-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, LzHZ/5KMlNoCgkg2yMmRKTJuwoBfCBK0Y86VPztPw1kb3MhnnZczlhfxWwXoTxqv grh5jp2def1Pe5ZKny+IJg== 0000950150-99-000185.txt : 19990223 0000950150-99-000185.hdr.sgml : 19990223 ACCESSION NUMBER: 0000950150-99-000185 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 16 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990222 FILER: COMPANY DATA: COMPANY CONFORMED NAME: AAMES FINANCIAL CORP/DE CENTRAL INDEX KEY: 0000879957 STANDARD INDUSTRIAL CLASSIFICATION: LOAN BROKERS [6163] IRS NUMBER: 954340340 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-13660 FILM NUMBER: 99546961 BUSINESS ADDRESS: STREET 1: 350 SOUTH GRAND AVE STREET 2: 52ND FLOOR CITY: LOS ANGELES STATE: CA ZIP: 90071 BUSINESS PHONE: 2132105000 MAIL ADDRESS: STREET 1: 3731 WILSHIRE BLVD 10TH FLOOR CITY: LOS ANGELES STATE: CA ZIP: 90010 10-Q 1 FORM 10-Q 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended December 31, 1998 or [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from _____to _____ COMMISSION FILE NUMBER 0-19604 AAMES FINANCIAL CORPORATION [Exact name of Registrant as specified in its charter] DELAWARE 95-4340340 [State or other jurisdiction of [I.R.S. Employer incorporation or organization] Identification No.]
350 SOUTH GRAND AVENUE, LOS ANGELES, CA 90071-3459 [Address of Registrant's principal executive offices including zip code] (323) 210-5000 [Registrant's telephone number, including area code] NO CHANGES [Former name, former address and former fiscal year, if changed since last report] Indicate by check mark whether the Registrant (1) has 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 ----- ----- At February 3, 1999, Registrant had 31,015,893 shares of common stock outstanding. 2 TABLE OF CONTENTS
ITEM NO. PAGE NO. - -------- -------- PART I - FINANCIAL INFORMATION Item 1 - Financial Statements Condensed Consolidated Balance Sheet at December 31, 1998 and June 30, 1998 (Restated) 3 Condensed Consolidated Statement of Operations for the three and six months ended December 31, 1998 and 1997 (Restated) 4 Condensed Consolidated Statement of Cash Flows for the six months ended December 31, 1998 and 1997 (Restated) 5 Notes to Condensed Consolidated Financial Statements 6-8 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations 9-43 Item 3 - Quantitative and Qualitative Disclosures About Market Risk 43 PART II - OTHER INFORMATION Item 6 - Exhibits and Reports on Form 8-K 44 Signature Page 46
2 3 AAMES FINANCIAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEET (Unaudited)
DECEMBER 31, 1998 JUNE 30, 1998 ----------------- ---------------- (Restated) ASSETS Cash and cash equivalents $ 11,790,000 12,322,000 Loans held for sale, at lower of cost or market 271,324,000 198,202,000 Accounts receivable 48,844,000 51,072,000 Interest-only strips, estimated at fair market value 323,246,000 490,542,000 Mortgage servicing rights, net 34,504,000 32,090,000 Equipment and improvements, net 14,730,000 13,939,000 Prepaid and other 17,210,000 17,020,000 ----------------- ---------------- Total assets $ 721,648,000 815,187,000 ================= ================ LIABILITIES AND STOCKHOLDERS' EQUITY Borrowings $ 306,990,000 286,990,000 Revolving warehouse facilities 249,500,000 141,012,000 Accounts payable and accrued expenses 45,003,000 49,964,000 Income taxes payable 14,792,000 33,170,000 ----------------- ---------------- Total liabilities 616,285,000 511,136,000 ----------------- ---------------- Stockholders' equity: Preferred Stock, par value $.001 per share, 1,000,000 shares authorized; none outstanding - - Common Stock, par value $.001 per share 50,000,000 shares authorized; 31,015,900 and 30,962,600 shares outstanding 31,000 31,000 Additional paid-in capital 250,096,000 249,851,000 Retained earnings (deficit) (144,764,000) 54,169,000 ----------------- ---------------- Total stockholders' equity 105,363,000 304,051,000 ----------------- ---------------- Total liabilities and stockholders' equity $ 721,648,000 815,187,000 ================= ================
See accompanying notes to consolidated financial statements. 3 4 AAMES FINANCIAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS (Unaudited)
Three Months Ended Six Months Ended --------------------------------- ------------------------------- December 31, December 31, December 31, December 31, 1998 1997 1998 1997 --------------- --------------- --------------- -------------- (Restated) (Restated) (Restated) Revenue: Gain on sale of loans $ 8,752,000 35,130,000 28,429,000 66,438,000 Net gain (loss) on valuation of interest-only strips and mortgage servicing rights (191,646,000) 5,726,000 (186,451,000) 10,755,000 Commissions 7,758,000 7,161,000 17,746,000 13,016,000 Loan servicing 11,629,000 10,362,000 20,854,000 20,144,000 Fees and other 9,084,000 11,962,000 22,760,000 24,487,000 -------------- --------------- --------------- -------------- Total revenue including valuation adjustment (154,423,000) 70,341,000 (96,662,000) 134,840,000 -------------- --------------- --------------- -------------- Expenses: Compensation 19,907,000 24,561,000 43,701,000 46,320,000 Production 10,559,000 7,541,000 21,489,000 13,338,000 General and administrative 13,784,000 9,580,000 27,172,000 17,665,000 Interest 9,403,000 10,819,000 22,285,000 20,917,000 -------------- --------------- --------------- -------------- Total expenses 53,653,000 52,501,000 114,647,000 98,240,000 -------------- --------------- --------------- -------------- Income (loss) before income taxes (208,076,000) 17,840,000 (211,309,000) 36,600,000 Provision (benefit) for income taxes (12,331,000) 8,670,000 (13,408,000) 17,497,000 -------------- --------------- --------------- -------------- Net income (loss) $ (195,745,000) 9,170,000 (197,901,000) 19,103,000 ============== =============== =============== ============== Net income (loss) per share: Basic $ (6.31) 0.33 (6.39) 0.69 Diluted (6.27) 0.29 (6.34) 0.59 Dividends per share - 0.03 0.03 0.07 Weighted average number shares outstanding: Basic 31,007,000 27,799,000 30,992,000 27,784,000 ============== =============== =============== ============== Diluted 31,211,000 34,949,000 31,239,000 35,272,000 ============== =============== =============== ==============
See accompanying notes to consolidated financial statements. 4 5 AAMES FINANCIAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF CASH FLOW (Unaudited)
SIX MONTHS ENDED -------------------------------------------- DECEMBER 31, DECEMBER 31, 1998 1997 --------------------- ------------------ (Restated) (Restated) Operating activities: Net income (loss) $ (197,901,000) $ 19,103,000 Adjustments to reconcile net income to net cash used in operating activities: Depreciation and amortization 2,469,000 1,845,000 Gain on sale of loans (35,716,000) (72,564,000) Net loss (gain) on valuation of interest-only strips and mortgage servicing rights 186,451,000 (10,755,000) Amortization (accretion) of interest-only strips 14,386,000 (3,523,000) Mortgage servicing rights originated (6,194,000) (10,664,000) Mortgage servicing rights amortized 5,955,000 4,087,000 Changes in assets and liabilities: Loans originated or purchased (1,275,276,000) (1,138,802,000) Proceeds from sale of loans 1,202,154,000 1,165,928,000 Increased (decrease) in: Accounts receivable 2,228,000 17,762,000 Prepaid and other (190,000) (751,000) Increase in (decrease) in: Accounts payable and accrued expenses (4,961,000) 9,008,000 Income taxes payable (18,378,000) 12,700,000 ---------------------- ------------------ Net cash used in operating activities (124,973,000) (6,626,000) ---------------------- ------------------ Investing activities: Purchases of equipment and property improvements (3,260,000) (1,995,000) --------------------- ------------------ Net cash used in investing activities (3,260,000) (1,995,000) --------------------- ------------------ Financing activities: Proceeds from sale of stock or exercise of options 235,000 244,000 Proceeds from borrowings 20,000,000 -- Net proceeds under revolving warehouse facilities 108,488,000 (8,000,000) Dividends paid (1,022,000) (1,834,000) --------------------- ------------------ Net cash provided by (used in) financing activities 127,701,000 (9,590,000) --------------------- ------------------ Net decrease in cash and cash equivalents (532,000) (18,211,000) Cash and cash equivalents at beginning of period 12,322,000 26,902,000 --------------------- ------------------ Cash and cash equivalents at end of period $ 11,790,000 $ 8,691,000 ===================== ==================
See accompanying notes to consolidated financial statements. 5 6 AAMES FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS NOTE 1: BASIS OF PRESENTATION The condensed consolidated financial statements of Aames Financial Corporation, a Delaware corporation, and its subsidiaries (collectively, the "Company") included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been omitted. The condensed consolidated financial statements include the accounts of the Company and all of its subsidiaries after eliminating all significant intercompany transactions and reflect all normal, recurring adjustments which are, in the opinion of management, necessary to present a fair statement of the results of operations of the Company for the interim periods reported. The results of operations for the Company for the three and six months ended December 31, 1998 are not necessarily indicative of the results expected for the full fiscal year. Additionally, certain amounts related to fiscal year 1998 have been reclassified to conform to the fiscal year 1999 presentation. NOTE 2: RESTATEMENT OF PRIOR PERIOD RESULTS In December 1998, the FASB issued, in question and answer format, "A Guide to Implementation of Statement 125 on Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, Questions and Answers, Second Edition" (the "Special Report"). The Special Report indicates that two methods have arisen in practice for accounting for credit enhancements relating to securitization. These methods are the cash-in method and the cash-out method. The cash-in method treats credit enhancements (pledged loans or cash) as belonging to the Company. As such, these assets are recorded at their face value as of the time they are received by the trust. The cash-out method treats credit enhancements as assets owned by the related securitization trust. As such, these assets are treated as part of the interest-only strips and are recorded at a discounted value for the period between when collected by the trust and released to the Company. The Special Report indicates that if no true market exists for credit enhancement assets, the cash-out method should be used to measure the fair value of credit enhancements. The Company has historically used the cash-in method to account for its interest-only strips. However, during the three months ended December 31, 1998, the Company retroactively changed its practice of measuring and accounting for its interest-only strips to the cash-out 6 7 method in response to the FASB's Special Report and to public comments from the Securities and Exchange Commission released on December 8, 1998. Under the cash-in method previously used by the Company, the assumed discount period for measuring the present value of the interest-only strips ended when the cash flows were received by the securitization trust; and, the initial deposits to overcollateralization accounts were recorded at face value. Under the cash-out method now required by the FASB and Securities and Exchange Commission, the assumed discount period for measuring the present value of the interest-only strips ends when cash, including the return of any initial deposits, is distributed to the Company on an unrestricted basis. The change to the cash-out method results only in a difference in the timing of revenue recognition from a securitization and has no effect on the total cash flows of securitization transactions. While the total amount of revenue recognized over the term of a securitization is the same under either method, the cash-out method results in lower initial gains on the sale of loans due to the longer discount period, and higher subsequent loan servicing revenue resulting from the impact of discounting cash flows. Accordingly, the Company's condensed consolidated results of operations of all periods prior to December 31, 1998 as presented herein have been restated. Results for the three months and six months ended December 31, 1998 also reflect the cash-out method. The Company's financial results for all prior periods will be restated to reflect the cash- out method of accounting and reporting for its interest-only strips. The aggregate pretax amount of this change in accounting is $67.1 million. As used throughout this document, interest-only strips includes overcollateralization amounts. 7 8 The restatement resulted in the following changes to prior financial information (Unaudited. Dollars in thousands, except per share amounts):
Three Six Months Months Ended Ended Year Ended June 30, ------------ ------------- ------------------------------------------------------- December 31, 1997 1998 1997 1996 1995 ----------------------------- ---------- ----------- ------------ ----------- Revenue: Previous $ 76,761 146,103 286,110 238,578 141,840 54,939 As restated 70,341 134,840 266,489 214,531 128,428 48,400 Net income: Previous 13,343 26,424 40,317 17,109 29,791 10,034 As restated 9,170 19,103 27,563 1,478 21,073 5,784 Earnings per share: Basic: Previous 0.48 0.95 1.41 0.65 1.37 0.74 As restated 0.33 0.69 0.97 0.06 0.97 0.43 Diluted: Previous 0.41 0.80 1.23 0.60 1.14 0.74 As restated 0.29 0.59 0.89 0.05 0.82 0.43 Interest-only strips: (end of period) Previous 481,354 481,354 554,161 383,249 173,789 56,960 As restated 426,093 426,093 490,542 339,251 153,838 50,421 Stockholders' equity: (end of period) Previous 293,188 293,188 345,403 268,354 133,429 80,047 As restated 257,268 257,268 304,051 239,755 120,461 75,797
NOTE 3: SUBSIDIARY GUARANTORS In October 1996, the Company completed an offering of its 9.125% Senior Notes due 2003 which were guaranteed by all of the Company's operating subsidiaries, all of which are wholly-owned. The guarantees are joint and several, full, complete and unconditional. There are no restrictions on the ability of such subsidiaries to transfer funds to the Company in the form of cash dividends, loans or advances. The Company is a holding company with limited assets or operations other than its investments in its subsidiaries. Separate financial statements of the guarantors are not presented because the aggregate total assets, net earnings and net equity of such subsidiaries are substantially equivalent to the total assets, net earnings and net equity of the Company on a consolidated basis. NOTE 4: SUBSEQUENT EVENT - ISSUANCE OF PREFERRED STOCK On February 10, 1999, the Company issued 26,704 shares of Series B Convertible Preferred Stock and 49,796 shares of Series C Convertible Preferred Stock to Capital Z Financial Services Fund II, L.P. (and certain investors designated by it) and received in return proceeds of $70.6 million, which were net of $5.9 million of issuance related expenses. 8 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of the financial condition and results of operations of the Company should be read in conjunction with the Company's Condensed Consolidated Financial Statements included in Item 1 of this Form 10-Q. SPECIAL NOTE REGARDING FORWARD-LOOKING INFORMATION This Report contains statements that constitute "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934 and Section 27A of the Securities Act of 1933. The words "expect," "estimate," "anticipate," "predict," "believe," and similar expressions and variations thereof are intended to identify forward-looking statements. Such statements appear in a number of places in this filing and include statements regarding the intent, belief or current expectations of the Company, its directors or officers with respect to, among other things (a) market conditions in the securitization, capital, credit and whole loan markets and their future impact on the Company's operations, (b) trends affecting the Company's liquidity position, including, but not limited to, its access to warehouse and other credit facilities and its ability to effect whole loan sales, (c) the impact of the various cash savings plans and other restructuring strategies being considered by the Company, (d) the Company's on-going efforts in improving its equity position, (e) trends affecting the Company's financial condition and results of operations, (f) the Company's plans to address the Year 2000 problem and (g) the Company's business and liquidity strategies. The stockholders of the Company are cautioned not to put undue reliance on such forward-looking statements. Such forward-looking statements are not guarantees of future performance and involve risks and uncertainties. Actual results may differ materially from those projected in this Report, for the reasons, among others, discussed under the captions, "Overview-Market Conditions," "- Recent Events," and "- Risk Factors." The Company undertakes no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date hereof. Readers should carefully review the factors referred to above and the other documents the Company files from time to time with the Securities and Exchange Commission, including the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1998, the quarterly reports on Form 10-Q filed by the Company during the remainder of fiscal 1999, and any current reports on Form 8-K filed by the Company. RECENT EVENTS On December 23, 1998 the Company entered into a Preferred Stock Purchase Agreement (the "Stock Purchase Agreement") with Capital Z Financial Services Fund II, L.P., a Bermuda limited partnership ("Capital Z"), providing for an equity investment of up to $100 million in the Company. The investment is to be made in three stages, as follows: (i) on February 10, 1999 (the "Initial Closing"), Capital Z and certain other investors designated by it purchased 26,704 shares of the Series B Convertible Preferred Stock ("Series B Preferred Stock") of the Company and 49,796 shares of the Series C Convertible Preferred Stock ("Series C Preferred Stock") of the Company for $1,000 9 10 per share, or an aggregate purchase price of $76.5 million (the "Initial Investment"); (ii) as soon as practicable following the Initial Investment, subject to the receipt of stockholder approval of an increase in the Company's authorized common and preferred stock (together with a 1000 to 1 stock split of the preferred stock (the "Recapitalization")), the Company intends to make a distribution in the form of a dividend to the common stockholders of the Company of nontransferable subscription rights to purchase up to $25 million of Series C Preferred Stock for $1.00 per share (the "Rights Offering"), and (iii) Capital Z has agreed to purchase any shares of the Series C Preferred Stock which are not purchased by common stockholders in the Rights Offering. In addition, certain members of the Company's management team have agreed to purchase 920 shares of the Series C Preferred Stock for $1,000 per share, and other members of the Management team have agreed to exercise their rights to purchase $1,667,000 shares of Series C Preferred Stock in the Rights Offering for $1.00 per share. On January 4, 1999, a designee of Capital Z received, as a standby commitment fee, warrants to purchase 1,250,000 of the Common Stock at an exercise price of $1.00 per share. In addition, at the time of the Initial Closing, the Company paid a designee of Capital Z a $1,000,000 transaction fee in connection with the transactions contemplated by the Stock Purchase Agreement and Capital Z received an additional warrant (the "Contingent Warrant") to purchase up to 3,000,000 shares of the common stock at an exercise price of $1.00 per share, which is exercisable only if the Recapitalization is not completed by June 30, 1999. In addition, in connection with the transactions contemplated by the Stock Purchase Agreement, the Company has paid Capital Z aggregate additional fees of $2,000,000 and has agreed to reimburse Capital Z for all of its expenses incurred in connection with the negotiation and execution of the Stock Purchase Agreement and the transactions contemplated thereby. Pursuant to the terms of the Series B Preferred Stock and Series C Preferred Stock, if the Company fails to effect the Recapitalization prior to June 30, 1999, (i) the dividend rate on the Series B Preferred Stock and Series C Preferred Stock will increase from 6.5% to 15% per annum and (ii) the Contingent Warrant will become exercisable. Further, prior to the Recapitalization, in addition to its regular dividend rights and rights in liquidation based on its stated value per share, the Series B Preferred Stock and Series C Preferred Stock will participate in dividends and rights in liquidation with holders of the common stock in any remaining assets of the Company. The Board of Directors of the Company, effective as of the Initial Closing, consists of nine Directors divided into two classes. One class, consisting of four Directors (the "Series B Directors") are elected by the holders of the Series B Preferred Stock, voting as a single class, annually and the other class of Directors, consisting of five Directors (the "Common Stock Directors"), one of whom is nominated by Capital Z, are elected by the holders of the common stock and the holders of the Series B Preferred Stock, voting together as a single class, for staggered three year terms. The holders of the Series C Preferred Stock are not entitled to vote with respect to the election of Directors. As of February 10, 1999, Capital Z holds Series B Preferred Stock and Series C Preferred Stock representing 100% of the voting rights entitled to elect the Series B Directors, 46.3% of the voting rights entitled to elect the Common Stock Directors and 69.8% of the voting rights entitled to vote with respect to all other matters. Moreover, the investment by Capital Z results in a change in control for income tax purposes thereby limiting future net operating loss and certain other future deductions. 10 11 OVERVIEW - MARKET CONDITIONS The results of operations for the quarter ended December 31, 1998 reflect the negative market conditions that existed in the quarter. While the U.S. capital and credit markets stabilized in December from the global economic crises of the previous months, the subprime home equity sector generally and the Company specifically continued to feel the adverse effects of restricted access to the capital and credit markets. As previously disclosed, the negative market conditions resulted in an operational loss for the quarter. Further, these negative market conditions caused the Company to record a net loss in valuation of its interest-only strips for the quarter in the amount of $192 million (the "Write-Down"). The Write-Down reflects the impact of these market conditions on the prepayment, loss and discount rate assumptions applied by the Company in estimating the fair value of its interest-only strips. See "- Certain Accounting Considerations -- Accounting for Securitizations." As has been previously disclosed, during the quarter, the Company was dependent upon one committed warehouse line in the amount of $300 million. Throughout the quarter, the Company attempted to obtain additional lines. However, the Company was unable to obtain such lines. In conjunction with the Initial Closing under the Stock Purchase Agreement, effective February 10, 1999, the Company obtained an additional $400 million in committed repurchase facilities and an additional $100 million in an uncommitted facility. Further, the Company is in negotiations with respect to additional warehouse and repurchase lines. However, there can be no assurance that such negotiations will be successful or that any additional warehouse or repurchase lines will be obtained. The Company was precluded from completing a securitization during the second fiscal quarter due to the negative cash flows associated with a securitization and the weak asset-backed market. Foregoing the higher gains of the securitization market had an adverse impact on the Company's profitability as it was forced to rely upon less profitable whole loan sales as a means of disposing of its loan production. Constraints upon the Company's access to warehouse funding sources contributed to the Company's need to expedite its whole loan sales putting further downward pressure on the whole loan prices. Moreover, the weakness in the asset-based market caused other subprime lenders to rely on the whole loan market for their loan disposition strategy. The result was an abundance in the supply, and a lowering of the prices paid (in some cases to prices lower than the Company's cost of producing loans), for whole loans and tightening of underwriting guidelines applied by the whole loan purchasers. The Company attempted to mitigate these effects by raising its prices and tightening its underwriting guidelines for its loan products which had the effect of decreasing loan production in the second quarter. See "- General." As previously disclosed, sales of loans in the whole loan market contributed to the loss in the quarter ended December 31, 1998. Additionally, the Company's sale of whole loans during the quarter on a servicing released basis precluded the growth of its servicing portfolio. Recent improvements in the asset-backed market and a reduction in the number of whole loan sellers have lessened the over-supply of loan product in that market and resulted in an increase in whole loan prices. Nevertheless, the profitability of the whole loan market is significantly lower 11 12 than the securitization market. In the quarter ended March 31, 1999, the Company expects to record a loss as it will continue to rely solely on the whole loan market for its loan dispositions and will not yet have realized the benefits from its cost savings plan. See "- Expenses." The Company will monitor market conditions and cash flow to determine the optimal time to re-enter the securitization market. Management currently expects that it will re-enter the securitization market in the June 1999 quarter. However, no assurance can be given that market conditions will not change or other events will not occur that would preclude or inhibit the Company's ability to complete a securitization in the June 1999 quarter. The Company's liquidity crisis was further exacerbated during the quarter ended December 31, 1998 by the requirement of the Company, as servicer of the loans it has securitized, to advance interest on delinquent loans in the securitized pools on a monthly basis. This short-term cash requirement arises once each month. Generally, the Company is obligated to make the servicing payment in the middle of the month. The cash advances are then reimbursed from payments received on performing loans in the pools, typically within 10 days. Under its then existing credit facilities, the Company did not have sufficient funds to make the payment in December 1998. However, an immediate insolvency crisis was averted when one of the Company's lenders expanded the Company's credit facility to provide the funds necessary to satisfy the December obligation. Management believes that this lender was willing to expand the facility due to the Company's then- advanced discussions with Capital Z. Advances under the facility were secured by certain of the Company's interest-only strips. Under the terms of the credit facility, funds were also available to help satisfy the January 1999 servicing advance conditioned on the Stock Purchase Agreement being in full force and effect, as well as the satisfaction of other conditions. If the Company would have been unable to arrange for funds necessary to make the servicing advances, the Company would very likely have had to engage in extraordinary transactions, such as seeking subservicing arrangements that included the obligation to make servicing advances or strategic asset sales, to provide the liquidity necessary to operate. In that event, the Company would very likely have been terminated as servicer. Any such termination would have had a material adverse effect on the Company and jeopardized its ability to continue to operate as a going concern. Management believes that the capital from the Initial Investment will assist the Company in satisfying its servicing advance obligations. See "- Liquidity." However, management is seeking to implement plans to reduce the burden of these advances on its available cash. These plans may include establishing working lines of credit secured by interest-only strips, credit-enhancing servicing advances to efficiently borrow against them, entering into sub-servicing arrangements (including the obligation to make servicing advances) with respect to certain pools of loans with the highest percentage of delinquencies or other financing arrangements. GENERAL The Company is a consumer finance company primarily engaged, through its subsidiaries, in the business of originating, purchasing, selling, and servicing home equity mortgage loans secured by single family residences. Upon its formation in 1991, the Company acquired Aames Home Loan, 12 13 a home equity lender founded in 1954. In August 1996, the Company acquired One Stop Mortgage, Inc. ("One Stop") which originates mortgage loans primarily through a broker network. In March 1998, the Company augmented its retail production by establishing One Stop Retail Direct ("Retail Direct"). Unlike the Company's traditional retail network, which uses a centralized marketing approach, Retail Direct uses a decentralized marketing approach at the branch level. The Company's principal market is borrowers whose financing needs are not being met by traditional mortgage lenders for a variety of reasons, including the need for specialized loan products or credit histories that may limit such borrowers' access to credit. The Company believes these borrowers continue to represent an underserved niche of the home equity loan market and present an opportunity to earn a superior return for the risk assumed. The residential mortgage loans originated and purchased by the Company, which include fixed and adjustable rate loans, are generally used by borrowers to consolidate indebtedness or to finance other consumer needs rather than to purchase homes. The Company originates and purchases loans nationally through three production channels - retail, broker and correspondent. In recent quarters, the Company has emphasized its core retail and broker loan production channels and decreased its reliance on correspondent purchases. During the three and six months ended December 31, 1998, the Company originated and purchased $550 million and $1.28 billion, respectively, of mortgage loans. The Company underwrites and appraises every loan it originates and generally reviews appraisals and re-underwrites all loans it purchases. Included in the $1.28 billion of loans originated during the six months ended December 31, 1998 is $14.4 million of commercial loans originated through the Company's commercial loan division which ceased operations in January 1999. The Company retains the servicing on the loans it originates or purchases and securitizes. The Company completed the transfer in-house of $1.64 billion of loans previously subserviced for the Company by third parties in the 18 month period ending December 31, 1998, $1.32 billion of which was transferred between December 1997 and March 1998. At December 31, 1998, the Company serviced 100% of its $4.43 billion servicing portfolio as compared to 75% of the $3.75 billion servicing portfolio at December 31, 1997. See "- Revenue." As a fundamental part of its business and financing strategy, the Company sells its loans to third party investors in the secondary market. The Company maximizes opportunities in its loan disposition transactions by selling its loan production through a combination of securitizations and whole loan sales, depending on market conditions, profitability and cash flows. For a discussion of the impact of current market conditions on the Company's loan disposition strategies, see "Overview - Market Conditions." The Company sold $501 million and $606 million of loans during the three months ended December 31, 1998 and 1997, respectively, and $1.20 billion and $1.15 billion of loans during the six months ended December 31, 1998 and 1997, respectively. Of the total amount of loans sold during the six months ended December 31, 1998 and 1997, $650 million and $1.10 billion were sold in securitizations, respectively. The Company did not complete a securitization during the quarter ended December 31, 1998. 13 14 The following table presents the volume of loans originated and purchased by the Company and the portfolio serviced by the Company during the periods presented:
THREE MONTHS ENDED SIX MONTHS ENDED DECEMBER 31, DECEMBER 31, --------------------------- ----------------------------- 1998 1997 1998 1997 ---- ---- ---- ---- (IN THOUSANDS) Broker network $ 289,492 273,756 640,293 (1) 535,590 Retail (2) 197,937 157,292 426,114 290,838 Correspondent 62,789 184,615 208,868 312,374 ----------- ------- ---------- -------- Total $ 550,218 615,663 1,275,275 1,138,802 =========== ======= ========== ========= Servicing portfolio at period end $4,429,000 (3) 3,751,000
- ------------------ (1) Includes $14.4 million of commercial loans. (2) Includes loans brokered to institutional investors for 1997. (3) Includes $248 million of loans subserviced for others by the Company on an interim basis. Total originations decreased 11% from $616 million for the quarter ended December 31, 1997 to $550 million for the quarter ended December 31, 1998. More dramatic, however, was the $175 million, or 24%, decline in originations from the previous fiscal quarter. The decline in originations resulted from a combination of the Company's limited warehouse capacity and price and underwriting changes implemented to permit the Company to access the whole loan market and stay within its liquidity constraints. See "- Overview - Market Conditions." Despite the decrease in total loan production on a sequential quarterly basis, the Company's core operations, retail and broker, increased 13% to $487 million for the quarter ended December 31, 1998 from $431 million for the quarter ended December 31, 1997. The growth in core originations was due primarily to the increase in retail and broker branches during the second fiscal quarter of 1998 over those operating in the comparable period in 1997. The Company's retail originations were $198 million for the quarter ended December 31, 1998 compared to $158 million for the quarter ended December 31, 1997. Origination volume for the broker network reached $289 million for the quarter ended December 31, 1998 compared to $274 million for the quarter ended December 31, 1997. Correspondent purchases were $63 million for the quarter ended December 31, 1998 compared to $185 million for the quarter ended December 31, 1997. The decline in the second fiscal quarter of 1998 in correspondent loan purchases reflects pricing changes implemented by the Company in response to the Company's liquidity constraints and the emphasis on core operation loan origination. Total loan production for the six months ended December 31, 1998 increased 12% to $1.28 billion from $1.14 billion for the six months ended December 31, 1997. The Company's retail originations increased 46% to $426 million for the six months ended December 31, 1998 compared to $291 million for the six months ended December 31, 1997. Origination volume for the broker network reached $640 million for the six months ended December 31, 1998, up 19% compared to $536 million for the six months ended December 31, 1997. Correspondent volume decreased 33% 14 15 from $312 million in the six months ended December 31, 1997 to $209 million for the six months ended December 31, 1998. See "- Overview - Market Conditions." In February 1999, the Company changed its pricing levels in its core loan production and correspondent loan production channels. Management expects that these changes will increase loan production from the December quarter's volumes. At February 9, 1999, the Company operated 89 retail loan offices serving 33 states (including the District of Columbia), compared to 73 offices serving 30 states at December 31, 1997. At February 9, 1999, the broker division operated 40 branches serving 46 states (including the District of Columbia), compared to 41 branches serving 39 states at December 31, 1997. At February 9, 1999, Retail Direct operated 21 offices serving 12 states. See "- Expenses." 15 16 CERTAIN ACCOUNTING CONSIDERATIONS New Accounting Development. In December 1998, the FASB issued, in question and answer format, "A Guide to Implementation of Statement 125 on Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, Questions and Answers, Second Edition" (the "Special Report"). The Special Report indicates that two methods have arisen in practice for accounting for credit enhancements relating to securitization. These methods are the cash-in method and the cash-out method. The cash-in method treats credit enhancements (pledged loans or cash) as belonging to the Company. As such, these assets are recorded at their face value as of the time they are received by the trust. The cash-out method treats credit enhancements as assets owned by the related securitization trust. As such, these assets are treated as part of the interest-only strips and are recorded at a discounted value for the period between when collected by the trust and released to the Company. The Special Report indicates that if no true market exists for credit enhancement assets, the cash-out method should be used to measure the fair value of credit enhancements. Restatement of Prior Period Results. The Company has historically used the cash-in method to account for its interest-only strips. However, during the three months ended December 31, 1998, the Company retroactively changed its practice of measuring and accounting for its interest-only strips to the cash-out method in response to the FASB's Special Report and to public comments from the Securities and Exchange Commission released on December 8, 1998. Under the cash-in method previously used by the Company, the assumed discount period for measuring the present value of the interest-only strips ended when the cash flows were received by the securitization trust; and, the initial deposits to overcollateralization accounts were recorded at face value. Under the cash-out method now required by the FASB and Securities and Exchange Commission, the assumed discount period for measuring the present value of the interest-only strips ends when cash, including the return of any initial deposits, is distributed to the Company on an unrestricted basis. The change to the cash-out method results only in a difference in the timing of revenue recognition from a securitization and has no effect on the total cash flows of securitization transactions. While the total amount of revenue recognized over the term of a securitization is the same under either method, the cash-out method results in lower initial gains on the sale of loans due to the longer discount period, and higher subsequent loan service revenue resulting from the impact of discounting cash flows. See "- Revenue." To quantify the impact of the change in accounting, the Company measured the difference between the face value of its residual assets and the value of its residual assets when measured on a discounted basis. Further, the Company used the same assumptions for prepayment, loss and discount rates as were used in the periods affected. The impact of moving to the cash-out method was approximately 11.5% of the interest-only strips asset (excluding the effects of the Write-Down). The use of such a percentage was deemed reasonable for purposes of restating prior period consolidated financial statements. 16 17 As a result, the Company's consolidated results of operations for all prior periods have been restated. The aggregate pretax amount of this change in accounting is $67.1 million. Results for the three months and six months ended December 31, 1998 also reflect the cash-out method. The restatement resulted in the following changes to prior financial information (Unaudited. Dollars in thousands, except per share amounts):
Three Six Months Months Ended Ended Year Ended June 30, ---------- ----------- ------------------------------------------------------ December 31, 1997 1998 1997 1996 1995 ------------------------------- --------- -------- ----------- --------- Revenue: Previous $ 76,761 146,103 286,110 238,578 141,840 54,939 As restated 70,341 134,840 266,489 214,531 128,428 48,400 Net income: Previous 13,343 26,424 40,317 17,109 29,791 10,034 As restated 9,170 19,103 27,563 1,478 21,073 5,784 Earnings per share: Basic: Previous 0.48 0.95 1.41 0.65 1.37 0.74 As restated 0.33 0.69 0.97 0.06 0.97 0.43 Diluted: Previous 0.41 0.80 1.23 0.60 1.14 0.74 As restated 0.29 0.59 0.89 0.05 0.82 0.43 Interest-only strips: (end of period) Previous 481,354 481,354 554,161 383,249 173,789 56,960 As restated 426,093 426,093 490,542 339,251 153,838 50,421 Stockholders' equity: (end of period) Previous 293,188 293,188 345,403 268,354 133,429 80,047 As restated 257,268 257,268 304,051 239,755 120,461 75,797
Accounting for Securitizations. Although the Company's loan disposition strategy relies on a combination of securitization transactions and whole loan sales, the Company relied solely on whole loan sales during the quarter ended December 31, 1998. The following discusses certain accounting considerations which arise only in the context of securitization transactions. In a securitization, the Company conveys loans that it has originated or purchased to a separate entity (such as a trust or trust estate) in exchange for cash proceeds and an interest in the loans securitized represented by the non-cash gain on sale of loans. The cash proceeds are raised through an offering of the pass-through certificates or bonds evidencing the right to receive principal payments on the securitized loans and the interest rate on the certificate balance or on the bonds. The non-cash gain on sale of loans represents the difference between the proceeds (including premiums) from the sale, net of related transaction costs, and the allocated carrying amount of the loans sold. The allocated carrying amount is determined by allocating the original amount of loans (including premiums paid on loans purchased) between the portion sold and any retained interests (interest-only strip), based on their relative fair values at the date of transfer. The interest-only strip 17 18 represents, over the estimated life of the loans, the present value of the estimated cash flows. These cash flows are determined by the excess of the weighted average coupon on each pool of loans sold over the sum of the interest rate paid to investors, the contractual servicing fee (currently .50%), a monoline insurance fee, if any, and an estimate for loan losses. In quarters where the Company engaged in a securitization transaction, net gains or losses in valuation of interest-only strips and mortgage servicing rights include the recognition of a gain or loss which represents the initial difference between the allocated carrying amount and the fair market value of the interest-only strip at the date of sale. Additionally, increases or decreases in valuation of the interest-only strips are also recognized as net gains or losses. Each agreement that the Company has entered into in connection with its securitizations requires either the overcollateralization of the trust or the establishment of a reserve account that may initially be funded by cash deposited by the Company. The Company determines the present value of the cash flows at the time each securitization transaction closes using certain estimates made by management at the time the loans are sold. These estimates include: (i) future rate of prepayment; (ii) discount rate used to calculate present value; and (iii) credit losses on loans sold. There can be no assurance of the accuracy of management's estimates. Rate of Prepayment. The estimated life of the securitized loans depends on the assumed annual prepayment rate which is a function of estimated voluntary (full and partial) and involuntary (liquidations) prepayments. The prepayment rate represents management's expectations of future prepayment rates based on prior and expected loan performance, the type of loans in the relevant pool (fixed or adjustable rate), the production channel which produced the loan, prevailing interest rates, the presence of prepayment penalties, the loan-to-value ratios and the credit grades of the loans included in the securitization and other industry data. The rate of prepayment may be affected by a variety of economic and other factors. Discount Rate. In order to determine the fair value of the cash flow from the interest-only strips, the Company discounts the cash flows based upon rates prevalent in the market. Credit Losses. In determining the estimate for credit losses on loans securitized, the Company uses assumptions that it believes are reasonable based on information from its prior securitizations, the loan-to-value ratios, credit grades of the loans included in the current securitizations and other industry data. The interest-only strips are recorded at estimated fair value and are marked to market through a charge (or credit) to earnings. On a quarterly basis, the Company reviews the fair value of the interest-only strips by analyzing its prepayment, discount rate and loss assumptions in relation to its actual experience and current rates of prepayment and loss prevalent in the industry and may adjust or take a charge to earnings through an adjustment to net gain or loss on valuation of interest-only strips. 18 19 In its regular quarterly review of its interest-only strip, the Company considered the historical performance of its securitized loan pools, the recent prepayment experience of those pools, the credit performance of previously securitized loans and other industry data and determined that it should adjust each of its assumptions (rate of prepayment, discount rate and credit loss) to reflect current market conditions. This change in estimates resulted in the Write-Down in the quarter ended December 31, 1998. The components of this adjustment are as follows: Rate of Prepayment. In its valuation analysis of prepayment speeds, the Company considered the relationship between the rate paid on the certificates or bonds issued in the securitization and the weighted average coupons on the mortgages outstanding in each securitization pool from time to time. Additionally, For the quarters up to and including September 30, 1998, prepayment rates used by the Company were held constant, e.g. flat, over the life of the pool. The estimates used by the Company for the quarters up to and including September 30, 1998 were flat prepayment rates ranging from 26% for fixed to 30.5% for adjustable and hybrid loan products. These rates represented a weighted average loan life of approximately 2.6 to 3.8 years. During the quarter ended December 31, 1998, the Company finalized the development of an enhanced analytical model which more precisely reflected the performance of the securitized loans. This analytical model enabled the Company to refine its estimate of the prepayment rates associated with the performance of its securitized loans. Additionally, data and information received from market participants (credit and capital providers) assisted the Company in its assessment of current market conditions which resulted in the Company applying a more precise valuation estimate to its prepayment assumptions. The Company incorporated this new information in developing its improved judgment as to prepayment speeds and changed its estimate of prepayment rates from a flat constant prepayment rate to a vectored rate, which more closely approximates the performance of the securitized loans. These revised prepayment rates resulted in a weighted average life of 2.86 years. The impact of the change in prepayment speeds amounted to approximately $62 million, which is included in the Write-Down recorded for the quarter ended December 31, 1998. Discount Rate. For the quarters up to and including September 30, 1998, the Company used the weighted average interest rates of the loans included in the pool as the best estimate available as an appropriate discount rate to determine fair value. As the market deteriorated in the quarter ended December 31, 1998, it became apparent that a change in discount rate would be required in order for the estimate of fair value to be consistent with market conditions. To determine the appropriate discount rate, the Company reviewed general market conditions as reflected by market sales of senior tranche asset-backed securities. Management believed that the pass-through rate on senior tranche securities should be lower than the discount rate applied to the subordinate, and higher risk, interest-only strips. However, the adversity of the market during the quarter ended December 31, 1998 was so severe that, in some instances, transactions of senior tranche asset-backed securities could not even be completed. Accordingly, the Company incorporated this current market information in developing its judgment as to the appropriate risk adjusted rate of return in establishing its change in estimate of the discount rate to be used in estimating the fair value of the interest-only strips. For the quarter ended December 31, 1998, the Company increased its discount rate to 15% to reflect current market conditions. The impact of this change in discount rate 19 20 amounted to approximately $65 million, which is included in the Write-Down recorded for the quarter ended December 31, 1998. Credit Losses. For the quarter up to and including September 30, 1998, the Company used a prospective cumulative loan loss estimate of 1.4% of the balance of the loans in the securitization pools as an appropriate estimate to determine fair value. This estimate was developed through a review of the credit performance of securitized loans in the aggregate. In conjunction with its previous quarterly review of loss estimates, the Company considered the level of delinquency of securitized loans and the percentage of annualized losses to securitized loans in the aggregate. As market conditions deteriorated in the quarter ended December 31, 1998, the Company refined its estimate of credit losses by expanding the factors it considers in developing its credit loss estimates to include loss and delinquency information by channel, credit grade and product, and information available from other market participants such as investment bankers, credit providers and credit agencies. For the quarter ended December 31, 1998, the percentage of losses to average servicing portfolio amounted to 1.08%, a significant increase from the previous quarter's level of .80%. The Company had seen levels spike to .96% in the quarter ended June 30, 1998 but then subside to the .80% previously noted. This trend was in line with the Company's assumption that losses were being realized as the servicing portfolio was transferred in-house from sub-servicers. See "-General." Management believes the increase in losses in the December 1998 quarter reflected general market conditions rather than the continuing effects of the transfer of servicing in-house. Publicly available information from investment banking firms and credit agencies began to indicate a market expectation that credit losses within the sub-prime home equity sector would rise. Those indications, in part, arise from the impact of the adverse market conditions on severely delinquent borrowers who, in a more favorable market, would avoid default by refinancing with other lenders. In the current market, with competition lessening and underwriting guidelines tightening, these borrowers are much more likely to default. Accordingly, the Company increased its prospective cumulative loan loss estimate to 2.7% of the balance of the loans in the securitization pools at December 31, 1998. This change in credit loss estimate resulted in a valuation adjustment of $67 million, which is included in the Write-Down recorded for the quarter ended December 31, 1998. Additionally, upon sale or securitization of servicing retained mortgages, the Company capitalizes the fair value of originated mortgage servicing rights ("OMSRs") assets separate from the loan. The Company determines fair value based on the present value of estimated net future cash flows related to servicing income. The cost allocated to the servicing rights is amortized over the period of estimated net future servicing fee income. The Company periodically reviews the valuation of capitalized servicing fees receivable. This review is performed on a disaggregated basis for the predominant risk characteristics of the underlying loans which are loan type and origination date. 20 21 RESULTS OF OPERATIONS - THREE AND SIX MONTHS ENDED DECEMBER 31, 1998 AND 1997 (RESTATED AND UNAUDITED) The following table sets forth information regarding the components of the Company's revenue and expenses for the three and six months ended December 31, 1998 and 1997:
Three Months Ended Six Months Ended December 31, December 31, ------------------------ ---------------- 1998 1997 1998 1997 ---- ---- ---- ---- (In thousands) Revenue: Gain on sale of loans $ 8,752 35,130 28,429 66,438 Net gain (loss) on valuation of interest-only strips (191,646) 5,726 (186,451) 10,755 Commissions 7,758 7,161 17,746 13,016 Loan servicing: Servicing spread 5,458 5,251 8,827 11,421 Prepayment fees 3,649 3,263 7,149 5,618 Late charge and other servicing fees 2,522 1,848 4,878 3,105 Fees and other: Closing 572 670 1,190 1,257 Appraisal 770 634 1,717 1,135 Underwriting 384 294 837 540 Interest income 7,208 10,078 18,722 21,109 Other 150 286 294 446 ---------- ------ -------- ------- Total revenue including valuation adjustments (154,423) 70,341 (96,662) 134,840 ---------- ------ -------- ------- Expense: Compensation 19,907 24,561 43,701 46,320 Production 10,559 7,541 21,489 13,338 General and administrative 13,784 9,580 27,172 17,665 Interest 9,403 10,819 22,285 20,917 ---------- ------ -------- ------- Total expense 53,653 52,501 114,647 98,240 ---------- ------ -------- ------- Income (loss) before income taxes (208,076) 17,840 (211,309) 36,600 Provision (benefit) for income taxes (12,331) 8,670 (13,408) 17,497 ---------- ------ -------- ------- Net income (loss) $ (195,745) 9,170 (197,901) 19,103 ========== ====== ======== =======
REVENUE Total revenue for the three and six months ended December 31, 1998 was $(154) million and $(96.7) million, as compared to $70.3 million and $135 million for the three and six months ended December 31, 1997, respectively. The 1998 period revenues include the Write-Down. Excluding the Write-Down, revenues for the three and six months ended December 31, 1998 were $37.2 million and $89.8 million, a 47.1% and 33.3% decrease from 1997's comparable periods. Excluding 21 22 the Write-Down, the decrease in total revenue during the quarter ended December 31, 1998 from the amount reported in the comparable period in 1997 primarily reflects the Company's reliance on whole loan sales for cash during the quarter. Gains associated with whole loans for cash are generally lower than those recognized when such loans are securitized. This disparity was exacerbated during the December 31, 1998 quarter as a consequence of the over-supply of product for sale in the marketplace due to weaknesses in the asset-backed market during the same period, as well as the Company's limited warehouse capacity during the quarter which necessitated the expedited sale of loans. See "- Overview - Market Conditions." During the three months ended December 31, 1997, the Company relied almost completely on the securitization market for its loan disposition strategy. In contrast, during the three months ended December 31, 1998, the Company relied exclusively on the whole loan market for its loan disposition strategy. Further contributing to the results for the three months ended December 31, 1998 was the 10.6% decrease in total loan production, from $616 million during the December 1997 quarter to $550 million during the 1998 comparable quarter. The decrease in total revenue during the six months ended December 31, 1998 from amounts reported in the comparable 1997 period was due primarily to lower premiums on whole loan sales, lower gains on sale resulting from hedge losses and lower than historical spreads on the Company's $650 million securitization closed in the quarter ended September 30, 1998. During the first fiscal quarter, the Company, as it had historically, hedged its fixed rate pipeline by purchasing hedges against U.S. Treasuries. In the past, changes in Treasury rates were generally reflected in the pass-through rates of the fixed rate portion of the Company's securitization. During fiscal 1999's first quarter, unsettled market conditions resulted in a $15.3 million loss on the Company's hedge position without an equivalent benefit from reductions in the pass-through rate paid on certificates sold in the fixed rate portion of the Company's securitization. Gain on sale for the three months ended December 31, 1998 declined $26.4, or 75.1%, from $35.1 million gain on sale recorded for the three months ended December 31, 1997. Gain on sale for the three months ended December 31, 1998 reflects the Company's reliance solely on the whole loan market for its loan disposition strategy. During 1997's comparable quarter, the Company relied almost completely on the securitization market for its loan disposition strategy. The gains associated with the whole loan sales were substantially less than the gains associated with the earlier quarter's securitization. Gain on sale for the six month period ended December 31, 1998, which decreased $38.0 million, or 57.2%, from 1997's comparable period, was also adversely affected by the $13.5 million hedge loss recorded in the period. (See above.) The lower prices paid in the whole loan market also reflect the Company's need to sell loans on an expedited basis to free up the limited warehouse capacity that existed during the quarter ended December 31, 1998. In that regard, during the quarter ended December 31, 1998, the Company entered into a forward commitment to sell $500 million, subsequently amended to $750 million, of loans to an affiliate of one of the Company's lenders. The commitment, which expires in May 1999, reflects the lower whole loan prices that existed during the quarter. As of January 31, 1999, the Company had satisfied $379 million of its commitment. Failure to satisfy the commitment subjects the Company to a substantial penalty. This commitment is expected to adversely impact the gain on sale recognized by the Company in subsequent quarters at least until the commitment is satisfied. Accordingly, the Company expects to record a loss in the quarter ended March 31, 1999, as it will continue to rely solely on the whole 22 23 loan market for its loan dispositions and will not yet have realized the benefits from its cost savings plan. Net gain (loss) on valuation of interest-only strips and mortgage servicing rights for the three months and six months ended December 31, 1998 primarily reflects the impact of the Write-Down recorded in the three month period ended December 31, 1998. The Company determines the fair value of the interest-only strips by applying certain assumptions as to prepayments, losses and discount rate to the future cash flows from prior securitizations. The negative market conditions that existed during the quarter, as well as the performance of the Company's pools of securitized loans, caused management to adjust these assumptions which resulted in the Write-Down. See "Certain Accounting Considerations -- Accounting for Securitizations." Net gain (loss) on valuation of interest-only strips and mortgage servicing rights for the three and six months ended December 31, 1997 in the amounts of $5.7 million and $10.8 million, respectively, represents the initial difference between the allocated carrying amount and the fair value of the interest-only strip at the date of the closing of the related securitization transaction. Commission revenue during the three and six month period ended December 31, 1998 was $7.76 million and $17.7 million, an 8.4% and 36.2% increase, respectively, from $7.16 million and $13.0 million during the three and six months ended December 31, 1997. The increase in commissions for the three and six months ended December 31, 1998 over the comparable 1997 periods was due to higher retail loan volume and higher commission rates earned on loan originations in the Company's retail and broker loan production channels. Loan servicing revenue for the three and six months ended December 31, 1998 increased to $11.6 million and $20.9 million, an increase of 11.5% and 4.0%, respectively, from $10.4 million and $20.1 million reported for the comparable periods in 1997. Loan servicing revenue consists of net servicing spread earned on the principal balances of the loans in the Company's loan servicing portfolio, prepayment fees, late charges and other fees retained by the Company in connection with the servicing of loans, increased by the accretion of the interest-only strips and reduced by the amortization of the OMSRs. The increase in loan servicing revenues for the three and six months ended December 31, 1998 was due primarily to higher balances of loans being serviced currently as compared to levels being serviced in the prior year. The Company's loan servicing portfolio at December 31, 1998 increased to $4.43 billion, up 18.1% from $3.75 billion at December 31, 1997. At December 31, 1998, 100% of the Company's $4.43 billion servicing portfolio was serviced in-house, compared to 75% at December 31, 1997. The growth of the Company's servicing portfolio will be negatively impacted by the Company's reliance on sales of whole loans on a servicing released basis. Nevertheless, management believes that the business of loan servicing provides a more consistent revenue stream and is less cyclical than the business of loan origination and purchasing. See "- Risk Factors -- Delinquencies and Losses in Securitization Trusts; Right to Terminate Mortgage Servicing; Negative Impact on Cash Flow." 23 24 The Company has historically experienced delinquency rates that are higher than those prevailing in its industry due to its origination of lower credit grade loans. At the end of calendar year 1996, the Company started to focus more on higher credit grade loans which should cause delinquencies in the Company's servicing portfolio to decrease in the future. See "- Revenue." However, by selling loans in the whole loan market on a servicing released basis, which the Company intends to do in the current quarter as it did in the preceding fiscal quarter, the Company will not be adding new loans to the servicing portfolio. The seasoning of the old portfolio without the addition of new loans could cause delinquency rates to rise. The delinquency rate for December 31, 1998 was 16.3% compared to 14.9% at December 31, 1997. In some cases, the Company has determined that the proceeds from the disposal of REO and foreclosed properties are maximized by accelerating disposition of REO properties rather than holding such properties until market conditions improve. During the six months ended December 31, 1998, losses increased to $20.6 million from $9.95 million in the comparable prior period due, in part, to a loss mitigation strategy adopted during the 1997 fiscal year of minimizing the REO holding period, thereby reducing carrying costs. This strategy was implemented in conjunction with the transfer in-house of a portion of its servicing portfolio that was previously subserviced by third parties. See "- General." It is the Company's goal to reduce the REO holding period to maximize the economics of liquidation transactions. Current loss levels have also increased due to the seasoning of the lower credit grade loans purchased in bulk and included in the Company's earlier trusts. The Company has reduced significantly its bulk purchase program and the purchase in bulk of lower credit grade loans. While the accelerated efforts to sell properties is expected to have a short-term impact on loss levels, the seasoning of the lower credit grade bulk portfolio may contribute to an increase in losses over time. Further, the adverse market conditions that existed in the quarter ended December 31, 1998 resulted in the tightening in underwriting guidelines by purchasers of whole loans and the insolvency of several large subprime home equity lenders. These factors have had the effect of decreasing the availability of credit to delinquent lower credit grade borrowers who in the past had avoided default by refinancing. Management believes that this will increase the Company's level of losses in future periods. The following table sets forth delinquency, foreclosure, and loss information of the Company's servicing portfolio for the periods indicated: 24 25
Year Ended Six Months Ended June 30, December 31, --------------------------------------- -------------------------- 1998 1997 1996 1998 1997 ---- ---- ---- ---- ---- (Dollars in thousands) Percentage of dollar amount of delinquent loans to loans serviced (period end) (1)(2)(3)(4) One month 3.8% 4.3 4.9 4.0 4.0 Two months 1.3 1.9 1.8 1.2 1.4 Three or more months: Not foreclosed (4)(5) 9.0 8.1 8.0 9.4 8.3 Foreclosed (6) 1.5 1.0 1.0 1.7 1.2 ------------ --------- ---------- ---------- ---------- Total 15.6% 15.3 15.7 16.3 14.9 ============ ========= ========== ========== ========== Percentage of dollar amount of loans foreclosed to loans serviced (period end)(2)(4) 2.0% 1.5 1.1 1.3 1.1 Number of loans foreclosed(7) 1,125 560 221 785 519 Principal amount of foreclosed loans(7) $ 84,613 48,029 14,349 57,814 41,975 Net losses on liquidations(8) 26,488 5,470 931 20,575 9,947 Percentage of annualized losses to average servicing portfolio(4) 0.72% 0.24 0.09 0.96 0.57 Servicing portfolio (period end) $ 4,147,000 3,174,000 1,370,000 4,429,000 3,751,000
- ------------ (1) Delinquent loans are loans for which more than one payment is due. (2) The delinquency and foreclosure percentages are calculated on the basis of the total dollar amount of mortgage loans originated or purchased by the Company and, in each case, serviced by the Company, and any subservicers as of the end of the periods indicated. Percentages for fiscal year 1996 have not been restated to include delinquencies on loans originated by One Stop. The Company believes any such adjustment would not be material. (3) At December 31, 1998, the dollar volume of loans delinquent more than 90 days in ten of the Company's REMIC trusts, five of which, plus one additional, also exceeded certain loss limits, formed in December 1992 and during the period from March 1995 to March 1997 exceeded the permitted limit in the related pooling and servicing agreements. See "-- Capital Resources" and "- Risk Factors -- Delinquencies and Losses in Securitizations; Trusts Right to Terminate Mortgage Servicing; Negative Impact on Cash Flow." (4) The servicing portfolio used in the percentage calculations includes $248 million of loans subserviced for others by the Company on an interim basis at December 31, 1998. (5) Represents loans which are in foreclosure but as to which foreclosure proceedings have not concluded. (6) Represents properties acquired following a foreclosure sale and still serviced by the Company. (7) The increase in the number of loans foreclosed and principal amount of loans foreclosed in the periods presented is due to the larger, more seasoned servicing portfolio. (8) Represents losses, net of gains, on foreclosed properties in pools sold during the period indicated. Fee and other revenue, which consist of fees received by the Company through its retail loan office network in the form of closing, appraisal, underwriting and other fees, and interest income, for the three and six months ended December 31, 1998 decreased 24.3% and 6.9% to $9.08 million and $22.8 million from $12.0 million and $24.5 million, respectively, when compared to the comparable 1997 periods. The dollar amount of fees and other revenue decreased during the three months ended December 31, 1998 from the comparable 1997 periods due to interest earned on lower 25 26 amounts of loans held by the Company during the period from origination or purchase of the loans until the date sold by the Company, offset by increasing weighted average interest rates on loans held. Interest income should continue to decline so long as the Company relies on whole loan sales which decreases the average number of days loans are held by the Company prior to sale. See "Overview - Market Conditions." EXPENSES Compensation expense for the three and six months ended December 31, 1998 decreased 19.1% and 5.6% from $24.6 million and $46.3 million for the three and six months ended December 31, 1997, respectively, to $19.9 million and $43.7 million for the three and six months ended December 31, 1998, respectively. This decrease was primarily due to employee attrition brought about by declines in branch expansion, a decrease in compensation incentives as a consequence of the decline in loan origination during the three and six months ended December 31, 1998 and the absence of incentive compensation due to the Company's results of operations. Compensation as a percentage of total loan originations and purchases decreased to 3.6% and 3.4% for the three and six months ended December 31, 1998, respectively, from 4.0% and 4.1% for the three and six months ended December 31, 1997, respectively. Also contributing to decreased compensation expenses was the waiver by Neil Kornswiet, President of the Company, of his quarterly bonus due for the quarters ended September 30, 1998 and December 31, 1998 in the aggregate amount of $3.1 million. In mid-February, 1999 and subsequent to the Initial Closing, management commenced a cost savings program designed to reduce the Company's operating expenses. The implementation of this recent cost savings plan initially included personnel reductions on a Company-wide basis. The effects of these reductions are expected to reduce compensation costs on an annualized basis in a pretax amount of approximately $6.7 million. The estimated pretax savings in compensation expense during the remainder of fiscal 1999 are expected to approximate $2.0 million. Severance costs, estimated at the pretax amount of approximately $500 thousand, will be recognized in the quarter ended March 31, 1999. Production expense, primarily advertising, outside appraisal costs, travel and entertainment, and credit reporting fees, increased 41.3% and 61.7% to $10.6 million and $21.5 million during the three and six months ended December 31, 1998, respectively, from $7.5 million and $13.3 million in the comparable periods last year. The increase in production expenses during the three and six months ended December 31, 1998 from amounts reported during the comparable periods in 1997 was due, in part, to the increase in retail loan volume, the rise in advertising costs and the additional cost of outsourcing appraisal work. Production costs as a percentage of total loan originations and purchases for the three and six months ended December 31, 1998 were 1.9% and 1.7%, respectively, compared to 1.2% for both of the three and six months ended December 31, 1997, respectively. This was due to the constriction of loan production after advertising expenses had already been incurred. General and administrative expense for the three and six months ended December 31, 1998 increased 43.8% and 53.7% to $13.8 million and $27.2 million, respectively, from $9.6 million and $17.7 million for the three and six months ended December 31, 1997, respectively. The increase was 26 27 primarily the result of increased occupancy, communication and technology costs related to the Company's core origination channel expansion and increased origination volumes and, to a lesser extent, increases in legal and other professional costs. As part of the costs savings program implemented in February, 1999, the Company ceased activities in certain retail and broker branches that were deemed unprofitable by management. The office space for such branches remains subject to operating leases that management has yet to sublease or terminate. If such office space is subleased at lease rates less than existing base lease terms or if the lease commitments are bought-out as a consequence of a negotiated lease termination, occupancy expense in future periods will increase for these effects. Interest expense during the three months ended December 31, 1998 decreased 13.0% to $9.4 million from $10.8 million in the comparable three month period in 1997. During the six months ended December 31, 1998, interest expense increased 6.7% to $22.3 million from $20.9 million during the six months ended December 31, 1997. The decrease in interest expense during the three months ended December 31, 1998 was due to lower borrowings used to fund lower loan originations relative to the comparable 1997 quarter. The increase in interest expense during the six months ended December 31, 1998 reflects the Company's recent increased reliance on external financing to fund loan originations and operations when compared to the comparable period in 1997. INCOME TAXES During the three and six months ended December 31, 1999, the Company recorded an estimated tax benefit of $12.3 million and $13.4 million, respectively, due to its net operating losses during those periods. The tax benefits reflect effective rates of (5.9%) and (6.3%), respectively, and are net of tax valuation adjustments recorded to account for estimated nonrealizable deferred tax assets. The investment in the Company by Capital Z results in a change in control for income tax purposes thereby limiting future net operating loss and certain other future deductions. During the three and six months ended December 31, 1997, the Company's provisions for taxes were $8.7 million and $17.5 million, respectively, reflecting effective estimated tax rates of 48.5% and 47.8%, respectively. FINANCIAL CONDITION Loans Held for Sale. The Company's portfolio of loans held for sale increased to $271 million at December 31, 1998, from $198 million at June 30, 1998. This increase is directly related to production volume and the size and timing of the Company's securitization and sales in the secondary market during the fiscal periods ended on such dates. During January 1999, the Company sold $127 million of the $271 million held for sale at December 31, 1998 in whole loan sales for cash. Accounts Receivable. Accounts receivable, representing servicing fees and advances and other receivables, decreased to $48.8 million at December 31, 1998, from $51.1 million at June 30, 1998. The level of servicing related advances, in any given period, is dependent on portfolio delinquencies and the timing of cash collections. 27 28 Interest-Only Strips. Interest-only strips decreased to $323 million at December 31, 1998 from $490 million at June 30, 1998 reflecting the Write-Down in the December quarter, offset by the non-cash gain recognized on the Company's securitization in the quarter ended September 30, 1998, net of amortization. Mortgage Servicing Rights, net. Mortgage servicing rights, net increased to $34.5 million at December 31, 1998 from $32.1 million at June 30, 1998 reflecting the capitalization of mortgage servicing rights on the securitization in the quarter ended September 30, 1998, net of amortization. Equipment and Improvements, net. Equipment and improvements, net, increased slightly to $14.7 million at December 31, 1998 from $13.9 million at June 30, 1998. Prepaid and Other Assets. Prepaid and other assets increased to $17.2 million at December 31, 1998 from $17.0 million at June 30, 1998. Borrowings. Borrowings at December 31, 1998 increased to $307 million from $287 million at June 30, 1998 due to advances on the Company's residual financing line completed in September 1998 which the Company used to fund its negative cash flow. Revolving Warehouse Facilities. Amounts outstanding under warehouse facilities increased to $250 million at December 31, 1998 from $141 million at June 30, 1998, primarily as a result of the increase in mortgage loans held for sale and from the negative cash flow from operations during the six months ended December 31, 1998 and the resulting decrease in equity capital. Proceeds from the Company's whole loan sales and securitizations are used to pay down the Company's warehouse facilities. LIQUIDITY The Company's operations require continued access to short-term and long-term sources of cash. The Company's primary operating cash requirements include the funding of: (i) mortgage loan originations and purchases prior to their securitization and sale, (ii) fees, expenses and hedging costs, if any, incurred in connection with the securitization and sale of loans, (iii) cash reserve accounts or overcollateralization requirements in connection with the securitization and sale of mortgage loans, (iv) tax payments due on recognition of non-cash gain on sale other than in a debt-for-tax securitization structure, (v) ongoing administrative and other operating expenses, (vi) interest and principal payments under the Company's warehouse credit facilities and other existing indebtedness, (vii) advances in connection with the Company's servicing portfolio and (viii) costs associated with expanding the Company's core production units. Historically, the Company funded its negative operating cash flow principally through borrowings from financial institutions, sales of equity securities and sales of senior and subordinated notes, among other sources. The deterioration of the credit and capital markets severely restricted 28 29 the Company's access to these markets during the quarter ended December 31, 1998 and in the current quarter until the Initial Closing on February 10, 1999. The $76.5 million ($70.6 million net of issuance expenses) in equity capital from the Initial Investment will help fund the Company's negative operating cash until additional working capital lines are established. The Company is currently in negotiations regarding establishing those lines. However, there can be no assurance that the Company will be able to establish those lines. There is a working capital sublimit in the Company's $300 million warehouse facility with a syndicate of banks. See "- Capital Resources." As previously disclosed, provisions in that line required the Company to maintain a certain level of profitability over two consecutive quarters. The loss incurred in the December 31, 1998 quarter caused the Company to violate this provision, as well as provisions requiring the Company to maintain a certain level of net worth and to satisfy certain debt to equity ratios. The Company received a waiver from the syndicate for those violations (the "Waiver"). This line, therefore, remains in place. It expires on April 8, 1999. See "- Overview - Market Conditions" and "- Recent Events." Under the terms of the Company's Indenture, dated October 21, 1996 with respect to its 9.125% Senior Notes due 2003, the Company's ability to incur certain additional indebtedness, including residual financing, is limited to two times adjusted stockholders' equity. In February 1999, the Company received a waiver from the holders of the Senior Notes, the effect of which was to permit the Company to record the Write-Down without violating the Indenture's limitations on indebtedness and conditioned upon the Initial Investment being made. Warehouse indebtedness is not included in the indebtedness limitations. The Company's new repurchase facilities contain similar limits on the Company's ability to incur additional indebtedness. Further, until the Company receives investment grade ratings for the notes issued under the Indenture, the amount of residual financing the Company may incur on its interest-only strips allocable to post-September 1996 securitizations is limited to 75% of the difference between such post-September 1996 residuals and $225 million. Under the Company's warehouse line which expires on April 8, 1999, the Company is currently limited to $50 million of indebtedness secured by its interest-only strips. Although the Company's loan disposition strategy consists of a combination of securitizations and whole loan sales, whole loan sales were the sole disposition method during the second fiscal quarter and will be the sole disposition method during the third fiscal quarter. The Company will continue to monitor market conditions and cash flow to determine the optimal time to re-enter the securitization market. Management currently anticipates that it will complete a securitization transaction during 1999's fourth fiscal quarter. However, no assurance can be given that market conditions will not change or other events will not occur that would preclude or inhibit the Company's ability to complete a securitization in the June 1999 quarter. During the three and six months ended December 31, 1998, the Company securitized -0- and $650 million, respectively, compared to $605 million and $1.1 billion, respectively, in the comparable 1997 periods. In connection with securitization transactions completed during these periods, the Company was required to provide credit enhancements in the form of overcollateralization amounts or reserve accounts. In addition, during the life of the related securitization trusts, the Company subordinates a portion of the excess cash flow otherwise due it to the rights of holders of senior interests as a credit enhancement to support the sale of the senior interests. The terms of the securitization trusts 29 30 generally require that all excess cash flow otherwise payable to the Company during the early months of the trusts be used to increase the cash reserve accounts or to repay the senior interests in order to increase overcollateralization to specified maximums. Overcollateralization requirements increase up to approximately twice the level otherwise required when the delinquency rates exceed the specified limit. At December 31, 1998, the Company was required to maintain an additional $85.0 million in overcollateralization amounts as a result of the level of its delinquency rates above that which would have been required to be maintained if the applicable delinquency rates had been below the specified limit. Of this amount, at December 31, 1998, $54.2 million remains to be added to the overcollateralization amounts from future spread income on the loans held by these trusts. See "Risk Factors -- Delinquencies and Losses in Securitization Trusts; Right to Terminate Mortgage Servicing; Negative Impact on Cash Flow." In the Company's securitizations structured as a REMIC, the recognition of non-cash gain on sale has a negative impact on the cash flow of the Company since the Company is required to pay federal and state taxes on a portion of these amounts in the period recognized although it does not receive the cash representing the gain until later periods as the related service fees are collected and applicable reserve or overcollateralization requirements are met. The Company's primary sources of liquidity are expected to be cash from the Initial Investment and the Rights Offering, fundings under warehouse facilities, working capital facilities and whole loan sales. See "- Overview - Market Conditions." The Company's primary and potential sources of liquidity as described in the paragraph above (assuming access to working capital financing, completion of the Rights Offering and implementation of the cash savings plans which by no means can be assured) are expected to be sufficient to fund the Company's liquidity requirements through at least the next 12 months if the Company's future operations are consistent with management's current growth expectations. If available at all, the type, timing and terms of financing selected by the Company will be dependent upon the Company's cash needs, the availability of other financing sources, limitations under debt covenants and the prevailing conditions in the financial markets. Further, the $100 million committed and $100 million uncommitted repurchase lines obtained on February 10, 1999 require the Company to obtain an additional working capital facility by no later than March 26, 1999. See "Capital Resources -- Warehouse, Repurchase and Working Capital Facilities." There can be no assurance that any such sources will be available to the Company at any given time or that favorable terms will be available. As a result of the limitations described above, the Company may be restricted in the amount of loans that it will be able to produce and dispose of. CAPITAL RESOURCES The Company has historically financed its operating cash requirements primarily through (i) warehouse facilities and working capital lines of credit, (ii) the securitization and sale of mortgage loans, and (iii) the issuance of debt and equity securities. Market conditions severely limited the 30 31 Company's ability to access the credit, securitization and capital markets during the quarter ended December 31, 1998. See "- Overview - Market Conditions." Warehouse, Repurchase and Working Capital Facilities. At December 31, 1998, the Company retained access to warehouse and other credit facilities with borrowing limits aggregating in excess of $1.0 billion. Changes in advance rates imposed by lenders effectively limited the Company to a single $300 million committed warehouse line during the December 31, 1998 quarter. The warehouse line includes a working capital line of credit with a syndicate of ten commercial banks. This facility is secured by loans originated and purchased by the Company, as well as certain servicing receivables. The loss reported for the December 31, 1998 quarter would have caused the Company to be in violation of certain financial covenants contained in the line. In February 1999, the Company received the Waiver. This line is currently scheduled to expire on April 8, 1999. The Company is engaging in efforts to establish a new syndicate. On February 10, 1999, and conditioned upon the Initial Closing occurring, the Company entered into two committed repurchase facilities aggregating $400 million and one uncommitted repurchase facility in the amount of $100 million. These facilities are each secured by the Company's home equity mortgage loans. One of the committed facilities, in the amount of $300 million, bears interest at a rate of 1.25% over one month LIBOR and expires on February 9, 2000, subject to different interest rates for selected sublimits under the facility. The other committed facility in the amount of $100 million bears interest at a rate of 1.50% over one month LIBOR and expires on February 9, 2000. The uncommitted facility bears interest at 1.50% over one month LIBOR and expires on February 9, 2000. The Company's ability to continue to draw under these three facilities is conditioned upon the Rights Offering closing on or prior to June 30, 1999. The Company will continue to require short-term warehouse facilities. If the Company is unable to maintain existing warehouse or repurchase lines, it would have to cease loan production operations which would negatively impact profitability and jeopardize the Company's ability to continue to operate as a going concern. In September 1998, the Company entered into a revolving line of credit with a maximum borrowing capacity of $50 million secured by certain of the Company's interest-only strips. The collateral is subject to mark-to-market valuation, or may otherwise be deemed unacceptable, in the sole discretion of the lender. To the extent such provisions result in a shortfall, the line provides for the term out of the loan or the delivery of additional collateral to bring the line back to compliance. Access to this line originally depended upon the Company completing a new securitization and pledging the related interest-only strips. However, during each of the months of December 1998 and January and February 1999, the lender allowed the Company to borrow $20 million on a short-term basis to satisfy the Company's obligation as servicer of the loans it securitizes to advance interest on delinquent loans. See "- Overview - Market Conditions." This line had $20 million outstanding at December 31, 1998 and expires on September 3, 1999. The Company is currently in negotiations with this line's lender for an additional repurchase facility. Management expects that any such repurchase facility will be conditioned, in part, on the prepayment and accelerated expiration of the revolving line of credit. See "- Risk Factors -- Dependence on Funding Sources." 31 32 Loan Sales. The Company's ability to sell loans originated and purchased by it in the secondary market is necessary to generate cash proceeds to pay down its warehouse and repurchase facilities and fund new originations and purchases. The ability of the Company to sell loans in the secondary market on acceptable terms is essential for the continuation of the Company's loan origination and purchase operations. Current market conditions have restricted access to the asset- backed market and adversely impacted the availability of, and pricing in, the whole loan market. See "- Overview - Market Conditions," and "- Risk Factors -- Risk of Adverse Changes in the Secondary Market for Mortgage Loans." Other Capital Resources. The Company has historically funded negative cash flow primarily from the sale of its equity and debt securities. However, current market conditions have restricted the Company's ability to access its traditional public equity and debt sources. In December 1991, July 1993, June 1995, October 1996 and April 1998, the Company effected public offerings of its common stock with net proceeds to the Company aggregating $217 million. In March 1995, the Company completed an offering of its 10.5% Senior Notes due 2002 with net proceeds to the Company of $22.2 million. In February 1996, the Company completed an offering of its 5.5% Convertible Subordinated Debentures due 2006 with net proceeds to the Company of $112 million. In October 1996, the Company completed an offering of its 9.125% Senior Notes due 2003 with net proceeds to the Company of $145 million. Under the agreements relating to these debt issuances, the Company is required to comply with various operating and financial covenants including covenants which may restrict the Company's ability to pay certain distributions, including dividends. At December 31, 1998, the Company had no money available for the payment of such distributions under the most restrictive of such covenants. On April 27, 1998, the Company issued 2.78 million shares of its common stock, or 9.9% of the Company's outstanding shares, to private entities controlled by Ronald Perelman and Gerald Ford, at an aggregate purchase price of approximately $38 million. The Company also issued warrants to these entities to purchase an aggregate additional 5.3 million shares (as adjusted) of the Company's common stock at an exercise price of $9.06 (as adjusted), subject to customary anti-dilution provisions. The warrants are exercisable only upon a change in control of the Company and expire in three years. On February 10, 1999, the Company raised an additional $76.5 million ($70.6 million net of issuance expenses) in the Initial Investment by Capital Z. Subsequent to receiving stockholder approval of the Recapitalization, the Company will commence the Rights Offering. Capital Z has agreed to purchase any shares of the Series C Preferred Stock which are not purchased by the common stockholders in the Rights Offering. The Company had cash and cash equivalents of approximately $11.8 million at December 31, 1998. See "- Risk Factors -- Negative Cash Flow and Capital Needs." YEAR 2000 COMPLIANCE AND TECHNOLOGICAL ENHANCEMENT 32 33 Readers are cautioned that forward-looking statements contained in this Year 2000 disclosure should be read in conjunction with the Company's disclosures under the heading, "Special Note on Forward-looking Statements," beginning on page 9 above. Readers should understand that the dates on which the Company believes the Year 2000 project will be completed are based upon management's best estimates, which were derived utilizing numerous assumptions of future events, including the availability of certain resources, third-party modification plans and other factors. However, there can be no guarantee that these estimates will be achieved, or that there will not be a delay in, or increased costs associated with, the implementation of the Company's Year 2000 Compliance Project. A delay in specific factors that might cause differences between the estimates and actual results include, but are not limited to, the availability and cost of personnel trained in these areas, the ability of locating and correcting all relevant computer codes, timely responses to and corrections by third parties and suppliers, the ability to implement interfaces between the new systems and the systems not being replaced, and similar uncertainties. Due to the general uncertainty inherent in the Year 2000 problem, resulting in part from the uncertainty of the Year 2000 readiness of third parties and the inter-connection of national and international businesses, the Company cannot ensure its ability to timely and cost effectively resolve problems associated with the Year 2000 issue that may effect its operations and business, or expose it to third party liability. The Company's year 2000 compliance program consists of four phases--inventory, risk assessment process, corrective action and testing. The Company has completed the inventory phase which included the identification of all computer hardware and software, electronic data exchanges, operating systems, communications systems and non-information items. As a corollary to the inventory phase, the Company has made inquiries of its significant vendors as to their year 2000 readiness. The Company has also completed the risk assessment process of assigning risk factors to each system used by the Company to determine the priority and resource allocation of its year 2000 efforts. The Company expects to complete the corrective action and testing phases with respect to mission critical systems by September 1999. The Company will complete any remaining testing and compliance by the end of 1999. Costs to Address the Company's Year 2000 Issues. The Company anticipates that costs relating to year 2000 issues are not expected to be material since the Company primarily relies on third party software for its primary information technology systems and does not require significant internal reprogramming resources to change program codes. The Company is in the process of converting or is scheduled to convert its major computer systems, including the loan origination system and the financial system from in-house to vendor-supported systems. These conversions were planned to upgrade and improve functionality rather than as a result of year 2000 issues. Risks of the Company's Year 2000 Issues. The most significant risk associated with the Company's year 2000 compliance would result from the loss of the Company's vendor supported servicing system and the inability to maintain the ongoing loan service operations, including payment processing, collections and investor remittance processing. The Company's servicing platform uses 33 34 software supplied by a subsidiary of Fiserv, Inc. To reduce the risk of non-compliance, the Company intends to rely on the vendor's representations regarding year 2000 compliance, the Company's testing efforts, as well as the testing results of other companies that use the same software. The testing and other costs relating to the Company's year 2000 compliance program are not expected to be material. Another year 2000 risk relates to the Company's vendor supported loan origination system. In the event of year 2000 issues with respect to the software used with such system (also supplied by a subsidiary of Fiserv, Inc.), the Company's ability to originate loans would be diminished and may result in reduced loan production until the problem is resolved. The Company intends to rely on the vendor's assurances and Company testing to minimize the risk of non-compliance of this system. Contingency Plans. The Company has not developed a contingency plan. The Company has no reason to believe that its most significant systems will not be year 2000 compliant. If testing indicates any of the systems are not compliant, the Company will develop appropriate contingency plans. RISK MANAGEMENT The Company is currently re-evaluating its current hedging policy, and currently has no effective hedge in place. While the Company monitors the interest rate environment and employs fixed rate hedging strategies, there can be no assurance that the earnings of the Company would not be adversely affected during any period of unexpected changes in interest rates or prepayment rates. RISK FACTORS Negative Cash Flow and Capital Needs. The Company has historically operated, and expects to continue to operate, on a negative cash flow basis. The Company's primary cash requirements include the funding of: (i) mortgage loan originations and purchases pending their securitization and sale; (ii) fees, expenses and hedging costs, if any, incurred in connection with the securitization of loans; (iii) cash reserve accounts or overcollateralization requirements in connection with the securitization and sale of the loans; (iv) tax payments due on recognition of non-cash gain on sale, other than in a debt-for-tax securitization structure; (v) ongoing administrative and other operating expenses; (vi) interest and principal payments under the Company's warehouse credit facilities and other existing indebtedness; (vii) advances in connection with the Company's servicing portfolio; and (viii) costs associated with expanding the Company's core production units. The more significant of these cash requirements is a result of the Company's use of securitization as a loan disposition strategy. In a securitization, the Company recognizes a non-cash gain on sale of the loans securitized upon the closing of the securitization, but does not receive the cash representing such gain until it receives the excess cash flow, which in general is payable over the actual life of the loans securitized after overcollateralization requirements are met. The Company incurs significant expense in connection with a securitization and generally incurs both current and deferred tax liabilities as a result of the gain on sale. Although the Company will not execute a securitization during the quarter 34 35 ended March 31, 1999 and will rely on whole loan sales for cash, the cash received upon such sales will not be sufficient to eliminate the Company's negative cash flow. Further, the Company has implemented, is in the process of implementing or has under discussion various cash savings plans. However, there can be no assurance that such plans will be successfully implemented or if successfully implemented will provide liquidity sufficient to eliminate the Company's negative cash flow. Therefore, the Company requires continued access to short- and long-term external sources of cash to fund its operations. The Company's primary sources of liquidity are expected to be cash from the Initial Investment and the Rights Offering, fundings under warehouse facilities, working capital facilities and whole loan sales. See "- Overview - Market Conditions." The Company's primary and potential sources of liquidity as described in the paragraph above (assuming access to working capital financing, completion of the Rights Offering and implementation of the cash savings plans which by no means can be assured) are expected to be sufficient to fund the Company's liquidity requirements through at least the next 12 months if the Company's future operations are consistent with management's current growth expectations. If available at all, the type, timing and terms of financing selected by the Company will be dependent upon the Company's cash needs, the availability of other financing sources, limitations under debt covenants and the prevailing conditions in the financial markets. There can be no assurance that any such sources will be available to the Company at any given time or that favorable terms will be available. As a result of the limitations described above, the Company may be restricted in the amount of loans that it will be able to produce and dispose of. Delinquencies and Losses in Securitization Trusts; Right to Terminate Mortgage Servicing; Negative Impact on Cash Flow. A substantial majority of the Company's servicing portfolio consists of loans securitized by the Company and sold to REMIC or owner trusts in securitization transactions. Generally, the form of agreement entered into in connection with these securitizations contains specified limits on delinquencies (i.e., loans past due 90 days or more) and losses that may be incurred in each trust. Losses occur when the liquidation proceeds from disposal of foreclosed properties, less liquidation expenses, are less than the principal balances of the loans previously secured by such properties and related interest and servicing advances (see below). If, at any measuring date, the delinquencies or losses with respect to any trust credit-enhanced by monoline insurance were to exceed the limits applicable to such trust, provisions of the agreements permit the monoline insurance company to terminate the Company's servicing rights to the affected trust. At December 31, 1998, the dollar volume of loans delinquent more than 90 days in the Company's 10 securitization trusts formed in December 1992 and during the period from March 1995 to March 1997 exceeded the permitted limit in the related pooling and servicing agreements. The higher delinquency rates negatively affect the Company's cash flows by increasing the required overcollateralization levels, thereby deferring the Company's receipt of cash and by obligating the Company, as servicer, to advance past due interest. Higher delinquency levels leading to higher loss levels also adversely influence the Company's assumptions underlying the gain on sale in a 35 36 securitization transaction. Additionally, the higher delinquency rates permit the monoline insurance company to terminate the Company's servicing rights with respect to the affected trusts. The Company has implemented various plans to lower the delinquency rates in its future trusts, including diversifying the loans it originates and purchases to include higher credit grade loans. The delinquency rate at December 31, 1998 was 16.3% and at June 30, 1998 was 15.6%. Five of the ten trusts referred to above plus one additional trust (representing in the aggregate 16% of the dollar volume of the Company's servicing portfolio) exceeded one of two loss limits at December 31, 1998. The limit that has been exceeded provides that losses may not exceed a certain threshold (which ranges from .50% to .94% of the original pool balances in the relevant securitization trusts) on a rolling 12 month basis. The other limit, which was not exceeded, provides that losses may not exceed a certain cumulative threshold (which ranges from 1.8% to 2.0% of the original pool balances in the relevant securitization trusts) since the inception of the trust. Management believes that current loss levels have increased in part due to a loss mitigation strategy of minimizing the real estate owned ("REO") holding period, thereby reducing carrying costs, which accelerated the volume of liquidated properties in the recent period. It is the Company's goal to reduce the REO holding period to maximize the economics of liquidation transactions. Current loss levels have also increased due to the seasoning of the lower credit grade loans purchased in bulk and included in the Company's earlier trusts. The Company has reduced significantly purchases in bulk of lower credit grade loans. While the accelerated efforts to sell properties is expected to have a short-term impact on loss levels, the seasoning of the lower credit grade bulk portfolio and the current origination of higher credit grade loans may contribute to an increase in losses over time. Further, the adverse market conditions that existed in the quarter ended December 31, 1998 resulted in the tightening in underwriting guidelines by purchasers of whole loans and the insolvency of several large subprime home equity lenders. These factors have had the effect of decreasing the availability of credit to delinquent lower credit grade borrowers who in the past had avoided default by refinancing. Management believes that this will increase the Company's level of losses. Although the monoline insurance company has the right to terminate servicing with respect to the trusts referred to above, no servicing rights have been terminated and the Company believes that the likelihood of such an event is remote. There can be no assurance, however, that the Company's servicing rights with respect to the mortgage loans in such trusts, or any other trusts which exceeds the specified delinquency or loss limits in future periods, will not be terminated. The Company's cash flow is also adversely impacted by high delinquency rates in its trusts. Generally, provisions in the agreements have the effect of requiring the overcollateralization account, which is funded primarily by the excess spread on the loans held in the trust, to be increased when the delinquency rates exceed the specified limit up to approximately twice the level otherwise required when the delinquency rates do not exceed the specified limit. As of December 31, 1998, the Company was required to maintain an additional $85 million in overcollateralization amounts as a result of the level of its delinquency rates above that which would have been required to be 36 37 maintained if the applicable delinquency rates had been below the specified limit. Of this amount, at December 31, 1998, $54.2 million remains to be added to the overcollateralization amounts from future spread income on the loans held by these trusts. Risk of Changes in Interest Rate Environment. A substantial and sustained increase in long-term interest rates could, among other things: (i) decrease the demand for consumer credit; (ii) adversely affect the ability of the Company to originate or purchase loans; and (iii) reduce the average size of loans underwritten by the Company. A significant decline in long-term interest rates could decrease the size of the Company's loan servicing portfolio by increasing the level of loan prepayments, thereby shortening the life and reducing the value of the Company's interest-only strips and also reduce the gains on loan dispositions. A substantial and sustained increase in short-term interest rates could, among other things, (i) increase the Company's borrowing cost and (ii) reduce the gains recognized by the Company upon their securitization and sale of loans. Year 2000 Compliance and Technology Enhancements. As part of the Company's overall systems enhancement program, the Company is utilizing both internal and external resources to identify, correct, reprogram or replace, and test its systems for year 2000 compliance. It is anticipated that all of the Company's year 2000 compliance efforts will be completed on time. There can be no assurance, however, that the systems of other companies on which the Company's systems rely will be timely reprogrammed for year 2000 compliance. The Company has recently installed and is testing a year 2000 compliant loan origination system that is expected to add approximately $2.0 million per year to the Company's technology costs over the next three years. Other technology enhancements are being reviewed but, to date, the costs for such enhancements have not been determined. Prepayment Risk. If actual prepayments occur more quickly than was projected at the time loans were sold, the carrying value of the interest-only strips may have to be adjusted through a charge to earnings in the period of adjustment. Non-cash gain on sale on securitizations has historically been the most significant component of the Company's reported revenues. Gain on sale represents the recognition of the present value of the excess cash flow on securitized loans, which is based on certain estimates made by management at the time loans are sold, including estimates regarding prepayment rates. The rate of prepayment of loans may be affected by a variety of economic and other factors, as discussed above. Estimates of prepayment rates are made based on management's expectations of future prepayment rates, which are based, in part, on the historic performance of the Company's loans and other considerations. See "- Certain Accounting Considerations." There can be no assurance of the accuracy of management's estimates. Credit Risk. Loans made to borrowers in the lower credit grades have historically resulted in a higher risk of delinquency and loss than loans made to borrowers who utilize conventional mortgage sources. While the Company believes that the underwriting criteria and collection methods it employs enable it to mitigate the higher risks inherent in loans made to these borrowers, no assurance can be given that such criteria or methods will afford adequate protection against such risks. 37 38 In the event that loans originated and purchased by the Company experience higher delinquencies, foreclosures or losses than anticipated, the Company's results of operations or financial condition could be adversely affected. Collateral securing the Company's loans may not be sufficient to cover the principal amount of the loans in the event of liquidation. Losses not covered by the underlying properties, if in excess of the Company's provision for such losses, could have a material adverse effect on the Company's results of operations and financial condition. In addition, historical loss rates affect the assumptions used by the Company in computing its non-cash gain on sale. Adjustable rate loans account for a substantial portion of the mortgage loans originated or purchased by the Company. Substantially all such adjustable rate mortgages include a "teaser" rate, i.e., an initial interest rate significantly below the fully indexed interest rate at origination. Although these loans are underwritten at the indexed rate as of the first adjustment date, credit-impaired borrowers may encounter financial difficulties as a result of increases in the interest rate over the life of the loan. Basis Risk. The value of the Company's interest-only strips created as a result of the securitization of adjustable rate mortgage ("ARM") loans is subject to so-called basis risk. Basis risk arises when the ARM (including fixed initial rate mortgage) loans in a securitization trust bear interest based on an index or adjustment period that is different from the mortgage-backed securities issued by the trust. Accordingly, in the absence of effective hedging strategies, in a period of increasing interest rates, the value of the interest-only strips would be adversely affected because the interest rates on the mortgage-backed securities issued by a securitization trust could adjust faster than the interest rates on the Company's ARMs in the trust. Moreover, ARMs are typically subject to periodic and lifetime interest rate caps, which limit the amount an ARM's interest rate can change during any given period. Hence, in a period of rapidly increasing interest rates, the value of the interest-only strips could be adversely affected in the absence of effective hedging strategies because the interest rates on the mortgage-backed securities issued by a securitization trust could increase without limitation by caps, while the interest rates on the Company's ARMs would be so limited. Dependence on Funding Sources. The Company is dependent upon its access to warehouse and other credit facilities in order to fund new originations and purchases of mortgage loans pending securitization or sale. At December 31, 1998, the Company effectively was limited to one $300 million committed warehouse line. This line expires in April 1999 and will most likely not be renewed. Effective February 10, 1999 and conditioned upon the Initial Closing occurring, the Company obtained two additional committed repurchase lines with aggregate borrowing capacity of $400 million and one $100 million uncommitted repurchase line. In September 1998, the Company entered into a $50 million revolving line of credit secured by its interest-only strips which expires on September 3, 1999. The Company currently has $20 million outstanding on this line. The Company is currently in negotiations with this line's lender for an additional repurchase facility. Management expects that any such repurchase facility will be conditioned, in part, on the prepayment and accelerated expiration of the revolving line of credit. The Company is currently negotiating with 38 39 various financial institutions and investment banks to obtain additional credit facilities. There can be no assurance that the Company will be able to secure such financing. Further, there can be no assurance that such financing will be obtainable on favorable terms. To the extent that the Company is unable to maintain existing facilities, arrange new warehouse or other credit facilities or obtain additional forward commitments, the Company may have to curtail loan origination and purchasing activities, which would have a material adverse effect on the Company's financial position and results of operations and jeopardize the Company's ability to continue to operate as a going concern. Risk of Adverse Changes in the Secondary Market for Mortgage Loans. The Company's ability to sell loans originated and purchased by it in the secondary market is necessary to generate cash proceeds to pay down its warehouse facilities and fund new originations and purchases. See "-- Dependence on Funding Sources." The ability of the Company to sell loans in the secondary market on acceptable terms is essential for the continuation of the Company's loan origination and purchase operations. The value of and market for the Company's loans are dependent upon a number of factors, including general economic conditions, interest rates and governmental regulations. Adverse changes in such factors may affect the Company's ability to securitize or sell whole loans for acceptable prices within a reasonable period of time. Adverse changes in the global markets severely weakened the asset-backed market. Although the asset-backed market has shown some recent improvement, many subprime lenders have continued to rely more heavily on the whole loan market for liquidity. This has resulted in an abundant supply of loans in the whole loan market thereby putting downward pressure on the price for loans so sold and tightening underwriting guidelines for loans to be purchased. In response to these conditions, the Company increased its prices and modified its underwriting guidelines. There can be no assurance, however, that these changes will make the whole loan market more profitable for, or more accessible to, the Company. The Company has in the past sold a substantial portion of its loans through securitizations, and will again securitize a significant portion of its loans. In order to gain access to the secondary market in securitization transactions, the Company has utilized monoline insurance companies to provide financial guarantee insurance on the senior interests in loans sold in the secondary market in order to obtain ratings for such interests. Although the Company has used the senior/subordinated structure, which relies on the internal credit enhancements of the pool rather than monoline insurance, the Company expects to utilize monoline insurance companies for at least a portion of its future securitizations. Any substantial reduction in the size or availability of the secondary market for the Company's loans, or the unwillingness of the monoline insurance companies to provide financial guarantee insurance for the senior interests in loans sold in the secondary market, or other accounting, tax or regulatory changes adversely affecting the Company's securitization program, could have a material adverse effect on the Company's financial position and results of operations. With its strategy of selling a portion of its loans on a whole loan basis in the secondary market, the Company relies on institutional purchasers, such as investment banks, financial institutions and other mortgage lenders, to purchase loans directly from the Company. There can be no assurance that such purchasers will be willing to purchase loans on terms satisfactory to the Company or that the market for such loans will continue. To the extent the Company cannot 39 40 successfully identify whole loan purchasers or negotiate favorable terms for loan purchases, the Company's results of operations and financial condition could be materially adversely affected. Dependence on Broker Network. The Company depends on independent mortgage brokers for the origination and purchase of its broker loans, which constitute a significant portion of the Company's loan production. These independent mortgage brokers negotiate with multiple lenders for each prospective borrower. The Company competes with these lenders for the independent brokers' business on pricing, service, loan fees, costs and other factors. The Company's competitors also seek to establish relationships with such brokers, who are not obligated by contract or otherwise to do business with the Company. The Company's future results of operations and financial condition may be vulnerable to changes in the volume and cost of its broker loans resulting from, among other things, competition from other lenders and purchasers of such loans. Competition. The Company faces intense competition in the business of originating, purchasing and selling mortgage loans. Competition among industry participants can take many forms, including convenience in obtaining a loan, customer service, marketing and distribution channels, amount and term of the loan, loan origination fees and interest rates. Many of the Company's competitors are substantially larger and have considerably greater financial, technical and marketing resources than the Company. The Company's competitors in the industry include other consumer finance companies, mortgage banking companies, commercial banks, investment banks, credit unions, thrift institutions, credit card issuers and insurance companies. In the future, the Company may also face competition from government-sponsored entities, such as FNMA and FHLMC. These government-sponsored entities may enter the subprime mortgage market and target potential customers in the Company's highest credit grades, who constitute a significant portion of the Company's customer base. The historical level of gains realized by the Company and its competitors on the sale of non-conforming mortgage loans could attract additional competitors into this market. Certain large finance companies and conforming mortgage originators have announced their intention to originate, or have purchased companies that originate and purchase, non-conforming mortgage loans, and some of these large mortgage companies, thrifts and commercial banks have begun offering non-conforming loan products to customers similar to the borrowers targeted by the Company. In addition, establishing a broker-sourced loan business requires a substantially smaller commitment of capital and human resources than a direct-sourced loan business. This relatively low barrier to entry permits new competitors to enter this market quickly and compete with the Company's wholesale lending business. Additional competition may lower the rates the Company can charge borrowers and increase the cost to purchase loans, thereby potentially lowering the gain on future loan sales or securitizations. Increased competition may also reduce the volume of the Company's loan origination and loan sales and increase the demand for the Company's experienced personnel and the potential that such personnel will leave the Company for the Company's competitors. 40 41 Competitors with lower costs of capital have a competitive advantage over the Company. During periods of declining rates, competitors may solicit the Company's customers to refinance their loans. In addition, during periods of economic slowdown or recession, the Company's borrowers may face financial difficulties and be more receptive to the offers of the Company's competitors to refinance their loans. The Company's correspondent and broker programs depend largely on independent mortgage bankers and brokers and other financial institutions for the purchases of new loans. The Company's competitors also seek to establish relationships with the same sources. The Company's future results may become more exposed to fluctuations in the volume and cost of the Company's purchases resulting from competition from other purchasers of such loans, market conditions and other factors. Concentration of Operations in California. At December 31, 1998, a significant portion of the loans serviced by the Company were secured by properties located in California. Because the Company's servicing portfolio is currently 21.5% concentrated in California, the Company's financial position and results of operations have been and are expected to continue to be influenced by general trends in the California economy and its residential real estate market. Residential real estate market declines may adversely affect the values of the properties securing loans such that the principal balances of such loans, together with any primary financing on the mortgaged properties, will equal or exceed the value of the mortgaged properties. In addition, California historically has been vulnerable to certain natural disaster risks, such as earthquakes and erosion-caused mudslides, which are not typically covered by the standard hazard insurance policies maintained by borrowers. Uninsured disasters may adversely impact the Company's ability to recover losses on properties affected by such disasters and adversely impact the Company's results of operations. Timing of Loan Sales. The Company's loan disposition strategy calls for substantially all of its production to be sold in the secondary market each quarter. However, market and other considerations, including the conformity of loan pools to monoline insurance company and rating agency requirements, could affect the timing of such transactions. Any delay in the sale of a significant portion of the Company's loan production beyond a quarter-end would postpone the recognition of gain on sale related to such loans until their sale and would likely result in losses for such quarter being reported by the Company. Economic Conditions. The risks associated with the Company's business become more acute in any economic slowdown or recession. Periods of economic slowdown or recession may be accompanied by decreased demand for consumer credit and declining real estate values. Any material decline in real estate values reduces the ability of borrowers to use home equity to support borrowings and increases the current combined loan-to-value ratios of loans previously made by the Company, thereby weakening collateral coverage and increasing the possibility of a loss in the event of liquidation. Further, delinquencies, foreclosures and losses generally increase during economic slowdowns or recessions. Because of the Company's focus on credit-impaired borrowers, the actual rates of delinquencies, foreclosures and losses on such loans could be higher than those generally experienced in the mortgage lending industry. In addition, in an economic slowdown or recession, 41 42 the Company's servicing costs may increase. Any sustained period of increased delinquencies, foreclosure, losses or increased costs could adversely affect the Company's ability to securitize or sell loans in the secondary market and could increase the cost of these transactions. See "-- Credit Risk" and "-- Risk of Adverse Changes in the Secondary Market for Mortgage Loans." Contingent Risks. Although the Company sells substantially all the mortgage loans which it originates or purchases, the Company retains some degree of credit risk on substantially all loans sold on a servicing retained basis. During the period of time that loans are held pending sale, the Company is subject to the various business risks associated with the lending business including the risk of borrower default, the risk of foreclosure and the risk that a rapid increase in interest rates would result in a decline in the value of loans to potential purchasers. The documents governing the Company's securitization program require the Company to establish deposit accounts or build overcollateralization levels through retention of excess cash flow distributions in such accounts or application of excess cash flow distributions to reduce the principal balances of the senior interests issued by the related trust, respectively. Such amounts serve as credit enhancement for the related trust and are therefore available to fund losses realized on loans held by such trust. The Company continues to be subject to the risks of default and foreclosure following securitization and the sale of loans to the extent of excess cash flow distributions required to be retained or applied to reduce principal from time-to-time. Such amounts are a condition to obtaining the requisite rating on the related interests in each trust. In addition, documents governing the Company's securitization program and whole loan sales require the Company to commit to repurchase or replace loans which do not conform to the representations and warranties made by the Company at the time of sale. When borrowers are delinquent in making monthly payments on loans included in a securitization trust, the Company is required to advance interest payments with respect to such delinquent loans. These advances require funding from the Company's capital resources but have priority of repayment from collections or recoveries on the loans in the related pool in the succeeding month. In the ordinary course of its business, the Company is subject to claims made against it by borrowers and private investors arising from, among other things, losses that are claimed to have been incurred as a result of alleged breaches of fiduciary obligations, misrepresentations, errors and omissions of employees and officers of the Company, incomplete documentation and failures by the Company to comply with various laws and regulations applicable to its business. The Company believes that liability with respect to any currently asserted claims or legal actions is not likely to be material to the Company's financial position or results of operations; however, any claims asserted in the future may result in legal expenses or liabilities which could have a material adverse effect on the Company's financial position and results of operations. Government Regulation. The Company's operations are subject to extensive regulation, supervision and licensing by federal, state and local governmental authorities and are subject to various laws and judicial and administrative decisions imposing requirements and restrictions on part or all of its operations. The Company's consumer lending activities are subject to the Federal Truth- 42 43 in-Lending Act and Regulation Z (including the Home Ownership and Equity Protection Act of 1994), the Federal Equal Credit Opportunity Act, as amended, and Regulation B, the Fair Credit Reporting Act of 1970, as amended, the Federal Real Estate Settlement Procedures Act and Regulation X, the Home Mortgage Disclosure Act, the Federal Debt Collection Practices Act and the National Housing Act of 1934, as well as other federal and state statutes and regulations affecting the Company's activities. The Company is also subject to the rules and regulations of, and examinations by, state regulatory authorities with respect to originating, processing, underwriting, selling, securitizing and servicing loans. These rules and regulations, among other things, impose licensing obligations on the Company, establish eligibility criteria for mortgage loans, prohibit discrimination, govern inspections and appraisals of properties and credit reports on loan applicants, regulate assessment, collection, foreclosure and claims handling, investment and interest payments on escrow balances and payment features, mandate certain disclosures and notices to borrowers and, in some cases, fix maximum interest rates, fees and mortgage loan amounts. Failure to comply with these requirements can lead to loss of approved status, certain rights of rescission for mortgage loans, class action lawsuits and administrative enforcement action. Members of Congress and government officials have from time-to-time suggested the elimination of the mortgage interest deduction for federal income tax purposes, either entirely or in part, based on borrower income, type of loan or principal amount. Because many of the Company's loans are made to borrowers for the purpose of consolidating consumer debt or financing other consumer needs, the competitive advantages of tax deductible interest, when compared with alternative sources of financing, could be eliminated or seriously impaired by such government action. Accordingly, the reduction or elimination of these tax benefits could have a material adverse effect on the demand for loans of the kind offered by the Company. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Securitizations - Hedging Interest Rate Risk. The most significant variable in the determination of gain on sale in a securitization is the spread between the weighted average coupon on the securitized loans and the pass-through interest rate. In the interim period between loan origination or purchase and securitization of such loans, the Company is exposed to interest rate risk. The majority of loans are securitized or sold within 90 days of origination or purchase. However, a portion of the loans are held for sale or securitization for as long as 12 months (or longer, in very limited circumstances) prior to securitization. If interest rates rise during the period that the mortgage loans are held, in the case of a securitization, the spread between the weighted average interest rate on the loans to be securitized and the pass-through interest rates on the securities to be sold (the latter having increased as a result of market rate movements) would narrow. Upon securitization, this would result in a reduction of the Company's related gain on sale. During the three and six months ended December 31,1998, gain on sale included a hedge gain of $1.8 million and a hedge loss of $13.5 million, respectively. Interest-Only Strips and OMSRs. The Company had interest-only strips of $323 million and $490 million outstanding at December 31, 1998 and June 30, 1998, respectively. The Company also 43 44 had OMSRs outstanding at December 31, 1998 and June 30, 1998 in the amount of $34.5 million and $32.1 million, respectively. Both of these instruments are valued at market at December 31, 1998 and June 30, 1998. The Company values these assets based on the present value of future cash flow streams net of expenses using various assumptions. See "Certain Accounting Considerations -- Accounting for Securitizations." These assets are subject to risk of accelerated mortgage prepayment or losses in excess of assumptions used in valuation. Ultimate cash flows realized from these assets would be reduced should prepayments or losses exceed assumptions used in the valuation. Conversely, cash flows realized would be greater should prepayments or losses be below expectations. PART II - OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 3.3 Certificate of Designation for Registrant's Series B Convertible Preferred Stock 3.4 Certificate of Designation for Registrant's Series C Convertible Preferred Stock 4.2(c) Amendment to Rights Agreement, dated as of December 23, 1998 (1) 4.7 Registration Rights Agreement, dated as of December 23, 1998 between Registrant and Capital Z Financial Services Fund II, L.P., and certain designated investors 10.22(b) First Amendment to Residuals Financing Agreement, dated as of October 6, 1998 between Registrant and NationsBank, N.A. 10.22(c) Second Amendment to Residual Financing Agreement, dated as of December 10, 1998 between Registrant and NationsBank, N.A. 10.23(a) Employment Agreement between Registrant and Cary H. Thompson 10.23(b) Amendment No. 1 to the Employment Agreement between the Registrant and Cary H. Thompson. 10.24 Management Investment Agreement between Registrant and Cary H. Thompson, dated as of February 10, 1999. 10.25 Employment Agreement between Registrant and Neil B. Kornswiet 10.26 Management Investment Agreement between Registrant and Neil B. Kornswiet, dated as of February 10, 1999. 10.27 Management Voting Agreement between Registrant, Cary H. Thompson and Neil B. Kornswiet, dated as of February 10, 1999.
44 45 10.28(a) Preferred Stock Purchase Agreement, dated as of December 23, 1998 between Registrant and Capital Z Financial Services Fund II, L.P. (1) 10.28(b) Amendment No. 1 to Preferred Stock Purchase Agreement, dated as of February 10, 1999 between Registrant and Capital Z Financial Services Fund II, L.P. 10.29 Second Supplemental Indenture, dated as of February 10, 1999, between Registrant, The Chase Manhattan Bank and certain wholly owned subsidiaries of Registrant, relating to Registrant's 9.125% Senior Notes due 2003. 11 Computation of Per Share Earnings (Loss) 27 Financial Disclosure Schedule
------------ (1) Incorporated by reference from Registrant's Current Report on Form 8-K dated December 31, 1998 (b) Reports on Form 8-K: During the fiscal quarter ended December 31, 1998, the Company filed (i) a Current Report on Form 8-K dated November 17, 1998 (earliest event reported November 16, 1998), reporting information under Item 5 with respect to discussions with a strategic partner for an equity infusion in the Company, first quarter earnings, production volume, the execution of a forward commitment, a loss on the Company's hedge position and cancellation of the Company's regular quarterly dividend; (ii) a Current Report on Form 8-K dated December 15, 1998 (earliest event reported December 14, 1998), reporting information under Item 5 with respect to the execution of the Second Amendment to the Residuals Financing Agreement by and among the Company and NationsBank, N.A. and the postponement of the Company's 1998 Annual Meeting; and (iii) a Current Report on Form 8-K dated December 31, 1998 (earliest event reported December 23, 1998), reporting information under Item 5 with respect to the execution of the Preferred Stock Purchase Agreement by and between the Company and Capital Z Financial Services Fund II, L.P. and an amendment of the Company's Rights Agreement. 45 46 AAMES FINANCIAL CORPORATION SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Report on Form 10-Q to be signed on its behalf by the undersigned, thereunto duly authorized. AAMES FINANCIAL CORPORATION Date: February 22, 1999 By: /s/ David A. Sklar ---------------------- David A. Sklar Executive Vice President-Finance and Chief Financial and Accounting Officer 46 47 AAMES FINANCIAL CORPORATION INDEX TO EXHIBITS
EXHIBIT NUMBER DESCRIPTION - ------- ----------- 3.3 Certificate of Designation for Registrant's Series B Convertible Preferred Stock 3.4 Certificate of Designation for Registrant's Series C Convertible Preferred Stock 4.2(c) Amendment to Rights Agreement, dated as of December 23, 1998 (1) 4.7 Registration Rights Agreement, dated as of December 23, 1998 between Registrant and Capital Z Financial Services Fund II, L.P., and certain designated investors 10.22(b) First Amendment to Residuals Financing Agreement, dated as of October 6, 1998 between Registrant and NationsBank, N.A. 10.22(c) Second Amendment to Residual Financing Agreement, dated as of December 10, 1998 between Registrant and NationsBank, N.A. 10.23(a) Employment Agreement between Registrant and Cary H. Thompson 10.23(b) Amendment No. 1 to the Employment Agreement between the Registrant and Cary H. Thompson. 10.24 Management Investment Agreement between Registrant and Cary H. Thompson, dated as of February 10, 1999. 10.25 Employment Agreement between Registrant and Neil B. Kornswiet 10.26 Management Investment Agreement between Registrant and Neil B. Kornswiet, dated as of February 10, 1999. 10.27 Management Voting Agreement between Registrant, Cary H. Thompson and Neil B. Kornswiet, dated as of February 10, 1999. 10.28(a) Preferred Stock Purchase Agreement, dated as of December 23, 1998 between Registrant and Capital Z Financial Services Fund II, L.P. (1) 10.28(b) Amendment No. 1 to Preferred Stock Purchase Agreement, dated as of February 10, 1999 between Registrant and Capital Z Financial Services Fund II, L.P. 10.29 Second Supplemental Indenture, dated as of February 10, 1999, between Registrant, The Chase Manhattan Bank and certain wholly owned subsidiaries of Registrant, relating to Registrant's 9.125% Senior Notes due 2003. 11 Computation of Per Share Earnings (Loss) 27 Financial Disclosure Schedule
------------ (1) Incorporated by reference from Registrant's Current Report on Form 8-K dated December 31, 1998 EX-3.3 2 CERTIF. OF DESIGNATION FOR SERIES B CONV. PREF.STK 1 EXHIBIT 3.3 - -------------------------------------------------------------------------------- CERTIFICATE OF THE VOTING POWERS, DESIGNATIONS, PREFERENCES AND RELATIVE, PARTICIPATING, OPTIONAL OR OTHER SPECIAL RIGHTS, AND QUALIFICATIONS, LIMITATIONS OR RESTRICTIONS THEREOF, OF SERIES B CONVERTIBLE PREFERRED STOCK OF AAMES FINANCIAL CORPORATION - -------------------------------------------------------------------------------- AAMES FINANCIAL CORPORATION, a corporation organized and existing under the General Corporation Law of the State of Delaware (the "Corporation"), hereby certifies that the following resolutions were adopted by the Board of Directors of the Corporation (the "Board of Directors") pursuant to authority of the Board of Directors as required by Section 151 of the Delaware General Corporation Law: RESOLVED, that pursuant to the authority granted to and vested in the Board of Directors in accordance with the provisions of the Certificate of Incorporation of the Corporation, as amended (the "Certificate of Incorporation"), the Board of Directors hereby creates a series of the Corporation's previously authorized preferred stock, par value $0.001 per share (the "Preferred Stock"), and hereby states the designation and number thereof, and fixes the voting powers, preferences and relative, participating, optional and other special rights, and the qualifications, limitations and restrictions thereof, as follows: SERIES B CONVERTIBLE PREFERRED STOCK: I. DESIGNATION AND AMOUNT The designation of this series of shares shall be "Series B Convertible Preferred Stock" (the "Series B Preferred Stock") par value $0.001 per share; the initial stated value per share shall be $1,000.00 (the "Initial Stated Value"); and the number of shares constituting such series shall be 100,000. The number of shares of the Series B Preferred Stock may be decreased from time to time by a resolution or resolutions of the Board of Directors; provided, however, that such number shall not be decreased below the aggregate number of shares of the Series B Preferred Stock then outstanding. II. RANK A. With respect to dividends, the Series B Preferred Stock shall rank (i) senior to each other class or series of Preferred Stock, except for the Series C Convertible Preferred Stock, par value $0.001 per share, of the Corporation (the "Series C Preferred Stock"); (ii) on a parity with the Series C Preferred Stock; and (iii) senior to the Corporation's Common Stock, par value $.001 per share (the "Common Stock"), and, except as specified above, all other classes and series of capital stock of the Corporation hereafter issued by the Corporation. With respect to dividends, all equity securities of the Corporation to which the Series B Preferred Stock ranks senior, including the Common Stock, are collectively referred to herein as the 2 "Junior Dividend Securities"; all equity securities of the Corporation with which the Series B Preferred Stock ranks on a parity, including the Series C Preferred Stock, are collectively referred to herein as the "Parity Dividend Securities"; and all equity securities of the Corporation (other than convertible debt securities) to which the Series B Preferred Stock ranks junior, with respect to dividends, are collectively referred to herein as the "Senior Dividend Securities." B. With respect to the distribution of assets upon liquidation, dissolution or winding up of the Corporation, whether voluntary or involuntary, the Series B Preferred Stock shall rank (i) senior to each other class or series of Preferred Stock of the Corporation, except for the Series C Preferred Stock; (ii) on a parity with the Series C Preferred Stock; and (iii) senior to the Common Stock, and, except as specified above, all other classes and series of capital stock of the Corporation hereafter issued by the Corporation. With respect to the distribution of assets upon liquidation, dissolution or winding up of the Corporation, whether voluntary or involuntary, all equity securities of the Corporation to which the Series B Preferred Stock ranks senior, including the Common Stock, are collectively referred to herein as "Junior Liquidation Securities"; all equity securities of the Corporation (other than convertible debt securities) to which the Series B Preferred Stock ranks on parity, including the Series C Preferred Stock, are collectively referred to herein as "Parity Liquidation Securities"; and all equity securities of the Corporation to which the Series B Preferred Stock ranks junior are collectively referred to herein as "Senior Liquidation Securities." C. The Series B Preferred Stock shall be subject to the creation of Junior Dividend Securities and Junior Liquidation Securities (collectively, "Junior Securities"), but no Parity Dividend Securities or Parity Liquidation Securities (collectively, "Parity Securities") (other than the Series C Preferred Stock) or Senior Dividend Securities or Senior Liquidation Securities (collectively, "Senior Securities") shall be created except in accordance with the terms hereof. III. DIVIDENDS A. DIVIDENDS. Subject to the terms of paragraph D below, shares of Series B Preferred Stock shall accumulate dividends at a rate of 6.5% per annum (the "Dividend Rate"), which dividends shall be paid quarterly in cash, in four equal quarterly installments on the last day of March, June, September and December of each year, or if any such date is not a Business Day, the Business Day next preceding such day (each such date, regardless of whether any dividends have been paid or declared and set aside for payment on such date, a "Dividend Payment Date"), to holders of record (the "Registered Holders") as they appear on the stock record books of the Corporation on the fifteenth day prior to the relevant Dividend Payment Date; provided, however, that during the Accrual Period (as defined in Article IX hereof) the Corporation shall have the option to accrue such dividends, which dividends, to the extent so accrued, shall compound quarterly. Prior to the consummation of the Recapitalization, dividends shall accrue and accumulate on the Initial Stated Value of each share of Series B Preferred Stock. Following the consummation of the Recapitalization, dividends shall accrue and accumulate on the Post-Recapitalization Stated Value of each share of Series B Preferred Stock. Dividends shall be paid only when, as and if declared by the Board of Directors out of funds at the time 2 3 legally available for the payment of dividends. Dividends shall begin to accumulate on outstanding shares of Series B Preferred Stock from the date of issuance and shall be deemed to accumulate from day to day whether or not earned or declared until paid. Dividends shall accumulate on the basis of a 360-day year consisting of twelve 30-day months (four 90-day quarters) and the actual number of days elapsed in the period for which payable. B. ACCUMULATION. Dividends on the Series B Preferred Stock shall be cumulative, and from and after (i) any Dividend Payment Date on which any dividend that has accumulated or been deemed to have accumulated through such date has not been paid in full (other than by reason of the election of the Corporation to accrue dividends during the Accrual Period); or (ii) any payment date set for a redemption on which such redemption payment has not been paid in full, additional dividends shall accumulate in respect of the amount of such unpaid dividends or unpaid redemption payment (the "Arrearage") at 125% of the stated dividend rate (or such lesser rate as may be the maximum rate that is then permitted by applicable law). Such additional dividends in respect of any Arrearage shall be deemed to accumulate from day to day whether or not earned or declared until the Arrearage is paid, shall be calculated as of such successive Dividend Payment Date, and shall constitute an additional Arrearage from and after any Dividend Payment Date to the extent not paid on such Dividend Payment Date. References in any Article herein to dividends that have accumulated or that have been deemed to have accumulated with respect to the Series B Preferred Stock shall include the amount, if any, of any Arrearage together with any dividends accumulated or deemed to have accumulated on such Arrearage pursuant to the immediately preceding two sentences. Additional dividends in respect of any Arrearage may be declared and paid at any time, in whole or in part, without reference to any regular Dividend Payment Date, to Registered Holders as they appear on the stock record books of the Corporation on such record date as may be fixed by the Board of Directors (which record date shall be no less than 10 days prior to the corresponding payment date). Dividends in respect of any Arrearage shall be paid in cash. C. METHOD OF PAYMENT. Dividends paid on the shares of Series B Preferred Stock in an amount less than the total amount of such dividends at the time accumulated and payable on all outstanding shares of Series B Preferred Stock shall be allocated pro rata on a share-by-share basis among all such shares then outstanding. After the Second Anniversary Date, dividends that are declared and paid in an amount less than the full amount of dividends accumulated on the Series B Preferred Stock (and on any Arrearage) shall be applied first to the earliest dividend which has not theretofore been paid. All cash payments of dividends on the shares of Series B Preferred Stock shall be made in such coin or currency of the United States of America as at the time of payment is legal tender for payment of public and private debts. D. SPECIAL DIVIDEND RIGHTS. 1. In addition to the dividend rights set forth in paragraph A above, prior to the consummation of the Recapitalization, the holders of shares of Series B Preferred Stock shall be entitled to receive, when, as and if declared by the Board of Directors out of funds legally available for such purpose, cash dividends in an amount per whole share (rounded to the nearest cent) equal to the Formula Number then in effect times the aggregate per share amount of all 3 4 cash dividends declared or paid on the Common Stock. If, prior to the consummation of the Recapitalization, the Corporation shall pay any dividend or make any distribution on the Common Stock payable in assets, securities or other forms of non-cash consideration, then, in each such case, the Corporation shall simultaneously pay or make on each whole outstanding share of the Series B Preferred Stock a dividend or distribution in like kind equal to the Formula Number then in effect times such dividend or distribution on each share of the Common Stock. The dividends and distributions on the Series B Preferred Stock pursuant to this paragraph are hereinafter referred to as "Participating Dividends." The Corporation shall declare each Participating Dividend immediately prior to or at the same time it declares any cash or non-cash dividend or distribution on the Common Stock in respect of which a Participating Dividend is required to be paid. No cash or non-cash dividend or distribution on the Common Stock in respect of which a Participating Dividend is required shall be paid or set aside for payment on the Common Stock unless a Participation Dividend in respect of such dividend shall be have been paid. Nothing contained in this paragraph D shall obligate the Company to declare or pay any dividend or other distribution on the Common Stock or (except pursuant to paragraph A of this Article III or in connection with a dividend or distribution on the Common Stock as provided in this paragraph D) the Series B Preferred Stock. 2. If the Recapitalization is not consummated prior to June 30, 1999, the Dividend Rate shall be deemed to be 15% per annum during the period commencing on such date and ending on the date the Recapitalization is consummated. IV. LIQUIDATION PREFERENCE A. PRIOR TO THE RECAPITALIZATION. In the event of a liquidation, dissolution or winding up of the Corporation, whether voluntary or involuntary, occurring prior to the consummation of the Recapitalization, the holders of then-outstanding shares of Series B Preferred Stock shall be entitled to receive out of the assets of the Corporation, whether such assets are capital or surplus of any nature, an amount per share equal to the sum of (i) the dividends, if any, accumulated or deemed to have accumulated thereon, to the date of final distribution to such holders, whether or not such dividends are declared; and (ii) the Initial Stated Value thereof, before any payment shall be made or any assets distributed to the holders of any Junior Liquidation Securities (the "Initial Preferred Distribution"). After the Initial Preferred Distribution has been made, the holders of Series B Preferred Stock shall be entitled to share pro rata with the holders of Common Stock in the distribution of any remaining assets of the Corporation on the basis of each whole outstanding share of the Series B Preferred Stock receiving an amount equal to the Formula Number then in effect times such distribution on each share of the Common Stock. The distributions on the Series B Preferred Stock pursuant to the immediately preceding sentence of this paragraph A are hereinafter referred to as "Participating Liquidation Distributions." No distribution on the Common Stock in respect of which a Participating Liquidation Distribution is required shall be paid or set aside for payment on the Common Stock unless a Participating Liquidation Distribution in respect of such distribution is concurrently paid. 4 5 B. AFTER THE RECAPITALIZATION. Subsequent to the consummation of the Recapitalization, the holders of the outstanding shares of Series B Preferred Stock shall be entitled to receive out of the assets of the Corporation, whether such assets are capital or surplus of any nature, an amount per share equal to the sum of (i) the dividends, if any, accumulated or deemed to have accumulated thereon to the date of final distribution to such holders, whether or not such dividends are declared; and (ii) the Post-Recapitalization Stated Value thereof, before any payment shall be made or any assets distributed to the holders of any Junior Liquidation Securities. After any such payment in full after the consummation of the Recapitalization, the holders of Series B Preferred Stock shall not, as such, be entitled to any further participation in any distribution of assets of the Corporation. C. PARITY SECURITIES. All the assets of the Corporation available for distribution to stockholders after the liquidation preferences of any Senior Liquidation Securities shall be distributed ratably (in proportion to the full distributable amounts to which holders of Series B Preferred Stock and Parity Liquidation Securities, if any, are respectively entitled upon such dissolution, liquidation or winding up) among the holders of the then-outstanding shares of Series B Preferred Stock and Parity Liquidation Securities, if any, when such assets are not sufficient to pay in full the aggregate amounts payable thereon. D. MERGER NOT A LIQUIDATION. Neither a consolidation or merger of the Corporation with or into any other Person or Persons, nor a sale, conveyance, lease, exchange or transfer of all or part of the Corporation's assets for cash, securities or other property to a Person or Persons shall be deemed to be a liquidation, dissolution or winding up of the Corporation for purposes of this Article IV, but the holders of shares of Series B Preferred Stock shall nevertheless be entitled from and after any such consolidation, merger or sale, conveyance, lease, exchange or transfer of all or part of the Corporation's assets to the rights provided by this Article IV following any such transaction. Notice of any voluntary or involuntary liquidation, dissolution or winding up of the Corporation, stating the payment date or dates when, and the place or places where, the amounts distributable to each holder of shares of Series B Preferred Stock in such circumstances shall be payable, shall be given by first-class mail, postage prepaid, mailed not less than 30 days prior to any payment date stated therein, to holders of record as they appear on the stock record books of the Corporation as of the date such notices are first mailed. V. REDEMPTION A. INTENTIONALLY OMITTED B. OPTIONAL REDEMPTION. Commencing on the earlier to occur of (x) the tenth anniversary of the Issue Date and (y) the date on which fewer than 25% of the shares of Series B Preferred Stock issued on the Issue Date remain outstanding, and at all times thereafter, the Corporation may, at its option, redeem all (but not less than all) outstanding shares of Series B Preferred Stock on a date specified by the Corporation (the "Optional Redemption Date") by paying the Redemption Price therefor in cash out of funds legally available for such purpose. C. NOTICE AND REDEMPTION PROCEDURES. Notice of the redemption of shares of Series B Preferred Stock pursuant to paragraph B of this Article V (a "Notice of Redemption") 5 6 shall be sent to the holders of record of the shares of Series B Preferred Stock to be redeemed by first class mail, postage prepaid, at each such holder's address as it appears on the stock record books of the Corporation not more than 120 nor fewer than 90 days prior to the Optional Redemption Date, which date shall be set forth in such notice (the "Redemption Date"); provided that failure to give such Notice of Redemption to any holder, or any defect in such Notice of Redemption to any holder shall not affect the validity of the proceedings for the redemption of any shares of Series B Preferred Stock held by any other holder. In order to facilitate the redemption of shares of Series B Preferred Stock, the Board of Directors may fix a record date for the determination of the holders of shares of Series B Preferred Stock to be redeemed not more than 30 days prior to the date the Notice of Redemption is mailed. On or after the Optional Redemption Date, each holder of the shares called for redemption shall surrender the certificate evidencing such shares to the Corporation at the place designated in such notice and shall thereupon be entitled to receive payment of the Redemption Price for such shares. From and after the Optional Redemption Date, all dividends on shares of Series B Preferred Stock shall cease to accumulate and all rights of the holders thereof as holders of Series B Preferred Stock shall cease and terminate, except to the extent the Corporation shall default in payment thereof on the Optional Redemption Date. D. DEPOSIT OF FUNDS. The Corporation shall, on or prior to the Optional Redemption Date, pursuant to paragraph C of this Article V, deposit with its transfer agent or other redemption agent in the Borough of Manhattan, The City of New York having a capital and surplus of at least $500,000,000 selected by the Board of Directors, as a trust fund for the benefit of the holders of the shares of Series B Preferred Stock to be redeemed, cash that is sufficient in amount to redeem the shares to be redeemed in accordance with the Notice of Redemption, with irrevocable instructions and authority to such transfer agent or other redemption agent to pay to the respective holders of such shares, as evidenced by a list of such holders certified by an officer of the Corporation, the Redemption Price for such shares upon surrender of their respective share certificates. Such deposit shall be deemed to constitute full payment of the Redemption Price for such shares to the holders, and from and after the date of such deposit, all rights of the holders of the shares of Series B Preferred Stock that are to be redeemed as stockholders of the Corporation with respect to such shares, except the right to receive the Redemption Price upon the surrender of their respective certificates, shall cease and terminate. No dividends shall accumulate on any shares of Series B Preferred Stock after the Optional Redemption Date for such shares (unless the Corporation shall fail to deposit cash sufficient to redeem all such shares). In case holders of any shares of Series B Preferred Stock called for redemption shall not, within two years after such deposit, claim the cash deposited for redemption thereof, such transfer agent or other redemption agent shall, upon demand, pay over to the Corporation the balance so deposited. Thereupon, such transfer agent or other redemption agent shall be relieved of all responsibility to the holders thereof and the sole right of such holders, with respect to shares to be redeemed, shall be to receive the Redemption Price as general creditors of the Corporation. Any interest accrued on any funds so deposited shall belong to the Corporation, and shall be paid to it from time to time on demand. 6 7 VI. RESTRICTIONS ON DIVIDENDS So long as any shares of the Series B Preferred Stock are outstanding, the Board of Directors shall not declare, and the Corporation shall not pay or set apart for payment any dividend on any Junior Securities or make any payment on account of, or set apart for payment money for a sinking or other similar fund for, the repurchase, redemption or other retirement of, any Junior Securities or Parity Securities or any warrants, rights or options exercisable for or convertible into any Junior Securities or Parity Securities (other than the repurchase, redemption or other retirement of debentures or other debt securities that are convertible or exchangeable into any Junior Securities or Parity Securities), or make any distribution in respect of the Junior Securities, either directly or indirectly, and whether in cash, obligations or shares of the Corporation or other property (other than distributions or dividends in Junior Securities to the holders of Junior Securities), and shall not permit any corporation or other entity directly or indirectly controlled by the Corporation to purchase or redeem any Junior Securities or Parity Securities or any warrants, rights, calls or options exercisable for or convertible into any Junior Securities or Parity Securities (other than the repurchase, redemption or other retirement of debentures or other debt securities that are convertible or exchangeable into any Junior Securities or Parity Securities or the repurchase, redemption or other retirement of Junior Securities or Parity Securities in exchange for Junior Securities or Parity Securities) unless prior to or concurrently with such declaration, payment, setting apart for payment, repurchase, redemption or other retirement or distribution, as the case may be, all accumulated and unpaid dividends on shares of the Series B Preferred Stock not paid on the dates provided for in paragraph A of Article III hereof (including Arrearages and accumulated dividends thereon) shall have been paid, except that when dividends are not paid in full as aforesaid upon the shares of Series B Preferred Stock, all dividends declared on the Series B Preferred Stock and any series of Parity Dividend Securities shall be declared and paid pro rata so that the amount of dividends so declared and paid on Series B Preferred Stock and such series of Parity Dividend Securities shall in all cases bear to each other the same ratio that accumulated dividends (including interest accrued on or additional dividends accumulated in respect of such accumulated dividends) on the shares of Series B Preferred Stock and such Parity Dividend Securities bear to each other. VII. VOTING RIGHTS A. On or prior to the consummation of the Recapitalization, the holders of Series B Preferred Stock shall be entitled to one thousand (1,000) votes per share of Series B Preferred Stock at each meeting of stockholders of the Corporation with respect to any and all matters presented to the stockholders of the Corporation for their action and consideration. After the consummation of the Recapitalization, the holders of Series B Preferred Stock shall be entitled to the number of votes per share of Series B Preferred Stock equal to the number of shares of Common Stock for which such share of Series B Preferred Stock is then convertible pursuant to Article VIII at each meeting of stockholders of the Corporation with respect to any and all matters presented to the stockholders of the Corporation for their action and consideration. 7 8 B. So long as any shares of the Series B Preferred Stock are outstanding, (i) each share of Series B Preferred Stock shall entitle the holder thereof to vote on all matters voted on by holders of Common Stock; and (ii) the shares of Series B Preferred Stock shall vote together with shares of Common Stock (and any shares of Series C Preferred Stock entitled to vote) as a single class. C. At each annual meeting of the stockholders of the Corporation, the holders of Series B Preferred Stock, voting as a separate class, shall have the right to elect, by the written consent (if action by written consent is permitted) or affirmative vote of the holders of a majority of the outstanding shares of Series B Preferred Stock, four members of a separate class of directors, each of whom shall serve until the next annual meeting of the stockholders of the Corporation or until his or her successor is elected and qualified. Such vote or consent shall be taken in accordance with the procedures specified in paragraph F below. The initial directors shall be Steven M. Gluckstern, Adam M. Mizel, Mani Sadeghi and David Spuria. D. Without the written consent (if action by written consent is permitted) or affirmative vote of the holders of a majority of the outstanding shares of Series B Preferred Stock and Series C Preferred Stock, voting together as a single class, the Corporation shall not (i) authorize, create or issue, or increase the authorized amount of, (x) any Senior Securities or Parity Securities or (y) any class or series of capital stock or any security convertible into or exercisable for any class or series of capital stock, redeemable mandatorily or redeemable at the option of the holder thereof or (ii) enter into any Transaction (as defined in paragraph H of Article VIII). Such vote or consent shall be taken in accordance with the procedures specified in paragraph F below. E. Without the written consent (if action by written consent is permitted) or affirmative vote of the holders of at least a majority of the outstanding shares of Series B Preferred Stock and Series C Preferred Stock, voting together as a single class, the Corporation shall not (i) amend, alter or repeal any provision of the Certificate of Incorporation or the Bylaws, if the amendment, alteration or repeal alters or changes the powers, preferences or special rights of the Series B Preferred Stock so as to affect them materially and adversely or (ii) authorize or take any other action if such action alters or changes any of the rights of the Series B Preferred Stock in any respect or otherwise would be inconsistent with the provisions of this Certificate of Designations and the holders of any class or series of the capital stock of the Corporation is entitled to vote thereon. Such vote or consent shall be taken in accordance with the procedures specified in paragraph F below. F. The foregoing rights of holders of shares of Series B Preferred Stock to take any actions as provided in this Article VII may be exercised at any annual meeting of stockholders or at a special meeting of stockholders held for such purpose as hereinafter provided or at any adjournment thereof, or by the written consent, delivered to the Secretary of the Corporation, of the holders of the minimum number of shares required to take such action, if action by written consent of stockholders of the Corporation is then permitted. 8 9 The Chairman of the Board of the Corporation may call, and upon written request of holders of record of 35% of the outstanding shares of Series B Preferred Stock, if the holders of Series B Preferred Stock are to vote separately as a single class, or the holders of record of 35% of the outstanding shares of Series B Preferred Stock and Series C Preferred Stock, if the holders of shares of Series B Preferred Stock are to vote as a class with the holders of shares of any Series C Preferred Stock, addressed to the Secretary of the Corporation at the principal office of the Corporation shall call, a special meeting of the holders of shares entitled to vote as provided herein. Such meeting shall be held within 30 days after delivery of such request to the Secretary, at the place and upon the notice provided by law and in the By-laws of the Corporation for the holding of meetings of stockholders. At each meeting of stockholders at which the holders of shares of Series B Preferred Stock shall have the right, voting separately as a single class or as a class with the holders of shares of any Series C Preferred Stock, to elect directors of the Corporation as provided in paragraph C above or to take any action, the presence in person or by proxy of the holders of record of one-third of the total number of shares of Series B Preferred Stock, if the holders of shares of Series B Preferred Stock are to vote separately as a single class, or the holders of record of one-third of the total number of shares of Series B Preferred Stock and Series C Preferred Stock, if the holder of shares of Series B Preferred Stock are to vote as a class with the holders of shares of Series C Preferred Stock, then outstanding and entitled to vote on the matter shall be necessary and sufficient to constitute a quorum. At any such meeting or at any adjournment thereof: (A) the absence of a quorum of the holders of shares of Series B Preferred Stock, if the holders of Series B Preferred Stock are to vote separately as a single class, shall not prevent the election of directors other than those to be elected by the holders of shares of Series B Preferred Stock, and the absence of a quorum of the holders of shares of any other class or series of capital stock shall not prevent the election of directors to be elected by the holders of shares of Series B Preferred Stock or the taking of any action as provided in this Article VII; and (B) in the absence of a quorum of the holders of shares of Series B Preferred Stock, if the holders of Series B Preferred Stock are to vote separately as a single class, or the holders of shares of Series B Preferred Stock and Series C Preferred Stock, if the holders of Series B Preferred Stock are to vote as a class with the holders of shares of Series C Preferred Stock, a majority of the holders of such shares present in person or by proxy shall have the power to adjourn the meeting as to the actions to be taken by the holders of shares of Series B Preferred Stock or the holders of Series B Preferred Stock and Series C Preferred Stock, as the case may be, from time to time and place to place without notice other than announcement at the meeting until a quorum shall be present. For taking of any action as provided in this Article VII by the holders of shares of Series B Preferred Stock voting separately as a single class or together with the holders of shares of Series B Preferred Stock and Series C Preferred Stock as a single class, as the case may be, each such holder shall have one vote for each share of such stock standing in his name on the 9 10 transfer books of the Corporation as of any record dated fixed for such purpose or, if no such date be fixed, at the close of business on the Business Day next preceding the day on which notice is given, or if notice if waived, at the close of business on the Business Day next preceding the day on which the meeting is held. In case any vacancy shall occur among the directors elected by the holders of shares of Series B Preferred Stock, as provided in paragraph C above, such vacancy may be filled for the unexpired portion of the term by vote of the remaining directors theretofore elected by such holders (if there is a remaining director), or the last remaining director's successor in office. If any such vacancy is not so filled within 20 days after the creation thereof or if all directors so elected by the holders of Series B Preferred Stock shall cease to serve as directors before their terms shall expire, the holders of the Series B Preferred Stock then outstanding and entitled to vote for such directors may, by written consent as herein provided (if action by written consent is permitted), or at a special meeting of such holders called as provided herein, elect successors to hold office for the unexpired terms of the directors whose places shall be vacant. Any director elected by the holders of shares of Series B Preferred Stock voting separately as a single class may be removed from office with or without cause by the vote or written consent (if action by written consent is permitted) of the holders of at least a majority of the outstanding shares of Series B Preferred Stock. A special meeting of the holders of shares of Series B Preferred Stock may be called in accordance with the procedures set forth in this paragraph F. G. The Corporation shall not enter into any agreement or issue any security that prohibits, conflicts or is inconsistent with, or would be breached by, the Corporation's performance of its obligations hereunder. VIII. CONVERSION The holders of the Series B Preferred Stock shall have conversion rights as follows: A. Each share of Series B Preferred Stock shall be convertible at the direction of, and by notice to the Corporation from, the holders of a majority of the outstanding shares of Series B Preferred Stock, at any time, at the office of the Corporation or any transfer agent for such Series, into one thousand (1,000) fully paid and nonassessable shares of Common Stock subject (x) to adjustment from time to time as provided below (as so adjusted, the "conversion ratio") and (y) (prior to the consummation of the Recapitalization) to limitations resulting from the available number of shares of Common Stock which may be reserved for issuance upon such conversion, provided ,that any conversion pursuant to this paragraph A of less than all of the outstanding shares of Series B Preferred Stock shall be on a pro rata basis amongst all holders of Series B Preferred Stock. After consummation of the Recapitalization, the number "1,000" in this paragraph shall be "1", subject to adjustment as provided in paragraph VIII.G. 10 11 B. If the holders of a majority of the outstanding shares of Series B Preferred Stock give notice of conversion under paragraph A above, the Corporation shall notify all other record holders of Series B Preferred Stock (a "Conversion Notice"). Following receipt of a Conversion Notice, the holders of Series B Preferred Stock shall surrender the certificate or certificates therefor duly endorsed, at the office of the Corporation or of any transfer agent for such Series, and shall state therein the name or names in which the certificate or certificates for shares of Common Stock are to be issued. The Corporation shall, as soon as practicable thereafter, issue and deliver at such office to such holder, or to the nominee or nominees of such holder, a certificate or certificates for the number of shares of Common Stock to which such holder shall be entitled as aforesaid. Such conversion shall be deemed to have been made immediately prior to the close of business on the date of such Conversion Notice and the person or persons entitled to receive the shares of Common Stock issuable upon such conversion shall be treated for all purposes as the recordholder or holders of such shares of Common Stock as of such date. The issuance of certificates or shares of Common Stock upon conversion of shares of Series B Preferred Stock shall be made without charge for any issue, stamp or other similar tax in respect of such issuance. C. No fractional shares shall be issued upon conversion of any shares of Series B Preferred Stock and the number of shares of Common Stock to be issued shall be rounded down to the nearest whole share, and the holder of Series B Preferred Stock shall be paid in cash for any fractional share. D. In case at any time or from time to time the Corporation shall pay any dividend or make any other distribution to the holders of its Common Stock or other class of securities, or shall offer for subscription pro rata to the holders of its Common Stock or other class of securities any additional shares of stock of any class or any other right, or there shall be any capital reorganization or reclassification of the Common Stock of the Corporation or consolidation or merger of the Corporation with or into another corporation, or any sale or conveyance to another corporation of the property of the Corporation as an entirety or substantially as an entirety, or there shall be a voluntary or involuntary dissolution, liquidation or winding up of the Corporation, then, in any one or more of said cases the Corporation shall give at least 20 days' prior written notice (the time of mailing of such notice shall be deemed to be the time of giving thereof) to the registered holders of the Series B Preferred Stock at the addresses of each as shown on the books of the Corporation maintained by the Transfer Agent thereof of the date on which (i) the books of the Corporation shall close or a record shall be taken for such stock dividend, 11 12 distribution or subscription rights or (ii) such reorganization, reclassification, consolidation, merger, sale or conveyance, dissolution, liquidation or winding up shall take place, as the case may be, provided that in the case of any Transaction to which paragraph H applies the Corporation shall give at least 30 days' prior written notice as aforesaid. Such notice shall also specify the date as of which the holders of the Common Stock of record shall participate in said dividend, distribution or subscription rights or shall be entitled to exchange their Common Stock for securities or other property deliverable upon such reorganization, reclassification, consolidation, merger, sale or conveyance or participate in such dissolution, liquidation or winding up, as the case may be. Failure to give such notice shall not invalidate any action so taken. E. From and after the Recapitalization, the Corporation shall at all times reserve and keep available out of its authorized but unissued shares of Common Stock, solely for the purpose of effecting the conversion of the shares of Series B Preferred Stock, such number of its shares of Common Stock as shall from time to time be sufficient to effect the conversion of all outstanding shares of Series B Preferred Stock, and if at any time the number of authorized but unissued shares of Common Stock shall not be sufficient to effect the conversion of all then outstanding shares of Series B Preferred Stock, then in addition to such other remedies as shall be available to the holder of Series B Preferred Stock, the Corporation will take such corporate action as may, in the opinion of its counsel, be necessary to increase its authorized but unissued shares of Common Stock to such number of shares as shall be sufficient for such purposes. F. Any notice required by the provisions of paragraph D to be given the holders of shares of Series B Preferred Stock shall be deemed given if sent by facsimile transmission, by telex, or if deposited in the United States mail, postage prepaid, and addressed to each holder of record at his, her or its address appearing on the books of the Corporation. G. The conversion ratio shall be subject to adjustment from time to time as follows: (i) In case the Corporation shall at any time or from time to time after the Issue Date (A) pay a dividend or make a distribution, on the outstanding shares of Common Stock in shares of Common Stock, (B) subdivide the outstanding shares of Common Stock into a larger number of shares of Common Stock, (C) combine the outstanding shares of Common Stock into a smaller number of shares or (D) issue by reclassification of the shares of Common Stock any shares of capital stock of the Corporation, then, and in each such case, the conversion ratio in effect immediately prior to such event or the record date therefor, whichever is earlier, shall be adjusted so that the holder of any shares of Series B Preferred Stock thereafter surrendered for conversion shall be entitled to receive the number of shares of Common Stock or other securities of the Corporation which such holder would have owned or have been entitled to receive after the happening of any of the events described above, had such shares of Series B Preferred Stock been surrendered for conversion immediately prior to the happening of such event or the record date therefor, whichever is earlier. An adjustment made pursuant to this clause (i) shall become effective (x) in the case of any such dividend or distribution, immediately after the close of business on the record date for the determination of holders of shares of Common Stock 12 13 entitled to receive such dividend or distribution, or (y) in the case of any such subdivision, reclassification or combination, at the close of business on the day upon which such corporate action becomes effective. (ii) In the case the Corporation shall, after the Issue Date, issue shares of Common Stock at a price per share, or securities convertible into or exchangeable for shares of Common Stock ("Convertible Securities") having a "Conversion Price" (as defined below) less than the Current Market Price (for a period of 15 consecutive trading days prior to such date), then, and in each such case, the conversion ratio shall be adjusted so that the holder of each share of Series B Preferred Stock shall be entitled to receive, upon the conversion thereof, the number of shares of Common Stock determined by multiplying (A) the applicable conversion ratio on the day immediately prior to such date by (B) a fraction, the numerator of which shall be the sum of (1) the number of shares of Common Stock outstanding on the date on which such shares or Convertible Securities are issued and (2) the number of additional shares of Common Stock issued, or into which the Convertible Securities may convert, and the denominator of which shall be the sum of (x) the number of shares of Common Stock outstanding on such date and (y) the number of shares of Common Stock which the aggregate consideration receivable by the Corporation for the total number of shares of Common Stock so issued, or the number of shares of Common Stock which the aggregate of the Conversion Price of such Convertible Securities so issued, would purchase at such Current Market price on such date. An adjustment made pursuant to this clause (ii) shall be made on the next Business Day following the date on which any such issuance is made and shall be effective retroactively immediately after the close of business on such date. For purposes of this clause (ii), the aggregate consideration receivable by the Corporation in connection with the issuance of any securities shall be deemed to be the sum of the aggregate offering price to the public (before deduction of underwriting discounts or commissions and expenses payable to third parties), and the "Conversion Price" of any Convertible Securities is the total amount received or receivable by the Corporation as consideration for the issue or sale of such Convertible Securities (before deduction of underwriting discounts or commissions and expenses payable to third parties) plus the minimum aggregate amount of additional consideration, if any, payable to the Corporation upon the conversion, exchange or exercise of any such Convertible Securities. Neither (A) the issuance of any shares of Common Stock (whether treasury shares or newly issued shares) pursuant to a dividend or distribution on, or subdivision, combination or reclassification of, the outstanding shares of Common Stock requiring an adjustment in the conversion ratio pursuant to clause (i) of this paragraph G, or pursuant to any employee benefit plan or program of the Corporation or pursuant to any option, warrant, right, or Convertible Security outstanding as of the date hereof (including, but not limited to, the Rights, the Series B Preferred Stock, the Series C Preferred Stock and the Warrants) nor (B) the issuance of shares of Common Stock pursuant thereto shall be deemed to 13 14 constitute an issuance of Common Stock or Convertible Securities by the Corporation to which this clause (ii) applies. Upon expiration of any Convertible Securities which shall not have been exercised or converted and for which an adjustment shall have been made pursuant to this clause (ii), the Conversion Price computed upon the original issue thereof shall upon expiration be recomputed as if the only additional shares of Common Stock issued were such shares of Common Stock (if any) actually issued upon exercise or conversion of such Convertible Securities and the consideration received therefor was the consideration actually received by the Corporation for the issue of such Convertible Securities (whether or not exercised or converted) plus the consideration actually received by the Corporation upon such exercise of conversion. (iii) In case the Corporation shall at any time or from time to time after the Issue Date declare, order, pay or make a dividend or other distribution (including, without limitation, any distribution of stock or other securities or property or rights or warrants to subscribe for securities of the Corporation or any of its Subsidiaries by way of dividend or spin-off), on its Common Stock, other than (A) regular quarterly dividends payable in cash in an aggregate amount not to exceed 15% of net income from continuing operations before extraordinary items of the Corporation, determined in accordance with generally accepted accounting principles, during the period (treated as one accounting period) commencing on July 1, 1998, and ending on the date such dividend is paid or (B) dividends or distributions of shares of Common Stock which are referred to in clause (i) of this paragraph G, then, and in each such case, the conversion ratio shall be adjusted so that the holder of each share of Series B Preferred Stock shall be entitled to receive, upon the conversion thereof, the number of shares of Common Stock determined by multiplying (1) the applicable conversion ratio on the day immediately prior to the record date fixed for the determination of stockholders entitled to receive such dividend or distribution by (2) a fraction, the numerator of which shall be the then Current Market Price per share of Common Stock for the period of 20 Trading Days preceding such record date, and the denominator of which shall be such Current Market Price per share of Common Stock for the period of 20 Trading Days preceding such record date, less the Fair Market Value (as defined in Article IX) per share of Common Stock (as determined in good faith by the Board of Directors of the Corporation, a certified resolution with respect to which shall be mailed to each holder of shares of Series B Preferred Stock) of such dividend or distribution; provided, however, that in the event of a distribution of shares of capital stock of a Subsidiary of the Corporation (a "Spin-Off") made to holders of shares of Common Stock, the numerator of such fraction shall be the sum of the Current Market Price per share of Common Stock for the period of 20 Trading Days preceding the 35th Trading Day after the effective date of such Spin-Off and the Current Market Price of the number of shares (or the fraction of a share) of capital stock of the Subsidiary which is 14 15 distributed in such Spin-Off in respect of one share of Common Stock for the period of 20 Trading Days preceding such 35th Trading Day and the denominator of which shall be the current market price per share of the Common Stock for the period of 20 Trading Days proceeding such 35th Trading Day. An adjustment made pursuant to this clause (iii) shall be made upon the opening of business on the next Business Day following the date on which any such dividend or distribution is made and shall be effective retroactively immediately after the close of business on the record date fixed for the determination of stockholders entitled to receive such dividend or distribution; provided, however, if the proviso to the preceding sentence applies, then such adjustment shall be made and be effective as of such 35th Trading Day after the effective date of such Spin-Off. (iv) For purposes of this paragraph G, the number of shares of Common Stock at any time outstanding shall not include any shares of Common Stock then owned or held by or for the account of the Corporation. (v) The term "dividend", as used in this paragraph G shall mean a dividend or other distribution upon stock of the Corporation except pursuant to the Rights Agreement (as defined in Article IX). Notwithstanding anything in this Article VIII to the contrary, the conversion ratio shall not be adjusted as a result of any dividend, distribution or issuance of securities of the Corporation pursuant to the Rights Agreement. (vi) Anything in this paragraph G to the contrary notwithstanding, the Corporation shall not be required to give effect to any adjustment in the conversion ratio unless and until the net effect of one or more adjustments (each of which shall be carried forward), determined as above provided, shall have resulted in a change of the conversion ratio by at least one-hundredth of one share of Common Stock, and when the cumulative net effect of more than one adjustment so determined shall be to change the conversion ratio by at least one-hundredth of one share of Common Stock, such change in conversion ratio shall thereupon be given effect. (vii) The certificate of any firm of independent public accountants of recognized standing selected by the Board of Directors of the Corporation (which may be the firm of independent public accountants regularly employed by the Corporation) shall be presumptively correct for any computation made under this paragraph G. (viii) If the Corporation shall take a record of the holders of its Common Stock for the purpose of entitling them to receive a dividend or other distribution, and shall thereafter and before the distribution to stockholders thereof legally abandon its plan to pay or deliver such dividend or distribution, then thereafter no adjustment in the number of shares of Common Stock issuable upon exercise of 15 16 the right of conversion granted by this paragraph G or in the conversion ratio then in effect shall be required by reason of the taking of such record. (ix) There shall be no adjustment of the conversion ratio in case of the issuance of any stock of the Corporation in a merger, reorganization, acquisition or other similar transaction except as set forth in paragraph G(i), G(ii) and H of this Article VIII. H. In case of any reorganization or reclassification of outstanding shares of Common Stock (other than a reclassification covered by paragraph G(i) of this Article VIII, or in case of any consolidation or merger of the Corporation with or into another corporation, or in the case of any sale or conveyance to another corporation of the property of the Corporation as an entirety or substantially as an entirety (each of the foregoing being referred to as a "Transaction"), each share of Series B Preferred Stock then outstanding shall thereafter be convertible into, in lieu of the Common Stock issuable upon such conversion prior to consummation of such Transaction, the kind and amount of shares of stock and other securities and property receivable (including cash) upon the consummation of such Transaction by a holder of that number of shares of Common Stock into which one share of Series B Preferred Stock was convertible immediately prior to such Transaction (including, on a pro rata basis, the cash, securities or property received by holders of Common Stock in any tender or exchange offer that is a step in such Transaction). In case securities or property other than Common Stock shall be issuable or deliverable upon conversion as aforesaid, then all reference in this paragraph H shall be deemed to apply, so far as appropriate and as nearly as may be, to such other securities or property. I. Upon any adjustment of the conversion ratio then in effect and any increase or decrease in the number of shares of Common Stock issuable upon the operation of the conversion set forth in Article VIII, then, and in each such case, the Corporation shall promptly deliver to the registered holders of the Series B Preferred and Common Stock, a certificate signed by the President or a Vice President and by the Treasurer or an Assistant Treasurer or the Secretary or an Assistant Secretary of the Corporation setting forth in reasonable detail the event requiring the adjustment and the method by which such adjustment was calculated and specifying the conversion ratio then in effect following such adjustment and the increased or decreased number of shares issuable upon the conversion set forth in this Article VIII. IX. ADDITIONAL DEFINITIONS For the purposes of this Certificate of Designations of Series B Preferred Stock, the following terms shall have the meanings indicated: "Accrual Period" means the end of the first quarterly period following the Second Anniversary Date. 16 17 "Beneficially Own" with respect to any securities means having "beneficial ownership" of such securities (as determined pursuant to Rule 13d-3 under the Exchange Act as in effect on the date hereof, except that a Person shall be deemed to Beneficially Own all such securities that such Person has the right to acquire whether such right is exercisable immediately or after the passage of time). The terms "Beneficial Ownership" and "Beneficial Owner" have correlative meanings. "Business Day" means any day, other than a Saturday, Sunday or a day on which banking institutions in the State of New York are authorized or obligated by law or executive order to close. "Bylaws" means the Bylaws of the Corporation, as amended. "Current Market Price", when used with reference to shares of Common Stock or other securities on any date, shall mean the closing price per share of Common Stock or such other securities on such date and, when used with reference to shares of Common Stock or other securities for any period shall mean the average of the daily closing prices per share of Common Stock or such other securities for such period. The closing price for each day shall be the last sale price, regular way, or, in case no such sale takes place on such day, the average of the closing bid and asked prices, regular way, in either case as reported in the principal consolidated transaction reporting system with respect to securities listed or admitted to trading on the New York Stock Exchange or, if the Common Stock or such other securities are not listed or admitted to trading on the New York Stock Exchange, as reported in the principal consolidated transaction reporting system with respect to securities listed on the principal national securities exchange on which the Common Stock or such other securities are listed or admitted to trading or, if the Common Stock is not listed or admitted to trading on any national securities exchange, the last quoted sale price or, if not so quoted, the average of the high bid and low asked prices in the over-the-counter market, as reported by the National Association of Securities Dealers, Inc. National Market System or such other securities are not quoted by any such organization, the average of the closing bid and asked prices as furnished by a professional market maker making a market in the Common Stock or such other securities selected by the Board of Directors of the Corporation. If the Common Stock or such other securities are not publicly held or so listed or publicly traded, "Current Market Price" shall mean the Fair Market Value per share of Common Stock or of such other securities as determined in good faith by the Board of Directors of the Corporation based on an opinion of an independent investment banking firm with an established national reputation as a valuer of securities, which opinion may be based on such assumption as such firm shall deem to be necessary and appropriate. "Equity Securities" of any Person means any and all common stock, preferred stock and any other class of capital stock of, and any partnership or limited liability company interests of such Person or any other similar interests of any Person that is not a corporation, partnership or limited liability company. "Exchange Act" means the U.S. Securities Exchange Act of 1934, as amended, and the rules and regulations promulgated thereunder, from time to time. 17 18 "Fair Market Value" shall mean the amount which a willing buyer would pay a willing seller in an arm's-length transaction. "Formula Number" shall mean one thousand (1,000) prior to consummation of the Recapitalization, provided, however, that if at any time prior to the consummation of the Recapitalization, the Corporation shall (i) declare or pay any dividend or make any distribution on the Common Stock, payable in shares of Common Stock; (ii) subdivide (by a stock split or otherwise) the outstanding shares of Common Stock into a larger number of shares of Common Stock; or (iii) combine (by a reverse stock split or otherwise) the outstanding shares of Common Stock into a smaller number of shares of Common Stock, then in each such case the Formula Number in effect immediately prior to such event shall be adjusted to a number determined by multiplying the Formula Number then in effect by a fraction, the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event (and rounding the result to the nearest whole number); and provided further, that, if prior to the consummation of the Recapitalization the Corporation shall issue any shares of its capital stock in a merger, reclassification, or change of the outstanding shares of Common Stock, then in each such event the Formula Number shall be appropriately adjusted to reflect such merger, reclassification, or change so that each share of Series B Preferred Stock continues to be the economic equivalent of a Formula Number of shares of Common Stock immediately prior to such merger, reclassification, or change. "Group" has the meaning set forth in Rule 13d-5 under the Exchange Act. "Issue Date" shall mean the first date on which shares of Series B Preferred Stock are issued. "Person" means any individual, corporation, company, association, partnership, joint venture, trust or unincorporated organization, or a government or any agency or political subdivision thereof. "Post-Recapitalization Stated Value" shall be equal to $1.00. "Recapitalization" means the amendment of the Corporation's Certificate of Incorporation to increase the authorized shares of Common Stock from 50,000,000 to 400,000,000, and the authorized shares of Preferred Stock from 1,000,000 to 200,000,000, and the subsequent one thousand-for-one split of Series B Preferred Stock and Series C Preferred Stock. "Redemption Price" of a share of Class B Preferred Stock shall mean the sum of (a) the dividends, if any, accumulated or deemed to have accumulated thereon to the Optional Redemption Date, whether or not such dividends are declared plus (b) either (i) the Initial Stated Value thereof (if the Recapitalization has not been consummated prior to June 30, 1999) or (ii) the Post-Recapitalization Stated Value thereof (if the Recapitalization has been consummated prior to June 30, 1999), in each case subject to adjustment for splits, reclassifications, recombinations or other similar events. 18 19 "Rights" shall mean any rights to purchase securities of the Corporation issued pursuant to any Rights Agreement. "Rights Agreement" shall mean the Rights Agreement, dated as of June 21, 1996, between the Company and Wells Fargo Bank as rights agent, and all amendments, supplements and replacements thereof. "Second Anniversary Date" means the second anniversary of the Issue Date. "Subsidiary" means, as to any Person, any other Person of which more than 50% of the shares of the Voting Securities or other voting interests are owned or controlled, or the ability to select or elect 50% or more of the directors or similar managers is held, directly or indirectly, by such first Person and one or more of its Subsidiaries. "Trading Day" means a day on which the principal national securities exchange on which the Common Stock is listed or admitted to trading is open for the transaction of business or, if the Common Stock is not listed or admitted to trading on any national securities exchange a Business Day. "Voting Securities" means, (i) with respect to the Company, the Equity Securities of the Company entitled to vote generally for the election of directors of the Company, and (ii) with respect to any other Person, any securities of or interests in such Person entitled to vote generally for the election of directors or any similar managing person of such Person. X. MISCELLANEOUS A. NOTICES. Any notice referred to herein shall be in writing and, unless first-class mail shall be specifically permitted for such notices under the terms hereof, shall be deemed to have been given upon personal delivery thereof, upon transmittal of such notice by telecopy (with confirmation of receipt by telecopy or telex) or five days after transmittal by registered or certified mail, postage prepaid, addressed as follows: (i) if to the Corporation, to its office at 2 California Plaza, 350 South Grand Avenue, Los Angeles, California 90071 (Attention: General Counsel) or to the transfer agent for the Series B Preferred Stock; (ii) if to a holder of the Series B Preferred Stock, to such holder at the address of such holder as listed in the stock record books of the Corporation (which may include the records of any transfer agent for the Series B Preferred Stock); or (iii) to such other address as the Corporation or such holder, as the case may be, shall have designated by notice similarly given. 19 20 B. REACQUIRED SHARES. Any shares of Series B Preferred Stock redeemed, purchased or otherwise acquired by the Corporation, directly or indirectly, in any manner whatsoever shall be retired and canceled promptly after the acquisition thereof (and shall not be deemed to be outstanding for any purpose) and, if necessary to provide for the lawful redemption or purchase of such shares, the capital represented by such shares shall be reduced in accordance with the Delaware General Corporation Law. All such shares of Series B Preferred Stock shall upon their cancellation and upon the filing of an appropriate certificate with the Secretary of State of the State of Delaware, become authorized but unissued shares of Preferred Stock, par value $0.001 per share, of the Corporation and may be reissued as part of another series of Preferred Stock, par value $0.001 per share, of the Corporation subject to the conditions or restrictions on issuance set forth herein. C. ENFORCEMENT. Any registered holder of shares of Series B Preferred Stock may proceed to protect and enforce its rights and the rights of such holders by any available remedy by proceeding at law or in equity to protect and enforce any such rights, whether for the specific enforcement of any provision in this Certificate of Designations or in aid of the exercise of any power granted herein, or to enforce any other proper remedy. D. TRANSFER TAXES. Except as otherwise agreed upon pursuant to the terms of this Certificate of Designations, the Corporation shall pay any and all documentary, stamp or similar issue or transfer taxes and other governmental charges that may be imposed under the laws of the United States of America or any political subdivision or taxing authority thereof or therein in respect of any issue or delivery of Common Stock on conversion of, or other securities or property issued on account of, shares of Series B Preferred Stock pursuant hereto or certificates representing such shares or securities. The Corporation shall not, however, be required to pay any such tax or other charge that may be imposed in connection with any transfer involved in the issue or transfer and delivery of any certificate for Common Stock or other securities or property in a name other than that in which the shares of Series B Preferred Stock so exchanged, or on account of which such securities were issued, were registered and no such issue or delivery shall be made unless and until the Person requesting such issue has paid to the Corporation the amount of any such tax or has established to the satisfaction of the Corporation that such tax has been paid or is not payable. E. TRANSFER AGENT. The Corporation may appoint, and from time to time discharge and change, a transfer agent for the Series B Preferred Stock. Upon any such appointment or discharge of a transfer agent, the Corporation shall send notice thereof by first-class mail, postage prepaid, to each holder of record of shares of Series B Preferred Stock. F. RECORD DATES. In the event that the Series B Preferred Stock shall be registered under either the Securities Act of 1933, as amended, or the Exchange Act, the Corporation shall establish appropriate record dates with respect to payments and other actions to be made with respect to the Series B Preferred Stock. 20 21 IN WITNESS WHEREOF, this Certificate of Designations is executed on behalf of the Corporation by its Executive vice President, General Counsel and Secretary and attested by its Assistant Secretary, this 10th day of February , 1999. AAMES FINANCIAL CORPORATION By: /s/ Barbara S. Polsky --------------------------------- Name: Barbara S. Polsky Title: Executive Vice President, General Counsel and Secretary [Corporate Seal] ATTEST: /s/ John F. Madden, Jr. - --------------------------------- John F. Madden Jr. Assistant Secretary 21 EX-3.4 3 CERTIF. OF DESIGNATION FOR SERIES C CONV.PREF.STK 1 EXHIBIT 3.4 - -------------------------------------------------------------------------------- CERTIFICATE OF THE VOTING POWERS, DESIGNATIONS, PREFERENCES AND RELATIVE, PARTICIPATING, OPTIONAL OR OTHER SPECIAL RIGHTS, AND QUALIFICATIONS, LIMITATIONS OR RESTRICTIONS THEREOF, OF SERIES C CONVERTIBLE PREFERRED STOCK OF AAMES FINANCIAL CORPORATION - -------------------------------------------------------------------------------- AAMES FINANCIAL CORPORATION, a corporation organized and existing under the General Corporation Law of the State of Delaware (the "Corporation"), hereby certifies that the following resolutions were adopted by the Board of Directors of the Corporation (the "Board of Directors") pursuant to authority of the Board of Directors as required by Section 151 of the Delaware General Corporation Law: RESOLVED, that pursuant to the authority granted to and vested in the Board of Directors in accordance with the provisions of the Certificate of Incorporation of the Corporation, as amended (the "Certificate of Incorporation"), the Board of Directors hereby creates a series of the Corporation's previously authorized preferred stock, par value $0.001 per share (the "Preferred Stock"), and hereby states the designation and number thereof, and fixes the voting powers, preferences and relative, participating, optional and other special rights, and the qualifications, limitations and restrictions thereof, as follows: SERIES C CONVERTIBLE PREFERRED STOCK: I. DESIGNATION AND AMOUNT The designation of this series of shares shall be "Series C Convertible Preferred Stock" (the "Series C Preferred Stock") par value $0.001 per share; the initial stated value per share shall be $1,000.00 (the "Initial Stated Value"); and the number of shares constituting such series shall be 100,000. The number of shares of the Series C Preferred Stock may be decreased from time to time by a resolution or resolutions of the Board of Directors; provided, however, that such number shall not be decreased below the aggregate number of shares of the Series C Preferred Stock then outstanding. II. RANK A. With respect to dividends, the Series C Preferred Stock shall rank (i) senior to each other class or series of Preferred Stock, except for the Series B Convertible Preferred Stock, par value $0.001 per share, of the Corporation (the "Series B Preferred Stock"); (ii) on a parity with the Series B Preferred Stock; and (iii) senior to the Corporation's Common Stock, par value $.001 per share (the "Common Stock"), and, except as specified above, all other classes and series of capital stock of the Corporation hereafter issued by the Corporation. With respect to dividends, all equity securities of the Corporation to which the Series C Preferred Stock ranks senior, including the Common Stock, are collectively referred to herein as the 2 "Junior Dividend Securities"; all equity securities of the Corporation with which the Series C Preferred Stock ranks on a parity, including the Series B Preferred Stock, are collectively referred to herein as the "Parity Dividend Securities"; and all equity securities of the Corporation (other than convertible debt securities) to which the Series C Preferred Stock ranks junior, with respect to dividends, are collectively referred to herein as the "Senior Dividend Securities." B. With respect to the distribution of assets upon liquidation, dissolution or winding up of the Corporation, whether voluntary or involuntary, the Series C Preferred Stock shall rank (i) senior to each other class or series of Preferred Stock, except for the Series B Preferred Stock; (ii) on a parity with the Series B Preferred Stock; and (iii) senior to the Common Stock, and, except as specified above, all other classes and series of capital stock of the Corporation hereafter issued by the Corporation. With respect to the distribution of assets upon liquidation, dissolution or winding up of the Corporation, whether voluntary or involuntary, all equity securities of the Corporation to which the Series C Preferred Stock ranks senior, including the Common Stock, are collectively referred to herein as "Junior Liquidation Securities"; all equity securities of the Corporation (other than convertible debt securities) to which the Series C Preferred Stock ranks on parity, including the Series B Preferred Stock, are collectively referred to herein as "Parity Liquidation Securities"; and all equity securities of the Corporation to which the Series C Preferred Stock ranks junior are collectively referred to herein as "Senior Liquidation Securities." C. The Series C Preferred Stock shall be subject to the creation of Junior Dividend Securities and Junior Liquidation Securities (collectively, "Junior Securities"), but no Parity Dividend Securities or Parity Liquidation Securities (collectively, "Parity Securities") (other than the Series B Preferred Stock) or Senior Dividend Securities or Senior Liquidation Securities (collectively, "Senior Securities") shall be created except in accordance with the terms hereof. III. DIVIDENDS A. DIVIDENDS. Subject to the terms of paragraph D below, shares of Series C Preferred Stock shall accumulate dividends at a rate of 6.5% per annum (the "Dividend Rate"), which dividends shall be paid quarterly in cash, in four equal quarterly installments on the last day of March, June, September and December of each year, or if any such date is not a Business Day, the Business Day next preceding such day (each such date, regardless of whether any dividends have been paid or declared and set aside for payment on such date, a "Dividend Payment Date"), to holders of record (the "Registered Holders") as they appear on the stock record books of the Corporation on the fifteenth day prior to the relevant Dividend Payment Date; provided, however, that during the Accrual Period (as defined in Article IX hereof) the Corporation shall have the option to accrue such dividends, which dividends, to the extent so accrued, shall compound quarterly. Prior to the consummation of the Recapitalization, dividends shall accrue and accumulate on the Initial Stated Value of each share of Series B Preferred Stock. Following the consummation of the Recapitalization, dividends shall accrue and accumulate on the Post-Recapitalization Stated Value of each share of Series B Preferred Stock. Dividends shall be paid only when, as and if declared by the Board of Directors out of funds at the time 2 3 legally available for the payment of dividends. Dividends shall begin to accumulate on outstanding shares of Series C Preferred Stock from the date of issuance and shall be deemed to accumulate from day to day whether or not earned or declared until paid. Dividends shall accumulate on the basis of a 360-day year consisting of twelve 30-day months (four 90-day quarters) and the actual number of days elapsed in the period for which payable. B. ACCUMULATION. Dividends on the Series C Preferred Stock shall be cumulative, and from and after (i) any Dividend Payment Date on which any dividend that has accumulated or been deemed to have accumulated through such date has not been paid in full (other than by reason of the election of the Corporation to accrue dividends during the Accrual Period); or (ii) any payment date set for a redemption on which such redemption payment has not been paid in full, additional dividends shall accumulate in respect of the amount of such unpaid dividends or unpaid redemption payment (the "Arrearage") at 125% of the stated dividend rate (or such lesser rate as may be the maximum rate that is then permitted by applicable law). Such additional dividends in respect of any Arrearage shall be deemed to accumulate from day to day whether or not earned or declared until the Arrearage is paid, shall be calculated as of such successive Dividend Payment Date, and shall constitute an additional Arrearage from and after any Dividend Payment Date to the extent not paid on such Dividend Payment Date. References in any Article herein to dividends that have accumulated or that have been deemed to have accumulated with respect to the Series C Preferred Stock shall include the amount, if any, of any Arrearage together with any dividends accumulated or deemed to have accumulated on such Arrearage pursuant to the immediately preceding two sentences. Additional dividends in respect of any Arrearage may be declared and paid at any time, in whole or in part, without reference to any regular Dividend Payment Date, to Registered Holders as they appear on the stock record books of the Corporation on such record date as may be fixed by the Board of Directors (which record date shall be no less than 10 days prior to the corresponding payment date). Dividends in respect of any Arrearage shall be paid in cash. C. METHOD OF PAYMENT. Dividends paid on the shares of Series C Preferred Stock in an amount less than the total amount of such dividends at the time accumulated and payable on all outstanding shares of Series C Preferred Stock shall be allocated pro rata on a share-by-share basis among all such shares then outstanding. After the Second Anniversary Date, dividends that are declared and paid in an amount less than the full amount of dividends accumulated on the Series C Preferred Stock (and on any Arrearage) shall be applied first to the earliest dividend which has not theretofore been paid. All cash payments of dividends on the shares of Series C Preferred Stock shall be made in such coin or currency of the United States of America as at the time of payment is legal tender for payment of public and private debts. D. SPECIAL DIVIDEND RIGHTS. 1. In addition to the dividend rights set forth in paragraph A above, prior to the consummation of the Recapitalization, the holders of shares of Series C Preferred Stock shall be entitled to receive, when, as and if declared by the Board of Directors out of funds legally available for such purpose, cash dividends in an amount per whole share (rounded to the nearest cent) equal to the Formula Number then in effect times the aggregate per share amount of all 3 4 cash dividends declared or paid on the Common Stock. If, prior to the consummation of the Recapitalization, the Corporation shall pay any dividend or make any distribution on the Common Stock payable in assets, securities or other forms of non-cash consideration, then, in each such case, the Corporation shall simultaneously pay or make on each whole outstanding share of the Series C Preferred Stock a dividend or distribution in like kind equal to the Formula Number then in effect times such dividend or distribution on each share of the Common Stock. The dividends and distributions on the Series C Preferred Stock pursuant to this paragraph D are hereinafter referred to as "Participating Dividends." The Corporation shall declare each Participating Dividend immediately prior to or at the same time it declares any cash or non-cash dividend or distribution on the Common Stock in respect of which a Participating Dividend is required to be paid. No cash or non-cash dividend or distribution on the Common Stock in respect of which a Participating Dividend is required shall be paid or set aside for payment on the Common Stock unless a Participation Dividend in respect of such dividend shall be have been paid. Nothing contained in this paragraph D shall obligate the Company to declare or pay any dividend or other distribution on the Common Stock or (except pursuant to paragraph A of this Article III or in connection with a dividend or distribution on the Common Stock as provided in this paragraph D) the Series B Preferred Stock. 2. If the Recapitalization is not consummated prior to June 30, 1999, the Dividend Rate shall be deemed to be 15% per annum during the period commencing on such date and ending on the date the Recapitalization is consummated. IV. LIQUIDATION PREFERENCE A. PRIOR TO THE RECAPITALIZATION. In the event of a liquidation, dissolution or winding up of the Corporation, whether voluntary or involuntary, occurring prior to the consummation of the Recapitalization, the holders of then-outstanding shares of Series C Preferred Stock shall be entitled to receive out of the assets of the Corporation, whether such assets are capital or surplus of any nature, an amount per share equal to the sum of (i) the dividends, if any, accumulated or deemed to have accumulated thereon, to the date of final distribution to such holders, whether or not such dividends are declared; and (ii) the Initial Stated Value thereof, before any payment shall be made or any assets distributed to the holders of any Junior Liquidation Securities (the "Initial Preferred Distribution"). After the Initial Preferred Distribution has been made, the holders of Series C Preferred Stock shall be entitled to share pro rata with the holders of Common Stock in the distribution of any remaining assets of the Corporation on the basis of each whole outstanding share of the Series C Preferred Stock receiving an amount equal to the Formula Number then in effect times such distribution on each share of the Common Stock. The distributions on the Series C Preferred Stock pursuant to the immediately preceding sentence of this paragraph A are hereinafter referred to as "Participating Liquidation Distributions." No distribution on the Common Stock in respect of which a Participating Liquidation Distribution is required shall be paid or set aside for payment on the Common Stock unless a Participating Liquidation Distribution in respect of such distribution is concurrently paid. 4 5 B. AFTER THE RECAPITALIZATION. Subsequent to the consummation of the Recapitalization, the holders of the outstanding shares of Series C Preferred Stock shall be entitled to receive out of the assets of the Corporation, whether such assets are capital or surplus of any nature, an amount per share equal to the sum of (i) the dividends, if any, accumulated or deemed to have accumulated thereon to the date of final distribution to such holders, whether or not such dividends are declared; and (ii) the Post-Recapitalization Stated Value thereof, before any payment shall be made or any assets distributed to the holders of any Junior Liquidation Securities. After any such payment in full after the consummation of the Recapitalization, the holders of Series C Preferred Stock shall not, as such, be entitled to any further participation in any distribution of assets of the Corporation. C. PARITY SECURITIES. All the assets of the Corporation available for distribution to stockholders after the liquidation preferences of any Senior Liquidation Securities shall be distributed ratably (in proportion to the full distributable amounts to which holders of Series C Preferred Stock and Parity Liquidation Securities, if any, are respectively entitled upon such dissolution, liquidation or winding up) among the holders of the then-outstanding shares of Series C Preferred Stock and Parity Liquidation Securities, if any, when such assets are not sufficient to pay in full the aggregate amounts payable thereon. D. MERGER NOT A LIQUIDATION. Neither a consolidation or merger of the Corporation with or into any other Person or Persons, nor a sale, conveyance, lease, exchange or transfer of all or part of the Corporation's assets for cash, securities or other property to a Person or Persons shall be deemed to be a liquidation, dissolution or winding up of the Corporation for purposes of this Article IV, but the holders of shares of Series C Preferred Stock shall nevertheless be entitled from and after any such consolidation, merger or sale, conveyance, lease, exchange or transfer of all or part of the Corporation's assets to the rights provided by this Article IV following any such transaction. Notice of any voluntary or involuntary liquidation, dissolution or winding up of the Corporation, stating the payment date or dates when, and the place or places where, the amounts distributable to each holder of shares of Series C Preferred Stock in such circumstances shall be payable, shall be given by first-class mail, postage prepaid, mailed not less than 30 days prior to any payment date stated therein, to holders of record as they appear on the stock record books of the Corporation as of the date such notices are first mailed. V. REDEMPTION A. INTENTIONALLY OMITTED B. OPTIONAL REDEMPTION. Commencing on the earlier to occur of (x) the tenth anniversary of the Issue Date and (y) the date on which fewer than 25% of the shares of Series C Preferred Stock issued on the Issue Date remain outstanding, and at all times thereafter, the Corporation may, at its option, redeem all (but not less than all) outstanding shares of Series C Preferred Stock on a date specified by the Corporation (the "Optional Redemption Date") by paying the Redemption Price therefor in cash out funds legally available for such purpose. C. NOTICE AND REDEMPTION PROCEDURES. Notice of the redemption of shares of Series C Preferred Stock pursuant to paragraph B of this Article V (a "Notice of Redemption") 5 6 shall be sent to the holders of record of the shares of Series C Preferred Stock to be redeemed by first class mail, postage prepaid, at each such holder's address as it appears on the stock record books of the Corporation not more than 120 nor fewer than 90 days prior to the Optional Redemption Date, which date shall be set forth in such notice (the "Redemption Date"); provided that failure to give such Notice of Redemption to any holder, or any defect in such Notice of Redemption to any holder shall not affect the validity of the proceedings for the redemption of any shares of Series C Preferred Stock held by any other holder. In order to facilitate the redemption of shares of Series C Preferred Stock, the Board of Directors may fix a record date for the determination of the holders of shares of Series C Preferred Stock to be redeemed not more than 30 days prior to the date the Notice of Redemption is mailed. On or after the Optional Redemption Date, each holder of the shares called for redemption shall surrender the certificate evidencing such shares to the Corporation at the place designated in such notice and shall thereupon be entitled to receive payment of the Redemption Price for such shares. From and after the Optional Redemption Date, all dividends on shares of Series C Preferred Stock shall cease to accumulate and all rights of the holders thereof as holders of Series C Preferred Stock shall cease and terminate, except to the extent the Corporation shall default in payment thereof on the Optional Redemption Date. D. DEPOSIT OF FUNDS. The Corporation shall, on or prior to the Optional Redemption Date, pursuant to paragraph C of this Article V, deposit with its transfer agent or other redemption agent in the Borough of Manhattan, The City of New York having a capital and surplus of at least $500,000,000 selected by the Board of Directors, as a trust fund for the benefit of the holders of the shares of Series C Preferred Stock to be redeemed, cash that is sufficient in amount to redeem the shares to be redeemed in accordance with the Notice of Redemption, with irrevocable instructions and authority to such transfer agent or other redemption agent to pay to the respective holders of such shares, as evidenced by a list of such holders certified by an officer of the Corporation, the Redemption Price upon surrender of their respective share certificates. Such deposit shall be deemed to constitute full payment of the Redemption Price for such shares to the holders, and from and after the date of such deposit, all rights of the holders of the shares of Series C Preferred Stock that are to be redeemed as stockholders of the Corporation with respect to such shares, except the right to receive the Redemption Price upon the surrender of their respective certificates, shall cease and terminate. No dividends shall accumulate on any shares of Series C Preferred Stock after the Optional Redemption Date, for such shares (unless the Corporation shall fail to deposit cash sufficient to redeem all such shares). In case holders of any shares of Series C Preferred Stock called for redemption shall not, within two years after such deposit, claim the cash deposited for redemption thereof, such transfer agent or other redemption agent shall, upon demand, pay over to the Corporation the balance so deposited. Thereupon, such transfer agent or other redemption agent shall be relieved of all responsibility to the holders thereof and the sole right of such holders, with respect to shares to be redeemed, shall be to receive the Redemption Price as general creditors of the Corporation. Any interest accrued on any funds so deposited shall belong to the Corporation, and shall be paid to it from time to time on demand. 6 7 VI. RESTRICTIONS ON DIVIDENDS So long as any shares of the Series C Preferred Stock are outstanding, the Board of Directors shall not declare, and the Corporation shall not pay or set apart for payment any dividend on any Junior Securities or make any payment on account of, or set apart for payment money for a sinking or other similar fund for, the repurchase, redemption or other retirement of, any Junior Securities or Parity Securities or any warrants, rights or options exercisable for or convertible into any Junior Securities or Parity Securities (other than the repurchase, redemption or other retirement of debentures or other debt securities that are convertible or exchangeable into any Junior Securities or Parity Securities), or make any distribution in respect of the Junior Securities, either directly or indirectly, and whether in cash, obligations or shares of the Corporation or other property (other than distributions or dividends in Junior Securities to the holders of Junior Securities), and shall not permit any corporation or other entity directly or indirectly controlled by the Corporation to purchase or redeem any Junior Securities or Parity Securities or any warrants, rights, calls or options exercisable for or convertible into any Junior Securities or Parity Securities (other than the repurchase, redemption or other retirement of debentures or other debt securities that are convertible or exchangeable into any Junior Securities or Parity Securities or the repurchase, redemption or other retirement of Junior Securities or Parity Securities in exchange for Junior Securities or Parity Securities) unless prior to or concurrently with such declaration, payment, setting apart for payment, repurchase, redemption or other retirement or distribution, as the case may be, all accumulated and unpaid dividends on shares of the Series C Preferred Stock not paid on the dates provided for in paragraph A of Article III hereof (including Arrearages and accumulated dividends thereon) shall have been paid, except that when dividends are not paid in full as aforesaid upon the shares of Series C Preferred Stock, all dividends declared on the Series C Preferred Stock and any series of Parity Dividend Securities shall be declared and paid pro rata so that the amount of dividends so declared and paid on Series C Preferred Stock and such series of Parity Dividend Securities shall in all cases bear to each other the same ratio that accumulated dividends (including interest accrued on or additional dividends accumulated in respect of such accumulated dividends) on the shares of Series C Preferred Stock and such Parity Dividend Securities bear to each other. VII. VOTING RIGHTS A. On or prior to the consummation of the Recapitalization, the holders of Series C Preferred Stock shall be entitled to one thousand (1,000) votes per share of Series C Preferred Stock at each meeting of stockholders of the Corporation with respect to any and all matters presented to the stockholders of the Corporation for their action and consideration, other than the election of directors. After the consummation of the Recapitalization, the holders of Series C Preferred Stock shall be entitled to the number of votes per share of Series C Preferred Stock equal to the number of shares of Common Stock for which such share of Series C Preferred Stock is then convertible pursuant to Article VIII at each meeting of stockholders of the Corporation with respect to any and all matters presented to the stockholders of the Corporation for their action and consideration, other than the election of directors. 7 8 B. So long as any shares of the Series C Preferred Stock are outstanding, (i) each share of Series C Preferred Stock shall entitle the holder thereof to vote on all matters voted on by holders of Common Stock, other than the election of directors; and (ii) the shares of Series C Preferred Stock shall vote together with shares of Common Stock and shares of Series B Preferred Stock as a single class. C. Without the written consent (if action by written consent is permitted) or affirmative vote of the holders of a majority of the outstanding shares of Series C Preferred Stock and Series B Preferred Stock, voting together as a single class, the Corporation shall not (i) authorize, create or issue, or increase the authorized amount of, (x) any Senior Securities or Parity Securities or (y) any class or series of capital stock or any security convertible into or exercisable for any class or series of capital stock, redeemable mandatorily or redeemable at the option of the holder thereof or (ii) enter into any Transaction (as defined in paragraph H of Article VIII). Such vote or consent shall be taken in accordance with the procedures specified in paragraph E below. D. Without the written consent (if action by written consent is permitted) or affirmative vote of the holders of at least a majority of the outstanding shares of Series C Preferred Stock and Series B Preferred Stock, voting together as a single class, the Corporation shall not (i) amend, alter or repeal any provision of the Certificate of Incorporation or the Bylaws, if the amendment, alteration or repeal alters or changes the powers, preferences or special rights of the Series C Preferred Stock so as to affect them materially and adversely or (ii) authorize or take any other action if such action alters or changes any of the rights of the Series C Preferred Stock in any respect or otherwise would be inconsistent with the provisions of this Certificate of Designations and the holders of any class or series of the capital stock of the Corporation is entitled to vote thereon. Such vote or consent shall be taken in accordance with the procedures specified in paragraph E below. E. The foregoing rights of holders of shares of Series C Preferred Stock to take any actions as provided in this Article VII may be exercised at any annual meeting of stockholders or at a special meeting of stockholders held for such purpose as hereinafter provided or at any adjournment thereof, or by the written consent, delivered to the Secretary of the Corporation, of the holders of the minimum number of shares required to take such action, if action by written consent of stockholders of the Corporation is then permitted. The Chairman of the Board of the Corporation may call, and upon written request of holders of record of 35% of the outstanding shares of Series C Preferred Stock and Series B Preferred Stock, addressed to the Secretary of the Corporation at the principal office of the Corporation shall call, a special meeting of the holders of shares entitled to vote as provided herein. Such meeting shall be held within 30 days after delivery of such request to the Secretary, at the place and upon the notice provided by law and in the By-laws of the Corporation for the holding of meetings of stockholders. At each meeting of stockholders at which the holders of shares of Series C Preferred Stock shall have the right to take any action, the presence in person or by proxy of the 8 9 holders of record of one-third of the total number of shares of Series C Preferred Stock and Series B Preferred Stock then outstanding and entitled to vote on the matter shall be necessary and sufficient to constitute a quorum. At any such meeting or at any adjournment thereof: (A) the absence of a quorum of the holders of shares of Series C Preferred Stock shall not prevent the election of directors to be elected by the holders of shares of Series B Preferred Stock or the taking of any action as provided in this Article VII; and (B) in the absence of a quorum of the holders of shares of Series C Preferred Stock and Series B Preferred Stock, a majority of the holders of such shares present in person or by proxy shall have the power to adjourn the meeting as to the actions to be taken by the holders of shares of Series C Preferred Stock and Series B Preferred Stock, from time to time and place to place without notice other than announcement at the meeting until a quorum shall be present. For taking of any action as provided in this Article VII by the holders of shares of Series C Preferred Stock and Series B Preferred Stock, each such holder shall have one vote for each share of such stock standing in his name on the transfer books of the Corporation as of any record dated fixed for such purpose or, if no such date be fixed, at the close of business on the Business Day next preceding the day on which notice is given, or if notice if waived, at the close of business on the Business Day next preceding the day on which the meeting is held. F. The Corporation shall not enter into any agreement or issue any security that prohibits, conflicts or is inconsistent with, or would be breached by, the Corporation's performance of its obligations hereunder. VIII. CONVERSION The holders of the Series C Preferred Stock shall have conversion rights as follows: A. Each share of Series C Preferred Stock shall be convertible at the direction of, and by notice to the Corporation from, (i) the holder thereof or (ii) the holders of a majority of the outstanding shares of Series C Preferred Stock, at any time, at the office of the Corporation or any transfer agent for such Series, into one thousand (1,000) fully paid and nonassessable shares of Common Stock subject (x) to adjustment from time to time as provided below (as so adjusted, the "conversion ratio") and (y) (prior to the consummation of the Recapitalization) to limitations resulting from the available number of shares of Common Stock which may be reserved for issuance upon such conversion, provided, that any conversion pursuant to clause (ii) above of less than all of the outstanding shares of Series C Preferred Stock shall be on a pro rata basis amongst all holders of Series C Preferred Stock. After consummation of the Recapitalization, the number "1,000" in this paragraph shall be "1", subject to adjustment as provided in paragraph VIII.G. 9 10 B. If a holder of Series C Preferred Stock gives notice (an "Optional Conversion Notice") of conversion under paragraph A above, such holder shall surrender with such Optional Conversion Notice the duly endorsed certificate or certificates for the Series C Preferred Stock being converted, at the office of the Corporation or of any transfer agent for such Series, and shall state therein the name or names in which the certificate or certificates for shares of Common Stock are to be issued. If the holders of a majority of the outstanding shares of Series C Preferred Stock give notice of conversion under paragraph A above, the Corporation shall notify all other record holders of Series C Preferred Stock (a "Mandatory Conversion Notice"). Following receipt of a Mandatory Conversion Notice, the holders of Series C Preferred Stock shall surrender the certificate or certificates therefor duly endorsed, at the office of the Corporation or of any transfer agent for such Series, and shall state therein the name or names in which the certificate or certificates for shares of Common Stock are to be issued. The Corporation shall, as soon as practicable after the surrender of a Series C Preferred Stock certificate or certificates pursuant to an Optional Conversion Notice or Mandatory Conversion Notice, issue and deliver at such office to such holder, or to the nominee or nominees of such holder, a certificate or certificates for the number of shares of Common Stock to which such holder shall be entitled as aforesaid. Such conversion shall be deemed to have been made immediately prior to the close of business on the date of such Optional Conversion Notice or Mandatory Conversion Notice, as applicable, and the person or persons entitled to receive the shares of Common Stock issuable upon such conversion shall be treated for all purposes as the recordholder or holders of such shares of Common Stock as of such date. The issuance of certificates or shares of Common Stock upon conversion of shares of Series C Preferred Stock shall be made without charge for any issue, stamp or other similar tax in respect of such issuance. C. No fractional shares shall be issued upon conversion of any shares of Series C Preferred Stock and the number of shares of Common Stock to be issued shall be rounded down to the nearest whole share, and the holder of Series C Preferred Stock shall be paid in cash for any fractional share. D. In case at any time or from time to time the Corporation shall pay any dividend or make any other distribution to the holders of its Common Stock or other class of securities, or shall offer for subscription pro rata to the holders of its Common Stock or other class of securities any additional shares of stock of any class or any other right, or there shall be any capital reorganization or reclassification of the Common Stock of the Corporation or consolidation or merger of the Corporation with or into another corporation, or any sale or conveyance to another corporation of the property of the Corporation as an entirety or substantially as an entirety, or there shall be a voluntary or involuntary dissolution, liquidation or winding up of the Corporation, then, in any one or more of said cases the Corporation shall give at least 20 days' prior written notice (the time of mailing of such notice shall be deemed to be the time of giving thereof) to the registered holders of the Series C 10 11 Preferred Stock at the addresses of each as shown on the books of the Corporation maintained by the Transfer Agent thereof of the date on which (i) the books of the Corporation shall close or a record shall be taken for such stock dividend, distribution or subscription rights or (ii) such reorganization, reclassification, consolidation, merger, sale or conveyance, dissolution, liquidation or winding up shall take place, as the case may be, provided that in the case of any Transaction to which paragraph H applies the Corporation shall give at least 30 days' prior written notice as aforesaid. Such notice shall also specify the date as of which the holders of the Common Stock of record shall participate in said dividend, distribution or subscription rights or shall be entitled to exchange their Common Stock for securities or other property deliverable upon such reorganization, reclassification, consolidation, merger, sale or conveyance or participate in such dissolution, liquidation or winding up, as the case may be. Failure to give such notice shall not invalidate any action so taken. E. From and after the Recapitalization, the Corporation shall at all times reserve and keep available out of its authorized but unissued shares of Common Stock, solely for the purpose of effecting the conversion of the shares of Series C Preferred Stock, such number of its shares of Common Stock as shall from time to time be sufficient to effect the conversion of all outstanding shares of Series C Preferred Stock, and if at any time the number of authorized but unissued shares of Common Stock shall not be sufficient to effect the conversion of all then outstanding shares of Series C Preferred Stock, then in addition to such other remedies as shall be available to the holder of Series C Preferred Stock, the Corporation will take such corporate action as may, in the opinion of its counsel, be necessary to increase its authorized but unissued shares of Common Stock to such number of shares as shall be sufficient for such purposes. F. Any notice required by the provisions of paragraph D to be given the holders of shares of Series C Preferred Stock shall be deemed given if sent by facsimile transmission, by telex, or if deposited in the United States mail, postage prepaid, and addressed to each holder of record at his, her or its address appearing on the books of the Corporation. G. The conversion ratio shall be subject to adjustment from time to time as follows: (i) In case the Corporation shall at any time or from time to time after the Issue Date (A) pay a dividend or make a distribution, on the outstanding shares of Common Stock in shares of Common Stock, (B) subdivide the outstanding shares of Common Stock into a larger number of shares of Common Stock, (C) combine the outstanding shares of Common Stock into a smaller number of shares or (D) issue by reclassification of the shares of Common Stock any shares of capital stock of the Corporation, then, and in each such case, the conversion ratio in effect immediately prior to such event or the record date therefor, whichever is earlier, shall be adjusted so that the holder of any shares of 11 12 Series C Preferred Stock thereafter surrendered for conversion shall be entitled to receive the number of shares of Common Stock or other securities of the Corporation which such holder would have owned or have been entitled to receive after the happening of any of the events described above, had such shares of Series C Preferred Stock been surrendered for conversion immediately prior to the happening of such event or the record date therefor, whichever is earlier. An adjustment made pursuant to this clause (i) shall become effective (x) in the case of any such dividend or distribution, immediately after the close of business on the record date for the determination of holders of shares of Common Stock entitled to receive such dividend or distribution, or (y) in the case of any such subdivision, reclassification or combination, at the close of business on the day upon which such corporate action becomes effective. (ii) In the case the Corporation shall, after the Issue Date, issue shares of Common Stock at a price per share, or securities convertible into or exchangeable for shares of Common Stock ("Convertible Securities") having a "Conversion Price" (as defined below) less than the Current Market Price (for a period of 15 consecutive trading days prior to such date), then, and in each such case, the conversion ratio shall be adjusted so that the holder of each share of Series C Preferred Stock shall be entitled to receive, upon the conversion thereof, the number of shares of Common Stock determined by multiplying (A) the applicable conversion ratio on the day immediately prior to such date by (B) a fraction, the numerator of which shall be the sum of (1) the number of shares of Common Stock outstanding on the date on which such shares or Convertible Securities are issued and (2) the number of additional shares of Common Stock issued, or into which the Convertible Securities may convert, and the denominator of which shall be the sum of (x) the number of shares of Common Stock outstanding on such date and (y) the number of shares of Common Stock which the aggregate consideration receivable by the Corporation for the total number of shares of Common Stock so issued, or the number of shares of Common Stock which the aggregate of the Conversion Price of such Convertible Securities so issued, would purchase at such Current Market price on such date. An adjustment made pursuant to this clause (ii) shall be made on the next Business Day following the date on which any such issuance is made and shall be effective retroactively immediately after the close of business on such date. For purposes of this clause (ii), the aggregate consideration receivable by the Corporation in connection with the issuance of any securities shall be deemed to be the sum of the aggregate offering price to the public (before deduction of underwriting discounts or commissions and expenses payable to third parties), and the "Conversion Price" of any Convertible Securities is the total amount received or receivable by the Corporation as consideration for the issue or sale of such Convertible Securities (before deduction of underwriting discounts or commissions and expenses payable to third parties) plus the minimum aggregate amount of additional consideration, if any, payable to the Corporation upon the conversion, exchange or exercise of any such Convertible Securities. Neither (A) 12 13 the issuance of any shares of Common Stock (whether treasury shares or newly issued shares) pursuant to a dividend or distribution on, or subdivision, combination or reclassification of, the outstanding shares of Common Stock requiring an adjustment in the conversion ratio pursuant to clause (i) of this paragraph G, or pursuant to any employee benefit plan or program of the Corporation or pursuant to any option, warrant, right, or Convertible Security outstanding as of the date hereof (including, but not limited to, the Rights, the Series B Preferred Stock, the Series C Preferred Stock and the Warrants) nor (B) the issuance of shares of Common Stock pursuant thereto shall be deemed to constitute an issuance of Common Stock or Convertible Securities by the Corporation to which this clause (ii) applies. Upon expiration of any Convertible Securities which shall not have been exercised or converted and for which an adjustment shall have been made pursuant to this clause (ii), the Conversion Price computed upon the original issue thereof shall upon such expiration be recomputed as if the only additional shares of Common Stock issued were such shares of Common Stock (if any) actually issued upon exercise of such Convertible Securities and the consideration received therefor was the consideration actually received by the Corporation for the issue of such Convertible Securities (whether or not exercised or converted) plus the consideration actually received by the Corporation upon such exercise of conversion. (iii) In case the Corporation shall at any time or from time to time after the Issue Date declare, order, pay or make a dividend or other distribution (including, without limitation, any distribution of stock or other securities or property or rights or warrants to subscribe for securities of the Corporation or any of its Subsidiaries by way of dividend or spin-off), on its Common Stock, other than (A) regular quarterly dividends payable in cash in an aggregate amount not to exceed 15% of net income from continuing operations before extraordinary items of the Corporation, determined in accordance with generally accepted accounting principles, during the period (treated as one accounting period) commencing on July 1, 1998, and ending on the date such dividend is paid or (B) dividends or distributions of shares of Common Stock which are referred to in clause (i) of this paragraph G, then, and in each such case, the conversion ratio shall be adjusted so that the holder of each share of Series C Preferred Stock shall be entitled to receive, upon the conversion thereof, the number of shares of Common Stock determined by multiplying (1) the applicable conversion ratio on the day immediately prior to the record date fixed for the determination of stockholders entitled to receive such dividend or distribution by (2) a fraction, the numerator of which shall be the then Current Market Price per share of Common Stock for the period of 20 Trading Days preceding such record date, and the denominator of which shall be such Current Market Price per share of Common Stock for the period of 20 Trading Days preceding such record date less the Fair Market Value (as defined in Article IX) per share of Common Stock (as determined in good faith by the Board of Directors of the Corporation, a certified resolution with 13 14 respect to which shall be mailed to each holder of shares of Series C Preferred Stock) of such dividend or distribution; provided, however, that in the event of a distribution of shares of capital stock of a Subsidiary of the Corporation (a "Spin-Off") made to holders of shares of Common Stock, the numerator of such fraction shall be the sum of the Current Market Price per share of Common Stock for the period of 20 Trading Days preceding the 35th Trading Day after the effective date of such Spin-Off and the Current Market Price of the number of shares (or the fraction of a share) of capital stock of the Subsidiary which is distributed in such Spin-Off in respect of one share of Common Stock for the period of 20 Trading Days preceding such 35th Trading Day and the denominator of which shall be the current market price per share of the Common Stock for the period of 20 Trading Days proceeding such 35th Trading Day. An adjustment made pursuant to this clause (iii) shall be made upon the opening of business on the next Business Day following the date on which any such dividend or distribution is made and shall be effective retroactively immediately after the close of business on the record date fixed for the determination of stockholders entitled to receive such dividend or distribution; provided, however, if the proviso to the preceding sentence applies, then such adjustment shall be made and be effective as of such 35th Trading Day after the effective date of such Spin-Off. (iv) For purposes of this paragraph G, the number of shares of Common Stock at any time outstanding shall not include any shares of Common Stock then owned or held by or for the account of the Corporation. (v) The term "dividend", as used in this paragraph G shall mean a dividend or other distribution upon stock of the Corporation except pursuant to the Rights Agreement (as defined in Article IX). Notwithstanding anything in this Article VIII to the contrary, the conversion ratio shall not be adjusted as a result of any dividend, distribution or issuance of securities of the Corporation pursuant to the Rights Agreement. (vi) Anything in this paragraph G to the contrary notwithstanding, the Corporation shall not be required to give effect to any adjustment in the conversion ratio unless and until the net effect of one or more adjustments (each of which shall be carried forward), determined as above provided, shall have resulted in a change of the conversion ratio by at least one-hundredth of one share of Common Stock, and when the cumulative net effect of more than one adjustment so determined shall be to change the conversion ratio by at least one-hundredth of one share of Common Stock, such change in conversion ratio shall thereupon be given effect. (vii) The certificate of any firm of independent public accountants of recognized standing selected by the Board of Directors of the Corporation (which may be the firm of independent public accountants regularly employed by the 14 15 Corporation) shall be presumptively correct for any computation made under this paragraph G. (viii) If the Corporation shall take a record of the holders of its Common Stock for the purpose of entitling them to receive a dividend or other distribution, and shall thereafter and before the distribution to stockholders thereof legally abandon its plan to pay or deliver such dividend or distribution, then thereafter no adjustment in the number of shares of Common Stock issuable upon exercise of the right of conversion granted by this paragraph G or in the conversion ratio then in effect shall be required by reason of the taking of such record. (ix) There shall be no adjustment of the conversion ratio in case of the issuance of any stock of the Corporation in a merger, reorganization, acquisition or other similar transaction except as set forth in paragraph G(i), G(ii) and H of this Article VIII. H. In case of any reorganization or reclassification of outstanding shares of Common Stock (other than a reclassification covered by paragraph G(i) of this Article VIII), or in case of any consolidation or merger of the Corporation with or into another corporation, or in the case of any sale or conveyance to another corporation of the property of the Corporation as an entirety or substantially as an entirety (each of the foregoing being referred to as a "Transaction"), each share of Series C Preferred Stock then outstanding shall thereafter be convertible into, in lieu of the Common Stock issuable upon such conversion prior to consummation of such Transaction, the kind and amount of shares of stock and other securities and property receivable (including cash) upon the consummation of such Transaction by a holder of that number of shares of Common Stock into which one share of Series C Preferred Stock was convertible immediately prior to such Transaction (including, on a pro rata basis, the cash, securities or property received by holders of Common Stock in any tender or exchange offer that is a step in such Transaction). In case securities or property other than Common Stock shall be issuable or deliverable upon conversion as aforesaid, then all reference in this paragraph H shall be deemed to apply, so far as appropriate and as nearly as may be, to such other securities or property. I. Upon any adjustment of the conversion ratio then in effect and any increase or decrease in the number of shares of Common Stock issuable upon the operation of the conversion set forth in Article VIII, then, and in each such case, the Corporation shall promptly deliver to the registered holders of the Series C Preferred and Common Stock, a certificate signed by the President or a Vice President and by the Treasurer or an Assistant Treasurer or the Secretary or an Assistant Secretary of the Corporation setting forth in reasonable detail the event requiring the adjustment and the method by which such adjustment was calculated and specifying the conversion ratio then in effect following such adjustment and 15 16 the increased or decreased number of shares issuable upon the conversion set forth in this Article VIII. IX. ADDITIONAL DEFINITIONS For the purposes of this Certificate of Designations of Series C Preferred Stock, the following terms shall have the meanings indicated: "Accrual Period" means the end of the first quarterly period following the Second Anniversary Date. "Beneficially Own" with respect to any securities means having "beneficial ownership" of such securities (as determined pursuant to Rule 13d-3 under the Exchange Act as in effect on the date hereof, except that a Person shall be deemed to Beneficially Own all such securities that such Person has the right to acquire whether such right is exercisable immediately or after the passage of time). The terms "Beneficial Ownership" and "Beneficial Owner" have correlative meanings. "Business Day" means any day, other than a Saturday, Sunday or a day on which banking institutions in the State of New York are authorized or obligated by law or executive order to close. "Bylaws" means the Bylaws of the Corporation, as amended. "Current Market Price", when used with reference to shares of Common Stock or other securities on any date, shall mean the closing price per share of Common Stock or such other securities on such date and, when used with reference to shares of Common Stock or other securities for any period shall mean the average of the daily closing prices per share of Common Stock or such other securities for such period. The closing price for each day shall be the last sale price, regular way, or, in case no such sale takes place on such day, the average of the closing bid and asked prices, regular way, in either case as reported in the principal consolidated transaction reporting system with respect to securities listed or admitted to trading on the New York Stock Exchange or, if the Common Stock or such other securities are not listed or admitted to trading on the New York Stock Exchange, as reported in the principal consolidated transaction reporting system with respect to securities listed on the principal national securities exchange on which the Common Stock or such other securities are listed or admitted to trading or, if the Common Stock is not listed or admitted to trading on any national securities exchange, the last quoted sale price or, if not so quoted, the average of the high bid and low asked prices in the over-the-counter market, as reported by the National Association of Securities Dealers, Inc. National Market System or such other securities are not quoted by any such organization, the average of the closing bid and asked prices as furnished by a professional market maker making a market in the Common Stock or such other securities selected by the Board of Directors of the Corporation. If the Common Stock or such other securities are not publicly held or so listed or publicly traded, "Current Market Price" shall mean the Fair Market Value per share of Common Stock or of such other securities as determined in good faith by the Board of Directors of the 16 17 Corporation based on an opinion of an independent investment banking firm with an established national reputation as a valuer of securities, which opinion may be based on such assumption as such firm shall deem to be necessary and appropriate. "Equity Securities" of any Person means any and all common stock, preferred stock and any other class of capital stock of, and any partnership or limited liability company interests of such Person or any other similar interests of any Person that is not a corporation, partnership or limited liability company. "Exchange Act" means the U.S. Securities Exchange Act of 1934, as amended, and the rules and regulations promulgated thereunder, from time to time. "Fair Market Value" shall mean the amount which a willing buyer would pay a willing seller in an arm's-length transaction. "Formula Number" shall mean one thousand (1,000) prior to consummation of the Recapitalization; provided, however, that if at any time prior to the consummation of the Recapitalization, the Corporation shall (i) declare or pay any dividend or make any distribution on the Common Stock, payable in shares of Common Stock; (ii) subdivide (by a stock split or otherwise) the outstanding shares of Common Stock into a larger number of shares of Common Stock; or (iii) combine (by a reverse stock split or otherwise) the outstanding shares of Common Stock into a smaller number of shares of Common Stock, then in each such case the Formula Number in effect immediately prior to such event shall be adjusted to a number determined by multiplying the Formula Number then in effect by a fraction, the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event (and rounding the result to the nearest whole number); and provided further, that, if prior to the consummation of the Recapitalization the Corporation shall issue any shares of its capital stock in a merger, reclassification, or change of the outstanding shares of Common Stock, then in each such event the Formula Number shall be appropriately adjusted to reflect such merger, reclassification, or change so that each share of Series C Preferred Stock continues to be the economic equivalent of a Formula Number of shares of Common Stock immediately prior to such merger, reclassification, or change. "Group" has the meaning set forth in Rule 13d-5 under the Exchange Act. "Issue Date" shall mean the first date on which shares of Series C Preferred Stock are issued. "Person" means any individual, corporation, company, association, partnership, joint venture, trust or unincorporated organization, or a government or any agency or political subdivision thereof. "Post-Recapitalization Stated Value" shall be equal to $1.00. 17 18 "Recapitalization" means the amendment of the Corporation's Certificate of Incorporation to increase the authorized shares of Common Stock from 50,000,000 to 400,000,000, and the authorized shares of Preferred Stock from 1,000,000 to 200,000,000, and the subsequent one thousand-for-one split of Series C Preferred Stock and Series B Preferred Stock. "Redemption Price" of a share of Series C Preferred Stock shall mean the sum of (a) the dividends, if any, accumulated or deemed to have accumulated thereon to the Optional Redemption Date, whether or not such dividends are declared plus (b) either (i) the Initial Stated Value thereof (if the Recapitalization has not been consummated prior to June 30, 1999) or (ii) the Post-Recapitalization Stated Value thereof (if the Recapitalization has been consummated prior to June 30, 1999), in each case subject to adjustment for splits, reclassifications, recombinations or similar events. "Rights" shall mean any rights to purchase securities of the Corporation issued pursuant to any Rights Agreement. "Rights Agreement" shall mean the Rights Agreement, dated as of June 21, 1996, between the Company and Wells Fargo Bank as rights agent, and all amendments, supplements and replacements thereof. "Second Anniversary Date" means the second anniversary of the Issue Date. "Subsidiary" means, as to any Person, any other Person of which more than 50% of the shares of the Voting Securities or other voting interests are owned or controlled, or the ability to select or elect 50% or more of the directors or similar managers is held, directly or indirectly, by such first Person and one or more of its Subsidiaries. "Trading Day" means a day on which the principal national securities exchange on which the Common Stock is listed or admitted to trading is open for the transaction of business or, if the Common Stock is not listed or admitted to trading on any national securities exchange a Business Day. "Voting Securities" means, (i) with respect to the Company, the Equity Securities of the Company entitled to vote generally for the election of directors of the Company, and (ii) with respect to any other Person, any securities of or interests in such Person entitled to vote generally for the election of directors or any similar managing person of such Person. X. MISCELLANEOUS A. NOTICES. Any notice referred to herein shall be in writing and, unless first-class mail shall be specifically permitted for such notices under the terms hereof, shall be deemed to have been given upon personal delivery thereof, upon transmittal of such notice by telecopy (with confirmation of receipt by telecopy or telex) or five days after transmittal by registered or certified mail, postage prepaid, addressed as follows: 18 19 (i) if to the Corporation, to its office at 2 California Plaza, 350 South Grand Avenue, Los Angeles, California 90071 (Attention: General Counsel) or to the transfer agent for the Series C Preferred Stock; (ii) if to a holder of the Series C Preferred Stock, to such holder at the address of such holder as listed in the stock record books of the Corporation (which may include the records of any transfer agent for the Series C Preferred Stock); or (iii) to such other address as the Corporation or such holder, as the case may be, shall have designated by notice similarly given. B. REACQUIRED SHARES. Any shares of Series C Preferred Stock redeemed, purchased or otherwise acquired by the Corporation, directly or indirectly, in any manner whatsoever shall be retired and canceled promptly after the acquisition thereof (and shall not be deemed to be outstanding for any purpose) and, if necessary to provide for the lawful redemption or purchase of such shares, the capital represented by such shares shall be reduced in accordance with the Delaware General Corporation Law. All such shares of Series C Preferred Stock shall upon their cancellation and upon the filing of an appropriate certificate with the Secretary of State of the State of Delaware, become authorized but unissued shares of Preferred Stock, par value $0.001 per share, of the Corporation and may be reissued as part of another series of Preferred Stock, par value $0.001 per share, of the Corporation subject to the conditions or restrictions on issuance set forth herein. C. ENFORCEMENT. Any registered holder of shares of Series C Preferred Stock may proceed to protect and enforce its rights and the rights of such holders by any available remedy by proceeding at law or in equity to protect and enforce any such rights, whether for the specific enforcement of any provision in this Certificate of Designations or in aid of the exercise of any power granted herein, or to enforce any other proper remedy. D. TRANSFER TAXES. Except as otherwise agreed upon pursuant to the terms of this Certificate of Designations, the Corporation shall pay any and all documentary, stamp or similar issue or transfer taxes and other governmental charges that may be imposed under the laws of the United States of America or any political subdivision or taxing authority thereof or therein in respect of any issue or delivery of Common Stock on conversion of, or other securities or property issued on account of, shares of Series C Preferred Stock pursuant hereto or certificates representing such shares or securities. The Corporation shall not, however, be required to pay any such tax or other charge that may be imposed in connection with any transfer involved in the issue or transfer and delivery of any certificate for Common Stock or other securities or property in a name other than that in which the shares of Series C Preferred Stock so exchanged, or on account of which such securities were issued, were registered and no such issue or delivery shall be made unless and until the Person requesting such issue has paid to the Corporation the amount of any such tax or has established to the satisfaction of the Corporation that such tax has been paid or is not payable. 19 20 E. TRANSFER AGENT. The Corporation may appoint, and from time to time discharge and change, a transfer agent for the Series C Preferred Stock. Upon any such appointment or discharge of a transfer agent, the Corporation shall send notice thereof by first-class mail, postage prepaid, to each holder of record of shares of Series C Preferred Stock. F. RECORD DATES. In the event that the Series C Preferred Stock shall be registered under either the Securities Act of 1933, as amended, or the Exchange Act, the Corporation shall establish appropriate record dates with respect to payments and other actions to be made with respect to the Series C Preferred Stock. 20 21 IN WITNESS WHEREOF, this Certificate of Designations is executed on behalf of the Corporation by its Executive Vice President, General Counsel and Secretary and attested by its Assistant Secretary, this 10th day of February , 1999. AAMES FINANCIAL CORPORATION By: /s/ Barbara S. Polsky --------------------------------- Name: Barbara S. Polsky Title: Executive Vice President, General Counsel and Secretary [Corporate Seal] ATTEST: /s/ John F. Madden, Jr. - --------------------------------- John F. Madden Jr. Assistant Secretary 21 EX-4.7 4 REGISTRATION RIGHTS AGREEMENT 1 EXHIBIT 4.7 AAMES FINANCIAL CORPORATION REGISTRATION RIGHTS AGREEMENT REGISTRATION RIGHTS AGREEMENT, dated as of December 23, 1998, among Capital Z Financial Services Fund II, L.P. ("Capital Z"), together with the other investors listed on Schedule I hereto (collectively, the "Investors"), and Aames Financial Corporation, a Delaware corporation (the "Company"). R E C I T A L S WHEREAS, the Investors, pursuant to the terms of a Preferred Stock Purchase Agreement, dated as of the date hereof, between Capital Z and the Company (the "Purchase Agreement"), (i) have agreed to purchase shares of Series B Convertible Preferred Stock, par value $0.001 per share, of the Company (the "Series B Preferred Stock") and Series C Convertible Preferred Stock, par value $0.001 per share, of the Company (the "Series C Preferred Stock" and, together with the Series B Preferred Stock, the "Preferred Stock"), (ii) have received on the date hereof warrants (the "Warrants") to purchase an aggregate of 1,250,000 shares of Common Stock, par value $0.001 per share (the "Common Stock"), of the Company, and (iii) are to receive additional Common Stock purchase warrants (the "Contingent Warrants" and, together with the Warrants, the "Investor Warrants") on the Initial Closing Date (as defined in the Purchase Agreement); and WHEREAS, the Company has agreed, as a condition precedent to Capital Z's obligations under the Purchase Agreement to grant the Investors certain registration rights; and WHEREAS, the Company and the Investors desire to define the registration rights of the Investors on the terms and subject to the conditions herein set forth. NOW, THEREFORE, in consideration of the foregoing premises and for other good and valuable consideration, the parties hereby agree as follows: 1. DEFINITIONS As used in this Agreement, the following terms have the respective meanings set forth below: Commission: shall mean the Securities and Exchange Commission or any other federal agency at the time administering the Securities Act; 2 Conversion Shares: shall mean the shares of Common Stock for which the Preferred Stock has been, or may be, converted. Exchange Act: shall mean the Securities Exchange Act of 1934, as amended, and the rules and regulations promulgated thereunder; Holder: shall mean any holder of Registrable Securities; Initiating Holder: shall mean (a) Capital Z or (b) any Holder or Holders of Registrable Securities aggregating at least 35% of (i) the aggregate number of shares of Preferred Stock held by all Holders, in the case of any registration of Preferred Stock, or (ii) the aggregate number of Conversion Shares and Warrant Shares held by all Holders, in the case of any registration of Conversion Shares or Warrant Shares (x) held by such Holders or (y) issued or issuable upon conversion of the Preferred Stock or exercise of the Investor Warrants; Person: shall mean an individual, partnership, joint-stock company, corporation, limited liability company, trust or unincorporated organization, and a government or agency or political subdivision thereof; register, registered and registration: shall mean a registration effected by preparing and filing a registration statement in compliance with the Securities Act (and any post-effective amendments filed or required to be filed) and the declaration or ordering of effectiveness of such registration statement; Registrable Securities: (A) the shares of Preferred Stock issued to the Investors pursuant to the Purchase Agreement, (B) the Warrant Shares, (C) the Conversion Shares, (D) any additional shares of Common Stock or Preferred Stock acquired by the Investors (but not their assignees, unless any such assignee shall have acquired at least a number of Preferred Stock or Conversion Shares equal to 15% of the shares of Preferred Stock or Conversion Shares originally issued to the Investors pursuant to the Purchase Agreement, adjusted for splits, combinations, and similar events), (E) any capital stock of the Company issued as a dividend or other distribution with respect to, or in exchange for or in replacement of, the shares of Preferred Stock or Common Stock referred to in clauses (A), (B), (C) or (D) above, until, in the case of any such securities, (i) a registration statement covering such securities has been declared effective by the Commission and such securities have been disposed of pursuant to such effective Registration Statement or (ii) such securities have been disposed of in open market transactions pursuant to Rule 144 under the Securities Act (or similar rule then in effect); 2 3 Registration Expenses: shall mean (x) all expenses incurred by the Company in compliance with Sections 2(a) and (b) hereof, excluding Selling Expenses, but including, without limitation, all registration and filing fees, printing expenses, blue sky fees and expenses and the expense of any special audits incident to or required by any such registration (but excluding the compensation of regular employees of the Company, which shall be paid in any event by the Company) and (y) all reasonable fees and disbursements of one counsel retained by the Holders of a majority of the Registrable Securities to be included in a particular registration; Security, Securities: shall have the meaning set forth in Section 2(1) of the Securities Act; Securities Act: shall mean the Securities Act of 1933, as amended, and the rules and regulations promulgated thereunder; Selling Expenses: shall mean all underwriting and selling discounts, fees and commissions applicable to the sale of Registrable Securities; and Warrant Shares: shall mean the shares of Common Stock for which the Investor Warrants have been, or may be, exercised. 2. REGISTRATION RIGHTS (a) Requested Registration. (i) Request for Registration. If the Company shall receive from an Initiating Holder, at any time, a written request that the Company effect any registration with respect to all or a part of the Registrable Securities, the Company will: (A) promptly give written notice of the proposed registration, qualification or compliance to all other Holders; and (B) as soon as reasonably practicable, use its reasonable best efforts to effect such registration (including, without limitation, the execution of an undertaking to file post-effective amendments, appropriate qualification under applicable blue sky or other state securities laws and appropriate compliance with applicable regulations issued under the Securities Act) as may be so requested and as would permit or facilitate the sale and distribution of all or such portion of such Registrable Securities as are specified in such request, together with all or such portion of the Registrable Securities of any Holder or Holders joining in such request as are specified in a written request received by the Company within 10 business days after written notice from the Company is given under 3 4 Section 2(a)(i)(A) above; provided that the Company shall not be obligated to effect, or take any action to effect, any such registration pursuant to this Section 2(a): (v) in any particular jurisdiction in which the Company would be required to execute a general consent to service of process in effecting such registration, qualification or compliance, unless the Company is already subject to service in such jurisdiction and except as may be required by the Securities Act or applicable rules or regulations thereunder; (w) (i) with respect to a request for registration of Warrant Shares or Conversion Shares, after the Company has effected five (5) such registrations pursuant to this Section 2(a) requested by an Initiating Holder and (ii) with respect to a request for registration of shares of Preferred Stock, after the Company has effected five (5) such registrations pursuant to this Section 2(a) requested by an Initiating Holder, and, in each case, such registrations have been declared or ordered effective and the sales of such Registrable Securities shall have closed; (x) if the Registrable Securities requested by all Holders to be registered pursuant to such request do not have an anticipated aggregate public offering price (before any underwriting discounts and commissions) of at least $10,000,000; or (y) if at the time of any request to register Registrable Securities, the Company is engaged or intends to engage in an acquisition, financing or other material transaction which, in the good faith determination of the Board of Directors of the Company, would be adversely affected by the requested registration to the material detriment of the Company, or the Board of Directors of the Company determines in good faith that the registration would require the disclosure of material information that the Company has a bona fide business purpose for preserving as confidential, and that the Company is not otherwise required by applicable securities laws or regulations to disclose, in which event, the Company may, at its option, direct that such request be delayed for a period not in excess of ninety days from the date of the determination by the Board of Directors, as the case may be, such right to delay a request to be exercised by the Company not more than once in any twelve-month period. 4 5 (z) with respect to Holders who are officers, directors or employees of the Company, if at the time of any request to register Registrable Securities, directors, officers, or employees of the Company are not permitted to offer or sell securities in accordance with the Company's policies. The registration statement filed pursuant to the request of an Initiating Holder may, subject to the provisions of Section 2(a)(ii) below, include other securities, other than Registrable Securities, of the Company which are held by the other stockholders ("Other Stockholders") of the Company. The Holders holding a majority of the Registrable Securities requested to be registered may, at any time prior to the effective date of the registration statement relating to such registration, revoke such request, without liability to the Company, such Holders, any of the other Holders or the Other Stockholders, by providing a written notice to the Company revoking such request, provided that such revoked request shall count against the registrations available to the Holders pursuant to Section 2(a)(x) unless such Holders pay the costs and expenses associated with such revoked request. Notwithstanding the foregoing provisions of this Section 2(a)(i), if the Initial Closing (as defined in the Purchase Agreement) does not take place for any reason whatsoever, the holder or holders of a majority of the Warrants shall be entitled to one demand registration right with respect to the Warrant Shares, subject to the other provisions of this Agreement. (ii) Underwriting. If the Initiating Holders intend to distribute the Registrable Securities covered by their request by means of an underwriting, they shall so advise the Company as a part of their request made pursuant to Section 2(a). If shares held by Other Stockholders are requested by such Other Stockholders to be included in any registration pursuant to this Section 2, the Company shall condition such inclusion on their acceptance of the further applicable provisions of this Section 2. The Initiating Holders whose Registrable Securities are to be included in such registration and the Company shall (together with all Other Stockholders proposing to distribute their securities through such underwriting) enter into an underwriting agreement in customary form with the representative of the underwriter or underwriters selected for such underwriting by such Initiating Holders and reasonably acceptable to the Company. Notwithstanding any other provision of this Section 2(a), if the representative advises the Holders in writing that marketing factors (including, without limitation, pricing considerations) require a limitation on the number of shares to be underwritten or a limitation on the inclusion of shares held by directors and officers of 5 6 the Company, the securities of the Company held by Other Stockholders shall be excluded from such registration to the extent so required by such limitation. If, after the exclusion of such shares, further reductions are still required, the Registrable Securities of the Company held by each Holder other than the Initiating Holders shall be excluded from such registration to the extent so required by such limitation. Thereafter, if still further reductions are required, the number of Registrable Securities included in the registration by each Initiating Holder shall be reduced on a pro rata basis (based on the number of Registrable Securities held by such Initiating Holder), by such minimum number of Registrable Securities as is necessary to comply with such request. No Registrable Securities or any other securities excluded from the underwriting by reason of the underwriter's marketing limitation shall be included in such registration. If any Other Stockholder who has requested inclusion in such registration as provided above disapproves of the terms of the underwriting, such person may elect to withdraw therefrom by written notice to the Company, the underwriter and the Initiating Holders. The securities so withdrawn shall also be withdrawn from registration. If the underwriter has not limited the number of Registrable Securities or other securities to be underwritten, the Company and officers and directors of the Company (including representatives and designees of Capital Z or the Series B Preferred Stock holders) may include its or their securities for its or their own account in such registration if the representative so agrees and if the number of Registrable Securities and other securities which would otherwise have been included in such registration and underwriting will not thereby be limited. (iii) Other Registration Rights. The Company shall not grant any registration rights inconsistent with the provisions of this Section 2(a) and in granting any demand registration rights hereafter shall provide that the Holders shall have the right to notice of the exercise of any such demand registration right and to participate in such registration on a pro rata basis. (b) Company Registration. (i) If the Company shall determine to register any of its equity securities either for its own account or any Other Stockholders, other than a registration relating solely to employee benefit plans, or a registration relating solely to a Commission Rule 145 transaction, or a registration on any registration form which does not permit secondary sales or does not include substantially the same information as would be required to be included in a registration statement covering the sale of Registrable Securities, the Company will: 6 7 (A) promptly give to each of the Holders a written notice thereof; and (B) include in such registration (and any related qualification under blue sky laws or other compliance), and in any underwriting involved therein, all the Registrable Securities specified in a written request or requests, made by the Holders within fifteen (15) days after receipt of the written notice from the Company described in clause (A) above, except as set forth in Section 2(b)(ii) below. The Company may terminate, in its sole and absolute discretion, any registration described in this Section 2(b) at any time prior to the effectiveness of the applicable registration statement. Upon such termination, the Company's obligations under this Section 2(b) with respect to such terminated registration shall terminate. (ii) Underwriting. If the registration of which the Company gives notice is for a registered public offering involving an underwriting, the Company shall so advise each of the Holders as a part of the written notice given pursuant to Section 2(b)(i)(A). In such event, the right of each of the Holders to registration pursuant to this Section 2(b) shall be conditioned upon such Holders' participation in such underwriting and the inclusion of such Holders' Registrable Securities in the underwriting to the extent provided herein. The Holders whose shares are to be included in such registration shall (together with the Company and the Other Stockholders distributing their securities through such underwriting) enter into an underwriting agreement in customary form with the representative of the underwriter or underwriters selected for underwriting by the Company. Notwithstanding any other provision of this Section 2(b), if the representative determines that marketing factors require a limitation on the number of shares to be underwritten or a limitation on the inclusion of shares held by directors and officers of the Company, the representative may (subject to the allocation priority set forth below) limit the number of Registrable Securities to be included in the registration and underwriting to not less than twenty five percent (25%) of the total number of shares to be included in such underwritten offering, subject to the Company's compliance with any registration obligations to any Demanding Holders (as hereinafter defined) participating in such registration. The Company shall so advise all holders of securities requesting registration, and the number of shares of securities that are entitled to be included in the registration and underwriting shall be allocated in the following manner: The securities of the Company held by officers, directors (including representatives and designees 7 8 of Capital Z or the Series B Preferred Stock holders) and Other Stockholders (other than Registrable Securities and other than securities held by holders who by contractual right demanded such registration ("Demanding Holders")) shall be excluded from such registration and underwriting to the extent required by such limitation, and, if a limitation on the number of shares is still required, the number of shares that may be included in the registration and underwriting by each of the Holders other than the Demanding Holders shall be excluded from such registration to the extent so required by such limitation. Thereafter, if still further reductions are required, the number of shares included in the registration by each of the Demanding Holders shall be reduced, on a pro rata basis (based on the number of shares held by such Demanding Holders), by such minimum number of shares as is necessary to comply with such limitation. If any of the Holders or any officer, director or Other Stockholder disapproves of the terms of any such underwriting, he may elect to withdraw therefrom by written notice to the Company and the underwriter. Any Registrable Securities or other securities excluded or withdrawn from such underwriting shall be withdrawn from such registration. (iii) Number and Transferability. Each of the Holders shall be entitled to have its shares included in an unlimited number of registrations pursuant to this Section 2(b). (c) Shelf Registration. (i) If requested by the Initiating Holder at any time after the date hereof, the Company shall file a "shelf" registration statement pursuant to Rule 415 (if then available) under the Securities Act (the "Shelf Registration") with respect to the resale of all or any portion of the Registrable Securities, as requested by the Initiating Holder. If such request is made, the Company shall (A) use its reasonable best efforts to have the Shelf Registration declared effective as promptly as practicable and (B) use its reasonable best efforts to keep the Shelf Registration continuously effective from the date such Shelf Registration is declared effective until the date specified in Section 2(i) in order to permit the prospectus forming a part thereof to be usable by Holders during such period. The Shelf Registration may not include other securities of the Company which are held by Other Stockholders. (ii) The Company shall supplement or amend the Shelf Registration, (A) as required by the registration form utilized by the Company or by the instructions applicable to such registration form or by the Securities Act or the rules and regulations promulgated thereunder, (B) to include in such Shelf Registration any additional securities that become Registrable Securities by operation of the definition 8 9 thereof and (C) following the written request of an Initiating Holder pursuant to Section 2(c)(iii) below, to cover offers and sales of all or a part of the Registrable Securities by means of an underwriting including the incorporation of any information required pursuant to Section 2(e)(x) below. The Company shall furnish to the Holders of the Registrable Securities to which the Shelf Registration relates copies of any such supplement or amendment sufficiently in advance (but in no event less than five business days in advance) of its use and/or filing with the Commission to allow the Holders a meaningful opportunity to comment thereon. (iii) The Holders may, at their election and upon written notice by the Initiating Holders to the Company, effect offers and sales under the Shelf Registration by means of one or more underwritten offerings, in which case the provisions of Section 2(a)(ii) above shall apply to any such underwritten distribution of securities under the Shelf Registration and such underwriting shall, if sales of Registrable Securities pursuant thereto shall have closed, be regarded as the exercise of one of the registration rights contemplated by Section 2(a) hereof. (iv) The rights of the Holders to request and effect a Shelf Registration hereunder and the Company's obligations to keep a Shelf Registration effective shall be subject to the restrictions and limitations set forth in Section 2(a)(x), (y) and (z). (d) Expenses of Registration. All Registration Expenses incurred in connection with any registration, qualification or compliance pursuant to this Section 2 (including all Registration Expenses incurred in connection with the Shelf Registration and any supplements or amendments thereto, whether or not it becomes effective, and whether all, none or some of the Registrable Securities are sold pursuant to the Shelf Registration) shall be borne by the Company, and all Selling Expenses shall be borne by the Holders of the securities so registered pro rata on the basis of the number of their shares so registered; provided, however, that if, as a result of the withdrawal of a request for registration by any of the Holders, as applicable, the registration statement does not become effective, the Holders and Other Stockholders requesting registration may elect to bear the Registration Expenses (pro rata on the basis of the number of their shares so included in the registration request, or on such other basis as such Holders and Other Stockholders may agree), in which case such registration shall not be counted as a registration pursuant to Section 2(a)(i)(B)(x). (e) Registration Procedures. In the case of each registration effected by the Company pursuant to this Section 2, the Company will keep the Holders holding Registrable Securities 9 10 requested to be included in such registration ("Participating Holders") advised in writing as to the initiation of each registration and as to the completion thereof. At its expense, the Company will: (i) other than the Shelf Registration, the obligations in respect of which are set forth in Section 2(c)(i)(B) above, keep such registration effective for a period of one hundred eighty (180) days or until the Participating Holders, as applicable, have completed the distribution described in the registration statement relating thereto, whichever first occurs; (ii) furnish to each Participating Holder, and to any underwriter before filing with the Commission, copies of any registration statement (including all exhibits) and any prospectus forming a part thereof and any amendments and supplements thereto (including, upon request, all documents incorporated or deemed incorporated by reference therein) prior to the effectiveness of such registration statement and including each preliminary prospectus, any summary prospectus or any term sheet (as such term is used in Rule 434 under the Securities Act)) and any other prospectus filed under Rule 424 under the Securities Act, which documents, other than exhibits and documents incorporated or deemed incorporated by reference, will be subject the review of the Participating Holders and any such underwriter for a period of at least five business days, and the Company shall not file any such registration statement or such prospectus or any amendment or supplement to such registration statement or prospectus to which any Participating Holder or any such underwriter shall reasonably object within five business days after the receipt thereof; a Participating Holder or such underwriter(s), if any, shall be deemed to have reasonably objected to such filing only if the registration statement, amendment, prospectus or supplement, as applicable, as proposed to be filed, contains a material misstatement or omission; (iii) furnish to each Participating Holder and to any underwriter, such number of conformed copies of the applicable registration statement and of each amendment and supplement thereto (in each case including all exhibits) and such number of copies of the prospectus forming a part of such registration statement (including each preliminary prospectus, any summary prospectus or any term sheet (as such term is used in Rule 434 under the Securities Act)) and any other prospectus filed under Rule 424 under the Securities Act, in conformity with the requirements of the Securities Act, and such other documents, including without limitation documents incorporated or deemed to be incorporated by reference prior to the effectiveness of such registration, as each of the Participating Holders or any such underwriter, from time to time may reasonably request; 10 11 (iv) to the extent practicable, promptly prior to the filing of any document that is to be incorporated by reference into any registration statement or prospectus forming a part thereof subsequent to the effectiveness thereof, and in any event no later than the date such document is filed with the Commission, provide copies of such document to the Participating Holders, if requested, and to any underwriter, make representatives of the Company available for discussion of such document and other customary due diligence matters; (v) make available at reasonable times for inspection by the Participating Holders, any underwriter participating in any disposition pursuant to such registration and any attorney or accountant retained by the Holders or any such underwriter, all financial and other records, pertinent corporate documents and properties of the Company and cause the officers, directors and employees of the Company to supply all information reasonably requested by the Participating Holders and any such underwriters, attorneys or accountants in connection with such registration subsequent to the filing of the applicable registration statement and prior to the effectiveness of the applicable registration statement, subject to the execution of a customary confidentiality agreement; (vi) use its reasonable best efforts (x) to register or qualify all Registrable Securities and other securities covered by such registration under such other securities or blue sky laws of such States of the United States of America where an exemption is not available and as the sellers of Registrable Securities covered by such registration shall reasonably request, (y) to keep such registration or qualification in effect for so long as the applicable registration statement remains in effect, and (z) to take any other action which may be reasonably necessary or advisable to enable such sellers to consummate the disposition in such jurisdictions of the securities to be sold by such sellers, except that the Company shall not for any such purpose be required to qualify generally to do business as a foreign corporation in any jurisdiction where it is not so qualified, or to subject itself to taxation in any such jurisdiction, or to execute a general consent to service of process in effecting such registration, qualification or compliance, unless the Company is already subject to service in such jurisdiction and except as may be required by the Securities Act or applicable rules or regulations thereunder; (vii) use its reasonable best efforts to cause all Registrable Securities covered by such registration statement to be registered with or approved by such other federal or state governmental agencies or authorities as may be necessary in the opinion of counsel to the Company and 11 12 counsel to the Participating Holders of Registrable Securities to enable the Holders thereof to consummate the disposition of such Registrable Securities in accordance with the plan of distribution described in the applicable registration statement; (viii) subject to Section 2(i) hereof, promptly notify each Holder of Registrable Securities covered by a registration statement (A) upon discovery that, or upon the happening of any event as a result of which, the prospectus forming a part of such registration statement, as then in effect, includes an untrue statement of a material fact or omits to state any material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading, (B) of the issuance by the Commission of any stop order suspending the effectiveness of such registration statement or the initiation of proceedings for that purpose, (C) of any request by the Commission for (1) amendments to such registration statement or any document incorporated or deemed to be incorporated by reference in any such registration statement, (2) supplements to the prospectus forming a part of such registration statement or (3) additional information, (D) of the receipt by the Company of any notification with respect to the suspension of the qualification or exemption from qualification of any of the Registrable Securities for sale in any jurisdiction or the initiation of any proceeding for such purpose, and at the request of any such Holder promptly prepare and furnish to it a reasonable number of copies of a supplement to or an amendment of such prospectus as may be necessary so that, as thereafter delivered to the purchasers of such securities, such prospectus shall not include an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading; (ix) use its reasonable best efforts to obtain the withdrawal of any order suspending the effectiveness of any such registration, or the lifting of any suspension of the qualification (or exemption from qualification) of any of the Registrable Securities for sale in any jurisdiction; (x) if requested by a Participating Holder, or any underwriter, subject to receipt of any required information from such Holder or underwriter, promptly incorporate in such registration statement or prospectus, pursuant to a supplement or post-effective amendment if necessary, such information as the Participating Holder and any underwriter may reasonably request to have included therein, including, without limitation, information relating to the "plan of distribution" of the Registrable Securities, information with respect to the number of shares of 12 13 Registrable Securities being sold to such underwriter, the purchase price being paid therefor and any other terms of the offering of the Registrable Securities to be sold in such offering and make all required filings of any such prospectus supplement or post-effective amendment as soon as practicable after the Company is notified of the matters to be incorporated in such prospectus supplement or post-effective amendment; (xi) furnish to the Participating Holders, addressed to them, an opinion of counsel for the Company, dated the date of the closing under the underwriting agreement, if any, or the date of effectiveness of the registration statement if such registration is not an underwritten offering, and use its reasonable best efforts to furnish to the Participating Holders, addressed to them, a "cold comfort" letter signed by the independent certified public accountants who have certified the Company's financial statements included in such registration, covering substantially the same matters with respect to such registration (and the prospectus included therein) and, in the case of such accountants' letter, with respect to events subsequent to the date of such financial statements, as are customarily covered in opinions of issuer's counsel and in accountants' letters delivered to underwriters in underwritten public offerings of securities and such other matters as the Participating Holders may reasonably request; (xii) provide promptly to the Participating Holders upon request any document filed by the Company with the Commission pursuant to the requirements of Section 13 and Section 15 of the Exchange Act; and (xiii) use its reasonable best efforts to cause all Registrable Securities included in any registration pursuant hereto to be listed on each securities exchange on which securities of the same class are then listed or, if not then listed on any securities exchange, to be eligible for trading in any over-the-counter market or trading system in which securities of the same class are then traded. (f) Indemnification. (i) The Company will indemnify each of the Holders, as applicable, each of its officers, directors and partners, and each person controlling each of the Holders (within the meaning of the Securities Act), with respect to each registration which has been effected pursuant to this Section 2, and each underwriter, if any, and each person who controls any underwriter, against all claims, losses, damages and liabilities (or actions in respect thereof) arising out of or based on any untrue statement (or alleged untrue statement) of a material fact contained in any preliminary, final or summary prospectus, offering circular 13 14 or other document (including any related registration statement, notification or the like, or any amendment or supplement to any of the foregoing) incident to any such registration, qualification or compliance, or based on any omission (or alleged omission) to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, or any violation (or alleged violation) by the Company of the Securities Act or the Exchange Act or any rule or regulation thereunder or of any applicable state or common law applicable to the Company and relating to action or inaction required of the Company in connection with any such registration, qualification or compliance, and (subject to Section 2(f)(iii)) will reimburse each of the Holders, each of its officers, directors and partners, and each person controlling each of the Holders, each such underwriter and each person who controls any such underwriter, for any legal and any other expenses reasonably incurred in connection with investigating and defending any such claim, loss, damage, liability or action, provided that the Company will not be liable in any such case to the extent that any such claim, loss, damage, liability or expense arises out of or is based on any untrue statement or omission based upon and in conformity with written information furnished to the Company by the Holders or underwriter and stated to be specifically for use therein. The foregoing indemnification shall remain in effect regardless of any investigation by any indemnified party and shall survive any transfer or assignment by a Holder of its Registrable Securities or of its rights pursuant to this Agreement. (ii) Each of the Holders will, if Registrable Securities held by it are included in the securities as to which such registration, qualification or compliance is being effected, indemnify on a several, but not joint basis, the Company, each of its directors and officers and each underwriter, if any, of the Company's securities covered by such a registration statement, each person who controls the Company or such underwriter, each Other Stockholder and each of their officers, directors, and partners, and each person controlling such Other Stockholder against all claims, losses, damages and liabilities (or actions in respect thereof) arising out of or based on any untrue statement (or alleged untrue statement) made by such Holder of a material fact contained in any such registration statement, prospectus, offering circular or other document, or any omission (or alleged omission) made by such Holder to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, and will reimburse the Company and such directors, officers, partners, persons, underwriters or control persons for any legal or any other expenses reasonably incurred in connection with investigating or defending any such claim, loss, damage, liability or action, in each case to the 14 15 extent, but only to the extent, that such untrue statement (or alleged untrue statement) or omission (or alleged omission) is made in such registration statement, prospectus, offering circular or other document in reliance upon and in conformity with written information furnished to the Company by such Holder and stated to be specifically for use therein; provided, however, that the obligations of each of the Holders hereunder shall be limited to an amount equal to the net proceeds to such Holder of securities sold pursuant to such registration statement or prospectus. (iii) Each party entitled to indemnification under this Section 2(f) (the "Indemnified Party") shall give notice to the party required to provide indemnification (the "Indemnifying Party") promptly after such Indemnified Party has actual knowledge of any claim as to which indemnity may be sought, and shall permit the Indemnifying Party to assume the defense of any such claim or any litigation resulting therefrom; provided that counsel for the Indemnifying Party, who shall conduct the defense of such claim or any litigation resulting therefrom, shall be approved by the Indemnified Party (whose approval shall not unreasonably be withheld) and the Indemnified Party may participate in such defense at such party's expense (unless the Indemnified Party shall have reasonably concluded upon advice from counsel that there may be a conflict of interest between the Indemnifying Party and the Indemnified Party in such action, in which case the reasonable fees and expenses of one firm of counsel (and one local counsel) shall be at the expense of the Indemnifying Party), and provided further that the failure of any Indemnified Party to give notice as provided herein shall not relieve the Indemnifying Party of its obligations under this Section 2 except to the extent the Indemnifying Party is materially prejudiced thereby. No Indemnifying Party, in the defense of any such claim or litigation shall, except with the consent of each Indemnified Party, consent to entry of any judgment or enter into any settlement which does not include as an unconditional term thereof the giving by the claimant or plaintiff to such Indemnified Party of a release from all liability in respect to such claim or litigation. Each Indemnified Party shall promptly furnish such information regarding itself or the claim in question as an Indemnifying Party may reasonably request in writing and as shall be reasonably required in connection with the defense of such claim and litigation resulting therefrom. (iv) If the indemnification provided for in this Section 2(f) is held by a court of competent jurisdiction to be unavailable to an Indemnified Party with respect to any loss, liability, claim, damage or expense referred to herein, then the Indemnifying Party, in lieu of indemnifying such Indemnified Party hereunder, shall contribute to the amount paid or payable by such Indemnified Party as a result 15 16 of such loss, liability, claim, damage or expense in such proportion as is appropriate to reflect the relative fault of the Indemnifying Party on the one hand and of the Indemnified Party on the other in connection with the statements or omissions which resulted in such loss, liability, claim, damage or expense, as well as any other relevant equitable considerations, provided, however, that no Person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any Person who was not guilty of any such fraudulent misrepresentation. The relative fault of the Indemnifying Party and of the Indemnified Party shall be determined by reference to, among other things, whether the untrue (or alleged untrue) statement of a material fact or the omission (or alleged omission) to state a material fact relates to information supplied by the Indemnifying Party or by the Indemnified Party and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. Notwithstanding the foregoing, no Holder will be required to contribute any amount pursuant to this paragraph (f) in excess of the total price at which the Registrable Securities of such Holder were offered to the public (less underwriting discounts and commissions, if any). Each Holder's obligations to contribute pursuant to this paragraph are several in the proportion that the proceeds of the offering received by such Holder bears to the total proceeds of the offering received by all the applicable Holders and not joint. (v) The foregoing indemnity agreement of the Company and Holders is subject to the condition that, insofar as they relate to any loss, claim, liability or damage made in a prospectus, preliminary prospectus or other offering document but eliminated or remedied in an amended prospectus, preliminary prospectus or other offering document delivered to an underwriter or Holder, as applicable (the "Final Prospectus"), such indemnity agreement shall not inure to the benefit of (A) any underwriter if a copy of the Final Prospectus was furnished to the underwriter and was not furnished to the person asserting the loss, liability, claim or damage at or prior to the time such action is required by the Securities Act or (B) in circumstances where no underwriter is acting as such in the offer and sale in question, any Holder who (1) either directly or through its agent provided the preliminary prospectus to the Person asserting the loss, liability, claim or damage, (2) was furnished with a copy of the Final Prospectus, and (3) did not furnish or cause to be furnished the Final Prospectus to the Person asserting the loss, liability, claim or damage at or prior to the time such action is required by the Securities Act. 16 17 (vi) Any indemnification payments required to be made to an Indemnified Party under this Section 2(f) shall be made as the related claims, losses, damages, liabilities or expenses are incurred. (g) Information by the Holders. Each of the Holders holding securities included in any registration shall furnish to the Company such information regarding such Holder and the distribution proposed by such Holder as the Company may reasonably request in writing and as shall be reasonably required in connection with any registration, qualification or compliance referred to in this Section 2. No Investor shall be required, in connection with any underwriting agreements entered into in connection with any registration, to provide any information, representations or warranties, or covenants with respect to the Company, its business or its operations, and such Investors shall not be required to provide any indemnification with respect to any registration statement except as specifically provided for in Section 2(f)(ii) hereof. (h) Rule 144 Reporting. With a view to making available the benefits of certain rules and regulations of the Commission which may permit the sale of restricted securities to the public without registration, the Company agrees to: (i) make and keep public information available as those terms are understood and defined in Rule 144 under the Securities Act ("Rule 144"), at all times; (ii) use its best efforts to file with the Commission in a timely manner all reports and other documents required of the Company under the Securities Act and the Exchange Act; and (iii) so long as the Holder owns any Registrable Securities, furnish to the Holder upon request, a written statement by the Company as to its compliance with the reporting requirements of Rule 144 and of the Securities Act and the Exchange Act, a copy of the most recent annual or quarterly report of the Company, and such other reports and documents so filed as the Holder may reasonably request in availing itself of any rule or regulation of the Commission allowing the Holder to sell any such securities without registration. (i) Termination. The registration rights set forth in this Section 2 shall not be available to any Holder if, in the opinion of counsel to the Company, all of the Registrable Securities then owned by such Holder could be sold in any 90-day period pursuant to Rule 144 (without giving effect to the provisions of Rule 144(k)) or at such time that no Registrable Securities are outstanding. The Company will arrange for a 17 18 provision to the transfer agent for such shares of an opinion of counsel in connection with any such sale under Rule 144. (j) Assignment. The registration rights set forth in Section 2 hereof may be assigned, in whole or in part, to any transferee of Registrable Securities (who shall be considered thereafter to be a Holder and shall be bound by all obligations and limitations of this Agreement). (k) The Holders agree that, upon receipt of any notice from the Company pursuant to Section 2(e)(viii), they shall immediately discontinue the disposition of Registrable Securities pursuant to the registration statement applicable to such Registrable Securities until they have received copies of the amended or supplemented prospectus as described in Section 2(e)(viii). The Holders shall destroy all copies in their possession of the registration statement and related materials covering such Registrable Securities at the time of receipt of the Company's notice. 3. MISCELLANEOUS (a) Directly or Indirectly. Where any provision in this Agreement refers to action to be taken by any Person, or which such Person is prohibited from taking, such provision shall be applicable whether such action is taken directly or indirectly by such Person. (b) Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of Delaware applicable to contracts made and to be performed entirely within such State. (c) Section Headings. The headings of the sections and subsections of this Agreement are inserted for convenience only and shall not be deemed to constitute a part thereof. (d) Notices. (i) All communications under this Agreement shall be in writing and shall be delivered by hand or by facsimile or mailed by overnight courier or by registered or certified mail, postage prepaid: (A) if to the Company, to Aames Financial Corporation, 2 California Plaza, 350 South Grand Avenue, Los Angeles, California 90071, facsimile no. (323) 210-4537 or at such other address or facsimile number as it may have furnished in writing to the Investors; (B) if to the Investors, at the address or facsimile number listed on Schedule I hereto, or at 18 19 such other address or facsimile number as may have been furnished in writing to the Company. (ii) Any notice so addressed shall be deemed to be given: if delivered by hand or facsimile, on the date of such delivery; if mailed by courier, on the first business day following the date of such mailing; and if mailed by registered or certified mail, on the third business day after the date of such mailing. (e) Reproduction of Documents. This Agreement and all documents relating thereto, including, without limitation, any consents, waivers and modifications which may hereafter be executed may be reproduced by the parties hereto by any photographic, photostatic, microfilm, microcard, miniature photographic or other similar process and the parties hereto may destroy any original document so reproduced. The parties hereto agree and stipulate that any such reproduction shall be admissible in evidence as the original itself in any judicial or administrative proceeding (whether or not the original is in existence and whether or not such reproduction was made by the Investors in the regular course of business) and that any enlargement, facsimile or further reproduction of such reproduction shall likewise be admissible in evidence. (f) Successors and Assigns. This Agreement shall inure to the benefit of and be binding upon the successors and assigns of each of the parties. (g) Entire Agreement; Amendment and Waiver. This Agreement constitutes the entire understanding of the parties hereto and supersedes all prior understanding among such parties. This Agreement may be amended, and the observance of any term of this Agreement may be waived, with (and only with) the written consent of the Company and the Investors holding a majority of the then outstanding Registrable Securities. (h) Severability. In the event that any part or parts of this Agreement shall be held illegal or unenforceable by any court or administrative body of competent jurisdiction, such determination shall not effect the remaining provisions of this Agreement which shall remain in full force and effect. (i) Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed an original and all of which together shall be considered one and the same agreement. 19 20 IN WITNESS WHEREOF, the undersigned have executed this Agreement as of the date first set forth above. AAMES FINANCIAL CORPORATION By /s/ Barbara S. Polsky ---------------------------------------- Name: Barbara S. Polsky Title: Executive Vice President INVESTORS: CAPITAL Z FINANCIAL SERVICES FUND II, L.P., By its General Partner CAPITAL Z PARTNERS, L.P., By its General Partner CAPITAL Z PARTNERS, LTD. By: /s/ Adam M. Mizel ------------------------------------ Name: Adam M. Mizel Title: Partner CAPITAL Z MANAGEMENT, INC. By: /s/ Adam M. Mizel ---------------------------------------- Name: Adam M. Mizel Title: Partner 20 21 SCHEDULE I NAME AND ADDRESS OF INVESTORS: Capital Z Financial Services Fund, L.P. One Chase Manhattan Plaza New York, New York 10005 Attention: David Spuria, Esq. Capital Z Management Inc. One Chase Manhattan Plaza New York, New York 10005 Attention: David Spuria, Esq. This schedule will be amended to include (i) Designated Purchasers under the Preferred Stock Purchase Agreement and (ii) the designees of Capital Z who will receive any of the Warrants. EX-10.22(B) 5 FIRST AMENDMENT TO RESIDUALS FINANCING AGREEMENT 1 EXHIBIT 10.22(b) FIRST AMENDMENT TO RESIDUALS FINANCING AGREEMENT THIS FIRST AMENDMENT TO RESIDUALS FINANCING AGREEMENT (this "Amendment") is made and dated as of the 6th day of October, 1998, by and among AAMES CAPITAL CORPORATION, a California corporation (the "Company"), AAMES FINANCIAL CORPORATION, a Delaware corporation and the sole shareholder of the Company (the "Parent"); and NATIONSBANK, N.A., a national banking association (the "Lender"). RECITALS A. Pursuant to that certain Residuals Financing Agreement dated as of September 4, 1998 among the Company, the Parent and the Lender (as amended, extended and replaced from time to time, the "Agreement" and with capitalized terms used herein and not otherwise defined herein used with the meanings given such terms in the Agreement), the Lender agreed to extend credit to the Company on the terms and subject to the conditions set forth therein. B. The parties hereto have agreed to amend the Agreement in certain respects, as set forth more particularly below. NOW, THEREFORE, in consideration of the above Recitals and for other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, the parties hereto hereby agree as follows: AGREEMENT 1. OTHER NATIONSBANK OBLIGATIONS. To reflect the agreement of the parties to use the Collateral to secure certain other obligations from time to time owed by the Company to the Lender, effective as of the Effective Date (as such term is defined in Paragraph 3 below): (a) A new definition of the term "Other NationsBank Obligations" is hereby added to Paragraph 11 of the Agreement, in correct alphabetical order, to read in its entirety as follows: "'OTHER NATIONSBANK OBLIGATIONS' shall mean any and all debts, obligations and liabilities of the Company to the Lender (whether now existing or hereafter arising, voluntary or involuntary, whether or not jointly owed with others, direct or indirect, absolute or contingent, liquidated or unliquidated, and whether or not from time to time decreased or extinguished and later increased, 2 created or incurred), other than the Obligations and any and all debts, obligations and liabilities of the Company to the Lender pursuant to the Warehousing Agreement." (b) Paragraph 1(a) of the Agreement is hereby amended to read in its entirety as follows: "1(a) REVOLVING CREDIT LIMIT. On the terms and subject to the conditions set forth herein, the Lender agrees that it shall from time to time to but not including the earlier to occur of the Conversion Date and the Maturity Date (as such terms and capitalized terms not otherwise defined herein are defined in Paragraph 11 below) make loans (the "Revolving Loans" or a "Revolving Loan") to the Company in an amount not to exceed, in the aggregate at any one time outstanding, the lesser of: (1) The Revolving Credit Limit; and (2) The Collateral Value of the Residuals Borrowing Base; minus, in each case, the aggregate amount of all outstanding Other NationsBank Obligations." (c) Paragraph 3(d)(1) of the Agreement is hereby amended to read in its entirety as follows: "(1) In the event the Lender shall determine on any date that the Collateral Value of the Residuals Borrowing Base is less than the sum of (i) the aggregate principal amount of Revolving Loans outstanding on such date, plus (ii) the aggregate amount of all Other NationsBank Obligations outstanding on such date, the Lender may, in its sole discretion, elect to deliver to the Company (which delivery may be by facsimile transmission) a Collateral Valuation Report so demonstrating. Upon receipt of such a Collateral Valuation Report, the Company shall, no later than thirty (30) days thereafter and subject to the right of the Company to exercise the Term-Out Option as provided in Paragraph 1(c) above, pay to the Lender an amount to prepay the Revolving Loans (a "Required Principal Prepayment") equal to the amount by which the sum of (i) the aggregate principal amount of Revolving Loans outstanding ON THE DATE OF PAYMENT by the Company, plus (ii) the aggregate amount of all Other NationsBank Obligations outstanding ON THE DATE OF PAYMENT by the Company exceeds the Collateral Value of the Residuals Borrowing Base ON THE DATE OF PAYMENT by the Company." (d) Paragraph 3(d)(2) of the Agreement is hereby amended to read in its entirety as follows: "(2) If, but only if, at such time as the Company shall be required to prepay Revolving Loans under subparagraph (1) of this Paragraph 3(d) 2 3 there shall not have occurred and be continuing an Event of Default or Potential Default, in lieu of making a Required Principal Prepayment thereunder or exercising the Term-Out Option, the Company may deliver to the Lender additional Eligible Residual Securities with an Established Collateral Value such that the sum of (i) the aggregate principal balance of Revolving Loans outstanding, and (ii) the aggregate amount of all Other NationsBank Obligations outstanding, does not exceed the Collateral Value of the Residuals Borrowing Base, it being expressly acknowledged and agreed by the Company that such additional Eligible Residual Securities must be delivered to the Lender no later than ten Business Days prior to the date on which the Required principal Prepayment is due to permit a timely determination as to eligibility to be made by the Lender." (e) Paragraph 1 of the Security Agreement is hereby amended to read in its entirety as follows: "1. GRANT OF SECURITY INTEREST. The Company hereby pledges and grants to the Lender a first priority, perfected security interest in the collateral described more particularly in Paragraph 2 below (collectively and severally, the "Collateral") to secure payment and performance of the Obligations and the Other NationsBank Obligations." 2. REAFFIRMATION OF LOAN DOCUMENTS. Each of the Company and the Parent hereby affirms and agrees that (a) except as expressly amended hereby, the execution and delivery by the Company and the Parent of and the performance of their obligations under this Amendment shall not in any way amend, impair, invalidate or otherwise affect any of the obligations of the Company or the Parent or the rights of the Lender under the Agreement, the Security Agreement, the Guaranty or any other Loan Document, (b) the term "Obligations" as used in the Loan Documents includes, without limitation, the Obligations of the Company under the Agreement as amended hereby. 3. EFFECTIVE DATE. This Amendment shall be effective as of the date (the "Effective Date") on which the Company has duly executed and delivered to the Lender this Amendment, as well as such corporate resolutions, incumbency certificates and other authorizing documentation as the Lender may reasonably request. 4. REPRESENTATIONS AND WARRANTIES. Each of the Company and the Parent hereby represents and warrants to the Lender as follows: (a) Each of the Company and the Parent has the corporate power and authority and the legal right to execute, deliver and perform this Amendment and has taken all necessary corporate action to authorize the execution, delivery and performance of this Amendment. This Amendment has been duly executed and delivered on behalf of the Company and the Parent and constitutes the legal, valid and binding obligations of each, enforceable against each in accordance with its terms. 3 4 (b) At and as of the date of execution hereof and at and as of the effective date of this Amendment and both prior to and after giving effect hereto: (i) the representations and warranties of the Company and the Parent contained in the Agreement and the other Loan Documents are accurate and complete in all respects, and (ii) there has not occurred an Event of Default or Potential Default. 5. NO OTHER AMENDMENT. Except as expressly amended hereby, the Loan Documents shall remain in full force and effect as written and amended to date. 6. COUNTERPARTS. This Amendment may be executed in any number of counterparts, each of which when so executed shall be deemed to be an original and all of which when taken together shall constitute one and the same agreement. IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed as of the day and year first above written. AAMES CAPITAL CORPORATION, a California corporation By: /S/ DAVID A. SKLAR ---------------------------------- Name: David A. Sklar --------------------------------- Title: EVP & CFO -------------------------------- AAMES FINANCIAL CORPORATION, a Delaware corporation By: /S/ BARBARA S. POLSKY ---------------------------------- Name: Barbara S. Polsky -------------------------------- Title: EVP & General Counsel ------------------------------- NATIONSBANK, N.A., a national banking association By: /S/ CAROLYN WARREN ---------------------------------- Name: Carolyn Warren -------------------------------- Title: Senior Vice President ------------------------------- 4 EX-10.22(C) 6 SECOND AMENDMENT TO RESIDUAL FINANCING AGREEMENT 1 EXHIBIT 10.22(c) SECOND AMENDMENT TO RESIDUALS FINANCING AGREEMENT THIS SECOND AMENDMENT TO RESIDUALS FINANCING AGREEMENT (this "Amendment") is made and dated as of the 10th day of December, 1998, by and among AAMES CAPITAL CORPORATION, a California corporation (the "Company"), AAMES FINANCIAL CORPORATION, a Delaware corporation and the sole shareholder of the Company (the "Parent"), and NATIONSBANK, N.A., a national banking association (the "Lender"). RECITALS A. Pursuant to that certain Residuals Financing Agreement dated as of September 4, 1998 among the Company, the Parent and the Lender (as amended, extended and replaced from time to time, the "Agreement" and with capitalized terms used herein and not otherwise defined herein used with the meanings given such terms in the Agreement), the Lender agreed to extend credit to the Company on the terms and subject to the conditions set forth therein. B. The Company wishes to pledge additional Collateral to create additional availability in the credit facility under the Agreement for a limited time period and the Lender has agreed to permit the creation of such temporary availability on certain terms and conditions, all as set forth more particularly below. NOW, THEREFORE, in consideration of the above Recitals and for other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, the parties hereto hereby agree as follows: AGREEMENT 1. DELIVERY OF ADDITIONAL COLLATERAL FOR TEMPORARY AVAILABILITY. On or before the Second Amendment Effective Date (as such term is defined in Paragraph 3 below), the Company shall deliver to The Chase Manhattan Bank, as custodian on behalf of the Lender (the "Custodian"), the certificates representing the Residual Mortgage-Backed Securities set forth on SCHEDULE I hereto, properly endorsed in blank for transfer (collectively, as so endorsed, the "Additional Collateral"), under cover of a letter addressed to the Lender requesting the Additional Collateral to be identified as Collateral for the Obligations pursuant to the Security Agreement. The parties hereto hereby agree that: (a) As of the Second Amendment Effective Date, the Additional Collateral shall constitute Eligible Residual Securities identified as Collateral pursuant to the 2 Security Agreement with an aggregate Established Collateral Value of $20,000,000.00. The Lender agrees that, on the terms and subject to the conditions set forth in the Agreement, it shall from time to time from and including the Second Amendment Effective Date to but not including the Temporary Availability Termination Date (as defined in Paragraph 1(b) below) make Revolving Loans under the Agreement on account of the increased availability under the Residuals Borrowing Base resulting from the delivery of the Additional Collateral (all such Revolving Loans, collectively, the "New Advances"). (b) On the earlier of December 31, 1998 and the date on which all outstanding New Advances have been repaid in full (as such date may be reinstated and extended pursuant to Paragraph 1(e) below, the "Temporary Availability Termination Date"): (i) The Additional Collateral shall automatically cease to constitute Eligible Residual Securities; (ii) The Collateral Value of the Residuals Borrowing Base shall be automatically reduced accordingly; and (iii) The New Advances shall become immediately due and payable in full. (c) If, but only if, the New Advances are paid in full in strict compliance with the requirement of Paragraph 1(d) below on or before the Temporary Availability Termination Date out of the Company's own funds (and not as a result of the sale or other disposition of any Collateral and application of funds therefrom), the Lender shall promptly release the Additional Collateral from the Lien under the Security Agreement and shall notify the Custodian to deliver the Additional Collateral to such Persons as the Company may direct. The parties hereto acknowledge and agree the Lender shall have no obligation to release the Additional Collateral except pursuant to the immediately preceding sentence, notwithstanding any circumstance which would prohibit the Company, or cause the Company to be unable, to timely repay the New Advances in accordance with Paragraph 1(d), including, without limitation, in the event the Company becomes involved in a bankruptcy or similar proceeding. The Lender acknowledges and agrees that in the event all Obligations under the Agreement are repaid in full, the Lender shall release all Collateral, including the Additional Collateral, in accordance with applicable laws. (d) Subject to the prepayment requirements under the Agreement and under Paragraphs 1(b)(iii) above and 1(f) below, the Company shall pay the principal amount of each New Advance no later than the earlier of (i) the tenth (10th) Business Day after the date such Revolving Loan is made and (ii) the Temporary Availability Termination Date. The Term-Out Option shall not be available with respect to any such Revolving Loan. 2 3 (e) In the event each of the following conditions shall have been satisfied on or before January 5, 1999 (the earliest date on which all such conditions shall have been satisfied being the "Reinstatement Date"): (i) The Company has delivered to the Lender evidence that a definitive agreement, in form and substance satisfactory to the Lender in its sole discretion, has been duly executed by Capital Z Partners Ltd. ("Capital Z"), pursuant to which agreement Capital Z is committed and obligated to make a capital investment in the Company in an amount not less than $100,000,000.00 subject to customary terms and conditions in such agreement; (ii)There exists no Event of Default or Potential Default other than any which has been waived by the Lender in its sole discretion; and (iii) The Company has re-delivered to the Lender (or the Custodian on behalf of the Lender) the Additional Collateral, under cover of a letter addressed to the Lender requesting the Additional Collateral to be identified as Collateral pursuant to the Security Agreement; then the Temporary Availability Termination Date shall be reinstated and extended to the earlier of January 31, 1999 and the date on which all outstanding New Advances advanced on and after the Reinstatement Date have been repaid in full. As of the Reinstatement Date, the Additional Collateral shall once again constitute Eligible Residual Securities identified as Collateral pursuant to the Security Agreement with an aggregate Established Collateral Value of $20,000,000.00, and the Lender agrees that, on the terms and subject to the conditions set forth in the Agreement, it shall from time to time from and including the Reinstatement Date to but not including the Temporary Availability Termination Date make New Advances. (f) The Company shall immediately prepay any outstanding Revolving Loans advanced pursuant to this Amendment from cash available to the Company for general corporate purposes. Notwithstanding the previous sentence, the Lender acknowledges that before such cash is applied to the prepayment of such Revolving Loans such cash will first be applied (i) to repay any outstanding "Tranche B Loans" to the extent required (and as such term is defined) under the terms of the Warehousing Agreement, (ii) to make payroll and payroll-related payments of the consolidated Parent as they become due, (iii) to pay net operating costs of the consolidated Parent not to exceed $1,000,000.00 on any one day, and (iv) to make payments to the State of California on account of escheat payments due pursuant to any notice received by the Parent. (g) The Lender hereby agrees that with respect to any Revolving Loan to be funded pursuant to this Amendment, the Lender shall not cite as grounds for refusing to fund such Revolving Loans pursuant to the terms of the Agreement the occurrence of events that have been disclosed and reported to the Lender in (i) the press release of the Company dated November 16, 1998, (ii) the Company's Form 10-Q filing for the quarter 3 4 ended September 30, 1998, and (iii) the cash flow projections delivered by the Company to the Lender concurrently herewith. Notwithstanding the foregoing, the Lender has not, and shall not be deemed to have, waived any Event of Default which does exist, has in the past existed, or at any time in the future may exist under the Agreement, and the Lender hereby reserves all rights, powers and remedies available to it under the Agreement and the other Loan Documents and under applicable law. 2. REAFFIRMATION OF LOAN DOCUMENTS. Each of the Company and the Parent hereby affirms and agrees that (a) except as expressly amended hereby, the execution and delivery by the Company and the Parent of and the performance of their obligations under this Amendment shall not in any way amend, impair, invalidate or otherwise affect any of the obligations of the Company or the Parent or the rights of the Lender under the Agreement, the Security Agreement, the Guaranty or any other Loan Document, (b) the term "Obligations" as used in the Loan Documents includes, without limitation, the Obligations of the Company under the Agreement as amended hereby. 3. SECOND AMENDMENT EFFECTIVE DATE. This Amendment shall be effective as of the earliest date (the "Second Amendment Effective Date") on which each of the following events shall have occurred: (a) Each of the Company and the Parent has duly executed and delivered to the Lender this Amendment; (b) The Company has duly delivered to the Custodian the Additional Collateral pursuant to Paragraph 1 above; and (c) Each of the Custodian, the Lender and the Company has duly executed a custody agreement in the form of EXHIBIT A attached hereto. 4. REPRESENTATIONS AND WARRANTIES. Each of the Company and the Parent hereby represents and warrants to the Lender that it has the corporate power and authority and the legal right to execute, deliver and perform this Amendment and has taken all necessary corporate action to authorize the execution, delivery and performance of this Amendment, and that this Amendment has been duly executed and delivered on behalf of the Company and the Parent and constitutes the legal, valid and binding obligations of each, enforceable against each in accordance with its terms. 5. NO OTHER AMENDMENT. Except as expressly amended hereby, the Loan Documents shall remain in full force and effect as written and amended to date. 6. COUNTERPARTS. This Amendment may be executed in any number of counterparts, each of which when so executed shall be deemed to be an original and all of which when taken together shall constitute one and the same agreement. 4 5 IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed as of the day and year first above written. AAMES CAPITAL CORPORATION, a California corporation By: /S/ BARBARA S. POLSKY ---------------------------------- Name: Barbara S. Polsky -------------------------------- Title: EVP & CFO ------------------------------- AAMES FINANCIAL CORPORATION, a Delaware corporation By: /S/ BARBARA S. POLSKY ---------------------------------- Name: Barbara S. Polsky -------------------------------- Title: EVP & General Counsel ------------------------------- NATIONSBANK, N.A., a national banking association By: /S/ CAROLYN WARREN ---------------------------------- Name: Carolyn Warren -------------------------------- Title: Senior Vice President ------------------------------- 5 6 SCHEDULE I SCHEDULE OF ADDITIONAL COLLATERAL Aames Mortgage Trust 1995-C Mortgage Pass-Through Certificate, Series 1995-C, Class R, Certificate No.: R02 Aames Mortgage Trust 1995-D Mortgage Pass-Through Certificate, Series 1995-D, Class R, Certificate No.: R02 Aames Mortgage Trust 1996-A Mortgage Pass-Through Certificate, Series 1996-A, Class R, Certificate No.: R02 Aames Mortgage Trust 1996-B Mortgage Pass-Through Certificate, Series 1996-B, Class R, Certificate No.: R02 Aames Mortgage Trust 1996-C Mortgage Pass-Through Certificate, Series 1996-C, Class R, Certificate No.: R02 6 EX-10.23(A) 7 EMPLOYMENT AGREEMENT REGISTRANT & CARY H. THOMPSON 1 EXHIBIT 10.23(a) EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT (the "AGREEMENT") is between Aames Financial Corporation, a Delaware corporation (the "COMPANY"), and Cary H. Thompson (the "EXECUTIVE"). This Agreement shall become effective (the "EFFECTIVE DATE") on the "Initial Closing Date," as such term is defined in the Purchase Agreement (defined below). BACKGROUND A. As of the Effective Date, the Company is or will be engaged primarily in originating, selling and servicing home mortgage loans. B. The Executive is currently a stockholder and officer of the Company, and as part of the closing (the "Closing") under the Preferred Stock Purchase Agreement by and among the Company and Capital Z Financial Services Fund II, L.P. ("Purchaser"), dated the 23rd day of December, 1998 (the "PURCHASE AGREEMENT"), the Company has agreed that, after the Effective Date, the Company will continue to employ the Executive to provide services for the benefit of the Company on the terms of this Agreement. If the Closing does not occur, this Agreement shall have no force or effect and the Employment Agreement dated May 8, 1997 shall remain in force. C. In exchange for the benefits provided for under this Agreement, except as otherwise specifically provided in this Agreement or in Exhibit A hereto, as of the Effective Date, the Executive hereby waives any and all rights and benefits accruing under all other employment, change in control, stock option and any and all other agreements (except for benefits provided under the Company's 401(k) plan or continued pursuant to Section 3C hereof, and stock options granted under the Aames Financial Corporation 1997 Non-Qualified Stock Option Plan, as Amended and Restated Effective May 22, 1998, the Aames Financial Corporation 1997 Stock Option Plan, the Aames Financial Corporation 1996 Stock Incentive Plan, as amended, the Aames Financial Corporation 1995 Stock Incentive Plan the Aames Financial Corporation 1991 Stock Incentive Plan and under the Stock Option Agreement between the Company and the Executive dated June 21, 1996, as amended August 26, 1998 (all of which shall be preserved)), between Executive and the Company and its subsidiaries that provide for the payment of compensation or benefits to Executive. In consideration of the foregoing and the mutual agreements set forth below, the parties agree as follows: 2 AGREEMENT - PRINCIPAL TERMS 1. Employment and Duties. The Company shall employ the Executive as its Chief Executive Officer, and the Executive accepts such employment on the terms and conditions of the Agreement. The Executive shall, while this Agreement remains in effect, have the duties, responsibilities, powers, and authority customarily associated with such position. The Executive shall report to, and follow the direction of, the Board of Directors of the Company (the "BOARD"). During each year of the Term (as hereinafter defined), the Company shall nominate the Executive for election as a member of the Board. In addition, the Executive also shall perform such other and unrelated services and duties as the Board may assign to him. The Executive shall diligently, competently, and faithfully perform all duties, and shall devote his entire business time, energy, attention, and skill to the performance of duties for the Company and its affiliates and will use his best efforts to promote the interests of the Company and its affiliates. 2. Term of Employment. Unless sooner terminated as provided in this Agreement, the initial term under this Agreement shall be five (5) years, starting on the Effective Date (the "INITIAL TERM"). The term of employment shall be renewed automatically for successive periods of one (1) year each (a "RENEWAL TERM") after the expiration of the Initial Term and any subsequent Renewal Term, unless the Board provides the Executive, or the Executive provides the Board, with written notice to the contrary at least one hundred twenty (120) days prior to the end of the Initial Term or any Renewal Term. The Initial Term and the Renewal Terms are referred to collectively as "TERMS." 3. Compensation. A. Salary. The Company shall pay the Executive an annual salary of $600,000 (the "BASE SALARY"), payable in substantially equal installments in accordance with the Company's payroll policy. The amount of Base Salary payable to Executive shall be reviewed at least annually; provided, however, that Executive's Base Salary shall not be reduced below $600,000 per annum during the term of this Agreement. B. Performance Bonus; Other Limitations. The Executive shall be entitled to an annual cash bonus on the basis outlined in Exhibit A. The covenants set forth in Exhibit A shall be binding upon the parties to the same extent as if set forth herein. C. Automobile. The Company's current policy with regard to the provision of an automobile to the Executive shall be maintained during the Term until such time as the Compensation Committee of the Board determines otherwise and provides other benefits not materially less favorable to Executive. -2- 3 D. Vacation. Executive shall be entitled to 5 weeks of paid vacation each year of employment with the Company for the term of this Agreement. In each case, such entitlement shall accrue pro rata over the contract year and shall be taken at such time or times as shall not unreasonably interfere with the operations of the Company. E. Insurance. During the Term, the Company shall maintain, at no cost to Executive, directors and officers liability insurance that covers the Executive in an amount of not less than $45,000,000. F. Stock Options. The Company shall grant to the Executive on the Effective Date an option to purchase 2,630,162 shares of the Company's common stock pursuant to and subject to the provisions of the Company's 1999 Stock Option Plan. Such option shall be subject to the terms of an option agreement substantially in the form annexed hereto as Exhibit B. G. Other Benefits. While this Agreement remains in effect, the Company shall continue to provide the Executive with (i) not less than $2,000,000 of standard term life insurance; (ii) medical and dental benefits for the Executive and his dependents substantially comparable to that provided immediately prior to the execution of this Agreement; (iii) a long-term disability policy providing for payments in an amount equal to 60% of the Executive's Base Salary, provided such a policy may be obtained at reasonable cost; and (iv) the Executive shall participate in such other savings, pension and retirement plans and other benefit plans or programs maintained by the Company for the benefit of its executives. 4. Expenses. The Company shall reimburse the Executive for all reasonable business expenses, that are incurred in accordance with the Company's policies as in effect from time to time, provided the Executive submits appropriate receipts or other documentation acceptable to the Company and as required by the Internal Revenue Service to qualify as ordinary and necessary business expenses under the Internal Revenue Code of 1986, as amended. 5. Termination. Notwithstanding anything in Paragraph 2 of this Agreement to the contrary, the term of this Agreement and Executive's services under this Agreement shall terminate upon the first to occur of the following events: A. At the end of the applicable Term of this Agreement, including any Renewal Terms. B. Upon the Executive's date of death or the date the Executive is given written notice that the Company has properly determined that he is disabled. For purposes of this Agreement, the Executive shall be properly deemed to be disabled if the Executive, as a result of illness or incapacity, shall be unable -3- 4 to perform substantially his required duties for a period of 120 consecutive days or for any aggregate period of 183 days in any twelve (12) month period. The Company shall notify the Executive that his employment has been terminated by written notice. The termination shall be effective on the tenth (10th) business day after the Executive receives the notice, unless the Executive returns to full-time performance of his duties before such tenth (10th) business day. C. On the date the Company provides the Executive with written notice that he is being terminated for "cause." For purposes of this Agreement, and as reasonably determined by the Company, the Executive shall be deemed terminated for cause if the Company terminates the Executive after finding that the Executive: (1) shall have been determined by a court of law to have committed any felony including, but not limited to, a felony involving fraud, theft, misappropriation, dishonesty, embezzlement, or any other crime involving moral turpitude, or if the Executive shall have been arrested or indicted for violation of any criminal statute constituting a felony, provided the Company reasonably determines that the continuation of the Executive's employment after such event would have an adverse impact on the operation or reputation of the Company or its affiliates (subsequent references to the "Company" in this Paragraph 5C shall be deemed to refer to the Company or its affiliates); (2) shall have committed one or more acts of gross negligence or willful misconduct, either within or outside the scope of his employment that, in the good faith opinion of the Board, materially impair the goodwill or business of the Company or cause material damage to its property, goodwill, or business, or would, if known, subject the Company to public ridicule; (3) shall have refused or failed to a material degree to perform his duties hereunder (continuing without cure for ten (10) days after receipt of written notice of need to cure); (4) shall have violated any material written Company policy provided to the Executive during or prior to the Term (continuing without cure for ten (10) days after receipt of written notice of need to cure) and that has caused material harm to the Company; or (5) knew or should have known, that the Company materially, and knowingly or intentionally breached any representation, warranty, or covenant under the Purchase Agreement, or that the Executive shall have materially and knowingly or intentionally breached any provision this Agreement; provided, however, that no termination of Executive's employment for Cause shall be deemed to have occurred unless Executive is given notice of the reason therefore including the allegations which may constitute reason for such termination and after (a) Executive is provided an opportunity to be heard by the Board or the Executive Committee thereof, and (b) such decision has been upheld by the Board or Executive Committee. D. On the date the Executive terminates his employment for "Good Reason." For purposes of this Agreement, -4- 5 "GOOD REASON" shall mean termination by the Executive within ninety (90) days of learning of the acts which are the basis for alleging Good Reason, because of the occurrence of any of the following acts, without the Executive's consent: (1) he has been demoted to a position of materially less stature or importance within the Company than the position described in Paragraph 1, (2) he has been assigned to duties that are of materially less importance than those required to be performed pursuant to Paragraph 1 of this Agreement, (3) the Company has failed to pay or provide material compensation or benefits that are required to be provided in this Agreement, or (4) the Company's principal executive offices have been relocated to any county other than Los Angeles County, CA or Orange County, CA., provided that no such termination shall be treated as for Good Reason unless the Executive shall have given the Company thirty (30) days advance written notice of his intention to terminate his employment for Good Reason, and the Company shall have failed to cure such acts within such thirty (30) day period. E. On the date the Executive terminates his employment for any reason, other than Good Reason, provided that the Executive shall give the Company thirty (30) days written notice prior to such date of his intention to terminate this Agreement. F. On the date the Company terminates the Executive's employment for any reason, other than a reason otherwise set forth in this Paragraph 5. Any purported termination of the Executive's employment for Cause which is finally determined to be without Cause shall be treated for all purposes of this Agreement as a termination pursuant to this Paragraph 5F. 6. Compensation Upon Termination. If the Executive's services are terminated pursuant to Paragraph 5, the Executive shall be entitled to the Base Salary through his final date of active employment, plus any accrued but unused vacation pay. If the Executive's services are terminated pursuant to Paragraph 5D or 5F, the Executive shall in addition be entitled to receive severance benefits for a period of 12 months payable in substantially equal installments in accordance with the Company's payroll policy, in an amount equal to (i) $2 million, if such termination occurs within one year from the Effective Date, (ii) $1.5 million, if such termination occurs after the first and on or before the second anniversary of the Effective Date, (iii) $1.0 million, if such termination occurs after the second and on or before the third anniversary of the Effective Date, (iv) $0.5 million, if such termination occurs after the fourth anniversary of the Effective Date, and (v) plus an amount, if any, (regardless of the date of termination) necessary to reimburse the Executive on a net after-tax basis for any applicable federal excise tax, provided in each case the Executive signs an agreement that releases the Company from actions, suits, claims, proceedings, and demands related to the period of employment -5- 6 and/or termination of employment. Executive agrees that if his employment is terminated for any reason, he shall immediately resign from all officer and director positions he then holds with the Company and each of its parents, affiliates and subsidiaries. 7. Offset. In the event severance benefits become payable to the Executive pursuant to Paragraph 6 above, such benefits, to the extent not theretofore paid, shall be reduced, on a dollar-for-dollar basis, by (i) any outstanding amounts owed by Executive to the Company and (ii) the amount of any compensation for services earned by Executive on account of his employment or consulting services with another business or on account of his self employment, from any source, whether paid currently or deferred. In such event, Executive shall cooperate with the Company and shall provide such information to the Company as it may reasonably require in order to calculate the amount of the reduction described above. 8. COBRA. If the Executive's services are terminated pursuant to Paragraph 5, the Executive shall also be entitled to any benefits mandated under the Consolidated Omnibus Budget Reconciliation Act of 1985 ("COBRA") or required under the terms of any death, insurance, or retirement plan, program, or agreement provided by the Company and to which the Executive is a party or in which the Executive is a participant, including, but not limited to, any short-term or long-term disability plan or program, if applicable. If the Executive elects COBRA continuation coverage, the Company shall pay for such health insurance coverage for the shorter of 12 months or the remaining Term at the same rate as it pays for health insurance coverage for its active employees (with the Executive required to pay for any employee-paid portion of such coverage). After the expiration of the period set forth in the prior sentence concludes, the Executive shall be responsible for the payment of all further premiums attributable to COBRA continuation coverage at the same rate as the Company charges all COBRA beneficiaries. However, no provision of this Agreement shall be construed to extend the period of time over which such COBRA continuation coverage is required to be provided to the Executive and/or his dependents. 9. Arbitration. Any dispute between the parties hereto respecting the meaning and intent of this Agreement or any of its terms and provisions shall be submitted for expedited arbitration in Los Angeles, California, in accordance with the National Rules of the American Arbitration Association for the Resolution of Employment Disputes then in effect, and the arbitration determination resulting from any such submission shall be final and binding upon the parties hereto. Judgment upon any arbitration award may be entered in any court of competent jurisdiction. The parties further agree that either party may at any time seek provisional relief, including, but not limited to a temporary restraining order or a preliminary injunction from -6- 7 any state or federal court in California, in connection with any dispute being submitted for arbitration. 10. Exclusive Employment; Confidentiality; Non-Solicitation. A. Executive agrees to perform his duties, responsibilities and obligations hereunder efficiently and to the best of his ability. Executive also agrees that he will not engage in any other business activities, pursued for gain, profit or other pecuniary advantage, that are competitive with the activities of the Company. Executive agrees that all of his activities as an employee of the Company shall be in conformity with all present and future policies, rules and regulations and directions of the Company not inconsistent with this Agreement. B. Executive acknowledges that his employment by the Company will bring him into close contact with many trade secrets and other confidential affairs of the Company and its clients and customers, including, without limitation, non-public information pertaining to ideas, knowledge, operations, computer hardware and software, systems, costs, profits, markets, sales, products, programs, interfaces, networks, protocols, data bases, key personnel, pricing policies, operational methods, concepts, data, equipment, models, compensation, suppliers, servicing, broker lists, customer lists, customers, potential customers, rate sheets, plans, concepts, strategies, or products, advertising, technical processes and applications and other business affairs and methods, plans for future developments and other information not readily available to the public or the Company's competitors or clients (collectively referred to hereinafter as "Information"). In consideration of the foregoing, the Executive agrees that he: (1) will keep secret and confidential all Information and will not use it for his own benefit or disclose it to, or use it for the benefit of, anyone other than the Company, either during or after his employment by the Company, except with the prior written consent of the Company; (2) will take all reasonable action that the Company deems necessary or appropriate to prevent unauthorized use or disclosure of or to protect the Company's interest in Information; (3) will deliver promptly to the Company upon termination of his employment by the Company or at any other time the Company may so request, all memoranda, notes, documentation, equipment, files, flowcharts, program listings, data listings, records, reports and other tangible manifestations of the Information (and all copies thereof), that he may then possess or have under his control; and (4) will, unless the Company otherwise agrees in writing, and without additional compensation, promptly disclose and, upon request, assign to the Company all rights to work product and business opportunities related to the present or, to the extent presented to the Board of Directors prior to termination of employment, contemplated business of the Company. -7- 8 C. Executive further agrees that if his employment is terminated during the three year period beginning on the Effective Date, he will abide by the limitations set forth in the following sentence (i) for a period of six months from the date of termination, if his employment is terminated pursuant to Paragraph 5B, 5D or 5F, and (ii) for a period of one year from the date of termination, if his employment is terminated by the Company pursuant to Paragraph 5C or if his employment is terminated by the Executive without Good Reason (the applicable period is referred to below as the "Nonsolicitation Period"). During the Nonsolicitation Period, the Executive agrees that he will not, without the Company's express written consent, himself or through any organization with which he is associated: (i) hire any person who was employed by the Company on the Executive's date of termination of employment or at any time within six months prior thereto or hire any agent, consultant, or independent contractor of the Company, or of any organization with respect to which the Company has agreed to a similar prohibition and of which the Employee has knowledge, or induce or attempt to induce any such person to discontinue such employment or affiliation with the Company or such organization, as the case may be, or (ii) induce or attempt to induce any client or customer of the Company on the date of termination to discontinue any business relationship or to refrain from entering into a new business relationship with the Company. D. Executive confirms and acknowledges that (i) he was represented by counsel of his own choosing during the negotiation of the limitations set forth in Paragraphs 10 and 11 of this Agreement, (ii) his strict adherence to the limitations imposed upon him thereunder, or under any agreement referenced therein, was a material factor in Purchaser's entering into the Purchase Agreement and agreeing to consummate the transactions contemplated thereby, and to pay the Executive the cash and equity-based compensation called for in this Agreement, (iii) the Company's ability to maintain continuing relationships with its employees without disruption was a material factor in Purchaser's entering into the Purchase Agreement and agreeing to consummate the transactions contemplated thereby, (iv) his failure to adhere to the obligations imposed by Paragraphs 10 and 11 of this Agreement will expose such Purchaser to substantial and irreparable harm. Accordingly, Executive agrees that the remedy at law for any breach by him of the covenants and agreements set forth in this Paragraph 10 or in Paragraph 11 below may be inadequate and that in the event of any such breach, the Company or its respective subsidiaries may, in addition to the other remedies that may be available to it at law, seek injunctive relief prohibiting him (together with all those persons associated with him) from breach of such covenants and agreements. 11. Non-Competition. The Company's obligation to provide the compensation due upon termination pursuant to the last sentence of Paragraph 6 hereof shall be contingent upon his not, -8- 9 directly or indirectly, owning, managing, operating, joining or controlling, becoming employed by or participating in the ownership, management, operation or control of, or becoming a consultant to or connected in any other manner with, any business, firm or corporation which is materially similar to or materially competes with the Company, provided, however, that the foregoing shall not preclude the Executive from providing investment banking services not involving the Company. For these purposes, Executive's ownership of securities of a public company not in excess of one percent of any class of such securities shall not be considered to be competition with the Company. AGREEMENT - MISCELLANEOUS 12. Entire Agreement. This Agreement sets forth the entire and final agreement and understanding of the Company and the Executive and contains all of the agreements made between them with respect to the subject matter hereof. This Agreement supersedes any and all other agreements, either oral or in writing, between the Company and the Executive with respect to Executive's provision of services to the Company. No change or modification of this Agreement shall be valid unless in writing and signed by the Company and the Executive. 13. Enforcement; Severability. Should a decision be entered by a court of competent jurisdiction that the character, duration or geographical scope of any provision of this Agreement is unreasonable, or that any provision of this Agreement is invalid or unenforceable for any reason, in whole or in part, then the Company and the Executive agree that such provision shall be construed by the court in such a manner as to impose all those restrictions on the Executive's conduct that are reasonable in light of the circumstances and as are necessary to assure to the Company the benefits of this Agreement and to render the provision valid and enforceable, and this Agreement shall be construed and enforced to the maximum extent permitted by law, as if such provision had been originally incorporated in this Agreement as so modified, restricted, or reformulated or as if such provision had not been originally included in this Agreement, as the case may be. The parties further agree to seek a lawful substitute for any provision found to be unlawful; provided, that, if the parties are unable to agree upon a lawful substitute, the parties desire and request that the arbitrator or other authority called upon to decide the enforceability of this Agreement modify those provisions such that, once modified, this Agreement will be enforceable to the maximum extent permitted by the law in existence at the time of the requested enforcement. 14. Miscellaneous. D. Notices. All notices required in connection with this Agreement shall be sufficiently given only if transmitted in writing and (i) personally delivered, or sent by first class, registered or certified mail, return receipt requested, postage -9- 10 prepaid, or by recognized overnight courier, (ii) sent by facsimile, provided a hard copy is mailed on that date to the party for whom such notices are intended, or (iii) sent by other means at least as fast and reliable as first class mail. A written notice shall be deemed to have been given to the recipient party on the earliest of (1) the date it shall be delivered to the address required by this Agreement; (2) the date delivery shall have been refused at the address required by this Agreement; (3) with respect to notices sent by mail or overnight courier, the date as of which the Postal Service or overnight courier, as the case may be, shall have indicated such notice to be undeliverable at the address required by this Agreement; or (4) with respect to a facsimile, the date on which the facsimile is sent and receipt is confirmed. Any and all notices referred to in this Agreement, or which either party desires to give to the other shall, in the case of the Executive, be addressed to his residence address given to the Company by the Executive in writing for this purpose, or failing receipt of such notice, to the last residence address on the Company's records, or in the case of the Company, to its principal office with a copy to Capital Z's principal office. E. Waiver of Breach. A waiver by the Company of a breach of any provision of this Agreement by the Executive shall not operate or be construed as a waiver of any subsequent breach by the Executive. No waiver shall be valid unless it is in writing and signed by an authorized officer of the Company (other than the Executive). F. Assignment. The Executive acknowledges that the services he is to render are unique and personal. Accordingly, the Executive may not assign any of his rights or delegate any of his duties or obligations under this Agreement. The rights and obligations of the Company under this Agreement shall inure to the benefit of and shall be binding upon the successors and assigns of the Company. G. Construction. The heading in this Agreement are inserted for convenience only and are not to be considered a construction of the provisions hereof. The Background recitals are incorporated in this Agreement as an integral part hereof and shall be considered as substantive and not precatory language. H. Execution of Agreement. This Agreement may be executed in several counterparts, each of which shall be considered an original, but which when taken together, shall constitute one agreement. -10- 11 I. Governing Law. This Agreement shall be construed in accordance with the laws of the State of California. COMPANY: EXECUTIVE: o By: /s/ Barbara S. Polsky /s/ Cary H. Thompson -------------------------- -------------------------- -11- 12 EXHIBIT A - - For bonuses after the 1999 calendar year, Executive shall receive a cash bonus paid annually on a calendar year basis ranging from 0-100% of total Base Salary, with an expected bonus of $400,000 and a bonus in excess of 100% of Base Salary for extraordinary performance. Bonuses shall be paid according to a budget approved by the Board of Directors of the Company and the achievement of other non-financial goals adopted by such Board. - - For so long as Capital Z and/or its Designated Purchasers under the Purchase Agreement own at least 25% of the voting securities of the Company, Executive covenants and agrees not to sell, assign or otherwise transfer, in any one twelve month period, more than 25% of the aggregate amount of shares of Company stock which the Executive owned immediately prior to the Effective Date. The Company, by action of its Board of Directors, agrees to consider whether to waive all or part of such limitation in the event of extraordinary hardship, which consent shall not be unreasonably withheld. -12- EX-10.23(B) 8 AMENDMENT NO. 1 TO THE EMPLOYMENT AGREEMENT 1 EXHIBIT 10.23(b) AMENDMENT NO. 1 TO THE EMPLOYMENT AGREEMENT BETWEEN CARY H. THOMPSON AND AAMES FINANCIAL CORPORATION The Employment Agreement (the "Agreement") between Cary H. Thompson (the "Executive") and Aames Financial Corporation, a Delaware corporation (the "Company"), to become effective immediately prior to the "Initial Closing Date," as such term is defined in the Preferred Stock Purchase Agreement by and among the Company and Capital Z Financial Services Fund II, L.P., dated the 23rd day of December, 1998, is hereby amended as follows: 1. Section 3F of the Agreement shall be amended by replacing "2,630,162" with "2,580,162" in each place that it appears in the Section. 2. Capitalized terms herein shall have the meanings ascribed to them in the Agreement. Except as amended hereby, the remaining provisions of the Agreement, as amended to date, shall remain in full force and effect. IN WITNESS WHEREOF, the Executive and the undersigned duly authorized officer of the Company have executed and delivered this amendment as of February 10, 1999. AAMES FINANCIAL CORPORATION By: /s/ Barbara S. Polsky ------------------------------ Cary H. Thompson /s/ Cary H. Thompson ---------------------------------- EX-10.24 9 MANAGEMENT INVESTMENT AGREEMENT 1 EXHIBIT 10.24 MANAGEMENT INVESTMENT AGREEMENT (CARY THOMPSON) MANAGEMENT INVESTMENT AGREEMENT (this "Agreement") dated as of December 23, 1998, between Aames Financial Corporation, a Delaware corporation (the "Company"), and Cary Thompson, an individual residing at 1944 Fairburn Avenue, Los Angeles, California, 09925 (the "Management Investor"). WHEREAS, on the date hereof, the Company and Capital Z Financial Services Fund II, L.P., a Bermuda limited partnership ("Capital Z"), are entering into a Preferred Stock Purchase Agreement (the "Purchase Agreement"), pursuant to which Capital Z has agreed to purchase, together with Capital Z Affiliates and co-investors as designated by Capital Z, shares of the Company's Series B Convertible Preferred Stock, par value $0.001 per share ("Series B Preferred Stock") and Series C Convertible Preferred Stock, par value $0.001 per share ("Series C Preferred Stock," and, together with the Series B Preferred Stock, "Senior Preferred Stock"), in the amounts and subject to the conditions set forth in the Purchase Agreement; and WHEREAS, the Management Investor is a senior management employee of the Company and, as a condition precedent to the closing of the transactions contemplated by the Purchase Agreement, certain senior management employees of the Company, including the Management Investor, are required to purchase Series C Preferred Stock from the Company; and WHEREAS, the Management Investor desires to purchase from the Company, and the Company desires to sell to the Management Investor, Series C Preferred Stock under the terms and conditions set forth in this Agreement. NOW THEREFORE, in consideration of the premises and the mutual covenants contained in this Agreement, and other good and valuable consideration, the sufficiency of which is hereby acknowledged, the parties hereto agree as follows: SECTION 1. Defined Terms. Capitalized terms used and not otherwise defined in this Agreement shall have the respective meanings assigned to them in the Purchase Agreement. SECTION 2. Sale and Delivery. (a) Upon the terms and subject to the conditions set forth herein, and conditioned upon the consummation of the Initial Closing, in reliance upon the representations and warranties of the Management Investor hereinafter set forth, and for the purchase price described in Section 2(b), at the Initial 2 Closing, the Company shall issue, sell and deliver to the Management Investor, and the Management Investor shall purchase from the Company, two hundred and fifty (250) shares of Series C Preferred Stock (such shares of Series C Preferred Stock are referred to collectively herein as the "Shares"). The number "250" in the preceding sentence shall be two hundred and fifty thousand (250,000) if the Recapitalization has been consummated prior to the Initial Closing Date). (b) The purchase price per share of Series C Preferred Stock shall be equal to the Purchase Price (as such term is defined in the Purchase Agreement) (as used herein, the "Purchase Price") and shall be paid in cash at the Initial Closing. (c) The purchase and sale of Shares shall occur on the Initial Closing Date and, at the Initial Closing: (i) the Company shall deliver to the Management Investor certificates representing the Shares, duly endorsed for transfer, transferring to the Management Investor good and marketable title to such Shares, free and clear of all liens and encumbrances; and (ii) the Management Investor shall deliver to the Company the Purchase Price, in immediately available funds to the account specified by the Company at least two Business Days prior to the Initial Closing Date; SECTION 3. Representations and Warranties of the Management Investor. The Management Investor hereby represents and warrants to the Company as follows: (a) The Shares (and the Underlying Common Shares) to be purchased by such Management Investor will be acquired for investment for the Management Investor's own account and not with a view to the resale or distribution of any part thereof, except in compliance with the provisions of the Securities Act of 1933, as amended (the "Securities Act"), or an exemption therefrom, and in compliance with the terms of this Agreement. The Management Investor is a senior management employee of the Company and is fully familiar with the business of the Company and with the risks associated with the purchase of the Shares pursuant to this Agreement. The Management Investor is an accredited investor as defined under Rule 501(a) under the Securities Act. (b) The Management Investor understands that the Shares and the Underlying Common Shares are characterized as "restricted securities" under the federal securities laws inasmuch as they are being acquired from the Company in a transaction not involving a public offering and that under such laws and applicable regulations such Shares (and the Underlying Common Shares) may be resold without registration under the Securities Act only in certain limited circumstances. -2- 3 (c) The Management Investor further agrees that each certificate representing the Shares (and the Underlying Common Shares) shall be stamped or otherwise imprinted with a legend substantially in the following form: "THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 AND MAY NOT BE TRANSFERRED OR OTHERWISE DISPOSED OF UNLESS SUCH SECURITIES HAVE BEEN REGISTERED UNDER THAT ACT OR AN EXEMPTION FROM REGISTRATION IS AVAILABLE. THE SECURITIES REPRESENTED BY THIS CERTIFICATE ARE SUBJECT TO RESTRICTIONS ON TRANSFER AND TO THE OTHER TERMS SET FORTH IN THAT CERTAIN MANAGEMENT INVESTMENT AGREEMENT, DATED AS OF DECEMBER 23, 1998, A COPY OF WHICH AGREEMENT HAS BEEN FILED WITH THE SECRETARY OF THE COMPANY AND ARE AVAILABLE UPON REQUEST." SECTION 4. Restrictions on Transfer of Shares. For a period commencing on the Initial Closing Date and ending on the fifth anniversary of the Initial Closing Date, the Management Investor may not sell, transfer, assign, pledge, hypothecate or otherwise dispose of (each, a "transfer") any of the Shares (or the Underlying Common Shares), without the prior express written consent of the Company, provided, however, that the foregoing restriction on transfer shall not apply (i) if Capital Z Beneficially Owns less than (A) fifty percent (50%) of the number of shares of Senior Preferred Stock purchased by Capital Z on the Initial Closing Date (the "Original Preferred Shares") or (B) if any Original Preferred Shares shall thereafter have been converted into Common Stock, fifty percent (50%) of the sum of (x) the aggregate number of shares Common Stock owned by Capital Z as a result of such conversion(s) plus (y) the aggregate number of shares Common Stock into which any remaining Original Preferred Shares owned by Capital Z may be converted (determined without regard to any limitations on conversion of such shares prior to the Recapitalization), in each case subject to adjustment for splits, combinations, reclassifications and similar events; (ii) if the Management Employee dies, retires, is terminated by the Company, or terminates his employment with the Company, subject to the provisions of Section 5 hereof; or (iii) a Change of Control (as defined in the New Option Plan) has occurred, but only if a Capital Z Realization Event (as defined in the New Option Plan) has also occurred on or prior to such Change of Control, and provided, further, that notwithstanding the foregoing restriction on transfer, the Management Investor may transfer, during the twelve-month period ending on the first anniversary of the Initial Closing Date and during each succeeding twelve-month period, up to 25% of the total number of Underlying Common Shares (whether structured as a transfer of Shares, Underlying Shares or a combination thereof) acquired hereunder (subject to adjustment for splits, combinations, reclassifications and similar events), it being further agreed that the Management Investor may request the Company's Board of -3- 4 Directors to allow the Management Investor to transfer Shares (or Underlying Common Shares) in excess of the 25% limitation described in this proviso if extraordinary liquidity needs have arisen with respect to the Management Investor, and, in such event, the Company (through its Board of Directors) will consider such request in good faith and will not unreasonably withhold its consent to a waiver of such limitation. SECTION 5. Company's Option to Purchase Shares. (a) In the event of the death or retirement from, or termination of employment for any reason with, the Company of the Management Investor (a "Termination Date"), the Company shall have the option, but not the obligation, to purchase all, or any portion, of the Shares (and any Underlying Common Shares that may have been acquired upon conversion of the Shares) then owned by the Management Investor at the Fair Market Value (as hereinafter defined) per Share and/or Underlying Common Share on the Business Day immediately prior to the date on which the Company exercises its option to purchase in accordance with the this Section 5. The Company may exercise the foregoing option at any time within 30 days after the Termination Date, by written notice to the Management Investor, or his legal representative in the case of death, stating a date and time for consummation of the purchase no less than 10 nor more than 30 days after giving of such notice. "Fair Market Value" per Share or per Underlying Common Share, as of any particular date, shall mean (a) in the case of a Share, the product obtained by multiplying (I) the Formula Number (as defined in the Certificate of Designations for the Senior Preferred Stock) in effect as of such date by (II) the Current Market Price (as defined in the Certificate of Designations for the Senior Preferred Stock) for the period of 15 consecutive Trading Days (as defined in the Certificate of Designations for the Senior Preferred Stock) prior to such date, or (b) in the case of an Underlying Share, the Current Market Price for the period of 15 consecutive Trading Days prior to such date. (b) At the closing of the purchase of Shares (and any Underlying Common Shares) by the Company pursuant to Section 4(a), the Management Investor will deliver the Shares (and any Underlying Common Shares) to the Company against payment by the Company to the Management Investor of the purchase price for such Shares (and any Underlying Common Shares). Such purchase price shall be paid in cash. SECTION 5. Termination. All rights and obligations of the parties hereunder shall terminate upon the date upon which the Purchase Agreement is terminated in accordance with its terms, provided, that any such termination that results from the breach by a party of his or its obligations hereunder shall not relieve such party from any liability for breach of this Agreement. -4- 5 SECTION 6. Further Assurances. The Management Investor shall, upon request of the Company, execute and deliver any additional documents and take such further actions as may reasonably be deemed by the Company to be necessary or desirable to carry out the provisions hereof. SECTION 7. Notices. All notices, requests, claims, demands and other communications under this Agreement shall be sufficiently given if sent by registered or certified mail, postage prepaid, or overnight air courier service, or telecopy or facsimile transmission (with hard copy to follow) to the parties at the following addresses (or at such other address for a party as shall be specified by like notice): (i) if to the Company, to the address set forth in Section 7.3 of the Purchase Agreement; and (ii) if to the Management Investor, to the address set forth for the Management Investor in the preamble to this Agreement or by telecopy to (323) 210-5253. SECTION 8. Headings. The headings contained in this Agreement are for reference purposes only and shall not affect in any way the meaning or interpretation of this Agreement. SECTION 9. Counterparts; Effectiveness. This Agreement may be executed in two or more counterparts, all of which shall be considered one and the same agreement and shall become effective when one or more counterparts have been signed by each of the Company and the Management Investor and delivered to the Company and the Management Investor. SECTION 10. Entire Agreement. This Agreement (including the documents and instruments referred to herein) constitutes the entire agreement, and supersedes all prior agreements and understandings, both written and oral, among the parties with respect to the subject matter hereof. SECTION 11. Governing Law. This Agreement shall be governed by, and construed in accordance with, the laws of the State of Delaware, without regard to any applicable conflicts of law principles of such State. SECTION 12. Successors and Assigns. Neither this Agreement nor any of the rights, interests or obligations under this Agreement shall be assigned, in whole or in part, by operation of law or otherwise, by any of the parties without the prior written consent of the other parties. Any assignment in violation of the foregoing shall be void. SECTION 13. Enforcement. Each party agrees that irreparable damage would occur and that the other party hereto would not have any adequate remedy at law in the event that any of the provisions of this Agreement were not performed in accordance with their specific terms or were otherwise breached. It is accordingly agreed that each party shall be entitled to an injunction or injunctions to prevent breaches by the other party -5- 6 hereto of this Agreement and to enforce specifically the terms and provisions of this Agreement in any court of the United States located in the State of Delaware or in Delaware State court, this being in addition to any other remedy to which they are entitled at law or in equity. In addition, each of the parties hereto (i) consents to submit such party to the personal jurisdiction of any Federal court located in the State of Delaware or any Delaware State court in the event any dispute arises out of this Agreement or any of the transactions contemplated hereby, (ii) agrees that such party will not attempt to deny or defeat such personal jurisdiction by motion or other request for leave from any such court and (iii) agrees that such party will not bring any action relating to this Agreement or any of the transactions contemplated hereby in any court other than a Federal court sitting in the State of Delaware of in Delaware State court. SECTION 14. Severability. If any term or provision hereof, or the application thereof to any circumstance, shall, to any extent, be held by a court of competent jurisdiction to be invalid or unenforceable with respect to such jurisdiction, and only to such extent, and the remainder of the terms and provisions hereof, and the application thereof to any other circumstance, shall remain in full force and effect, shall not in any way be affected, impaired or invalidated, and shall be enforced to the fullest extent permitted by law, and the parties hereto shall reasonably negotiate in good faith a substitute term or provision that comes as close as possible to the invalidated or unenforceable term or provision, and that puts each party in a position as nearly comparable as possible to the position each such party would have been in but for the finding of invalidity or unenforceability, while remaining valid and enforceable. SECTION 15. Amendment; Modification; Waiver. No amendment, modification or waiver in respect of this Agreement shall be effective against any party unless it shall be in writing and signed by such party. SECTION 16. Expenses. The Company and the Management Investor shall each bear their own legal fees and other costs and expenses with respect to the negotiation, execution and delivery of this Agreement and consummation of the transactions contemplated hereby. -6- 7 IN WITNESS WHEREOF, the Company and the Management Investor have caused this Agreement to be duly executed and delivered as of the date first written above. AAMES FINANCIAL CORPORATION By: /s/ Barbara S. Polsky ------------------------------- Name: Barbara S. Polsky Title: Executive Vice President MANAGEMENT INVESTOR: /s/ Cary H. Thompson -------------------------------------- Cary Thompson -7- EX-10.25 10 EMPLOYMENT AGREEMENT REGISTRANT & NEIL KORNSWIET 1 EXHIBIT 10.25 EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT (the "AGREEMENT") is between Aames Financial Corporation, a Delaware corporation (the "COMPANY"), and Neil B. Kornswiet (the "EXECUTIVE"). This Agreement shall become effective (the "EFFECTIVE DATE") on the "Initial Closing Date," as such term is defined in the Purchase Agreement (defined below). BACKGROUND A. As of the Effective Date, the Company is or will be engaged primarily in originating, selling and servicing home mortgage loans. B. The Executive is currently a stockholder and officer of the Company, and as part of the closing (the "Closing") under the Preferred Stock Purchase Agreement by and among the Company and Capital Z Financial Services Fund II, L.P. ("Purchaser"), dated the 23rd day of December, 1998 (the "PURCHASE AGREEMENT"), the Company has agreed that, after the Effective Date, the Company will continue to employ the Executive to provide services for the benefit of the Company on the terms of this Agreement. If the Closing does not occur, this Agreement shall have no force or effect and the Employment Agreement dated August 26, 1998 shall remain in force. C. In exchange for the benefits provided for under this Agreement, except as otherwise specifically provided in this Agreement or in Exhibit A hereto, as of the Effective Date, the Executive hereby waives any and all rights and benefits accruing under all other employment, change in control, and any and all other agreements between Executive and the Company and its subsidiaries that provide for the payment of compensation or benefits to Executive, other than (i) benefits provided under the Company's 401(k) plan, (ii) benefits continued pursuant to Section 3C hereof, and (iii) stock options granted under the Aames Financial Corporation 1997 Non-Qualified Stock Option Plan, as Amended and Restated Effective May 22, 1998, the Aames Financial Corporation 1997 Stock Option Plan, the Aames Financial Corporation 1996 Stock Incentive Plan, as amended, the Aames Financial Corporation 1995 Stock Incentive Plan, the Aames Financial Corporation 1991 Stock Incentive Plan and under those certain assumption option agreements entered into by the Company in connection with its acquisition of One Stop Mortgage, Inc., pursuant to an Agreement dated August 12, 1996, which, to the extent practicable, will be modified to provide for transfer to the Executive in the event they are forfeited by the original grantees after August 12, 1996, provided that the Executive shall in no event acquire greater rights under such assumption options than those held by the optionees to whom they were originally issued, all of which options shall be preserved. 2 In consideration of the foregoing and the mutual agreements set forth below, the parties agree as follows: AGREEMENT - PRINCIPAL TERMS 1. Employment and Duties. The Company shall employ the Executive as its President responsible for day to day operation of the Company and its subsidiaries, and the Executive accepts such employment on the terms and conditions of the Agreement. The Executive shall, while this Agreement remains in effect, have the duties, responsibilities, powers, and authority customarily associated with such position. The Executive shall report to, and follow the direction of, the Board of Directors of the Company (the "BOARD"). During each year of the Term (as hereinafter defined), the Company shall nominate the Executive for election as a member of the Board. In addition, the Executive also shall perform such other and unrelated services and duties as the Board may assign to him. The Executive shall diligently, competently, and faithfully perform all duties, and shall devote his entire business time, energy, attention, and skill to the performance of duties for the Company and its affiliates and will use his best efforts to promote the interests of the Company and its affiliates. 2. Term of Employment. Unless sooner terminated as provided in this Agreement, the initial term under this Agreement shall be five (5) years, starting on the Effective Date (the "INITIAL TERM"). The term of employment shall be renewed automatically for successive periods of one (1) year each (a "RENEWAL TERM") after the expiration of the Initial Term and any subsequent Renewal Term, unless the Board provides the Executive, or the Executive provides the Board, with written notice to the contrary at least one hundred twenty (120) days prior to the end of the Initial Term or any Renewal Term. The Initial Term and the Renewal Terms are referred to collectively as "TERMS." 3. Compensation. A. Salary. The Company shall pay the Executive an annual salary of $600,000 (the "BASE SALARY"), payable in substantially equal installments in accordance with the Company's payroll policy. The amount of Base Salary payable to Executive shall be reviewed at least annually; provided, however, that Executive's Base Salary shall not be reduced below $600,000 per annum during the term of this Agreement. B. Performance Bonus; Other Limitations. The Executive shall be entitled to annual cash bonuses, and other extraordinary compensation and benefits on the basis outlined in Exhibit A. The covenants set forth in Exhibit A shall be binding upon the parties to the same extent as if set forth herein. - 2 - 3 C. Automobile. The Company's current policy with regard to the provision of an automobile to the Executive shall be maintained during the Term until such time as the Compensation Committee of the Board determines otherwise and provides other benefits not materially less favorable to Executive. D. Vacation. Executive shall be entitled to 5 weeks of paid vacation each year of employment with the Company for the term of this Agreement. In each case, such entitlement shall accrue pro rata over the contract year and shall be taken at such time or times as shall not unreasonably interfere with the operations of the Company. E. Insurance. During the Term, the Company shall maintain, at no cost to Executive, directors and officers liability insurance that covers the Executive in an amount of not less than $45,000,000. F. Stock Options. The Company shall grant to the Executive on the Effective Date an option to purchase 3,214,642 million shares of the Company's common stock pursuant to and subject to the provisions of the Company's 1999 Stock Option Plan. Such option shall be subject to the terms of an option agreement substantially in the form annexed hereto as Exhibit B. G. Other Benefits. While this Agreement remains in effect, the Company shall continue to provide the Executive with (i) not less than $2,000,000 of standard term life insurance; (ii) medical and dental benefits for the Executive and his dependents substantially comparable to that provided immediately prior to the execution of this Agreement; (iii) a long-term disability policy providing for payments in an amount equal to 60% of the Executive's Base Salary, provided such a policy may be obtained at reasonable cost; and (iv) the Executive shall participate in such other savings, pension and retirement plans and other benefit plans or programs maintained by the Company for the benefit of its executives. 4. Expenses. The Company shall reimburse the Executive for all reasonable business expenses, that are incurred in accordance with the Company's policies as in effect from time to time, provided the Executive submits appropriate receipts or other documentation acceptable to the Company and as required by the Internal Revenue Service to qualify as ordinary and necessary business expenses under the Internal Revenue Code of 1986, as amended. 5. Termination. Notwithstanding anything in Paragraph 2 of this Agreement to the contrary, the term of this Agreement and Executive's services under this Agreement shall terminate upon the first to occur of the following events: A. At the end of the applicable Term of this Agreement, including any Renewal Terms. - 3 - 4 B. Upon the Executive's date of death or the date the Executive is given written notice that the Company has properly determined that he is disabled. For purposes of this Agreement, the Executive shall be properly deemed to be disabled if the Executive, as a result of illness or incapacity, shall be unable to perform substantially his required duties for a period of 120 consecutive days or for any aggregate period of 183 days in any twelve (12) month period. The Company shall notify the Executive that his employment has been terminated by written notice. The termination shall be effective on the tenth (10th) business day after the Executive receives the notice, unless the Executive returns to full-time performance of his duties before such tenth (10th) business day. C. On the date the Company provides the Executive with written notice that he is being terminated for "cause." For purposes of this Agreement, and as reasonably determined by the Company, the Executive shall be deemed terminated for cause if the Company terminates the Executive after finding that the Executive: (1) shall have been determined by a court of law to have committed any felony including, but not limited to, a felony involving fraud, theft, misappropriation, dishonesty, embezzlement, or any other crime involving moral turpitude, or if the Executive shall have been arrested or indicted for violation of any criminal statute constituting a felony, provided the Company reasonably determines that the continuation of the Executive's employment after such event would have an adverse impact on the operation or reputation of the Company or its affiliates (subsequent references to the "Company" in this Paragraph 5C shall be deemed to refer to the Company or its affiliates); (2) shall have committed one or more acts of gross negligence or willful misconduct, either within or outside of the scope of his employment that, in the good faith opinion of the Board, materially impair the goodwill or business of the Company or cause material damage to its property, goodwill, or business, or would, if known, subject the Company to public ridicule; (3) shall have refused or failed to a material degree to perform his duties hereunder (continuing without cure for ten (10) days after receipt of written notice of need to cure); (4) shall have violated any material written Company policy provided to the Executive during or prior to the Term (continuing without cure for ten (10) days after receipt of written notice of need to cure) and that has caused material harm to the Company; or (5) knew, or should have known, that the Company materially, and knowingly or intentionally breached any representation, warranty, or covenant under the Purchase Agreement, or that the Executive shall have materially and knowingly or intentionally breached any provision this Agreement; provided, however, that no termination of Executive's employment for Cause shall be deemed to have occurred unless Executive is given notice of the reason therefore including the allegations which may constitute reason for such termination and after (a) Executive is provided an opportunity to be heard by the Board or the Executive Committee thereof, and (b) - 4 - 5 such decision has been upheld by the Board or Executive Committee. D. On the date the Executive terminates his employment for "Good Reason." For purposes of this Agreement, "GOOD REASON" shall mean termination by the Executive within ninety (90) days of learning of the acts which are the basis for alleging Good Reason, because of the occurrence of any of the following acts, without the Executive's consent: (1) he has been demoted to a position of materially less stature or importance within the Company than the position described in Paragraph 1, (2) he has been assigned to duties that are of materially less importance than, or materially inconsistent with, those required to be performed pursuant to Paragraph 1 of this Agreement, (3) the Company has failed to pay or provide material compensation or benefits that are required to be provided by this Agreement, or (4) the Company's principal executive offices have been relocated to any county other than Los Angeles County, CA or Orange County, CA., provided that no such termination shall be treated as for Good Reason unless the Executive shall have given the Company thirty (30) days advance written notice of his intention to terminate his employment for Good Reason, and the Company shall have failed to cure such acts within such thirty (30) day period. E. On the date the Executive terminates his employment for any reason, other than Good Reason, provided that the Executive shall give the Company thirty (30) days written notice prior to such date of his intention to terminate this Agreement. F. On the date the Company terminates the Executive's employment for any reason, other than a reason otherwise set forth in this Paragraph 5. Any purported termination of the Executive's employment for Cause which is finally determined to be without Cause shall be treated for all purposes of this Agreement as a termination pursuant to this Paragraph 5F. 6. Compensation Upon Termination. If the Executive's services are terminated pursuant to Paragraph 5, the Executive shall be entitled to the Base Salary through his final date of active employment, plus any accrued but unused vacation pay. If the Executive's services are terminated pursuant to Paragraph 5D or 5F, the Executive shall in addition be entitled to receive severance benefits for a period of 12 months payable in substantially equal installments in accordance with the Company's payroll policy, in an amount equal to (i) $2 million, if such termination occurs within one year from the Effective Date, (ii) $1.5 million, if such termination occurs after the first and on or before the second anniversary of the Effective Date, (iii) $1.0 million, if such termination occurs after the second and on or before the third anniversary of the Effective Date, (iv) $0.5 million, if such termination occurs after the fourth anniversary of the Effective Date, and (v), plus an amount, if any, - 5 - 6 (regardless of the date of termination) necessary to reimburse the Executive on a net after-tax basis for any applicable federal excise tax, provided in each case the Executive signs an agreement that releases the Company from actions, suits, claims, proceedings, and demands related to the period of employment and/or termination of employment. Executive agrees that if his employment is terminated for any reason, he shall immediately resign from all officer and director positions he then holds with the Company and each of its parents, affiliates and subsidiaries. 7. Offset. In the event that severance benefits become payable to the Executive pursuant to Paragraph 6 above, such benefits, to the extent not theretofore paid, shall be reduced, on a dollar-for-dollar basis, by (i) any outstanding amounts owed by Executive to the Company and (ii) the amount of any compensation for services earned by Executive on account of his employment or consulting services with another business or on account of his self employment, from any source, whether paid currently or deferred. In such event, Executive shall cooperate with the Company and shall provide such information to the Company as it may reasonably require in order to calculate the amount of the reduction described above. 8. COBRA. If the Executive's services are terminated pursuant to Paragraph 5, the Executive shall also be entitled to any benefits mandated under the Consolidated Omnibus Budget Reconciliation Act of 1985 ("COBRA") or required under the terms of any death, insurance, or retirement plan, program, or agreement provided by the Company and to which the Executive is a party or in which the Executive is a participant, including, but not limited to, any short-term or long-term disability plan or program, if applicable. If the Executive elects COBRA continuation coverage, the Company shall pay for such health insurance coverage for the shorter of 12 months or the remaining Term at the same rate as it pays for health insurance coverage for its active employees (with the Executive required to pay for any employee-paid portion of such coverage). After the expiration of the period set forth in the prior sentence concludes, the Executive shall be responsible for the payment of all further premiums attributable to COBRA continuation coverage at the same rate as the Company charges all COBRA beneficiaries. However, no provision of this Agreement shall be construed to extend the period of time over which such COBRA continuation coverage is required to be provided to the Executive and/or his dependents. 9. Arbitration. Any dispute between the parties hereto respecting the meaning and intent of this Agreement or any of its terms and provisions shall be submitted for expedited arbitration in Los Angeles, California, in accordance with the National Rules of the American Arbitration Association for the Resolution of Employment Disputes then in effect, and the arbitration determination resulting from any such submission shall be final - 6 - 7 and binding upon the parties hereto. Judgment upon any arbitration award may be entered in any court of competent jurisdiction. The parties further agree that either party may at any time seek provisional relief, including, but not limited to a temporary restraining order or a preliminary injunction, from any state or federal court in California, in connection with any dispute being submitted for arbitration. 10. Exclusive Employment; Confidentiality; Non-Solicitation. A. Executive agrees to perform his duties, responsibilities and obligations hereunder efficiently and to the best of his ability. Executive also agrees that he will not engage in any other business activities, pursued for gain, profit or other pecuniary advantage, that are competitive with the activities of the Company. Executive agrees that all of his activities as an employee of the Company shall be in conformity with all present and future policies, rules and regulations and directions of the Company not inconsistent with this Agreement. B. Executive acknowledges that his employment by the Company will bring him into close contact with many trade secrets and other confidential affairs of the Company and its clients and customers, including, without limitation, non-public information pertaining to ideas, knowledge, operations, computer hardware and software, systems, costs, profits, markets, sales, products, programs, interfaces, networks, protocols, data bases, key personnel, pricing policies, operational methods, concepts, data, equipment, models, compensation, suppliers, servicing, broker lists, customer lists, customers, potential customers, rate sheets, plans, concepts, strategies, or products, advertising, technical processes and applications and other business affairs and methods, plans for future developments and other information not readily available to the public or the Company's competitors or clients (collectively referred to hereinafter as "Information"). In consideration of the foregoing, the Executive agrees that he: (1) will keep secret and confidential all Information and will not use it for his own benefit or disclose it to, or use it for the benefit of, anyone other than the Company, either during or after his employment by the Company, except with the prior written consent of the Company; (2) will take all reasonable action that the Company deems necessary or appropriate to prevent unauthorized use or disclosure of or to protect the Company's interest in Information; (3) will deliver promptly to the Company upon termination of his employment by the Company or at any other time the Company may so request, all memoranda, notes, documentation, equipment, files, flowcharts, program listings, data listings, records, reports and other tangible manifestations of the Information (and all copies thereof), that he may then possess or have under his control; and (4) will, unless the Company otherwise agrees in writing, and without additional compensation, promptly disclose and, upon request, assign to the Company all rights to work product and - 7 - 8 business opportunities related to the present or, to the extent presented to the Board of Directors prior to termination of employment, contemplated business of the Company. C. Executive further agrees that if his employment is terminated during the three year period beginning on the Effective Date, he will abide by the limitations set forth in the following sentence (i) for a period of six months from the date of termination, if his employment is terminated pursuant to Paragraph 5B, 5D or 5F, and (ii) for a period of one year from the date of termination, if his employment is terminated by the Company pursuant to Paragraph 5C or if his employment is terminated by the Executive without Good Reason (the applicable period is referred to below as the "Nonsolicitation Period"). During the Nonsolicitation Period, the Executive agrees that he will not, without the Company's express written consent, himself or through any organization with which he is associated: (i) hire any person who was employed by the Company on the Executive's date of termination of employment or at any time within six months prior thereto, or hire any agent, consultant, or independent contractor of the Company, or of any organization with respect to which the Company has agreed to a similar prohibition and of which the Employee has knowledge, or induce or attempt to induce any such person to discontinue such employment or affiliation with the Company or such organization, as the case may be, or (ii) induce or attempt to induce any client or customer of the Company on the date of termination to discontinue any business relationship or to refrain from entering into a new business relationship with the Company. D. Executive confirms and acknowledges that (i) he was represented by counsel of his own choosing during the negotiation of the limitations set forth in Paragraphs 10 and 11 of this Agreement, (ii) his strict adherence to the limitations imposed upon him thereunder, or under any agreement referenced therein, was a material factor in Purchaser's entering into the Purchase Agreement and agreeing to consummate the transactions contemplated thereby, and to pay the Executive the cash and equity-based compensation called for in this Agreement, (iii) the Company's ability to maintain continuing relationships with its employees without disruption was a material factor in Purchaser's entering into the Purchase Agreement and agreeing to consummate the transactions contemplated thereby, (iv) his failure to adhere to the obligations imposed by Paragraphs 10 and 11 of this Agreement will expose such Purchaser to substantial and irreparable harm. Accordingly, Executive agrees that the remedy at law for any breach by him of the covenants and agreements set forth in this Paragraph 10 or in Paragraph 11 below may be inadequate and that in the event of any such breach, the Company or its respective subsidiaries may, in addition to the other remedies that may be available to it at law, seek injunctive relief prohibiting him (together with all those persons associated with him) from breach of such covenants and agreements. - 8 - 9 11. Non-Competition. Executive reconfirms and acknowledges his duties and obligations under the Non-Compete Agreement dated August 28th, 1996. The Company agrees to release him from such obligations on the earlier to occur of (x) the expiration of any Nonsolicitation Period referred to in Section 10(c) hereof, and (y) the third anniversary of the Effective Date. AGREEMENT - MISCELLANEOUS 12. Entire Agreement. This Agreement sets forth the entire and final agreement and understanding of the Company and the Executive and contains all of the agreements made between them with respect to the subject matter hereof. This Agreement supersedes any and all other agreements, either oral or in writing, between the Company and the Executive with respect to Executive's provision of services to the Company. No change or modification of this Agreement shall be valid unless in writing and signed by the Company and the Executive. 13. Enforcement; Severability. Should a decision be entered by a court of competent jurisdiction that the character, duration or geographical scope of any provision of this Agreement is unreasonable, or that any provision of this Agreement is invalid or unenforceable for any reason, in whole or in part, then the Company and the Executive agree that such provision shall be construed by the court in such a manner as to impose all those restrictions on the Executive's conduct set forth in this Agreement or in the Non-Compete Agreement dated August 28, 1996 that are reasonable in light of the circumstances and as are necessary to assure to the Company the benefits of this Agreement and to render the provision valid and enforceable, and this Agreement shall be construed and enforced to the maximum extent permitted by law, as if such provision had been originally incorporated in this Agreement as so modified, restricted, or reformulated or as if such provision had not been originally included in this Agreement, as the case may be. The parties further agree to seek a lawful substitute for any provision found to be unlawful; provided, that, if the parties are unable to agree upon a lawful substitute, the parties desire and request that the arbitrator or other authority called upon to decide the enforceability of this Agreement modify those provisions such that, once modified, this Agreement will be enforceable to the maximum extent permitted by the law in existence at the time of the requested enforcement. 14. Miscellaneous. A. Notices. All notices required in connection with this Agreement shall be sufficiently given only if transmitted in writing and (i) personally delivered, or sent by first class, registered or certified mail, return receipt requested, postage prepaid, or by recognized overnight courier, (ii) sent by facsimile, provided a hard copy is mailed on that date to the party for whom such notices are intended, or (iii) sent by other - 9 - 10 means at least as fast and reliable as first class mail. A written notice shall be deemed to have been given to the recipient party on the earliest of (1) the date it shall be delivered to the address required by this Agreement; (2) the date delivery shall have been refused at the address required by this Agreement; (3) with respect to notices sent by mail or overnight courier, the date as of which the Postal Service or overnight courier, as the case may be, shall have indicated such notice to be undeliverable at the address required by this Agreement; or (4) with respect to a facsimile, the date on which the facsimile is sent and receipt is confirmed. Any and all notices referred to in this Agreement, or which either party desires to give to the other shall, in the case of the Executive, be addressed to the residence address given to the Company by the Executive in writing for this purpose, or failing receipt of such notice, to the last residence address on the Company's records, or in the case of the Company, to its principal office with a copy to Capital Z's principal office. B. Waiver of Breach. A waiver by the Company of a breach of any provision of this Agreement by the Executive shall not operate or be construed as a waiver of any subsequent breach by the Executive. No waiver shall be valid unless it is in writing and signed by an authorized officer of the Company (other than the Executive). C. Assignment. The Executive acknowledges that the services he is to render are unique and personal. Accordingly, the Executive may not assign any of his rights or delegate any of his duties or obligations under this Agreement. The rights and obligations of the Company under this Agreement shall inure to the benefit of and shall be binding upon the successors and assigns of the Company. D. Construction. The heading in this Agreement are inserted for convenience only and are not to be considered a construction of the provisions hereof. The Background recitals are incorporated in this Agreement as an integral part hereof and shall be considered as substantive and not precatory language. E. Execution of Agreement. This Agreement may be executed in several counterparts, each of which shall be considered an original, but which when taken together, shall constitute one agreement. F. Governing Law. This agreement shall be construed in accordance with the laws of the State of California. COMPANY: EXECUTIVE: By: /s/ David Sklar /s/ Neil B. Kornswiet --------------------------- --------------------------- - 10 - 11 EXHIBIT A - - Within two weeks of the Effective Date, Company shall pay Executive $1,460,000, such amount being in full and complete satisfaction of all amounts owed Executive in respect of his June 1998 bonus accrued by the Company. - - Subject to execution by the Executive of the promissory note attached hereto as Exhibit C, the Company shall pay Executive a guaranteed cash bonus for the 1999 calendar year (the "1999 Bonus"), such bonus to be paid within two weeks following the Effective Date, in an amount equal to $540,000. The 1999 Bonus shall be paid in the form of a recourse loan, which shall be forgiven and treated as paid in full so long as Executive remains employed by the Company through the first anniversary of the Effective Date, or through the date of any earlier termination of Executive's employment under Paragraphs 5B, 5D or 5F of the Employment Agreement. Executive to receive a cash supplemental bonus for his first year of employment of $300,000, such bonus to be paid within 2-1/2 months after the first anniversary of the Effective Date, subject to the Board's determination that the Company has completed a satisfactory program of cost reductions by such anniversary date (the "1999 Supplemental Bonus"). - - For bonuses after the 1999 calendar year, Executive shall receive a cash bonus paid annually on a calendar year basis ranging from 0-100% of total Base Salary, with an expected bonus of $400,000, and a bonus in excess of 100% of Base Salary for extraordinary performance. Bonuses shall be paid according to a budget approved by the Board of Directors of the Company and the achievement of other non-financial goals adopted by such Board. - - Subject to execution by the Executive of the promissory note attached hereto as Exhibit I-2 to the Management Investment Agreement, the Company shall loan Executive an amount equal to the purchase price of 100% of his pro-rata ownership position in the shareholders rights offering (the "Rights Offering Advance"). The Rights Offering Advance shall be in the form of a loan, which shall be nonrecourse provided Executive remains employed by the Company through the first anniversary of the Effective Date, or through the date of any earlier termination of Executive's employment under Paragraph 5B, 5D or 5F of the Employment Agreement. - - For so long as Capital Z and/or its Designated Purchasers under the Purchase Agreement own at least 25% of the outstanding voting securities of the Company, Executive covenants and agrees not to sell, assign or otherwise transfer, during his employment with the Company, in any one twelve month period, more than 25% of the aggregate amount of shares of Company stock which the Executive owned immediately A-1 12 prior to the Effective Date. The Company, by action of its Board of Directors, agrees to consider whether to waive all or part of such limitation in the event of extraordinary hardship, which consent shall not be unreasonably withheld. A-2 13 EXHIBIT B MODEL OPTION AGREEMENT NON-QUALIFIED STOCK OPTION AGREEMENT UNDER THE 1999 AAMES FINANCIAL CORPORATION STOCK OPTION PLAN THIS AGREEMENT, made this day of , , by and between Aames Financial Corporation, a Delaware corporation (the "Company"), and (the "Optionee") W I T N E S S E T H: WHEREAS, the Optionee is now employed by the Company in a key capacity, and the Company desires to have him remain in such employment and to afford him the opportunity to acquire, or enlarge, his ownership of the Company's Common Stock, par value $.01 per share ("Stock"), so that he may have a direct proprietary interest in the Company's success; WHEREAS, all capitalized terms not otherwise defined herein shall have the same meaning as set forth in the Company's Stock Option Plan; NOW, THEREFORE, in consideration of the covenants and agreements herein contained, the parties hereto hereby agree as follows: B-1 14 1. GRANT OF OPTION. Subject to the terms and conditions set forth herein and in the Company's Stock Option Plan (the "Plan"), the Company hereby grants to the Optionee, during the period commencing on the date of this Agreement and ending ten years from the date hereof (the "Termination Date"), the right and option (the right to purchase any one share of Stock hereunder being an "Option") to purchase from the Company, at a price of $1.00 per share, an aggregate of shares of Stock. 2. LIMITATIONS ON EXERCISE OF OPTION. (a) Subject to the terms and conditions set forth herein, all Options shall vest and become exercisable on the ninth anniversary of the date of grant (the "Grant Date"), provided that Optionee remains an employee of the Company on such date, subject to earlier vesting, based upon the Company's attainment of the following share price values: (i) 25% of the Options shall vest at such time as the Stock's Fair Market Value is first, while the Optionee is employed by the Company and after the Grant Date, at or above $1.30 per share; (ii) an additional 25% of the Options shall vest at such time as the Stock's Fair Market Value is first, while the Optionee is employed by the Company and after the Grant Date, at or above $1.75 per share; and (iii) an additional 50% of the Options shall vest at such time as the Stock's Fair Market Value is first, while the Optionee is employed by the Company and after the Grant Date, at or above $2.50 per share; provided, however, that any such acceleration shall be limited according to the following schedule: not more than 15% of the Options that have become vested based upon performance shall become exercisable before the first anniversary of the Grant Date; not more than an additional 15% of the Options that have become vested based upon performance shall become exercisable before the second anniversary of the Grant Date; not more than an additional 20% of the Options that have become vested based upon performance shall become exercisable before each of the third and fourth anniversaries of the Grant Date; and the remaining 30% of the Options that have become vested based upon performance shall not become exercisable before the fifth anniversary of the Grant Date; and further provided, that if the Optionee is terminated without Cause or the Optionee terminates his employment for Good Reason, after a date when any of the performance thresholds set forth in clause (i), (ii) or (iii) of this paragraph 2(a) has been satisfied, then , in computing the exercisability limitation set forth in the preceding proviso, an additional 15% of the Options that have become vested based upon performance shall be exercisable over and above the Options that become exercisable without regard to this proviso. (b) Any provision of paragraph 2(a) hereof to the contrary notwithstanding, but subject to Article XI(c) of the Plan, upon a Change in Control, 100% of the Options shall vest and B-2 15 become exercisable, provided, however, that no such exercise rights shall arise unless (i) if a Change in Control occurs within 12 months of the consummation of the transactions contemplated by the Purchase Agreement (the "Closing Date"), the Change in Control Price is at or above $1.50 per share or (ii) if a Change in Control occurs more than twelve months from the Closing Date, the Change in Control Price is at or above $2.50 per share (or if the Change in Control Price is less than $2.50 but above $1.30 or $1.75 per share the acceleration of vesting shall result, but only to the extent such acceleration would have resulted pursuant to paragraph 2(a)(i) or 2(a)(ii) above, without regard to service requirements). 3. TERMINATION OF EMPLOYMENT. An Optionee's rights upon termination of employment shall be as set forth in Article VI of the Plan. 4. METHOD OF EXERCISING OPTION. (a) The Optionee may exercise any or all of the Options by delivering to the Company a written notice signed by the Optionee stating the number of Options that the Optionee has elected to exercise at that time and full payment of the purchase price of the shares to be thereby purchased from the Company. Payment of the purchase price of the shares may be made (a) by certified or bank cashier's check payable to the order of the Company, (b) by surrender or delivery to the Company of shares of Stock or other property acceptable to the Committee in its sole discretion, which Stock or other property shall have a value equal to the purchase price or (c) by delivery to the Committee of a copy of irrevocable instructions to a stockbroker to deliver promptly to the Company an amount of sale or loan proceeds sufficient to pay the purchase price. (b) At the time of exercise, the Optionee shall pay to the Company such amount as the Company deems necessary to satisfy its obligation to withhold Federal, state or local income or other taxes incurred by reason of the exercise or the transfer of shares thereupon. B-3 16 5. ISSUANCE OF SHARES. As promptly as practical after receipt of such written notification and full payment of such purchase price and any required income tax withholding amount, the Company shall issue or transfer to the Optionee the number of shares with respect to which Options have been so exercised, and shall deliver to the Optionee a certificate or certificates therefor, registered in the Optionee's name. 6. COMPANY; OPTIONEE. (a) The term "Company" as used in this Agreement with reference to employment shall include the Company and its subsidiaries. The term "subsidiary" as used in this Agreement shall mean any subsidiary of the Company as defined in Section 424(f) of the Code. (b) Whenever the word "Optionee" is used in any provision of this Agreement under circumstances where the provision should logically be construed to apply to the executors, the administrators, or the person or persons to whom the Options may be transferred by will or by the laws of descent and distribution, the word "Optionee" shall be deemed to include such person or persons. 7. NON-TRANSFERABILITY. The Options are not transferable by the Optionee otherwise than by will or the laws of descent and distribution and are exercisable during the Optionee's lifetime only by him. No assignment or transfer of the Options, or of the rights represented thereby, whether voluntary or involuntary, by operation of law or otherwise (except by will or the laws of descent and distribution), shall vest in the assignee or transferee any interest or right herein whatsoever, but immediately upon such assignment or transfer the Options shall terminate and become of no further effect. Unless otherwise provided by the Committee at the time of exercise, Optionee shall enter into a binding agreement with the Company at the time of grant pursuant to which Optionee agrees, during any period when the Minimum Stock Ownership Threshold is met or exceeded, (i) not to sell, assign or otherwise transfer more than 25% of the Stock purchased pursuant to an Option in any given year and (ii) in aggregate not to sell, assign or otherwise transfer more than 25% of the Stock purchased pursuant to an Option over a five year period beginning on the effective date of the Plan. Appropriate legends shall be placed on the stock certificates evidencing shares issued upon exercise of options to reflect such transfer restrictions. B-4 17 8. RIGHTS AS STOCKHOLDER. The Optionee or a transferee of the Options shall have no rights as a stockholder with respect to any share covered by the Options until he shall have become the holder of record of such share, and no adjustment shall be made for dividends or distributions or other rights in respect of such share for which the record date is prior to the date upon which he shall become the holder or record thereof. 9. RECAPITALIZATIONS, REORGANIZATIONS, ETC. (a) The existence of the Options shall not affect in any way the right or power of the Company or its stockholders to make or authorize any or all adjustments, recapitalizations, reorganizations or other changes in the Company's capital structure or its business, or any merger or consolidation of the Company, or any issue of stock or of options, warrants or rights to purchase stock or of bonds, debentures, preferred or prior preference stocks ahead of or affecting the Stock or the rights thereof or convertible into or exchangeable for Stock, or the dissolution or liquidation of the Company, or any sale or transfer of all or any part of its assets or business, or any other corporate act or proceeding, whether of a similar character or otherwise. (b) The shares with respect to which the Options are granted are shares of Stock of the Company as presently constituted, but if, and whenever, prior to the delivery by the Company of all of the shares of the Stock with respect to which the Options are granted, the Company shall effect a subdivision or consolidation of shares of the Stock outstanding, without receiving compensation therefor in money, services or property, the number and price of shares remaining under the Options shall be appropriately adjusted. Such adjustment shall be made by the Committee, whose determination as to what adjustment shall be made, and the extent thereof, shall be final, binding and conclusive. Any such adjustment may provide for the elimination of any fractional share which might otherwise become subject to the Options. (c) In the event of any change in the outstanding shares of Stock by reason of any recapitalization, merger, consolidation, spin-off, combination or exchange of shares or other corporate change, or any distributions to common shareholders other than cash dividends, the Committee shall make such substitution or adjustment, if any, as it deems to be equitable, as to the number or kind or shares of Stock or other securities covered by the Options and the option price thereof. The Committee shall notify the Optionee of any intended sale of B-5 18 all or substantially all of the Company's assets within a reasonable time prior to such sale. (d) Except as hereinbefore expressly provided, the issue by the Company of shares of stock of any class, or securities convertible into or exchangeable for shares of stock of any class, for cash or property, or for labor or services, either upon direct sale or upon the exercise of options, rights or warrants to subscribe therefore, or to purchase the same, or upon conversion of shares or obligation of the Company convertible into such shares or other securities, shall not affect, and no adjustment by reason thereof shall be made with respect to, the number or price of shares of Stock subject to the Options. 10. COMPLIANCE WITH LAW. Notwithstanding any of the provisions hereof, the Optionee hereby agrees that he will not exercise the Options, and that the Company will not be obligated to issue or transfer any shares to the Optionee hereunder, if the exercise hereof or the issuance or transfer of such shares shall constitute a violation by the Optionee or the Company of any provisions of any law or regulation of any governmental authority. Any determination in this connection by the Committee shall be final, binding and conclusive. The Company shall in no event be obliged to register any securities pursuant to the Securities Act of 1933 (as now in effect or as hereafter amended) or to take any other affirmative action in order to cause the exercise of the Options or the issuance or transfer of shares pursuant thereto to comply with any law or regulation of any governmental authority. 11. NOTICE. Every notice or other communication relating to this Agreement shall be in writing, and shall be mailed to or delivered to the party for whom it is intended at such address as may from time to time be designated by it in a notice mailed or delivered to the other party as herein provided, provided that, unless and until some other address be so designated, all notices or communications by the Optionee to the Company shall be mailed or delivered to the Company at its principal executive office, and all notices or communications by the Company to the Optionee may be given to the Optionee personally or may be mailed to him at the address shown below his signature to this Agreement. 12. NON-QUALIFIED OPTIONS. The Options granted hereunder are not intended to be incentive stock options within the meaning of Section 422 of the Code. B-6 19 13. BINDING EFFECT. Subject to Section 7 hereof, this Agreement shall be binding upon the heirs, executors, administrators and successors of the parties hereto. 14. GOVERNING LAW. This Agreement shall be construed and interpreted in accordance with the laws of the State of Delaware. 15. PLAN. The terms and provisions of the Plan are incorporated herein by reference. In the event of a conflict or inconsistency between discretionary terms and provisions of the Plan and the express provisions of this Agreement, this Agreement shall govern and control. In all other instances of conflicts or inconsistencies or omissions, the terms and provisions of the Plan shall govern and control. B-7 20 IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first above written. AAMES FINANCIAL CORPORATION By: _______________________________ Optionee B-8 21 EXHIBIT C PROMISSORY NOTE AND WAIVER $540,000 LOS ANGELES, CALIFORNIA January __, 1999 FOR VALUE RECEIVED, the undersigned Neil B. Kornswiet (hereinafter "Kornswiet") hereby promises to pay to the order of Aames Financial Corporation, 350 S. Grand Avenue, Los Angeles, California 90071 (hereinafter called the "Company") the principal amount of FIVE HUNDRED AND FORTY THOUSAND DOLLARS ($540,000) together with the interest on the unpaid balance of such principal amount from the date hereof at the lowest rate of interest prescribed by Section 7872 of the Internal Revenue Code of 1986 that would permit imputation of interest under such section to be avoided. This Note and the indebtedness evidenced hereby are being provided pursuant to the terms of the agreement effective as of January , 1999 between Kornswiet and the Company (the "Employment Agreement"). Subject to the terms and conditions herein, if Kornswiet is employed by the Company for the full period from January __, 1999 through the first anniversary of the "Effective Date", as such term is defined in Kornswiet's Employment Agreement (the "Effective Date") or through the date of any earlier termination of Executive's employment by the Company pursuant to Paragraphs 5A, B, or F of the Employment Agreement or by the Executive pursuant to Paragraph 5D of the Employment Agreement, the principal on this Note, together with the interest accrued on such principal shall be forgiven by the Company in full and this Note shall be marked canceled. The Company shall also reimburse Kornswiet on a net after-tax basis for any tax liability attributable to the forgiveness of interest. In the event Kornswiet's employment with the Company is terminated prior to the first anniversary of the Effective Date, pursuant to Paragraph 5C of the Employment Agreement or in the event that Kornswiet terminates his employment with the Company prior to the first anniversary of the Effective Date for other than "good reason" (as defined in the Paragraph 5D of the Employment Agreement), Kornswiet shall repay the full principal amount evidenced by this Note, together with the interest accrued on such principal, within fourteen (14) days of such termination date. Unless this note is forgiven by the Company pursuant to the third paragraph hereof, the Company shall have the right to set off any amounts which Kornswiet owes the Company hereunder C-1 22 against any monies which the Company or any of its subsidiaries may owe to Kornswiet, of any nature whatsoever, including without limitation, any compensation and any severance owed under the Employment Agreement or any other benefit owed to or held by Kornswiet as an employee of the Company or any of its subsidiaries, and Kornswiet hereby agrees to and authorizes any such setoff. If payment of the principal, together with the interest accrued on such principal, on this Note is not paid in accordance with the terms aforementioned, then this Note shall be deemed to be in default and if suit is brought to collect this Note, the Company shall be entitled to collect, in addition to any principal outstanding, together with the interest accrued on such Note, all reasonable costs and expenses to include, but not necessarily be limited to, reasonable attorneys' fees and expenses. Presentment, notice of dishonor and protest are hereby waived by Kornswiet. This Note shall be binding upon Kornswiet and his heirs, executors, administrators, and legal representatives. No delay or omission on the part of the Company in exercising any rights hereunder shall operate as a waiver of such rights or of any other right of the Company, nor shall any delay, omission or waiver on any one occasion be deemed as a bar to or waiver of the same or any other right on any future occasion. This Note may not be changed or terminated orally. Kornswiet shall have the right to prepay the principal of this Note, together with the accrued and unpaid interest on such principal, in whole or in part, at any time or times, without penalty. Regardless of whether this Note is forgiven, Kornswiet acknowledges having received the entire principal amount of this Note from the Company and hereby waives all rights, if any, to his 1999 Bonus (as defined in Exhibit A of the Employment Agreement). All rights and obligations hereunder shall be governed by, and construed and enforced in accordance with, the substantive laws of the State of Delaware, and this Note is executed as, and shall have effect of, a sealed instrument. If any provision of this transaction is inconsistent with the laws and statutes of the State of Delaware, the rest of the transaction shall not be affected, and that part that is not in accord with the said laws shall be adjusted to so comply. C-2 23 IN WITNESS WHEREOF, the undersigned has executed this Note as an instrument under seal this ____ day of January, 1999. ------------------------ C-3 EX-10.26 11 MANAGEMENT INVESTMENT AGREEMENT 1 EXHIBIT 10.26 MANAGEMENT INVESTMENT AGREEMENT (NEIL KORNSWIET) MANAGEMENT INVESTMENT AGREEMENT (this "Agreement") dated as of December 23, 1998, between Aames Financial Corporation, a Delaware corporation (the "Company"), and Neil Kornswiet, an individual residing at 16105 Whitecap Lane, Huntington Beach, California, 96249 (the "Management Investor"). WHEREAS, on the date hereof, the Company and Capital Z Financial Services Fund II, L.P., a Bermuda limited partnership ("Capital Z"), are entering into a Preferred Stock Purchase Agreement (the "Purchase Agreement"), pursuant to which Capital Z has agreed to purchase, together with Capital Z Affiliates and co-investors as designated by Capital Z, shares of the Company's Series B Convertible Preferred Stock, par value $0.001 per share ("Series B Preferred Stock") and Series C Convertible Preferred Stock, par value $0.001 per share ("Series C Preferred Stock," and, together with the Series B Preferred Stock, "Senior Preferred Stock"), in the amounts and subject to the conditions set forth in the Purchase Agreement; and WHEREAS, the Management Investor is a senior management employee of the Company and, as a condition precedent to the closing of the transactions contemplated by the Purchase Agreement, certain senior management employees of the Company, including the Management Investor, are required to purchase Series C Preferred Stock from the Company; and WHEREAS, the Management Investor desires to purchase from the Company, and the Company desires to sell to the Management Investor, Series C Preferred Stock under the terms and conditions set forth in this Agreement. NOW THEREFORE, in consideration of the premises and the mutual covenants contained in this Agreement, and other good and valuable consideration, the sufficiency of which is hereby acknowledged, the parties hereto agree as follows: SECTION 1. Defined Terms. Capitalized terms used and not otherwise defined in this Agreement shall have the respective meanings assigned to them in the Purchase Agreement. SECTION 2. Sale and Delivery. (a) Upon the terms and subject to the conditions set forth herein, and conditioned upon the consummation of the Initial Closing, in reliance upon the representations and warranties of the Management Investor hereinafter set forth, and -1- 2 for the purchase price described in Section 2(b), the Company shall issue, sell and deliver to the Management Investor pursuant to the Rights Offering, and the Management Investor shall purchase from the Company pursuant to the Rights Offer, an aggregate of $1,667,000 in stated value (at $1.00 per share) of Series C Preferred Stock (such shares of Series C Preferred Stock are referred to collectively herein as the "Shares") at the price per share at which Series C Preferred Stock is offered in the Rights Offer, subject to the terms and conditions of the Rights Offering. (b) The purchase price for the Shares purchased by the Management Investor shall be paid by delivery by the Management Investor to the Company of a 6.5% promissory note having an original principal amount equal to such amount (the "Note"), the form of which Note is attached hereto as Exhibit A. (c) The purchase and sale of Shares by the Management Investor shall occur at the time and place provided for in the Rights Offer, and at the closing of such purchase and sale of Shares by the Management Investor: (i) the Company shall deliver to the Management Investor certificates representing the Shares, duly endorsed for transfer, transferring to the Management Investor good and marketable title to such Shares, free and clear of all liens and encumbrances; and (ii) the Management Investor shall deliver to the Company: (A) any documents required to be submitted by a Company shareholder desiring to participate in the Rights Offer; (B) the Note; and (C) a pledge agreement (the "Pledge Agreement") substantially in the form attached hereto as Exhibit B, pursuant to which Pledge Agreement, among other things, the Management Investor's obligations under the Note shall be secured by a pledge of (i) the Shares, (ii) the shares of Common Stock that may be acquired upon conversion of the Shares (the "Underlying Common Shares"), and (iii) certain other collateral described therein. SECTION 3. Representations and Warranties of the Management Investor. The Management Investor hereby represents and warrants to the Company as follows: (a) The Shares (and the Underlying Common Shares) to be purchased by such Management Investor will be acquired for investment for the Management Investor's own account and not with -2- 3 a view to the resale or distribution of any part thereof, except in compliance with the provisions of the Securities Act of 1933, as amended (the "Securities Act"), or an exemption therefrom, and in compliance with the terms of this Agreement. The Management Investor is a senior management employee of the Company and is fully familiar with the business of the Company and with the risks associated with the purchase of the Shares pursuant to this Agreement. The Management Investor is an accredited investor as defined under Rule 501(a) under the Securities Act. (b) The Management Investor understands that the Shares and the Underlying Common Shares are characterized as "restricted securities" under the federal securities laws inasmuch as they are being acquired from the Company in a transaction not involving a public offering and that under such laws and applicable regulations such Shares (and the Underlying Common Shares) may be resold without registration under the Securities Act only in certain limited circumstances. (c) The Management Investor further agrees that each certificate representing the Shares (and the Underlying Common Shares) shall be stamped or otherwise imprinted with a legend substantially in the following form: "THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 AND MAY NOT BE TRANSFERRED OR OTHERWISE DISPOSED OF UNLESS SUCH SECURITIES HAVE BEEN REGISTERED UNDER THAT ACT OR AN EXEMPTION FROM REGISTRATION IS AVAILABLE. THE SECURITIES REPRESENTED BY THIS CERTIFICATE ARE SUBJECT TO RESTRICTIONS ON TRANSFER AND TO THE OTHER TERMS SET FORTH IN THAT CERTAIN MANAGEMENT INVESTMENT AGREEMENT, DATED AS OF DECEMBER 23, 1998, AND BY A CERTAIN RELATED PLEDGE AGREEMENT, BETWEEN THE COMPANY AND NEIL KORNSWIET, A COPY OF WHICH AGREEMENTS HAVE BEEN FILED WITH THE SECRETARY OF THE COMPANY AND ARE AVAILABLE UPON REQUEST." SECTION 4. Restrictions on Transfer of Shares. For a period commencing on the Initial Closing Date and ending on the fifth anniversary of the Initial Closing Date, the Management Investor may not sell, transfer, assign, pledge, hypothecate or otherwise dispose of (each, a "transfer") any of the Shares (or the Underlying Common Shares), without the prior express written consent of the Company, provided, however, that the foregoing restriction on transfer shall not apply (i) if Capital Z Beneficially Owns less than (A) fifty percent (50%) of the number of shares of Senior Preferred Stock purchased by Capital Z on the Initial Closing Date (the "Original Preferred Shares") or (B) if any Original Preferred Shares shall thereafter have been converted into Common Stock, fifty percent (50%) of the sum of (x) the aggregate number of shares Common Stock owned by Capital Z as a result of such conversion(s) plus (y) the aggregate number -3- 4 of shares Common Stock into which any remaining Original Preferred Shares owned by Capital Z may be converted (determined without regard to any limitations on conversion of such shares prior to the Recapitalization), in each case subject to adjustment for splits, combinations, reclassifications and similar events; (ii) if the Management Employee dies, retires, is terminated by the Company, or terminates his employment with the Company, subject to the provisions of Section 5 hereof; or (iii) a Change of Control (as defined in the New Option Plan) has occurred, but only if a Capital Z Realization Event (as defined in the New Option Plan) has also occurred on or prior to such Change of Control, and provided, further, that notwithstanding the foregoing restriction on transfer, the Management Investor may transfer, during the twelve-month period ending on the first anniversary of the Initial Closing Date and during each succeeding twelve-month period, up to 25% of the total number of Underlying Common Shares (whether structured as a transfer of Shares, Underlying Shares or a combination thereof) acquired hereunder (subject to adjustment for splits, combinations, reclassifications and similar events), it being further agreed that the Management Investor may request the Company's Board of Directors to allow the Management Investor to transfer Shares (or Underlying Common Shares) in excess of the 25% limitation described in this proviso if extraordinary liquidity needs have arisen with respect to the Management Investor, and, in such event, the Company (through its Board of Directors) will consider such request in good faith and will not unreasonably withhold its consent to a waiver of such limitation. SECTION 5. Company's Option to Purchase Shares. (a) In the event of the death or retirement from, or termination of employment for any reason with, the Company of the Management Investor (a "Termination Date"), the Company shall have the option, but not the obligation, to purchase all, or any portion, of the Shares (and any Underlying Common Shares that may have been acquired upon conversion of the Shares) then owned by the Management Investor at the Fair Market Value (as hereinafter defined) per Share and/or Underlying Common Share on the Business Day immediately prior to the date on which the Company exercises its option to purchase in accordance with the this Section 5. The Company may exercise the foregoing option at any time within 30 days after the Termination Date, by written notice to the Management Investor, or his legal representative in the case of death, stating a date and time for consummation of the purchase no less than 10 nor more than 30 days after giving of such notice. "Fair Market Value" per Share or per Underlying Common Share, as of any particular date, shall mean (a) in the case of a Share, the product obtained by multiplying (I) the Formula Number (as defined in the Certificate of Designations for the Senior Preferred Stock) in effect as of such date by (II) the Current Market Price (as defined in the Certificate of Designations for the Senior Preferred Stock) for the period of 15 consecutive Trading Days (as defined in the Certificate of Designations for -4- 5 the Senior Preferred Stock) prior to such date, or (b) in the case of an Underlying Share, the Current Market Price for the period of 15 consecutive Trading Days prior to such date. (b) At the closing of the purchase of Shares (and any Underlying Common Shares) by the Company pursuant to Section 4(a), the Management Investor will deliver the Shares (and any Underlying Common Shares) to the Company against payment by the Company to the Management Investor of the purchase price for such Shares (and any Underlying Common Shares). Such purchase price shall be paid in cash, provided that if any principal or accrued but unpaid interest is then outstanding under the Note, the cash portion of the purchase price shall be reduced by the amount of such outstanding principal and accrued interest on the Note (with such reduction being applied first to any accrued interest and then to principal), and, if no principal or accrued interest is then remaining on the Note, the Note shall be canceled. SECTION 5. Termination. All rights and obligations of the parties hereunder shall terminate upon the date upon which the Purchase Agreement is terminated in accordance with its terms, provided, that any such termination that results from the breach by a party of his or its obligations hereunder shall not relieve such party from any liability for breach of this Agreement. SECTION 6. Further Assurances. The Management Investor shall, upon request of the Company, execute and deliver any additional documents and take such further actions as may reasonably be deemed by the Company to be necessary or desirable to carry out the provisions hereof. SECTION 7. Notices. All notices, requests, claims, demands and other communications under this Agreement shall be sufficiently given if sent by registered or certified mail, postage prepaid, or overnight air courier service, or telecopy or facsimile transmission (with hard copy to follow) to the parties at the following addresses (or at such other address for a party as shall be specified by like notice): (i) if to the Company, to the address set forth in Section 7.3 of the Purchase Agreement; and (ii) if to the Management Investor, to the address set forth for the Management Investor in the preamble to this Agreement or by telecopy to (323) 210-4537. SECTION 8. Headings. The headings contained in this Agreement are for reference purposes only and shall not affect in any way the meaning or interpretation of this Agreement. SECTION 9. Counterparts; Effectiveness. This Agreement may be executed in two or more counterparts, all of which shall be considered one and the same agreement and shall become effective when one or more counterparts have been signed by each of the Company and the Management Investor and delivered to the Company and the Management Investor. -5- 6 SECTION 10. Entire Agreement. This Agreement (including the documents and instruments referred to herein) constitutes the entire agreement, and supersedes all prior agreements and understandings, both written and oral, among the parties with respect to the subject matter hereof. SECTION 11. Governing Law. This Agreement shall be governed by, and construed in accordance with, the laws of the State of Delaware, without regard to any applicable conflicts of law principles of such State. SECTION 12. Successors and Assigns. Neither this Agreement nor any of the rights, interests or obligations under this Agreement shall be assigned, in whole or in part, by operation of law or otherwise, by any of the parties without the prior written consent of the other parties. Any assignment in violation of the foregoing shall be void. SECTION 13. Enforcement. Each party agrees that irreparable damage would occur and that the other party hereto would not have any adequate remedy at law in the event that any of the provisions of this Agreement were not performed in accordance with their specific terms or were otherwise breached. It is accordingly agreed that each party shall be entitled to an injunction or injunctions to prevent breaches by the other party hereto of this Agreement and to enforce specifically the terms and provisions of this Agreement in any court of the United States located in the State of Delaware or in Delaware State court, this being in addition to any other remedy to which they are entitled at law or in equity. In addition, each of the parties hereto (i) consents to submit such party to the personal jurisdiction of any Federal court located in the State of Delaware or any Delaware State court in the event any dispute arises out of this Agreement or any of the transactions contemplated hereby, (ii) agrees that such party will not attempt to deny or defeat such personal jurisdiction by motion or other request for leave from any such court and (iii) agrees that such party will not bring any action relating to this Agreement or any of the transactions contemplated hereby in any court other than a Federal court sitting in the State of Delaware of in Delaware State court. SECTION 14. Severability. If any term or provision hereof, or the application thereof to any circumstance, shall, to any extent, be held by a court of competent jurisdiction to be invalid or unenforceable with respect to such jurisdiction, and only to such extent, and the remainder of the terms and provisions hereof, and the application thereof to any other circumstance, shall remain in full force and effect, shall not in any way be affected, impaired or invalidated, and shall be enforced to the fullest extent permitted by law, and the parties hereto shall reasonably negotiate in good faith a substitute term or provision that comes as close as possible to the invalidated or unenforceable term or provision, and that puts each party in a -6- 7 position as nearly comparable as possible to the position each such party would have been in but for the finding of invalidity or unenforceability, while remaining valid and enforceable. SECTION 15. Amendment; Modification; Waiver. No amendment, modification or waiver in respect of this Agreement shall be effective against any party unless it shall be in writing and signed by such party. SECTION 16. Expenses. The Company and the Management Investor shall each bear their own legal fees and other costs and expenses with respect to the negotiation, execution and delivery of this Agreement and consummation of the transactions contemplated hereby. -7- 8 IN WITNESS WHEREOF, the Company and the Management Investor have caused this Agreement to be duly executed and delivered as of the date first written above. AAMES FINANCIAL CORPORATION By /s/ Barbara S. Polsky --------------------------------- Name: Barbara S. Polsky Title: Executive Vice President MANAGEMENT INVESTOR: /s/ Neil B. Kornswiet ---------------------------------------- Neil Kornswiet -8- 9 EXHIBIT A TO MANAGEMENT INVESTMENT AGREEMENT (NEIL KORNSWIET) FORM OF SECURED PROMISSORY NOTE $ , 1999 ---------- -------- FOR VALUE RECEIVED, Neil Kornswiet (the "Maker"), hereby promises to pay to the order of Aames Financial Corporation, a Delaware corporation ("Aames"), 2 California Plaza, 350 South Grand Avenue, Los Angeles, CA 90071 or such address as Aames shall have given to the Maker, the principal sum of DOLLARS and 00/100 ($_______), plus interest, which shall accrue from the date hereof, on the unpaid principal balance of this Note at such address, at the rate of 6.5% per annum (computed on the basis of a 360-day year) until the principal amount hereof has been repaid in full, on ________, 2004. The Maker shall have the option to prepay the principal amount and accrued interest on this Note, in whole or in part, at any time, without payment of premium or penalty. During the period in which this Note is outstanding, the Maker shall make an annual mandatory prepayment against the outstanding principal balance of, and accrued interest on, this Note an amount equal to 25% of the aggregate cash bonuses (if any) paid to Maker in respect of the fiscal year ended immediately prior to such payment date, net of income taxes payable thereon, such payments to be made within two business days after receipt of the cash bonus paid at the end of such fiscal year and to be applied first, against any accrued and unpaid interest on this Note and then, to the outstanding principal balance of this Note. In addition, upon receipt by the Maker of any proceeds from the transfer of the securities pledged under the Pledge Agreement (as defined below) or dividends, interest payments or other distributions of cash in respect of such pledged securities, the Maker shall make an immediate prepayment in respect of the Note in an amount equal to the after tax amount of such proceeds, dividends, payments or distributions, with such prepayments to be applied first to the payment of all interest accrued on, and then to the payment of unpaid principal of, this Note. Payments of principal and interest shall be made in such currency of the United States as at the time of payment shall be legal tender for the payment of public and private debts. Aames and the Maker have entered into a pledge agreement dated the date hereof (the "Pledge Agreement") providing, among A-1 10 other things, for the securing of this Note by a pledge of the Pledged Collateral (as defined in the Pledge Agreement). If any of the following events (each, an "Event of Default") shall occur: (a) the Maker shall default in the payment of any part of the principal or interest on this Note when the same shall become due and payable, whether at maturity, by acceleration or otherwise and such default continues for more than 10 days after receipt of notice from Aames; (b) the Maker's employment with Aames shall have ceased for any reason whatsoever or for no reason, whether such cessation is voluntary or involuntary, and regardless of whether the Maker may claim such cessation of employment constitutes a wrongful termination of employment; (c) the Maker shall (i) become insolvent or be unable, or admit in writing his inability, to pay his debts as they mature; (ii) make a general assignment for the benefit of creditors; (iii) be adjudicated as bankrupt or insolvent or file a voluntary petition in bankruptcy; (iv) file a petition or an answer seeking an arrangement with creditors to take advantage of any insolvency law; or (v) file an answer admitting to the material obligations or consent to, or default in answering, or fail to have dismissed within 60 days after the filing thereof, a petition filed against him in any bankruptcy or insolvency proceeding; or (d) any breach of the Maker's obligations under the Pledge Agreement shall have occurred and be continuing or any representation or warranty made thereunder shall be false in any material respect, then, the holder of this Note may at any time by written notice to the Maker, declare the entire unpaid principal of and the interest accrued on this Note through the date of such Event of Default to be forthwith due and payable, without other notices or demands of any kind, all of which are hereby waived by the Maker. Subject to the terms and conditions herein, if Maker is employed by Aames for the full period from the date hereof through the first anniversary of the Effective Date, as such term is defined in Maker's current Employment Agreement with Aames (the "Employment Agreement"), or through the date of any earlier termination of Maker's employment by Aames pursuant to Paragraphs 5A, B, or F of the Employment Agreement or by the Maker pursuant to Paragraph 5D of the Employment Agreement, the indebtedness evidenced by this Note shall be nonrecourse (i.e., Aames shall not have recourse to any assets of Maker for any liability under or in connection with the Pledge Agreement other than the Pledged Collateral and, Aames shall not be liable for any deficiency A-2 11 owing in respect of such liabilities in the event the proceeds derived from the sale of such Pledged Collateral are insufficient to pay such liabilities. The Maker agrees to pay to the holder hereof all expenses incurred by such holder, including reasonable attorneys' fees, in enforcing and collecting this Note. The Maker hereby forever waives presentment, demand, presentment for payment, protest, notice of protest, notice of dishonor of this Note and all other demands and notices in connection with the delivery, acceptance, performance and enforcement of this Note. This Note shall be paid without deduction by reason of any set-off, defense or counterclaim of the Maker. This Note shall be governed by and construed in accordance with the laws of the State of Delaware, without giving effect to conflicts of law principles thereof, shall be binding upon the heirs or legal representatives of the Maker and shall inure to the benefits of the successors and assigns of Aames. --------------------------------- Neil Kornswiet A-3 12 EXHIBIT B TO MANAGEMENT INVESTMENT AGREEMENT (NEIL KORNSWIET) FORM OF PLEDGE AGREEMENT PLEDGE AGREEMENT ("Agreement"), dated as of _____, 1999, made by Neil Kornswiet, an individual residing at 16105 Whitecap Lane, Huntington Beach, CA, 92649 (the "Pledgor"), to Aames Financial Corporation, a Delaware corporation ("Aames"). WHEREAS, on the date hereof, the Pledgor is purchasing shares of Aames' Series C Convertible Preferred Stock, par value $0.001 per share ("Series C Preferred Stock"), pursuant to a Management Investment Agreement, dated the date hereof, between Pledgor and Aames (the "Management Investment Agreement"); and WHEREAS, as part of the transactions contemplated by the Management Investment Agreement, the Pledgor is executing and delivering to Aames a Secured Promissory Note dated as of the date hereof in favor of Aames (the "Aames Note") as part of the purchase price for the Series C Preferred Stock, and (ii) in accordance with the terms and conditions set forth herein, pledge the Series C Preferred Stock, together with any shares of Aames' common stock, par value $0.001 per share that may be acquired upon conversion of the Series C Preferred Stock (the "Underlying Common Shares, and, together with the shares of Series C Preferred Stock, the "Pledged Shares"). NOW, THEREFORE, in consideration of the premises and the mutual covenants contained in this Agreement, and in order to induce Aames to accept the Aames Note, the Pledgor hereby agrees as follows: SECTION 1. Pledge. The Pledgor hereby pledges to Aames, and grants to Aames a security interest in, the following (the "Pledged Collateral"): (i) the Pledged Shares and the certificates representing the Pledged Shares, and all dividends, cash, B-1 13 instruments and other property of any character whatsoever (including, without limitation, shares of Common Stock) from time to time received, receivable or otherwise distributed or distributable in respect of or in exchange for any or all of the Pledged Shares; and (ii) all proceeds of any and all of the foregoing collateral (including, without limitation, proceeds that constitute property of the types described above). SECTION 2. Security for Obligations. This Agreement secures the payment of all obligations, whether for principal, interest, fees, expenses or otherwise, now or hereafter existing, of the Pledgor under the Aames Note and under this Agreement (all such obligations of the Pledgor being the "Obligations"). Without limiting the generality of the foregoing, this Agreement secures the payment of all amounts which constitute part of the Obligations and would be owed by the Pledgor to Aames under the Aames Note or this Agreement but for the fact that they are unenforceable or not allowable due to the existence of a bankruptcy, reorganization or similar proceeding involving the Pledgor. SECTION 3. Delivery of Pledged Collateral. All certificates or instruments representing or evidencing the Pledged Collateral shall be delivered to and held by or on behalf of Aames pursuant hereto and shall be in suitable form for transfer by delivery, or shall be accompanied by duly executed instruments of transfer or assignment in blank, all in form and substance satisfactory to Aames. Aames shall have the right, at any time in its discretion and without notice to the Pledgor, to transfer to or to have registered in the name of Aames or any of its nominees any or all of the Pledged Collateral, subject only to the revocable rights specified in Section 6(a). For the better perfection of Aames's rights in and to the Pledged Collateral, the Pledgor shall forthwith, upon the pledge of any Pledged Collateral hereunder, cause such Pledged Collateral to be registered in the name of Aames or such nominee or nominees of Aames as Aames shall direct, subject only to the revocable rights specified in Section 6(a). In addition, Aames shall have the right at any time to exchange certificates or instruments representing or evidencing Pledged Collateral for certificates or instruments of smaller or larger denominations. SECTION 4. Representations and Warranties. The Pledgor represents and warrants as follows: B-2 14 (a) Neither the execution nor the delivery by the Pledgor of this Agreement nor the consummation by the Pledgor of the transactions contemplated hereby, nor compliance with nor fulfillment by the Pledgor of the terms and provisions hereof, will conflict with or result in a breach of the terms, conditions or provisions of or constitute a default under any lease, contract, instrument, mortgage, deed of trust, trust deed or deed to secure debt evidencing or securing indebtedness for borrowed money, financing lease, law, rule, regulation, judgment, order, award, decree or other restriction of any kind to which the Pledgor is a party or by which he is bound. (b) This Agreement has been duly executed and delivered by the Pledgor and is the legal, valid and binding obligation of the Pledgor, enforceable against the Pledgor in accordance with its terms. (c) There is no action, lawsuit, claim, counterclaim, proceeding, or investigation (or group of related actions, lawsuits, claims, proceedings or investigations) pending or, to the knowledge of the Pledgor, threatened, relating to or challenging the Pledgor's obligations under this Agreement or the pledge of the Pledged Collateral hereunder. (d) The Pledgor is the legal and beneficial owner of the Pledged Collateral free and clear of any lien, security interest, option or other charge or encumbrance except for the security interest created by this Agreement. (e) The pledge of the Pledged Shares pursuant to this Agreement creates a valid and perfected first priority security interest in the Pledged Collateral, securing the payment of the Obligations. (f) No consent of any other person or entity and no authorization, approval, or other action by, and no notice to or filing with, any governmental authority or regulatory body is required (i) for the pledge by the Pledgor of the Pledged Collateral pursuant to this Agreement or for the execution, delivery or performance of this Agreement by the Pledgor, (ii) for the perfection or maintenance of the B-3 15 security interest created hereby (including the first priority nature of such security interest) or (iii) for the exercise by Aames of the voting or other rights provided for in this Agreement or the remedies in respect of the Pledged Collateral pursuant to this Agreement (except as may be required in connection with any disposition of any portion of the Pledged Collateral by laws affecting the offering and sale of securities generally). (g) There are no conditions precedent to the effectiveness of the Pledgor's obligations under this Agreement that have not been satisfied or waived. SECTION 5. Further Assurances. (a) The Pledgor agrees that at any time and from time to time, at the expense of the Pledgor, the Pledgor will promptly execute and deliver all further instruments and documents, and take all further action, that may be necessary or desirable, or that Aames may reasonably request, in order to perfect and protect any security interest granted or purported to be granted hereby or to enable Aames to exercise and enforce its rights and remedies hereunder with respect to any Pledged Collateral. (b) The Pledgor hereby authorizes Aames to file one or more financing or continuation statements, and amendments thereto, relating to all or any part of the Pledged Collateral without the signature of the Pledgor where permitted by law. A photocopy or other reproduction of this Agreement or any financing statement covering the Pledged Collateral or any part thereof shall be sufficient as a financing statement where permitted by law. SECTION 6. Voting Rights; Dividends, Etc. (a) so long as no Event of Default (as defined in the Aames Note) or event which, with the giving of notice or the lapse of time, or both, would become such an Event of Default shall have occurred and be continuing: (i) The Pledgor shall be entitled to exercise or refrain from exercising any and all voting and other consensual rights pertaining to the Pledged Collateral or any part thereof for any purpose not inconsistent with the terms of this Agreement or the Aames Note; provided, however, that the Pledgor shall not exercise or refrain from B-4 16 exercising any such right if, in Aames's judgment, such action would have a material adverse effect on the value of the Pledged Collateral or any part thereof. (ii) The Pledgor shall be entitled to any and all dividends paid in respect of the Pledged Collateral; provided, however, that any and all dividends paid or payable other than in cash in respect of, and instruments and other property received, receivable or otherwise distributed in respect of or in exchange for, any Pledged Collateral, shall be, and shall be forthwith delivered to Aames to hold as, Pledged Collateral and shall, if received by the Pledgor, be received in trust for the benefit of Aames, be segregated from the other property or funds of the Pledgor, and be forthwith delivered to Aames as Pledged Collateral in the same form as so received (with any necessary endorsement or assignment); and provided, further, that the after tax amount of any cash dividends, proceeds, or other distributions paid in respect of the Pledged Collateral shall be applied as an immediate prepayment in respect of the Aames Note, with such prepayments to be applied first to the payment of all interest accrued on, and then to the payment of unpaid principal of, the Aames Note. (iii) Aames shall execute and deliver (or cause to be executed and delivered) to the Pledgor all such proxies and other instruments as the Pledgor may reasonably request for the purpose of enabling the Pledgor to exercise the voting and other rights which it is entitled to exercise pursuant to paragraph (i) above and to receive the dividends which it is authorized to receive and retain pursuant to paragraph (ii) above. (b) Upon the occurrence and during the continuance of an Event of Default or an event which, with the giving of notice or the lapse of time, or both, would become an Event of Default: (i) All rights of the Pledgor (x) to exercise or refrain from exercising the voting and other consensual rights which it would otherwise be entitled to exercise pursuant to Section 6(a)(i) shall, upon notice to the Pledgor by Aames, cease and (y) to receive the dividends payments which it would otherwise be authorized to receive and retain pursuant to Section 6(a)(ii) shall automatically cease, and all such rights shall thereupon become vested in Aames (or its designee), who shall thereupon have the sole B-5 17 right to exercise or refrain from exercising such voting and other consensual rights and to receive and hold as Pledged Collateral such dividends. (ii) All dividends which are received by the Pledgor contrary to the provisions of paragraph (i) of this Section 6(b) shall be received in trust for the benefit of Aames, shall be segregated from other funds of the Pledgor and shall be forthwith paid over to Aames as Pledged Collateral in the same form as so received (with any necessary endorsement). SECTION 7. Transfers and Other Liens. The Pledgor agrees that it will not (i) sell, assign (by operation of law or otherwise) or otherwise dispose of, or grant any option with respect to, any of the Pledged Collateral or (ii) create or permit to exist any lien, security interest, option or other charge or encumbrance upon or with respect to any of the Pledged Collateral, except for the security interest under this Agreement and except for any such sale the proceeds from which are used to repay all unpaid principal of, and accrued interest on, the Aames Note (with such proceeds first being applied to accrued interest and then to principal). SECTION 8. Appointment of Attorney-in-Fact. The Pledgor hereby appoints [_______] the Pledgor's attorney-in-fact, with full authority in the place and stead of the Pledgor and in the name of the Pledgor or otherwise, from time to time in Aames's discretion to take any action and to execute any instrument that Aames may deem necessary or advisable to accomplish the purposes of this Agreement (subject to the rights of the Pledgor under Section 6), including, without limitation, to receive, indorse and collect all instruments made payable to the Pledgor representing any dividend or other distribution in respect of the Pledged Collateral or any part thereof and to give full discharge for the same. SECTION 9. Aames May Perform. If the Pledgor fails to perform any agreement contained herein and does not cure such failure within 10 days after its receipt of written notice from Aames, Aames may itself perform, or cause performance of, such agreement, and the expenses of Aames incurred in connection therewith shall be payable by the Pledgor under Section 12. B-6 18 SECTION 10. Aames' Duties. The powers conferred on Aames hereunder are solely to protect its interest in the Pledged Collateral and shall not impose any duty upon it to exercise any such powers. Except for the safe custody of any Pledged Collateral in its possession and the accounting for moneys actually received by it hereunder, Aames shall have no duty as to any Pledged Collateral as to ascertaining or taking action with respect to calls, conversions, exchanges, maturities, tenders or other matters relative to any Pledged Collateral, whether or not Aames has or is deemed to have knowledge of such matters, or as to the taking of any necessary steps to preserve rights against any parties or any other rights pertaining to any Pledged Collateral. Aames shall be deemed to have exercised reasonable care in the custody and preservation of any Pledged Collateral in its possession if such Pledged Collateral is accorded treatment substantially equal to that which Aames accords its own property. SECTION 11. Remedies upon Default. If any Event of Default shall have occurred and be continuing: (a) Aames may exercise in respect of the Pledged Collateral, in addition to other rights and remedies provided for herein or otherwise available to it, all the rights and remedies of a secured party on default under the Uniform Commercial Code in effect in the State of Delaware at that time (the "Code") (whether or not the Code applies to the affected Collateral), and may also, without notice except as specified below, sell the Pledged Collateral or any part thereof in one or more parcels at public or private sale, at any exchange or broker's board or elsewhere, for cash, on credit or for future delivery, and upon such other terms as Aames may deem commercially reasonable. The Pledgor agrees that, to the extent notice of sale shall be required by law, at least ten days' notice to the Pledgor of the time and place of any public sale or the time after which any private sale is to be made shall constitute reasonable notification. Aames shall not be obligated to make any sale of Pledged Collateral regardless of notice of sale having been given. Aames may adjourn any public or private sale from time to time by announcement at the time and place fixed therefor, and such sale may, without further notice, be made at the time and place to which it was so adjourned. (b) Any cash held by Aames as Pledged Collateral and all cash proceeds received by Aames in respect of any sale of, collection from or other realization upon all or any part of the Pledged Collateral may, in the discretion of B-7 19 Aames, be held by Aames as collateral for, and/or then or at any time thereafter be applied (after payment of any amounts payable to Aames pursuant to Section 12) in whole or in part by Aames against, all or any part of the Obligations in such order as Aames shall elect. Any surplus of such cash or cash proceeds held by Aames and remaining after payment in full of all the Obligations shall be paid over to the Pledgor or to whomsoever may be lawfully entitled to receive such surplus. SECTION 12. Expenses. The Pledgor will upon demand pay to Aames the amount of any and all reasonable expenses, including the reasonable fees and expenses of its counsel and of any experts and agents, which Aames may incur in connection with (i) the exercise or enforcement of any of the rights of Aames hereunder or (ii) the failure by the Pledgor to perform or observe any of the provisions hereof. SECTION 13. Security Interest Absolute. The obligations of the Pledgor under this Agreement are independent of the Obligations, and a separate action or actions may be brought and prosecuted against the Pledgor to enforce this Agreement. All rights of Aames and security interests hereunder, and all obligations of the Pledgor hereunder, shall be absolute and unconditional irrespective of: (i) any lack of validity or enforceability of the Aames Note any other agreement or instrument relating thereto; (ii) any change in the time, manner or place of payment of, or in any other term of, all or any of the obligations, or any other amendment or waiver of or any consent to any departure from the Aames Note; (iii) any taking, exchange, release or nonperfection of any other collateral, or any taking, release or amendment or waiver of or consent to departure from any guaranty, for all or any of the Obligations; (iv) any manner of application of collateral, or proceeds thereof, to all or any of the Obligations, or any B-8 20 manner of sale or other disposition of any collateral for all or any of the Obligations or any other assets of the Pledgor; (v) any other circumstance which might otherwise constitute a defense available to, or a discharge of, the Pledgor. SECTION 14. Amendments, Etc. No amendment or waiver of any provision of this Agreement shall in any event be effective unless the same shall be in writing and signed by the parties hereto, and no consent to any departure by one party herefrom, shall in any event be effective unless the same shall be in writing and signed by the other party, and then such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given. SECTION 15. Notices, Etc. All notices and other communications provided for hereunder shall be in writing (including telecopier, telegraphic or telex communication) and sent by express courier, telecopied, telegraphed, telexed or hand-delivered, if to the Pledgor, at his address first set forth above; and, if to Aames, at its address at 2 California Plaza, 350 South Grand Avenue, Los Angeles, CA 90071, Attention: Cary Thompson; or, as to each party, at such other address as shall be designated by such party in a written notice to the other party. All such notices and communications shall, when sent by express courier, be effective three days after being sent, when telecopied, telegraphed, telexed or hand-delivered, be effective when telecopied, delivered to the telegraph company, confirmed by telex answerback or delivered, respectively. SECTION 16. Continuing Security Interest; Assignments Under Aames Note. This Agreement shall create a continuing security interest in the Pledged Collateral and shall (i) remain in full force and effect until the payment in full of the Obligations and all other amounts payable under this Agreement, (ii) be binding upon the Pledgor, its successors and assigns and (iii) inure to the benefit of, and be enforceable by, Aames and its successors, transferees and assigns. Without limiting the generality of the foregoing clause (iii), Aames may assign or otherwise transfer all or any portion of its rights and obligations under the Aames Note to any other person or entity, and such other person or entity shall thereupon become vested with all the benefits in respect thereof granted to Aames herein or otherwise. Upon the payment in full of the Obligations and B-9 21 all other amounts payable under this Agreement, the security interest granted hereby shall terminate and all rights to the Pledged Collateral shall revert to the Pledgor. Upon any such termination, Aames will, at the Pledgor's expense, return to the Pledgor such of the Pledged Collateral as shall not have been sold or otherwise applied pursuant to the terms hereof and execute and deliver to the Pledgor such documents as the Pledgor shall reasonably request to evidence such termination. SECTION 17. Governing Law; Terms. THIS AGREEMENT SHALL BE GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH, THE LAWS OF THE STATE OF DELAWARE EXCEPT TO THE EXTENT THAT THE VALIDITY OR PERFECTION OF THE SECURITY INTEREST HEREUNDER, OR REMEDIES HEREUNDER, IN RESPECT OF ANY PARTICULAR PLEDGED COLLATERAL ARE GOVERNED BY THE LAWS OF A JURISDICTION OTHER THAN THE STATE OF DELAWARE. Unless otherwise defined herein or in the Aames Note, terms defined in Article 9 of the Code are used herein as therein defined. B-10 22 IN WITNESS WHEREOF, the Pledgor has caused this Agreement to be duly executed and delivered by its officer thereunto duly authorized as of the date first above written. ------------------------------ Neil Kornswiet ACKNOWLEDGED AND AGREED: AAMES FINANCIAL CORPORATION By: ------------------------- Name: Title: B-11 EX-10.27 12 MANAGEMENT VOTING AGREEMENT 1 EXHIBIT 10.27 MANAGEMENT VOTING AGREEMENT MANAGEMENT VOTING AGREEMENT dated as of December 23, 1998, among Capital Z Financial Services Fund II, L.P., a Bermuda limited partnership ("Capital Z"), and Cary Thompson and Neil Kornswiet (collectively, the "Shareholders"). WHEREAS, the Shareholders desire that the Aames Financial Corporation, a Delaware corporation (the "Company"), and Capital Z enter into a Preferred Stock Purchase Agreement dated as of the date hereof (as the same may be amended from time to time, the "Purchase Agreement"), which provides, among other things, that Capital Z, together with certain Capital Z affiliates and co-investors as provided therein, will purchase shares of the Company's Series B Convertible Preferred Stock, par value $0.001 per share ("Series B Preferred Stock") and Series C Convertible Preferred Stock, par value $0.001 per share ("Series C Preferred Stock," and, together with the Series B Preferred Stock, "Senior Preferred Stock"), in the amounts and subject to the conditions set forth in the Purchase Agreement; and WHEREAS, the Shareholders are executing this Agreement as an inducement to the Company and Capital Z to execute and deliver the Purchase Agreement. NOW THEREFORE, in consideration of the execution and delivery by the Company and Capital Z of the Purchase Agreement and the mutual covenants, conditions and agreements contained therein and herein, the parties hereto agree as follows: SECTION 1. Representations and Warranties. Each of the Shareholders severally and not jointly represents and warrants to the Company and Capital Z as to himself (and not as to any other Shareholder) as follows: (a) Such Shareholder is the record and beneficial owner of the number of shares of the Company's common stock, par value $0.001 per share ("Common Stock") (together with any shares of Common Stock or other voting securities of the Company, including, without limitation, Senior Preferred Stock, with respect to which the Shareholder obtains voting power after the 2 date hereof, the "Shares"), as set forth on Exhibit A hereto (which Exhibit shall be amended after the date hereof to include any voting securities of the Company with respect to which the Shareholder obtains voting power after the date hereof). Except for such number of Shares and except for Shares, if any, (i) issuable in connection with options outstanding as of the date hereof or (ii) which such Shareholder has agreed to purchase in connection with the transactions contemplated by the Purchase Agreement, such Shareholder is not the record or beneficial owner of any shares of Common Stock. (b) Such Shareholder has the authority to execute, deliver and perform this Agreement without the necessity of obtaining any third party consent, approval, authorization or waiver, or giving of any notice or otherwise, except for such consents as have been obtained, are unconditional and are in full force and effect. (c) This Agreement has been duly executed and delivered by such Shareholder and, assuming due execution and delivery thereof by the Company and Capital Z, constitutes the legal, valid, and binding obligation of such Shareholder enforceable against the Shareholder in accordance with its terms, except as enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or similar laws affecting the enforcement of creditors' rights generally and by general principles of equity (whether enforcement is sought by proceedings in equity or at law). (d) The execution, delivery, and performance of this Agreement by such Shareholder will not (i) result in the breach of or constitute a default under any contract to which such Shareholder is subject, (ii) constitute a violation of any Law applicable or relating to such Shareholder or (iii) result in the creation of any Lien. (e) Except for this Agreement, there are no voting trusts or other agreements or understandings, including, without limitation, any proxies, in effect governing the voting of the Shares. (f) Such Shareholder does not hold, and has not issued, any proxies, or securities convertible into or exchangeable for or any options, warrants, or other rights to purchase or subscribe for any shares of Common Stock. -2- 3 (g) The Shares and the certificates representing such Shares are now and until the earlier to occur of June 30, 1999 and consummation of the Recapitalization will be held by such Shareholder, or by a nominee or custodian for the benefit of such Shareholder, free and clear of all Liens, proxies, voting trusts or agreements, understandings or arrangements or any other encumbrances whatsoever other than as created by this Agreement. (h) Such Shareholder understands and acknowledges that the Company and Capital Z are entering into the Purchase Agreement in reliance upon such Shareholder's execution and delivery of this Agreement. (i) There are no undertakings, agreements, arrangements or understandings of the type required to be disclosed by the Company pursuant to Item 404 of Regulation S-K under the Securities Act in filings by the Company with the Securities and Exchange Commission in effect between such Shareholder, or any of his or her affiliates, on the one hand, and the Company or any of its subsidiaries, on the other hand, which have not been fully and completely disclosed, in writing, to Capital Z. SECTION 2. Voting Agreement. Each Shareholder agrees with, and covenants to, Capital Z as follows: (a) At the Shareholders' Meeting or at any adjournment thereof or in any other circumstances upon which a vote, consent or other approval will be held or solicited with respect to the increase of the authorized capital stock of the Company as contemplated by the Purchase Agreement (the "Charter Amendment"), such Shareholder shall vote (or cause to be voted) or shall consent, execute a consent or cause to be executed a consent in respect of the Shares in favor of the Charter Amendment and the Stock Split. (b) At any meeting of shareholders of the Company or at any adjournment thereof or in any other circumstances upon which their vote, consent or other approval is sought while the Purchase Agreement remains in effect, such Shareholder shall vote (or cause to be voted) the Shares against (i) any Alternative Transaction or any action which is a component of any Alternative Transaction or would be a component of an Alternative Transaction if it were contained in a proposal, or (ii) any other matter submitted to the shareholders of the Company, including, without -3- 4 limitation, any amendment of the Company's Certificate of Incorporation or By-Laws, which matter would in any manner partially or wholly prevent or materially impede, interfere with or delay any of the transactions contemplated by the Purchase Agreement, as determined in good faith by Purchaser and with respect to which Purchaser provides written notice to the Shareholder. (c) In the event that the Recapitalization (as defined in the Purchase Agreement) is not consummated prior to June 30, 1999, each Shareholder agrees to vote all Shares for which he has or shares the power to vote, or grant a consent for approval in respect of such Shares in any manner permitted by the DGCL, as such Shareholder is directed by the board of directors of the Company, on any matters submitted to the shareholders of the Company, other than the election of directors. The foregoing agreement shall terminate automatically upon the termination of this Agreement with respect to any Shares owned by such person upon transfer of such Shares pursuant to Section 7. The Company shall be a third party beneficiary of this Agreement for the purposes of this Section 2(c). (d) Each Shareholder represents and warrants to the Company and Capital Z that any proxies heretofore given in respect of the Shares are not irrevocable, and that any such proxies are hereby revoked, to the extent in conflict with Section 2(c) hereof. (e) Each Shareholder hereby affirms that the irrevocable proxy set forth in this Section 2 is given in connection with the execution of the Purchase Agreement, and that such irrevocable proxy is given to secure the performance of the duties of such Shareholder under this Agreement. Each Shareholder hereby further affirms that the irrevocable proxy is coupled with an interest and may under no circumstances be revoked. Each Shareholder hereby ratifies and confirms all that such irrevocable proxy may lawfully do or cause to be done by virtue hereof. Such irrevocable proxy is executed and intended to be irrevocable in accordance with the provisions of Section 212(e) of the DGCL. SECTION 3. Covenants of the Shareholder. Each Shareholder agrees with, and covenants to, Capital Z that such Shareholder shall not on or prior to the earlier to occur of June 30, 1999 or the consummation of the Recapitalization, (i) -4- 5 transfer (which term shall include, without limitation, for the purposes of this Agreement, any sale, gift, pledge, encumbrance (other than an unforeclosed pledge or encumbrance for financing purposes where the Shareholder retains sole voting power with respect to all pledged securities), or other disposition), or consent to any transfer of, any or all the Shares or any interest therein, unless the transferee(s) of such Shares agrees in writing to be bound by the provisions of this Agreement applicable to such Shareholder, (ii) grant any proxy, power-of-attorney or other authorization in or with respect to such Shares, except under or in accordance or not in conflict with this Agreement, or (iii) deposit such Shares into a voting trust, enter into a voting agreement or arrangement with respect to such Shares or otherwise limit such Shareholder's power to vote his or her Shares in a manner that conflicts with this Agreement. SECTION 4. Certain Events. In the event of any stock split, stock dividend, merger, reorganization, recapitalization or other change in the capital structure of the Company affecting the Common Stock, or the acquisition of additional shares of Common Stock or other voting securities of the Company by such Shareholder, the number of Shares set forth in Section 1(a) hereof shall be adjusted appropriately and this Agreement and the obligations hereunder shall attach to any additional shares of Common Stock or other voting securities of the Company issued to or acquired by such Shareholder. SECTION 5. Shareholder Capacity. No person executing this Agreement who is or becomes a director of the Company makes any agreement or understanding herein in his or her capacity as such director. Each Shareholder signs solely in such Shareholder's capacity as the record and beneficial owner of the Shares. SECTION 6. Further Assurances. Each Shareholder shall, upon request of Capital Z, execute and deliver any additional documents and take such further actions as may reasonably be deemed by Capital Z to be necessary or desirable to carry out the provisions hereof. SECTION 7. Termination. This Agreement, and all rights and obligations of the parties hereunder, shall terminate upon the date upon which the Recapitalization has been consummated and the Shareholder Approval has been obtained or the Purchase Agreement is earlier terminated in accordance with its -5- 6 terms, except that no Shareholder shall be relieved of any liability for breach of this Agreement by such Shareholder prior to such termination. Further, this Agreement shall terminate with respect to any Shares which are transferred as permitted by Section 3 hereof. SECTION 8. Defined Terms. Capitalized terms used and not otherwise defined in this Agreement shall have the respective meanings assigned to them in the Purchase Agreement. SECTION 9. Notices. All notices, requests, claims, demands and other communications under this Agreement shall be sufficiently given if sent by registered or certified mail, postage prepaid, or overnight air courier service, or telecopy or facsimile transmission (with hard copy to follow) to the parties at the following addresses (or at such other address for a party as shall be specified by like notice): (i) if to Capital Z, to the address set forth in Section 7.3 of the Purchase Agreement; and (ii) if to any Shareholder, to the address set forth opposite such Shareholder's name on Exhibit A hereto. SECTION 10. Headings. The headings contained in this Agreement are for reference purposes only and shall not affect in any way the meaning or interpretation of this Agreement. SECTION 11. Counterparts; Effectiveness. This Agreement may be executed in two or more counterparts, all of which shall be considered one and the same agreement and shall become effective as to any Shareholder when one or more counterparts have been signed by Capital Z and such Shareholder and delivered to Capital Z and such Shareholder. SECTION 12. Entire Agreement. This Agreement (including the documents and instruments referred to herein) constitutes the entire agreement, and supersedes all prior agreements and understandings, both written and oral, among the parties with respect to the subject matter hereof. SECTION 13. Governing Law. This Agreement shall be governed by, and construed in accordance with, the laws of the State of Delaware, without regard to any applicable conflicts of law principles of such State. SECTION 14. Successors and Assigns. Neither this Agreement nor any of the rights, interests or obligations under this Agreement shall be assigned, in whole or in part, by -6- 7 operation of law or otherwise, by any of the parties without the prior written consent of the other parties, except as expressly contemplated by Section 3(a), and except that Capital Z may assign its rights under this Agreement to any transferee of any of the Company's securities acquired by it under the Purchase Agreement (and any such transferee may similarly assign its rights in connection with any further transfer of such securities, in whole or in part). Any assignment in violation of the foregoing shall be void. SECTION 15. Enforcement. Each party agrees that irreparable damage would occur and that the other party hereto would not have any adequate remedy at law in the event that any of the provisions of this Agreement were not performed in accordance with their specific terms or were otherwise breached. It is accordingly agreed that each party shall be entitled to an injunction or injunctions to prevent breaches by the other party hereto of this Agreement and to enforce specifically the terms and provisions of this Agreement in any court of the United States located in the State of Delaware or in Delaware State court, this being in addition to any other remedy to which they are entitled at law or in equity. In addition, each of the parties hereto (i) consents to submit such party to the personal jurisdiction of any Federal court located in the State of Delaware or any Delaware State court in the event any dispute arises out of this Agreement or any of the transactions contemplated hereby, (ii) agrees that such party will not attempt to deny or defeat such personal jurisdiction by motion or other request for leave from any such court and (iii) agrees that such party will not bring any action relating to this Agreement or any of the transactions contemplated hereby in any court other than a Federal court sitting in the State of Delaware or a Delaware State court. SECTION 16. Severability. If any term or provision hereof, or the application thereof to any circumstance, shall, to any extent, be held by a court of competent jurisdiction to be invalid or unenforceable with respect to such jurisdiction, and only to such extent, and the remainder of the terms and provisions hereof, and the application thereof to any other circumstance, shall remain in full force and effect, shall not in any way be affected, impaired or invalidated, and shall be enforced to the fullest extent permitted by law, and the parties hereto shall reasonably negotiate in good faith a substitute term or provision that comes as close as possible to the invalidated -7- 8 or unenforceable term or provision, and that puts each party in a position as nearly comparable as possible to the position each such party would have been in but for the finding of invalidity or unenforceability, while remaining valid and enforceable. SECTION 17. Amendment; Modification; Waiver. No amendment, modification or waiver in respect of this Agreement shall be effective against any party unless it shall be in writing and signed by such party. -8- 9 IN WITNESS WHEREOF, Capital Z and the Shareholders have caused this Agreement to be duly executed and delivered as of the date first written above. CAPITAL Z FINANCIAL SERVICES FUND II, L.P., By its General Partner CAPITAL Z PARTNERS, L.P., By its General Partner CAPITAL Z PARTNERS, LTD. By: /s/ Adam M. Mizel -------------------------------- Name: Adam M. Mizel Title: Partner SHAREHOLDERS: /s/ Cary H. Thompson ------------------------------------- Cary Thompson /s/ Neil B. Kornswiet ------------------------------------- Neil Kornswiet -9- EX-10.28(B) 13 AMENDMENT NO.1 TO PREFERRED STOCK PURCHASE AGMT. 1 EXHIBIT 10.28(b) AMENDMENT NO. 1 TO PREFERRED STOCK PURCHASE AGREEMENT This AMENDMENT, dated as of February 10, 1999, to that certain Preferred Stock Purchase Agreement dated as of December 23, 1998, is made and entered into between Aames Financial Corporation, a Delaware corporation (the "Company"), and Capital Z Financial Services Fund II, L.P., a Bermuda limited partnership ("Capital Z"). RECITALS WHEREAS, the parties hereto have entered into a Preferred Stock Purchase Agreement dated as of December 23, 1998 (the "Stock Purchase Agreement"); and WHEREAS, such parties desire to amend the Stock Purchase Agreement as set forth herein. NOW, THEREFORE, in consideration of the mutual covenants and agreements herein contained, and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows: ARTICLE I. DEFINITIONS Section 1.1. Definitions. Capitalized terms used herein that are defined in the Stock Purchase Agreement are used herein as so defined. ARTICLE II. AMENDMENTS The Stock Purchase Agreement is hereby amended as follows: (a) Section 2.2 is amended in its entirety by replacing such section with the following: "Section 2.2. Issuance, Sale and Purchase of Senior Preferred Stock. (a) Upon the terms and subject to the conditions set forth in this Agreement, and in reliance upon the representations and warranties hereinafter set forth, at the Initial Closing, the Company will issue, sell, and deliver to the Purchaser (including the Designated Purchasers), and the Purchaser will purchase from the Company, (i) 26,704 shares of Series B Preferred Stock and (ii) 49,796 shares of Series C Preferred Stock. The purchase price per share of Senior Preferred Stock shall equal $1,000.00 (the "Purchase Price"). 2 (b) The Senior Preferred Stock shall be issued to Capital Z and to its Designated Purchaser as follows: 26,704 shares of Series B Preferred Stock to Capital Z; 48,296 shares of Series C Preferred Stock to Capital Z; and 1,500 shares of Series C Preferred Stock to Georges St. Laurent." (b) Section 2.5(b) is amended by deleting the last sentence thereof and replacing such sentence with the following: "At the earlier to occur of (i) the day the Recapitalization is consummated and (ii) June 30, 1999, the Purchaser may, at its option, (I) if on the day the Recapitalization is consummated, exchange up to 3,000,000 shares of Series C Preferred Stock acquired at the Initial Closing or (II) if on June 30, 1999, exchange up to 3,000 shares of Series C Preferred Stock acquired at the Initial Closing, in either case for an equivalent number of shares of Series B Preferred Stock; provided, that, immediately following such exchange, the total number of outstanding shares of Series B Preferred Stock do not represent more than 49.99% of the total voting power of the Company entitled to vote for the election of directors of the Company." (c) Section 4.4 is amended by adding the following sentences at the end of such section: "Notwithstanding the prior sentence, in the event that the Company is unable to cause the Existing Rights Agreement to be amended by the Initial Closing, the Company shall cause the Existing Rights Agreement to be so amended promptly after the Initial Closing Date. At the request of Capital Z, the Company will promptly take all actions necessary to redeem the Existing Rights." (d) The Series B Certificate of Designations (Exhibit A to the Stock Purchase Agreement) is amended in its entirety by replacing such Series B Certificate of Designations with the Series B Certificate of Designations attached to this Amendment as Exhibit A. (e) The Series C Certificate of Designations (Exhibit B to the Stock Purchase Agreement) is amended in its entirety by replacing such Series C Certificate of Designations with the Series C Certificate of Designations attached to this Amendment as Exhibit B. (f) The Contingent Warrant (Exhibit E to the Stock Purchase Agreement) is amended in its entirety by replacing such -2- 3 Contingent Warrant with the Contingent Warrant attached to this Amendment as Exhibit C. ARTICLE III. MISCELLANEOUS PROVISIONS Section 3.1. Counterparts. For the convenience of the parties, any number of counterparts of this Amendment may be executed by any one or more of the parties hereto, and each such executed counterpart shall be, and shall be deemed to be, an original, but all of which together shall constitute one and the same instrument. Section 3.2. Ratification. The Stock Purchase Agreement, as amended hereby, is hereby ratified and confirmed. -3- 4 IN WITNESS WHEREOF, the parties hereto have caused this instrument to be executed to be effective as of the 10th day of February, 1999. AAMES FINANCIAL CORPORATION By: /s/ Cary H. Thompson ---------------------------------------- Name: Cary H. Thompson Title: Chief Executive Officer CAPITAL Z FINANCIAL SERVICES FUND II, L.P., By its General Partner CAPITAL Z PARTNERS, L.P., By its General Partner CAPITAL Z PARTNERS, LTD. By: /s/ Adam M. Mizel ---------------------------------- Name: Adam M. Mizel Title: Partner -4- 5 EXHIBIT A - -------------------------------------------------------------------------------- CERTIFICATE OF THE VOTING POWERS, DESIGNATIONS, PREFERENCES AND RELATIVE, PARTICIPATING, OPTIONAL OR OTHER SPECIAL RIGHTS, AND QUALIFICATIONS, LIMITATIONS OR RESTRICTIONS THEREOF, OF SERIES B CONVERTIBLE PREFERRED STOCK OF AAMES FINANCIAL CORPORATION - -------------------------------------------------------------------------------- AAMES FINANCIAL CORPORATION, a corporation organized and existing under the General Corporation Law of the State of Delaware (the "Corporation"), hereby certifies that the following resolutions were adopted by the Board of Directors of the Corporation (the "Board of Directors") pursuant to authority of the Board of Directors as required by Section 151 of the Delaware General Corporation Law: RESOLVED, that pursuant to the authority granted to and vested in the Board of Directors in accordance with the provisions of the Certificate of Incorporation of the Corporation, as amended (the "Certificate of Incorporation"), the Board of Directors hereby creates a series of the Corporation's previously authorized preferred stock, par value $0.001 per share (the "Preferred Stock"), and hereby states the designation and number thereof, and fixes the voting powers, preferences and relative, participating, optional and other special rights, and the qualifications, limitations and restrictions thereof, as follows: SERIES B CONVERTIBLE PREFERRED STOCK: I. DESIGNATION AND AMOUNT The designation of this series of shares shall be "Series B Convertible Preferred Stock" (the "Series B Preferred Stock") par value $0.001 per share; the initial stated value per share shall be $1,000.00 (the "Initial Stated Value"); and the number of shares constituting such series shall be 100,000. The number of shares of the Series B Preferred Stock may be decreased from time to time by a resolution or resolutions of the Board of Directors; provided, however, that such number shall not be decreased below the aggregate number of shares of the Series B Preferred Stock then outstanding. II. RANK A. With respect to dividends, the Series B Preferred Stock shall rank (i) senior to each other class or series of Preferred Stock, except for the Series C Convertible Preferred Stock, par value $0.001 per share, of the Corporation (the "Series C Preferred Stock"); (ii) on a parity with the Series C Preferred Stock; and (iii) senior to the Corporation's Common Stock, par value $.001 per share (the "Common Stock"), and, except as specified above, all other classes and series of capital stock of the Corporation hereafter issued by the Corporation. With respect to dividends, all equity securities of the Corporation to which the Series B Preferred Stock ranks senior, including the Common Stock, are collectively referred to herein as the 6 "Junior Dividend Securities"; all equity securities of the Corporation with which the Series B Preferred Stock ranks on a parity, including the Series C Preferred Stock, are collectively referred to herein as the "Parity Dividend Securities"; and all equity securities of the Corporation (other than convertible debt securities) to which the Series B Preferred Stock ranks junior, with respect to dividends, are collectively referred to herein as the "Senior Dividend Securities." B. With respect to the distribution of assets upon liquidation, dissolution or winding up of the Corporation, whether voluntary or involuntary, the Series B Preferred Stock shall rank (i) senior to each other class or series of Preferred Stock of the Corporation, except for the Series C Preferred Stock; (ii) on a parity with the Series C Preferred Stock; and (iii) senior to the Common Stock, and, except as specified above, all other classes and series of capital stock of the Corporation hereafter issued by the Corporation. With respect to the distribution of assets upon liquidation, dissolution or winding up of the Corporation, whether voluntary or involuntary, all equity securities of the Corporation to which the Series B Preferred Stock ranks senior, including the Common Stock, are collectively referred to herein as "Junior Liquidation Securities"; all equity securities of the Corporation (other than convertible debt securities) to which the Series B Preferred Stock ranks on parity, including the Series C Preferred Stock, are collectively referred to herein as "Parity Liquidation Securities"; and all equity securities of the Corporation to which the Series B Preferred Stock ranks junior are collectively referred to herein as "Senior Liquidation Securities." C. The Series B Preferred Stock shall be subject to the creation of Junior Dividend Securities and Junior Liquidation Securities (collectively, "Junior Securities"), but no Parity Dividend Securities or Parity Liquidation Securities (collectively, "Parity Securities") (other than the Series C Preferred Stock) or Senior Dividend Securities or Senior Liquidation Securities (collectively, "Senior Securities") shall be created except in accordance with the terms hereof. III. DIVIDENDS A. DIVIDENDS. Subject to the terms of paragraph D below, shares of Series B Preferred Stock shall accumulate dividends at a rate of 6.5% per annum (the "Dividend Rate"), which dividends shall be paid quarterly in cash, in four equal quarterly installments on the last day of March, June, September and December of each year, or if any such date is not a Business Day, the Business Day next preceding such day (each such date, regardless of whether any dividends have been paid or declared and set aside for payment on such date, a "Dividend Payment Date"), to holders of record (the "Registered Holders") as they appear on the stock record books of the Corporation on the fifteenth day prior to the relevant Dividend Payment Date; provided, however, that during the Accrual Period (as defined in Article IX hereof) the Corporation shall have the option to accrue such dividends, which dividends, to the extent so accrued, shall compound quarterly. Prior to the consummation of the Recapitalization, dividends shall accrue and accumulate on the Initial Stated Value of each share of Series B Preferred Stock. Following the consummation of the Recapitalization, dividends shall accrue and accumulate on the Post-Recapitalization Stated Value of each share of Series B Preferred Stock. Dividends shall be paid only when, as and if declared by the Board of Directors out of funds at the time 2 7 legally available for the payment of dividends. Dividends shall begin to accumulate on outstanding shares of Series B Preferred Stock from the date of issuance and shall be deemed to accumulate from day to day whether or not earned or declared until paid. Dividends shall accumulate on the basis of a 360-day year consisting of twelve 30-day months (four 90-day quarters) and the actual number of days elapsed in the period for which payable. B. ACCUMULATION. Dividends on the Series B Preferred Stock shall be cumulative, and from and after (i) any Dividend Payment Date on which any dividend that has accumulated or been deemed to have accumulated through such date has not been paid in full (other than by reason of the election of the Corporation to accrue dividends during the Accrual Period); or (ii) any payment date set for a redemption on which such redemption payment has not been paid in full, additional dividends shall accumulate in respect of the amount of such unpaid dividends or unpaid redemption payment (the "Arrearage") at 125% of the stated dividend rate (or such lesser rate as may be the maximum rate that is then permitted by applicable law). Such additional dividends in respect of any Arrearage shall be deemed to accumulate from day to day whether or not earned or declared until the Arrearage is paid, shall be calculated as of such successive Dividend Payment Date, and shall constitute an additional Arrearage from and after any Dividend Payment Date to the extent not paid on such Dividend Payment Date. References in any Article herein to dividends that have accumulated or that have been deemed to have accumulated with respect to the Series B Preferred Stock shall include the amount, if any, of any Arrearage together with any dividends accumulated or deemed to have accumulated on such Arrearage pursuant to the immediately preceding two sentences. Additional dividends in respect of any Arrearage may be declared and paid at any time, in whole or in part, without reference to any regular Dividend Payment Date, to Registered Holders as they appear on the stock record books of the Corporation on such record date as may be fixed by the Board of Directors (which record date shall be no less than 10 days prior to the corresponding payment date). Dividends in respect of any Arrearage shall be paid in cash. C. METHOD OF PAYMENT. Dividends paid on the shares of Series B Preferred Stock in an amount less than the total amount of such dividends at the time accumulated and payable on all outstanding shares of Series B Preferred Stock shall be allocated pro rata on a share-by-share basis among all such shares then outstanding. After the Second Anniversary Date, dividends that are declared and paid in an amount less than the full amount of dividends accumulated on the Series B Preferred Stock (and on any Arrearage) shall be applied first to the earliest dividend which has not theretofore been paid. All cash payments of dividends on the shares of Series B Preferred Stock shall be made in such coin or currency of the United States of America as at the time of payment is legal tender for payment of public and private debts. D. SPECIAL DIVIDEND RIGHTS. 1. In addition to the dividend rights set forth in paragraph A above, prior to the consummation of the Recapitalization, the holders of shares of Series B Preferred Stock shall be entitled to receive, when, as and if declared by the Board of Directors out of funds legally available for such purpose, cash dividends in an amount per whole share (rounded to the nearest cent) equal to the Formula Number then in effect times the aggregate per share amount of all 3 8 cash dividends declared or paid on the Common Stock. If, prior to the consummation of the Recapitalization, the Corporation shall pay any dividend or make any distribution on the Common Stock payable in assets, securities or other forms of non-cash consideration, then, in each such case, the Corporation shall simultaneously pay or make on each whole outstanding share of the Series B Preferred Stock a dividend or distribution in like kind equal to the Formula Number then in effect times such dividend or distribution on each share of the Common Stock. The dividends and distributions on the Series B Preferred Stock pursuant to this paragraph are hereinafter referred to as "Participating Dividends." The Corporation shall declare each Participating Dividend immediately prior to or at the same time it declares any cash or non-cash dividend or distribution on the Common Stock in respect of which a Participating Dividend is required to be paid. No cash or non-cash dividend or distribution on the Common Stock in respect of which a Participating Dividend is required shall be paid or set aside for payment on the Common Stock unless a Participation Dividend in respect of such dividend shall be have been paid. Nothing contained in this paragraph D shall obligate the Company to declare or pay any dividend or other distribution on the Common Stock or (except pursuant to paragraph A of this Article III or in connection with a dividend or distribution on the Common Stock as provided in this paragraph D) the Series B Preferred Stock. 2. If the Recapitalization is not consummated prior to June 30, 1999, the Dividend Rate shall be deemed to be 15% per annum during the period commencing on such date and ending on the date the Recapitalization is consummated. IV. LIQUIDATION PREFERENCE A. PRIOR TO THE RECAPITALIZATION. In the event of a liquidation, dissolution or winding up of the Corporation, whether voluntary or involuntary, occurring prior to the consummation of the Recapitalization, the holders of then-outstanding shares of Series B Preferred Stock shall be entitled to receive out of the assets of the Corporation, whether such assets are capital or surplus of any nature, an amount per share equal to the sum of (i) the dividends, if any, accumulated or deemed to have accumulated thereon, to the date of final distribution to such holders, whether or not such dividends are declared; and (ii) the Initial Stated Value thereof, before any payment shall be made or any assets distributed to the holders of any Junior Liquidation Securities (the "Initial Preferred Distribution"). After the Initial Preferred Distribution has been made, the holders of Series B Preferred Stock shall be entitled to share pro rata with the holders of Common Stock in the distribution of any remaining assets of the Corporation on the basis of each whole outstanding share of the Series B Preferred Stock receiving an amount equal to the Formula Number then in effect times such distribution on each share of the Common Stock. The distributions on the Series B Preferred Stock pursuant to the immediately preceding sentence of this paragraph A are hereinafter referred to as "Participating Liquidation Distributions." No distribution on the Common Stock in respect of which a Participating Liquidation Distribution is required shall be paid or set aside for payment on the Common Stock unless a Participating Liquidation Distribution in respect of such distribution is concurrently paid. 4 9 B. AFTER THE RECAPITALIZATION. Subsequent to the consummation of the Recapitalization, the holders of the outstanding shares of Series B Preferred Stock shall be entitled to receive out of the assets of the Corporation, whether such assets are capital or surplus of any nature, an amount per share equal to the sum of (i) the dividends, if any, accumulated or deemed to have accumulated thereon to the date of final distribution to such holders, whether or not such dividends are declared; and (ii) the Post-Recapitalization Stated Value thereof, before any payment shall be made or any assets distributed to the holders of any Junior Liquidation Securities. After any such payment in full after the consummation of the Recapitalization, the holders of Series B Preferred Stock shall not, as such, be entitled to any further participation in any distribution of assets of the Corporation. C. PARITY SECURITIES. All the assets of the Corporation available for distribution to stockholders after the liquidation preferences of any Senior Liquidation Securities shall be distributed ratably (in proportion to the full distributable amounts to which holders of Series B Preferred Stock and Parity Liquidation Securities, if any, are respectively entitled upon such dissolution, liquidation or winding up) among the holders of the then-outstanding shares of Series B Preferred Stock and Parity Liquidation Securities, if any, when such assets are not sufficient to pay in full the aggregate amounts payable thereon. D. MERGER NOT A LIQUIDATION. Neither a consolidation or merger of the Corporation with or into any other Person or Persons, nor a sale, conveyance, lease, exchange or transfer of all or part of the Corporation's assets for cash, securities or other property to a Person or Persons shall be deemed to be a liquidation, dissolution or winding up of the Corporation for purposes of this Article IV, but the holders of shares of Series B Preferred Stock shall nevertheless be entitled from and after any such consolidation, merger or sale, conveyance, lease, exchange or transfer of all or part of the Corporation's assets to the rights provided by this Article IV following any such transaction. Notice of any voluntary or involuntary liquidation, dissolution or winding up of the Corporation, stating the payment date or dates when, and the place or places where, the amounts distributable to each holder of shares of Series B Preferred Stock in such circumstances shall be payable, shall be given by first-class mail, postage prepaid, mailed not less than 30 days prior to any payment date stated therein, to holders of record as they appear on the stock record books of the Corporation as of the date such notices are first mailed. V. REDEMPTION A. INTENTIONALLY OMITTED B. OPTIONAL REDEMPTION. Commencing on the earlier to occur of (x) the tenth anniversary of the Issue Date and (y) the date on which fewer than 25% of the shares of Series B Preferred Stock issued on the Issue Date remain outstanding, and at all times thereafter, the Corporation may, at its option, redeem all (but not less than all) outstanding shares of Series B Preferred Stock on a date specified by the Corporation (the "Optional Redemption Date") by paying the Redemption Price therefor in cash out of funds legally available for such purpose. C. NOTICE AND REDEMPTION PROCEDURES. Notice of the redemption of shares of Series B Preferred Stock pursuant to paragraph B of this Article V (a "Notice of Redemption") 5 10 shall be sent to the holders of record of the shares of Series B Preferred Stock to be redeemed by first class mail, postage prepaid, at each such holder's address as it appears on the stock record books of the Corporation not more than 120 nor fewer than 90 days prior to the Optional Redemption Date, which date shall be set forth in such notice (the "Redemption Date"); provided that failure to give such Notice of Redemption to any holder, or any defect in such Notice of Redemption to any holder shall not affect the validity of the proceedings for the redemption of any shares of Series B Preferred Stock held by any other holder. In order to facilitate the redemption of shares of Series B Preferred Stock, the Board of Directors may fix a record date for the determination of the holders of shares of Series B Preferred Stock to be redeemed not more than 30 days prior to the date the Notice of Redemption is mailed. On or after the Optional Redemption Date, each holder of the shares called for redemption shall surrender the certificate evidencing such shares to the Corporation at the place designated in such notice and shall thereupon be entitled to receive payment of the Redemption Price for such shares. From and after the Optional Redemption Date, all dividends on shares of Series B Preferred Stock shall cease to accumulate and all rights of the holders thereof as holders of Series B Preferred Stock shall cease and terminate, except to the extent the Corporation shall default in payment thereof on the Optional Redemption Date. D. DEPOSIT OF FUNDS. The Corporation shall, on or prior to the Optional Redemption Date, pursuant to paragraph C of this Article V, deposit with its transfer agent or other redemption agent in the Borough of Manhattan, The City of New York having a capital and surplus of at least $500,000,000 selected by the Board of Directors, as a trust fund for the benefit of the holders of the shares of Series B Preferred Stock to be redeemed, cash that is sufficient in amount to redeem the shares to be redeemed in accordance with the Notice of Redemption, with irrevocable instructions and authority to such transfer agent or other redemption agent to pay to the respective holders of such shares, as evidenced by a list of such holders certified by an officer of the Corporation, the Redemption Price for such shares upon surrender of their respective share certificates. Such deposit shall be deemed to constitute full payment of the Redemption Price for such shares to the holders, and from and after the date of such deposit, all rights of the holders of the shares of Series B Preferred Stock that are to be redeemed as stockholders of the Corporation with respect to such shares, except the right to receive the Redemption Price upon the surrender of their respective certificates, shall cease and terminate. No dividends shall accumulate on any shares of Series B Preferred Stock after the Optional Redemption Date for such shares (unless the Corporation shall fail to deposit cash sufficient to redeem all such shares). In case holders of any shares of Series B Preferred Stock called for redemption shall not, within two years after such deposit, claim the cash deposited for redemption thereof, such transfer agent or other redemption agent shall, upon demand, pay over to the Corporation the balance so deposited. Thereupon, such transfer agent or other redemption agent shall be relieved of all responsibility to the holders thereof and the sole right of such holders, with respect to shares to be redeemed, shall be to receive the Redemption Price as general creditors of the Corporation. Any interest accrued on any funds so deposited shall belong to the Corporation, and shall be paid to it from time to time on demand. 6 11 VI. RESTRICTIONS ON DIVIDENDS So long as any shares of the Series B Preferred Stock are outstanding, the Board of Directors shall not declare, and the Corporation shall not pay or set apart for payment any dividend on any Junior Securities or make any payment on account of, or set apart for payment money for a sinking or other similar fund for, the repurchase, redemption or other retirement of, any Junior Securities or Parity Securities or any warrants, rights or options exercisable for or convertible into any Junior Securities or Parity Securities (other than the repurchase, redemption or other retirement of debentures or other debt securities that are convertible or exchangeable into any Junior Securities or Parity Securities), or make any distribution in respect of the Junior Securities, either directly or indirectly, and whether in cash, obligations or shares of the Corporation or other property (other than distributions or dividends in Junior Securities to the holders of Junior Securities), and shall not permit any corporation or other entity directly or indirectly controlled by the Corporation to purchase or redeem any Junior Securities or Parity Securities or any warrants, rights, calls or options exercisable for or convertible into any Junior Securities or Parity Securities (other than the repurchase, redemption or other retirement of debentures or other debt securities that are convertible or exchangeable into any Junior Securities or Parity Securities or the repurchase, redemption or other retirement of Junior Securities or Parity Securities in exchange for Junior Securities or Parity Securities) unless prior to or concurrently with such declaration, payment, setting apart for payment, repurchase, redemption or other retirement or distribution, as the case may be, all accumulated and unpaid dividends on shares of the Series B Preferred Stock not paid on the dates provided for in paragraph A of Article III hereof (including Arrearages and accumulated dividends thereon) shall have been paid, except that when dividends are not paid in full as aforesaid upon the shares of Series B Preferred Stock, all dividends declared on the Series B Preferred Stock and any series of Parity Dividend Securities shall be declared and paid pro rata so that the amount of dividends so declared and paid on Series B Preferred Stock and such series of Parity Dividend Securities shall in all cases bear to each other the same ratio that accumulated dividends (including interest accrued on or additional dividends accumulated in respect of such accumulated dividends) on the shares of Series B Preferred Stock and such Parity Dividend Securities bear to each other. VII. VOTING RIGHTS A. On or prior to the consummation of the Recapitalization, the holders of Series B Preferred Stock shall be entitled to one thousand (1,000) votes per share of Series B Preferred Stock at each meeting of stockholders of the Corporation with respect to any and all matters presented to the stockholders of the Corporation for their action and consideration. After the consummation of the Recapitalization, the holders of Series B Preferred Stock shall be entitled to the number of votes per share of Series B Preferred Stock equal to the number of shares of Common Stock for which such share of Series B Preferred Stock is then convertible pursuant to Article VIII at each meeting of stockholders of the Corporation with respect to any and all matters presented to the stockholders of the Corporation for their action and consideration. 7 12 B. So long as any shares of the Series B Preferred Stock are outstanding, (i) each share of Series B Preferred Stock shall entitle the holder thereof to vote on all matters voted on by holders of Common Stock; and (ii) the shares of Series B Preferred Stock shall vote together with shares of Common Stock (and any shares of Series C Preferred Stock entitled to vote) as a single class. C. At each annual meeting of the stockholders of the Corporation, the holders of Series B Preferred Stock, voting as a separate class, shall have the right to elect, by the written consent (if action by written consent is permitted) or affirmative vote of the holders of a majority of the outstanding shares of Series B Preferred Stock, four members of a separate class of directors, each of whom shall serve until the next annual meeting of the stockholders of the Corporation or until his or her successor is elected and qualified. Such vote or consent shall be taken in accordance with the procedures specified in paragraph F below. The initial directors shall be Steven M. Gluckstern, Adam M. Mizel, Mani Sadeghi and David Spuria. D. Without the written consent (if action by written consent is permitted) or affirmative vote of the holders of a majority of the outstanding shares of Series B Preferred Stock and Series C Preferred Stock, voting together as a single class, the Corporation shall not (i) authorize, create or issue, or increase the authorized amount of, (x) any Senior Securities or Parity Securities or (y) any class or series of capital stock or any security convertible into or exercisable for any class or series of capital stock, redeemable mandatorily or redeemable at the option of the holder thereof or (ii) enter into any Transaction (as defined in paragraph H of Article VIII). Such vote or consent shall be taken in accordance with the procedures specified in paragraph F below. E. Without the written consent (if action by written consent is permitted) or affirmative vote of the holders of at least a majority of the outstanding shares of Series B Preferred Stock and Series C Preferred Stock, voting together as a single class, the Corporation shall not (i) amend, alter or repeal any provision of the Certificate of Incorporation or the Bylaws, if the amendment, alteration or repeal alters or changes the powers, preferences or special rights of the Series B Preferred Stock so as to affect them materially and adversely or (ii) authorize or take any other action if such action alters or changes any of the rights of the Series B Preferred Stock in any respect or otherwise would be inconsistent with the provisions of this Certificate of Designations and the holders of any class or series of the capital stock of the Corporation is entitled to vote thereon. Such vote or consent shall be taken in accordance with the procedures specified in paragraph F below. F. The foregoing rights of holders of shares of Series B Preferred Stock to take any actions as provided in this Article VII may be exercised at any annual meeting of stockholders or at a special meeting of stockholders held for such purpose as hereinafter provided or at any adjournment thereof, or by the written consent, delivered to the Secretary of the Corporation, of the holders of the minimum number of shares required to take such action, if action by written consent of stockholders of the Corporation is then permitted. 8 13 The Chairman of the Board of the Corporation may call, and upon written request of holders of record of 35% of the outstanding shares of Series B Preferred Stock, if the holders of Series B Preferred Stock are to vote separately as a single class, or the holders of record of 35% of the outstanding shares of Series B Preferred Stock and Series C Preferred Stock, if the holders of shares of Series B Preferred Stock are to vote as a class with the holders of shares of any Series C Preferred Stock, addressed to the Secretary of the Corporation at the principal office of the Corporation shall call, a special meeting of the holders of shares entitled to vote as provided herein. Such meeting shall be held within 30 days after delivery of such request to the Secretary, at the place and upon the notice provided by law and in the By-laws of the Corporation for the holding of meetings of stockholders. At each meeting of stockholders at which the holders of shares of Series B Preferred Stock shall have the right, voting separately as a single class or as a class with the holders of shares of any Series C Preferred Stock, to elect directors of the Corporation as provided in paragraph C above or to take any action, the presence in person or by proxy of the holders of record of one-third of the total number of shares of Series B Preferred Stock, if the holders of shares of Series B Preferred Stock are to vote separately as a single class, or the holders of record of one-third of the total number of shares of Series B Preferred Stock and Series C Preferred Stock, if the holder of shares of Series B Preferred Stock are to vote as a class with the holders of shares of Series C Preferred Stock, then outstanding and entitled to vote on the matter shall be necessary and sufficient to constitute a quorum. At any such meeting or at any adjournment thereof: (A) the absence of a quorum of the holders of shares of Series B Preferred Stock, if the holders of Series B Preferred Stock are to vote separately as a single class, shall not prevent the election of directors other than those to be elected by the holders of shares of Series B Preferred Stock, and the absence of a quorum of the holders of shares of any other class or series of capital stock shall not prevent the election of directors to be elected by the holders of shares of Series B Preferred Stock or the taking of any action as provided in this Article VII; and (B) in the absence of a quorum of the holders of shares of Series B Preferred Stock, if the holders of Series B Preferred Stock are to vote separately as a single class, or the holders of shares of Series B Preferred Stock and Series C Preferred Stock, if the holders of Series B Preferred Stock are to vote as a class with the holders of shares of Series C Preferred Stock, a majority of the holders of such shares present in person or by proxy shall have the power to adjourn the meeting as to the actions to be taken by the holders of shares of Series B Preferred Stock or the holders of Series B Preferred Stock and Series C Preferred Stock, as the case may be, from time to time and place to place without notice other than announcement at the meeting until a quorum shall be present. For taking of any action as provided in this Article VII by the holders of shares of Series B Preferred Stock voting separately as a single class or together with the holders of shares of Series B Preferred Stock and Series C Preferred Stock as a single class, as the case may be, each such holder shall have one vote for each share of such stock standing in his name on the 9 14 transfer books of the Corporation as of any record dated fixed for such purpose or, if no such date be fixed, at the close of business on the Business Day next preceding the day on which notice is given, or if notice if waived, at the close of business on the Business Day next preceding the day on which the meeting is held. In case any vacancy shall occur among the directors elected by the holders of shares of Series B Preferred Stock, as provided in paragraph C above, such vacancy may be filled for the unexpired portion of the term by vote of the remaining directors theretofore elected by such holders (if there is a remaining director), or the last remaining director's successor in office. If any such vacancy is not so filled within 20 days after the creation thereof or if all directors so elected by the holders of Series B Preferred Stock shall cease to serve as directors before their terms shall expire, the holders of the Series B Preferred Stock then outstanding and entitled to vote for such directors may, by written consent as herein provided (if action by written consent is permitted), or at a special meeting of such holders called as provided herein, elect successors to hold office for the unexpired terms of the directors whose places shall be vacant. Any director elected by the holders of shares of Series B Preferred Stock voting separately as a single class may be removed from office with or without cause by the vote or written consent (if action by written consent is permitted) of the holders of at least a majority of the outstanding shares of Series B Preferred Stock. A special meeting of the holders of shares of Series B Preferred Stock may be called in accordance with the procedures set forth in this paragraph F. G. The Corporation shall not enter into any agreement or issue any security that prohibits, conflicts or is inconsistent with, or would be breached by, the Corporation's performance of its obligations hereunder. VIII. CONVERSION The holders of the Series B Preferred Stock shall have conversion rights as follows: A. Each share of Series B Preferred Stock shall be convertible at the direction of, and by notice to the Corporation from, the holders of a majority of the outstanding shares of Series B Preferred Stock, at any time, at the office of the Corporation or any transfer agent for such Series, into one thousand (1,000) fully paid and nonassessable shares of Common Stock subject (x) to adjustment from time to time as provided below (as so adjusted, the "conversion ratio") and (y) (prior to the consummation of the Recapitalization) to limitations resulting from the available number of shares of Common Stock which may be reserved for issuance upon such conversion, provided ,that any conversion pursuant to this paragraph A of less than all of the outstanding shares of Series B Preferred Stock shall be on a pro rata basis amongst all holders of Series B Preferred Stock. After consummation of the Recapitalization, the number "1,000" in this paragraph shall be "1", subject to adjustment as provided in paragraph VIII.G. 10 15 B. If the holders of a majority of the outstanding shares of Series B Preferred Stock give notice of conversion under paragraph A above, the Corporation shall notify all other record holders of Series B Preferred Stock (a "Conversion Notice"). Following receipt of a Conversion Notice, the holders of Series B Preferred Stock shall surrender the certificate or certificates therefor duly endorsed, at the office of the Corporation or of any transfer agent for such Series, and shall state therein the name or names in which the certificate or certificates for shares of Common Stock are to be issued. The Corporation shall, as soon as practicable thereafter, issue and deliver at such office to such holder, or to the nominee or nominees of such holder, a certificate or certificates for the number of shares of Common Stock to which such holder shall be entitled as aforesaid. Such conversion shall be deemed to have been made immediately prior to the close of business on the date of such Conversion Notice and the person or persons entitled to receive the shares of Common Stock issuable upon such conversion shall be treated for all purposes as the recordholder or holders of such shares of Common Stock as of such date. The issuance of certificates or shares of Common Stock upon conversion of shares of Series B Preferred Stock shall be made without charge for any issue, stamp or other similar tax in respect of such issuance. C. No fractional shares shall be issued upon conversion of any shares of Series B Preferred Stock and the number of shares of Common Stock to be issued shall be rounded down to the nearest whole share, and the holder of Series B Preferred Stock shall be paid in cash for any fractional share. D. In case at any time or from time to time the Corporation shall pay any dividend or make any other distribution to the holders of its Common Stock or other class of securities, or shall offer for subscription pro rata to the holders of its Common Stock or other class of securities any additional shares of stock of any class or any other right, or there shall be any capital reorganization or reclassification of the Common Stock of the Corporation or consolidation or merger of the Corporation with or into another corporation, or any sale or conveyance to another corporation of the property of the Corporation as an entirety or substantially as an entirety, or there shall be a voluntary or involuntary dissolution, liquidation or winding up of the Corporation, then, in any one or more of said cases the Corporation shall give at least 20 days' prior written notice (the time of mailing of such notice shall be deemed to be the time of giving thereof) to the registered holders of the Series B Preferred Stock at the addresses of each as shown on the books of the Corporation maintained by the Transfer Agent thereof of the date on which (i) the books of the Corporation shall close or a record shall be taken for such stock dividend, distribution or subscription rights or (ii) such reorganization, reclassification, consolidation, merger, sale or conveyance, dissolution, liquidation or winding up shall take place, as the case may be, provided that in the case of any Transaction to which paragraph H applies the Corporation shall give at least 30 days' prior written notice as aforesaid. Such notice shall also specify the date as of which the holders of the Common Stock of record shall participate in said dividend, 11 16 distribution or subscription rights or shall be entitled to exchange their Common Stock for securities or other property deliverable upon such reorganization, reclassification, consolidation, merger, sale or conveyance or participate in such dissolution, liquidation or winding up, as the case may be. Failure to give such notice shall not invalidate any action so taken. E. From and after the Recapitalization, the Corporation shall at all times reserve and keep available out of its authorized but unissued shares of Common Stock, solely for the purpose of effecting the conversion of the shares of Series B Preferred Stock, such number of its shares of Common Stock as shall from time to time be sufficient to effect the conversion of all outstanding shares of Series B Preferred Stock, and if at any time the number of authorized but unissued shares of Common Stock shall not be sufficient to effect the conversion of all then outstanding shares of Series B Preferred Stock, then in addition to such other remedies as shall be available to the holder of Series B Preferred Stock, the Corporation will take such corporate action as may, in the opinion of its counsel, be necessary to increase its authorized but unissued shares of Common Stock to such number of shares as shall be sufficient for such purposes. F. Any notice required by the provisions of paragraph D to be given the holders of shares of Series B Preferred Stock shall be deemed given if sent by facsimile transmission, by telex, or if deposited in the United States mail, postage prepaid, and addressed to each holder of record at his, her or its address appearing on the books of the Corporation. G. The conversion ratio shall be subject to adjustment from time to time as follows: (i) In case the Corporation shall at any time or from time to time after the Issue Date (A) pay a dividend or make a distribution, on the outstanding shares of Common Stock in shares of Common Stock, (B) subdivide the outstanding shares of Common Stock into a larger number of shares of Common Stock, (C) combine the outstanding shares of Common Stock into a smaller number of shares or (D) issue by reclassification of the shares of Common Stock any shares of capital stock of the Corporation, then, and in each such case, the conversion ratio in effect immediately prior to such event or the record date therefor, whichever is earlier, shall be adjusted so that the holder of any shares of Series B Preferred Stock thereafter surrendered for conversion shall be entitled to receive the number of shares of Common Stock or other securities of the Corporation which such holder would have owned or have been entitled to receive after the happening of any of the events described above, had such shares of Series B Preferred Stock been surrendered for conversion immediately prior to the happening of such event or the record date therefor, whichever is earlier. An adjustment made pursuant to this clause (i) shall become effective (x) in the case of any such dividend or distribution, immediately after the close of business on the record date for the determination of holders of shares of Common Stock 12 17 entitled to receive such dividend or distribution, or (y) in the case of any such subdivision, reclassification or combination, at the close of business on the day upon which such corporate action becomes effective. (ii) In the case the Corporation shall, after the Issue Date, issue shares of Common Stock at a price per share, or securities convertible into or exchangeable for shares of Common Stock ("Convertible Securities") having a "Conversion Price" (as defined below) less than the Current Market Price (for a period of 15 consecutive trading days prior to such date), then, and in each such case, the conversion ratio shall be adjusted so that the holder of each share of Series B Preferred Stock shall be entitled to receive, upon the conversion thereof, the number of shares of Common Stock determined by multiplying (A) the applicable conversion ratio on the day immediately prior to such date by (B) a fraction, the numerator of which shall be the sum of (1) the number of shares of Common Stock outstanding on the date on which such shares or Convertible Securities are issued and (2) the number of additional shares of Common Stock issued, or into which the Convertible Securities may convert, and the denominator of which shall be the sum of (x) the number of shares of Common Stock outstanding on such date and (y) the number of shares of Common Stock which the aggregate consideration receivable by the Corporation for the total number of shares of Common Stock so issued, or the number of shares of Common Stock which the aggregate of the Conversion Price of such Convertible Securities so issued, would purchase at such Current Market price on such date. An adjustment made pursuant to this clause (ii) shall be made on the next Business Day following the date on which any such issuance is made and shall be effective retroactively immediately after the close of business on such date. For purposes of this clause (ii), the aggregate consideration receivable by the Corporation in connection with the issuance of any securities shall be deemed to be the sum of the aggregate offering price to the public (before deduction of underwriting discounts or commissions and expenses payable to third parties), and the "Conversion Price" of any Convertible Securities is the total amount received or receivable by the Corporation as consideration for the issue or sale of such Convertible Securities (before deduction of underwriting discounts or commissions and expenses payable to third parties) plus the minimum aggregate amount of additional consideration, if any, payable to the Corporation upon the conversion, exchange or exercise of any such Convertible Securities. Neither (A) the issuance of any shares of Common Stock (whether treasury shares or newly issued shares) pursuant to a dividend or distribution on, or subdivision, combination or reclassification of, the outstanding shares of Common Stock requiring an adjustment in the conversion ratio pursuant to clause (i) of this paragraph G, or pursuant to any employee benefit plan or program of the Corporation or pursuant to any option, warrant, right, or Convertible Security outstanding as of the date hereof (including, but not limited to, the Rights, the Series B Preferred Stock, the Series C Preferred Stock and the Warrants) nor (B) the issuance of shares of Common Stock pursuant thereto shall be deemed to 13 18 constitute an issuance of Common Stock or Convertible Securities by the Corporation to which this clause (ii) applies. Upon expiration of any Convertible Securities which shall not have been exercised or converted and for which an adjustment shall have been made pursuant to this clause (ii), the Conversion Price computed upon the original issue thereof shall upon expiration be recomputed as if the only additional shares of Common Stock issued were such shares of Common Stock (if any) actually issued upon exercise or conversion of such Convertible Securities and the consideration received therefor was the consideration actually received by the Corporation for the issue of such Convertible Securities (whether or not exercised or converted) plus the consideration actually received by the Corporation upon such exercise of conversion. (iii) In case the Corporation shall at any time or from time to time after the Issue Date declare, order, pay or make a dividend or other distribution (including, without limitation, any distribution of stock or other securities or property or rights or warrants to subscribe for securities of the Corporation or any of its Subsidiaries by way of dividend or spin-off), on its Common Stock, other than (A) regular quarterly dividends payable in cash in an aggregate amount not to exceed 15% of net income from continuing operations before extraordinary items of the Corporation, determined in accordance with generally accepted accounting principles, during the period (treated as one accounting period) commencing on July 1, 1998, and ending on the date such dividend is paid or (B) dividends or distributions of shares of Common Stock which are referred to in clause (i) of this paragraph G, then, and in each such case, the conversion ratio shall be adjusted so that the holder of each share of Series B Preferred Stock shall be entitled to receive, upon the conversion thereof, the number of shares of Common Stock determined by multiplying (1) the applicable conversion ratio on the day immediately prior to the record date fixed for the determination of stockholders entitled to receive such dividend or distribution by (2) a fraction, the numerator of which shall be the then Current Market Price per share of Common Stock for the period of 20 Trading Days preceding such record date, and the denominator of which shall be such Current Market Price per share of Common Stock for the period of 20 Trading Days preceding such record date, less the Fair Market Value (as defined in Article IX) per share of Common Stock (as determined in good faith by the Board of Directors of the Corporation, a certified resolution with respect to which shall be mailed to each holder of shares of Series B Preferred Stock) of such dividend or distribution; provided, however, that in the event of a distribution of shares of capital stock of a Subsidiary of the Corporation (a "Spin-Off") made to holders of shares of Common Stock, the numerator of such fraction shall be the sum of the Current Market Price per share of Common Stock for the period of 20 Trading Days preceding the 35th Trading Day after the effective date of such Spin-Off and the Current Market Price of the number of shares (or the fraction of a share) of capital stock of the Subsidiary which is 14 19 distributed in such Spin-Off in respect of one share of Common Stock for the period of 20 Trading Days preceding such 35th Trading Day and the denominator of which shall be the current market price per share of the Common Stock for the period of 20 Trading Days proceeding such 35th Trading Day. An adjustment made pursuant to this clause (iii) shall be made upon the opening of business on the next Business Day following the date on which any such dividend or distribution is made and shall be effective retroactively immediately after the close of business on the record date fixed for the determination of stockholders entitled to receive such dividend or distribution; provided, however, if the proviso to the preceding sentence applies, then such adjustment shall be made and be effective as of such 35th Trading Day after the effective date of such Spin-Off. (iv) For purposes of this paragraph G, the number of shares of Common Stock at any time outstanding shall not include any shares of Common Stock then owned or held by or for the account of the Corporation. (v) The term "dividend", as used in this paragraph G shall mean a dividend or other distribution upon stock of the Corporation except pursuant to the Rights Agreement (as defined in Article IX). Notwithstanding anything in this Article VIII to the contrary, the conversion ratio shall not be adjusted as a result of any dividend, distribution or issuance of securities of the Corporation pursuant to the Rights Agreement. (vi) Anything in this paragraph G to the contrary notwithstanding, the Corporation shall not be required to give effect to any adjustment in the conversion ratio unless and until the net effect of one or more adjustments (each of which shall be carried forward), determined as above provided, shall have resulted in a change of the conversion ratio by at least one-hundredth of one share of Common Stock, and when the cumulative net effect of more than one adjustment so determined shall be to change the conversion ratio by at least one-hundredth of one share of Common Stock, such change in conversion ratio shall thereupon be given effect. (vii) The certificate of any firm of independent public accountants of recognized standing selected by the Board of Directors of the Corporation (which may be the firm of independent public accountants regularly employed by the Corporation) shall be presumptively correct for any computation made under this paragraph G. (viii) If the Corporation shall take a record of the holders of its Common Stock for the purpose of entitling them to receive a dividend or other distribution, and shall thereafter and before the distribution to stockholders thereof legally abandon its plan to pay or deliver such dividend or distribution, then thereafter no adjustment in the number of shares of Common Stock issuable upon exercise of 15 20 the right of conversion granted by this paragraph G or in the conversion ratio then in effect shall be required by reason of the taking of such record. (ix) There shall be no adjustment of the conversion ratio in case of the issuance of any stock of the Corporation in a merger, reorganization, acquisition or other similar transaction except as set forth in paragraph G(i), G(ii) and H of this Article VIII. H. In case of any reorganization or reclassification of outstanding shares of Common Stock (other than a reclassification covered by paragraph G(i) of this Article VIII, or in case of any consolidation or merger of the Corporation with or into another corporation, or in the case of any sale or conveyance to another corporation of the property of the Corporation as an entirety or substantially as an entirety (each of the foregoing being referred to as a "Transaction"), each share of Series B Preferred Stock then outstanding shall thereafter be convertible into, in lieu of the Common Stock issuable upon such conversion prior to consummation of such Transaction, the kind and amount of shares of stock and other securities and property receivable (including cash) upon the consummation of such Transaction by a holder of that number of shares of Common Stock into which one share of Series B Preferred Stock was convertible immediately prior to such Transaction (including, on a pro rata basis, the cash, securities or property received by holders of Common Stock in any tender or exchange offer that is a step in such Transaction). In case securities or property other than Common Stock shall be issuable or deliverable upon conversion as aforesaid, then all reference in this paragraph H shall be deemed to apply, so far as appropriate and as nearly as may be, to such other securities or property. I. Upon any adjustment of the conversion ratio then in effect and any increase or decrease in the number of shares of Common Stock issuable upon the operation of the conversion set forth in Article VIII, then, and in each such case, the Corporation shall promptly deliver to the registered holders of the Series B Preferred and Common Stock, a certificate signed by the President or a Vice President and by the Treasurer or an Assistant Treasurer or the Secretary or an Assistant Secretary of the Corporation setting forth in reasonable detail the event requiring the adjustment and the method by which such adjustment was calculated and specifying the conversion ratio then in effect following such adjustment and the increased or decreased number of shares issuable upon the conversion set forth in this Article VIII. IX. ADDITIONAL DEFINITIONS For the purposes of this Certificate of Designations of Series B Preferred Stock, the following terms shall have the meanings indicated: "Accrual Period" means the end of the first quarterly period following the Second Anniversary Date. 16 21 "Beneficially Own" with respect to any securities means having "beneficial ownership" of such securities (as determined pursuant to Rule 13d-3 under the Exchange Act as in effect on the date hereof, except that a Person shall be deemed to Beneficially Own all such securities that such Person has the right to acquire whether such right is exercisable immediately or after the passage of time). The terms "Beneficial Ownership" and "Beneficial Owner" have correlative meanings. "Business Day" means any day, other than a Saturday, Sunday or a day on which banking institutions in the State of New York are authorized or obligated by law or executive order to close. "Bylaws" means the Bylaws of the Corporation, as amended. "Current Market Price", when used with reference to shares of Common Stock or other securities on any date, shall mean the closing price per share of Common Stock or such other securities on such date and, when used with reference to shares of Common Stock or other securities for any period shall mean the average of the daily closing prices per share of Common Stock or such other securities for such period. The closing price for each day shall be the last sale price, regular way, or, in case no such sale takes place on such day, the average of the closing bid and asked prices, regular way, in either case as reported in the principal consolidated transaction reporting system with respect to securities listed or admitted to trading on the New York Stock Exchange or, if the Common Stock or such other securities are not listed or admitted to trading on the New York Stock Exchange, as reported in the principal consolidated transaction reporting system with respect to securities listed on the principal national securities exchange on which the Common Stock or such other securities are listed or admitted to trading or, if the Common Stock is not listed or admitted to trading on any national securities exchange, the last quoted sale price or, if not so quoted, the average of the high bid and low asked prices in the over-the-counter market, as reported by the National Association of Securities Dealers, Inc. National Market System or such other securities are not quoted by any such organization, the average of the closing bid and asked prices as furnished by a professional market maker making a market in the Common Stock or such other securities selected by the Board of Directors of the Corporation. If the Common Stock or such other securities are not publicly held or so listed or publicly traded, "Current Market Price" shall mean the Fair Market Value per share of Common Stock or of such other securities as determined in good faith by the Board of Directors of the Corporation based on an opinion of an independent investment banking firm with an established national reputation as a valuer of securities, which opinion may be based on such assumption as such firm shall deem to be necessary and appropriate. "Equity Securities" of any Person means any and all common stock, preferred stock and any other class of capital stock of, and any partnership or limited liability company interests of such Person or any other similar interests of any Person that is not a corporation, partnership or limited liability company. "Exchange Act" means the U.S. Securities Exchange Act of 1934, as amended, and the rules and regulations promulgated thereunder, from time to time. 17 22 "Fair Market Value" shall mean the amount which a willing buyer would pay a willing seller in an arm's-length transaction. "Formula Number" shall mean one thousand (1,000) prior to consummation of the Recapitalization, provided, however, that if at any time prior to the consummation of the Recapitalization, the Corporation shall (i) declare or pay any dividend or make any distribution on the Common Stock, payable in shares of Common Stock; (ii) subdivide (by a stock split or otherwise) the outstanding shares of Common Stock into a larger number of shares of Common Stock; or (iii) combine (by a reverse stock split or otherwise) the outstanding shares of Common Stock into a smaller number of shares of Common Stock, then in each such case the Formula Number in effect immediately prior to such event shall be adjusted to a number determined by multiplying the Formula Number then in effect by a fraction, the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event (and rounding the result to the nearest whole number); and provided further, that, if prior to the consummation of the Recapitalization the Corporation shall issue any shares of its capital stock in a merger, reclassification, or change of the outstanding shares of Common Stock, then in each such event the Formula Number shall be appropriately adjusted to reflect such merger, reclassification, or change so that each share of Series B Preferred Stock continues to be the economic equivalent of a Formula Number of shares of Common Stock immediately prior to such merger, reclassification, or change. "Group" has the meaning set forth in Rule 13d-5 under the Exchange Act. "Issue Date" shall mean the first date on which shares of Series B Preferred Stock are issued. "Person" means any individual, corporation, company, association, partnership, joint venture, trust or unincorporated organization, or a government or any agency or political subdivision thereof. "Post-Recapitalization Stated Value" shall be equal to $1.00. "Recapitalization" means the amendment of the Corporation's Certificate of Incorporation to increase the authorized shares of Common Stock from 50,000,000 to 400,000,000, and the authorized shares of Preferred Stock from 1,000,000 to 200,000,000, and the subsequent one thousand-for-one split of Series B Preferred Stock and Series C Preferred Stock. "Redemption Price" of a share of Class B Preferred Stock shall mean the sum of (a) the dividends, if any, accumulated or deemed to have accumulated thereon to the Optional Redemption Date, whether or not such dividends are declared plus (b) either (i) the Initial Stated Value thereof (if the Recapitalization has not been consummated prior to June 30, 1999) or (ii) the Post-Recapitalization Stated Value thereof (if the Recapitalization has been consummated prior to June 30, 1999), in each case subject to adjustment for splits, reclassifications, recombinations or other similar events. 18 23 "Rights" shall mean any rights to purchase securities of the Corporation issued pursuant to any Rights Agreement. "Rights Agreement" shall mean the Rights Agreement, dated as of June 21, 1996, between the Company and Wells Fargo Bank as rights agent, and all amendments, supplements and replacements thereof. "Second Anniversary Date" means the second anniversary of the Issue Date. "Subsidiary" means, as to any Person, any other Person of which more than 50% of the shares of the Voting Securities or other voting interests are owned or controlled, or the ability to select or elect 50% or more of the directors or similar managers is held, directly or indirectly, by such first Person and one or more of its Subsidiaries. "Trading Day" means a day on which the principal national securities exchange on which the Common Stock is listed or admitted to trading is open for the transaction of business or, if the Common Stock is not listed or admitted to trading on any national securities exchange a Business Day. "Voting Securities" means, (i) with respect to the Company, the Equity Securities of the Company entitled to vote generally for the election of directors of the Company, and (ii) with respect to any other Person, any securities of or interests in such Person entitled to vote generally for the election of directors or any similar managing person of such Person. X. MISCELLANEOUS A. NOTICES. Any notice referred to herein shall be in writing and, unless first-class mail shall be specifically permitted for such notices under the terms hereof, shall be deemed to have been given upon personal delivery thereof, upon transmittal of such notice by telecopy (with confirmation of receipt by telecopy or telex) or five days after transmittal by registered or certified mail, postage prepaid, addressed as follows: (i) if to the Corporation, to its office at 2 California Plaza, 350 South Grand Avenue, Los Angeles, California 90071 (Attention: General Counsel) or to the transfer agent for the Series B Preferred Stock; (ii) if to a holder of the Series B Preferred Stock, to such holder at the address of such holder as listed in the stock record books of the Corporation (which may include the records of any transfer agent for the Series B Preferred Stock); or (iii) to such other address as the Corporation or such holder, as the case may be, shall have designated by notice similarly given. 19 24 B. REACQUIRED SHARES. Any shares of Series B Preferred Stock redeemed, purchased or otherwise acquired by the Corporation, directly or indirectly, in any manner whatsoever shall be retired and canceled promptly after the acquisition thereof (and shall not be deemed to be outstanding for any purpose) and, if necessary to provide for the lawful redemption or purchase of such shares, the capital represented by such shares shall be reduced in accordance with the Delaware General Corporation Law. All such shares of Series B Preferred Stock shall upon their cancellation and upon the filing of an appropriate certificate with the Secretary of State of the State of Delaware, become authorized but unissued shares of Preferred Stock, par value $0.001 per share, of the Corporation and may be reissued as part of another series of Preferred Stock, par value $0.001 per share, of the Corporation subject to the conditions or restrictions on issuance set forth herein. C. ENFORCEMENT. Any registered holder of shares of Series B Preferred Stock may proceed to protect and enforce its rights and the rights of such holders by any available remedy by proceeding at law or in equity to protect and enforce any such rights, whether for the specific enforcement of any provision in this Certificate of Designations or in aid of the exercise of any power granted herein, or to enforce any other proper remedy. D. TRANSFER TAXES. Except as otherwise agreed upon pursuant to the terms of this Certificate of Designations, the Corporation shall pay any and all documentary, stamp or similar issue or transfer taxes and other governmental charges that may be imposed under the laws of the United States of America or any political subdivision or taxing authority thereof or therein in respect of any issue or delivery of Common Stock on conversion of, or other securities or property issued on account of, shares of Series B Preferred Stock pursuant hereto or certificates representing such shares or securities. The Corporation shall not, however, be required to pay any such tax or other charge that may be imposed in connection with any transfer involved in the issue or transfer and delivery of any certificate for Common Stock or other securities or property in a name other than that in which the shares of Series B Preferred Stock so exchanged, or on account of which such securities were issued, were registered and no such issue or delivery shall be made unless and until the Person requesting such issue has paid to the Corporation the amount of any such tax or has established to the satisfaction of the Corporation that such tax has been paid or is not payable. E. TRANSFER AGENT. The Corporation may appoint, and from time to time discharge and change, a transfer agent for the Series B Preferred Stock. Upon any such appointment or discharge of a transfer agent, the Corporation shall send notice thereof by first-class mail, postage prepaid, to each holder of record of shares of Series B Preferred Stock. F. RECORD DATES. In the event that the Series B Preferred Stock shall be registered under either the Securities Act of 1933, as amended, or the Exchange Act, the Corporation shall establish appropriate record dates with respect to payments and other actions to be made with respect to the Series B Preferred Stock. 20 25 IN WITNESS WHEREOF, this Certificate of Designations is executed on behalf of the Corporation by its Executive vice President, General Counsel and Secretary and attested by its Assistant Secretary, this 10th day of February , 1999. AAMES FINANCIAL CORPORATION By: -------------------------------------- Name: Title: [Corporate Seal] ATTEST: - ----------------------------------- 21 26 EXHIBIT B - -------------------------------------------------------------------------------- CERTIFICATE OF THE VOTING POWERS, DESIGNATIONS, PREFERENCES AND RELATIVE, PARTICIPATING, OPTIONAL OR OTHER SPECIAL RIGHTS, AND QUALIFICATIONS, LIMITATIONS OR RESTRICTIONS THEREOF, OF SERIES C CONVERTIBLE PREFERRED STOCK OF AAMES FINANCIAL CORPORATION - -------------------------------------------------------------------------------- AAMES FINANCIAL CORPORATION, a corporation organized and existing under the General Corporation Law of the State of Delaware (the "Corporation"), hereby certifies that the following resolutions were adopted by the Board of Directors of the Corporation (the "Board of Directors") pursuant to authority of the Board of Directors as required by Section 151 of the Delaware General Corporation Law: RESOLVED, that pursuant to the authority granted to and vested in the Board of Directors in accordance with the provisions of the Certificate of Incorporation of the Corporation, as amended (the "Certificate of Incorporation"), the Board of Directors hereby creates a series of the Corporation's previously authorized preferred stock, par value $0.001 per share (the "Preferred Stock"), and hereby states the designation and number thereof, and fixes the voting powers, preferences and relative, participating, optional and other special rights, and the qualifications, limitations and restrictions thereof, as follows: SERIES C CONVERTIBLE PREFERRED STOCK: I. DESIGNATION AND AMOUNT The designation of this series of shares shall be "Series C Convertible Preferred Stock" (the "Series C Preferred Stock") par value $0.001 per share; the initial stated value per share shall be $1,000.00 (the "Initial Stated Value"); and the number of shares constituting such series shall be 100,000. The number of shares of the Series C Preferred Stock may be decreased from time to time by a resolution or resolutions of the Board of Directors; provided, however, that such number shall not be decreased below the aggregate number of shares of the Series C Preferred Stock then outstanding. II. RANK A. With respect to dividends, the Series C Preferred Stock shall rank (i) senior to each other class or series of Preferred Stock, except for the Series B Convertible Preferred Stock, par value $0.001 per share, of the Corporation (the "Series B Preferred Stock"); (ii) on a parity with the Series B Preferred Stock; and (iii) senior to the Corporation's Common Stock, par value $.001 per share (the "Common Stock"), and, except as specified above, all other classes and series of capital stock of the Corporation hereafter issued by the Corporation. With respect to dividends, all equity securities of the Corporation to which the Series C Preferred Stock ranks senior, including the Common Stock, are collectively referred to herein as the 27 "Junior Dividend Securities"; all equity securities of the Corporation with which the Series C Preferred Stock ranks on a parity, including the Series B Preferred Stock, are collectively referred to herein as the "Parity Dividend Securities"; and all equity securities of the Corporation (other than convertible debt securities) to which the Series C Preferred Stock ranks junior, with respect to dividends, are collectively referred to herein as the "Senior Dividend Securities." B. With respect to the distribution of assets upon liquidation, dissolution or winding up of the Corporation, whether voluntary or involuntary, the Series C Preferred Stock shall rank (i) senior to each other class or series of Preferred Stock, except for the Series B Preferred Stock; (ii) on a parity with the Series B Preferred Stock; and (iii) senior to the Common Stock, and, except as specified above, all other classes and series of capital stock of the Corporation hereafter issued by the Corporation. With respect to the distribution of assets upon liquidation, dissolution or winding up of the Corporation, whether voluntary or involuntary, all equity securities of the Corporation to which the Series C Preferred Stock ranks senior, including the Common Stock, are collectively referred to herein as "Junior Liquidation Securities"; all equity securities of the Corporation (other than convertible debt securities) to which the Series C Preferred Stock ranks on parity, including the Series B Preferred Stock, are collectively referred to herein as "Parity Liquidation Securities"; and all equity securities of the Corporation to which the Series C Preferred Stock ranks junior are collectively referred to herein as "Senior Liquidation Securities." C. The Series C Preferred Stock shall be subject to the creation of Junior Dividend Securities and Junior Liquidation Securities (collectively, "Junior Securities"), but no Parity Dividend Securities or Parity Liquidation Securities (collectively, "Parity Securities") (other than the Series B Preferred Stock) or Senior Dividend Securities or Senior Liquidation Securities (collectively, "Senior Securities") shall be created except in accordance with the terms hereof. III. DIVIDENDS A. DIVIDENDS. Subject to the terms of paragraph D below, shares of Series C Preferred Stock shall accumulate dividends at a rate of 6.5% per annum (the "Dividend Rate"), which dividends shall be paid quarterly in cash, in four equal quarterly installments on the last day of March, June, September and December of each year, or if any such date is not a Business Day, the Business Day next preceding such day (each such date, regardless of whether any dividends have been paid or declared and set aside for payment on such date, a "Dividend Payment Date"), to holders of record (the "Registered Holders") as they appear on the stock record books of the Corporation on the fifteenth day prior to the relevant Dividend Payment Date; provided, however, that during the Accrual Period (as defined in Article IX hereof) the Corporation shall have the option to accrue such dividends, which dividends, to the extent so accrued, shall compound quarterly. Prior to the consummation of the Recapitalization, dividends shall accrue and accumulate on the Initial Stated Value of each share of Series B Preferred Stock. Following the consummation of the Recapitalization, dividends shall accrue and accumulate on the Post-Recapitalization Stated Value of each share of Series B Preferred Stock. Dividends shall be paid only when, as and if declared by the Board of Directors out of funds at the time 2 28 legally available for the payment of dividends. Dividends shall begin to accumulate on outstanding shares of Series C Preferred Stock from the date of issuance and shall be deemed to accumulate from day to day whether or not earned or declared until paid. Dividends shall accumulate on the basis of a 360-day year consisting of twelve 30-day months (four 90-day quarters) and the actual number of days elapsed in the period for which payable. B. ACCUMULATION. Dividends on the Series C Preferred Stock shall be cumulative, and from and after (i) any Dividend Payment Date on which any dividend that has accumulated or been deemed to have accumulated through such date has not been paid in full (other than by reason of the election of the Corporation to accrue dividends during the Accrual Period); or (ii) any payment date set for a redemption on which such redemption payment has not been paid in full, additional dividends shall accumulate in respect of the amount of such unpaid dividends or unpaid redemption payment (the "Arrearage") at 125% of the stated dividend rate (or such lesser rate as may be the maximum rate that is then permitted by applicable law). Such additional dividends in respect of any Arrearage shall be deemed to accumulate from day to day whether or not earned or declared until the Arrearage is paid, shall be calculated as of such successive Dividend Payment Date, and shall constitute an additional Arrearage from and after any Dividend Payment Date to the extent not paid on such Dividend Payment Date. References in any Article herein to dividends that have accumulated or that have been deemed to have accumulated with respect to the Series C Preferred Stock shall include the amount, if any, of any Arrearage together with any dividends accumulated or deemed to have accumulated on such Arrearage pursuant to the immediately preceding two sentences. Additional dividends in respect of any Arrearage may be declared and paid at any time, in whole or in part, without reference to any regular Dividend Payment Date, to Registered Holders as they appear on the stock record books of the Corporation on such record date as may be fixed by the Board of Directors (which record date shall be no less than 10 days prior to the corresponding payment date). Dividends in respect of any Arrearage shall be paid in cash. C. METHOD OF PAYMENT. Dividends paid on the shares of Series C Preferred Stock in an amount less than the total amount of such dividends at the time accumulated and payable on all outstanding shares of Series C Preferred Stock shall be allocated pro rata on a share-by-share basis among all such shares then outstanding. After the Second Anniversary Date, dividends that are declared and paid in an amount less than the full amount of dividends accumulated on the Series C Preferred Stock (and on any Arrearage) shall be applied first to the earliest dividend which has not theretofore been paid. All cash payments of dividends on the shares of Series C Preferred Stock shall be made in such coin or currency of the United States of America as at the time of payment is legal tender for payment of public and private debts. D. SPECIAL DIVIDEND RIGHTS. 1. In addition to the dividend rights set forth in paragraph A above, prior to the consummation of the Recapitalization, the holders of shares of Series C Preferred Stock shall be entitled to receive, when, as and if declared by the Board of Directors out of funds legally available for such purpose, cash dividends in an amount per whole share (rounded to the nearest cent) equal to the Formula Number then in effect times the aggregate per share amount of all 3 29 cash dividends declared or paid on the Common Stock. If, prior to the consummation of the Recapitalization, the Corporation shall pay any dividend or make any distribution on the Common Stock payable in assets, securities or other forms of non-cash consideration, then, in each such case, the Corporation shall simultaneously pay or make on each whole outstanding share of the Series C Preferred Stock a dividend or distribution in like kind equal to the Formula Number then in effect times such dividend or distribution on each share of the Common Stock. The dividends and distributions on the Series C Preferred Stock pursuant to this paragraph D are hereinafter referred to as "Participating Dividends." The Corporation shall declare each Participating Dividend immediately prior to or at the same time it declares any cash or non-cash dividend or distribution on the Common Stock in respect of which a Participating Dividend is required to be paid. No cash or non-cash dividend or distribution on the Common Stock in respect of which a Participating Dividend is required shall be paid or set aside for payment on the Common Stock unless a Participation Dividend in respect of such dividend shall be have been paid. Nothing contained in this paragraph D shall obligate the Company to declare or pay any dividend or other distribution on the Common Stock or (except pursuant to paragraph A of this Article III or in connection with a dividend or distribution on the Common Stock as provided in this paragraph D) the Series B Preferred Stock. 2. If the Recapitalization is not consummated prior to June 30, 1999, the Dividend Rate shall be deemed to be 15% per annum during the period commencing on such date and ending on the date the Recapitalization is consummated. IV. LIQUIDATION PREFERENCE A. PRIOR TO THE RECAPITALIZATION. In the event of a liquidation, dissolution or winding up of the Corporation, whether voluntary or involuntary, occurring prior to the consummation of the Recapitalization, the holders of then-outstanding shares of Series C Preferred Stock shall be entitled to receive out of the assets of the Corporation, whether such assets are capital or surplus of any nature, an amount per share equal to the sum of (i) the dividends, if any, accumulated or deemed to have accumulated thereon, to the date of final distribution to such holders, whether or not such dividends are declared; and (ii) the Initial Stated Value thereof, before any payment shall be made or any assets distributed to the holders of any Junior Liquidation Securities (the "Initial Preferred Distribution"). After the Initial Preferred Distribution has been made, the holders of Series C Preferred Stock shall be entitled to share pro rata with the holders of Common Stock in the distribution of any remaining assets of the Corporation on the basis of each whole outstanding share of the Series C Preferred Stock receiving an amount equal to the Formula Number then in effect times such distribution on each share of the Common Stock. The distributions on the Series C Preferred Stock pursuant to the immediately preceding sentence of this paragraph A are hereinafter referred to as "Participating Liquidation Distributions." No distribution on the Common Stock in respect of which a Participating Liquidation Distribution is required shall be paid or set aside for payment on the Common Stock unless a Participating Liquidation Distribution in respect of such distribution is concurrently paid. 4 30 B. AFTER THE RECAPITALIZATION. Subsequent to the consummation of the Recapitalization, the holders of the outstanding shares of Series C Preferred Stock shall be entitled to receive out of the assets of the Corporation, whether such assets are capital or surplus of any nature, an amount per share equal to the sum of (i) the dividends, if any, accumulated or deemed to have accumulated thereon to the date of final distribution to such holders, whether or not such dividends are declared; and (ii) the Post-Recapitalization Stated Value thereof, before any payment shall be made or any assets distributed to the holders of any Junior Liquidation Securities. After any such payment in full after the consummation of the Recapitalization, the holders of Series C Preferred Stock shall not, as such, be entitled to any further participation in any distribution of assets of the Corporation. C. PARITY SECURITIES. All the assets of the Corporation available for distribution to stockholders after the liquidation preferences of any Senior Liquidation Securities shall be distributed ratably (in proportion to the full distributable amounts to which holders of Series C Preferred Stock and Parity Liquidation Securities, if any, are respectively entitled upon such dissolution, liquidation or winding up) among the holders of the then-outstanding shares of Series C Preferred Stock and Parity Liquidation Securities, if any, when such assets are not sufficient to pay in full the aggregate amounts payable thereon. D. MERGER NOT A LIQUIDATION. Neither a consolidation or merger of the Corporation with or into any other Person or Persons, nor a sale, conveyance, lease, exchange or transfer of all or part of the Corporation's assets for cash, securities or other property to a Person or Persons shall be deemed to be a liquidation, dissolution or winding up of the Corporation for purposes of this Article IV, but the holders of shares of Series C Preferred Stock shall nevertheless be entitled from and after any such consolidation, merger or sale, conveyance, lease, exchange or transfer of all or part of the Corporation's assets to the rights provided by this Article IV following any such transaction. Notice of any voluntary or involuntary liquidation, dissolution or winding up of the Corporation, stating the payment date or dates when, and the place or places where, the amounts distributable to each holder of shares of Series C Preferred Stock in such circumstances shall be payable, shall be given by first-class mail, postage prepaid, mailed not less than 30 days prior to any payment date stated therein, to holders of record as they appear on the stock record books of the Corporation as of the date such notices are first mailed. V. REDEMPTION A. INTENTIONALLY OMITTED B. OPTIONAL REDEMPTION. Commencing on the earlier to occur of (x) the tenth anniversary of the Issue Date and (y) the date on which fewer than 25% of the shares of Series C Preferred Stock issued on the Issue Date remain outstanding, and at all times thereafter, the Corporation may, at its option, redeem all (but not less than all) outstanding shares of Series C Preferred Stock on a date specified by the Corporation (the "Optional Redemption Date") by paying the Redemption Price therefor in cash out funds legally available for such purpose. C. NOTICE AND REDEMPTION PROCEDURES. Notice of the redemption of shares of Series C Preferred Stock pursuant to paragraph B of this Article V (a "Notice of Redemption") 5 31 shall be sent to the holders of record of the shares of Series C Preferred Stock to be redeemed by first class mail, postage prepaid, at each such holder's address as it appears on the stock record books of the Corporation not more than 120 nor fewer than 90 days prior to the Optional Redemption Date, which date shall be set forth in such notice (the "Redemption Date"); provided that failure to give such Notice of Redemption to any holder, or any defect in such Notice of Redemption to any holder shall not affect the validity of the proceedings for the redemption of any shares of Series C Preferred Stock held by any other holder. In order to facilitate the redemption of shares of Series C Preferred Stock, the Board of Directors may fix a record date for the determination of the holders of shares of Series C Preferred Stock to be redeemed not more than 30 days prior to the date the Notice of Redemption is mailed. On or after the Optional Redemption Date, each holder of the shares called for redemption shall surrender the certificate evidencing such shares to the Corporation at the place designated in such notice and shall thereupon be entitled to receive payment of the Redemption Price for such shares. From and after the Optional Redemption Date, all dividends on shares of Series C Preferred Stock shall cease to accumulate and all rights of the holders thereof as holders of Series C Preferred Stock shall cease and terminate, except to the extent the Corporation shall default in payment thereof on the Optional Redemption Date. D. DEPOSIT OF FUNDS. The Corporation shall, on or prior to the Optional Redemption Date, pursuant to paragraph C of this Article V, deposit with its transfer agent or other redemption agent in the Borough of Manhattan, The City of New York having a capital and surplus of at least $500,000,000 selected by the Board of Directors, as a trust fund for the benefit of the holders of the shares of Series C Preferred Stock to be redeemed, cash that is sufficient in amount to redeem the shares to be redeemed in accordance with the Notice of Redemption, with irrevocable instructions and authority to such transfer agent or other redemption agent to pay to the respective holders of such shares, as evidenced by a list of such holders certified by an officer of the Corporation, the Redemption Price upon surrender of their respective share certificates. Such deposit shall be deemed to constitute full payment of the Redemption Price for such shares to the holders, and from and after the date of such deposit, all rights of the holders of the shares of Series C Preferred Stock that are to be redeemed as stockholders of the Corporation with respect to such shares, except the right to receive the Redemption Price upon the surrender of their respective certificates, shall cease and terminate. No dividends shall accumulate on any shares of Series C Preferred Stock after the Optional Redemption Date, for such shares (unless the Corporation shall fail to deposit cash sufficient to redeem all such shares). In case holders of any shares of Series C Preferred Stock called for redemption shall not, within two years after such deposit, claim the cash deposited for redemption thereof, such transfer agent or other redemption agent shall, upon demand, pay over to the Corporation the balance so deposited. Thereupon, such transfer agent or other redemption agent shall be relieved of all responsibility to the holders thereof and the sole right of such holders, with respect to shares to be redeemed, shall be to receive the Redemption Price as general creditors of the Corporation. Any interest accrued on any funds so deposited shall belong to the Corporation, and shall be paid to it from time to time on demand. 6 32 VI. RESTRICTIONS ON DIVIDENDS So long as any shares of the Series C Preferred Stock are outstanding, the Board of Directors shall not declare, and the Corporation shall not pay or set apart for payment any dividend on any Junior Securities or make any payment on account of, or set apart for payment money for a sinking or other similar fund for, the repurchase, redemption or other retirement of, any Junior Securities or Parity Securities or any warrants, rights or options exercisable for or convertible into any Junior Securities or Parity Securities (other than the repurchase, redemption or other retirement of debentures or other debt securities that are convertible or exchangeable into any Junior Securities or Parity Securities), or make any distribution in respect of the Junior Securities, either directly or indirectly, and whether in cash, obligations or shares of the Corporation or other property (other than distributions or dividends in Junior Securities to the holders of Junior Securities), and shall not permit any corporation or other entity directly or indirectly controlled by the Corporation to purchase or redeem any Junior Securities or Parity Securities or any warrants, rights, calls or options exercisable for or convertible into any Junior Securities or Parity Securities (other than the repurchase, redemption or other retirement of debentures or other debt securities that are convertible or exchangeable into any Junior Securities or Parity Securities or the repurchase, redemption or other retirement of Junior Securities or Parity Securities in exchange for Junior Securities or Parity Securities) unless prior to or concurrently with such declaration, payment, setting apart for payment, repurchase, redemption or other retirement or distribution, as the case may be, all accumulated and unpaid dividends on shares of the Series C Preferred Stock not paid on the dates provided for in paragraph A of Article III hereof (including Arrearages and accumulated dividends thereon) shall have been paid, except that when dividends are not paid in full as aforesaid upon the shares of Series C Preferred Stock, all dividends declared on the Series C Preferred Stock and any series of Parity Dividend Securities shall be declared and paid pro rata so that the amount of dividends so declared and paid on Series C Preferred Stock and such series of Parity Dividend Securities shall in all cases bear to each other the same ratio that accumulated dividends (including interest accrued on or additional dividends accumulated in respect of such accumulated dividends) on the shares of Series C Preferred Stock and such Parity Dividend Securities bear to each other. VII. VOTING RIGHTS A. On or prior to the consummation of the Recapitalization, the holders of Series C Preferred Stock shall be entitled to one thousand (1,000) votes per share of Series C Preferred Stock at each meeting of stockholders of the Corporation with respect to any and all matters presented to the stockholders of the Corporation for their action and consideration, other than the election of directors. After the consummation of the Recapitalization, the holders of Series C Preferred Stock shall be entitled to the number of votes per share of Series C Preferred Stock equal to the number of shares of Common Stock for which such share of Series C Preferred Stock is then convertible pursuant to Article VIII at each meeting of stockholders of the Corporation with respect to any and all matters presented to the stockholders of the Corporation for their action and consideration, other than the election of directors. 7 33 B. So long as any shares of the Series C Preferred Stock are outstanding, (i) each share of Series C Preferred Stock shall entitle the holder thereof to vote on all matters voted on by holders of Common Stock, other than the election of directors; and (ii) the shares of Series C Preferred Stock shall vote together with shares of Common Stock and shares of Series B Preferred Stock as a single class. C. Without the written consent (if action by written consent is permitted) or affirmative vote of the holders of a majority of the outstanding shares of Series C Preferred Stock and Series B Preferred Stock, voting together as a single class, the Corporation shall not (i) authorize, create or issue, or increase the authorized amount of, (x) any Senior Securities or Parity Securities or (y) any class or series of capital stock or any security convertible into or exercisable for any class or series of capital stock, redeemable mandatorily or redeemable at the option of the holder thereof or (ii) enter into any Transaction (as defined in paragraph H of Article VIII). Such vote or consent shall be taken in accordance with the procedures specified in paragraph E below. D. Without the written consent (if action by written consent is permitted) or affirmative vote of the holders of at least a majority of the outstanding shares of Series C Preferred Stock and Series B Preferred Stock, voting together as a single class, the Corporation shall not (i) amend, alter or repeal any provision of the Certificate of Incorporation or the Bylaws, if the amendment, alteration or repeal alters or changes the powers, preferences or special rights of the Series C Preferred Stock so as to affect them materially and adversely or (ii) authorize or take any other action if such action alters or changes any of the rights of the Series C Preferred Stock in any respect or otherwise would be inconsistent with the provisions of this Certificate of Designations and the holders of any class or series of the capital stock of the Corporation is entitled to vote thereon. Such vote or consent shall be taken in accordance with the procedures specified in paragraph E below. E. The foregoing rights of holders of shares of Series C Preferred Stock to take any actions as provided in this Article VII may be exercised at any annual meeting of stockholders or at a special meeting of stockholders held for such purpose as hereinafter provided or at any adjournment thereof, or by the written consent, delivered to the Secretary of the Corporation, of the holders of the minimum number of shares required to take such action, if action by written consent of stockholders of the Corporation is then permitted. The Chairman of the Board of the Corporation may call, and upon written request of holders of record of 35% of the outstanding shares of Series C Preferred Stock and Series B Preferred Stock, addressed to the Secretary of the Corporation at the principal office of the Corporation shall call, a special meeting of the holders of shares entitled to vote as provided herein. Such meeting shall be held within 30 days after delivery of such request to the Secretary, at the place and upon the notice provided by law and in the By-laws of the Corporation for the holding of meetings of stockholders. At each meeting of stockholders at which the holders of shares of Series C Preferred Stock shall have the right to take any action, the presence in person or by proxy of the 8 34 holders of record of one-third of the total number of shares of Series C Preferred Stock and Series B Preferred Stock then outstanding and entitled to vote on the matter shall be necessary and sufficient to constitute a quorum. At any such meeting or at any adjournment thereof: (A) the absence of a quorum of the holders of shares of Series C Preferred Stock shall not prevent the election of directors to be elected by the holders of shares of Series B Preferred Stock or the taking of any action as provided in this Article VII; and (B) in the absence of a quorum of the holders of shares of Series C Preferred Stock and Series B Preferred Stock, a majority of the holders of such shares present in person or by proxy shall have the power to adjourn the meeting as to the actions to be taken by the holders of shares of Series C Preferred Stock and Series B Preferred Stock, from time to time and place to place without notice other than announcement at the meeting until a quorum shall be present. For taking of any action as provided in this Article VII by the holders of shares of Series C Preferred Stock and Series B Preferred Stock, each such holder shall have one vote for each share of such stock standing in his name on the transfer books of the Corporation as of any record dated fixed for such purpose or, if no such date be fixed, at the close of business on the Business Day next preceding the day on which notice is given, or if notice if waived, at the close of business on the Business Day next preceding the day on which the meeting is held. F. The Corporation shall not enter into any agreement or issue any security that prohibits, conflicts or is inconsistent with, or would be breached by, the Corporation's performance of its obligations hereunder. VIII. CONVERSION The holders of the Series C Preferred Stock shall have conversion rights as follows: A. Each share of Series C Preferred Stock shall be convertible at the direction of, and by notice to the Corporation from, (i) the holder thereof or (ii) the holders of a majority of the outstanding shares of Series C Preferred Stock, at any time, at the office of the Corporation or any transfer agent for such Series, into one thousand (1,000) fully paid and nonassessable shares of Common Stock subject (x) to adjustment from time to time as provided below (as so adjusted, the "conversion ratio") and (y) (prior to the consummation of the Recapitalization) to limitations resulting from the available number of shares of Common Stock which may be reserved for issuance upon such conversion, provided, that any conversion pursuant to clause (ii) above of less than all of the outstanding shares of Series C Preferred Stock shall be on a pro rata basis amongst all holders of Series C Preferred Stock. After consummation of the Recapitalization, the number "1,000" in this paragraph shall be "1", subject to adjustment as provided in paragraph VIII.G. 9 35 B. If a holder of Series C Preferred Stock gives notice (an "Optional Conversion Notice") of conversion under paragraph A above, such holder shall surrender with such Optional Conversion Notice the duly endorsed certificate or certificates for the Series C Preferred Stock being converted, at the office of the Corporation or of any transfer agent for such Series, and shall state therein the name or names in which the certificate or certificates for shares of Common Stock are to be issued. If the holders of a majority of the outstanding shares of Series C Preferred Stock give notice of conversion under paragraph A above, the Corporation shall notify all other record holders of Series C Preferred Stock (a "Mandatory Conversion Notice"). Following receipt of a Mandatory Conversion Notice, the holders of Series C Preferred Stock shall surrender the certificate or certificates therefor duly endorsed, at the office of the Corporation or of any transfer agent for such Series, and shall state therein the name or names in which the certificate or certificates for shares of Common Stock are to be issued. The Corporation shall, as soon as practicable after the surrender of a Series C Preferred Stock certificate or certificates pursuant to an Optional Conversion Notice or Mandatory Conversion Notice, issue and deliver at such office to such holder, or to the nominee or nominees of such holder, a certificate or certificates for the number of shares of Common Stock to which such holder shall be entitled as aforesaid. Such conversion shall be deemed to have been made immediately prior to the close of business on the date of such Optional Conversion Notice or Mandatory Conversion Notice, as applicable, and the person or persons entitled to receive the shares of Common Stock issuable upon such conversion shall be treated for all purposes as the recordholder or holders of such shares of Common Stock as of such date. The issuance of certificates or shares of Common Stock upon conversion of shares of Series C Preferred Stock shall be made without charge for any issue, stamp or other similar tax in respect of such issuance. C. No fractional shares shall be issued upon conversion of any shares of Series C Preferred Stock and the number of shares of Common Stock to be issued shall be rounded down to the nearest whole share, and the holder of Series C Preferred Stock shall be paid in cash for any fractional share. D. In case at any time or from time to time the Corporation shall pay any dividend or make any other distribution to the holders of its Common Stock or other class of securities, or shall offer for subscription pro rata to the holders of its Common Stock or other class of securities any additional shares of stock of any class or any other right, or there shall be any capital reorganization or reclassification of the Common Stock of the Corporation or consolidation or merger of the Corporation with or into another corporation, or any sale or conveyance to another corporation of the property of the Corporation as an entirety or substantially as an entirety, or there shall be a voluntary or involuntary dissolution, liquidation or winding up of the Corporation, then, in any one or more of said cases the Corporation shall give at least 20 days' prior written notice (the time of mailing of such notice shall be deemed to be the time of giving thereof) to the registered holders of the Series C 10 36 Preferred Stock at the addresses of each as shown on the books of the Corporation maintained by the Transfer Agent thereof of the date on which (i) the books of the Corporation shall close or a record shall be taken for such stock dividend, distribution or subscription rights or (ii) such reorganization, reclassification, consolidation, merger, sale or conveyance, dissolution, liquidation or winding up shall take place, as the case may be, provided that in the case of any Transaction to which paragraph H applies the Corporation shall give at least 30 days' prior written notice as aforesaid. Such notice shall also specify the date as of which the holders of the Common Stock of record shall participate in said dividend, distribution or subscription rights or shall be entitled to exchange their Common Stock for securities or other property deliverable upon such reorganization, reclassification, consolidation, merger, sale or conveyance or participate in such dissolution, liquidation or winding up, as the case may be. Failure to give such notice shall not invalidate any action so taken. E. From and after the Recapitalization, the Corporation shall at all times reserve and keep available out of its authorized but unissued shares of Common Stock, solely for the purpose of effecting the conversion of the shares of Series C Preferred Stock, such number of its shares of Common Stock as shall from time to time be sufficient to effect the conversion of all outstanding shares of Series C Preferred Stock, and if at any time the number of authorized but unissued shares of Common Stock shall not be sufficient to effect the conversion of all then outstanding shares of Series C Preferred Stock, then in addition to such other remedies as shall be available to the holder of Series C Preferred Stock, the Corporation will take such corporate action as may, in the opinion of its counsel, be necessary to increase its authorized but unissued shares of Common Stock to such number of shares as shall be sufficient for such purposes. F. Any notice required by the provisions of paragraph D to be given the holders of shares of Series C Preferred Stock shall be deemed given if sent by facsimile transmission, by telex, or if deposited in the United States mail, postage prepaid, and addressed to each holder of record at his, her or its address appearing on the books of the Corporation. G. The conversion ratio shall be subject to adjustment from time to time as follows: (i) In case the Corporation shall at any time or from time to time after the Issue Date (A) pay a dividend or make a distribution, on the outstanding shares of Common Stock in shares of Common Stock, (B) subdivide the outstanding shares of Common Stock into a larger number of shares of Common Stock, (C) combine the outstanding shares of Common Stock into a smaller number of shares or (D) issue by reclassification of the shares of Common Stock any shares of capital stock of the Corporation, then, and in each such case, the conversion ratio in effect immediately prior to such event or the record date therefor, whichever is earlier, shall be adjusted so that the holder of any shares of 11 37 Series C Preferred Stock thereafter surrendered for conversion shall be entitled to receive the number of shares of Common Stock or other securities of the Corporation which such holder would have owned or have been entitled to receive after the happening of any of the events described above, had such shares of Series C Preferred Stock been surrendered for conversion immediately prior to the happening of such event or the record date therefor, whichever is earlier. An adjustment made pursuant to this clause (i) shall become effective (x) in the case of any such dividend or distribution, immediately after the close of business on the record date for the determination of holders of shares of Common Stock entitled to receive such dividend or distribution, or (y) in the case of any such subdivision, reclassification or combination, at the close of business on the day upon which such corporate action becomes effective. (ii) In the case the Corporation shall, after the Issue Date, issue shares of Common Stock at a price per share, or securities convertible into or exchangeable for shares of Common Stock ("Convertible Securities") having a "Conversion Price" (as defined below) less than the Current Market Price (for a period of 15 consecutive trading days prior to such date), then, and in each such case, the conversion ratio shall be adjusted so that the holder of each share of Series C Preferred Stock shall be entitled to receive, upon the conversion thereof, the number of shares of Common Stock determined by multiplying (A) the applicable conversion ratio on the day immediately prior to such date by (B) a fraction, the numerator of which shall be the sum of (1) the number of shares of Common Stock outstanding on the date on which such shares or Convertible Securities are issued and (2) the number of additional shares of Common Stock issued, or into which the Convertible Securities may convert, and the denominator of which shall be the sum of (x) the number of shares of Common Stock outstanding on such date and (y) the number of shares of Common Stock which the aggregate consideration receivable by the Corporation for the total number of shares of Common Stock so issued, or the number of shares of Common Stock which the aggregate of the Conversion Price of such Convertible Securities so issued, would purchase at such Current Market price on such date. An adjustment made pursuant to this clause (ii) shall be made on the next Business Day following the date on which any such issuance is made and shall be effective retroactively immediately after the close of business on such date. For purposes of this clause (ii), the aggregate consideration receivable by the Corporation in connection with the issuance of any securities shall be deemed to be the sum of the aggregate offering price to the public (before deduction of underwriting discounts or commissions and expenses payable to third parties), and the "Conversion Price" of any Convertible Securities is the total amount received or receivable by the Corporation as consideration for the issue or sale of such Convertible Securities (before deduction of underwriting discounts or commissions and expenses payable to third parties) plus the minimum aggregate amount of additional consideration, if any, payable to the Corporation upon the conversion, exchange or exercise of any such Convertible Securities. Neither (A) 12 38 the issuance of any shares of Common Stock (whether treasury shares or newly issued shares) pursuant to a dividend or distribution on, or subdivision, combination or reclassification of, the outstanding shares of Common Stock requiring an adjustment in the conversion ratio pursuant to clause (i) of this paragraph G, or pursuant to any employee benefit plan or program of the Corporation or pursuant to any option, warrant, right, or Convertible Security outstanding as of the date hereof (including, but not limited to, the Rights, the Series B Preferred Stock, the Series C Preferred Stock and the Warrants) nor (B) the issuance of shares of Common Stock pursuant thereto shall be deemed to constitute an issuance of Common Stock or Convertible Securities by the Corporation to which this clause (ii) applies. Upon expiration of any Convertible Securities which shall not have been exercised or converted and for which an adjustment shall have been made pursuant to this clause (ii), the Conversion Price computed upon the original issue thereof shall upon such expiration be recomputed as if the only additional shares of Common Stock issued were such shares of Common Stock (if any) actually issued upon exercise of such Convertible Securities and the consideration received therefor was the consideration actually received by the Corporation for the issue of such Convertible Securities (whether or not exercised or converted) plus the consideration actually received by the Corporation upon such exercise of conversion. (iii) In case the Corporation shall at any time or from time to time after the Issue Date declare, order, pay or make a dividend or other distribution (including, without limitation, any distribution of stock or other securities or property or rights or warrants to subscribe for securities of the Corporation or any of its Subsidiaries by way of dividend or spin-off), on its Common Stock, other than (A) regular quarterly dividends payable in cash in an aggregate amount not to exceed 15% of net income from continuing operations before extraordinary items of the Corporation, determined in accordance with generally accepted accounting principles, during the period (treated as one accounting period) commencing on July 1, 1998, and ending on the date such dividend is paid or (B) dividends or distributions of shares of Common Stock which are referred to in clause (i) of this paragraph G, then, and in each such case, the conversion ratio shall be adjusted so that the holder of each share of Series C Preferred Stock shall be entitled to receive, upon the conversion thereof, the number of shares of Common Stock determined by multiplying (1) the applicable conversion ratio on the day immediately prior to the record date fixed for the determination of stockholders entitled to receive such dividend or distribution by (2) a fraction, the numerator of which shall be the then Current Market Price per share of Common Stock for the period of 20 Trading Days preceding such record date, and the denominator of which shall be such Current Market Price per share of Common Stock for the period of 20 Trading Days preceding such record date less the Fair Market Value (as defined in Article IX) per share of Common Stock (as determined in good faith by the Board of Directors of the Corporation, a certified resolution with 13 39 respect to which shall be mailed to each holder of shares of Series C Preferred Stock) of such dividend or distribution; provided, however, that in the event of a distribution of shares of capital stock of a Subsidiary of the Corporation (a "Spin-Off") made to holders of shares of Common Stock, the numerator of such fraction shall be the sum of the Current Market Price per share of Common Stock for the period of 20 Trading Days preceding the 35th Trading Day after the effective date of such Spin-Off and the Current Market Price of the number of shares (or the fraction of a share) of capital stock of the Subsidiary which is distributed in such Spin-Off in respect of one share of Common Stock for the period of 20 Trading Days preceding such 35th Trading Day and the denominator of which shall be the current market price per share of the Common Stock for the period of 20 Trading Days proceeding such 35th Trading Day. An adjustment made pursuant to this clause (iii) shall be made upon the opening of business on the next Business Day following the date on which any such dividend or distribution is made and shall be effective retroactively immediately after the close of business on the record date fixed for the determination of stockholders entitled to receive such dividend or distribution; provided, however, if the proviso to the preceding sentence applies, then such adjustment shall be made and be effective as of such 35th Trading Day after the effective date of such Spin-Off. (iv) For purposes of this paragraph G, the number of shares of Common Stock at any time outstanding shall not include any shares of Common Stock then owned or held by or for the account of the Corporation. (v) The term "dividend", as used in this paragraph G shall mean a dividend or other distribution upon stock of the Corporation except pursuant to the Rights Agreement (as defined in Article IX). Notwithstanding anything in this Article VIII to the contrary, the conversion ratio shall not be adjusted as a result of any dividend, distribution or issuance of securities of the Corporation pursuant to the Rights Agreement. (vi) Anything in this paragraph G to the contrary notwithstanding, the Corporation shall not be required to give effect to any adjustment in the conversion ratio unless and until the net effect of one or more adjustments (each of which shall be carried forward), determined as above provided, shall have resulted in a change of the conversion ratio by at least one-hundredth of one share of Common Stock, and when the cumulative net effect of more than one adjustment so determined shall be to change the conversion ratio by at least one-hundredth of one share of Common Stock, such change in conversion ratio shall thereupon be given effect. (vii) The certificate of any firm of independent public accountants of recognized standing selected by the Board of Directors of the Corporation (which may be the firm of independent public accountants regularly employed by the 14 40 Corporation) shall be presumptively correct for any computation made under this paragraph G. (viii) If the Corporation shall take a record of the holders of its Common Stock for the purpose of entitling them to receive a dividend or other distribution, and shall thereafter and before the distribution to stockholders thereof legally abandon its plan to pay or deliver such dividend or distribution, then thereafter no adjustment in the number of shares of Common Stock issuable upon exercise of the right of conversion granted by this paragraph G or in the conversion ratio then in effect shall be required by reason of the taking of such record. (ix) There shall be no adjustment of the conversion ratio in case of the issuance of any stock of the Corporation in a merger, reorganization, acquisition or other similar transaction except as set forth in paragraph G(i), G(ii) and H of this Article VIII. H. In case of any reorganization or reclassification of outstanding shares of Common Stock (other than a reclassification covered by paragraph G(i) of this Article VIII), or in case of any consolidation or merger of the Corporation with or into another corporation, or in the case of any sale or conveyance to another corporation of the property of the Corporation as an entirety or substantially as an entirety (each of the foregoing being referred to as a "Transaction"), each share of Series C Preferred Stock then outstanding shall thereafter be convertible into, in lieu of the Common Stock issuable upon such conversion prior to consummation of such Transaction, the kind and amount of shares of stock and other securities and property receivable (including cash) upon the consummation of such Transaction by a holder of that number of shares of Common Stock into which one share of Series C Preferred Stock was convertible immediately prior to such Transaction (including, on a pro rata basis, the cash, securities or property received by holders of Common Stock in any tender or exchange offer that is a step in such Transaction). In case securities or property other than Common Stock shall be issuable or deliverable upon conversion as aforesaid, then all reference in this paragraph H shall be deemed to apply, so far as appropriate and as nearly as may be, to such other securities or property. I. Upon any adjustment of the conversion ratio then in effect and any increase or decrease in the number of shares of Common Stock issuable upon the operation of the conversion set forth in Article VIII, then, and in each such case, the Corporation shall promptly deliver to the registered holders of the Series C Preferred and Common Stock, a certificate signed by the President or a Vice President and by the Treasurer or an Assistant Treasurer or the Secretary or an Assistant Secretary of the Corporation setting forth in reasonable detail the event requiring the adjustment and the method by which such adjustment was calculated and specifying the conversion ratio then in effect following such adjustment and 15 41 the increased or decreased number of shares issuable upon the conversion set forth in this Article VIII. IX. ADDITIONAL DEFINITIONS For the purposes of this Certificate of Designations of Series C Preferred Stock, the following terms shall have the meanings indicated: "Accrual Period" means the end of the first quarterly period following the Second Anniversary Date. "Beneficially Own" with respect to any securities means having "beneficial ownership" of such securities (as determined pursuant to Rule 13d-3 under the Exchange Act as in effect on the date hereof, except that a Person shall be deemed to Beneficially Own all such securities that such Person has the right to acquire whether such right is exercisable immediately or after the passage of time). The terms "Beneficial Ownership" and "Beneficial Owner" have correlative meanings. "Business Day" means any day, other than a Saturday, Sunday or a day on which banking institutions in the State of New York are authorized or obligated by law or executive order to close. "Bylaws" means the Bylaws of the Corporation, as amended. "Current Market Price", when used with reference to shares of Common Stock or other securities on any date, shall mean the closing price per share of Common Stock or such other securities on such date and, when used with reference to shares of Common Stock or other securities for any period shall mean the average of the daily closing prices per share of Common Stock or such other securities for such period. The closing price for each day shall be the last sale price, regular way, or, in case no such sale takes place on such day, the average of the closing bid and asked prices, regular way, in either case as reported in the principal consolidated transaction reporting system with respect to securities listed or admitted to trading on the New York Stock Exchange or, if the Common Stock or such other securities are not listed or admitted to trading on the New York Stock Exchange, as reported in the principal consolidated transaction reporting system with respect to securities listed on the principal national securities exchange on which the Common Stock or such other securities are listed or admitted to trading or, if the Common Stock is not listed or admitted to trading on any national securities exchange, the last quoted sale price or, if not so quoted, the average of the high bid and low asked prices in the over-the-counter market, as reported by the National Association of Securities Dealers, Inc. National Market System or such other securities are not quoted by any such organization, the average of the closing bid and asked prices as furnished by a professional market maker making a market in the Common Stock or such other securities selected by the Board of Directors of the Corporation. If the Common Stock or such other securities are not publicly held or so listed or publicly traded, "Current Market Price" shall mean the Fair Market Value per share of Common Stock or of such other securities as determined in good faith by the Board of Directors of the 16 42 Corporation based on an opinion of an independent investment banking firm with an established national reputation as a valuer of securities, which opinion may be based on such assumption as such firm shall deem to be necessary and appropriate. "Equity Securities" of any Person means any and all common stock, preferred stock and any other class of capital stock of, and any partnership or limited liability company interests of such Person or any other similar interests of any Person that is not a corporation, partnership or limited liability company. "Exchange Act" means the U.S. Securities Exchange Act of 1934, as amended, and the rules and regulations promulgated thereunder, from time to time. "Fair Market Value" shall mean the amount which a willing buyer would pay a willing seller in an arm's-length transaction. "Formula Number" shall mean one thousand (1,000) prior to consummation of the Recapitalization; provided, however, that if at any time prior to the consummation of the Recapitalization, the Corporation shall (i) declare or pay any dividend or make any distribution on the Common Stock, payable in shares of Common Stock; (ii) subdivide (by a stock split or otherwise) the outstanding shares of Common Stock into a larger number of shares of Common Stock; or (iii) combine (by a reverse stock split or otherwise) the outstanding shares of Common Stock into a smaller number of shares of Common Stock, then in each such case the Formula Number in effect immediately prior to such event shall be adjusted to a number determined by multiplying the Formula Number then in effect by a fraction, the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event (and rounding the result to the nearest whole number); and provided further, that, if prior to the consummation of the Recapitalization the Corporation shall issue any shares of its capital stock in a merger, reclassification, or change of the outstanding shares of Common Stock, then in each such event the Formula Number shall be appropriately adjusted to reflect such merger, reclassification, or change so that each share of Series C Preferred Stock continues to be the economic equivalent of a Formula Number of shares of Common Stock immediately prior to such merger, reclassification, or change. "Group" has the meaning set forth in Rule 13d-5 under the Exchange Act. "Issue Date" shall mean the first date on which shares of Series C Preferred Stock are issued. "Person" means any individual, corporation, company, association, partnership, joint venture, trust or unincorporated organization, or a government or any agency or political subdivision thereof. "Post-Recapitalization Stated Value" shall be equal to $1.00. 17 43 "Recapitalization" means the amendment of the Corporation's Certificate of Incorporation to increase the authorized shares of Common Stock from 50,000,000 to 400,000,000, and the authorized shares of Preferred Stock from 1,000,000 to 200,000,000, and the subsequent one thousand-for-one split of Series C Preferred Stock and Series B Preferred Stock. "Redemption Price" of a share of Series C Preferred Stock shall mean the sum of (a) the dividends, if any, accumulated or deemed to have accumulated thereon to the Optional Redemption Date, whether or not such dividends are declared plus (b) either (i) the Initial Stated Value thereof (if the Recapitalization has not been consummated prior to June 30, 1999) or (ii) the Post-Recapitalization Stated Value thereof (if the Recapitalization has been consummated prior to June 30, 1999), in each case subject to adjustment for splits, reclassifications, recombinations or similar events. "Rights" shall mean any rights to purchase securities of the Corporation issued pursuant to any Rights Agreement. "Rights Agreement" shall mean the Rights Agreement, dated as of June 21, 1996, between the Company and Wells Fargo Bank as rights agent, and all amendments, supplements and replacements thereof. "Second Anniversary Date" means the second anniversary of the Issue Date. "Subsidiary" means, as to any Person, any other Person of which more than 50% of the shares of the Voting Securities or other voting interests are owned or controlled, or the ability to select or elect 50% or more of the directors or similar managers is held, directly or indirectly, by such first Person and one or more of its Subsidiaries. "Trading Day" means a day on which the principal national securities exchange on which the Common Stock is listed or admitted to trading is open for the transaction of business or, if the Common Stock is not listed or admitted to trading on any national securities exchange a Business Day. "Voting Securities" means, (i) with respect to the Company, the Equity Securities of the Company entitled to vote generally for the election of directors of the Company, and (ii) with respect to any other Person, any securities of or interests in such Person entitled to vote generally for the election of directors or any similar managing person of such Person. X. MISCELLANEOUS A. NOTICES. Any notice referred to herein shall be in writing and, unless first-class mail shall be specifically permitted for such notices under the terms hereof, shall be deemed to have been given upon personal delivery thereof, upon transmittal of such notice by telecopy (with confirmation of receipt by telecopy or telex) or five days after transmittal by registered or certified mail, postage prepaid, addressed as follows: 18 44 (i) if to the Corporation, to its office at 2 California Plaza, 350 South Grand Avenue, Los Angeles, California 90071 (Attention: General Counsel) or to the transfer agent for the Series C Preferred Stock; (ii) if to a holder of the Series C Preferred Stock, to such holder at the address of such holder as listed in the stock record books of the Corporation (which may include the records of any transfer agent for the Series C Preferred Stock); or (iii) to such other address as the Corporation or such holder, as the case may be, shall have designated by notice similarly given. B. REACQUIRED SHARES. Any shares of Series C Preferred Stock redeemed, purchased or otherwise acquired by the Corporation, directly or indirectly, in any manner whatsoever shall be retired and canceled promptly after the acquisition thereof (and shall not be deemed to be outstanding for any purpose) and, if necessary to provide for the lawful redemption or purchase of such shares, the capital represented by such shares shall be reduced in accordance with the Delaware General Corporation Law. All such shares of Series C Preferred Stock shall upon their cancellation and upon the filing of an appropriate certificate with the Secretary of State of the State of Delaware, become authorized but unissued shares of Preferred Stock, par value $0.001 per share, of the Corporation and may be reissued as part of another series of Preferred Stock, par value $0.001 per share, of the Corporation subject to the conditions or restrictions on issuance set forth herein. C. ENFORCEMENT. Any registered holder of shares of Series C Preferred Stock may proceed to protect and enforce its rights and the rights of such holders by any available remedy by proceeding at law or in equity to protect and enforce any such rights, whether for the specific enforcement of any provision in this Certificate of Designations or in aid of the exercise of any power granted herein, or to enforce any other proper remedy. D. TRANSFER TAXES. Except as otherwise agreed upon pursuant to the terms of this Certificate of Designations, the Corporation shall pay any and all documentary, stamp or similar issue or transfer taxes and other governmental charges that may be imposed under the laws of the United States of America or any political subdivision or taxing authority thereof or therein in respect of any issue or delivery of Common Stock on conversion of, or other securities or property issued on account of, shares of Series C Preferred Stock pursuant hereto or certificates representing such shares or securities. The Corporation shall not, however, be required to pay any such tax or other charge that may be imposed in connection with any transfer involved in the issue or transfer and delivery of any certificate for Common Stock or other securities or property in a name other than that in which the shares of Series C Preferred Stock so exchanged, or on account of which such securities were issued, were registered and no such issue or delivery shall be made unless and until the Person requesting such issue has paid to the Corporation the amount of any such tax or has established to the satisfaction of the Corporation that such tax has been paid or is not payable. 19 45 E. TRANSFER AGENT. The Corporation may appoint, and from time to time discharge and change, a transfer agent for the Series C Preferred Stock. Upon any such appointment or discharge of a transfer agent, the Corporation shall send notice thereof by first-class mail, postage prepaid, to each holder of record of shares of Series C Preferred Stock. F. RECORD DATES. In the event that the Series C Preferred Stock shall be registered under either the Securities Act of 1933, as amended, or the Exchange Act, the Corporation shall establish appropriate record dates with respect to payments and other actions to be made with respect to the Series C Preferred Stock. 20 46 IN WITNESS WHEREOF, this Certificate of Designations is executed on behalf of the Corporation by its Executive Vice President, General Counsel and Secretary and attested by its Assistant Secretary, this 10th day of February , 1999. AAMES FINANCIAL CORPORATION By: -------------------------------------- Name: Title: [Corporate Seal] ATTEST: 21 47 EXHIBIT C THIS WARRANT AND THE SECURITIES REPRESENTED HEREBY HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR THE SECURITIES LAWS OF ANY STATE AND MAY NOT BE SOLD OR OTHERWISE TRANSFERRED IN THE ABSENCE OF SUCH REGISTRATION OR AN EXEMPTION THEREFROM UNDER SUCH ACT AND UNDER ANY SUCH APPLICABLE STATE LAWS, OR IN VIOLATION OF THE PROVISIONS OF THIS WARRANT. FORM OF CONTINGENT WARRANT To Purchase Common Stock of AAMES FINANCIAL CORPORATION 48 TABLE OF CONTENTS
Page ---- ARTICLE 1. DEFINITIONS...............................................................1 ARTICLE 2. EXERCISE OF WARRANT.......................................................4 Section 2.1. Manner of Exercise...............................................4 Section 2.2. Payment of Taxes.................................................6 Section 2.3. Fractional Shares................................................6 ARTICLE 3. TRANSFER, DIVISION AND COMBINATION........................................6 Section 3.1. Transfer.........................................................6 Section 3.2. Division and Combination.........................................7 Section 3.3. Expenses.........................................................7 Section 3.4. Maintenance of Books.............................................7 ARTICLE 4. ADJUSTMENTS...............................................................7 Section 4.1. Stock Dividends, Subdivisions, Combinations and Reclassifications................................................7 Section 4.2. Issuance of Additional Shares of Common Stock or Convertible Securities...........................................8 Section 4.3. Certain Other Distributions......................................9 Section 4.4. Other Provisions Applicable to Adjustments Under This Section.........................................................10 Section 4.5. Reorganization, Reclassification, Merger, Consolidation or Disposition of Assets........................................12 Section 4.6. Notices.........................................................12 Section 4.7. Certificates....................................................13 ARTICLE 5. NO IMPAIRMENT............................................................13 ARTICLE 6. RESERVATION AND AUTHORIZATION OF COMMON STOCK; REGISTRATION WITH OR APPROVAL OF ANY GOVERNMENTAL AUTHORITY...................................14 ARTICLE 7. STOCK AND WARRANT TRANSFER BOOKS.........................................14 ARTICLE 8. RESTRICTIONS ON TRANSFERABILITY...........................................14 Section 8.1. Restrictive Legend..............................................15 Section 8.2. Transfers.......................................................15 Section 8.3. Termination of Restrictions.....................................16 ARTICLE 9. SUPPLYING INFORMATION....................................................16 ARTICLE 10. LOSS OR MUTILATION.......................................................16 ARTICLE 11. OFFICE OF THE COMPANY....................................................17 ARTICLE 12. REGISTRATION RIGHTS......................................................17 ARTICLE 13. LIMITATION OF LIABILITY..................................................17
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Page ---- ARTICLE 14. REPRESENTATION OF HOLDER.................................................17 ARTICLE 15. MISCELLANEOUS............................................................17 Section 15.1. Nonwaiver and Expenses.........................................17 Section 15.2. No Rights As Stockholder.......................................18 Section 15.3. Notice Generally...............................................18 Section 15.4. Successors and Assigns.........................................19 Section 15.5. Amendment......................................................19 Section 15.6. Severability...................................................19 Section 15.7. Headings.......................................................19 Section 15.8. Governing Law..................................................19 Section 15.9. Mutual Waiver of Jury Trial....................................19
ii 50 THIS WARRANT AND THE SECURITIES REPRESENTED HEREBY HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR THE SECURITIES LAWS OF ANY STATE AND MAY NOT BE SOLD OR OTHERWISE TRANSFERRED IN THE ABSENCE OF SUCH REGISTRATION OR AN EXEMPTION THEREFROM UNDER SUCH ACT AND UNDER ANY SUCH APPLICABLE STATE LAWS, OR IN VIOLATION OF THE PROVISIONS OF THIS WARRANT. WARRANT To Purchase 3,000,000 Shares of Common Stock of AAMES FINANCIAL CORPORATION THIS IS TO CERTIFY THAT Capital Z Management, Inc., or its registered assigns, is entitled, subject to the provisions of the last sentence of this paragraph, at any time after June 30, 1999 and prior to December 31, 2004 (the "Expiration Date"), to purchase from Aames Financial Corporation, a Delaware corporation (the "Company"), 3,000,000 shares of common stock, par value $0.001 per share, of the Company (the "Common Stock"), subject to adjustment as provided herein, in whole or in part, including fractional parts, at a purchase price of $1.00 per share (the "Exercise Price"), subject to adjustment as set forth herein, all on the terms and conditions and pursuant to the provisions hereinafter set forth. Capitalized terms not otherwise defined herein are used as defined in the Preferred Stock Purchase Agreement. Notwithstanding anything to the contrary set forth in this Warrant, (i) this Warrant shall not be exercisable by the holder hereof if the Recapitalization is completed prior to June 30, 1999 and (ii) if the Recapitalization is not completed prior to June 30, 1999, this Warrant shall be exercisable by the holder hereof into the greater of (x) 1,221,398 shares of Common Stock and (y) such number of shares of Common Stock as may be available for issuance by the Company, up to a maximum of 3,000,000 shares of Common Stock. ARTICLE 1. DEFINITIONS As used in this Warrant, the following terms have the respective meanings set forth below: "Additional Shares of Common Stock" shall mean all shares of Common Stock issued by the Company after the Issue Date, other than Warrant Stock. 51 "Business Day" shall mean any day that is not a Saturday or Sunday or a day on which banks are required or permitted to be closed in the State of New York. "Capital Z" shall have the meaning set forth in the first paragraph hereof. "Commission" shall mean the Securities and Exchange Commission. "Common Stock" shall have the meaning set forth in the first paragraph hereof. "Company" shall have the meaning set forth in the first paragraph hereof. "Conversion Price" shall have the meaning set forth in Section 4.2 hereof. "Convertible Securities" shall mean evidences of indebtedness, shares of stock or other securities which are convertible into or exchangeable, with or without payment of additional consideration in cash or property, for Additional Shares of Common Stock, either immediately or upon the occurrence of a specified date or a specified event. "Current Market Price" shall mean, when used with reference to shares of Common Stock or other securities on any date, the closing price per share of Common Stock or such other securities on such date and, when used with reference to shares of Common Stock or other securities for any period shall mean the average of the daily closing prices per share of Common Stock or such other securities for such period. The closing price for each day shall be the last sale price, regular way, or, in case no such sale takes place on such day, the average of the closing bid and asked prices, regular way, in either case as reported in the principal consolidated transaction reporting system with respect to securities listed or admitted to trading on the New York Stock Exchange or, if the Common Stock or such other securities are not listed or admitted to trading on the New York Stock Exchange, as reported in the principal consolidated transaction reporting system with respect to securities listed on the principal national securities exchange on which the Common Stock or such other securities are listed or admitted to trading or, if the Common Stock is not listed or admitted to trading on any national securities exchange, the last quoted sale price or, if not so quoted, the average of the high bid and low asked prices in the over-the-counter market, as reported by the National Association of Securities Dealers, Inc. National Market System or such other securities are not quoted by any such organization, the average of the closing bid and asked prices as furnished by a professional market maker making a market in the Common Stock or such other securities selected by the Board of Directors of the Corporation. If the Common Stock or such other 2 52 securities are not publicly held or so listed or publicly traded, "Current Market Price" shall mean the Fair Market Value per share of Common Stock or of such other securities as determined in good faith by the Board of Directors of the Corporation based on an opinion of an independent investment banking firm with an established national reputation as a valuer of securities, which opinion may be based on such assumption as such firm shall deem to be necessary and appropriate. "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended, and the rules and regulations of the Commission thereunder. "Exercise Price" shall have the meaning set forth in the first paragraph hereof. "Expiration Date" shall have the meaning set forth in the first paragraph hereof. "Fair Market Value" shall mean the amount which a willing buyer would pay a willing seller in an arm's-length transaction. "GAAP" shall mean generally accepted accounting principles in the United States of America as from time to time in effect. "holder" shall mean, as the context requires, the Person in whose name this Warrant is registered on the books of the Company maintained for such purpose and/or the Person holding any Warrant Stock. "Issue Date" shall mean the date on which this Warrant is issued. "Person" shall mean any individual, sole proprietorship, partnership, joint venture, trust, corporation or other entity and shall include any successor (by merger or otherwise) of such entity. "Preferred Stock Purchase Agreement" shall mean the Preferred Stock Purchase Agreement, dated as of December 23, between the Company and Capital Z, as amended. "Registration Rights Agreement" shall mean the Registration Rights Agreement, dated as of the date hereof, between the Company and Capital Z, as amended. "Restricted Common Stock" shall mean shares of Common Stock which are, or which upon their issuance on the exercise of this Warrant would be, evidenced by a certificate bearing the restrictive legend set forth in Section 8.1(a). 3 53 "Securities Act" shall mean the Securities Act of 1933, as amended, and the rules and regulations of the Commission thereunder. "Series B Preferred Stock" shall mean the Series B Convertible Preferred Stock, par value $0.001 per share, to be issued pursuant to the Preferred Stock Purchase Agreement. "Series C Preferred Stock" shall mean the Series C Convertible Preferred Stock, par value $0.001 per share, to be issued pursuant to the Preferred Stock Purchase Agreement. "Subsidiary" shall mean any corporation of which an aggregate of more than 50% of the outstanding stock having ordinary voting power to elect a majority of the board of directors of such corporation (irrespective of whether, at the time, stock of any other class or classes of such corporation shall have or might have voting power by reason of the happening of any contingency) is at the time, directly or indirectly, owned legally or beneficially by the Company and/or one or more Subsidiaries of the Company. "Trading Day" means a day on which the principal national securities exchange on which the Common Stock is listed or admitted to trading is open for the transaction of business or, if the Common Stock is not listed or admitted to trading on any national securities exchange, a Business Day. "Transaction" shall have the meaning set forth in Section 4.5 hereof. "transfer" shall mean any transfer, sale, encumbrance, hypothecation or other disposition of this Warrant or any Warrant Stock or of any interest in either thereof. "Transfer Notice" shall have the meaning set forth in Section 8.2. "Warrant Price" shall mean an amount equal to (i) the number of shares of Common Stock being purchased upon exercise of this Warrant pursuant to Section 2.1, multiplied by (ii) the Exercise Price as of the date of such exercise. "Warrant Stock" shall mean the shares of Common Stock purchased by the holder of this Warrant upon the exercise thereof. ARTICLE 2. EXERCISE OF WARRANT Section 2.1. Manner of Exercise. From and after the date hereof and until 5:00 P.M., New York time, on the Expiration Date, the holder may exercise this Warrant for all or any part of the number of shares of Common Stock purchasable hereunder. 4 54 In order to exercise this Warrant, in whole or in part, the holder shall deliver to the Company at its office at 2 California Plaza, 350 South Grand Avenue, Los Angeles, California 90071, or at the office or agency designated by the Company pursuant to Section 11, (i) a written notice of the holder's election to exercise this Warrant, which notice shall specify the number of shares of Common Stock to be purchased, (ii) payment of the Warrant Price in the manner provided below, and (iii) this Warrant. Such notice shall be substantially in the form of the subscription form appearing at the end of this Warrant as Exhibit A, duly executed by or on behalf of the holder. Upon receipt thereof, the Company shall, as promptly as practicable, and in any event within five (5) Business Days thereafter, execute or cause to be executed and deliver or cause to be delivered to the holder a certificate or certificates representing the aggregate number of full shares of Common Stock issuable upon such exercise, together with cash in lieu of any fraction of a share, as hereinafter provided. The stock certificate or certificates so delivered shall be, to the extent possible, in such denomination or denominations as such holder shall request in the notice and shall be registered in the name of the holder or, subject to Section 8, such other name as shall be designated in the notice. This Warrant shall be deemed to have been exercised and such certificate or certificates shall be deemed to have been issued, and the holder or any other Person so designated to be named therein shall be deemed to have become a holder of record of such shares for all purposes, as of the date the notice, together with the cash, check or checks and/or securities, if any, and this Warrant, are received by the Company as described above and all taxes required to be paid by the holder, if any, pursuant to Section 2.2 prior to the issuance of such shares have been paid. If this Warrant shall have been exercised in part, the Company shall, at the time of delivery of the certificate or certificates representing Warrant Stock, deliver to the holder a new Warrant evidencing the rights of the holder to purchase the unpurchased shares of Common Stock called for by this Warrant, which new Warrant shall in all other respects be identical with this Warrant, or, at the request of the holder, appropriate notation may be made on this Warrant and the same returned to the holder. Payment of the Warrant Price shall be made at the option of the holder by cash, wire transfer to an account in a bank located in the United States designated for such purpose by the Company, or certified or official bank check, or by transfer to the Company of shares of Series B Preferred Stock or Series C Preferred Stock, or any combination thereof. In the event of the application shares of Series B Preferred Stock or Series C Preferred Stock to the payment of the Warrant Price, the amount to be credited to the payment of the Warrant Price shall be the Initial Stated Value per share, in the case of any such application prior to the consummation of the Recapitalization, or the Post-Recapitalization Stated Value per share, in the case of any such application after the consummation of the 5 55 Recapitalization, in each case, plus an amount per share equal to all accrued and unpaid dividends thereon, whether or not declared, to the date of such exercise, provided that no such credit shall be made with respect to any such dividends if the holder of such shares held such shares on the record date therefor. Section 2.2. Payment of Taxes. The Company shall pay all expenses in connection with, and all taxes and other governmental charges that may be imposed with respect to, the issue or delivery of the Warrant Shares, unless such tax or charge is imposed by law upon the holder, in which case such taxes or charges shall be paid by the holder. The Company shall not be required, however, to pay any tax or other charge imposed in connection with any transfer involved in the issue of any certificate for shares of Common Stock issuable upon exercise of this Warrant in any name other than that of the holder, and in such case the Company shall not be required to issue or deliver any stock certificate until such tax or other charge has been paid or it has been established to the satisfaction of the Company that no such tax or other charge is due. Section 2.3. Fractional Shares. The Company shall not be required to issue a fractional share of Common Stock upon exercise of this Warrant. As to any fraction of a share which the holder of this Warrant would otherwise be entitled to purchase upon such exercise, the Company shall pay a cash adjustment in respect of such final fraction in an amount equal to the same fraction of the Current Market Price per share of Common Stock on the date of exercise. ARTICLE 3. TRANSFER, DIVISION AND COMBINATION Section 3.1. Transfer. Subject to compliance with Section 8, transfer of this Warrant and all rights hereunder, in whole or in part, shall be registered on the books of the Company to be maintained for such purpose, upon surrender of this Warrant at the principal office of the Company referred to in Section 2.1 or the office or agency designated by the Company pursuant to Section 11, together with a written assignment of this Warrant substantially in the form of Exhibit B hereto duly executed by the holder or its agent or attorney and funds sufficient to pay any transfer taxes payable upon the making of such transfer. Upon such surrender and, if required, such payment, the Company shall, subject to Section 8, execute and deliver a new Warrant or Warrants in the name(s) of the assignee or assignees and in the denomination(s) specified in such instrument of assignment, and shall issue to the assignor a new Warrant evidencing the portion of this Warrant not so assigned, and this Warrant shall promptly be canceled. A Warrant, if properly assigned in compliance with Section 8, may be exercised by a new holder for the purchase of shares of Common Stock without having a new Warrant issued. 6 56 Section 3.2. Division and Combination. Subject to Section 8, this Warrant may be divided or combined with other Warrants upon presentation hereof at the aforesaid office or agency of the Company, together with a written notice specifying the names and denominations in which new Warrants are to be issued, signed by the holder or its agent or attorney. Subject to compliance with Section 3.1 and with Section 8, as to any transfer which may be involved in such division or combination, the Company shall execute and deliver a new Warrant or Warrants in exchange for the Warrant or Warrants to be divided or combined in accordance with such notice. Section 3.3. Expenses. The Company shall prepare, issue and deliver at its own expense (other than transfer taxes) the new Warrant or Warrants under this Section 3. Section 3.4. Maintenance of Books. The Company agrees to maintain, at its aforesaid office or agency, books for the registration and the registration of transfer of the Warrants. ARTICLE 4. ADJUSTMENTS The number of shares of Common Stock for which this Warrant is exercisable, or the price at which such shares may be purchased upon exercise of this Warrant, shall be subject to adjustment from time to time as set forth in this Section 4. The Company shall give the holder notice of any event described below which requires an adjustment pursuant to this Section 4 at the time of such event. Section 4.1. Stock Dividends, Subdivisions, Combinations and Reclassifications. If the Company shall at any time or from time to time after the Issue Date: (a) pay a dividend or make a distribution, on the outstanding shares of Common Stock in Additional Shares of Common Stock, (b) subdivide its outstanding shares of Common Stock into a larger number of shares of Common Stock, (c) combine its outstanding shares of Common Stock into a smaller number of shares of Common Stock, or (d) issue by reclassification of its shares of Common Stock any shares of capital stock of the Company, then, and in each such case, the number of shares of Common Stock issuable upon exercise of the Warrants evidenced hereby immediately prior to such event or the record date therefor, whichever is earlier, shall be adjusted so that the holder of any Warrant evidenced hereby thereafter exercised shall be entitled to receive the number of shares of Common Stock or other 7 57 securities of the Company which such holder would have owned or have been entitled to receive after the happening of any of the events described above, had such Warrant been exercised immediately prior to the happening of such event or the record date therefor, whichever is earlier. An adjustment made pursuant to this Section 4.1 shall become effective (x) in the case of any such dividend or distribution, immediately after the close of business on the record date for the determination of holders of shares of Common Stock entitled to receive such dividend or distribution, or (y) in the case of any such subdivision, reclassification or combination, at the close of business on the day upon which such corporate action becomes effective. Section 4.2. Issuance of Additional Shares of Common Stock or Convertible Securities. In the case the Corporation shall, after the Issue Date, issue or sell: (a) Additional Shares of Common Stock at a price per share, or (b) Convertible Securities having a Conversion Price per share, less than the Current Market Price (for a period of 15 consecutive Trading Days prior to such date), then, and in each such case, the number of shares of Common Stock issuable upon exercise of the Warrants evidenced hereby shall be adjusted so that the holder of each Warrant evidenced hereby shall be entitled to receive, upon the exercise thereof, the number of shares of Common Stock determined by multiplying (A) the number of shares of Common Stock issuable upon exercise of the Warrants evidenced hereby on the day immediately prior to such date by (B) a fraction, the numerator of which shall be the sum of (1) the number of shares of Common Stock outstanding on the date on which such shares or Convertible Securities are issued and (2) the number of Additional Shares of Common Stock issued, or into which the Convertible Securities may convert, and the denominator of which shall be the sum of (x) the number of shares of Common Stock outstanding on such date and (y) the number of shares of Common Stock which the aggregate consideration receivable by the Company for the total number of shares of Common Stock so issued, or the number of shares of Common Stock which the aggregate of the Conversion Price of such Convertible Securities so issued, would purchase at the Current Market Price on such date. An adjustment made pursuant to this Section 4.2 shall be made on the next Business Day following the date on which any such issuance is made and shall be effective retroactively immediately after the close of business on such date. For purposes of this Section 4.2, the aggregate consideration receivable by the Company in connection with the issuance of any securities shall be deemed to be the sum of the aggregate offering price to the public (before deduction of underwriting 8 58 discounts or commissions and expenses payable to third parties), and the "Conversion Price" of any Convertible Securities is the total amount received or receivable by the Company as consideration for the issue or sale of such Convertible Securities (before deduction of underwriting discounts or commissions and expenses payable to third parties) plus the minimum aggregate amount of additional consideration, if any, payable to the Corporation upon the conversion, exchange or exercise of any such Convertible Securities. Neither (A) the issuance of any shares of Common Stock (whether treasury shares or newly issued shares) pursuant to a dividend or distribution on, or subdivision, combination or reclassification of, the outstanding shares of Common Stock requiring an adjustment in the number of shares of Common Stock issuable upon exercise of the Warrants evidenced hereby pursuant to Section 4.1, or pursuant to any employee benefit plan or program of the Company or pursuant to any option, warrant, right, or Convertible Security outstanding as of the date hereof (including, but not limited to, the Rights, the Series B Preferred Stock, the Series C Preferred Stock and the Warrants) nor (B) the issuance of shares of Common Stock pursuant thereto shall be deemed to constitute an issuance of Common Stock or Convertible Securities by the Company to which this Section 4.2 applies. Upon expiration of any Convertible Securities which shall not have been exercised or converted and for which an adjustment shall have been made pursuant to this Section 4.2, the Conversion Price computed upon the original issue thereof shall upon expiration be recomputed as if the only additional shares of Common Stock issued were such shares of Common Stock (if any) actually issued upon exercise or conversion of such Convertible Securities and the consideration received therefor was the consideration actually received by the Corporation for the issue of such Convertible Securities (whether or not exercised or converted) plus the consideration actually received by the Corporation upon such exercise of conversion. Section 4.3. Certain Other Distributions. In case the Company shall at any time or from time to time after the Issue Date declare, order, pay or make a dividend or other distribution (including, without limitation, any distribution of stock or other securities or property or rights or warrants to subscribe for securities of the Company or any of its Subsidiaries by way of dividend or spin-off), on its Common Stock, other than: (a) regular quarterly dividends payable in cash in an aggregate amount not to exceed 15% of net income from continuing operations before extraordinary items of the Company, determined in accordance with GAAP, during the period (treated as one accounting period) commencing on July 1, 1998, and ending on the date such dividend is paid, or 9 59 (b) dividends or distributions of shares of Common Stock which are referred to in Section 4.1, then, and in each such case, the number of shares of Common Stock issuable upon exercise of the Warrants evidenced hereby shall be adjusted so that the holder of each share of each Warrant evidenced thereby shall be entitled to receive, upon the exercise thereof, the number of shares of Common Stock determined by multiplying (1) the number of shares of Common Stock issuable upon exercise of the Warrants evidenced hereby on the day immediately prior to the record date fixed for the determination of stockholders entitled to receive such dividend or distribution by (2) a fraction, the numerator of which shall be the then Current Market Price per share of Common Stock for the period of 20 Trading Days preceding such record date, and the denominator of which shall be the Current Market Price per share of Common Stock for the period of 20 Trading Days preceeding such record date, less the Fair Market Value per share of Common Stock (as determined in good faith by the Board of Directors of the Company, a certified resolution with respect to which shall be mailed to the holder of the Warrants evidenced hereby) of such dividend or distribution; provided, however, that in the event of a distribution of shares of capital stock of a Subsidiary of the Company (a "Spin-Off") made to holders of shares of Common Stock, the numerator of such fraction shall be the sum of the Current Market Price per share of Common Stock for the period of 20 Trading Days preceding the 35th Trading Day after the effective date of such Spin-Off and the Current Market Price of the number of shares (or the fraction of a share) of capital stock of the Subsidiary which is distributed in such Spin-Off in respect of one share of Common Stock for the period of 20 Trading Days preceding such 35th Trading Day and the denominator of which shall be the Current Market Price per share of the Common Stock for the period of 20 Trading Days proceeding such 35th Trading Day. An adjustment made pursuant to this Section 4.3 shall be made upon the opening of business on the next Business Day following the date on which any such dividend or distribution is made and shall be effective retroactively immediately after the close of business on the record date fixed for the determination of stockholders entitled to receive such dividend or distribution; provided, however, if the proviso to the preceding sentence applies, then such adjustment shall be made and be effective as of such 35th Trading Day after the effective date of such Spin-Off. Section 4.4. Other Provisions Applicable to Adjustments Under This Section. The following provisions shall be applicable to the making of adjustments provided for in this Section 4: (a) For purposes of this Section 4, the number of shares of Common Stock at any time outstanding shall not 10 60 include any shares of Common Stock then owned or held by or for the account of the Company. (b) The term "dividend", as used in this Section 4 shall mean a dividend or other distribution upon stock of the Company except pursuant to the Rights Agreement. Notwithstanding anything in this Section 4 to the contrary, the number of shares of Common Stock issuable upon exercise of the Warrants evidenced hereby shall not be adjusted as a result of any dividend, distribution or issuance of securities of the Company pursuant to the Rights Agreement. (c) Notwithstanding anything in this Section 4 to the contrary, the Company shall not be required to give effect to any adjustment in the number of shares of Common Stock issuable upon exercise of the Warrants evidenced hereby unless and until the net effect of one or more adjustments (each of which shall be carried forward), determined as above provided, shall have resulted in a change in the number of shares of Common Stock issuable upon exercise of the Warrants evidenced hereby by at least one-hundredth of one share of Common Stock, and when the cumulative net effect of more than one adjustment so determined shall be to change the number of shares of Common Stock issuable upon exercise of the Warrants evidenced hereby by at least one-hundredth of one share of Common Stock, such change in the number of shares of Common Stock issuable upon exercise of the Warrants evidenced hereby shall thereupon be given effect. (d) The certificate of any firm of independent public accountants of recognized standing selected by the Board of Directors of the Company (which may be the firm of independent public accountants regularly employed by the Company) shall be presumptively correct for any computation made under this Section 4. (e) If the Company shall take a record of the holders of its Common Stock for the purpose of entitling them to receive a dividend or other distribution, and shall thereafter and before the distribution to stockholders thereof legally abandon its plan to pay or deliver such dividend or distribution, then, no adjustment in the number of shares of Common Stock issuable upon exercise of the Warrants evidenced hereby shall be required by reason of the taking of such record. (f) There shall be no adjustment of the number of shares of Common Stock issuable upon exercise of the Warrants evidenced hereby in case of the issuance of any stock of the Company in a merger, reorganization, acquisition or other similar transaction except as set forth in Sections 4.1, 4.2 and 4.5. 11 61 (g) Notwithstanding anything herein to the contrary, the Company agrees not to enter into any transaction which, by reason of any adjustment hereunder, would cause the Exercise Price to be less than the par value per share of Common Stock. (h) Upon each adjustment to the number of shares of Common Stock issuable upon exercise of the Warrants pursuant to Sections 4.1, 4.2 or 4.3, the Exercise Price effective immediately prior to the making of such adjustment shall thereafter be adjusted to be the amount obtained by (i) multiplying (A) the applicable number of shares of Common Stock issuable upon exercise of the Warrants immediately prior to such adjustment by (B) the Exercise Price in effect immediately prior to such adjustment and (ii) dividing the product so obtained by the number of shares of Common Stock issuable upon exercise of the Warrants immediately after such adjustment. Section 4.5. Reorganization, Reclassification, Merger, Consolidation or Disposition of Assets. In case of any reorganization or reclassification of outstanding shares of Common Stock (other than a reclassification covered by Section 4.1), or in case of any consolidation or merger of the Company with or into another corporation, or in the case of any sale or conveyance to another corporation of the property of the Company as an entirety or substantially as an entirety (each of the foregoing being referred to as a "Transaction"), each such Warrant then outstanding shall thereafter be exercisable for, in lieu of the Common Stock issuable upon such exercise prior to consummation of the Transaction, the kind and amount of shares of stock and other securities and property receivable (including cash) upon the consummation of the Transaction by a holder of that number of shares of Common Stock issuable upon exercise of such Warrant immediately prior to the Transaction (including, on a pro rata basis, the cash, securities or property received by holders of Common Stock in any tender or exchange offer that is a step in the Transaction). Section 4.6. Notices to Warrantholders. In case at any time or from time to time, prior to the Expiration Date, the Company shall pay any dividend or make any other distribution to the holders of its Common Stock, or shall offer for subscription pro rata to the holders of its Common Stock any additional shares of stock of any class or any other right, or there shall be any capital reorganization or reclassification of the Common Stock of the Company or consolidation or merger of the Company with or into another corporation, or any sale or conveyance to another corporation of the property of the Company as an entirety or substantially as an entirety, or there shall be a voluntary or involuntary dissolution, liquidation or winding up of the Company, then, in any one or more of said cases the Company shall give at least 20 days' prior written notice (the time of mailing of such notice shall be deemed to be the time of giving thereof) 12 62 to the registered holder of the Warrants evidenced hereby at its address as shown on the books of the Company maintained by the Transfer Agent thereof of the date on which (i) the books of the Company shall close or a record shall be taken for such stock dividend, distribution or subscription rights or (ii) such reorganization, reclassification, consolidation, merger, sale or conveyance, dissolution, liquidation or winding up shall take place, as the case may be, provided that in the case of any Transaction to which Section 4.5 applies the Company shall give at least 30 days' prior written notice as aforesaid. Such notice shall also specify the date as of which the holders of the Common Stock of record shall participate in said dividend, distribution or subscription rights or shall be entitled to exchange their Common Stock for securities or other property deliverable upon such reorganization, reclassification, consolidation, merger, sale or conveyance or participate in such dissolution, liquidation or winding up, as the case may be. Failure to give such notice shall not invalidate any action so taken. Section 4.7. Certificates. Upon any adjustment of the number of shares of Common Stock issuable upon exercise of the Warrants evidenced hereby or of the Exercise Price, then, and in each such case, the Company shall promptly deliver to the holders of the Warrants and the Common Stock, a certificate signed by the President or a Vice President and by the Treasurer or an Assistant Treasurer or the Secretary or an Assistant Secretary of the Company setting forth in reasonable detail the event requiring the adjustment and the method by which such adjustment was calculated and specifying the increased or decreased number of shares of Common Stock issuable upon exercise of the Warrants evidenced hereby and the Exercise Price then in effect following such adjustment. ARTICLE 5. NO IMPAIRMENT The Company shall not by any action including, without limitation, amending its certificate of incorporation or through any reorganization, transfer of assets, consolidation, merger, dissolution, issue or sale of securities or any other voluntary action, avoid or seek to avoid the observance or performance of any of the terms of this Warrant, but will at all times in good faith assist in the carrying out of all such terms and in the taking of all such actions as may be necessary or appropriate to protect the rights of the holder of the Warrant against impairment. Without limiting the generality of the foregoing, the Company will (a) not increase the par value of any shares of Common Stock receivable upon the exercise of this Warrant above the Exercise Price immediately prior to such increase in par value, (b) take all such action as may be necessary or appropriate in order that the Company may validly and legally issue fully paid and nonassessable shares of Common Stock, free and clear of any liens, claims, encumbrances and restrictions (other than as provided herein) upon the exercise of this 13 63 Warrant, and (c) use its best efforts to obtain all such authorizations, exemptions or consents from any public regulatory body having jurisdiction thereof as may be necessary to enable the Company to perform its obligations under this Warrant. Upon the request of the holder of the Warrant, the Company will at any time during the period this Warrant is outstanding acknowledge in writing, in form satisfactory to the holder of this Warrant, the continuing validity of this Warrant and the obligations of the Company hereunder. ARTICLE 6. RESERVATION AND AUTHORIZATION OF COMMON STOCK; REGISTRATION WITH OR APPROVAL OF ANY GOVERNMENTAL AUTHORITY The Company covenants and agrees that, until the Expiration Date, the Company shall at all times reserve and keep available for issue upon the exercise of Warrants such number of its authorized but unissued shares of Common Stock as will be sufficient to permit the exercise in full of all outstanding Warrants. All shares of Common Stock which shall be so issuable, when issued upon exercise of Warrants and payment therefor in accordance with the terms of such Warrant, shall be duly and validly issued, fully paid and nonassessable and free and clear of any liens, claims and restrictions (other than as provided herein). No stockholder of the Company has or shall have any preemptive rights to subscribe for such shares of Common Stock. Before taking any action which would result in an adjustment in the number of shares of Common Stock for which this Warrant is exercisable or in the Exercise Price, the Company shall obtain all such authorizations or exemptions thereof, or consents thereto, as may be necessary from any public regulatory body or bodies having jurisdiction thereof. ARTICLE 7. STOCK AND WARRANT TRANSFER BOOKS The Company will not at any time, except upon dissolution, liquidation or winding up of the Company, close its stock transfer books or Warrant transfer books so as to result in preventing or delaying the exercise or transfer of any Warrant. ARTICLE 8. RESTRICTIONS ON TRANSFERABILITY The Warrants and the Warrant Stock shall not be transferred before satisfaction of the conditions specified in this Section 8, which conditions are intended to ensure compliance with the provisions of the Securities Act and state securities laws with respect to the Transfer of any Warrant or any Warrant Stock. The holder, by acceptance of this Warrant, agrees to be bound by the provisions of this Section 8. 14 64 Section 8.1. Restrictive Legend. (a) Except as otherwise provided in this Section 8, each certificate for Warrant Stock initially issued upon the exercise of this Warrant, and each certificate for Warrant Stock issued to any subsequent transferee of any such certificate, shall be stamped or otherwise imprinted with a legend in substantially the following form: "The shares represented by this certificate have not been registered under the Securities Act of 1933, as amended, or the securities laws of any state and are subject to the conditions specified in a certain Warrant dated February 10, 1999, originally issued by Aames Financial Corporation. The shares represented by this certificate may not be transferred in violation of such Act and laws, the rules and regulations thereunder or the provisions of the Warrant. A copy of the form of said Warrant is on file with the Secretary of Aames Financial Corporation. The holder of this certificate, by acceptance of this certificate, agrees to be bound by the provisions of such Warrant." (b) Except as otherwise provided in this Section 8, each Warrant shall be stamped or otherwise imprinted with a legend in substantially the following form: "This Warrant and the securities represented hereby have not been registered under the Securities Act of 1933, as amended, or the securities laws of any state and may not be sold or otherwise transferred in the absence of such registration or an exemption therefrom under such Act and under any such applicable state laws, or in violation of the provisions of this Warrant." Section 8.2. Transfers. Prior to any transfer or attempted transfer of any Warrants or any shares of Restricted Common Stock, the holder of such Warrants or Restricted Common Stock shall give notice (a "Transfer Notice") to the Company of such holder's intention to effect such transfer, describing the manner and circumstances of the proposed transfer, and obtain from counsel a written opinion addressed and reasonably satisfactory to the Company that the proposed transfer of such Warrants or such Restricted Common Stock may be effected without registration under the Securities Act and applicable state securities laws. After receipt of the Transfer Notice and written opinion, the Company shall, within two Business Days thereof, so notify the holder of such Warrants or such Restricted Common Stock and such holder shall thereupon be entitled to transfer such warrants or such Restricted Common Stock, in 15 65 accordance with the terms of the Transfer Notice. Each certificate, if any, evidencing such shares of Restricted Common Stock issued upon such transfer shall bear the restrictive legend set forth in Section 8.1(a), and each Warrant issued upon such transfer shall bear the restrictive legend set forth in Section 8.1(b), unless in the written opinion of counsel addressed to the Company such legend is not required in order to ensure compliance with the Securities Act. Section 8.3. Termination of Restrictions. Notwithstanding the foregoing provisions of Section 8, the restrictions imposed by this Section 8 upon the transferability of the Warrants, the Warrant Stock and the Restricted Common Stock (or Common Stock issuable upon the exercise of the Warrants) and the legend requirements of Section 8.1 shall terminate as to any particular Warrant or share of Warrant Stock or Restricted Common Stock (or Common Stock issuable upon the exercise of the Warrants) (i) as to the Warrant Stock and Restricted Common Stock, when and so long as the resale of such security shall have been effectively registered under the Securities Act and disposed of pursuant thereto, or (ii) as to the Warrant, Warrant Stock and Restricted Common Stock, when the holder of the Warrant, Warrant Stock or Restricted Common Stock shall have delivered to the Company the written opinion of counsel addressed and reasonably satisfactory to the Company stating that such legend is not required in order to ensure compliance with the Securities Act. Whenever the restrictions imposed by this Section shall terminate as to any share of Restricted Common Stock, as hereinabove provided, the holder thereof shall be entitled to receive from the Company, at the Company's expense (except for any transfer taxes), a new certificate representing such Common Stock not bearing the restrictive legend set forth in Section 8.1(a). ARTICLE 9. SUPPLYING INFORMATION The Company shall cooperate with the holder of the Warrant and the holder of Restricted Common Stock in supplying such information as may be reasonably requested by such holder or reasonably necessary for such holder to complete and file any information reporting forms presently or hereafter required by the Commission as a condition to the availability of an exemption from the Securities Act for the sale of any Warrant or Restricted Common Stock. ARTICLE 10. LOSS OR MUTILATION Upon receipt by the Company from any holder of evidence reasonably satisfactory to the Company of the ownership of and the loss, theft, destruction or mutilation of this Warrant and indemnity reasonably satisfactory to it and in case of mutilation upon surrender and cancellation hereof, the Company will execute 16 66 and deliver in lieu hereof a new Warrant of like tenor to the holder; provided, in the case of mutilation, no indemnity shall be required if this Warrant in identifiable form is surrendered to the Company for cancellation. ARTICLE 11. OFFICE OF THE COMPANY As long as any of the Warrants remain outstanding, the Company shall maintain an office or agency (which may be the principal executive offices of the Company) where the Warrants may be presented for exercise, registration of transfer, division or combination as provided in this Warrant. ARTICLE 12. REGISTRATION RIGHTS The Warrant Stock issuable upon exercise of this Warrant are entitled to the benefits of the Registration Rights Agreement. The Company shall keep a copy of the Registration Rights Agreement, and any amendments thereto, at the office or agency designated by the Company pursuant to Section 11 and shall furnish copies thereof to the holder upon request. ARTICLE 13. LIMITATION OF LIABILITY No provision hereof, in the absence of affirmative action by the holder to purchase shares of Common Stock, and no enumeration herein of the rights or privileges of the holder hereof, shall give rise to any liability of the holder for the purchase price of any Common Stock or as a stockholder of the Company, whether such liability is asserted by the Company or by creditors of the Company. ARTICLE 14. REPRESENTATION OF HOLDER The holder represents that it is acquiring the Warrant and the Warrant Stock for the purpose of investment and not with a view to the resale or distribution hereof or thereof; provided, that the disposition of holder's property shall at all times be and remain within its control. ARTICLE 15. MISCELLANEOUS Section 15.1. Nonwaiver and Expenses. No course of dealing or any delay or failure to exercise any right hereunder on the part of the parties shall operate as a waiver of such right or otherwise prejudice the parties' rights, powers or remedies. If the Company fails to comply with any provision of this Warrant, the Company shall pay to the holder such amounts as 17 67 shall be sufficient to cover any costs and expenses including, but not limited to, reasonable attorneys' fees incurred by the holder in collecting any amounts due pursuant hereto or in otherwise enforcing any of its rights, powers or remedies hereunder. Section 15.2. No Rights As Stockholder. The Person in whose name this Warrant is registered shall be deemed the owner hereof and of the Warrants evidenced hereby for all purposes. The registered holder of this Warrant shall not be entitled to any rights whatsoever as a stockholder of the Company except as herein provided. Section 15.3. Notice Generally. Any notice, demand, request, consent, approval, declaration, delivery or other communication hereunder to be made pursuant to the provisions of this Warrant shall be sufficiently given or made if in writing and either delivered in person with receipt acknowledged or sent by registered or certified mail, return receipt requested, postage prepaid, addressed as follows: (a) If to the holder, at its last known address appearing on the books of the Company maintained for such purpose. (b) If to the Company: Aames Financial Corporation 2 California Plaza 350 South Grand Avenue Los Angeles, California 90071 Attention: Cary Thompson Fax No.: (323) 210-4537 with a copy to: Troop Steuber Pasich Reddick & Tobey 2029 Century Park East Los Angeles, California 90067 Attention: C. N. Franklin Reddick, Esq. Fax No.: (310) 728-2204 or at such other address as may be substituted by notice given as herein provided. The giving of any notice required hereunder may be waived in writing by the party entitled to receive such notice. Every notice, demand, request, consent, approval, declaration, delivery or other communication hereunder shall be deemed to have been duly given or served on the date on which personally delivered, with receipt acknowledged, or three (3) Business Days after the same shall have been deposited in the United States mail. 18 68 Section 15.4. Successors and Assigns. Subject to the provisions of Sections 3.1 and 8, (i) this Warrant and the rights evidenced hereby shall inure to the benefit of and be binding upon the successors of the Company and the successors and assigns of the holder, and (ii) the provisions of this Warrant are intended to be for the benefit of all holders from time to time of this Warrant, and shall be enforceable by any such holders. Section 15.5. Amendment. The Warrants may be modified or amended or the provisions thereof waived with the written consent of the Company and the holders of the majority of the portion of this Warrant then outstanding. Section 15.6. Severability. Wherever possible, each provision of this Warrant shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Warrant shall be prohibited by or invalid under applicable law, such provision shall be ineffective to the extent of such prohibition or invalidity, without invalidating the remainder of such provision or the remaining provisions of this Warrant. Section 15.7. Headings. The headings used in this Warrant are for the convenience of reference only and shall not, for any purpose, be deemed a part of this Warrant. Section 15.8. Governing Law. This Warrant shall be governed by and construed in accordance with the laws of the State of Delaware, without giving effect to conflicts of law principles thereof. Section 15.10. Mutual Waiver of Jury Trial. BECAUSE DISPUTES ARISING IN CONNECTION WITH COMPLEX FINANCIAL TRANSACTIONS ARE MOST QUICKLY AND ECONOMICALLY RESOLVED BY AN EXPERIENCED AND EXPERT PERSON AND THE PARTIES WISH APPLICABLE STATE AND FEDERAL LAWS TO APPLY (RATHER THAN ARBITRATION RULES), THE PARTIES DESIRE THAT THEIR DISPUTES BE RESOLVED BY A JUDGE APPLYING SUCH APPLICABLE LAWS. THEREFORE, TO ACHIEVE THE BEST COMBINATION OF THE BENEFITS OF THE JUDICIAL SYSTEM AND OF ARBITRATION, THE PARTIES HERETO WAIVE ALL RIGHT TO TRIAL BY JURY IN ANY ACTION, SUIT OR PROCEEDING BROUGHT TO ENFORCE OR DEFEND ANY RIGHTS OR REMEDIES UNDER THIS WARRANT. 19 69 IN WITNESS WHEREOF, the Company has caused this Warrant to be duly executed by its authorized officer on _______________, 1998. AAMES FINANCIAL CORPORATION By: -------------------------------------- Name: Title: 20 70 EXHIBIT A SUBSCRIPTION FORM [To be executed only upon exercise of Warrant] The undersigned registered owner of this Warrant irrevocably exercises this Warrant for the purchase of _____ Shares of Common Stock of AAMES FINANCIAL CORPORATION and herewith makes payment therefor, all at the price and on the terms and conditions specified in this Warrant and requests that certificates for the shares of Common Stock hereby purchased (and any securities or other property issuable upon such exercise) be issued in the name of and delivered to __________________ whose address is ____________________ and, if such shares of Common Stock shall not include all of the shares of Common Stock issuable as provided in this Warrant, that a new Warrant of like tenor and date for the balance of the shares of Common Stock issuable hereunder be delivered to the undersigned. (Name of Registered Owner) - -------------------------------- (Signature of Registered owner) - -------------------------------- (Street Address) - -------------------------------- (City) (State) (Zip Code) - -------------------------------- NOTICE: The signature on this subscription must correspond with the name as written upon the face of the within Warrant in every particular, without alteration or enlargement or any change whatsoever. 71 EXHIBIT B ASSIGNMENT FORM FOR VALUE RECEIVED the undersigned registered owner of this Warrant hereby sells, assigns and transfers unto the Assignee named below all of the rights of the undersigned under this Warrant, with respect to the number of shares of Common Stock set forth below: Name and Address of Assignee No. of Shares of Common Stock - ---------------------------- ----------------------------- and does hereby irrevocably constitute and appoint ____________ attorney-in-fact to register such transfer on the books of AAMES FINANCIAL CORPORATION maintained for the purpose, with full power of substitution in the premises. Dated: ------------------------------ Name: ------------------------------- Signature: -------------------------- Witness: ---------------------------- NOTICE: The signature on this assignment must correspond with the name as written upon the face of the within Warrant in every particular, without alteration or enlargement or any change whatsoever. EX-10.29 14 SECOND SUPPLEMENTAL INDENTURE 1 EXHIBIT 10.29 AAMES FINANCIAL CORPORATION, ISSUER THE SUBSIDIARY GUARANTORS AND THE CHASE MANHATTAN BANK TRUSTEE SECOND SUPPLEMENTAL INDENTURE DATED AS OF FEBRUARY 10, 1999 ---------- $150,000,000 9.125% SENIOR NOTES DUE 2003 Supplementing the Indenture dated as of October 21, 1996 between Aames Financial Corporation, as Issuer, and The Chase Manhattan Bank, as Trustee, as amended and supplemented to date 2 THIS SECOND SUPPLEMENTAL INDENTURE (the "Second Supplemental Indenture"), dated as of February 10, 1999 among AAMES FINANCIAL CORPORATION, a Delaware corporation (the "Company"), the SUBSIDIARY GUARANTORS listed on the signature page hereto (the "Subsidiary Guarantors") and THE CHASE MANHATTAN BANK, a New York banking corporation, as Trustee (the "Trustee"), to the Indenture dated as of October 21, 1996 (the "Original Indenture"), as amended and supplemented by a First Supplemental Indenture dated as of October 21, 1996 (the "First Supplemental Indenture") (the Original Indenture as so amended and supplemented by the First Supplemental Indenture, the "Indenture"). WITNESSETH: WHEREAS, the Company has issued its 9.125% Senior Notes Due 2003 (the "Securities") pursuant to the Indenture; WHEREAS, the Company has entered into a Preferred Stock Purchase Agreement dated as of December 23, 1998 (the "Preferred Stock Purchase Agreement") with Capital Z Financial Services Fund II, L.P., a Bermuda limited partnership ("Capital Z"), pursuant to which and subject to the terms and conditions thereof, Capital Z will make an equity investment in the Company of up to $100 million. The Preferred Stock Purchase Agreement provides, among other things, for (i) the investment of $75 million through the purchase by Capital Z or its designees of newly designated Series B Convertible Preferred Stock (the "Series B Stock") of the Company and newly designated Series C Convertible Preferred Stock of the Company (the "Series C Stock") in a private placement transaction (the "Initial Closing"); (ii) after the Initial Closing and completion of a recapitalization of the Company, an offering to the Company's stockholders of non-transferable rights to purchase up to $25 million of Series C Stock; and (iii) the sale to Capital Z or its designees of any and all shares of Series C Stock not purchased by the Company's stockholders in such rights offering (the transactions referred to in clauses (i), (ii) and (iii) are collectively referred to as the "Preferred Stock Issuance"). WHEREAS, the Company has solicited the consent of the registered holders (the "Holders") of the Securities as of January 11, 1999, the record date set by the Company, to (i) waive the obligation of the Company upon the change of control resulting from the Preferred Stock Issuance under Section 5.14 of the Indenture to purchase any or all of the Securities at 101% of principal amount, plus accrued and unpaid interest to the date of repurchase to facilitate the Preferred Stock Issuance (the "Change of Control Waiver") and (ii) waive the requirement in the definition thereof that "Consolidated Net Worth" be based on the balance sheet for the most recent fiscal quarter to allow for immediate recognition, when made at the Initial Closing, of the $75 million investment by Capital Z under the Preferred Stock Purchase Agreement in Series B Stock and Series C Stock as an addition to the Company's Consolidated Net Worth as of December 31, 1998 (the "Net Worth Definition Waiver"). WHEREAS, the Trustee has received evidence satisfactory to it of the consent of the Holders of at least a majority in principal amount of the Securities outstanding which are not owned by the Company or its affiliates to the Change of Control Waiver and to the Net Worth Definition Waiver pursuant to Section 9.02 of the Indenture. NOW, THEREFORE, intending to be legally bound hereby, the parties agree as follows. Capitalized terms used herein and not otherwise defined shall have the meanings assigned to them in the Indenture. 3 ARTICLE I CHANGE OF CONTROL WAIVER All Holders and every subsequent holder of the Securities shall be bound by the following waiver of the Indenture and the Securities: Such persons expressly waive the applicability of Section 5.14 of the Indenture to the change of control resulting from the Preferred Stock Issuance under the Preferred Stock Purchase Agreement, including any obligation on the part of the Company to offer to repurchase any or all of the Securities at 101% of the principal amount, together with accrued and unpaid interest, as a result of the change of control resulting from the Preferred Stock Issuance. ARTICLE II NET WORTH DEFINITION WAIVER All Holders and every subsequent holder of the Securities shall be bound by the following waiver of the Indenture and the Securities: Such persons expressly waive the requirement in the definition thereof that "Consolidated Net Worth" be based on the balance sheet for the most recent fiscal quarter to allow for immediate recognition, when made at the Initial Closing, of the $75 million investment in Series B Stock and Series C Stock under the Preferred Stock Purchase Agreement as an addition to the Company's Consolidated Net Worth as of December 31, 1998. ARTICLE III MISCELLANEOUS Section 3.1 Except as waived hereby, all of the terms of the Indenture shall remain and continue in full force and effect and are hereby confirmed in all respects. Section 3.2 This Second Supplemental Indenture and each and every provision hereof shall be deemed to be a contract made under the laws of the State of New York and for all purposes shall be construed in accordance with the laws of such State. Section 3.3 This Second Supplemental Indenture may be executed in any number of counterparts, each of which shall be an original; but such counterparts shall constitute but one and the same instrument. Section 3.4 In entering into this Second Supplemental Indenture, the Trustee shall be entitled to the benefit of every provision of the Indenture relating to the conduct or affecting the liability of or affording protection to the Trustee, whether or not elsewhere herein so provided. [Signature page follows] 2 4 IN WITNESS WHEREOF, the parties hereto have caused this Second Supplemental Indenture to be duly executed, and their respective corporate seals to be hereunto affixed and attested, all as of the date hereof. AAMES FINANCIAL CORPORATION OXFORD AVIATION CORPORATION, INC. By: /s/ Barbara S. Polsky By: /s/ Barbara S. Polsky ------------------------------- -------------------------------------- Name: Barbara S. Polsky Name: Barbara S. Polsky Title: Executive Vice President Title: Executive Vice President AAMES CAPITAL CORPORATION ROSSMORE FINANCIAL INSURANCE SERVICES, INC. By: /s/ Barbara S. Polsky By: /s/ Barbara S. Polsky ------------------------------- -------------------------------------- Name: Barbara S. Polsky Name: Barbara S. Polsky Title: Executive Vice President Title: Executive Vice President AAMES FUNDING CORPORATION SERRANO INSURANCE SERVICES, INC. By: /s/ Barbara S. Polsky By: /s/ Barbara S. Polsky ------------------------------- -------------------------------------- Name: Barbara S. Polsky Name: Barbara S. Polsky Title: Executive Vice President Title: Executive Vice President ONE STOP MORTGAGE, INC. WINDSOR MANAGEMENT CO. By: /s/ Barbara S. Polsky By: /s/ Barbara S. Polsky ------------------------------- -------------------------------------- Name: Barbara S. Polsky Name: Barbara S. Polsky Title: Executive Vice President Title: Executive Vice President THE CHASE MANHATTAN BANK, as trustee By: /s/ Susan Lai ------------------------------ Name: Susan Lai Title: Trust Officer EX-11 15 COMPUTATION OF PER SHARE EARNINGS(LOSS) 1 EXHIBIT 11 AAMES FINANCIAL CORPORATION COMPUTATION OF EARNINGS (LOSS) PER SHARE FOR THE THREE MONTHS AND SIX MONTHS ENDED DECEMBER 31, 1998 AND DECEMBER 31, 1997
THREE MONTHS ENDED SIX MONTHS ENDED DECEMBER 31, DECEMBER 31, ------------------------------ ------------------------------- 1998 1997 1998 1997 ------------- ------------ ------------- -------------- (Restated) (Restated) (Restated) Basic earnings (loss) per common share: Net income (loss) for calculating basic earnings (loss) per common share ($ 195,745,000) $ 9,170,000 ($ 197,901,000) $ 19,103,000 ============= ============ ============= ============== Average common shares outstanding 31,007,000 27,799,000 30,992,000 27,784,000 ------------- ------------ ------------- -------------- Basic earnings (loss) per common share ($6.31) $0.33 ($6.39) $0.69 ============= ============ ============= ============== Diluted earnings (loss) per common share: Net income (loss) ($ 195,745,000) $ 9,170,000 ($ 197,901,000) $ 19,103,000 ============= ============ ============= ============== Adjust net income to add back the after-tax amount of interest recognized in the period associated with the convertible subordinated notes - 909,000 - 1,760,000 ------------- ------------ ------------- -------------- Adjusted net income (loss) ($ 195,745,000) $ 10,079,000 ($ 197,901,000) $ 20,863,000 ============= ============ ============= ============== Average common shares outstanding 31,007,000 27,799,000 30,992,000 27,784,000 Add exercise of options and warrants 204,000 1,043,000 247,000 1,381,000 Convertible subordinated notes - 6,107,000 - 6,107,000 ------------- ------------ ------------- -------------- Diluted shares outstanding 31,211,000 34,949,000 31,239,000 35,272,000 ============= ============ ============= ============== Diluted earnings (loss) per common share ($6.27) $0.29 ($6.34) $0.59 ============= ============ ============= ==============
EX-27 16 FINANCIAL DATA SCHEDULE
5 6-MOS JUN-30-1999 JUL-01-1998 DEC-31-1998 11,790,000 0 424,468,000 664,000 271,324,000 706,918,000 27,279,000 12,549,000 721,648,000 329,295,000 286,990,000 0 0 31,000 105,332,000 721,648,000 (96,662,000) (96,662,000) 21,489,000 21,489,000 70,873,000 0 22,285,000 (211,309,000) 13,408,000 0 0 0 0 (197,901,000) (6.39) (6.34) For purposes of this exhibit, Primary means Basic.
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