exercisable as a
result of the acceleration of vesting. The decision to accelerate the vesting of
the options was made primarily to reduce non-cash compensation expenses that
would have been recorded in our income statement in future periods upon the
adoption of Financial Accounting Standards Board Statement No. 123(R) in January
2006.
For the six months ended June 30, 2006, we recorded no stock-based compensation
costs. There were no option awards granted during the six-month period ended
June 30, 2006, and there was no vesting of option awards for options granted
prior to January 1, 2006, because all options outstanding as of December 31,
2005 were fully vested at that time. As of June 30, 2006, there are no
unrecognized stock-based compensation costs to be recognized over future
periods.
Prior to January 1, 2006, as was permitted by Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"),
we accounted for stock-based employee compensation plans in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" and related interpretations, whereby stock options are recorded at
intrinsic value equal to the excess of the share price over the exercise price
at the date of grant. We provided the pro forma net income (loss), pro forma
earnings (loss) per share, and stock based compensation plan disclosure
requirements set forth in SFAS No. 123.
25
FORWARD LOOKING STATEMENTS
This report on Form 10-Q includes certain "forward-looking statements,"
including, without limitation, the statements or implications to the effect that
prepayments as a percentage of original balances will approximate 22.3% to 35.0%
cumulatively over the lives of the related automobile contracts, and that net
credit losses as a percentage of original balances will approximate 11.7% to
19.9% cumulatively over the lives of the related automobile contracts. Other
forward-looking statements may be identified by the use of words such as
"anticipates," "expects," "plans," "estimates," or words of like meaning. As to
the specifically identified forward-looking statements, factors that could
affect charge-offs and recovery rates include changes in the general economic
climate, which could affect the willingness or ability of obligors to pay
pursuant to the terms of automobile contracts, changes in laws respecting
consumer finance, which could affect our ability to enforce rights under
automobile contracts, and changes in the market for used vehicles, which could
affect the levels of recoveries upon sale of repossessed vehicles. Factors that
could affect our revenues in the current year include the levels of cash
releases from existing pools of automobile contracts, which would affect our
ability to purchase automobile contracts, the terms on which we are able to
finance such purchases, the willingness of Dealers to sell automobile contracts
to us on the terms that we offer, and the terms on which we are able to complete
term securitizations once automobile contracts are acquired. Factors that could
affect our expenses in the current year include competitive conditions in the
market for qualified personnel, and interest rates (which affect the rates that
we pay on Notes issued in our securitizations). The statements concerning our
structuring future securitization transactions as secured financings and the
effects of such structures on financial items and on our future profitability
also are forward-looking statements. Any change to the structure of our
securitization transaction could cause such forward-looking statements not to be
accurate. Both the amount of the effect of the change in structure on our
profitability and the duration of the period in which our profitability would be
affected by the change in securitization structure are estimates. The accuracy
of such estimates will be affected by the rate at which we purchase and sell
automobile contracts, any changes in that rate, the credit performance of such
automobile contracts, the financial terms of future securitizations, any changes
in such terms over time, and other factors that generally affect our
profitability.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
We are subject to interest rate risk during the period between when automobile
contracts are purchased from Dealers and when such automobile contracts become
part of a term securitization. Specifically, the interest rates on the warehouse
facilities are adjustable while the interest rates on the automobile contracts
are fixed. Historically, our term securitization facilities have had fixed rates
of interest. To mitigate some of this risk, we have in the past, and intend to
continue to, structure certain of our securitization transactions to include
pre-funding structures, in which the amount of Notes issued exceeds the amount
of automobile contracts initially sold to the Trusts. In pre-funding, the
proceeds from the pre-funded portion are held in an escrow account until we
sells the additional automobile contracts to the Trust in amounts up to the
balance of the pre-funded escrow account. In pre-funded securitizations, we lock
in the borrowing costs with respect to the automobile contracts it subsequently
delivers to the Trust. However, we incur an expense in pre-funded
securitizations equal to the difference between the money market yields earned
on the proceeds held in escrow prior to subsequent delivery of automobile
contracts and the interest rate paid on the Notes outstanding, as to the amount
of which there can be no assurance.
There have been no material changes in market risks since December 31, 2005.
26
ITEM 4. CONTROLS AND PROCEDURES
We maintain a system of internal controls and procedures designed to provide
reasonable assurance as to the reliability of our published financial statements
and other disclosures included in this report. As of the end of the period
covered by this report, we evaluated the effectiveness of the design and
operation of such disclosure controls and procedures. Based upon that
evaluation, the principal executive officer (Charles E. Bradley, Jr.) and the
principal financial officer (Jeffrey P. Fritz) concluded that the disclosure
controls and procedures are effective in recording, processing, summarizing and
reporting, on a timely basis, material information relating to us that is
required to be included in our reports filed under the Securities Exchange Act
of 1934. There have been no significant changes in our internal controls over
financial reporting during our most recently completed fiscal quarter that
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information provided under the caption "Legal Proceedings" in our Annual
Report on Form 10-K for the year ended December 31, 2005, is incorporated herein
by reference. In addition, the reader should be aware of the following:
The Annual Report on Form 10-K disclosed that a purported class action filed in
Alabama state court had been removed to federal bankruptcy court, that the
bankruptcy court had remanded the matter to state court, and that we had
appealed that ruling. The federal district court, in which the appeal was heard,
has since ordered the bankruptcy court to decide whether the plaintiff has
standing to pursue her claims, and, if standing is found, to reconsider its
remand decision. The matter is currently pending before the bankruptcy court.
Although we believe that we have one or more defenses to each of the claims made
in this lawsuit, no discovery has yet been conducted and the case remains in its
earliest stages. Accordingly, there can be no assurance as to its outcome.
We are routinely involved in various legal proceedings resulting from our
consumer finance activities and practices, both continuing and discontinued. We
believe that there are substantive legal defenses to such claims, and intend to
defend them vigorously. There can be no assurance, however, as to the outcome.
ITEM 1A. RISK FACTORS
We remind the reader that risk factors are set forth in Item 1A of our report on
Form 10-K, filed with the U.S. Securities and Exchange Commission on March 13,
2006.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
During the three months ended June 30, 2006, we purchased a total of 100,666
shares of our common stock, as described in the following table:
27
ISSUER PURCHASES OF EQUITY SECURITIES
TOTAL NUMBER OF APPROXIMATE DOLLAR
TOTAL SHARES PURCHASED AS VALUE OF SHARES THAT
NUMBER OF AVERAGE PART OF PUBLICLY MAY YET BE PURCHASED
SHARES PRICE PAID ANNOUNCED PLANS OR UNDER THE PLANS OR
PERIOD (1) PURCHASED PER SHARE PROGRAMS(2) PROGRAMS
----------- ---------- ------------------- --------------------
April 2006 5,965 $ 7.51 5,965 $4,219,606
May 2006 36,628 7.57 36,628 3,936,683
June 2006 58,073 7.04 58,073 3,519,531
----------- ---------- -------------------
100,666 $ 7.26 100,666
=========== ========== ===================
- ------------------------
(1) EACH MONTHLY PERIOD IS THE CALENDAR MONTH.
(2) WE ANNOUNCED IN AUGUST 2000 OUR INTENTION TO PURCHASE UP TO $5 MILLION OF
OUR OUTSTANDING SECURITIES, INCLUSIVE OF ANNUAL $1 MILLION SINKING FUND
REDEMPTIONS ON OUR RISING INTEREST REDEEMABLE SUBORDINATED SECURITIES DUE 2006.
IN OCTOBER 2002, THE JULY 2000 PROGRAM HAVING BEEN EXHAUSTED, OUR BOARD OF
DIRECTORS AUTHORIZED THE PURCHASE OF UP TO AN ADDITIONAL $5 MILLION OF SUCH
SECURITIES. AN ADDITIONAL $5 MILLION WAS LATER AUTHORIZED BY OUR BOARD OF
DIRECTORS IN OCTOBER 2004.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Our annual meeting of shareholders was held on June 15, 2006. At the meeting,
each of the seven nominees to the Board of Directors was elected for a one-year
term by the shareholders, with votes cast as follows:
NOMINEE VOTES FOR VOTES WITHHELD
------- --------- --------------
Charles E. Bradley, Jr. 18,941,808 409,480
E. Bruce Fredrikson 18,941,808 409,480
John E. McConnaughy, Jr. 18,439,859 911,429
John G. Poole 18,786,070 565,218
William B. Roberts 18,443,449 907,839
John C. Warner 18,941,808 409,480
Daniel S. Wood 18,443,449 907,839
The shareholders also approved the three other proposals placed before the
annual meeting. Those proposals were as to ratify the appointment of McGladrey &
Pullen LLP as independent auditors of the Company for the fiscal year ending
December 31, 2006, to approve our 2006 Long-Term Equity Incentive Plan, and to
approve the material terms of our Executive Management Bonus Plan. Votes on the
proposals were cast as follows:
28
Ratification of Approval of our 2006 Approval of the material terms
Selection of Long-Term Equity Incentive of our Executive Management
Independent Auditors Plan Bonus Plan
-------------------- --------------------------- -------------------------------
For 19,196,297 11,289,068 12,173,050
Against 36,926 1,152,179 260,547
Abstain 118,065 988,814 996,464
Broker Non-votes 50,544 5,971,771 5,971,771
ITEM 6. EXHIBITS
The exhibits listed below are filed with this report.
3.2 Bylaws. (incorporated by reference to Exhibit 3.2 to the registrant's
current report on form 8-K filed with the Commission on sugust 8, 2006)
4.1 CPS 2006 Long-Term Equity Incentive Plan, (incorporated by reference to
Appendix A to the registrant's proxy statement filed with the
Commission on May 19, 2006)
4.5.5 Fifth Amendment to the Third Amended and Restated Securities Purchase
Agreement dated as of January 29, 2004, between the registrant and
Levine Leichtman Capital Partners II, L.P.
4.7.1 Amendment to 11.75% Secured Senior Note Due 2006 (Term E Note)
4.8.1 Amendment to 11.75% Secured Senior Note Due 2006(Term F Note)
4.14 Instruments defining the rights of holders of long-term debt of certain
consolidated subsidiaries of the registrant are omitted pursuant to the
exclusion set forth in subdivisions (b)(iv)(iii)(A) and (b)(v) of Item
601 of Regulation S-K (17 CFR 229.601). The registrant agrees to
provide copies of such instruments to the United States Securities and
Exchange Commission upon request.
4.15 Form of Indenture, dated as of June 1, 2006, respecting notes issued by
CPS Auto Receivables Trust 2006-B.
10.5.1 Amendment No. 1, dated as of June 30, 2006, to Second Amended And
Restated Sale And Servicing Agreement dated as of April 18, 2006
31.1 Rule 13a-14(a) Certification of the Chief Executive Officer of the
registrant.
31.2 Rule 13a-14(a) Certification of the Chief Financial Officer of the
registrant.
32 Section 1350 Certifications.*
* These Certifications shall not be deemed "filed" for purposes of
Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise
subject to the liability of that section. These Certifications shall not be
deemed to be incorporated by reference into any filing under the Securities
Act of 1933, as amended, or the Exchange Act, except to the extent that the
registration statement specifically states that such Certifications are
incorporated therein.
29
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
CONSUMER PORTFOLIO SERVICES, INC.
(Registrant)
Date: August 11, 2006
/s/ CHARLES E. BRADLEY, JR.
-------------------------------------------------
Charles E. Bradley, Jr.
PRESIDENT AND CHIEF EXECUTIVE OFFICER
(Principal Executive Officer)
Date: August 11, 2006
/s/ JEFFREY P. FRITZ
-------------------------------------------------
Jeffrey P. Fritz
SENIOR VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
(Principal Financial Officer)
30