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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10
GENERAL FORM FOR REGISTRATION OF SECURITIES
Pursuant to Section 12(b) or (g) of the Securities Exchange Act of 1934
THE CREDIT STORE, INC.
(Exact name of registrant as specified in its charter)
Delaware 87-029-6990
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
3401 North Louise Avenue
Sioux Falls, South Dakota 57107
(Address of principal executive offices) (zip code)
(800) 240-1855
(Issuer's telephone number, including area code)
Securities to be registered under Section 12(b) of the Act:
Title of each class Name of each exchange on which
to be so registered each class is to be registered
None None
Securities to be registered under Section 12(g) of the Act:
Common Stock, par value $0.001
(Title of Class)
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ITEM 1 - BUSINESS
The Credit Store, Inc. is a technology based, financial services company
that provides credit card products to consumers who may otherwise fail to
qualify for a traditional unsecured bank credit card. The Company reaches these
consumers by acquiring portfolios of non-performing consumer receivables and
offering a new credit card to those consumers who agree to pay all or a portion
of the outstanding amount due on their debt. The new card is issued with an
initial balance and credit line equal to the agreed repayment amount. After
appropriate seasoning, the Company seeks to sell or securitize the credit card
receivables generated by this business strategy. The Company offers other forms
of settlement to those consumers who do not accept the credit card offer.
GENERAL DEVELOPMENT OF BUSINESS
The Company was incorporated in 1972 in Utah as Valley West Development
Corporation, changed its corporate domicile to Delaware in 1995, and changed its
name to Credit Store, Inc. on October 8, 1996. Prior to October 8, 1996, the
Company discontinued operations of its prior line of business which was
unrelated to its current operations. On December 4, 1996, the Company acquired
from Taxter One LLC ("Taxter") all the capital stock of Service One Holdings
Inc. ("Holdings"). At the time of the acquisition, Holdings' sole asset was the
capital stock of Service One International Corporation ("SOIC"), which had been
engaged since January 1996 in the business of acquiring non-performing consumer
debt portfolios, and the marketing and servicing of credit cards, generated from
these portfolios. From 1982 through December 1995, SOIC had been a marketer and
servicer of secured credit cards for a South Dakota bank under a contractual
arrangement which expired in December 1995. Following the acquisition of
Holdings, the Company engaged directly, and through SOIC and its affiliates, in
the acquisition of non-performing consumer debt and the marketing and servicing
of credit cards generated from these portfolios. In February 1998, Holdings and
Credit Store Mortgage, Inc., a wholly-owned subsidiary of the Company, were each
merged into the Company. In March 1998, SOIC was merged into the Company and the
Company's name was changed to The Credit Store, Inc.
NARRATIVE DESCRIPTION OF BUSINESS
The Company is primarily in the business of providing credit card products
to consumers who may otherwise fail to qualify for a traditional unsecured bank
credit card. The Company reaches these consumers by acquiring portfolios of
non-performing consumer receivables at a substantial discount from the actual
outstanding balance and offering a new credit card to those consumers who agree
to pay all or a portion of the outstanding amount due on their debt. The new
card is issued with an initial balance and credit line equal to the agreed
repayment amount. The Company's objective is to have these new credit card
receivables, over time, become seasoned and to sell and/or securitize these
seasoned assets at a price substantially in excess of the Company's investment
in the receivables.
Under the Company's marketing approach, consumers are offered an
opportunity to settle their debt, typically at a discount, to transfer the
settled amount to a newly issued unsecured MasterCard(R) or Visa(R) credit card,
and to begin establishing a positive credit history by making timely and
consistent payments on the newly issued credit card. After making principal
payments on the transferred balance, the consumer can begin using the credit
card for new purchases or cash advances and may be granted increased credit
limits over time based on their payment performance. The Company's credit card
offer is attractive to a significant percentage of the consumers contacted by
the Company, who given the nonperforming status of their debt, are typically
receiving few or no solicitations from traditional credit card companies. Many
of these consumers cannot easily obtain an unsecured credit card, want to
improve their credit standing or have experienced the negative aspects of not
having access to the credit card payment system for travel and the daily
purchase of goods and services. The Company's approach
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differs from traditional credit card companies that compete for new customers
through mass marketing and direct mail campaigns on the basis of interest rates,
fees, and services offered.
INDUSTRY OVERVIEW
The Company operates in the consumer finance industry, competing with
issuers of revolving credit products and other buyers of non-performing consumer
debt.
The United States Federal Reserve reported that American consumers owed an
aggregate of $1.36 trillion of debt at the end of August 1999, exclusive of home
mortgages, and that the size of the revolving credit market in the United States
was in excess of $587 billion as of the end of August 1999, up from $383 billion
at the end of 1994. The United States Federal Reserve also reported that pools
of securitized revolving credit assets totaled $309 billion at the end of August
1999, up from $96 billion at the end of 1994. The Company believes that the
purchasing convenience associated with unsecured credit cards has driven the
growth of credit cards and has made them the preferred consumer credit vehicle.
In addition, the Company believes that the purchase of consumer goods and
services over the Internet will continue to fuel the demand for credit cards.
The Company also believes that the relative liquidity and predictability of
these assets has fostered the widespread acceptance of revolving credit
securitizations by investors.
While traditional banking organizations have enjoyed significant
advantages in consumer lending compared to non-bank providers of consumer loans,
greater access to capital and the emergence of securitization markets, coupled
with technological advances, has allowed non-banks to compete effectively with
banks in this arena. The Company believes that future success in the credit card
industry will continue to be experienced primarily by highly focused
organizations that are adept at using information and technology to market their
products and manage risk within their portfolios.
Credit card issuers make credit cards available to their clients in a
variety of ways. Many issuers offer cards as a convenience to existing clients,
a strategy to create greater affinity and client loyalty. This is generally the
case with credit cards offered by department stores, who offer private label
credit cards, as well as smaller banks and credit unions. In contrast, the
larger credit card issuers who control the vast majority of the market use mass
mailing of credit card offers to consumers as the most cost-effective means of
achieving the growth rates they seek. Often this process is accomplished by
obtaining a list of names of individuals who meet the issuer's credit guidelines
from one of the national credit bureaus. The Company sources its customers by
purchasing charged-off consumer debt from banks and finance companies and
believes that the purchase of charged-off debt is an efficient means to source
new credit card customers in its target market.
The Company sources its new customers from the portfolios of
non-performing consumer debt that it acquires. The Company believes that the
market for buying and selling non-performing consumer debt portfolios has
expanded due to a steadily increasing volume of charged-off consumer debt
coupled with a shift by originating institutions toward selling their portfolios
of non-performing consumer loans. Historically, originating institutions had
relied upon large internal collection staffs for their initial collection
efforts and outside collection agencies for accounts delinquent more than 180
days. As buyers emerged to purchase non-performing debt, originating
institutions have increasingly sold these portfolios for cash. Institutions will
usually sell accounts when the market prices exceed the net present value of
retaining and working the accounts. In deciding whether to sell accounts,
sellers also evaluate the potential return on investment of reinvesting the cash
proceeds from portfolio sales in the core operations of originating and
servicing new loans.
According to the Debt Sales Directory, published by Faulkner & Gray, a
leading receivables management publisher, the sales volume of charged-off debt
by initial credit grantors has grown from $2.5 billion in 1990, to $18.5 billion
in 1998, to an estimated $22.5 billion in 1999. These numbers exclude resale
volume, which is also
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significant in size. Sellers have developed a variety of ways to sell
non-performing receivables. Some originating institutions pursue auction type
sales by constructing a portfolio of receivables and seeking bids from specially
invited competing parties. This approach has resulted in an increase in the
number of receivables portfolios offered for sale by account brokers. Other
means of selling receivables include privately negotiated direct sales when the
originating institution contacts known, reputable purchasers and the terms of
sale are negotiated. Originating institutions have also entered into "forward
flow" contracts that provide for an originating institution to sell some or all
of its receivables over a period of time to a single third party.
BUSINESS OPERATIONS
The Company's operations integrate the following disciplines: (1)
portfolio acquisitions; (2) marketing and card origination; (3) customer service
and collections; and (4) receivables sales and securitizations.
PORTFOLIO ACQUISITIONS:
The Company acquires non-performing credit card receivables, consumer
installment loans, and automobile deficiencies on a nationwide basis, from a
wide range of originating institutions, including banks and finance companies.
Through May 31, 1999, the Company has acquired in excess of $3 billion in
receivables. These portfolios have been purchased by the Company for a nominal
percentage of the face amount of the debt, typically ranging from 0.50% to 3.00%
of the receivable balance. A typical portfolio contains between 5,000 and
150,000 consumer accounts that have been typically charged-off by the original
lending institution and have passed through various stages of collection
efforts. The size of each account has typically ranged between $1,000 and
$6,000, with an average balance since the Company began purchasing
non-performing portfolios of approximately $2,100.
The consumer debt and credit card industries generally categorize
delinquent and charged-off accounts into three groups: primary, secondary and
tertiary. Primary accounts are typically 120 to 270 days past due and are in the
process of being placed with collection agencies or collection attorneys for the
first time. Secondary accounts are 270 to 360 days past due and may have already
been placed with one collection agency. Tertiary accounts have already been
placed unsuccessfully with more than two collection agencies. The Company
acquires primarily tertiary accounts.
The Company has also purchased "bankruptcy" and "out of statute" accounts.
A "bankruptcy account" is one with respect to which the debtor has filed a
bankruptcy petition and may have had their debt discharged. The Company is not
presently offering credit cards to bankruptcy accounts. An "out of statute"
account is one with respect to which the statute of limitations for collection
of the debt has expired. Debt that is "out of statute" will not be enforced by a
court of law. Accordingly, the likelihood of recoveries from such accounts is
lower than on accounts that are currently enforceable by a court of law.
The Company continually seeks new and continuing sources of non-performing
portfolios for purchase. Once such portfolios are located, an acquisition team
is responsible for coordinating due diligence, stratifying and analyzing the
portfolio characteristics, projecting conversions to new credit cards and the
total cash collections on the accounts. The acquisition team is also responsible
for preparing bid proposals for review and approval by senior management,
processing and tracking the bids, documenting and closing the purchase, and
coordinating the receipt of account documentation and media for acquired
portfolios.
The Company uses its proprietary analytical methodology and database to
evaluate a potential portfolio purchase. The Company has developed a large and
valuable database of performance characteristics from the over $3 billion of
receivables it has purchased since inception that enables it to predict future
portfolio performance. This methodology and database comprise the model which
the Company uses to analyze and price the potential
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portfolio purchase. The Company believes that its methodology permits it to
accurately price portfolio purchases so it may realize an appropriate return on
capital from its new credit card originations and the subsequent cash flows
generated from these new credit cards.
MARKETING AND CARD ORIGINATION:
Marketing Strategy. Once a portfolio acquisition is completed, the
receivables and accounts in an acquired portfolio are processed by the Company's
marketing and card origination departments. The Company believes that its
consumer friendly and hands-on approach to the consumer is a key component of
its business strategy. Many of the receivables acquired by the Company represent
obligations of individuals who have, in the past several years, experienced some
life-altering event, such as divorce, career displacement or major medical
illness, and have recovered or currently are recovering financially from their
setback. Potential customers are contacted through direct mail and by telephone
and offered the opportunity to settle their debt and obtain an unsecured credit
card which can be used to make new purchases. A customer who accepts the
Company's offer is issued a new unsecured credit card by an unaffiliated issuing
bank. The card has an outstanding balance and credit limit equal to the amount
agreed upon by the customer to settle his outstanding debt. As the customer
makes principal payments on the outstanding balance, the customer frees up his
credit limit for new purchases. In addition, the Company may increase the credit
limit for customers who make a certain number of payments on the settled amount.
The Company reports the payment history on the credit card to the major credit
bureaus. By settling the defaulted debt in this manner, the Company believes it
provides its customers with an opportunity to establish a positive payment
history on their credit record by making timely and consistent payments on their
new credit card.
The Company believes its business strategy affords it more flexibility
than originating institutions and third-party collection agencies in recovering
all or a portion of the amount owed on an account. Factors that contribute to
this increased flexibility include: (i) the Company is able to settle the
account with the consumer at an amount that fits within the consumer's budget
because the Company acquired the account at a substantial discount from the
actual outstanding balance; (ii) the Company offers a new unsecured credit card
which has utility to the consumer due to its revolving nature; (iii) the Company
is not limited by many of the cultural and regulatory constraints that influence
account resolution decisions of banks, savings and loan and other financial
institutions; and (iv) the Company is not bound by the limited time periods to
resolve receivables faced by third-party collection agencies.
CARD ORIGINATION. In the Company's experience, much of the account
information contained in the portfolios it acquires is stale. Accordingly, once
a particular portfolio has been purchased, a "scrubbing" process begins.
Scrubbing describes the process of electronically updating phone numbers and
addresses on each account purchased. Scrubbing is done pursuant to an agreement
with a third party that specializes in locating consumers with little or no
credit history. The Company has also developed proprietary models which allow it
to focus on accounts with the best marketing potential. The Company believes
that using third-party scrubbing services produces quality results and allows it
to efficiently focus its resources on marketing and servicing its customers.
Contemporaneously with the initial scrubbing, the Company conducts an analysis
to determine which accounts in the acquired portfolio should be returned to the
seller because they do not meet the criteria established for each account under
the terms of the portfolio acquisition agreement. Although the terms of each
portfolio acquisition agreement differ, examples of accounts that may be
returned under the typical portfolio acquisition agreement include debts paid
off prior to the Company's acquisition, debts in which the consumer filed
bankruptcy prior to the Company's acquisition and debts in which the consumer
was deceased prior to the Company's acquisition. Typically, the agreement with
the seller of the portfolio allows the Company a specified period of time from
the date of purchase to return such non-qualifying accounts in the portfolio.
Under the typical portfolio acquisition agreement, the seller either replaces a
returned account or refunds the portion of the purchase price attributable to
the account.
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Once the portfolio has been scrubbed, the Company uses both direct mail
and phone contact to market the credit card product. The Company operates a
25,000 square foot direct mail and account file storage center (the "Mail
Center") in Sioux Falls, South Dakota. The Mail Center is equipped with
high-speed printing, folding, inserting, zip sorting and mailing equipment
capable of sending 100,000 pieces per day. Having its direct mail operations
in-house allows the Company to manage high quality direct mail campaigns in a
cost-effective manner. The Mail Center is linked electronically with the
Company's operation center, allowing the Mail Center to receive database
information to print and mail specific mail campaigns. The Company also
maintains a trained telemarketing sales force that operates from the Company's
Sioux Falls, South Dakota headquarters. The group is supported by a
state-of-the-art auto-dialer, which enables telemarketers to effectively manage
their large inventory of accounts. The Company employs approximately 70
telemarketers (35 per shift) which results in 100,000 to 150,000 production
hours annually. This enables the Company to maximize calling efficiency and
customer contact capabilities. The Company currently has space and system
capacity to significantly expand its telemarketing staff. The auto-dialer
enhances productivity via high-speed dialing coupled with a screening process to
detect no-answers, nonexistent numbers and answering machines. This technology
allows sales agents to concentrate their efforts on actual customers. Phone
numbers are loaded into the auto-dialer and cleared during each shift of sales
agents to ensure all numbers have been called. In addition to outbound
telemarketing calls, the Company receives incoming calls that are prompted by
mailings. Incoming calls are routed directly to the telemarketing department
where sales agents service the inquiry.
The telemarketing agents are trained to understand the customer base,
keeping in mind that the individual has experienced collection techniques
employed by several agencies. The Company believes the utility of an unsecured
credit card often is a major benefit to this segment of consumers because they
may not qualify for a traditional unsecured account. The Company also believes
that an important feature of its program is the opportunity to settle an old
account and to gain the opportunity to establish a positive payment history on
one's credit record by making timely and consistent payments on a new credit
card.
The table below summarizes the Company's standard credit card program as
currently offered:
Initial Credit Line: Settlement Amount
Annual Fee: $0 the 1st year; $35 annual thereafter
Interest Rate: 18.9% or 19.9%
Grace Period: 25 Days
Late Fee: $10.00
Over Limit Fee: $10.00
Cash Advance Fee: Greater of 2% or $2.00
Minimum Payment: Greater of 3% or $10.00
For any customer who does not wish to maintain a new credit card account
but who agrees to settle his previously charged-off debt account, the Company
has established a non-card resolutions department whereby the customer can make
an installment or lump sum payment to settle his obligation.
The Company also offers the convenience of an Automatic Payment Program
("APP") to its customers, whereby the customer authorizes the Company to
withdraw from the customer's bank account the monthly minimum credit card
payment. Approximately 18% of the Company's customers are currently using APP.
Accounts on APP have a lower incidence of delinquency than those accounts that
are not on APP.
Applicants who meet defined underwriting or exception criteria and satisfy
all verification standards are notified of acceptance into the program and
issued a card. Although the initial credit limit of the credit card is fully
utilized when issued, an applicant regains availability of credit on the card as
and to the extent the applicant makes principal payments. The applicant may also
earn additional credit by establishing a positive payment history with the
Company. Applicants failing to meet the defined underwriting or exception
criteria or to satisfy all verification
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standards are notified of denial in accordance with the Equal Credit Opportunity
Act. Such applicants are offered installment and lump sum payment options to
settle their debt. Historically, over 95% of the applicants have qualified for
the credit card.
Once a customer has accepted the offer and has cleared the underwriting
process, the relevant data is transmitted to First Data Resources, Inc. ("FDR")
to establish the new account on FDR's credit card processing system. The Company
has arranged, through two unaffiliated banks, to issue the credit cards and for
FDR to provide certain cardholder services including data processing, card
issuance, monthly customer statement processing, and customer correspondence.
FDR is a subsidiary of First Data Corporation, a provider of information
processing and related services, including cardholder processing and merchant
processing, for major financial institutions throughout the United States. The
Company believes that outsourcing these services to FDR gives the Company
certain operational efficiencies and the flexibility to handle additional
growth.
CUSTOMER SERVICE AND COLLECTIONS:
The Company believes that in order to maximize the customer's payment
performance, it is imperative to have a sophisticated, highly structured
hands-on approach to educating and servicing the customers and addressing
situations that would result in default without attention and assistance from
the Company. The front-end servicing group, the customer service group, and the
back-end servicing group are key components of the Company's credit card
servicing and collections functions.
The front-end servicing group conducts, among other services, the
Company's "Welcome Aboard" program by verifying that the customer has received
the credit card and that the customer thoroughly understands the program and how
to use the credit card. In addition, the front-end servicing group places calls
to customers at other critical junctures, including approximately ten days prior
to the first payment due date and at various other specified times if a customer
becomes delinquent in his payments. The front-end servicing group also pursues
all first payment defaults and handles the majority of inbound collection calls.
These calls are a part of the Company's educational approach with customers that
stresses the importance and benefits of making timely and consistent payments.
The customer service group handles calls from customers regarding their
accounts, including balance inquiries, billing inquires and disputes, requests
for replacement cards, requests for temporary credit line increases and requests
for evidence of account activity. Customer service representatives counsel the
customer on use of the card and continue the process of instilling the
importance and benefits of making timely and consistent payments.
The back-end servicing group is responsible for collection of delinquent
credit card accounts in a prompt, professional and thorough manner in order to
reduce net credit losses. The Company uses state of the art predictive and power
dialing technology to maximize collector productivity, and heavily emphasizes
the "instant payment" products such as Western Union Quick Collect. Collection
calls are prioritized based on models developed by the Company for their
specific customer base. The Company maintains a strict reage policy which allows
accounts to be reaged if the cardholder displays a desire to correct the status
of the account as well as an ability to continue making monthly payments on the
account. The Company has systemic restrictions in place which prevent customer
service representatives from performing unauthorized reaging of accounts. In an
effort to maximize cash flow, the settlement of an account may be negotiated in
cases where the Company has determined that the account is destined to become a
charge-off and there is no potential to retain the customer. Accounts are
charged off and taken as a loss either after formal notification of bankruptcy
or when they become contractually 120 days past due. Accounts identified as
fraud losses are immediately reserved for and charged off no later than 90 days
after the last activity. Charged-off accounts are referred to the Company's
Resolutions Department for further recovery efforts.
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FINANCINGS, RECEIVABLE SALES, AND SECURITIZATIONS:
An important piece of the Company's business strategy is to securitize
seasoned receivables and/or sell receivables to third parties for cash, thereby
realizing an economic gain in an amount equal to the excess of the cash proceeds
from the sale or securitization over the Company's cost basis in the
receivables.
The Company has significant ongoing cash needs to fund its operations and
to fund the purchase of non-performing consumer debt portfolios. The Company's
ability to sell or securitize the receivables and/or finance these receivables
on-balance sheet is critical to the future and growth of the business. In order
to sell or securitize its receivables, the Company maintains a detailed database
concerning the status and performance of each of the receivables in its
portfolio. Maintaining this database is necessary for the Company to provide
historical performance information to potential lenders and purchasers of its
receivables. Potential lenders and purchasers assess the Company's portfolio of
receivables according to a variety of factors including monthly repayment rates
by the cardholders and annualized default rates.
During the fiscal year ended May 31, 1999, the Company sold approximately
$7.0 million in credit card receivables to a third party for $5 million. In
addition, the Company completed three securitizations of seasoned credit card
receivables ("Receivables") with a principal balance of approximately $20.4
million with three unconsolidated wholly-owned qualified special purpose
entities ("SPE's"). All credit cards sold in these transactions were current
with a minimum of eight consecutive payments made on each account. The SPE's
financed the purchase of the Receivables with a series of loans from an
investment bank ("Lender") totaling approximately $13 million. The Company sold
the receivables to the SPE's for approximately $17.3 million. The difference
between the sales price and debt proceeds was accounted for as a capital
contribution by the Company. In November 1999, the Company sold the stock of its
three SPE's for approximately $8.4 million in cash. Subsequent to the stock
sale, the Receivables owned by the SPE's were sold to an unaffiliated credit
card bank. The Company intends to securitize receivables in the capital markets
and sell receivables to unaffiliated credit card banks in the ordinary course of
business.
The Company also maintains a senior secured revolving credit line with
Coast Business Credit, a division of Southern Pacific Bank. The credit line was
established in May 1998 for $5 million and was subsequently increased to $10
million in June 1999 and to $15 million in December 1999. The line of credit
expires in June 2001 and is secured by substantially all of the Company's
assets. Borrowings under the credit line are based on a formula which is
dependent primarily upon the performance and seasoning of the Company's credit
card receivables.
The Company has also received secured financing from a related party which
is subordinated to the Company's senior secured revolving credit line. See "Item
7 - Certain Relationships and Related Transactions." The principal amount
outstanding of these subordinated notes totaled $10,009,042 at May 31, 1997,
$27,674,940 at May 31, 1998 and $17,674,940 at May 31, 1999.
In October 1999, the Company established a $17.5 million secured revolving
credit line with General Electric Capital Corporation to finance the acquisition
of non-performing consumer debt portfolios. The borrower is a bankruptcy remote
special purpose entity, Credit Store Capital, Corp. ("CSCC"), established by the
Company for this transaction. Borrowings are non-recourse to the Company and
based on the age of the non-performing consumer debt portfolios acquired by the
Company coupled with contracts that CSCC enters into to resell portfolios to
other debt buyers. The transfer of receivables to CSCC by the Company does not
qualify for sale treatment under SFAS 125. CSCC will be fully consolidated with
the Company's financial results.
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COMPETITIVE CONDITIONS
The Company experiences competition in all segments of its business
operations. The Company competes with a wide range of third-party collection
companies and other financial services companies seeking to purchase portfolios
of non-performing consumer debt and with traditional collection companies
seeking consignments of such debt for collection. The Company also competes with
companies that provide financing to consumers that have previously defaulted on
a debt obligation. As more buyers enter the market to purchase portfolios of
non-performing consumer debt, the price for the purchase of such portfolios may
increase and the Company's business strategy may become less profitable or
viable. Some of these competitors may have substantially greater personnel and
financial resources than the Company. The Company believes its major competitors
include CapitalOne Inc., Outsourcing Solutions, Inc., Providian Bancorp, and
West Capital Corporation. The Company believes it competes effectively based on
what it believes are superior information technology capabilities, which enable
it to evaluate, and purchase receivables, more effectively than some of its
competitors. Further, the Company believes it differentiates itself from most of
its competitors through its innovative credit card program which allows the
consumer to resolve a prior obligation in a positive manner.
GOVERNMENT REGULATION
The Company's collection practices, business operations and credit card
receivables are subject to numerous federal and state consumer protection laws
and regulations imposing licensing and other requirements with respect to
purchasing, collecting, making and enforcing consumer loans. The Company
conducts periodic compliance reviews and, if necessary, implements procedures to
bring the Company into compliance with all applicable state and federal
regulatory requirements. The failure to comply with such statutes or regulations
could have a material adverse effect on the Company's results of operations or
financial condition.
The Fair Debt Collection Practices Act (FDCPA) and comparable state
statutes establish specific guidelines and procedures that debt collectors must
follow to communicate with consumer debtors, including the time, place and
manner of such communications. It is the Company's policy to comply with the
provisions of the FDCPA and comparable state statutes in all of its collection
activities, although it may not be specifically subject thereto. If these laws
apply to some or all of the Company's collection activities, the Company's
failure to comply with such laws could have a material adverse effect on the
Company.
As a purchaser of consumer receivables, the Company may acquire certain
receivables subject to legitimate claims, defenses or rights of offset on the
part of the consumer. As a result, the Company may not be able to collect
certain receivables it has purchased. For example, the Company, as previously
described, acquires "out of statute" accounts which are subject to a statute of
limitations defense, and may also acquire some credit card accounts where
customers cannot be held liable for, or their liability may be limited with
respect to, charges to a credit card account that were a result of an
unauthorized use of a credit card.
The relationship of a customer and a credit card issuer is extensively
regulated by federal and state consumer protection and related laws and
regulations. While the Company itself is not a credit card issuer, because many
of its receivables are originated through credit card transactions, certain of
the Company's operations are affected by such laws and regulations. Significant
laws include the Federal Truth-In-Lending Act, the Fair Credit Billing Act, the
Equal Credit Opportunity Act, the Fair Credit Reporting Act and the Electronic
Funds Transfer Act (and the Federal Reserve Board's regulations which relate to
these Acts), as well as comparable statutes in those states in which customers
reside or in which the originating institutions are located. State laws may also
limit the interest rate and the fees that a credit card issuer or other consumer
lender may impose on its customers. Among other things, the laws and regulations
applicable to credit card issuers impose disclosure requirements when a credit
card account is advertised, when it is applied for and when it is opened, at the
end of monthly billing cycles and at year end. Federal law requires credit card
issuers to disclose to consumers the interest rates, fees, grace periods and
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balance calculation methods associated with their credit card accounts, among
other things. In addition, customers are entitled under current laws to have
payments and credits applied to their credit card accounts promptly, to receive
prescribed notices and to require billing errors to be resolved promptly. In
addition, some laws prohibit certain discriminatory practices in connection with
the extension of credit. Failure by the originating institutions or the Company
to comply with applicable statutes, rules and regulations could create claims
and/or rights of offset by the customers which could have a material adverse
effect on the Company.
Changes in any such laws or regulations, or in the interpretation or
application thereof, could have a material adverse effect on the Company.
Various proposals which could affect the Company's business have been introduced
in Congress in recent years, including, among others, proposals relating to
imposing a statutory cap on credit card interest rates, substantially revising
the laws governing consumer bankruptcy, limiting the use of social security
numbers, permitting affiliations between banks and commercial, insurance or
securities firms, and other regulatory restructuring proposals. There have also
been proposals in state legislatures in recent years to restrict telemarketing
activities, impose statutory caps on consumer interest rates, limit the use of
social security numbers and expand consumer protection laws. It is impossible to
determine whether any of these proposals will become law and, if so, what impact
they will have on the Company.
Due to the consumer-oriented nature of the collections and credit card
industry, there is a risk that the Company or other industry participants may be
named as defendants in litigation involving alleged violations of federal and
state laws and regulations, including consumer protection laws, and consumer law
torts, including fraud. A significant judgment against the Company or within the
industry in connection with any such litigation could have a material adverse
effect on the Company's results of operations or financial condition. See
"Item 8 - Legal Proceedings."
EMPLOYEES
As of December 22, 1999, the Company had 299 employees. No employee group
is covered under a collective bargaining agreement. The Company conducts on-site
training in all facets of its business and does not anticipate difficulties in
hiring from the local market. The Company believes its relationship with its
employees is good.
TECHNOLOGY AND SYSTEMS
The Company utilizes a variety of management information and
telecommunications systems to enhance productivity in all areas of its business.
The Company utilizes the latest technology in its operations and employs
multiple levels of backup to minimize the risk of systemic breakdown.
The Company implemented a new proprietary credit card origination and
servicing system ("NOCS") in fiscal year 1999, which among other advances, will
make the Company Year 2000 compliant. NOCS puts all aspects of the Company's
operation on a seamless platform from the time a new portfolio is purchased
until an account is converted to a new credit card and set up on the First Data
Resources ("FDR") credit card servicing platform. NOCS includes specialized
applications for telesales, underwriting, non-card collections, payment
processing, account scrubbing processes, portfolio stratification, and customer
service.
The overall computing platform is client-server, Windows NT/SQL based, SQL
and scaleable to accommodate the Company's growth plans. The Company employs the
latest technology in telephony, including a predictive auto-dialer and voice
recognition technology. The telephony platform is capable of supporting in
excess of 2000 workstations and the Company believes it is easily expandable to
accommodate the Company's growth plans.
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The Company uses FDR as its third party processor of credit card data and
merchant interchange. Among the services that FDR provides is the processing and
mailing of the monthly cardholder statements. FDR, the largest card processor in
the world, provides these services to major financial institutions throughout
the United States.
The Company uses image-based technology and processing to minimize paper
flow wherever possible. The Company has also invested in the latest data
warehousing technologies to support its data mining strategies. The Company
believes data warehousing gives them a distinct competitive advantage in the
portfolio analysis and acquisitions aspect of its business. In addition, the
Company believes data warehousing will give it an advantage in the
securitization markets through its ability to provide a sophisticated level of
performance detail to investors.
IMPACT OF THE YEAR 2000 COMPUTER PROBLEM
OVERVIEW. The Year 2000 issue arises out of potential problems with
computer systems or any equipment with computer chips that use dates where the
date has been stored as just two digits (e.g., 98 for 1998). On January 1, 2000,
any clock or date recording mechanism, including date sensitive software, which
uses only two digits to represent the year, may recognize a date using 00 as the
year 1900 rather than the year 2000. This could result in a system failure or
miscalculations and cause a disruption of operations, including, among other
things, a temporary inability to process transactions, send letters and
statements or engage in similar activities.
STATE OF READINESS. The Company believes it has replaced or modified all
of its material computer systems and business applications software so that its
computer systems will properly utilize dates beyond December 31, 1999 and does
not believe that any further material expenditures will be necessary to make
these systems Year 2000 compliant. The Company created a Year 2000 Project Team
which identified all internal systems and third party vendors and evaluated them
as critical or non-critical. The team then evaluated and addressed all systems
and any Year 2000 issues applicable to each system. Throughout this process,
comprehensive Year 2000 information was documented and saved.
Most of the Company's major vendors are large institutions, which the
Company believes either are or will become Year 2000 compliant due to the
regulated nature of their businesses and the size and financial strength of
these businesses. To date, the Company has been able to convert data received
from lenders and other third parties rendering it Year 2000 compliant and
expects that it will continue to be able to do so in the future.
The Company believes that its most critical outside vendor is FDR which
provides services to the Company, including data processing, card issuance,
monthly customer statement processing and customer correspondence. The Company
believes that FDR applied substantial time and resources into its Year 2000
compliance efforts. FDR has certified to the Company that all FDR systems are
Year 2000 compliant.
COSTS. To date, the Company has incurred less than $100,000 in third-party
expenses as a result of the Company's Year 2000 compliance efforts. The Company
believes it has replaced or modified all of its critical computer systems and
business applications software in the normal course of its business expansion
and that its computer systems are currently Year 2000 compliant. The Company
used in-house programmers for most of the modifications and did not separately
account for the costs of making these systems Year 2000 compliant. Year 2000
issues with third-party processing vendors were addressed internally between the
Company and each specific vendor.
WORST-CASE SCENARIO. The Company believes that its worst-case scenario is
that its outside vendors (such as FDR) are not Year 2000 compliant due to
unforeseen or unexpected problems with their systems that their Year 2000
testing did not discover and that there are errors and/or delays in processing
or billing the credit card accounts.
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Since FDR services all of the Companies credit card receivables, any Year 2000
problem at FDR could cause a material disruption in the Company's business.
Management believes that the cost of any such disruption would have a material
adverse effect on the Company's results and financial condition.
RISKS. The Company is not currently aware of any internal Year 2000
compliance problem that could reasonably be expected to have a material adverse
effect on the Company's business, operating results or financial condition.
However, the Company may discover unanticipated Year 2000 compliance problems in
the Company's computer infrastructure that will require substantial revisions or
replacements. In addition, third-party software, hardware, or services
incorporated into our material systems or other systems upon which we rely may
need to be revised or replaced. Such revisions and replacements could be time
consuming and expensive.
The computer systems of governmental agencies, utility companies,
third-party service providers and others outside of our control may not be Year
2000 compliant. The failure by such entities to achieve timely Year 2000
compliance could result in a systemic failure beyond our control, such as
prolonged telecommunications or electrical failures. If a protracted disruption
in electrical power or telecommunications services were to occur, the Company's
collection and marketing efforts, and therefore its operations, could be
materially adversely affected.
CONTINGENCY PLAN. The Company has contingency plans that include, in the
event of computer hardware or software non-compliance, identification and
replacement of critical products as appropriate. In the event of vendor-related
Year 2000 problems, alternate vendors who have the ability to provide similar
products or services have been identified. On December 31, 1999, personnel will
be present to monitor our systems and software for Year 2000 issues, which our
compliance team will then address. The Year 2000 project team identified a
period of time before and after January 1, 2000 which it identified as Year 2000
critical. Specific personnel have been assigned to test, monitor, evaluate and
address any Year 2000 issues prior to January 1, 2000 and beyond.
THIRD-PARTY SERVICING
At May 31, 1999, the Company serviced approximately 20,000 accounts
subject to third party servicing agreements. The vast majority of these accounts
were owned by the special purpose corporations used for the Company's three
securitizations. The Company intends to concentrate on servicing its own
accounts and accounts that it has either securitized or sold to third party
investors.
ITEM 2 - FINANCIAL INFORMATION
SELECTED FINANCIAL DATA
The following selected financial data presented below should be read in
conjunction with the Company's consolidated financial statements and the notes
thereto. The selected statement of operations data with respect to the years
ended December 31, 1994 and 1995 and the period from January 1, 1996 to
October 8, 1996 and the selected balance sheet data at December 31, 1994 and
1995 and at October 8, 1996 are derived from the audited financial statements of
the Company's predecessor, SOIC. The statement of operations data with respect
to the years ended May 31, 1997, 1998 and 1999 and the balance sheet data at
May 31, 1997, 1998 and 1999 are derived from, and are qualified by reference to,
the Company's audited financial statements included elsewhere herein. The
consolidated financial statements for the years ended May 31, 1998 and 1999 were
audited by Grant Thornton, LLP, independent auditors, and the consolidated
financial statements for the year ended May 31, 1997 were audited by Tanner &
Co., independent auditors. The selected financial data as of August 31, 1998 and
1999 for the three months then ended were derived from the Company's unaudited
consolidated financial statements included elsewhere herein and, in the opinion
of management, includes all material adjustments (consisting only of normal
recurring adjustments) necessary for a fair presentation of the financial
condition and results of operations for such periods. Operating results for the
three months ended August 31, 1999 are not necessarily indicative of results
that
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may be expected for the remainder of the fiscal year ending May 31, 2000. The
following financial information should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" below.
PREDECESSOR(1) COMPANY
--------------------------------------------------------------------------------------------------------
JANUARY 1,
FOR THE YEAR ENDED DECEMBER 31 1996 TO FOR THE YEAR ENDED
OCTOBER 8, MAY 31
-------------------------------- ------------------------------------------------------
1994 1995 1996 1997 1998 1999
--------------- --------------- ----------------------------------- ----------------- -----------------
CONSOLIDATED OPERATIONS
DATA:
Income from credit
card receivables* $ 71,174 $ 3,951,602 $ 6,438,460
Revenue in excess of
cost recovered* 3,934 8,042,255 21,852,316
Gain on sale of
portfolios* - - 11,851,080
Servicing fees and
other income $9,052,306 $6,528,503 $ 2,078,506 1,601,228 1,292,596 1,564,356
--------------- --------------- ----------------------------------- ----------------- -----------------
Total revenue 9,052,306 6,258,503 2,078,506 2,576,336 13,286,453 41,706,212
Provision for losses - - - 1,494,001 6,483,736 4,607,081
--------------- --------------- ----------------------------------- ----------------- -----------------
Net revenue 9,052,306 6,258,503 2,078,506 1,082,335 6,802,717 37,099,131
Net income (loss) 2,242,672 2,727,711 (1,512,488) (14,246,259) (29,151,330) 3,633,697
Comprehensive
income (loss)* (14,246,259) (29,151,330) 6,130,845
Dividends on
preferred stock* (7,397) (399,996) (1,799,999)
--------------- --------------- ----------------------------------- ----------------- -----------------
Net income (loss)
applicable to common
shareholders $2,242,672 $2,727,711 $(1,512,488) $(14,253,656) $(29,551,326) $1,833,698
=============== =============== ===============--================== ================= =================
Net income (loss) per
common share, basic
and diluted $ 0.45 $ 0.55 $ (0.30) $ (0.55) $ (0.89) $ 0.05
=============== =============== ===============--================== ================= =================
CONSOLIDATED BALANCE SHEET
DATA:
Cash and restricted cash $ 515,600 $ 279,357 $ 58,162 $ 2,685,581 $ 8,205,071 $4,283,930
Investment in
on-performing
consumer debt, net* 8,352,749 6,125,511 3,227,711
Credit card receivables,
net* 2,566,909 12,919,970 18,631,403
Notes payable - - 1,158,336 428,973 5,902,041 6,086,766
Subordinated notes and
accrued interest-related
party - - 880,000 10,446,043 31,807,322 19,246,595
------------------ ----------------- -----------------
Total assets 1,547,899 524,579 2,884,860 24,903,167 40,176,415 45,991,970
Total liabilities 784,695 279,960 4,007,145 18,118,396 47,366,530 33,692,311
Total stockholders'
equity (deficit) 763,204 244,619 (1,122,285) 6,784,771 (7,190,115) 12,299,659
COMPANY
-----------------------------------
FOR THE THREE MONTHS ENDED
AUGUST 31
-----------------------------------
1998 1999
---------------- ----------------
CONSOLIDATED OPERATIONS
DATA:
Income from credit
card receivables* $ 1,453,124 $ 2,041,574
Revenue in excess of
cost recovered* 4,718,504 5,199,917
Gain on sale of
portfolios* 3,343,694 -
Servicing fees and
other income 699,805 883,134
----------------- ----------------
Total revenue 10,215,127 8,124,625
Provision for losses 1,388,679 2,034,876
----------------- ----------------
Net revenue 8,826,448 6,089,749
Net income (loss) 208,782 (2,511,573)
Comprehensive
income (loss)* 208,782 (1,733,742)
Dividends on
preferred stock* (299,999) (500,000)
----------------- ----------------
Net income (loss)
applicable to common
shareholders $ (91,217) $(3,011,573)
================= ================
Net income (loss) per
common share, basic
and diluted $ (0.00) $ (0.09)
================= ================
CONSOLIDATED BALANCE SHEET
DATA:
Cash and restricted cash $5,524,378 $2,531,428
Investment in
on-performing
consumer debt, net* 5,612,313 2,397,154
Credit card receivables,
net* 15,442,739 24,476,584
Notes payable 5,821,686 11,811,174
Subordinated notes and
accrued interest-related
party 22,651,522 19,484,130
----------------- ----------------
Total assets 39,975,281 50,641,174
Total liabilities 36,956,614 39,206,007
Total stockholders'
equity (deficit) 3,018,667 11,435,167
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PREDECESSOR(1) COMPANY
--------------------------------------------------------------------------------------------------------
JANUARY 1,
FOR THE YEAR ENDED DECEMBER 31 1996 TO FOR THE YEAR ENDED
OCTOBER 8, MAY 31
-------------------------------- ------------------------------------------------------
1994 1995 1996 1997 1998 1999
--------------- --------------- ----------------------------------- ----------------- -----------------
SELECTED OPERATING DATA:
Outstanding balance of
non-performing debt
acquired during the period* $1,067,579,343 $890,634,206 $891,904,454
Credit card receivables
Owned and managed* 35,709,395 84,830,552 89,149,715
Number of accounts
owned and managed* 26,803 84,351 94,278
Total employees, end
of period* 233 292 305
COMPANY
-----------------------------------
FOR THE THREE MONTHS ENDED
AUGUST 31
-----------------------------------
1998 1999
---------------- ----------------
SELECTED OPERATING DATA:
Outstanding balance of
non-performing debt
acquired during the period* $523,915,479 $91,481,699
Credit card receivables
Owned and managed* 90,528,114 88,560,248
Number of accounts
owned and managed* 88,197 95,197
Total employees, end
of period* 296 294
- ---------------------
* Information not applicable for predecessor company.
(1) The information for the fiscal years ended December 31, 1994 and 1995 and
for the period from January 1, 1996 to October 8, 1996 relates to SOIC, the
Company's predecessor. See "Item 1 -- Business -- General Development of
Business" and Note A of Notes to Consolidated Financial Statements.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following management discussion and analysis focuses on those factors
that had a material effect on the Company's financial results of operations and
financial condition for fiscal years ended May 31, 1997, 1998 and 1999 and the
three months ended August 31, 1998 and 1999. The following discussion of the
Company's financial condition and results of operations should be read in
connection with the Company's consolidated financial statements and notes
thereto appearing elsewhere herein. The following discussion contains certain
forward-looking statements that involve risk and uncertainties. The Company's
actual results could differ materially from those discussed herein. Factors that
could cause or contribute to such differences include, but are not limited to,
risks and uncertainties related to the need for additional funds, the rapid
growth of the operations and the ability of the Company to operate profitably
after the initial growth period is completed. For a more extensive discussion of
such risks and uncertainties, see "Cautionary Statements and Factors that may
Affect Future Results," below. The Company undertakes no obligation to publicly
release the results of any revisions to those forward-looking statements that
may be made to reflect any future events or circumstances.
OVERVIEW
The Credit Store, Inc. is a technology based, financial services company
that provides credit card products to consumers who may otherwise fail to
qualify for a traditional unsecured bank credit card. The Company reaches these
consumers by acquiring portfolios of non-performing consumer receivables and
offering a new credit card to those consumers who agree to pay all or a portion
of the outstanding amount due on their debt. The new card is issued with an
initial balance and credit line equal to the agreed repayment amount. After
appropriate seasoning, the Company seeks to sell or securitize the credit card
receivables generated by this business strategy. The Company offers other forms
of settlement to those consumers who do not accept the credit card offer.
The Company was incorporated in 1972 in Utah as Valley West Development
Corporation, changed its corporate domicile to Delaware in 1995, and changed its
name to Credit Store, Inc. on October 8, 1996. Prior to October 8, 1996, the
Company discontinued operations of its prior line of business which was
unrelated to its current operations. On December 4, 1996, the Company acquired
from Taxter, all the capital stock of Holdings. At the time of the acquisition,
Holdings' sole asset was the capital stock of SOIC, which had been engaged since
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January 1996 in the business of acquiring non-performing consumer debt
portfolios, and the marketing and servicing of credit cards generated from these
portfolios. From 1982 through December 1995, SOIC had been a marketer and
servicer of secured credit cards for a South Dakota bank under a contractual
arrangement which expired in December 1995. Following the acquisition of
Holdings, the Company engaged directly, and through SOIC and its affiliates, in
the acquisition of non-performing consumer debt and the marketing and servicing
of credit cards generated from these portfolios. In February 1998, Holdings and
Credit Store Mortgage, Inc., a wholly owned subsidiary of the Company, were each
merged into the Company and the Company's name was changed to The Credit Store,
Inc. As a result of the above, and because the Company had no operations during
the period from May 31, 1996 to October 8,1996, the operations for the period
ended May 31, 1997 are not comparable to any prior period, including the period
immediately prior to the acquisition when the predecessor was owned and managed
by different groups. Further, the operations of the Company's predecessor, SOIC,
did not include many of the activities currently engaged in by the Company.
ACCOUNTING.
INVESTMENTS IN NON-PERFORMING CONSUMER DEBT. The Company accounts for its
investments in non-performing consumer debt in accordance with the provisions of
the American Institute of Certified Public Accountants' Practice Bulletin 6,
"Amortization of Discounts on Certain Acquired Loans," which prescribes two
methods (yield method and cost recovery method) for amortizing the excess of
face value over the purchase price of acquired portfolios. Under Practice
Bulletin 6, a company may use the yield method of accounting if the company has
the experience and data to predict the amount and timing of collections that
will be received from the acquired portfolio. Under the yield method, the
acquirer makes an estimate of the amount and timing of collections on an
acquired portfolio and accretes the discount into income over the economic life
of the acquired portfolio according to an internal rate of return established
for the acquired portfolio. Given the Company's short history, the Company
believes it is required to use the cost recovery method to account for the
acquired portfolios. Under the cost recovery method, the Company records the
purchase price of a portfolio and any costs directly related to the purchase as
an investment in non-performing consumer debt on the balance sheet. Cash flows
related to the acquired portfolio are applied to reduce the investment on the
balance sheet to zero prior to recognizing revenue from that portfolio. Once the
cost of a portfolio has been recovered, the ensuing cash flow is recorded as the
excess of revenue over cost recovered. The Company adopted cost recovery in
fiscal year 1998 and restated the results of fiscal year 1997 to conform to the
cost recovery presentation.
CREDIT CARD RECEIVABLES. The Company records the amounts funded for new
purchases and cash advances, accrued interest on new purchases and cash
advances, and accrued fees, less a provision for losses as net credit card
receivables on the balance sheet. This amount is substantially below the amount
owed to the Company by the cardholder. At May 31, 1999, the Company owned
$55,184,540 in credit card receivables. The amount of funded purchases and
advances, accrued interest on the purchases and advances, and accrued fees, were
recorded on the Company's balance sheet less a provision for losses as
$18,631,403. As a credit card account continues to perform and season, the
credit card receivable on the balance sheet approaches the amount actually owed
by the cardholder to the Company.
SECURITIZATIONS. The Company completed three securitizations of credit
card receivables (the "Receivables") with a principal balance of approximately
$20.4 million with three unconsolidated wholly-owned qualified special purpose
entities (the "SPE's). All credit cards sold in these transactions were current
with a minimum of eight consecutive payments made on each account. The SPE's
financed the purchase of the Receivables with a series of loans from an
investment bank (the "Lender") totaling approximately $13 million. The Company
sold the Receivables to the SPE's for approximately $17.3 million. The
difference between the sales price and debt proceeds was accounted for as a
capital contribution by the Company.
Under the provisions of SFAS 125, the securitizations are accounted for as
sales. As a result, the Company recognized a pre-tax gain of approximately $8
million and recorded a retained interest in securitized credit card
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receivables at an allocated basis in the amount of approximately $1.3 million
based on its relative fair value. At May 31, 1999, the allocated basis amount
was adjusted to a fair value of approximately $5.1 million, resulting in
approximately $3.8 million of unrealized gain on the retained interest in
securitized credit card receivables. The unrealized gain was recorded net of tax
of approximately $1.3 million, resulting in approximately $2.5 million as a
separate component of stockholders' equity and a component of Consolidated
Statement of Operations and Comprehensive Income (Loss). In estimating the fair
value of the retained interest, the Company has estimated net cash flows based
on the Company's historical collection results for similar receivables and
discounted it using an appropriate rate.
The retained interest in securitized credit card receivables is treated as
a debt security classified as available-for-sale in accordance with SFAS No.
115, "Accounting for Certain Investments in Debt and Equity Securities," and is
carried at fair value. At the time of securitization, the retained interest is
initially recorded at the basis allocated in accordance with SFAS No. 125. This
original cost basis is adjusted to fair value, which is based on the discounted
anticipated future cash flows on a "cash out" basis, with such adjustment (net
of related deferred income taxes) recorded as a component of other comprehensive
income. The cash out method projects cash collections to be received only after
all amounts owed to investors and lenders have been remitted.
Income on the retained interest is accrued based on the effective interest
rate applied to its original cost basis, adjusted for accrued interest and
principal paydowns. The effective interest rate is the internal rate of return
determined based on the timing and amounts of anticipated future cash flow
projections for the underlying pool of securitized credit card receivables. The
Company monitors impairment of the retained interest based on discounted
anticipated future cash flows of the underlying receivables on a cash out basis
compared to the original cost basis of the retained interest, adjusted for
accrued interest and principal repayments.
In November 1999, the Company sold the stock of its three SPE's
for approximately $8.4 million in cash. The fair value of the SPE's was
approximately $6.2 million at August 31, 1999.
COMPREHENSIVE INCOME. The Financial Accounting Standards Board issued SFAS
No. 130, "Reporting Comprehensive Income," which is effective for fiscal years
beginning after December 15, 1997. SFAS No. 130 establishes standards for
reporting and display of comprehensive income and its components (revenue,
expenses, gains and losses) in a full set of general-purpose financial
statements. All items required to be recognized under accounting standards as
components of comprehensive income are required by SFAS No. 130 to be reported
in a financial statement that is displayed with the same prominence as other
financial statements. SFAS No. 130 does not require a specific format for that
financial statement but requires that an enterprise display an amount
representing total comprehensive income for the period in that financial
statement. Pursuant to SFAS No. 130, an enterprise must classify items of other
comprehensive income by their nature in a financial statement and display the
accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in capital in the equity section of a statement of
financial position. Reclassification of financial statements for earlier periods
provided for comparative purposes is required. For the year ended May 31, 1998,
the Company had no sources of other comprehensive income. For the year ended May
31, 1999, the Company's investment in securitizations is classified as available
for sale; and, therefore, in accordance with SFAS No. 115, the Company
recognizes as other comprehensive income the unrealized gains or losses for the
difference between the amortized cost and estimated fair value, net of tax.
RESULTS OF OPERATIONS
FISCAL YEAR ENDED MAY 31, 1999 COMPARED TO FISCAL YEAR ENDED MAY 31, 1998:
Revenues. Total revenue for the fiscal year ended May 31, 1999 was
$41,706,212, a 214% increase from revenue of $13,286,453 during the fiscal year
ended May 31, 1998. The increase was primarily due to a
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combination of increased revenues from a maturing credit card portfolio,
portfolio securitizations and portfolio sales. Income from credit card
receivables increased 63% from $3,951,602 in fiscal 1998 to $6,438,460 in fiscal
1999 due to an increase in the weighted average credit card receivables funded.
Income from credit card receivables represents interest and fees on new advances
or purchases made by holders of the Company's credit cards on an accrual basis.
Revenue in excess of costs recovered increased 172% from $8,042,255 in fiscal
1998 to $21,852,316 in fiscal 1999 due to increased cash flow related to
acquired portfolios and the effect of fully recovering the acquisition costs on
many of the acquired portfolios. The Company's portfolio sales and
securitizations resulted in an $11,851,080 gain on sales of portfolios. There
were no such sales in the previous fiscal year. Servicing fees and other income
increased 21% from $1,292,596 in fiscal 1998 to $1,564,356 in fiscal 1999 due to
a higher average number of accounts under management subject to a servicing fee.
EXPENSES. Salaries and employee benefits decreased 6% from $13,268,863 in
fiscal 1998 to $12,484,582 in fiscal 1999 based on an average lower number of
full-time equivalents. Interest expense decreased 15% from $4,760,905 in fiscal
1998 to $4,029,491 in fiscal 1999 based on a lower average amount of debt
outstanding due to the conversion of $10 million of subordinated debt to
preferred stock in May 1998, the conversion of $10 million of subordinated debt
to preferred stock in August 1998 and a reduction in the interest rate on its
senior debt. The provision for losses decreased 29% from $6,483,736 in fiscal
1998 to $4,607,081 in fiscal 1999 based on the experience of a more seasoned
portfolio. Professional fees decreased 36% from $4,215,891 in fiscal 1998 to
$2,701,016 in fiscal 1999 as the Company moved beyond its startup period
requiring fewer outside professional services. Depreciation and amortization
decreased 19% from $3,223,620 in fiscal 1998 to $2,614,216 in fiscal 1999.
Fiscal 1998 included an $816,667 writedown of existing software systems. Third
party card services increased 46% from $3,097,347 in fiscal 1998 to $4,518,919
in fiscal 1999 in line with the increase in the average number of accounts under
management. Mail processing increased 28% from $1,121,623 in fiscal 1998 to
$1,434,506 in fiscal 1999 largely in line with increased marketing campaigns on
existing portfolios of non-performing debt. Rental expenses decreased 7% from
$825,517 in fiscal 1998 to $766,832 in fiscal 1999. Royalty expense, pursuant to
mutual business development agreement, increased 644% from $207,238 in fiscal
1998 to $1,541,944 in fiscal 1999. The royalty expense is accrued when new
credit card accounts make their third payment according to terms of the
cardholder agreement. Increased royalty expense is due to a higher percentage of
cards reaching a third payment due to a more thorough sales process and better
account retention in the early months of a new account. See Note K of Notes to
Consolidated Financial Statements. Other operating expenses as a group were
stable, increasing 2% from $5,233,043 in fiscal 1998 to $5,360,337 in fiscal
1999.
Income before taxes in fiscal 1999 was $1,647,288 compared to a loss
before taxes of $29,151,330 in fiscal 1998. The Company recognized a tax benefit
of $1,986,409 in fiscal 1999 leading to a net income of $3,633,697 in fiscal
1999 compared to a net loss of $29,151,330 in fiscal 1998. The Company recorded
unrealized gains on its securitizations of $2,497,148, which, after adding to
net income, produces a comprehensive income of $6,130,845. There were no sources
of comprehensive income in fiscal 1998.
NET INCOME (LOSS). Dividends on preferred stock have not been declared and
are not yet payable, however, the Company treats the dividends as declared and
payable for the purpose of calculating net income applicable to common
shareholders and earnings per share. Preferred dividends for fiscal 1999
increased 350% from $399,996 in fiscal 1998 to $1,799,999 in fiscal 1999 due to
the conversion of an aggregate of $20 million of subordinated debt to preferred
stock in May and August 1998. After the effect of preferred dividends, net
income applicable to common shareholders in fiscal 1999 was $1,833,698 in fiscal
1999 compared to a net loss applicable to common shareholders of $29,551,326 for
fiscal 1998.
FISCAL YEAR ENDED MAY 31, 1998 COMPARED TO FISCAL YEAR ENDED MAY 31, 1997:
Revenues. Total revenue for the fiscal year ended May 31, 1998 was
$13,286,453, a 303% increase from $3,294,428 for the fiscal year ended May 31,
1997. The increase was primarily due to a combination of increased revenues from
a growing portfolios of performing credit card receivables and a full 12 months
of operations
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compared to just under eight months of operations in fiscal 1997. Income from
credit card receivables increased 307% from $971,174 in fiscal 1997 to
$3,951,602 in fiscal 1998. Revenue in excess of cost recovered was $8,042,255 in
fiscal 1998 compared to $3,934 in fiscal 1997 due to the startup nature of the
operation in fiscal 1997. Servicing fees and other income decreased 19% from
$1,601,228 in fiscal 1997 to $1,292,596 in fiscal 1998 as the Company
de-emphasized servicing for third parties in order to concentrate on servicing
and developing its own portfolios.
EXPENSES. The provision for losses increased 333% from $1,494,001 in
fiscal 1997 to $6,483,736 in fiscal 1998 as the portfolio of performing credit
card receivables grew and as the volume of funded cardholder charges and cash
advances grew proportionately. Interest expense increased 533% from $751,729 to
$4,760,905 based on a higher level of debt outstanding during fiscal 1998 as
compared to fiscal 1997. Salaries and employee benefits increased 120% from
$6,031,513 in fiscal 1997 to $13,268,863 in fiscal 1998 due to increased full
time equivalents and a full 12 months of operations. Professional fees increased
77% from $2,388,274 in fiscal 1997 to $4,215,891 in fiscal 1998 as the Company
continued to incur expenses related to startup. Depreciation and amortization
increased 239% from $952,362 in fiscal 1997 to $3,223,620 in fiscal 1998 as the
Company invested in equipment and incurred a full year of depreciation related
to it. Third party credit card services increased 244% from $899,986 in fiscal
1997 to $3,097,347 in fiscal 1998 due to the increased number of accounts
serviced and a full 12 months of fees experienced in fiscal 1998. All other
expenses as a group increased 53% from $4,823,026 in fiscal 1997 to $7,387,421
in fiscal 1998 primarily due to the inclusion of a full 12 months of costs in
the period.
NET LOSS. The above factors combined to produce net loss before preferred
dividends of $29,151,330 in fiscal 1998 compared to a net loss before preferred
dividends of $14,246,259 in fiscal 1997. After accounting for preferred
dividends of $399,996 in fiscal year 1998 and $7,397 in fiscal 1997, the net
loss applicable to common shareholders was $29,551,326 in fiscal 1998 compared
to $14,253,656 in fiscal 1997.
QUARTER ENDED AUGUST 31, 1999 COMPARED TO QUARTER ENDED AUGUST 31, 1998:
REVENUES. Total revenue for the fiscal quarter ended August 31, 1999 (the
first quarter of fiscal year 2000) was $8,124,625 a 21% decrease from
$10,215,127 during the fiscal quarter ended August 31, 1998 (the first quarter
of fiscal year 1999). During the first quarter of fiscal 1999, the Company
completed its first portfolio sale to a bank which produced a $3,343,694 gain on
sale. The Company did not conduct a portfolio sale or securitization during the
first quarter of fiscal 2000. Other revenue components core revenue increased
18% during the first quarter of fiscal 2000. Income from credit card receivables
increased 41% from $1,453,125 in the first quarter of fiscal 1999 to $2,041,574
in the same period of fiscal 2000 due to a higher average amount of funded
credit card receivables during the period. Revenue in excess of costs recovered
increased 10% from $4,718,504 in the first quarter of fiscal 1999 to $5,199,917
in the same period of fiscal 2000 due to the continued maturation of the
acquired portfolios. Servicing fees and other income increased 28% from $699,804
in the first quarter of fiscal 1999 to $883,134 in the same period of fiscal
2000 based on servicing fees earned from securitized portfolios. The provision
for losses increased 47% from $1,388,679 in the first quarter of fiscal 1999 to
$2,034,876 in the same period of fiscal 2000 and increased as a percentage of
core revenue from 20% to 25% due to a higher level of principal funded on the
credit cards as discussed above. The above factors combined for a 31% decrease
in net revenue after the provision for losses, from $8,826,448 in the first
quarter of fiscal 1999 to $6,089,749 in the same period of fiscal 2000.
EXPENSES. Salaries and employee benefits increased 4% from $3,138,712 in
the first quarter of fiscal 1999 to $3,267,585 in the same period of fiscal 2000
based on a higher average number of employees and increased wage rates, but
declined as a percentage of core revenue from 46% to 40% based on declining unit
costs. Interest expense decreased 21% from $1,282,538 in the first quarter of
fiscal 1999 to $1,007,902 in the same period of fiscal 2000 based on a lower
average amount of debt outstanding due to the conversion of $10 million of
subordinated debt to preferred stock that took place in August 1998. This
conversion also allowed interest expense to decline as a percentage of core
revenue from 19% in the first quarter of fiscal 1999 to 12% in the same period
of
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fiscal 2000. Professional fees increased 28% from $393,894 in the first quarter
of fiscal 1999 to $502,035 in the same period of fiscal 2000, but remained
stable as a percentage of core revenue at 6%. Depreciation and amortization
increased 9% from $620,539 in the first quarter of fiscal 1999 to $678,236 in
the same period of fiscal 2000, and showed only a slight decrease as a
percentage of core revenue from 9% to 8%. The increase is due to continued
investments in technology. Third-party credit card services increased 3% from
$1,021,907 in the first quarter of fiscal 1999 to $1,056,045 in the same period
of fiscal 2000 and declined as a percentage of core revenue from 15% to 13% as
unit costs declined. All other operating expenses declined 3% as a group from
$2,160,076 in the first quarter of fiscal 1999 to $2,089,518 in the same period
of fiscal 2000 and declined from 31% to 22% as a percentage of core revenue due
to more efficient operating systems and declines in per unit costs.
The above combined for a net loss before preferred dividends of $2,511,572
for the first quarter of fiscal 2000 versus net income of $208,782 in the first
quarter of fiscal 1999. After preferred dividends of $500,000 in the first
quarter of fiscal 2000, the net loss applicable to common shareholders was
$3,011,572 compared to preferred dividends of $299,999 and a net loss of $91,217
in the first quarter of fiscal 1999.
LIQUIDITY AND CAPITAL RESOURCES
The Company's seeks to maintain an adequate level of liquidity through
active management of assets and liabilities. Because the characteristics of its
assets and liabilities change, liquidity management is a dynamic process
affected significantly by the maturity of the Company's assets and the
seasonality of the credit card business which places significant demands on
funding new charges and cash advances during certain times of the year,
including the year-end holiday season.
At May 31, 1997, the Company had $2,685,581 of cash and cash equivalents,
compared to $8,205,071 at May 31, 1998 and $4,283,930 at May 31, 1999. The
Company maintains restricted cash reserves at its banks to facilitate the
funding of new charges and advances on its customers' credit cards. These
restricted balances were $1,000,000 at May 31, 1997, $1,000,000 at May 31, 1998,
and $750,000 at May 31, 1999. At August 31, 1998, the Company had $5,524,377 in
cash and cash equivalents, of which $1,000,000 was restricted. At August 31,
1999, the Company had $2,531,428 in cash and cash equivalents, of which $750,000
was restricted.
A significant source of liquidity for the Company has been the sale and
securitization of credit card receivables. During the fiscal year ended May 31,
1999, the Company sold approximately $7.0 million in face amount of receivables
to a third party for $5 million and raised approximately $13 million from three
securitizations of seasoned credit card receivables totaling $20.4 million.
The Company also maintains a senior secured revolving credit line with a
bank. The credit line was established in April 1998 for $5 million and was
subsequently increased to $10 million in June 1999. The line of credit expires
in July 2001 and is secured by substantially all of the Company's assets.
The Company has also received secured financing from a related party,
which is subordinated to the Company's senior lender. See "Item 7 - Certain
Relationships and Related Transactions." The principal amount outstanding of
these subordinated notes totaled $10,009,042 at May 31, 1997, $27,674,940 at May
31, 1998 and $17,674,940 at May 31, 1999. As noted in Item 7, $10 million of
this subordinated debt was converted to Series D Preferred Stock in May 1998. In
August 1998, an additional $10 million of debt was converted to Series E
Preferred Stock.
In October 1999, the Company established a $17.5 million secured revolving
credit line with a commercial finance company to finance the acquisition of
non-performing consumer debt portfolios. The borrower is a wholly owned,
bankruptcy remote special purpose entity established by the Company for this
transaction. The transfer of receivables to this SPE by the Company does not
qualify for sale treatment under SFAS 125. The SPE will be fully
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consolidated with the Company's financial results. See "Item 1 - Business;
Narrative Description of Business--Business Operations."
CAPITAL EXPENDITURES AND PORTFOLIO ACQUISITIONS
During fiscal 1999, the Company invested $8,837,087 to acquire portfolios
of non-performing consumer debt, a decrease of 45% from the $16,031,225 invested
in fiscal 1998, which was a 11% increase over the $14,469,333 invested fiscal
1997.
The Company invested $682,539 in property and equipment during fiscal 1999
compared to $4,170,472 in fiscal 1998 and $10,164,477 in fiscal 1997. A majority
of the hardware commitments to build the Company's business platform were made
in fiscal years 1997 and 1998. During the first quarter of fiscal 2000, the
Company invested $33,923 in new capital equipment compared to $171,623 during
the first quarter of fiscal 1999.
The Company plans to make continued investments in technology and
non-performing portfolios for the remainder of the fiscal year, the amount of
which will depend on the amount of financing and new capital available for such
investments. The Company believes that its asset securitization programs,
together with the revolving credit facility, long term debt issuance, equity
issuance, and cash flow from operations, will provide adequate liquidity to the
Company for meeting anticipated cash needs, although no assurance can be given
to that effect.
INFLATION
The Company believes that inflation has not had a material impact on its
results of operations for the three years ended May 31, 1999.
CAUTIONARY STATEMENTS AND FACTORS THAT MAY AFFECT FUTURE RESULTS
Certain statements made in this Registration Statement on Form 10, which
are summarized below, are forward-looking statements that involve risks and
uncertainties, and actual results may be materially different. Some factors that
could cause actual results to differ include, but are not limited to, those
identified as follows:
RISKS ASSOCIATED WITH NON-PERFORMING RECEIVABLES. The business of the
Company consists of acquiring and collecting non-performing consumer receivables
which, in general, have been deemed uncollectible and, consequently, written-off
by the originating institution. Prior to the Company's acquisition of the
receivables, numerous attempts generally have been made by the originating
institutions to collect on the non-performing accounts, typically through
in-house collection departments, as well as third-party collection agencies. The
Company acquires the receivables at a significantly discounted price and
believes it can successfully obtain recoveries on the receivables in amounts in
excess of its acquisition cost for the receivables. While the Company believes
its knowledge of the market and its ability to collect and convert
non-performing accounts into new credit card accounts enables the Company to
minimize the higher risks inherent in the purchase of non-performing debt, no
assurance can be given that the Company has adequate protection against these
risks. In the event that the conversion of charged-off accounts to credit card
accounts and/or the collection on receivables is less than anticipated, or if
the new credit card accounts experience higher delinquency rates or losses than
anticipated, the Company's financial condition and results of operations will be
adversely affected.
RISKS ASSOCIATED WITH RAPID GROWTH. Since inception, the Company has grown
rapidly, placing significant demands on its management, administrative,
operational and financial resources. The Company seeks to continue its growth
trends, which could place additional demands on its resources. Future growth
will depend on numerous factors, including the development of additional
relationships with banks willing to issue credit cards for the Company, the
availability of additional financing to purchase non-performing portfolios and
finance its ongoing
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operations, the ability to sell and securitize the Company's seasoned credit
card receivables, the ability to maintain a high quality of customer service,
and the recruitment, motivation and retention of qualified personnel.
Sustained growth also may require the implementation of enhancements to
its operational and financial systems and may require additional management,
operational and financial resources. There can be no assurance that the Company
will be able to manage its expanding operations effectively or to maintain its
historical level of cash flows from the portfolios it has purchased, or that it
will be able to maintain or accelerate its growth, and any failure to do so
could have a materially adverse effect on the Company's business, results of
operations, and financial condition.
POTENTIAL FLUCTUATIONS IN QUARTERLY OPERATING RESULTS AND CASH
REQUIREMENTS. The timing of portfolio acquisitions along with the timing of its
seasoned credit card receivables sales and securitizations can affect the timing
of recorded income and result in periodic fluctuations in the Company's
quarterly operating results. The timing of any sale or securitization
transaction is affected by a number of factors beyond the Company's control
including market conditions and the presence of investors and lenders interested
in the Company's seasoned credit card accounts.
The Company may experience seasonal fluctuations in cash requirements due
to a variety of factors beyond the Company's control including the rate at which
customers pay down their credit card balance and the rate at which the customers
make new purchases and cash advances on their accounts. The Company may
experience higher cash requirements during the year-end holiday season and at
other times during the year when customers make new purchases on their credit
cards at a faster rate than they pay their debts.
NET LOSSES; ACCUMULATED DEFICIT. The Company has incurred substantial net
losses and had an accumulated deficit of approximately $39.9 million at May 31,
1999. Significant expenditures have been made to build the infrastructure
necessary to acquire charged-off portfolios, market and create new credit card
accounts from these portfolios, and service the resulting base of credit card
accounts. There can be no assurance that the Company will be able to maintain
profitable long enough to recover the accumulated deficit to date. Results of
operations will depend upon numerous factors including without limitation, costs
associated with the purchase of charged-off consumer debt portfolios and the
marketing, origination and servicing of the Company's credit card receivables,
the revenue generated from the Company's credit card portfolio, the availability
of additional financing to purchase non-performing consumer debt portfolios and
finance working capital, the performance of the Company's receivables, the
ability to sell and securitize the Company's seasonal credit card receivables,
and the market acceptance of the Company's products and services.
ADDITIONAL FINANCING REQUIREMENTS; POTENTIAL UNAVAILABILITY OF ADDITIONAL
FINANCING. The Company has a substantial ongoing need for liquidity to finance
its operations, and this need is expected to increase along with the growth in
the Company's business. The Company's primary operating cash requirements
include the purchase of non-performing portfolios, the marketing, servicing and
collection of credit cards, and ongoing administrative expenses.
The Company funds its cash requirements through a combination of cash flow
from operations, asset sales and securitizations, loans and other financing
transactions.
There can be no assurance that the Company will be able to sell or
securitize its seasoned credit card receivables in the future or raise
additional debt financing. In the event additional financing is unavailable to
the Company and additional receivable sales and securitizations are not
completed, the Company will be materially adversely affected.
RISKS ASSOCIATED WITH ACCOUNTING ESTIMATES. The Company uses gain on sale
accounting, pursuant to which the Company records the unrealized gain from the
sale of receivables in securitization transactions as a
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component of Comprehensive Income and as retained interest in securitized
receivables on the balance sheet. The unrealized gain is an estimate based upon
management's assessment of future payment and default rates and other
considerations in light of conditions existing at the time of the estimate. If
actual default rates, with respect to those receivables included in
securitizations, are higher than the Company projected at the time of sale of
the receivables, the Company would be required to record a charge to
comprehensive income in future periods which would also reduce the Company's
retained interest on the balance sheet.
LACK OF SEASONING OF CREDIT CARD PORTFOLIO. The average age of a credit
card issuer's portfolio of accounts is an indicator of the stability of
delinquency and default levels of that portfolio; a portfolio of older accounts
generally behaves more predictably than a newly originated portfolio. The
majority of the credit card receivables owned by the Company are less than three
years old as of December 1999. As a result there can be no assurance as to the
levels of delinquencies and defaults, which may affect the Company's earnings
through net charge-offs over time. Any material increases in delinquencies and
defaults above management's expectations would have a material adverse effect on
the Company's results of operations and financial condition.
LIMITED MARKET FOR THE COMPANY'S CREDIT CARD RECEIVABLES. The Company's
future is highly dependent upon the Company's ability to sell or securitize its
portfolios of credit cards that have been generated from non-performing debt.
Although to date, the Company has sold two portfolios and completed three
securitizations, no assurance can be given that any more will be sold or
securitized. While there have been securitizations completed by companies that
purchase non-performing consumer debt portfolios and subsequently attempt to
collect on these accounts, the Company is unaware of any significant
securitization of credit card receivables generated from portfolios of
non-performing debt. The Company believes that the market for receivables of
this nature is limited and that there can be no assurance that any such market
will develop to the stage where the Company can be assured of buyers for it's
securitizations and portfolio sales.
RISKS ASSOCIATED WITH SECURITIZATION. The Company completed its first
securitzations in fiscal 1999. The transactions resulted in recognition of a
gain on sale and the recording of the retained interests in the securitizations
for financial reporting purposes. These and future securitizations have the
effect of reducing income from credit card receivables and revenue in excess of
cost recovered partially offset by the receipt of servicing income, and the
accretion income on the residual investment in the securitizations. In addition,
in accordance with SFAS 115 unrealized holding gains and losses, net of the
related tax effect, are not reflected in earnings but are recorded as a separate
component of comprehensive income until realized. A decline in the value of an
available-for-sale security below cost that is deemed other than temporary is
charged to earnings and results in the establishment of a new cost basis for the
security and, therefore, could have an adverse effect on the Company's financial
position and/or results of operations. Any downward adjustment in the carrying
amount of this or future residual interests could also have an adverse effect on
the market price of the Company's Common Stock. The Company intends to pursue
additional securitizations and portfolio sales, if any, will cause fluctuations
in the Company's quarterly income and will affect period-to-period comparisons.
There also can be no assurance that the Company will be able to complete future
securitizations at all or on terms favorable to it.
ADVERSE PUBLICITY MAY IMPAIR ACCEPTANCE OF THE COMPANY'S PRODUCTS. Critics
of the credit card industry have in the past focused on marketing practices that
they claim encourage consumers to borrow more money than they should, as well as
on pricing practices that they claim are either confusing or result in prices
that are too high. Increased criticism of the industry or criticism of the
Company in the future could hurt client acceptance of the Company's products or
lead to changes in the law or regulatory environment, either of which would
significantly harm the Company's business.
PLEDGE OF ALL ASSETS OF THE COMPANY. On April 30, 1998, the Company, to
secure its payment and performance under its senior secured debt financing,
granted the lender a security interest in all of the Company's assets in, among
other things, all receivables, inventory and equipment. The Company had
previously pledged its assets to its major shareholder as collateral for the
loans evidenced by certain shareholder notes. See "Item 7 -
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Certain Relationships and Related Transactions." All shareholder notes have been
subordinated to the Company's senior debt lender. By pledging all of its assets
to secure financings, the Company may find it more difficult to secure
additional financing in the future.
ADEQUACY OF BACKUP SERVICING FACILITY. The Company, through the issuing
bank's arrangement with FDR, uses FDR for third-party processing of credit card
data and services. The Company provides credit card data to FDR on a daily basis
and such data is backed up and stored by FDR. The Company's marketing data on
its purchased portfolios is backed up on a daily basis and is stored off-site.
While it is currently evaluating a second service center, the Company does
not have a back-up servicer for its portfolio of credit cards, nor does it have
a back-up telemarketer for its marketing programs. However, in the event of a
disaster or other occurrence that closes the Company's main facility or shuts
down its primary and redundant data connections to FDR, the Company's business
would be interrupted during the period required to repair its data lines and/or
facilities or to relocate to temporary facilities. Such interruption in the
Company's operations could have a material adverse impact on its business and
revenues. The Company is evaluating back-up servicing and marketing solutions
that can seamlessly move servicing and marketing operations to alternative
locations or to third-party service providers in a manner that would minimize
losses in the event of a disaster or other occurrence that affects the Company's
primary facility or data transmission to third parties.
RELIANCE UPON CREDIT CARD ISSUERS. The Company is not licensed to nor does
it currently have the ability independently to issue credit cards. Accordingly,
the Company is dependent upon third-party financial institutions to issue credit
cards to the Company's customers. The Company currently has two banks through
which cards are issued. If the Company's existing credit card issuers
discontinue their agreements with the Company, the Company will be forced to
seek out new credit card issuers who are willing to issue credit cards to
consumers with an impaired credit history. Termination of the existing credit
card issuer agreements would thus have a material adverse impact on the business
of the Company.
LABOR AVAILABILITY. The credit card industry is labor intensive and
generally experiences a high rate of turnover in personnel. A high turnover rate
among the Company's employees would increase the Company's recruiting and
training costs and could adversely impact the overall recovery of its
receivables. In addition, Sioux Falls, South Dakota experiences a low incidence
of unemployment. If the Company were unable to recruit and retain a sufficient
number of employees, it would be forced to limit its growth or possibly curtail
its operations. Growth in the Company's business will require it to continue to
recruit and train significant numbers of qualified personnel. There can be no
assurance that the Company will be able to continue to hire, train and retain a
sufficient number of qualified employees.
AVAILABILITY OF ADDITIONAL RECEIVABLES FOR PURCHASE. The Company's success
is dependent on the continued availability of non-performing portfolios that
meet its requirements. The availability of portfolios of receivables for future
purchase at prices favorable to the Company is dependent on a number of factors
outside of the control of the Company, including the continuation of the current
growth trend in credit card and consumer installment debt. Curtailment of that
trend could result in less credit being extended by lending institutions and
consequently fewer receivables available for purchase at prices that conform to
the Company's strategy for profitable collection. In addition, to the extent
consumers with negative credit history have less difficulty in obtaining credit,
especially obtaining unsecured credit cards, there may be less consumer demand
for the Company's product. The possible entry of new competitors (including
competitors that historically have focused on the acquisition of different asset
types) may adversely affect the Company's access to portfolios. The Company's
access to receivables portfolios may also be adversely affected if traditional
credit card lenders rehabilitate their own non-performing credit card
receivables. In addition, overly aggressive pricing by competitors could have
the effect of raising the cost of portfolios of receivables above those that
conform to the Company's pricing models. Any decrease in availability of
receivables or any increase in the cost of receivables, may have a material
adverse impact on the Company's operations.
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RISKS ASSOCIATED WITH FLUCTUATION IN ECONOMIC CONDITIONS. During strong
economic cycles, available credit, including consumer credit, generally
increases and payment delinquencies and defaults generally decrease. During
periods of economic slowdown and recession, such delinquencies and defaults
generally increase. No assurances can be given that the Company's credit card
losses and delinquencies would not worsen in a weak economic cycle. Significant
increases in credit card losses would weaken the financial condition of the
Company.
DEPENDENCE ON TECHNOLOGY; RISK OF BUSINESS INTERRUPTION. The Company's
success is dependent in large part on its continued investment in sophisticated
telecommunications and computer systems, including predictive dialers, automated
call distribution systems and digital switching equipment. The Company has
invested significantly in technology in an effort to remain competitive and
anticipates that it will be necessary to continue to do so in the future.
Moreover, computer and telecommunications technologies are evolving rapidly and
are characterized by short product life cycles, which requires the Company to
anticipate and stay current with technological developments. There can be no
assurance that the Company will be successful in anticipating, managing or
adopting such technological changes on a timely basis or that the Company will
have the capital resources available to invest in new technologies.
EVOLVING BUSINESS PRACTICES. While the Company may, from time to time,
develop additional products and services, there can be no assurance that such
products and services will be completed or successfully marketed and
implemented. Consumer preferences for credit card and credit related products
are difficult to predict, specifically where consumers have experienced past
credit difficulties. There can be no assurance that the products and services
introduced by the Company will be accepted by credit card holders, or that the
Company's methodology for restructuring past consumer debt delinquency will be
accepted by the consumer. Failure to obtain significant customer satisfaction or
market share for the Company's products and services would have a material
adverse effect on the Company.
LACK OF LIQUIDITY OF COMMON STOCK. The Company's Common Stock currently
trades on the NASDAQ OTC Bulletin Board under the symbol "PLCR." While a number
of registered broker-dealers are currently making a market in the Company's
Common Stock, there can be no assurance that an active public market for the
Company's Common Stock will be sustained. Accordingly, investors may not be able
to sell their Common Stock should they desire to do so, or may be able to do so
only at lower than desired prices. While no prediction can be made as to the
effect, if any, that future sales of shares of the Company's Common Stock, or
the availability of additional shares for future sales, will have on the market
price of the Common Stock prevailing from time to time, sales of substantial
amounts of Common Stock or the perception that such sales could occur, would
likely adversely affect the market price for the Common Stock.
DEPENDENCE ON KEY PERSONNEL. The Company is dependent upon the continued
contributions of its officers and other key employees. Although the Company has
entered into employment agreements with Martin J. Burke, its Chief Executive
Officer and Chairman of the Board of Directors, Kevin T. Riordan, its President
and Chief Operating Officer, Michael J. Philippe, its Executive Vice President
and Chief Financial Officer, and Richard S. Angel, its Executive Vice President
and General Counsel, the loss of the services of any such individual or the
services of certain other officers or key employees could have a material
adverse effect on the Company's business and prospects. See "Item 5 - Directors
and Executive Officers."
CONTROL BY MAJOR SHAREHOLDERS. Jay L. Botchman, a director of the Company,
is the principal stockholder of Taxter and owns all of the outstanding capital
stock of J.L.B. of Nevada, Inc. ("JLB"). Mr. Botchman, individually and through
his control of Taxter and JLB, beneficially owns all of the preferred stock of
the Company. See "Item 4 - Security Ownership of Certain Beneficial Owners and
Management." The terms of the preferred stock of the Company contain
preferential rights for the holders of preferred stock, including preferential
dividends and voting rights. See "Item 11 - Description of Securities to be
Registered; Preferred Stock." As of December 15, 1999, Taxter owned
approximately 45.1% of the Common Stock of the Company and controls
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approximately 87.86% of all stockholder votes primarily as a result of its
ownership of 1,200,000 shares of the Company's Series A Preferred Stock. Under
the provisions of the Company's Certificate of Incorporation, the outstanding
shares of Series A Preferred Stock represent 80% of all votes entitled to be
voted at any meeting of the Shareholders of the Company, subject to dilution to
the extent capital stock of the Company is subsequently issued. Currently, the
shares of the Series A Preferred Stock represent approximately 77.88% of all
votes entitled to be voted at any meeting of the stockholders of the Company.
Accordingly, Mr. Botchman, as Managing Member of Taxter, is in a position to
elect all of the directors of the Company and direct stockholder approval upon
all issues to be voted upon by the stockholders of the Company, thereby
controlling the Company. If Mr. Botchman were to cease to be the Managing Member
of Taxter for any reason, Martin J. Burke, the Company's Chief Executive
Officer, would become the Managing Member of Taxter pursuant to the terms of the
Taxter Operating Agreement.
PROPRIETARY RIGHTS; SUBSTANTIAL DEPENDENCE UPON PROPRIETARY INFORMATION.
The Company is the owner of certain proprietary data and analytical computer
programs, methods and related know-how for evaluating portfolios of
non-performing debt and predicting future performance of the portfolios which
are important to the Company's operations. The Company currently relies upon a
combination of contract provisions and trade secret laws to attempt to protect
its proprietary rights. Although the Company intends to protect its rights
vigorously, there can be no assurance that any of the foregoing measures will be
successful.
CONSUMER PROTECTION LAWS. The Company's collection practices, business
operations and credit card receivables are subject to numerous federal and state
consumer protection laws and regulations imposing licensing and other
requirements with respect to purchasing, collecting, making and enforcing
consumer loans. The Company conducts periodic compliance reviews and, if
necessary, implements procedures to bring the Company into compliance with all
applicable state and federal regulatory requirements. Failure by the Company to
comply with such statutes or regulations could have a material adverse effect on
the Company's results of operations or financial condition. In addition, due to
the consumer-oriented nature of the collections and credit card industry, there
is a risk that the Company or other industry participants may be named as
defendants in litigation involving alleged violations of federal and state laws
and regulations, including consumer protection laws, and consumer law torts,
including fraud. A significant judgment against the Company or within the
industry in connection with any such litigation could have a material adverse
effect on the Company's results of operations or financial condition. See
"Item 1 - Business; Government Regulation."
POSSIBLE EFFECTS OF BLANK CHECK PREFERRED STOCK; ANTITAKEOVER PROVISIONS;
ISSUANCE OF ADDITIONAL SHARES OF PREFERRED STOCK. The Company's Certificate of
Incorporation authorizes the issuance of "blank check" preferred stock with such
designations, rights and preferences as may be determined from time to time by
the Company's Board of Directors. Accordingly, the Board of Directors is
empowered, without stockholder approval, to issue preferred stock with dividend,
liquidation, conversion, voting or other rights which could adversely affect the
relative voting power or other rights of the holders of the Company's Common
Stock. In December 1996, the Company issued 5,000 shares of its 1,000,000 "blank
check" preferred shares designated as Series C Preferred Stock. In May 1998, the
Company issued 10,000 shares of its 1,000,000 "blank check" preferred shares
designated as Series D Preferred Stock. In August 1998, the Company issued
10,000 shares of its 1,000,000 "blank check" preferred shares designated as
Series E Preferred Stock. See "Item 11 - Description of Securities to be
Registered; preferred stock." In the event of additional issuances, the
preferred stock may be used, under certain circumstances, as a method of
discouraging, delaying or preventing a change in control of the Company and
could prevent stockholders from receiving a premium for their shares in the
event of a third party tender offer or change of control transaction. 2,025,000
shares of preferred stock are outstanding as of the date of this Registration
Statement. There can be no assurance that the Company will not issue additional
shares of preferred stock in the future. When the Company issues additional
preferred stock, the issuance may have a dilutive effect upon the holders of the
Company's Common Stock. In addition, the Company is subject to Section 203 of
the Delaware General Corporation Law which, subject to certain exceptions,
prohibits a Delaware corporation from engaging in any of a broad range of
business combinations with an "interested stockholder" for a period of three
years following the date that such stockholder became an interested stockholder.
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The issuance of any additional shares of preferred stock having rights
superior to those of the Common Stock may result in a decrease in the value or
market price of the Common Stock. Holders of preferred stock may have the right
to receive dividends, certain preferences in liquidation and conversion rights.
The issuance of preferred stock could, under certain circumstances, have the
effect of delaying, deferring or preventing a change in control of the Company
without further vote or action by the stockholders and may adversely affect the
voting and other rights of the holders of Common Stock.
LIMITATIONS ON LIABILITY OF DIRECTORS AND OFFICERS. The Company's
Certificate of Incorporation contains provisions limiting the liability of
directors of the Company for monetary damages to the fullest extent permissible
under Delaware law. This is intended to eliminate the personal liability of a
director for monetary damages in an action brought by or in the right of the
Company for breach of a director's duties to the Company or its stockholders
except in certain limited circumstances. In addition, the By-laws of the Company
contain provisions requiring the Company to indemnify directors, officers,
employees and agents of the Company serving at the request of the Company
against expenses, judgments (including derivative actions), fines and amounts
paid in settlement. This indemnification is limited to actions taken in good
faith in the reasonable belief that the conduct was lawful and in or not opposed
to the best interests of the Company. The By-laws of the Company provide for the
indemnification of directors and officers in connection with civil, criminal,
administrative or investigative proceedings when acting in their capacities as
agents for the Company. The foregoing provisions may reduce the likelihood of
derivative litigation against directors and officers and may discourage or deter
stockholders or management from suing directors or officers for breaches of
their duties to the Company, even though such an action, if successful, might
otherwise benefit the Company and its stockholders.
OUTSTANDING OPTIONS. As of December 15, 1999 the Company had granted
options to purchase 5,253,000 shares of Common Stock pursuant to stock option
and warrant agreements entered into by the Company with certain individuals
associated with the Company. While a portion of such options are not immediately
exercisable, any exercise could cause immediate and substantial dilution.
Certain principal stockholders have demand and "piggy-back" registration rights
with respect to their securities. Exercise of such rights could involve
substantial expense to the Company.
COMMON STOCK ELIGIBLE FOR FUTURE SALE. Future sales of shares of Common
Stock by existing stockholders under Rule 144 ("Rule 144") of the Securities Act
of 1933, as amended (the "Securities Act"), or through the exercise of
outstanding registration rights or the issuance of shares of Common Stock upon
the exercise of Options could materially adversely affect the market price of
the Common Stock. A material reduction in the market price of the Company's
Common Stock could materially impair the Company's future ability to raise
capital through an offering of equity securities. A substantial number of shares
of Common Stock are available for sale under Rule 144 in the public market or
will become available for sale in the near future. In addition, certain
shareholders have demand registration rights, and a registration statement would
be prepared to register their 8,157,500 shares of Common Stock in the event of
such demand. Three officers of the Company, Martin J. Burke, Richard S. Angel,
Michael J. Philippe have piggyback registration rights with respect to the
shares of Common Stock issuable upon the exercise of the options received by
them pursuant to the terms of their employment agreements. See "Item 6 -
Executive Compensation; Employment Agreements."
RISK OF LOW-PRICED SECURITIES. The Securities Enforcement and Penny Stock
Reform Act of 1990 requires additional disclosure relating to the market for
penny stocks in connection with trades in any stock defined as a penny stock.
Commission regulations generally define a penny stock to be an equity security
that has a market price of less than $5.00 per share, subject to certain
exceptions. As the Company does not currently satisfy the requirements to comply
with any exception, the regulations require the delivery, prior to certain
transactions involving the Company's Common Stock, of a disclosure schedule
explaining the penny stock market and the risks associated therewith.
Transactions that meet the requirements of Regulation D under the Securities Act
or
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transactions with an issuer not involving a public offering pursuant to
Section 4(2) of the Securities Act are exempt from the disclosure schedule
delivery requirements.
Since the Company is subject to the penny stock regulations cited above,
trading in the Company's securities is covered by Rule 15g-9 promulgated under
the Securities Exchange Act of 1934, as amended (the "Exchange Act") for
non-NASDAQ and non-national securities exchange listed securities. Under such
rule, broker/dealers who recommend such securities to persons other than
established customers and accredited investors must make a special written
suitability determination for the purchaser and receive the purchaser's written
agreement to a transaction prior to sale.
If market makers are unable to make a market in the Company's securities,
the market liquidity for the Company's securities could be adversely affected.
In such event, the absence of liquidity of the Company's Common Stock could
limit the ability of broker/dealers to sell the Company's securities and thus
the ability of holders of the Company's securities to sell their securities in
the secondary market.
ITEM 3 - PROPERTIES
The Company's headquarters consist of a 30,000 square foot leased facility
in Sioux Falls, South Dakota. The lease expires on September 30, 2011. The
Company owns an additional 5 acres of undeveloped property adjacent to this site
that can be utilized for expansion purposes.
The Company's Mail Center consists of a 25,000 square foot leased facility
in Sioux Falls, South Dakota. The lease was amended on November 18, 1997 to
extend the terms of the lease for two years commencing on March 1, 1998 and
ending on February 28, 2000.
ITEM 4 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding the
beneficial ownership of the Company's Common Stock and Preferred Stock as of
December 15, 1999, based upon the most recent information available to the
Company for (i) each person known by the Company who owns beneficially more than
five percent of any class of capital stock of the Company, (ii) each of the
Company's directors (iii) the Company's Chief Executive Officer and each of the
four other most highly compensated executive officers (the "Named Executive
Officers") and (iv) all officers and directors of the Company as a group. Except
as set forth below, each stockholder's address is c/o the Company, 3401 North
Louise Avenue, Sioux Falls, South Dakota 57107.
COMMON STOCK PREFERRED STOCK (1)
------------ -------------------
NUMBER PERCENTAGE NUMBER PERCENTAGE
OF SHARES OF SHARES OF SHARES OF SHARES
--------- ---------- --------- ----------
Principal Shareholders:
Taxter One LLC 15,678,000 45.1% 2,000,000(2) 100%(2)
565 Taxter Road
Elmsford, NY 10523
J.L.B. of Nevada, Inc. 6,650,000(3) 16.1% 20,000(4) 100%(4)
1500 E. Tropicana Ave.
Suite 100
Las Vegas, NV 89119
Michael Lauer 8,252,500(5) 23.7% -- --
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Directors and Named Executive Officers:
Martin J. Burke 1,000,000(6) 2.8% -- --
Kevin T. Riordan 815,000(7) 2.3% -- --
Michael J. Philippe 355,334(8) 1.0% -- --
Richard S. Angel 250,000(9) * -- --
Cynthia D. Hassoun 50,000(10) * -- --
Jay L. Botchman(11) 22,328,000(3) 53.9% 2,025,000(11) 100%(11)
Barry E. Breeman 75,000(12) * -- --
J. Richard Budd, III 91,300(13) * -- --
Geoffrey A. Thompson 95,000(14) * -- --
All directors and executive officers as a group 25,125,234(15) 57.2% 2,025,000(11) 100%(11)
- ----------------
* Less than 1%
(1) The Company currently has outstanding 1,200,000 shares of Series A
Preferred Stock, 80,000 shares of Series B Preferred Stock, 5,000 shares of
Series C Preferred Stock, 10,000 shares of Series D Preferred Stock, and
10,000 shares of Series E Preferred Stock, all of which are owned by one of
Jay L. Botchman, a director of the Company, Taxter and JLB all of which and
are under the control of Mr. Botchman. See "Item 11--Description of
Securities to be Registered; Preferred Stock."
(2) Consists of 1,200,000 shares of Series A Preferred Stock and 800,000 shares
of Series B Preferred Stock held by Taxter.
(3) Includes 3,800,000 shares of Common Stock issuable upon conversion of
10,000 shares of Series D Preferred Stock held by JLB and 2,850,000 shares
of Common Stock issuable upon conversion of 10,000 shares of Series E
Preferred Stock held by JLB.
(4) Consists of 10,000 Series D Preferred Stock and 10,000 Series E Preferred
Stock held by JLB.
(5) Consists of 2,987,500 shares of Common Stock owned by Lancer Partners,
L.P., 4,730,000 shares of Common Stock owned by Lancer Offshore, Inc., and
535,000 shares of Common Stock owned by Michael Lauer. Mr. Lauer is the
investment manager for Lancer Partners, L.P. and Lancer Offshore, Inc. and
has the authority to vote and dispose of all shares of Common Stock owned
by these entities.
(6) Consists of 1,000,000 shares issuable upon the exercise of options
exercisable at a price of $2.00 per share.
(7) Includes shares issuable upon the exercise of options exercisable in the
following amounts and prices: 300,000 shares at $2.00 per share, 100,000
shares at $2.70 per share, and 200,000 shares at $2.40 per share. Includes
215,000 shares owned by Mr. Riordan's wife, of which shares Mr. Riordan
disclaims beneficial ownership.
(8) Includes shares issuable upon the exercise of options exercisable in the
following amounts and prices: 50,000 shares at $2.00 per share, 100,000
shares at $2.70 per share, and 200,000 shares at $2.40 per share.
(9) Includes shares issuable upon the exercise of options exercisable in the
following amounts and prices: 50,000 shares at $2.00 per share, 100,000
shares at $2.70 per share, and 100,000 shares at $2.40 per share.
(10) Consists of 250,000 shares issuable upon the exercise of options
exercisable at a price of $2.00 per share.
(11) Includes 5,000 shares of Series C Preferred Stock held of record by Jay L.
Botchman, 1,200,000 shares of Series A Preferred Stock and 800,000 shares
of Series B Preferred Stock held of record by Taxter and the 10,000 shares
of Series D Preferred Stock and 10,000 shares of Series E Preferred Stock
held of record by JLB. Mr. Botchman owns approximately 99.95% of the
membership interests in Taxter and owns 100% of the outstanding capital
stock of JLB.
(12) Consists of 75,000 shares issuable upon the exercise of options exercisable
at a price of $2.00 per share.
(13) Includes 75,000 shares issuable upon the exercise of options exercisable at
a price of $2.00 per share.
(14) Includes 75,000 shares issuable upon the exercise of options exercisable at
a price of $2.19 per share.
(15) Includes 65,000 shares issuable upon the exercise of options in addition to
those shares set forth in footnote 3 and footnotes 6 through 14. Also
includes 500 shares owned by William Buriak's wife.
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ITEM 5 - DIRECTORS AND EXECUTIVE OFFICERS
The Company's directors, executive officers and key employees are as
follows:
Name Age Position
---- --- --------
Martin J. Burke, III 41 Chairman of the Board of Directors and Chief Executive Officer
Kevin T. Riordan 47 President and Chief Operating Officer
Michael J. Philippe 41 Executive Vice President, Chief Financial Officer and Treasurer
Richard S. Angel 41 Executive Vice President and General Counsel
William Buriak 45 Senior Vice President and Chief Information Officer
Cynthia D. Hassoun 49 Senior Vice President and Corporate Secretary
Michael L. Neher 35 Senior Vice President
Jonathan Pike 38 Senior Vice President
Patrick Steffl 33 Senior Vice President
Jay L. Botchman 67 Director
Barry Breeman 50 Director
J. Richard Budd, III 47 Director
Geoffrey Thompson 59 Director
Each director of the Company holds office until the next annual meeting of
the stockholders, or until his successor is elected and qualified. The Company's
By-laws provide for not less than one director. The By-laws permit the Board of
Directors to fill any vacancy on the Board. Officers serve at the discretion of
the Board of Directors.
The principal occupation and business experience of each officer, director
and key employee of the Company is as follows:
MARTIN J. BURKE, III. Mr. Burke has been the Chief Executive Officer of
the Company since October 1996. Mr. Burke has served as the Chairman of the
Board of Directors of the Company since May 1998, prior to which he had been
Vice-Chairman of the Board of Directors. From March 1995 through September 1996,
Mr. Burke was the Chairman of American Home Credit, a company engaged in the
financing of sub-prime debt. During 1994, Mr. Burke sat on the Board of the
corporate finance subsidiary of G & L Realty, a R.E.I.T. specializing in medical
offices and nursing homes. From November 1983 through May 1998, Mr. Burke was
Chief Executive Officer and principal owner of The Martin Burke Company, a
company engaged in structuring and arranging financing for sophisticated real
estate transactions and start-up corporations.
KEVIN T. RIORDAN. Mr. Riordan has been the President and Chief Operating
Officer of the Company since April 1997. From February 1995 to March 1997, Mr.
Riordan served as President and Chief Executive Officer of Long Beach Acceptance
Corp., a subsidiary of Long Beach Mortgage Corp. From February 1985 to February
1995, Mr. Riordan was President and Chief Executive Officer of Alliance Funding
Company and its successor in interest Alliance Funding Company, a division of
Superior Bank FSB. Prior to 1985, Mr. Riordan acted as Senior Vice President of
American Funding, a national consumer mortgage company.
MICHAEL J. PHILIPPE. In June 1999, Mr. Philippe was elected Executive Vice
President, Chief Financial Officer and Treasurer of the Company. Mr. Philippe
joined the Company in June 1997 as Vice President of Finance and became Chief
Financial Officer in September 1997. The prior 13 years, Mr. Philippe served as
a Vice President and Manager for The Sumitomo Bank, Ltd. and its predecessors.
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RICHARD S. ANGEL. Mr. Angel joined the Company in August 1997 as Vice
President, Secretary and Corporate Counsel. In June 1999, Mr. Angel was elected
Executive Vice President and General Counsel of the Company. From January 1992
to August 1997, Mr. Angel was a shareholder in the law firm of Buchalter, Nemer,
Fields & Younger in Los Angeles, California. From May 1985 to December 1991 he
was an associate with such firm.
WILLIAM G. BURIAK. Mr. Buriak joined the Company as Chief Information
Officer July 1999. From November 1996 to July 1999, Mr. Buriak was Director of
Management Information Services and Director of Business Office Operations for
CCDM, a non-profit healthcare system in Perth Amboy, New Jersey. From June 1986
to November 1996, Mr. Buriak was Assistant Vice President at Beneficial Finance
Corporation in Peapack, New Jersey.
CYNTHIA D. HASSOUN. Ms. Hassoun joined the Company in October 1997 as
Chief Coordinating Officer. In April 1999, Ms. Hassoun was elected Corporate
Secretary of the Company and she was elected Senior Vice President of the
Company in June 1999. From April 1997 to September 1997, Ms. Hassoun served as a
consultant to the Company. From January 1992 to November 1996, Ms. Hassoun was
Vice President of Customer Service for Superior Bank FSB, a savings bank.
MICHAEL L. NEHER. Mr. Neher joined the Company as Senior Vice President
responsible for Non-Card Resolutions and Portfolio Divestitures in November
1999. From September 1998 to October 1999, Mr. Neher was the Assistant Vice
President for Outsourcing-Card Services/Consumer Products of the Atlanta Georgia
operation of the Bank of Hawaii. From December 1995 to September 1998, he was
the Regional Sales Manager for Primus Automotive Financial Services, Atlanta,
Georgia. From June 1993 to November 1995, Mr. Neher served as the Business Line
Supervisor, Collections and Recovery-Consumer Loans for Ocwen Federal Bank &
Trust FSB, West Palm Beach, Florida.
JONATHAN L. PIKE. Mr. Pike has been the Sr. Vice President of Operations
for the Company since August 1999. From November 1997 to July 1999, Mr. Pike
served as Vice President of Credit Risk for Stage Stores in Houston, Texas. From
August 1992 until November 1997, Mr. Pike served as Director of Strategic
Marketing and Director of Risk Management for First Data Corporation in Omaha,
Nebraska.
PATRICK STEFFL. Mr. Steffl was elected Senior Vice President of the
Company in June 1999. Prior to joining the Company in August 1997 as Vice
President of Marketing, Mr. Steffl had been with Fingerhut Companies, Inc. in
Minnetonka, Minnesota since 1989, managing mail and telemarketing media of six
phone centers throughout the country.
JAY L. BOTCHMAN. Mr. Botchman has been a director of the Company since
October 1996. From October 1996 through May 1998, Mr. Botchman served as the
Chairman of the Board of Directors of the Company. Mr. Botchman also serves as
the Chairman and majority owner of Taxter. For more than the past five years,
Mr. Botchman has been the owner of J.L.B. Equities, Inc. and JLB, both of which
are investment and commercial finance companies. In addition, Mr. Botchman acts
as a consultant to various entities in the consumer finance business.
BARRY E. BREEMAN. Mr. Breeman joined the Board of Directors in September
1998. Since April 1998, Mr. Breeman has been Vice Chairman and Chief Investment
Officer of Manley-Berenson Realty & Development, LLC. From January 1991 to the
present, Mr. Breeman has been the managing member of Cambridge Real Estate
Services, LLC, a real estate investment banking services business. From January
1980 to December 1991, he was President, Chief Executive Officer and a director
of Carnegie Realty Holdings Corp. and its subsidiaries.
J. RICHARD BUDD, III. Mr. Budd joined the Board of Directors in
September 1998. Mr. Budd served as Senior Vice President of Metallurg, Inc.,
an international specialty metals producer, from January 1996 to October
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1998. From July 1994 to January 1996, Mr. Budd served as Vice President and
Director of Cityscape Corp and from 1992 to 1994, Mr. Budd worked as a
consultant with the consulting firm of Zolfo Cooper LLC. Prior to 1992, Mr. Budd
was Executive Vice President of European American Bank and President and Chief
Executive of Euram Management, Inc., a subsidiary of ABN AMRO Bank NV, a foreign
bank holding company.
GEOFFREY A. THOMPSON. Mr. Thompson joined the Board of Directors in April
1999. Mr. Thompson retired from Marine Midland Bank, Inc., Buffalo, New York in
October 1992, where he had served as President and Chief Executive Officer. Mr.
Thompson currently serves on the board of directors of Magnavision Corp., a
provider of private cable (wireless compatible communication) to colleges,
hospitals and nursing homes. In addition, he serves on the boards of three
privately-held corporations and four not-for-profit corporations.
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ITEM 6 - EXECUTIVE COMPENSATION
The following summary compensation table sets forth information concerning
the annual compensation paid by the Company to the Named Executive Officers for
services rendered during the fiscal years ended May 31, 1999, May 31, 1998 and
May 31, 1997.
SUMMARY COMPENSATION TABLE
LONG-TERM
COMPENSATION
------------
AWARDS
------------
ANNUAL COMPENSATION NUMBER OF
------------------- SECURITIES
FISCAL UNDERLYING
NAME AND PRINCIPAL POSITION YEAR(1) SALARY BONUS OPTION (#)
- --------------------------- ------- ------ ----- -----------
Martin J. Burke, III 1999 $60,000.00 -- --
Chairman of the Board 1998 62,518.48 -- 1,000,000
and Chief Executive Officer 1997 29,999.97 -- --
Kevin Riordan 1999 $305,769.20 -- 100,000
President and Chief 1998 305,968.06 -- 300,000
Operating Officer 1997 39,230.78 -- --
Michael J. Philippe
Executive Vice President, 1999 $184,951.60 $5,000 100,000
Chief Financial Officer and 1998 161,233.76 -- 100,000
Treasurer 1997 -- -- --
Richard S. Angel 1999 $220,154.00 -- 100,000
Executive Vice President 1998 153,989.12 -- 100,000
and General Counsel 1997 -- -- --
Cynthia D. Hassoun 1999 $152,884.90 -- --
Senior Vice President and 1998 92,223.15 $50,000 75,000
Corporate Secretary 1997 -- -- --
- ---------------------
(1) The Named Executive Officers commenced their employment with the Company as
follows: Mr. Burke, October 1996; Mr. Riordan, April 1997; Mr. Philippe,
June 1997; Mr. Angel, August 1997; Ms. Hassoun, October 1997.
CREDIT CARD FOR OFFICERS
Mr. Burke has a personal credit card from the Company that he uses for
personal purposes. The terms of the credit card impose interest at the rate of
18.9% APR, with a minimum monthly payment equal to 3.0% of the outstanding
balance. The credit limit on the card is $450,000. As of May 31, 1999, the
balance due on the credit card was $442,094.14.
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OPTION/SAR GRANTS IN LAST FISCAL YEAR
The following table contains information concerning the grant of stock
options to the Named Executive Officers for the Company's fiscal year ended May
31, 1999. These grants are also reflected in the Summary Compensation Table,
above.
% OF TOTAL POTENTIAL REALIZABLE
NUMBER OF OPTIONS VALUE AT ASSUMED
SECURITIES GRANTED ANNUAL RATES OF STOCK PRICE
UNDERLYING TO APPRECIATION FOR OPTION TERM(2)
OPTIONS EMPLOYEES EXERCISE EXPIRATION -------------------------------
NAME GRANTED(1) IN YEAR PRICE DATE 5% 10%
- ---- ---------- --------- -------- ---------- -- ---
Kevin Riordan 100,000 13% $2.70 August 9, 2003 $36,000 $117,000
Michael J. Philippe 100,000 13% $2.70 August 9, 2003 $36,000 $117,000
Richard S. Angel 100,000 13% $2.70 August 9, 2003 $36,000 $117,000
- ------------------
(1) Option granted to the Company's 1997 Stock Option Plan, as amended. See
"Stock Option Plan."
(2) Potential realized values shown above represent the potential gains based
upon compound price appreciation of 5% and 10% from the date of grant
through the full option term. The acutual value realized, if any, on stock
option exercises will be dependent upon overall market conditions and the
future performance of the Company and its Common Stock. There is no
assurance that the actual value will approximate the amounts reflected in
this table.
The following table summarizes option exercises by the Named Executive
Officers of the Company during fiscal 1999 and the value of unexercised stock
options as of May 31, 1999.
AGGREGATED OPTION EXERCISES IN FISCAL 1999 AND FISCAL YEAR-END OPTION VALUES
NUMBER OF SHARES VALUE OF UNEXERCISED
SHARES UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
ACQUIRED OPTIONS AT FISCAL YEAR-END AT FISCAL YEAR-END(1)
ON VALUE ------------------------------ -----------------------------
NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ------------------- -------- -------- ----------- ------------- ----------- -------------
Martin J. Burke 0 0 1,000,000 0 $562,000 0
Kevin Riordan 0 0 400,000 0 $168,600 0
Michael J. Philippe 0 0 125,000 75,000 $14,050 $42,150
Richard S. Angel 0 0 125,000 75,000 $14,050 $42,150
Cynthia D. Hassoun 0 0 25,000 50,000 $14,050 $28,100
- ------------------------------------
- ---------------------
(1) Value is based on the per share closing price of the Company's Common Stock
on May 28, 1999, the last trading day of fiscal 1999, which was $2.562.
STOCK OPTION PLAN
In March 1997, the Board of Directors adopted and the stockholders
approved the Company's 1997 Stock Option Plan. The Board of Directors and the
stockholders approved an amendment to the 1997 Stock Option Plan in December
1997 (as amended, the "Amended 1997 Stock Option Plan"). The Amended 1997 Stock
Option Plan
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provides for the grant of (i) options that are intended to qualify as incentive
stock options ("Incentive Stock Options") within the meaning of Section 422 of
the Internal Revenue Code of 1986, as amended (the "Code"), to employees and
(ii) options not intended to so qualify ("Nonqualified Stock Options") to
employees (including directors and officers who are employees of the Company),
directors and consultants. The total number of shares of Common Stock for which
options may be granted under the Amended 1997 Stock Option Plan is 4,000,000
shares. As of May 31, 1999, the Company had granted options to purchase
2,871,500 shares of Common Stock under the Amended 1997 Stock Option Plan. The
term of each option granted pursuant to the Amended 1997 Stock Option Plan shall
be established by the Board of Directors, or a committee of the Board of
Directors, in its sole discretion; provided, however, that the maximum term of
each Incentive Stock Option granted pursuant to the Amended 1997 Stock Option
Plan is ten years. Options shall become exercisable at such times and in such
installments as the Board of Directors, or a committee of the Board of
Directors, shall provide in the terms of each individual option. The exercise
price per share of these options shall be determined by the Board of Directors,
in their sole discretion, as set forth in the applicable option contract;
provided, however, that the exercise price of an Incentive Stock Option shall
not be less than the fair market value of the Common Stock subject to such
option on the date of grant; and further, provided, that if, at the time an
Incentive Stock Option is granted, the optionee owns (or is deemed to own under
Section 424(d) of the Code) stock possessing more than 10% of the total combined
voting power of all classes of stock of the Company, of any of its subsidiaries
or of a parent entity, the exercise price of such Incentive Stock Option shall
not be less than 110% of the fair market value of the Common Stock subject to
such Incentive Stock Option on the date of grant.
The Amended 1997 Stock Option Plan is administered by the Board of
Directors or a committee of the Board of Directors, which determines the terms
of options granted, including the exercise price, the number of shares subject
to the option and the terms and conditions of exercise. No option granted under
the Amended 1997 Stock Option Plan is transferable by the optionee other than by
will or the laws of descent and distribution, and each option is exercisable
during the lifetime of the optionee only by such optionee.
OTHER OPTIONS
On December 4, 1996, Taxter entered into a First Amended Stock Option
Agreement with one of the sellers of the Holdings stock (the "Selling Entities")
and the assignee of the other Selling Entity (the "Amended Option Holders")
canceling an original Stock Option Agreement between the Company and the Selling
Entities. Each of the Amended Option Holders, their assignees or designees have
the option (the "Option") to purchase from Taxter 4,000,000 shares of Common
Stock of the Company and 400,000 shares of Series B Preferred Stock of the
Company, exercisable in full by the Amended Option Holders, their assignees or
designees, at any one time commencing October 8, 1999 and terminating on
October 9, 2000, for an aggregate purchase price of $500,000. The Option
immediately terminates if, at any time prior to the Amended Option Holders
exercising their Options, Taxter tenders to each of the Amended Option Holders
$50,000,000. In the agreement, Taxter agreed to various transfer restrictions,
and the Amended Option Holders received certain registration rights.
COMPENSATION OF DIRECTORS
Directors J. Richard Budd, III, Barry E. Breeman and Geoffrey A. Thompson
each receive $50,000 as annual compensation for their services as directors of
the Company. In addition, Mr. Budd and Mr. Breeman were each granted options to
purchase 75,000 shares with an exercise price of $2.00 per share. Mr. Thompson
received options to purchase 75,000 shares an exercise price of $2.19 per share.
Martin Burke, who is Chairman of the Board of Directors and the Chief Executive
Officer of the Company, does not receive compensation for his services as a
director, but does receive compensation in connection for his services as Chief
Executive Officer. Jay Botchman does not receive compensation for his services
as a director. The Board of Directors may authorize the payment of compensation
to directors for their attendance at regular and special meetings of the Board
of Directors and for
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attendance at meetings of committees of the Board of Directors as is customary
for similar companies. Directors are reimbursed for their reasonable
out-of-pocket expenses incurred in connection with their duties as directors or
officers of the Company.
EMPLOYMENT AGREEMENTS
On March 27, 1997 the Company entered into a five year employment
agreement with Martin Burke, the Company's Chief Executive Officer. Under the
terms of the employment agreement, Mr. Burke will receive an annual base salary
of $60,000 for each year of his employment subject to annual review by the Board
of Directors. In addition, Mr. Burke has the right to receive under the terms of
the employment agreement (i) 1.5% of the annual net earnings of the Company
before taxes as reflected on the Company's certified financial statements, and
(ii) options to purchase 1,000,000 shares of the Company's Common Stock at a
purchase price of $2.00 per share for a period of five years commencing
March 27, 1997. The employment agreement also entitles Mr. Burke to all employee
benefit plans such as medical and dental coverage, life insurance, pension and
profit-sharing plans, that may be maintained by the Company. Under the terms of
the employment agreement, employment terminates upon death or total disability
of Mr. Burke and may be terminated by the Company for cause (such as misconduct,
disregard of instructions from the Board, commission of certain crimes or acts
or a material breach of the terms of the employment agreement.) The employment
agreement contains a change in control provision that provides Mr. Burke with
the right to terminate his employment within 60 days of the date of a change in
control and have such termination treated as a termination without cause meaning
that Mr. Burke shall have the right to continue to be compensated through the
term of the employment agreement. For purposes of the employment agreement, a
change of control is deemed to have occurred at such time as either (a) Taxter
owns directly or indirectly less than 10% of the Common Stock of the Company and
less than 50% of each other outstanding class of securities the majority vote of
which is required for shareholder action, or (b) Jay Botchman owns less than 50%
of the membership interest in Taxter. The employment agreement also contains
certain customary terms regarding proprietary information, confidentiality, and
the surrender of records upon termination. A copy of the employment agreement
has been filed as an exhibit hereto.
On April 1, 1997, the Company entered into a five year employment
agreement with Kevin Riordan, the Company's President and Chief Operating
Officer. Under the terms of the employment agreement, Mr. Riordan receives an
annual base salary of $300,000 for each year of his employment subject to annual
review by the Board of Directors of the Company. In addition to the base salary,
the Company agreed to pay Mr. Riordan a signing bonus of $2,000,000.
Additionally, he was granted options to purchase 300,000 shares of the Company's
Common Stock at an exercise price of $2.00 per share. Such options are
exercisable commencing April 1, 1999, and shall expire on the earlier of March
31, 2002, or the termination of Mr. Riordan's employment with the Company. The
employment agreement also entitles Mr. Riordan to all employee benefit plans
such as medical and dental coverage, life insurance, pension and profit-sharing
plans, that may be maintained by the Company. Under the employment agreement,
employment terminates upon death or total disability of Mr. Riordan and may be
terminated by the Company for cause (such as misconduct, disregard of
instructions from the Board of Directors, commission of certain crimes or acts
or a material breach of the terms of the employment agreement.) The employment
agreement also contains certain customary terms regarding proprietary
information, confidentiality, and the surrender of records upon termination. A
copy of the employment agreement has been filed as an exhibit hereto.
On June 17, 1997, the Company entered into an employment agreement with
Michael J. Philippe, Company's Chief Financial Officer and an Executive Vice
President, which was amended effective June 1, 1999 to extend the term of the
agreement to June 20, 2002. Under the terms of the employment agreement, as
amended, Mr. Philippe receives an annual base salary of $210,000 subject to
annual review by the Board of Directors. In addition, Mr. Philippe received
under the terms of the employment agreement options to purchase 100,000 shares
of the Company's Common Stock at a purchase price of $2.00 per share. The
options to purchase the option shares
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vest as follows: (i) 25,000 option shares on December 15, 1997, which have
vested, (ii) 25,000 option shares on June 17, 1999, which have vested, and (iii)
50,000 option shares on June 17, 2000. The options are exercisable, according to
their vesting schedules, for a period of five years from the date they were
granted. The employment agreement also entitles Mr. Philippe to all employee
benefit plans such as medical and dental coverage, life insurance, pension and
profit-sharing plans, that may be maintained by the Company. Under the terms of
the employment agreement, employment terminates upon death or total disability
of Mr. Philippe and may be terminated by the Company for cause (such as
misconduct, disregard of instructions from the Board of Directors, commission of
certain crimes or acts or a material breach of the terms of the employment
agreement.) The employment agreement contains a change in control provision that
provides Mr. Philippe with the right to terminate his employment within 60 days
of the date of a change in control and have such termination treated as a
termination without cause, meaning that Mr. Philippe shall have the right to
continue to be compensated through the term of the employment agreement. For
purposes of the employment agreement, a change of control is deemed to have
occurred at such time as either (a) Taxter owns directly or indirectly less than
10% of the Common Stock of the Company and less than 50% of each other
outstanding class of securities the majority vote of which is required for
shareholder action, or (b) Jay Botchman owns less than 50% of the membership
interests in Taxter. The employment agreement also contains certain customary
terms regarding proprietary information, confidentiality, and the surrender of
records upon termination. A copy of the employment agreement has been filed as
an exhibit.
On August 1, 1997, the Company entered into an employment agreement with
Richard S. Angel, the Company's General Counsel and an Executive Vice President,
which was amended effective June 1, 1999 to extend the term of the agreement to
September 30, 2000. Under the terms of the employment agreement, as amended, Mr.
Angel receives an annual base salary of $240,000 per year subject to annual
review by the Board of Directors. In addition, Mr. Angel received under the
terms of the employment agreement options to purchase 100,000 shares of the
Company's Common Stock at a purchase price of $2.00 per share. The options to
purchase the option shares vest as follows: (i) 25,000 option shares on December
15, 1997, which have (ii) 25,000 option shares on July 31, 1999, which have
vested, and (iii) 50,000 option shares on July 31, 2000. The options are
exercisable, according to their vesting schedules, for a period of five years
from the date they were granted. The employment agreement also entitles Mr.
Angel to all employee benefit plans such as medical and dental coverage, life
insurance, pension and profit-sharing plans, that may be maintained by the
Company. Under the terms of the employment agreement, employment terminates upon
death or total disability of Mr. Angel and may be terminated by the Company for
cause (such as misconduct, disregard of instructions from the Board of
Directors, commission of certain crimes or acts or a material breach of the
terms of the employment agreement.) The employment agreement contains a change
in control provision that provides Mr. Angel with the right to terminate his
employment within 60 days of the date of a change in control and have such
termination treated as a termination without cause, meaning that Mr. Angel shall
have the right to continue to be compensated through the term of the employment
agreement. For purposes of the employment agreement, a change of control is
deemed to have occurred at such time as either (a) Taxter owns directly or
indirectly less than 10% of the Common Stock of the Company and less than 50% of
each other outstanding class of securities the majority vote of which is
required for shareholder action, or (b) Jay Botchman owns less than 50% of the
membership interests in Taxter. The employment agreement also contains certain
customary terms regarding proprietary information, confidentiality, and the
surrender of records upon termination. A copy of the employment agreement has
been filed as an exhibit hereto.
On October 15, 1997, the Company entered into a three-year agreement with
Cynthia Hassoun, the Corporate Secretary and a Senior Vice President. Under the
terms of the agreement, Ms. Hassoun receives an annual base salary of $150,000.
In addition, Ms. Hassoun received a $50,000 signing bonus, compensation for all
relocation expenses and 75,000 stock options. Under the terms of the agreement,
25,000 of Ms. Hassoun's stock options vest on October 15 of the years 1998, 1999
and 2000. The exercise price of all of the options is $2.00 per share. The
letter agreement also entitles Ms. Hassoun to all employee benefit plans, such
as medical and dental coverage, life insurance, and pension and profit-sharing
plans, that may be maintained by the Company.
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ITEM 7 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
During fiscal year 1998, the Company issued subordinated promissory notes
to JLB, a corporation wholly-owned by Jay L. Botchman, a director of the
Company, totaling $40,000,000 which are payable on demand and bear interest at
the rate of 12% per annum. $30,000,000 of the new notes were issued in exchange
for outstanding notes totaling $11,518,042 which carried an interest rate of 12%
per annum and $18,481,958 in new debt. Interest expense on these notes was
$2,307,467 and $3,635,891 for the years ended May 31, 1999 and 1998,
respectively. On May 29, 1999, JLB forgave $5,000,000 of interest on these
subordinated notes in return for 4,000,000 warrants (described below) and for
the Company's assumption of certain obligations of several companies affiliated
with JLB. Accrued interest related to subordinated notes payable to JLB was
approximately $1.3 million and $4.0 million, respectively, at May 31, 1999 and
1998.
On February 27, 1998, the Company issued a subordinated promissory note
payable to Mr. Botchman in the amount of $350,000 payable on demand with
interest of 12% per annum. Interest expense for the year ended May 31, 1999 and
May 31, 1998 was $42,583 and $10,733. This note was issued per an agreement
dated February 27, 1998 between Mr. Botchman and the Company. As part of the
terms of the agreement, the Company agreed to purchase an interest in certain
investment securities, owned by Mr. Botchman, of a subprime mortgage banking
company. The mortgage company had subsequent financial difficulties and ceased
operations. The Company wrote off this investment and a receivable due from this
company of approximately $189,000 during the fiscal year ended May 31, 1998.
As of May 31, 1999, the Company, through its wholly-owned subsidiary,
American Credit Alliance, Inc., has an $880,000 note payable to JLB with an
interest rate of 10% per annum. Interest expense for the year ended May 31, 1999
and May 31, 1998 was $89,222, and $85,195, respectively.
The Company made a series of investments, during the period May 1997
through December 1997, amounting to $508,600 in a subprime mortgage banking
company affiliated with JLB. At May 31, 1998 as there was substantial doubt
regarding the subprime mortgage banking company's ability to continue as a going
concern, the Company wrote off its investment in this company in the amount of
$508,600 in addition to a receivable of $183,000 from the same company.
The Series A Preferred Stock and Series B Preferred Stock were each issued
at $1.00 per share (total of $2,000.00) for all of Taxter's shares of Holdings.
See "Item 1 - Business; General Development of Business." The Series A Preferred
Stock, as a class, has 80% of the voting rights in the Company. The Series B
Preferred Stock has one vote per share. The Series A Preferred Stock and the
Series B Preferred Stock each have a liquidation preference of $1.00 per share
and will each earn cumulative dividends at a rate of 5% per annum. After five
years, (i) the Series A Preferred Stock and the Series B Preferred Stock will be
redeemable at the option of the Company, and (ii) the Series B Preferred Stock
will be convertible at the option of the holder into Series A Preferred Stock on
a share-for-share basis.
On December 31, 1996, the Company issued 5,000 shares of Series C
Preferred Stock to Mr. Botchman for $5,000,000 consideration. The Series C
Preferred Stock earns cumulative dividends at 6% per annum. The shares also have
liquidation preference of $1,000 per share. The Series A and B Preferred Stock
rank senior to the Series C Preferred Stock with respect to dividend and
liquidation rights.
On May 29, 1998, the Company issued 10,000 shares of Series D Preferred
Stock to JLB in exchange for the cancellation of the outstanding principal
amount of the $10,000,000 promissory note dated August 1, 1997 payable by the
Company to JLB. The Company created Series D Preferred Stock on May 29, 1998.
The Series D Preferred Stock is non-voting and will earn a dividend of 8% per
annum payable annually on December 31. The shares have a par value of $0.001 per
share and a stated value of $1,000 per share. The shares have a liquidation
preference of $1,000 per share. The Series D Preferred Stock ranks senior to the
Series A, B and C with respect to dividend and
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liquidation rights. Each share of Series D Preferred Stock is convertible into
380 shares of Common Stock. The agreement between the Company and JLB with
respect to the issuance of the Series D Preferred Stock grants JLB piggyback
registration rights for any Common Stock issuable upon conversion of the shares
of Series D Preferred Stock.
On August 31, 1998 the Company issued 10,000 shares of Series E Preferred
Stock to JLB in exchange for JLB agreeing to cancel the principal outstanding
under a $10,000,000 subordinated promissory note dated August 1, 1997. The
holder of Series E Preferred Stock is entitled to dividends at a rate of 8% of
stated value per annum payable in cash commencing on December 31, 1998. Each
share of Series E Preferred Stock is convertible into 285 shares of Common
Stock. The agreement between the Company and JLB with respect to the issuance of
the Series E Preferred Stock grants JLB piggyback registration rights for any
Common Stock issuable upon conversion of the shares of Series E Preferred Stock.
As of May 31, 1999 and May 31, 1998, accumulated preferred dividends
undeclared and unpaid on preferred stock amounted to approximately $2.2 and $0.4
million respectively.
Taxter, an entity in which Mr. Botchman is a managing member, as part of
the purchase price of acquiring Holdings, granted the former owners of Holdings
a future interest in Holdings in the form of an identical option to each former
owner of Holdings to purchase 2,000 shares of Holdings from Taxter for $500,000.
Following the acquisition of Holdings by the Company, these options were amended
to enable each of the former owners of Holdings to purchase 4,000,000 shares of
the Company's Common Stock and 400,000 shares of the Company's Series B
Preferred Stock for $500,000.
On May 29, 1999, the Board of Directors granted JLB a warrant to purchase
up to 4,000,000 shares of the Common Stock of the Company. The warrant is
exercisable one year after the grant date at an exercise price of $3.25 per
share and expires May 29, 2004.
ITEM 8 - LEGAL PROCEEDINGS
The Company, in the ordinary course of business, receives notices of
consumer complaints from regulatory agencies and reviews these complaints in
accordance with internal policy.
On October 24, 1996, the Company, SOIC and certain former officers and
directors of SOIC were sued in the United States District Court for the Northern
District of Illinois in an action entitled Louis G. Apostol, as Administrator
for the Estate of Curtis Kim v. M. Reza Fayazi, et al. This action was brought
as a class action on behalf of persons purportedly solicited to voluntarily
repay debt that had been discharged in bankruptcy to open credit card accounts.
The complaint alleged that these practices violated the bankruptcy code, various
consumer protection statutes, including the Fair Debt Collection Practices Act,
the Truth in Lending Act, the Colorado Uniform Consumer Credit Code, the
Illinois Consumer Fraud Act and RICO. Plaintiffs also asserted common law
theories of recovery. The district court dismissed all bankruptcy-related claims
on the grounds that they should be asserted in the bankruptcy court. On November
9, 1998, a complaint was filed in the United States Bankruptcy Court for the
Northern District of Illinois. The complaints seek (i)
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monetary damages, (ii) declaratory judgments that the agreements reached with
plaintiffs have no legal effect, (iii) criminal contempt, (iv) injunctive relief
to prohibit defendants from purchasing or selling debts that have been
discharged in bankruptcy and to rescind any such agreements, and to require
cessation of collection efforts and the removal of debts from credit reports.
On May 14, 1998, the Company was sued in the United States District Court
for the District of Rhode Island in an action entitled McGlynn v. The Credit
Store, Inc., et al. The action is brought as a class action on behalf of persons
who allegedly were solicited to voluntarily repay debt that had been discharged
in bankruptcy. The complaint alleges that inducing repayment of discharged debt
violates the Bankruptcy Code, and the Fair Debt Collection Practices Act. The
complaint also contains a common law theory of recovery. The complaints seek (i)
monetary damages, (ii) a declaratory judgment that the agreements reached with
plaintiffs have no legal effect, (iii) criminal contempt, and (iv) injunctive
relief to preclude defendants from purchasing or selling debts that have been
discharged in bankruptcy.
On June 1, 1998, the Company was sued in the United States District Court
for the Northern District of Illinois in an action entitled Le v. The Credit
Store, Inc., et al. The action is brought as a class action on behalf of certain
persons who were allegedly part of a portfolio of consumer debt purchased by the
Company. The complaint alleges that these people were sent letters by the
Company attempting to collect debts previously discharged in bankruptcy and that
these actions violate the Fair Debt Collection Practices Act. The complaint
seeks monetary damages.
On May 27, 1999, the Company was sued in the United States District Court
for the District of Florida in an action entitled McIntyre v. Credit Store Inc.
The action is brought as a class action on behalf of certain persons to whom the
Company sent written communications and alleges that such communications violate
the Fair Debt Collection Practices Act and statutory provisions of Florida and
South Dakota law. On May 21, 1999, the Company was sued in the United States
District Court for the District of Arizona in an action entitled Bingham v. The
Credit Store, Inc. The action is brought as a class action on behalf of certain
persons to whom the Company sent written communications and alleges that such
communications violate the Fair Debt Collection Practices Act. Both complaints
seek monetary damages and declaratory judgments that the Company's mailers
violate statutory provisions.
The Company does not believe that these suits will have a material adverse
effect on the consolidated financial position of the Company, nor on the results
of operations.
ITEM 9 - MARKET PRICE OF AND DIVIDENDS ON THE COMPANY'S COMMON STOCK AND RELATED
STOCKHOLDER MATTERS
The Company's Common Stock is presently traded on the Electronic Bulletin
Board under trading symbol "PLCR". The quotations are inter-dealer prices
without retail mark-ups, mark-downs or commissions and may not represent actual
transactions.
The high and low bid prices for the Company's Common Stock for each
quarter for the past three years were as follows:
Period High Low
------ ---- ---
1997 First Quarter $ N/A $ N/A
Second Quarter 13 3/4 4 1/2
Third Quarter 12 5 3/4
Fourth Quarter 9 1/4 5 1/4
1998 First Quarter $ 9 3/8 $ 5 3/4
Second Quarter 7 5/8 2 7/8
Third Quarter 3 3/4 1 1/2
Fourth Quarter 2 15/16 1 9/32
1999 First Quarter $ 3 7/8 $ 1 7/8
Second Quarter 2 3/4 1 3/4
Third Quarter 2 15/16 1 7/8
Fourth Quarter 2 5/8 1 15/16
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2000 First Quarter $ 3 17/32 $ 2 13/32
Second Quarter $ 5 7/15 $ 2 9/16
Third Quarter (as of 12/15/99) $ 4 13/16 $ 4 9/16
As of December 15, 1999, there were 949 holders of record of the Company's
Common Stock.
The Company has not paid any cash dividends on its Common Stock and does
not anticipate paying cash dividends in the foreseeable future. The Company
anticipates that it will follow a policy of retaining earnings, if any, to
finance the expansion and development of the Company. The Board of Directors of
the Company will review its dividend policy from time to time to determine the
feasibility and desirability of paying dividends, after giving consideration to
the Company's results of operations, financial condition, capital requirements
and such other factors as the Board of Directors deems relevant.
Each issued and outstanding share of Series A Preferred Stock and Series B
Preferred Stock will be entitled, as and when declared by the Board of
Directors, to receive, out of any assets at the time legally available therefor,
dividends at the rate of $.05 per share, per annum. Such dividends on the Series
A and Series B Preferred Stock are prior in preference to any outstanding shares
of Common Stock or of Preferred Stock, other than Series D and Series E
Preferred Stock.
Subject to the right of the holders of the Series B Preferred Stock to
receive a preferential dividend, the holders of shares of Series C Preferred
Stock will be entitled, as and when declared by the Board of Directors, to
receive, out of any assets at the time legally available therefor, dividends at
the rate of 6% per share per annum, payable in cash commencing on December 31,
1997. Such dividends on the Series C Preferred Stock are prior in preference to
any declaration or payment of any distribution on any outstanding shares of
Common Stock or any Preferred Stock which by its terms is junior to Series C
Preferred Stock, but are junior in preference to Series A, Series B, Series D
and Series E Preferred Stock.
The holder of shares of Series D Preferred Stock will be entitled, as and
when declared by the Board of Directors, to receive, out of any assets at the
time legally available therefor, dividends at the rate of 8% per share per
annum, payable in cash commencing on December 31, 1998 and thereafter on the
last day of December of each year that any such shares are outstanding. Such
dividends on the Series D Preferred Stock are prior in preference to any
declaration or payment of any distribution on any other outstanding shares of
Common Stock or of Preferred Stock, other than Series E Preferred Stock.
The holders of shares of Series E Preferred Stock shall be entitled to
receive, out of any assets at the time legally available therefor and when and
as declared by the Board of Directors of the Company, dividends calculated on
the stated value per share at the rate of 8% per share per annum, payable in
cash commencing on December 31, 1998, and thereafter on the last day of December
of each year that any such shares shall be outstanding. Such dividends on the
Series E Preferred Stock are prior in preference to any declaration or payment
of any distribution on any other outstanding shares of Common Stock or Preferred
Stock.
Other than the foregoing, the Company does not anticipate the declaration
or payment of any dividends in the foreseeable future. There can be no assurance
that cash dividends of any kind will ever be paid.
ITEM 10 - RECENT SALES OF UNREGISTERED SECURITIES
The Company issued the following securities during the prior three fiscal
years without registering the securities under the Securities Act:
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Issuance of Capital Stock:
1. On September 12, 1996, the Company issued 20,000,000 shares of Common
Stock to Jay Botchman for aggregate consideration of $20,000. Mr. Botchman
subsequently transferred these shares to Taxter.
2. On December 4, 1996, Taxter exchanged all of its shares of Common Stock in
Service One Holdings for the issuance by the Company of 1,200,000 shares
of Series A Preferred Stock and 800,000 shares of Series B Preferred Stock
of the Company to Taxter.
3. On December 31, 1996, the Company issued 5,000 shares of Series C
Preferred Stock to Jay Botchman in exchange for aggregate consideration of
$5,000,000.
4. On February 19, 1997, the Company sold 830,000 shares of Common Stock
to Lancer Partners, L.P., Lancer Offshore Inc., Lancer Voyager Fund, and
Michael Lauer (collectively, the "Lancer Group") for aggregate
consideration of $6,017,500.
5. On March 12, 1997 the Company privately sold 827,500 shares of Common
Stock to the Lancer Group for aggregate consideration of $5,999,375.
6. On January 2, 1998, the Company privately sold 1,250,000 shares of
Common Stock to the Lancer Group for aggregate consideration of
$2,500,000.
7. On February 2, 1998, the Company privately sold 1,250,000 shares of
Common Stock to the Lancer Group for aggregate consideration of
$2,500,000.
8. On May 29, 1998, the Company issued 10,000 shares of Series D Preferred
Stock to JLB in exchange for JLB agreeing to cancel $10,000,000 of the
principal outstanding under the $10,000,000 Subordinated Promissory Note
dated August 1, 1997.
9. On August 31, 1998, the Company issued 10,000 shares of Series E Preferred
Stock to JLB in exchange for JLB agreeing to cancel $10,000,000 of the
principal outstanding under the $20,000,000 Subordinated Promissory Note
dated August 1, 1997.
Grant of Stock Options and Warrants:
1. On March 27, 1997, the Company granted options to purchase 950,000 shares
of Common Stock at an exercise price of $5.50 per share for employees.
2. On December 15, 1997, the Company granted options to purchase 935,500
shares of the Common Stock under the Amended 1997 Stock Option Plan at an
exercise price of $2.00 per share to employees, granted options to
purchase 1,000,000 shares of Common Stock under the Amended 1997 Stock
Option Plan at an exercise price of $2.00 per share to a director of the
Company and granted options to purchase 600,000 shares of Common Stock at
an exercise price of $2.00 per share to employees.
3. On January 16, 1998, the Company granted options to purchase 170,500
shares of Common Stock under the Amended 1997 Stock Option Plan at an
exercise price of $2.50 per share to employees.
4. On April 30, 1998, the Company issued to Coast Business Credit, a division
of Southern Pacific Bank, a warrant to purchase 650,247 shares of the
Common Stock at an exercise price of $2.50. The warrant was issued in
connection with a loan from Coast Business Credit to the Company.
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5. On August 3, 1998, the Company granted options to purchase 10,000 shares
of Common Stock under the Amended 1997 Stock Option Plan at an exercise
price of $3.00 per share to employees.
6. On August 10, 1998, the Company granted options to purchase 300,000 shares
of Common Stock under the Amended 1997 Stock Option Plan at an exercise
price of $2.70 per share to employees.
7. On September 15, 1998, the Company granted options to purchase 10,000
shares of Common Stock under the Amended 1997 Stock Option Plan at an
exercise price of $2.00 per share to employees.
8. On November 23, 1998, the Company granted options to purchase a total of
150,000 shares of Common Stock under the Amended 1997 Stock Option Plan
at an exercise price of $2.00 per share to two directors of the Company.
9. On February 15, 1999, the Company granted options to purchase 13,000
shares of Common Stock under the Amended 1997 Stock Option Plan at an
exercise price of $2.38 per share to employees.
10. On March 17, 1999, the Company granted options to purchase 200,500 shares
of Common Stock under the Amended 1997 Stock Option Plan at an exercise
price of $2.00 per share to employees.
11. On March 18, 1999, the Company issued a warrant to purchase 1,000,000
shares of Common Stock to Business Transactions Express, Inc. at an
exercise price of $2.00 per share. The warrant was issued in
connection with the execution of a strategic modeling services agreement
between the Company and Business Transactions Express, Inc.
12. On March 22, 1999, the Company granted options to purchase 3,500 shares of
Common Stock under the Amended 1997 Stock Option Plan at an exercise price
of $2.30 per share to employees.
13. On March 29, 1999, the Company granted options to purchase 3,500 shares of
Common Stock under the Amended 1997 Stock Option Plan at an exercise price
of $2.30 per share to employees.
14. On April 15, 1999, the Company granted options to purchase 75,000 shares
of Common Stock under the Amended 1997 Stock Option Plan at an exercise
price of $2.19 per share to a director of the Company.
15. On June 1, 1999, the Company granted options to purchase 503,000 shares of
Common Stock under the Amended 1997 Stock Option Plan at an exercise price
of $2.40 per share to employees.
16. On June 22, 1999, the Company issued a warrant to purchase 4,000,000
shares of Common Stock to JLB at an exercise price of $3.25 per share
issued as partial consideration for JLB's forgiveness of certain
interest owed to JLB by the Company.
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17. On July 26, 1999, the Company granted options to purchase 10,000 shares
of Common Stock under the Amended 1997 Stock Option Plan at an exercise
price of $2.88 per share to employees.
18. On August 1, 1999, the Company granted options to purchase 22,000 shares
of Common Stock under the Amended 1997 Stock Option Plan at an exercise
price of $3.00 per share to employees.
19. On August 3, 1999, the Company granted options to purchase 10,000
shares of Common Stock under the Amended 1997 Stock Option Plan at an
exercise price of $2.97 per share to employees.
20. On August 27, 1999, the Company granted options to purchase 10,000 shares
of Common Stock under the Amended 1997 Stock Option Plan at an exercise
price of $2.69 per share to employees.
21. On September 1, 1999, the Company granted options to purchase 1,500 shares
of Common Stock under the Amended 1997 Stock Option Plan at an exercise
price of $2.75 per share to employees.
22. On September 10, 1999, the Company issued a warrant for 25,000 shares of
Common Stock to Cappello Capital Corp. at an exercise price of $2.56 per
share. The warrant was issued in connection with Cappello Capital Corp.
providing financial advisory services to the Company.
23. On September 16, 1999, the Company granted options to purchase 8,000
shares of Common Stock under the Amended 1997 Stock Option Plan at an
exercise price of $2.75 per share to employees.
24. On October 18, 1999, the Company granted options to purchase 2,000 shares
of Common Stock under the Amended 1997 Stock Option Plan at an exercise
price of $2.75 per share to employees.
25. On October 25, 1999, the Company granted options to purchase 5,000 shares
of Common Stock under the Amended 1997 Stock Option Plan at an exercise
price of $3.13 per share to employees.
26. On November 8, 1999, the Company granted options to purchase 10,000 shares
of Common Stock under the Amended 1997 Stock Option Plan at an exercise
price of $3.88 per share to employees.
27. On November 19, 1999, the Company granted options to purchase 310,000
shares of Common Stock under the Amended 1997 Stock Option Plan at an
exercise price of $3.44 per share to employees.
28. On November 29, 1999, the Company granted options to purchase 15,000
shares of Common Stock under the Amended 1997 Stock Option Plan at an
exercise price of $5.00 per share to employees.
The sales were made in reliance on an exemption from the registration
requirements of the Securities Act set forth in Section 4(2) of the Securities
Act relating to sales by an issuer not involving any public offering or the
rules and regulations promulgated under Section 4(2) of the Securities Act or,
in the case of certain options to purchase the Company's common stock issued to
employees, directors, officers, consultants and advisers, Rule 701 under the
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Securities Act. All of the securities described above are deemed restricted
securities for the purposes of the Securities Act.
ITEM 11 - DESCRIPTION OF SECURITIES TO BE REGISTERED
COMMON STOCK
The Company is authorized to issue up to 65,000,000 shares of Common
Stock, par value $.001 per share. As of the date of this registration statement
there are 34,761,965 issued and outstanding shares of Common Stock.
VOTING, SHAREHOLDERS' MEETINGS AND RESOLUTIONS. Holders of Common Stock
have one vote for each share held on all matters submitted to a vote of
stockholders, but such votes are subject to the voting preference of the holders
of the Series A Preferred Stock. Holders of the Series A Preferred Stock,
regardless of the number of such shares outstanding and as long as at least one
of such shares is outstanding, shall represent 80% of all votes entitled to be
voted at any annual or special meeting of the shareholders of the Company,
subject to dilution by capital stock of the Company issued after the date of
issuance of the Series Preferred Stock. Holders of Series B Preferred Stock have
one vote on all matters as to which holders of common stock shall be entitled to
vote.
DIVIDEND AND LIQUIDATION RIGHTS. Subject to the prior rights of any series
of preferred stock, as described below, which may from time to time be
outstanding, holders of Common Stock are entitled to receive dividends when, as
and if declared by the Board of Directors out of funds legally available
therefor and, upon the liquidation, dissolution or winding up of the Company,
are entitled to share ratably in all assets remaining after payment of
liabilities and payment of accrued dividends and liquidation preferences on the
preferred stock. Holders of Common Stock have no preemptive rights and have no
rights to convert their Common Stock into any other securities.
PREFERRED STOCK
The following series of preferred stock are currently issued by the
Company.
SERIES A PREFERRED STOCK
There are 2,000,000 shares of Series A Preferred Stock, $.001 par value
(the "Series A Preferred Stock") authorized of which 1,200,000 shares are issued
and outstanding.
DIVIDENDS. Each issued and outstanding share of Series A Preferred Stock
shall be entitled to receive, pari passu with the Series B Preferred Stock, out
of any assets at the time legally available therefor and when and as declared by
the Board of Directors of the Company, dividends at the rate of $.05 per share,
per annum. Such dividends accrue on each share of Series A Preferred Stock from
the initial date of issuance thereof whether or not earned or declared.
VOTING RIGHTS. Except as otherwise required by law or by the certificate
of incorporation of the Company, based on the number of shares of the Company's
capital stock outstanding upon the date of issuance, the outstanding shares of
Series A Preferred Stock, regardless of the number of such shares outstanding
and as long as at least one of such shares is outstanding, shall represent 80%
of all votes entitled to be voted at any annual or special meeting of the
shareholders of the Company subject to dilution by subsequently issued capital
stock of the Company. Currently, the shares of the Series A Preferred Stock
represent approximately 77.88% of all votes entitled to be voted at any annual
or special meeting of the shareholders of the Company. Each share of Series A
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Preferred Stock shall represent its proportionate share of the 80% which is
allocated to the outstanding shares of Series A Preferred Stock.
REDEMPTION. At any time after December 31, 2001, the Company may redeem
all or part of the outstanding shares of Series A and Series B Preferred Stock,
treated as one class, at a cash price equal one dollar ($1.00) per share,
together will all unpaid dividends to and including the date of redemption,
provided that the Company provides written notice to the holders of such stock
to be redeemed at least 20 days prior to the date specified for redemption.
LIQUIDATION. In the event of any voluntary or involuntary liquidation,
dissolution or winding up of the Company, the holders of shares of Series A and
Series B Preferred Stock then outstanding, treated as one class, shall be
entitled to be paid, out of the assets of the Company available for distribution
to its stockholders, whether from capital, surplus or earnings, before any
payment shall be made in respect of the Company's Common Stock or Series C
Preferred Stock, an amount equal to $1.00 per share, plus all unpaid dividends
thereon to the date fixed for distribution.
RANK. The Series A Preferred Stock shall, with respect to dividend rights
and rights on liquidation, winding up and dissolution, (i) rank pari passu with
the Series B Preferred Stock, (ii) rank senior to any of the Company's Common
Stock, the Company's Series C Preferred Stock and any other class or series of
stock of the Company which by its terms shall rank junior to the Series A
Preferred Stock, and (iii) rank junior to the Series D and Series E Preferred
Stock and any other class or series of stock of the Company which by its terms
shall rank senior to the Series A Preferred Stock
SERIES B PREFERRED STOCK
There are 800,000 shares of Series B Preferred Stock, $.001 par value (the
"Series B Preferred Stock"), of which 800,000 shares are issued and outstanding.
DIVIDENDS. Each issued and outstanding share of Series B Preferred Stock
shall be entitled to receive, pari passu with the Series A Preferred Stock, out
of any assets at the time legally available therefor and when and as declared by
the Board of Directors of the Company, dividends at the rate of $.05 per share
per annum. Such dividends accrue on each share of Series B Preferred Stock from
the initial date of issuance thereof whether or not earned or declared.
VOTING RIGHTS. Each outstanding share of Series B Preferred Stock shall
entitle the holder thereof to one vote on all matters as to which holders of
common stock shall be entitled to vote.
REDEMPTION. At any time after December 31, 2001, the Company may redeem
all or part of the outstanding shares of Series A and Series B Preferred Stock,
treated as one class, at a cash price equal one dollar ($1.00) per share,
together will all unpaid dividends to and including the date of redemption,
provided that the Company provides written notice to the holders of such stock
to be redeemed at least 20 days prior to the date specified for redemption.
LIQUIDATION. In the event of any voluntary or involuntary liquidation,
dissolution or winding up of the Company, the holders of shares of Series A and
Series B Preferred Stock then outstanding, treated as one class, shall be
entitled to be paid, out of the assets of the Company available for distribution
to its stockholders, whether from capital, surplus or earnings, before any
payment shall be made in respect of the Company's Common Stock or Series C
Preferred Stock, an amount equal to $1.00 per share, plus all unpaid dividends
thereon to the date fixed for distribution.
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CONVERSION. At any time after December 31, 2001, the holders of
outstanding shares of Series B Preferred Stock, at their option, may convert
said shares, in whole or in part, on a share for share basis, to shares of
Series A Preferred Stock.
RANK. The Series B Preferred Stock shall, with respect to dividend rights
and rights on liquidation, winding up and dissolution, (i) rank pari passu with
the Series A Preferred Stock, (ii) rank senior to any of the Company's Common
Stock, the Company's Series C Preferred Stock and any other class or series of
stock of the Company which by its terms shall rank junior to the Series A
Preferred Stock, and (ii) rank junior to the Series D and Series E Preferred
Stock and any other class or series of stock of the Company which by its terms
shall rank senior to the Series B Preferred Stock
SERIES C PREFERRED STOCK
There are 5,000 shares of Series C Preferred Stock, $.001 par value (the
"Series C Preferred Stock") of which 5,000 shares are issued and outstanding.
DIVIDENDS. The holders of shares of Series C Preferred Stock shall be
entitled to receive, out of any assets at the time legally available therefor
and when and as declared by the Board of Directors of the Company, dividends at
the rate of 6% per share per annum, payable in cash commencing on December 31,
1997. Such dividends accrue on each share of Series C Preferred Stock from the
initial date of issuance thereof whether or not earned or declared.
VOTING RIGHTS. The holders of the Series C Preferred Stock shall not have
the right to vote on matters presented to the stockholders of the Company,
except as provided by the General Corporation Law of the State of Delaware.
REDEMPTION. At any time after December 31, 1998, the Company may redeem
all or part of the outstanding shares of the Series C Preferred Stock, at a cash
price equal to $1,000 per share, together with all unpaid dividends to and
including the date of redemption, provided that the Company provides written
notice to the holders of such stock to be redeemed at least 20 days prior to the
date specified for redemption.
LIQUIDATION. In the event of any voluntary or involuntary liquidation,
dissolution, or winding up of the Company, the holders of shares of Series C
Preferred Stock then outstanding, shall be entitled to be paid, out of the
assets of the Company available for distribution, whether from capital, surplus
or earnings, before any payment shall be made in respect of the Company's Common
Stock, an amount equal to $1,000 per share, plus all unpaid dividends thereon to
the date fixed for distribution.
RANK. The Series C Preferred Stock, with respect to dividend rights and
rights on liquidation, winding up and dissolution, (i) ranks senior to any class
of the Company's Common Stock, and any other series of capital stock of the
Company which by its terms ranks junior to the Series C Preferred Stock, and
(ii) ranks junior to the Series A, Series B, Series D and Series E Preferred
Stock, and any other class or series of stock of the Company which by its terms
ranks senior to the Series C Preferred Stock.
SERIES D PREFERRED STOCK
There are 10,000 shares of Series D Preferred Stock, $.001 par value (the
"Series D Preferred Stock") of which 10,000 shares are issued and outstanding.
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DIVIDENDS. The holders of shares of Series D Preferred Stock shall be
entitled to receive, out of any assets at the time legally available therefor
and when and as declared by the Board of Directors of the Company, dividends
calculated on the stated value per share at the rate of 8% per share per annum,
and no more, payable in cash commencing on December 31, 1998, and thereafter on
the last day of December of each year that any such shares shall be outstanding.
Such dividends accrue on each share of Series D Preferred Stock from the initial
date of issuance thereof whether or not earned or declared.
VOTING RIGHTS. Except as otherwise required by law, the holders of Series
D Preferred Stock shall not be entitled to vote upon any matter relating to the
business or affairs of the Company or for any other purpose.
REDEMPTION. The Company may, at the option of the Board of Directors,
redeem all or part of the outstanding shares of the Series D Preferred Stock at
a cash price equal to $1,000 per share, together with all unpaid dividends to
and including the redemption date (the "Series D Redemption Price"); provided,
however, that payment of the Series D Redemption Price shall be made from any
funds of the Company legally available therefor; provided that the Company shall
give written notice by mail, postage prepaid, to the holders of such stock to be
redeemed at least 20 days prior to the date specified for redemption (the
"Series D Redemption Date"); and provided further that such holders may, at any
time prior to the Series D Redemption Date, convert their shares of Series D
Preferred Stock. The holder of any shares of Series D Preferred Stock shall have
the right, at such holder's option, at any time (and from time to time) prior to
May 31, 2001, to convert any of such shares into that number of fully paid and
nonassessable shares of common stock (calculated as to each conversion to the
nearest 1/100th of a share) equal to the Conversion Rate (as defined below)
multiplied by the number of shares of Series D Preferred Stock to be converted.
The "Conversion Rate" per share of Series D Preferred Stock is 380 shares of
Common Stock.
LIQUIDATION. In the event of any voluntary or involuntary liquidation,
dissolution, or winding up of the Company, the holders of shares of the Series D
Preferred Stock then outstanding, shall be entitled to be paid, out of the
assets of the Company available for distribution to its stockholders, whether
from capital, surplus or earnings, before any payment shall be made in respect
of the Company's Common Stock, an amount equal to $1,000 per share, plus all
unpaid dividends thereon to the date fixed for distribution.
RANK. The Series D Preferred Stock shall, with respect to dividend rights
and rights on liquidation, winding up and dissolution, (i) rank senior to any of
the Company's Common Stock, the Company's Series A, Series B and Series C
Preferred Stock and any other class or series of stock of the Company which by
its terms shall rank junior to the Series D Preferred Stock, and (ii) rank
junior to the Series E Preferred Stock and any other class or series of stock of
the Company which by its terms shall rank senior to the Series D Preferred Stock
SERIES E PREFERRED STOCK
There are 20,000 shares of Series E Preferred Stock, $.001 par value (the
"Series E Preferred Stock") of which 10,000 shares are issued and outstanding.
DIVIDENDS. The holders of shares of Series E Preferred Stock shall be
entitled to receive, out of any assets at the time legally available therefor
and when and as declared by the Board of Directors of the Company, dividends
calculated on the stated value per share at the rate of 8% per share per annum,
and no more, payable in cash commencing on December 31, 1998, and thereafter on
the last day of December of each year that any such shares shall be outstanding.
Such dividends accrue on each share of Series E Preferred Stock from the initial
date of issuance thereof whether or not earned or declared.
VOTING RIGHTS. Except as otherwise required by law, the holders of Series
E Preferred Stock are not entitled to vote upon any matter relating to the
business or affairs of the Company or for any other purpose.
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REDEMPTION. The Company may, at the option of the Board of Directors,
redeem all or part of the outstanding shares of the Series E Preferred Stock at
a cash price equal to $1,000 per share, together with all unpaid dividends to
and including the redemption date (the "Series E Redemption Price"); provided,
however, that payment of the Redemption Price shall be made from any funds of
the Company legally available therefor; provided that the Company shall give
written notice by mail, postage prepaid, to the holders of such stock to be
redeemed at least 20 days prior to the date specified for redemption (the
"Series E Redemption Date"); and provided further that such holders may, at any
time prior to the Series E Redemption Date, convert their shares of Series E
Preferred Stock. The holder of any shares of Series E Preferred Stock shall have
the right, at such holder's option, at any time (and from time to time) prior to
August 31, 2001, to convert any of such shares into that number of fully paid
and nonassessable shares of common stock (calculated as to each conversion to
the nearest 1/100th of a share) equal to the Conversion Rate (as defined below)
multiplied by the number of shares of Series E Preferred Stock to be converted.
The "Conversion Rate" per share of Series E Preferred Stock is 285 shares of
Common Stock.
LIQUIDATION. In the event of any voluntary or involuntary liquidation,
dissolution, or winding up of the Company, the holders of shares of the Series E
Preferred Stock then outstanding, shall be entitled to be paid, out of the
assets of the Company available for distribution to its stockholders, whether
from capital, surplus or earnings, before any payment shall be made in respect
of the Company's Common Stock, an amount equal to $1,000 per share, plus all
unpaid dividends thereon to the date fixed for distribution.
RANK. The Series E Preferred Stock shall, with respect to dividend rights
and rights on liquidation, winding up and dissolution, (i) rank senior to any of
the Company's Common Stock, the Company's Series A, Series B, Series C and
Series D Preferred Stock and any other class or series of stock of the Company
which by its terms shall rank junior to the Series E Preferred Stock, and (ii)
rank junior to any class or series of stock of the Company which by its terms
shall rank senior to the Series E Preferred Stock
UNDESIGNATED PREFERRED STOCK
The number of shares constituting the undesignated Preferred Stock (the
"Preferred Stock") is 965,000, $.001 par value. The Preferred Stock may be
issued in one or more series, the terms of which may be determined at the time
of issuance by the Board of Directors, without further action by stockholders,
and may include voting rights, preferences as to dividends and liquidation,
conversion and redemption rights and sinking fund provisions.
ANTI-TAKEOVER PROVISIONS OF THE DELAWARE GENERAL CORPORATION LAW
The Company is subject to the provisions of Section 203 of the
Delaware General Corporation Law ("DGCL"). In general, this statute prohibits a
publicly held Delaware corporation from engaging, under certain circumstances,
in a "business combination" with an "interested stockholder" for a period of
three years after the date of the transaction in which the person became an
interested stockholder unless (i) prior to the date at which the stockholder
became an interested stockholder, the Board of Directors approved either the
business combination or the transaction in which the person became an interested
stockholder; (ii) the stockholder acquires more than 85% of the outstanding
voting stock of the corporation (excluding shares held by directors who are
officers or held in certain employee stock plans) upon consummation of the
transaction in which the stockholder became an interested stockholder; or (iii)
the business combination is approved by the Board of Directors and by at least
66-2/3% of the outstanding voting stock of the corporation (excluding shares
held by the interested stockholder) at a meeting of stockholders (and not by
written consent) held on or subsequent to the date such stockholder became an
interested stockholder. An "interested stockholder" is a person who, together
with affiliates and associates, owns (or at any time within the prior three
years did own) 15% or more of the corporation's voting stock. Section 203
defines a
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"business combination" to include, without limitation, mergers, consolidations,
stock sales and asset-based transactions and other transactions resulting in a
financial benefit to the interested stockholder.
ITEM 12 - INDEMNIFICATION OF DIRECTORS AND OFFICERS
LIMITATION ON DIRECTOR'S LIABILITY
In accordance with the DGCL, the Certificate of Incorporation provides
that the directors of the Company shall not be personally liable to the Company
or its stockholders for monetary damages for breach of duty as a director except
(i) for any breach of the director's duty of loyalty to the Company and its
stockholders; (ii) for acts or omissions not in good faith or which involve
intentional misconduct, or knowing violation of law; (iii) under Section 174 of
the DGCL, which relates to unlawful payments of dividends and unlawful stock
repurchases and redemptions; or (iv) for any transaction from which the director
derived an improper personal benefit. This provision does not eliminate a
director's fiduciary duties; it merely eliminates the possibility of damage
awards against a director personally which may be occasioned by certain
unintentional breaches (including situations that may involve grossly negligent
business decisions) by the director of those duties. The provision has no effect
on the availability of equitable remedies, such as injunctive relief or
rescission, which might be necessitated by a director's breach of his or her
fiduciary duties. However, equitable remedies may not be available as a
practical matter where transactions (such as merger transactions) have already
been consummated. The inclusion of this provision in the Certificate of
Incorporation may have the effect of reducing the likelihood of derivative
litigation against directors and may discourage or deter stockholders or
management from bringing a lawsuit against directors for breach of their duty of
care, even though such an action, if successful, might otherwise have benefited
the Company and its stockholders.
INDEMNIFICATION
The Certificate of Incorporation provides that the Company shall indemnify
its officers, directors, employees and agents to the fullest extent permitted by
the DGCL. Section 145 of the DGCL provides that the Company may indemnify any
person who was or is a party, or is threatened to be made a party, to any
threatened, pending or completed action, suit or proceeding, whether civil,
criminal, administrative or investigative (other than a "derivative" action by
or in the right of the Company) by reason of the fact that such person is or was
a director, officer, employee or agent of the Company, against expenses
(including attorneys' fees), judgments, fines and amounts paid in settlement in
connection with such action, suit or proceeding if such person acted in good
faith and in a manner such person reasonably believed to be in or not opposed to
the best interests of the Company, and, with respect to any criminal action or
proceeding, had no reasonable cause to believe was unlawful. A similar standard
of care is applicable in the case of derivative actions, except that no
indemnification shall be made where the person is adjudged to be liable to the
Company, unless and only to the extent that the Court of Chancery of the State
of Delaware or the court in which such action was brought determines that such
person is fairly and reasonably entitled to such indemnity and such expenses.
ITEM 13 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements and the report thereon of
Grant Thornton LLP, independent certified public accountants, dated August 16,
1999 are filed as part of this Registration Statement. See Item 15.
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ITEM 14 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On July 8 the Board of Directors recommended the appointment of Grant
Thornton LLP as the Company's auditors for the year ended May 31, 1998 and
determined not to engage Tanner & Co. ("Tanner") as the Company's auditors for
the year ended May 31, 1998. The Board had previously appointed Tanner as
auditors for the May 31, 1997 financial statements. The reports of Tanner on the
financial statements of the Company for the period ended May 31, 1997 did not
contain any adverse opinion or disclaimer of an opinion and were not qualified
or modified as to uncertainty audit scope or accounting principles. During the
fiscal year in the period ended May 31, 1997, and the subsequent interim periods
preceding the Company's decision, there were no disagreements with Tanner on any
matter of accounting principles or practices, financial statement disclosure, or
auditing scope or procedure or any reportable events as defined in Item 304 in
Regulation S-K.
ITEM 15 - FINANCIAL STATEMENTS AND EXHIBITS
(a) Index to Financial Statements
The Financial Statements required by this item are submitted in a separate
section beginning on page F-1 of this registration statement
PAGE
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Report of Certified Public Accountants (Grant Thornton LLP) F-2
Report of Independent Certified Public Accountants (Tanner & Company LLP) F-3
Consolidated Balance Sheets F-4 - F-5
Consolidated Statements of Operations and Comprehensive Income (Loss) F-6
Consolidated Statement of Stockholders' Equity (Deficit) F-7 - F-8
Consolidated Statements of Cash Flows F-9 - F-11
Notes to Consolidated Financial Statements F-12 - F-38
(b) Index to Exhibits
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
3.1 Amended and Restated Certificate of Incorporation
3.2 Amended and Restated By-Laws
4 Specimen certificate representing shares of Common Stock
10.1 Amended and Restated Lease Agreement dated December 12, 1996
between Service One International Corporation and Donald A.
Dunham, Jr.
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EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
10.2 Amendment No. One to the Amended and Restated Lease Agreement
dated June 11, 1997 between Service One International
Corporation and Donald A. Dunham, Jr.
10.3 Amendment No. Two to the Amended and Restated Lease Agreement
dated July 31, 1997 between Service One International
Corporation and Donald A. Dunham, Jr.
10.4 Lease Agreement dated February 28, 1997 between Service One
International Corporation and Eagle Properties, L.L.C.
10.5 Addendum to Lease Agreement dated November 18, 1997 between
Service One International Corporation and Eagle Properties,
L.L.C.
10.6 Mutual Business Development Agreement dated as of October 8,
1996, between Service One International Corporation and the O.
Pappalimberis Trust
10.7 Amendment dated as of December 16, 1997 to the Mutual Business
Development Agreement dated as of October 8, 1996, such
amendment among O. Pappalimberis Trust, Taxter One LLC, Service
One International Corporation, Eikos Management, LLC and
Thesseus International Asset Fund
10.8 Amendment dated September 1, 1998 to the Mutual Business
Development Agreement dated as of October 8, 1996, as amended,
between the Company and Eikos Management LLC
10.9 Mutual Business Development Agreement dated as of October 8,
1996, between Service One International Corporation and
Renaissance Trust I
10.10 Strategic Modeling Agreement dated March 18, 1999, between the
Company and Business Transactions Express, Inc.
10.11 Warrant to purchase Common Stock of the Company issued to JLB on
June 22, 1999
10.12 Loan and Security Agreement, dated as of April 30, 1998, between
the Company and Coast Business Credit, a division of Southern
Pacific Bank
10.13 First Amendment to Loan and Security Agreement, dated as of
September 30, 1998, between the Company and Coast Business
Credit, a division of Southern Pacific Bank
10.14 Second Amendment to Loan and Security Agreement, dated as of
December 1, 1998, between the Company and Coast Business Credit,
a division of Southern Pacific Bank
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EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
10.15 Amendment Number Two to Loan and Security Agreement, dated as of
April 27, 1999, between the Company and Coast Business Credit, a
division of Southern Pacific Bank
10.16 Fourth Amendment to Loan and Security Agreement, dated as of May
27, 1999, between the Company and Coast Business Credit, a
division of Southern Pacific Bank
10.17 Amendment Number Five to Loan and Security Agreement, dated as
of June 25, 1999, between the Company and Coast Business Credit,
a division of Southern Pacific Bank
10.18 Amendment Number Six to Loan and Security Agreement Dated as of
December 6, 1999 between the Company and Coast Business Credit,
a division of Southern Pacific Bank
10.19 Security Agreement dated as of August 1, 1997, between J.B.L. of
Nevada, Inc., Credit Store Mortgage, Inc., New Beginnings Corp.,
Consumer Debt Acquisitions, Inc., Sleepy Hollow Associates,
Inc., Service One Holdings Inc., Service One International
Corporation, American Credit Alliance, Inc., Service One
Receivables Acquisition Corporation, the Company, Service One
Commercial Corporation and Soiland Company
10.20 First Amendment to Security Agreement, dated as of October 23,
1997 between J.B.L. of Nevada, Inc., the Company and Credit
Store Mortgage, Inc., New Beginnings Corp., Consumer Debt
Acquisitions, Inc., Sleepy Hollow Associates, Inc., Service One
Holdings, Inc., Service One International Corporation, Service
One Receivables Acquisition Corporation, the Company, Service
One Commercial Corporation and Soiland Company
10.21 Second Amendment to Security Agreement, dated as of November 21,
1997 between J.B.L. of Nevada, Inc., the Company, Sleepy Hollow
Associates, Inc., Service One International Corporation,
American Credit Alliance, Inc. and Service One Receivables
Acquisition Corporation
10.22 Credit Agreement Dated as of October 15, 1999 among Credit Store
Capital Corp., the Company, The Lenders Signatory thereto from
time to time, and General Electric Capital Corporation
10.23 Amended 1997 Stock Option Plan of the Company
10.24 Employment Agreement dated March 27, 1997, between the Company
and Martin Burke
10.25 Letter from Martin Burke dated March 27, 1997, regarding credit
card repayment terms
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EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
10.26 Employment Agreement dated April 1, 1997, between the Company
and Kevin Riordan
10.27 Employment Agreement dated June 17, 1997, between the Company
and Michael Philippe
10.28 Amendment to Employment Agreement between Company and Michael
Philippe dated December 15, 1999
10.29 Employment Agreement dated August 1, 1997, between the Company
and Richard Angel
10.30 Amendment to Employment Agreement between Company and Richard
Angel dated December 15, 1999
10.31 Employment Agreement dated October 15, 1997, between the Company
and Cynthia Hassoun
10.32 Employment Agreement dated July 15, 1999, between the Company
and William Buriak
10.33 Employment Agreement dated July 21, 1999, between the Company
and Jonathan Pike
10.34 Employment Agreement dated July 3, 1997, between the Company and
Patrick Steffl
10.35 Employment Agreement dated October 19, 1999, between the Company
and Michael L. Neher
10.36 Bankcard Marketing Agreement between the Company and Bank of
Hoven dated February 9, 1999
10.37 Purchase Agreement between Bank of Hoven and the Company dated
February 9, 1999
10.38 Bankcard Marketing Agreement between Service One International
Corporation and First National Bank in Brookings dated October
2, 1997
10.39 Purchase Agreement between First National Bank in Brookings and
Service One International Corporation doing business as TCS
Services, Inc. dated October 2, 1997
10.40 Amendment to Purchase Agreement by First National Bank in
Brookings and the Company dated August 31, 1998
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EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
10.41 Letter Agreement Regarding Bankcard Marketing Agreement and
Purchasing Agreement between the Company and First National Bank
in Brookings dated August 17, 1999
10.42 Agreement Regarding Transfer of Accounts between the Company and
First National Bank in Brookings dated December 14, 1998
10.43 Subordinated Grid Promissory Note of the Company in favor of JLB
dated August 1, 1997 in the amount of $20,000,000
10.44 Subordinated Grid Promissory Note of the Company in favor of JLB
dated October 23, 1997 in the amount of $5,000,000
10.45 Subordinated Grid Promissory Note of the Company in favor of JLB
dated November 21, 1997 in the amount of $5,000,000
16 Letter re Change in Certifying Accountant from Tanner & Company
21 List of Subsidiaries
27.1 Financial Data Schedule
27.2 Financial Data Schedule
27.3 Financial Data Schedule
27.4 Financial Data Schedule
27.5 Financial Data Schedule
27.6 Financial Data Schedule
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SIGNATURES
In accordance with Section 12 of the Securities Exchange Act of 1934, the
Company has duly caused this registration statement to be signed on its behalf
by the undersigned, thereunto duly authorized.
THE CREDIT STORE, INC.
Dated: December 29, 1999
By /s/ Martin J. Burke, III
---------------------------------
Martin J. Burke, III
Chief Executive Officer
By /s/ Michael J. Philippe
---------------------------------
Michael J. Philippe
Chief Financial Officer
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I N D E X
Page
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Report of Independent Certified Public Accountants (GT) F-2
Report of Independent Certified Public Accountants (Tanner) F-3
Consolidated Financial Statements
Consolidated Balance Sheets F-4 - F-5
Consolidated Statements of Operations and Comprehensive
Income (Loss) F-6
Consolidated Statement of Stockholders' Equity (Deficit) F-7 - F-8
Consolidated Statements of Cash Flows F-9 - F-11
Notes to Consolidated Financial Statements F-12 - F-38
F-1
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REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
THE CREDIT STORE, INC.
We have audited the accompanying consolidated balance sheets of The Credit
Store, Inc. (a Delaware corporation) (the "Company") and subsidiaries as of May
31, 1999 and 1998, and the related consolidated statements of operations and
comprehensive income (loss), stockholders' equity (deficit) and cash flows for
the years then ended. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of The Credit Store,
Inc. and subsidiaries as of May 31, 1999 and 1998, and the consolidated results
of their operations and their consolidated cash flows for the year then ended in
conformity with generally accepted accounting principles.
/s/ GRANT THORNTON LLP
New York, New York
August 16, 1999
F-2
58
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
THE CREDIT STORE, INC. AND
SERVICE ONE INTERNATIONAL CORPORATION
We have audited the accompanying consolidated statements of operations and
comprehensive income (loss), stockholders' equity (deficit) and cash flows of
The Credit Store, Inc. (a Delaware corporation) (the "Company") and its
subsidiaries and Service One International Corporation ("The Predecessor") for
the year ended May 31, 1997 and the period January 1, 1996 to October 8, 1996,
respectively. These financial statements are the responsibility of the Company's
and the Predecessor's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated statements of operations,
stockholders' equity (deficit) and cash flows are free of material misstatement.
An audit includes examining, on a test basis, evidence supporting the amounts
and disclosures in the consolidated statements of operations, stockholders'
equity (deficits) and cash flows. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall presentation of the consolidated statements of
operations, stockholders' equity (deficit) and cash flows. We believe that our
audits of the consolidated statements of operations and comprehensive income
(loss), stockholders' equity (deficit) and cash flows provide a reasonable basis
for our opinion.
In our opinion, the consolidated statements of operations and comprehensive
income (loss), stockholders' equity (deficit) and cash flows referred to above
present fairly, in all material respects, the consolidated results of their
operations and the consolidated cash flows of The Credit Store, Inc. and
subsidiaries and the Predecessor for the year ended May 31, 1997 and the period
January 1, 1996 to October 8, 1996, respectively in conformity with generally
accepted accounting principles.
We also audited the adjustments described in Note P to the consolidated
financial statements that were applied to restate the consolidated statements of
operations, stockholders' equity (deficit) and cash flows for the year ended May
31, 1997. In our opinion, such adjustments are appropriate and have been
properly applied.
/s/ TANNER + CO.
Salt Lake City, Utah
August 1, 1997 except for Note P,
which is dated November 17, 1998
as to the Company, and June 20, 1997
as to the Predecessor
F-3
59
The Credit Store, Inc.
CONSOLIDATED BALANCE SHEETS
May 31,
AUGUST 31, ---------------------------------
ASSETS 1999 1999 1998
----------- ------------- ------------
(UNAUDITED)
Cash $ 1,781,428 $ 3,533,930 $ 7,205,071
Restricted cash 750,000 750,000 1,000,000
Accounts and notes receivables, net of allowance for
doubtful accounts of $725,064, at August 31, 1999
and $746,463 and $780,027 at May 31, 1999 and
1998, respectively 1,052,203 1,150,207 492,666
Prepaid expenses 697,856 618,198 444,836
Amounts due from special purpose entities 1,466,511 1,230,700
Investments in consumer debt and credit cards
Investments in nonperforming consumer debt, net
of cost recovery of $37,888,811, $36,109,936
and $24,375,047 at August 31, 1999 and at
May 31, 1999 and 1998, respectively 2,397,154 3,227,711 6,125,511
Credit card receivables, net of provision for
losses and unearned fees of $4,558,588,
$3,247,806 and $3,904,812 at August 31, 1999
and at May 31, 1999 and 1998, respectively 24,476,584 18,631,403 12,919,970
Investment in unconsolidated affiliate 1,632,728 1,612,648 1,287,465
Retained interest in securitized credit card receivables 6,231,270 5,130,372
Property and equipment, net of accumulated depreciation
of $5,828,709 $5,202,266 and $2,795,673 at
August 31, 1999, and at May 31, 1999 and 1998,
Respectively 5,540,093 6,132,612 7,396,616
Goodwill, net of accumulated amortization of $604,264,
$552,470 and $345,294 at August 31, 1999, and at
May 31, 1999 and 1998, respectively 2,503,381 2,555,175 2,762,351
Deferred tax asset 700,000 700,000
Other assets 1,411,966 719,014 541,929
----------- ----------- -----------
Total assets $50,641,174 $45,991,970 $40,176,415
=========== =========== ===========
The accompanying notes are an integral part of these statements.
F-4
60
The Credit Store, Inc.
CONSOLIDATED BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS' May 31,
EQUITY (DEFICIT) AUGUST 31, ---------------------------------
1999 1999 1998
----------- -------------- ------------
(UNAUDITED)
Liabilities
Accounts payable and accrued expenses $ 3,581,345 $ 3,611,334 $ 4,245,019
Accrued royalties 378,395 702,075 261,667
Notes payable 11,811,174 6,086,766 5,902,041
Capitalized lease obligations 3,950,963 4,045,541 5,150,481
Subordinated notes and accrued interest payable -
related party 19,484,130 19,246,595 31,807,322
----------- ------------ ------------
Total liabilities 39,206,007 33,692,311 47,366,530
----------- ------------ ------------
Stockholders' equity (deficit)
Series A Preferred Stock, $.001 par value; 2,000,000 shares authorized;
1,200,000 shares issued and outstanding;
stated at liquidation value of $1 per share 1,200,000 1,200,000 1,200,000
Series B Preferred Stock, $.001 par value; 800,000 shares
authorized; 800,000 shares issued and outstanding;
stated at liquidation value of $1 per share 800,000 800,000 800,000
Series C Preferred Stock; 5,000 shares
authorized; 5,000 shares issued and outstanding;
stated at liquidation value of $1,000 per share 5,000,000 5,000,000 5,000,000
Series D Preferred Stock, $.001 par value; 10,000 shares
authorized; 10,000 shares issued and outstanding;
stated at liquidation value of $1,000 per share 10,000,000 10,000,000 10,000,000
Series E Preferred Stock, $.001 par value; 20,000 shares
authorized; 10,000 shares issued and outstanding;
stated at liquidation value of $1,000 per share 10,000,000 10,000,000
Common Stock, $.001 par value; 65,000,000 shares authorized at August 31,
1999 and 50,000,000 shares authorized at May 31, 1999 and 1998;
34,761,965 shares issued and outstanding at August 31, 1999
and at May 31, 1999 and 1998 34,762 34,762 34,762
Additional paid-in capital 23,539,962 22,670,711 19,311,782
Unrealized gain from retained interest in securitized
receivables, net of tax 3,274,978 2,497,148
Accumulated deficit (42,414,535) (39,902,962) (43,536,659)
------------ ------------ ------------
Total stockholders' equity (deficit) 11,435,167 12,299,659 (7,190,115)
------------ ------------ ------------
Total liabilities and stockholders' equity (deficit) $ 50,641,174 $ 45,991,970 $ 40,176,415
============ ============ ============
The accompanying notes are an integral part of these statements.
F-5
61
The Credit Store, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
For the three January 1,
For the years ended 1996 to
months ended August 31, May 31, October 8,
-------------------------- ---------------------------------------- 1996
1999 1998 1999 1998 1997 ("Predecessor")
---------- ---------- ---------- --------- ---------- ---------------
(unaudited)
Revenue
Income from credit card
receivables $ 2,041,574 $ 1,453,124 $ 6,438,460 $ 3,951,602 $ 971,174
Revenue in excess of cost
recovered 5,199,917 4,718,504 21,852,316 8,042,255 3,934
Gain on sales of portfolios 3,343,694 11,851,080
Servicing fees and other
income 883,134 699,805 1,564,356 1,292,596 1,601,228 $ 2,078,506
------------ ------------ ----------- ------------ ----------- -------------
Total revenue 8,124,625 10,215,127 41,706,212 13,286,453 2,576,336 2,078,506
Provision for losses 2,034,876 1,388,679 4,607,081 6,483,736 1,494,001 -
----------- ----------- ----------- ------------ ------------ -------------
Net revenue 6,089,749 8,826,448 37,099,131 6,802,717 1,082,335 2,078,506
Expenses
Salaries and employee 3,267,585 3,138,712 12,484,582 13,268,863 6,154,929 1,757,101
benefits
Interest expense 1,007,902 1,282,538 4,029,491 4,760,905 751,729 151,906
Professional fees 502,035 393,894 2,701,016 4,215,891 2,388,274 76,753
Depreciation and amortization 678,236 620,539 2,614,216 3,223,620 952,362 138,338
Third-party credit card 1,056,045 1,021,907 4,518,919 3,097,347 899,986 -
services
Mail processing 256,775 401,165 1,434,506 1,121,623 527,372 666,889
Rental expense 184,920 203,265 766,832 825,517 349,383 76,283
Royalty expense 111,321 426,890 1,541,944 207,238 1,229,180 -
Other 1,536,503 1,128,756 5,360,337 5,233,043 2,075,379 1,144,004
----------- ----------- ----------- ------------ ------------ ------------
Total expenses 8,601,322 8,617,666 35,451,843 35,954,047 15,328,594 4,011,274
----------- ----------- ---------- ----------- ----------- ------------
Income (loss) before income taxes (2,511,573) 208,782 1,647,288 (29,151,330) (14,246,259) (1,932,768)
Income tax benefit - - 1,986,409 - - 420,280
----------- ----------- ---------- ----------- ----------- ------------
Net income (loss) (2,511,573) 208,782 3,633,697 (29,151,330) (14,246,259) (1,512,488)
Unrealized gain on retained
interest
in securitized credit card
receivables, net of tax 777,830 - 2,497,148 - - -
----------- ---------- ---------- ----------- ----------- ------------
Comprehensive income (loss) $ (1,733,743) $ 208,782 $ 6,130,845 $(29,151,330) $(14,246,259) $ (1,512,488)
============ ============= ============ ============ ============ =============
Net income (loss) $ (2,511,573) $ 208,782 $ 3,633,697 $(29,151,330) $(14,246,259) $ (1,512,488)
Dividends on preferred stock (500,000) (299,999) (1,799,999) (399,996) (7,397) -
------------ ------------- ------------ ------------ ------------ ------------
Net income (loss), applicable to
common shareholders $ (3,011,573) $ (91,217) $ 1,833,698 $(29,551,326) $(14,253,656) $ (1,512,488)
============ ============= ============ ============ ============ =============
Income (loss) per share
Basic and diluted $(.09) $.00 $.05 $ (.89) $(.55) $(.30)
===== ==== ==== ====== ===== =====
Weighted-average common shares
outstanding
Basic 34,761,965 34,761,965 34,761,965 33,109,781 25,912,465 5,000,000
========== ========== ========== =========== =========== ============
Diluted 34,761,965 34,761,965 38,436,119 33,109,781 25,912,465 5,000,000
========== ========== ========== =========== =========== ============
The accompanying notes are an integral part of these statements.
F-6
62
The Credit Store, Inc.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
Periods ended August 31, 1999, and May 31, 1999, 1998 and 1997
Common
stock -
Common shares
stock - ($.001 par Series A Series B Series C Series D
shares value) Preferred Preferred Preferred Preferred
------ ------ --------- --------- --------- ---------
Formation of Predecessor 5,000,000 $ 5,000
========== ========
Net loss
Balance at October 8, 1996 5,000,000 $ 5,000
========== ========
Formation of Company,
October 8, 1996 12,049,965 $ 12,050 $1,200,000 $800,000 $5,000,000
Net loss
Issuance of common stock 20,157,500 20,158
---------- -------- ---------- -------- ----------
Balance at May 31, 1997 32,207,465 32,208 1,200,000 800,000 5,000,000
Net loss
Issuance of Series D Preferred
Stock in exchange for $10 million
subordinated note $10,000,000
Issuance of common stock 2,554,500 2,554
---------- -------- ---------- -------- ---------- -----------
Balance at May 31, 1998 34,761,965 34,762 1,200,000 800,000 5,000,000 10,000,000
Net income
Unrealized gain on retained interest in
securitization, net of tax
Issuance of Series E Preferred
Stock in exchange for $10 million
subordinated note
Issuance of 4 million warrants in lieu
of payment of accrued interest on
subordinated debt
---------- -------- ---------- -------- ---------- -----------
Balance at May 31, 1999 34,761,965 34,762 1,200,000 800,000 5,000,000 10,000,000
---------- -------- ---------- -------- ---------- -----------
Net loss
Unrealized gain on retained interest in
securitized receivables, net of tax
Issuance of 528,677 warrants in lieu of
payment for assets acquired
Balance at August 31, 1999 34,761,965 $ 34,762 $1,200,000 $800,000 $5,000,000 $10,000,000
========== ======== ========== ======== ========== ===========
The accompanying notes are an integral part of this statement.
F-7
63
The Credit Store, Inc.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT) (CONTINUED)
Periods ended August 31, 1999, and May 31, 1999, 1998 and 1997
Additional Other Total
Series E paid-in Accumulated comprehensive stockholders'
Preferred capital deficit income equity (deficit)
--------- ---------- ----------- ------------- ----------------
Formation of Predecessor $ 385,203 $ 390,203
Net loss $ (1,512,488) (1,512,488)
----------- ------------ -------------
Balance at October 8, 1996 $ 385,203 $ (1,512,488) $ (1,122,285)
=========== ============ =============
Formation of Company,
October 8, 1996 $ 121,175 $ (131,673) $ 7,001,552
Net loss (14,246,259) (14,246,259)
Dividends (7,397) (7,397)
Issuance of common stock 14,016,717 14,036,875
----------- ------------ -------------
Balance at May 31, 1997 14,137,892 (14,385,329) 6,784,771
Net loss (29,151,330) (29,151,330)
Issuance of Series D Preferred
Stock in exchange for $10 million
subordinated note 10,000,000
Issuance of common stock 5,173,890 5,176,444
----------- ------------ -------------
Balance at May 31, 1998 19,311,782 (43,536,659) (7,190,115)
Net income 3,633,697 3,633,697
Unrealized gain on retained interest
in
securitization, net of tax $2,497,148 2,497,148
Issuance of Series E Preferred
Stock in exchange for $10 million
subordinated note $10,000,000 10,000,000
Issuance of 4 million warrants in
lieu
of payment of accrued interest on
subordinated debt 3,358,929 3,358,929
----------- ----------- ------------ ---------- -------------
Balance at May 31, 1999 10,000,000 22,670,711 (39,902,962) 2,497,148 12,299,659
----------- ----------- ------------ ---------- -------------
Net loss (2,511,573) (2,511,573)
Unrealized gain on retained interest
in
securitized receivables, net of tax 777,830 777,830
Issuance of 528,677 warrants in lieu
of
payment for services 869,251 869,251
----------- ----------- ------------ ---------- -------------
Balance at August 31, 1999 $10,000,000 $23,539,962 $(42,414,535) $3,274,978 $ 11,435,167
=========== =========== ============ ========== =============
The accompanying notes are an integral part of this statement.
F-8
64
The Credit Store, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
January 1,
For the three For the years ended 1996 to
months ended August 31, May 31, October 8,
-------------------------- ---------------------------------------- 1996
1999 1998 1999 1998 1997 ("Predecessor")
---------- ---------- ---------- --------- ---------- ---------------
(unaudited)
Cash flows from operating
activities
Net income (loss) $(2,511,573) $ 208,782 $ 3,633,697 $(29,151,330) $(14,246,259) $ (1,512,488)
Adjustments to reconcile net
income (loss) to net cash
used
in operating activities
Provision for credit card
losses 2,034,876 1,388,679 4,607,081 6,483,736 1,494,001
Amortization of discount
on performing credit
card
portfolio (269,204)
Provision for losses on
accounts receivable 768,860 780,027 199,797
Depreciation and
amortization 678,236 620,539 2,614,216 3,223,620 952,362 138,338
Deferred tax benefit (1,986,409) (420,280)
Loss from unconsolidated
affiliates (20,080) (111,586) (325,183) (277,159) (1,010,306)
Gain on sale of credit
card
receivable portfolios (543,430) (11,851,080)
Royalty payment in kind (221,536) (694,751)
Services received for
stock
issued 176,444
(Increase) decrease in
Restricted cash 250,000 (1,000,000)
Accounts and notes
receivables 98,004 (119,773) (1,426,401) (473,436) (999,054) (72,069)
Receivable from uncon-
solidated affiliate (235,811) (1,230,700)
Prepaid expenses (79,658) (20,892) (173,362) (327,177) (117,659) (13,308)
Accrued interest on
funds advanced on
credit cards 82,488 (263,255) (62,722)
Accrued fees 291,161 (48,382) (575,225)
Other assets 176,298 (463,893) (177,085) (383,338) (158,591)
Increase (decrease) in
Unearned fees 53,725 81,784 184,551 216,721
Accounts payable and
accrued expenses (29,989) (809,950) (633,685) 2,495,854 1,683,604 670,993
Deferred revenue 166,800
Accrued interest payable
on subordinated notes 237,534 844,200 2,439,273 3,675,381 457,001
Accrued royalties (323,679) (4,647) 661,944 (570,262) 1,526,680
----------- ---------- ------------- ------------ ------------ -------------
Net cash provided by
(used in) operating
activities (191,321) 1,069,813 (2,492,170) (15,137,307) (11,856,371) (1,042,014)
=========== ========== ============= ============ ============ =============
F-9
65
The Credit Store, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
January 1,
For the three For the years ended 1996 to
months ended August 31, May 31, October 8,
-------------------------- --------------------------------------- 1996
1999 1998 1999 1998 1997 ("Predecessor")
---------- ---------- ---------- --------- ---------- ---------------
(unaudited)
Cash flows from investing activities
Collection of funds advanced
on credit cards $ 5,381,006 $ 4,071,291 $ 13,305,543 $ 1,887,306 $ 1,063,729
Cash received on collection of
nonperforming consumer debt 1,778,877 4,585,606 11,734,887 18,258,463 6,116,584
Funds advanced for retained
interest in securitized
credit card receivables (323,068) - (1,346,815)
Proceeds from sale of credit
card receivable portfolios 17,129,109 $ 1,300,000
Funds advanced on credit cards (8,959,980) (7,521,093) (29,460,286) (18,629,185) (4,486,692)
Purchase of nonperforming
consumer debt portfolios (948,320) (4,072,408) (8,837,087) (16,031,225) (14,469,333)
Purchase of performing
consumer debt portfolios (4,085,604)
Development of proprietary
software (202,760) (460,497)
Purchase of property and
equipment (33,923) (171,623) (682,539) (4,170,472) (10,164,477) (957,720)
Cash received in purchase of
subsidiary 58,162
----------- ----------- ------------ ----------- ------------ -----------
Net cash provided by
(used in) investing
activities (7,191,012) (3,310,987) 1,382,315 (18,685,113) (21,882,027) 342,280
----------- ----------- ------------ ----------- ------------ -----------
Cash flows from financing activitie
Proceeds from debt 6,079,590 246,751 576,643 33,240,887 10,794,741 1,546,842
Payments on debt (355,182) (327,106) (2,032,989) (101,921) (356,726) (1,068,303)
Borrowings from sale/leaseback
transactions 424,000 25,138 559,713 3,146,275 4,442,520
Payments on capital lease (518,577) (384,302) (1,664,653) (1,943,331) (494,983)
obligations
Proceeds from issuance of stock - - 5,000,000 21,036,875
----------- ----------- ------------ ----------- ------------ -----------
Net cash provided by
(used in) financing
activities 5,629,831 (439,519) (2,561,286) 39,341,910 35,422,427 478,539
----------- ----------- ------------ ----------- ------------ -----------
NET INCREASE
(DECREASE) IN
CASH (1,752,502) (2,680,693) (3,671,141) 5,519,490 1,684,029 (221,195)
Cash at beginning of year 3,533,930 7,205,071 7,205,071 1,685,581 1,552 279,357
----------- ----------- ------------ ----------- ------------ -----------
Cash at end of year $ 1,781,428 $ 4,524,378 $ 3,533,930 $ 7,205,071 $ 1,685,581 $ 58,162
=========== =========== ============ =========== ============ ===========
F-10
66
The Credit Store, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
January 1,
For the three For the years ended 1996 to
months ended August 31, May 31, October 8,
-------------------------- ---------------------------------------- 1996
1999 1998 1999 1998 1997 ("Predecessor")
---------- ---------- ---------- --------- ---------- ---------------
(unaudited)
Supplemental disclosures of cash
flow information:
Cash paid during the year for
Interest $ 471,524 $ 438,338 $ 1,592,864 $ 1,006,663 $ 306,691 $ 144,573
Noncash financing activities:
Series E and D preferred
stock issued in exchange for
subordinated note $10,000,000 $ 10,000,000 $10,000,000
Obligations assumed in lieu
of payment of accrued interest
on subordinated debt $ 1,641,071
Issuance of warrants in lieu
of payment of accrued interest
on subordinated debt $ 3,358,929
Issuance of warrants in lieu
of payment for assets acquired $ 869,249
Property and equipment
provided with debt $3,754,408
The accompanying notes are an integral part of these statements.
F-11
67
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 1999, 1998, 1997 and January 1, 1996
to October 8, 1996 ("Predecessor"), and for the three
months ended
(unaudited) August 31, 1999 and 1998
NOTE A - ORGANIZATION
The Credit Store, Inc. (the "Company") is a technology-based nationwide
financial services company engaged in the acquisition and recovery of
nonperforming consumer debt and the origination and servicing of credit
cards to consumers who may otherwise fail to qualify for a traditional
unsecured bank credit card. The Company acquires portfolios of
nonperforming consumer debt and originates new credit cards to those
customers who agree to pay all or a portion of the outstanding amount due
on their debt. The new credit card is issued with an initial balance and
credit line equal to the agreed repayment amount. After making principal
payments on the transferred balance, the customer can begin using the
credit card for new purchases or advances up to a limit equal to the
original settlement amount of the debt and may be granted subsequent credit
line increases. After appropriate seasoning, the Company attempts to sell
or securitize the credit card receivables. The Company pursues other
recovery methods with respect to those accounts it is unable to convert to
credit cards.
The Company was incorporated in 1972 in Utah as Valley West Development
Corporation, changed its corporate domicile to Delaware in 1995, and
changed its name to The Credit Store, Inc. on October 8, 1996.
On October 8, 1996, Taxter One LLC ("Taxter") acquired Service One
Holdings, Inc. ("Holdings") from two selling entities ("Selling Entities").
Holdings, through its wholly-owned subsidiary, Service One International
Corporation, Inc. ("SOIC"), engaged in the business of acquiring
non-performing consumer debt portfolios, and the marketing and servicing of
credit cards. SOIC (the "Predecessor") is the predecessor of the Company.
At the time of the acquisition, Holdings owned all of the capital stock of
Service One International Corporation ("SOIC"), its sole asset, which was
engaged in the business of acquiring nonperforming consumer debt
portfolios, and the marketing and servicing of credit cards. On December 4,
1996, the Company acquired all of the capital stock of Holdings from
Taxter. Following the acquisition of Holdings, the Company engaged
directly, and through SOIC and its affiliates, in the acquisition of
nonperforming consumer debt portfolios and the marketing and servicing of
credit cards. Holdings and SOIC were merged into the Company in February
and March, 1998, respectively. For accounting purposes, the acquisition of
Holdings and SOIC by the Company has been accounted for as the acquisition
of Holdings by the Company. In connection with the acquisition by Taxter of
Holdings (and its subsidiary, SOIC), the agreements provided, among other
obligations, for:
- A cash payment of $2 million by Taxter to the Selling Entities at
closing.
- An option for each of the Selling Entities to acquire 4,000,000
shares of common stock and 400,000 shares of Series B Preferred
Stock from Taxter.
- Royalty fees of up to $25,000,000 payable to each Selling Entity
by SOIC.
F-12
68
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996
to October 8, 1996 ("Predecessor"), and for the three
months ended
(unaudited) August 31, 1999 and 1998
NOTE A (CONTINUED)
The excess of the (cash) purchase price over the fair value of the net
assets acquired was allocated to goodwill and amounted to $3.1 million.
The assets acquired and liabilities assumed (in millions) were:
Assets acquired $ 2.9
Liabilities assumed $(4.0)
Cash paid $(2.0)
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
1. Principles of Consolidation
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All significant intercompany
transactions have been eliminated.
2. Cash and Cash Equivalents
For purposes of the statement of cash flows, cash includes all cash and
investments with original maturities to the Company of three months or
less when purchased except restricted cash. The Company maintains its
cash in bank deposit accounts which at times may exceed federally
insured limits. The Company classifies as restricted cash $750,000 at
August 31, 1999 and at May 31, 1999 and $1,000,000 at May 31, 1998, on
deposit with a bank in order to facilitate funding of credit card
loans.
3. Investments and Credit Card Receivables
Investments in nonperforming consumer debt consist of portfolios of
consumer debt purchased by the Company, which is recorded at cost, less
cost recovered. Cost is substantially less than the remaining
outstanding balance of these portfolios. To the extent that the cost of
a particular
F-13
69
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996
to October 8, 1996 ("Predecessor"), and for the three
months ended
(unaudited) August 31, 1999 and 1998
NOTE B (CONTINUED)
portfolio of debt purchased exceeds the estimated amount of cash
expected to be collected, a valuation allowance would be recognized in
the amount of such impairment.
Credit card receivables consist of amounts funded by the Company for
new purchases or advances, accrued interest on new purchases and
advances, and accrued fees, less a provision for losses.
Investment in unconsolidated affiliate represents the Company's 50%
ownership interest in an entity involved in substantially the same
business as the Company and is recorded on the equity method of
accounting.
4. Securitization Accounting
Statement of Financial Accounting Standards No. 125 ("SFAS No. 125"),
"Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities," requires an entity to recognize the
financial and servicing assets it controls and the liabilities it has
incurred and to derecognize financial assets when control has been
surrendered. The basis of securitized financial assets is allocated to
the assets sold, the servicing asset or liability and retained interest
based on their relative fair values at the transfer date in determining
the gain on the securitization transaction.
SFAS No. 125 requires an entity to recognize a servicing asset or
servicing liability each time it undertakes an obligation to service
financial assets that have been securitized and amortize it over the
period of estimated net servicing income. Servicing assets or
liabilities are amortized in proportion to and over the period of
estimated net servicing income or loss. As of August 31, 1999 and May
31, 1999 there is no servicing asset or liability, as servicing revenue
was equivalent to servicing cost.
5. Retained Interest in Securitized Credit Card Receivables
The retained interest in securitized credit card receivables is treated
as a debt security classified as available-for-sale in accordance with
Statement of Financial Accounting Standards No. 115 ("SFAS No. 115"),
"Accounting for Certain Investments in Debt and Equity Securities," and
is carried at fair value. At the time of securitization, the retained
interest is initially recorded at the basis allocated in accordance
with SFAS No. 125. This original cost basis is adjusted to fair value,
which is based on the discounted anticipated future cash flows on a
"cash out" basis, with such adjustment (net of related deferred income
taxes) recorded as a component of other comprehensive income. The cash
out method projects cash collections to be received only after all
amounts owed to investors have been remitted.
F-14
70
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996
to October 8, 1996 ("Predecessor"), and for the three
months ended
(unaudited) August 31, 1999 and 1998
NOTE B (CONTINUED)
Income on the retained interest is accrued based on the effective
interest rate applied to its original cost basis, adjusted for accrued
interest and principal paydowns. The effective interest rate is the
internal rate of return determined based on the timing and amounts of
anticipated future cash flow projections for the underlying pool of
securitized credit card receivables.
The Company monitors impairment of the retained interest based on
discounted anticipated future cash flows of the underlying receivables
on a cash out basis compared to the original cost basis of the retained
interest, adjusted for accrued interest and principal paydowns. The
discount rate is based on an acceptable rate of return adjusted for
specific risk factors. The retained interest is evaluated for
impairment by management monthly based on current market and cash flow
assumptions applied to the underlying receivables. Provisions for
losses are charged to earnings when it is determined that the retained
interest's original cost basis, adjusted for accrued interest and
principal paydowns, is greater than the present value of expected
future cash flows. No provision for losses was recorded as of August
31, 1999 and May 31, 1999.
6. Property and Equipment
Property and equipment are recorded at cost, less accumulated
depreciation and amortization. Depreciation and amortization on capital
leases and property and equipment are determined using the
straight-line method over the estimated useful lives of the assets or
terms of the lease. Expenditures for maintenance and repairs are
expensed when incurred and betterments are capitalized.
7. Goodwill
Goodwill originating from the acquisition of companies acquired in
purchase transactions is being amortized using the straight-line method
over fifteen years.
The Company evaluates the realizability of goodwill based on
expectations of future non-discounted cash flows and operating income
related to purchased businesses.
8. Revenue Recognition
Income from credit cards receivable represents interest and fees on new
advances or purchases made by holders of the Company's credit cards on
an accrual basis.
F-15
71
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996
to October 8, 1996 ("Predecessor"), and for the three
months ended
(unaudited) August 31, 1999 and 1998
NOTE B (CONTINUED)
Revenue in excess of cost recovery is accounted for on a pool basis
using the cost recovery method of accounting in accordance with
Practice Bulletin No. 6, "Amortization of Discounts on Certain Acquired
Loans." Under the cost recovery method of accounting, all cash receipts
relating to individual portfolios of nonperforming consumer debt are
applied first to recover the cost of the portfolios, prior to
recognizing any revenue. Cash receipts in excess of cost of acquired
portfolios is then recognized as revenue.
Servicing revenues are fees related to processing and managing credit
cards for third parties. These revenues are recognized when the related
services are provided.
9. Allowance for Loan Losses
The provision for possible credit losses includes current period losses
and an amount which, in the judgment of management, is necessary to
maintain the allowance for possible credit losses at a level that
reflects known and inherent risks in the credit card loan portfolio.
Credit card accounts are generally charged off at the end of the month
during which the loan becomes contractually 120 days past due, with the
exception of bankrupt accounts, which are charged off immediately upon
formal notification of bankruptcy, and accounts of deceased cardholders
without a surviving, contractually liable individual, which are also
charged off immediately upon notification.
10. Use of Estimates
In preparing financial statements in conformity with generally accepted
accounting principles, management is required to make estimates and
assumptions that affect the reported amounts of assets and liabilities,
the disclosure of contingent assets and liabilities at the date of the
financial statements, and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
Significant estimates have been made by management with respect to the
timing and amount of collection of future cash flows from nonperforming
consumer debt and credit card receivables ("Portfolios"). Among other
things, the estimated future cash flows of the Portfolios are used to
F-16
72
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996
to October 8, 1996 ("Predecessor"), and for the three
months ended
(unaudited) August 31, 1999 and 1998
NOTE B (CONTINUED)
recognize impairment in investment in nonperforming consumer debt,
provision for losses on credit card receivables and fair value of
retained interest in securitized credit card receivables. Actual
results could differ from these estimates, making it reasonably
possible that a change in these estimates could occur within one year.
On a periodic basis, management reviews the estimate of future
collections, and it is reasonably possible that its assessment may
change based on actual results and other factors. The change could be
material.
11. Income Taxes
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax
purposes.
12. Earnings Per Share
Earnings per share are calculated under the provisions of Statement of
Financial Accounting Standards No. 128 ("SFAS No. 128"), "Earnings Per
Share." SFAS No. 128 requires the presentation and disclosure of basic
earnings per share, and, if applicable, diluted earnings per share.
Basic earnings per share is computed by dividing income applicable to
common stockholders by the weighted-average number of common shares
outstanding during the period. Income (loss) applicable to common
stockholders is computed by deducting dividends on preferred stock from
net income or loss. Diluted earnings per share are based on the
weighted-average number of common and common equivalent shares
outstanding. The calculation takes into account the shares that may be
issued upon exercise of stock options, reduced by the shares that may
be repurchased with the funds received from the exercise, based on the
average price during the year. In computing diluted earnings per share,
only potential common shares that are dilutive (those that reduce
earnings per share) are included. Exercise of stock options is not
assumed if the result would be antidilutive, such as when a loss from
continuing operations is reported.
13. Reporting Comprehensive Income
The Financial Accounting Standards Board ("FASB") issued Statement of
Financial Accounting Standards No. 130 ("SFAS No. 130"), "Reporting
Comprehensive Income," which is effective for fiscal years beginning
after December 15, 1997. The Statement establishes standards for
reporting
F-17
73
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996
to October 8, 1996 ("Predecessor"), and for the three
months ended
(unaudited) August 31, 1999 and 1998
NOTE B (CONTINUED)
and display of comprehensive income and its components (revenue,
expenses, gains and losses) in a full set of general-purpose financial
statements. The Statement requires all items required to be recognized
under accounting standards as components of comprehensive income, to be
reported in a financial statement that is displayed with the same
prominence as other financial statements. SFAS No. 130 does not require
a specific format for that financial statement but requires that an
enterprise display an amount representing total comprehensive income
for the period in that financial statement. The Statement requires that
an enterprise classify items of other comprehensive income by their
nature in a financial statement and display the accumulated balance of
other comprehensive income separately from retained earnings and
additional paid-in capital in the equity section of a statement of
financial position. Reclassification of financial statements for
earlier periods provided for comparative purposes is required. For the
three months ended August 31, 1998 and for the years ended May 31, 1998
and 1997 and for the period January 1, 1996 to October 8, 1996, the
Company had no sources of other comprehensive income. For the three
months ended August 31, 1999 and for the year ended May 31, 1999, the
Company's investment in securitizations is classified as available for
sale; as such, in accordance with SFAS No. 115, the Company recognizes
as other comprehensive income the unrealized gains or losses for the
difference between the amortized cost and estimated fair value.
14. Reclassification
Certain reclassifications have been made to prior period amounts to
conform to the current period presentation.
15. Interim Period Information
The unaudited consolidated financial statements as of August 31, 1999
and for the three-month periods ended August 31, 1999 and 1998 have
been prepared in accordance with generally accepted accounting
principles for interim financial information and the instruction to
Form 10-Q and do not include all of the information and notes required
by generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments consisting of
normal recurring accruals considered necessary for a fair presentation
of the results for the interim period have been included.
F-18
74
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996
to October 8, 1996 ("Predecessor"), and for the three
months ended
(unaudited) August 31, 1999 and 1998
NOTE C - INVESTMENTS IN NONPERFORMING CONSUMER DEBT
AND CREDIT CARD RECEIVABLES
Investments in Nonperforming Consumer Debt
The Company acquires portfolios of nonperforming consumer installment debt,
credit card receivables, and automobile deficiency debt from originating
financial institutions. These debts are acquired at a substantial discount
from the actual consumer outstanding balance. The remaining outstanding
balance of the debt acquired by the Company at August 31, 1999, May 31,
1999 and 1998 was approximately $2.1 billion, $2.0 billion and $1.8
billion, respectively. The Company's objective is to offer the consumer an
opportunity to settle these debts, typically at a discount, and transfer
the settled amount to a newly issued credit card. (See Credit Card
Receivables below.)
Investments in nonperforming consumer debt consist of:
May 31,
AUGUST 31, -------------------------------
1999 1999 1998
------------- ------------ ------------
(UNAUDITED)
Cost of portfolios purchased including capitalized
acquisition costs of $2,292,153, $2,079,897
and $1,504,549 $ 40,285,965 $ 39,337,647 $ 30,500,558
Cost recovered (37,888,811) (36,109,936) (24,375,047)
------------ ----------- -----------
Investment in nonperforming consumer debt $ 2,397,154 $ 3,227,711 $ 6,125,511
============ ============ ============
Credit Card Receivables
Upon settlement of the debt, a credit card is issued to the consumer with
the opening balance and credit line equal to the settlement amount. After
making principal payments on the transferred balance, the customer may use
the credit card for new purchases and cash advances up to their available
credit limit, which may be increased from time to time based on their
consecutive payment history. Total credit card balances in the chart below
represent the total amount owed to the Company by the cardholders.
Available credit represents the amount that the Company would be obligated
to fund if the credit cards were fully utilized by the cardholders.
F-19
75
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996
to October 8, 1996 ("Predecessor"), and for the three
months ended
(unaudited) August 31, 1999 and 1998
NOTE C (CONTINUED)
For financial statement purposes the Company records as credit card
receivables, the amount funded on new advances and purchases, accrued
interest on new advances and accrued fees, less a provision for losses on
credit card receivables and unearned fees.
AUGUST 31, May 31,
-------------------------------
1999 1999 1998
------------- ------------ -----------
(UNAUDITED)
Total credit card balances $ 64,886,600 $ 55,184,540 $74,096,668
============ ============ ===========
Available credit $ 5,432,626 $ 4,296,364 $ 6,093,820
============ ============ ===========
Principal funded on new advances and purchases $ 28,218,329 $ 21,303,274 $15,875,198
Accrued interest on principal funded 404,125 243,489 325,977
Accrued fees 412,718 332,446 623,607
------------ ------------ -----------
29,035,172 21,879,209 16,824,782
------------ ------------ -----------
Less
Provision for losses on credit card receivables 4,103,591 2,846,533 3,688,091
Unearned fees 454,997 401,273 216,721
------------ ------------ -----------
4,558,588 3,247,806 3,904,812
------------ ------------ -----------
Credit card receivables $ 24,476,584 $ 18,631,403 $12,919,970
============ ============ ===========
NOTE D - SECURITIZATION OF CREDIT CARD RECEIVABLE PORTFOLIOS
During the fiscal year ended May 31, 1999, the Company completed three
securitizations of seasoned credit card receivables ("Receivables") of
approximately $20.4 million with three unconsolidated wholly-owned
qualified special purpose entities ("SPE's"). All credit cards sold in
these transactions were current with a minimum of eight payments made on
each account. The SPE's financed the purchase of
F-20
76
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996
to October 8, 1996 ("Predecessor"), and for the three
months ended
(unaudited) August 31, 1999 and 1998
NOTE D (CONTINUED)
the Receivables with a series of loans from an investment bank ("Lender")
totaling approximately $13 million. The loans to two of the SPE's have
revolving periods for a specified number of months as defined by the loan
agreement, during which, after new charges are funded and fees and interest
are paid, excess cash collections can be used by the SPE's to purchase
additional accounts from the Company. The loan to the third SPE does not
have a revolving period and uses the excess cash collections to prepay the
loan. During the amortization period on these loans, all cash collections
relating to the lenders' interest in the collateral are used to repay
principal, after the payment-related servicing fees and interest are made.
All new charges on the sold accounts are either sold to the SPE or
contributed in exchange for an equity interest until such time as the loans
are repaid. While the loans are in place, there are restrictions on
payments that can be made by the Company to certain related parties.
Under the provisions of SFAS No. 125, the securitizations are accounted for
as sales. As a result, the Company recognized a pre-tax gain of
approximately $8 million and recorded a retained interest in securitized
credit card receivables at an allocated basis in the amount of
approximately $1.3 million based on its relative fair value as discussed in
Note B. At August 31, 1999 and May 31, 1999, the allocated basis amount was
adjusted to a fair value of approximately $6.2 million and $5.1 million,
respectively, resulting in approximately $1.1 million and $3.8 million,
respectively, of unrealized gain on the retained interest in securitized
credit card receivables. The unrealized gain was recorded net of tax of
approximately $.3 million and $1.3 million, respectively, resulting in
approximately $3.3 million and $2.5 million, respectively, as a separate
component of stockholders' equity and approximately $.8 million and $2.5
million as a component of Consolidated Statement of Operations and
Comprehensive Income (Loss), respectively. In estimating the fair value of
the retained interest, the Company has estimated net cash flows based on
the Company's historical collection results for similar receivables and
discounted it using an appropriate rate. At August 31, 1999 and May 31,
1999, the Company discounted the estimated net cash flows at twenty-three
percent.
In accordance with the terms of the securitization, the Company deposited
$962,000 in a spread account with a third party bank to be used as the
reserve for the benefit of the lender to the SPE's. This amount is released
to the Company as it is replaced by excess cash flow generated by the
receivables.
As of August 31, 1999 and May 31, 1999, the Company included $1,466,511 and
$1,230,700, respectively, in amounts due from SPE's representing funds
advanced with respect to revolving period requirements and servicing fee
income which are paid to the Company on a monthly basis.
F-21
77
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996
to October 8, 1996 ("Predecessor"), and for the three
months ended
(unaudited) August 31, 1999 and 1998
NOTE E - PROPERTY AND EQUIPMENT
Property and equipment consist of the following at:
Useful May 31,
life AUGUST 31, --------------------------------
(in years) 1999 1999 1998
------------ ------------ ------------ ------------
(UNAUDITED)
Computer equipment and
software 3 - 5 $ 6,654,228 $ 6,631,043 $ 6,063,242
Office equipment 5 - 7 2,275,037 2,275,037 2,271,184
Furniture and fixtures 5 - 7 1,194,139 1,183,400 1,105,230
Proprietary software 5 460,497 460,497
Leasehold improvements Life of leases 654,475 654,475 622,207
------------ ------------ ------------
11,238,376 11,204,452 10,061,863
Less accumulated depreciation
and amortization (5,828,709) (5,202,266) (2,795,673)
------------ ------------ ------------
5,409,667 6,002,186 7,266,190
------------ ------------ ------------
Land 130,426 130,426 130,426
------------ ------------ ------------
$ 5,540,093 $ 6,132,612 $ 7,396,616
============ ============ ============
NOTE F - NOTES PAYABLE
Notes payable consist of the following:
May 31,
AUGUST 31, --------------------------------
1999 1999 1998
------------ ------------ ------------
(UNAUDITED)
Note payable - bank $ 9,724,366 $3,644,776 $4,630,890
Note payable - other lenders 1,892,146 2,217,714 944,099
Note payable - previous owner 194,662 224,276 327,052
------------ ---------- ----------
$ 11,811,174 $6,086,766 $5,902,041
============ ========== ==========
F-22
78
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996
to October 8, 1996 ("Predecessor"), and for the three
months ended
(unaudited) August 31, 1999 and 1998
NOTE F (CONTINUED)
Note Payable - Bank
On April 30, 1998, the Company entered into a financing agreement with a
bank. The revolving line of credit, which may not exceed $5,000,000 or 35%
of the Company's eligible receivables as defined by the agreement, is used
for general working capital purposes. This line is collateralized by
substantially all of the Company's assets. Interest is charged at the prime
rate plus 2.75% per annum. On June 25, 1999, the rate was reduced to prime
rate plus 2.5% per annum and the line of credit increased to $10,000,000.
The agreement is in effect until July 29, 2001. Interest expense for the
three months ended August 31, 1999 and 1998 and for the years ended May 31,
1999 and 1998 was $220,596, $164,771, $617,249 and $27,936, respectively.
Note Payable - Other Lenders
The Company has uncollateralized installment notes with respect to
purchases of nonperforming consumer debt in addition to assuming
installment obligations from the closing of certain affiliated mortgage
companies (see Note L). The notes have various maturity dates through May
2002, with interest rates ranging up to 23.7%. Interest expense for the
three months ended August 31, 1999 and 1998, and the years ended May 31,
1999, 1998 and 1997 was $54,702, $17,302, $65,353, $51,925 and $0,
respectively.
Note Payable - Previous Owner
The Company assumed debt of the Selling Entities representing part of their
purchase price of SOIC on January 2, 1996 (see Note K). Under the
agreement, the previous owner is being paid on a 10%, $550,000 note
collateralized by the stock of the Company payable in monthly installments
maturing February 2001. Interest expense for the three months ended August
31, 1999 and 1998, and for the years ended May 31, 1999, 1998 and 1997 and
for the period January 1, 1996 to October 8, 1996 of the "Predecessor" was
$5,443, $7,952, $25,769, $38,310 and $53,299 and $34,982, respectively.
F-23
79
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996 to
October 8, 1996 ("Predecessor"), and for the three months ended
(unaudited) August 31, 1999 and 1998
NOTE F (CONTINUED)
At May 31, 1999, future minimum principal payments for all notes payable
were as follows:
Year Amount
---- ------
2000 $1,575,964
2001 612,624
2002 3,898,178
---------
$6,086,766
==========
NOTE G - CAPITAL LEASES
The Company leases computer equipment, furniture and fixtures under
long-term leases and has the option to purchase the equipment for a nominal
cost at the termination of the lease. Assets under capital leases have been
capitalized at a cost of $6,526,915, $6,526,915 and $6,501,777,
respectively, and have accumulated amortization of $4,050,529, $3,646,314
and $2,000,609, respectively, at August 31, 1999, May 31, 1999 and 1998.
Future minimum lease payments for capitalized leases are as follows at May
31, 1999:
Year ending May 31, Amount
------------------- ------
2000 $2,521,835
2001 1,429,304
2002 959,866
2003 85,570
----------
4,996,575
Less amount representing interest (951,034)
----------
$4,045,541
==========
Amortization expense for assets under capital leases during the three
months ended August 31, 1999 and 1998 was $404,215 and $383,126,
respectively, and during fiscal 1999, 1998, 1997 and for the period January
1, 1996 to October 8, 1996 was $1,645,705, $1,535,029, $126,606 and
$69,000, respectively.
F-24
80
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996 to
October 8, 1996 ("Predecessor"), and for the three months ended
(unaudited) August 31, 1999 and 1998
NOTE H - STOCK OPTIONS AND STOCK-BASED COMPENSATION
1. Stock Options
The Board of Directors of the Company approved the Company's 1997
Stock Option Plan (the "Plan"). The Plan authorizes the grant of stock
options covering 4,000,000 shares of the Company's common stock. In
addition, the Board of Directors has granted stock options outside the
Plan covering a total of 1,550,000 shares of Common Stock. The Board
of Directors has the authority to determine the key employees,
consultants, and directors who shall be granted options as well as the
number of options granted and the nature of each grant. The options
granted under the Plan may be either incentive stock options or
nonqualified stock options.
Information regarding the stock options is summarized below:
Year ended May 31,
-----------------------------------------------------------------------
1999 1998 1997
---------------------- ---------------------- ---------------------
June 1, June 1, Weighted- Weighted- Weighted-
1999 to 1998 to average average average
August 1, August 1, Number exercise Number exercise Number exercise
1999 1998 of options price of options price of options price
---- ---- ---------- ----- ---------- ----- ---------- -----
Outstanding at beginning
of period 4,346,500 3,656,000 3,656,000 $2.93 2,550,000 $5.76
===== =====
Options granted 555,000 300,000 690,500 $2.35 3,021,000 (1) 2.45 2,550,000 $5.76
Options modified/
cancelled (1,915,000)(1) 5.93
--------- ---------- --------- ----- ---------- ----- --------- -----
Outstanding at end of
period 4,901,500 3,956,000 4,346,500 $2.84 3,656,000 $2.93 2,550,000 $5.76
========= ========== ========= ===== ========== ===== ========= =====
Exercisable at end of
period 4,400,060 $2,695,000 3,305,500 $3.08 2,395,000 $3.39 2,550,000 $5.76
========= ========== ========= ===== ========== ===== ========= =====
(1) On December 15, 1997, the Board of Directors authorized the
modification of stock options covering an aggregate of 1,915,000
shares of common stock adjusting the exercise price from $6.00 per
share to $2.00 per share. The affected stock option agreements were
cancelled and new options were issued containing identical provisions
other than the exercise price.
F-25
81
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996 to
October 8, 1996 ("Predecessor"), and for the three months ended
(unaudited) August 31, 1999 and 1998
NOTE H (CONTINUED)
2. Stock-Based Compensation
In October 1995, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 123 ("SFAS No. 123"),
"Accounting for Stock-Based Compensation," which established financial
accounting and reporting standards for stock-based compensation. The
new standard defines a fair value method of accounting for an employee
stock option or similar equity instrument. This statement gives
entities the choice between adopting the fair value method or
continuing to use the intrinsic value method under Accounting
Principles Board ("APB") Opinion No. 25 with footnote disclosures of
the pro forma effects as if the fair value method has been adopted.
The Company has opted for the latter approach. Accordingly, no
compensation expense has been recognized for stock options. Had
compensation expense for the Company's stock options been determined
based on the fair value at the grant date for awards for the three
months ended August 31, 1999 and 1998, and for the years ended May 31,
1999, 1998 and 1997 consistent with the provisions of SFAS No. 123,
the Company's results of operations would be the pro forma amounts
indicated below.
For the three For the years ended
months ended August 31, May 31,
-------------------------- --------------------------------------------
1999 1998 1999 1998 1997
---------- ---------- ---------- ---------- --------
(unaudited)
Net income (loss) applicable to
common shareholders:
- as reported $ (3,011,573) $ (91,217) $ 1,833,698 $ (29,551,326) $ (14,253,656)
- pro forma (3,377,099) (708,115) 50,109 (30,214,556) (25,746,656)
Income per share - as reported
Basic and diluted $ (.09) $ (.00) $ .05 $ (.89) $ (.55)
Income per share - pro forma
Basic and diluted (.10) (.02) .00 (.91) (.99)
F-26
82
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996 to
October 8, 1996 ("Predecessor"), and for the three months ended
(unaudited) August 31, 1999 and 1998
NOTE H (CONTINUED)
The fair value of each option grant is established on the date of grant
using the Black-Scholes option pricing model with the following
assumptions:
For the three For the years ended
months ended August 31, May 31,
1999 1998 1999 1998 1997
---------- ---------- ---------- ---------- --------
(unaudited)
Expected dividend yield $ - $ - $ - $ - $ -
Expected stock price volatility 90% 120% 90% 120% 50%
Expected life of options 5 or 10 years 5 or 10 years 5 or 10 years 5 or 10 years 5 years
The risk-free interest rate used in the valuation of the option grants
ranged from 5.85% to 5.98% for the three months ended August 31, 1999,
5.43% for the three months ended August 31, 1998, 4.80% to 5.47% for the
year ended May 31, 1999, 5.75% to 5.81% for the year ended May 31, 1998,
and was 4.50% for the year ended May 31, 1997, depending on the expiration
date of the options.
The weighted-average fair value of options granted during the three months
ended August 31, 1999 and 1998, was $1.79 and $2.28, respectively, and
during the years ended May 31, 1999, 1998, 1997 was $1.70, $1.95 and $4.51,
respectively. The Company granted stock options whose weighted-average
exercise price and weighted-average fair value was $2.35 and $1.79,
respectively, for the three months ended August 31, 1999 and 1998 and $2.35
and $1.70, respectively, for the year ended May 31, 1999 and 1998.
On April 30, 1998, the Company granted 650,247 warrants to purchase shares
of the Company's common stock for $2.50 per share to the bank with which it
has a financing agreement. 278,677 of the shares were exercisable
immediately, while the remaining 371,570 were exercisable on June 25, 1999,
when the Company's line of credit increased to $10 million (see Note F).
The fair value of the warrants was $1.01 at the date of grant. For the
three months ended August 31, 1999, amortization expense was $297,101.
On March 18, 1999, the Company granted a five-year warrant to purchase
250,000 shares of the Company's common stock at $2.00 per share to a vendor
that the Company uses. The fair value of the warrant was $.85 per share.
For the three months ended August 31, 1999, amortization expense was
$14,167.
F-27
83
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996 to
October 8, 1996 ("Predecessor"), and for the three months ended
(unaudited) August 31, 1999 and 1998
NOTE H (CONTINUED)
The following table summarizes information about stock options outstanding
at August 31, 1999 and May 31, 1999:
Options outstanding Options exercisable
----------------------------------- ---------------------------
Weighted-
average
Number remaining Weighted- Number Weighted- Number
Range of outstanding contractual average exercisable Average outstanding
exercise at life exercise at Exercise at
prices August 31, 1999 (years) price August 31, 1999 price May 31, 1999
---------- --------------- ----------- -------- --------------- ---------- ------------
$2.00 - $2.50 3,589,500 4.48 $2.09 3,130,060 $2.07 3,086,500
2.51 - 3.00 362,000 4.08 3.03 320,000 2.71 310,000
3.01 - 5.50 950,000 3.04 5.50 950,000 5.50 950,000
--------- --------- ---------
4,901,500 4.17 $3.06 4,400,060 $2.86 4,346,500
========= ========= =========
Options outstanding Options exercisable
- ----------------------- --------------------------
Weighted-
average
remaining Weighted- Number Weighted-
contractual average exercisable average
life exercise at exercise
(years) price May 31, 1999 price
- ----------- --------- --------------- ----------
4.68 $2.03 2,050,500 $2.01
4.19 2.71 305,000 2.70
3.29 5.50 950,000 5.50
----------
4.34 $2.84 3,305,500 $3.08
=========
F-28
84
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996 to
October 8, 1996 ("Predecessor"), and for the three months ended
(unaudited) August 31, 1999 and 1998
NOTE I - INCOME TAXES
Deferred income tax assets (liabilities) consist of the following:
January 1,
For the three For the years ended 1996 to
months ended August 31, May 31, October 8,
-------------------------- ----------------------------------------- 1996
1999 1998 1999 1998 1997 ("Predecessor")
---------- ---------- ---------- ---------- ---------- ---------------
(unaudited)
Deferred tax assets
Net operating loss
carryforward $ 17,287,943 $ 11,993,614 $ 16,854,132 $ 13,223,300 $ 4,477,728 $ 657,000
Allowance for doubtful
accounts 1,641,743 1,399,914 1,221,619 1,519,160 366,000
------------ ------------ ------------ ------------ ----------- ----------
Total deferred tax
assets 18,929,686 13,393,528 18,075,751 14,742,460 4,843,728 657,000
Less valuation allowance (12,649,447) (13,393,528) (12,059,974) (14,742,460) (4,843,728) (237,000)
------------ ------------ ------------ ------------ ----------- ----------
Net deferred tax asset 6,280,239 - 6,015,777 - -
Deferred tax liabilities
Gain on sales of portfolios (4,029,268) - (4,029,368) (420,000)
Unrealized gain on retained
interest in securitization (1,550,971) - (1,286,409)
------------ ------------ ------------
Net deferred tax
liabilities (5,580,239) - (5,315,777) - - -
------------ ------------ ------------ ------------ ----------- ----------
Net deferred tax asset $ 700,000 $ - $ 700,000 $ - $ - $ -
============ ============ ============ ============ =========== ==========
The difference between the total income tax benefit and the income tax
expense computed using the applicable Federal income tax rate was as
follows:
January 1,
For the three For the years ended 1996 to
months ended August 31, May 31, October 8,
-------------------------- ----------------------------------------- 1996
1999 1998 1999 1998 1997 ("Predecessor")
---------- ---------- ---------- ---------- ---------- ---------------
(unaudited)
Computed Federal income
taxes at 34% $ 853,935 $ 70,986 $ 560,077 $(10,047,450) $(4,843,728) $ 657,000
Increase (release) of
deferred tax asset
valuation allowance (853,935) (70,986) (2,546,486) 10,047,450 4,843,728 (237,280)
--------- -------- ---------- ------------ ----------- ---------
Income tax benefit $ - $ - $(1,986,409) $ - $ - $ 419,720
======== ======== =========== ============ =========== =========
F-29
85
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996 to
October 8, 1996 ("Predecessor"), and for the three months ended
(unaudited) August 31, 1999 and 1998
NOTE I (CONTINUED)
At August 31, 1999, May 31, 1999 and 1998, the Company has a net operating
loss carryforward available to offset future taxable income of
approximately $50,800,000, $49,500,000 and $43,000,000, respectively, which
will begin to expire in 2012. The benefit of the net operating loss
carryforwards is dependent upon the tax laws in effect at the time the net
operating loss carryforwards are to be utilized and the change of control
rules.
The Company has provided a valuation allowance against the net operating
losses and the provision for bad debts. Realization of these assets is
dependent on future taxable income.
NOTE J - EMPLOYEE BENEFIT PLANS
In January 1998, the Company adopted a defined contribution 401(k)
profit-sharing plan for its employees. All employees working at least 1,000
hours per year are eligible to participate in the plan. Employees could
contribute up to 15% of their salary up to $10,000 and $9,500 for the
calendar years 1999 and 1998, respectively. The plan requires the employer
to match 100% of the first 3% of compensation contributed to the plan by
the employees. Employer contributions vest at a rate of 20% per year.
Additional employer contributions are allowable at the discretion of the
Board of Directors. The contributions to this plan by the Company at August
31, 1999 and 1998, and at May 31, 1999 and 1998 was $48,355, $38,522,
$79,958 and $84,573, respectively.
Prior to January 1998, employees of the Company participated in the defined
contribution profit sharing plan of Service One International Corporation
Employee Savings Plan, a wholly-owned subsidiary of the Company. This plan
contained the same terms and provisions as the Company's current plan
except that the employer contribution was 100% of the first 1% of employee
contributions. Contributions by the Company to this plan were $12,342 and
$7,912 for the years ended May 31, 1998 and 1997, respectively. The assets
of this plan were transferred into the new plan as of January 1, 1998.
NOTE K - MUTUAL BUSINESS DEVELOPMENT AGREEMENT
The Selling Entities entered into Mutual Business Development Agreements
("Development Agreements") in connection with the sale of Holdings to
Taxter. Pursuant to the terms of the
F-30
86
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996 to
October 8, 1996 ("Predecessor"), and for the three months ended
(unaudited) August 31, 1999 and 1998
NOTE K (CONTINUED)
Development Agreements, SOIC agreed to pay a base fee of $510,000 to each
Selling Entity (which was paid in its entirety by May 31, 1998) and a
royalty equal to five percent of the balance transfer amount, as defined,
on all converted credit card accounts which: (i) are delivered to a
pre-securitization credit facility, (ii) become a qualifying receivable, or
(iii) meet other specified account age and payment parameters. A qualifying
receivable is defined as any converted account on which the cardholder has
made three consecutive payments within certain time restrictions. In
addition, the Company is required to pay royalties equal to five percent of
all principal cash collections on certain accounts that are not converted
to credit cards. The term of each of the Development Agreements is six
years and the total royalty, if earned, payable to each of the Selling
Entities, after certain deductions and exclusions, shall not exceed
$25,000,000. For the three months ended August 31, 1999 and for the years
ended May 31, 1999, 1998 and 1997, $111,321, $1,541,944, $207,238 and
$1,229,180, respectively, of royalty expenses were incurred with $378,395,
$702,075, and $261,667, payable at August 31, 1999, May 31, 1999 and 1998,
respectively, under the Development Agreements. One of the Development
Agreements was amended on September 1, 1998. The amendment, clarifies the
amount and timing of payments, gives the Company a buyout option and
alternate royalty payment options, and extends the term of the agreement to
May 31, 2005. The Company, which assumed the obligations of its predecessor
SOIC, assumed SOIC's liabilities under the Development Agreements.
Taxter, as part of the purchase price of acquiring Holdings, granted the
Selling Entities a future interest in Holdings in the form of an identical
option to each selling entity to purchase 2,000 shares each of Holdings
from Taxter for $500,000. Following the acquisition of Holdings by the
Company, these options were amended to enable the Selling Entities to
purchase 4,000,000 shares each of the Company's common stock and 400,000
shares each of the Company's Series B Preferred Stock for $500,000.
NOTE L - RELATED PARTY TRANSACTIONS
During fiscal year 1998, the Company issued subordinated promissory notes
to JLB of Nevada, Inc. ("JLB"), an entity wholly owned by Jay L. Botchman
("Botchman"), totalling $40,000,000 payable on demand with interest of 12%
per annum. Of the new notes, $30,000,000 was issued in exchange for
outstanding notes totalling $11,518,042 which carried an interest rate of
12% per annum and
F-31
87
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996 to
October 8, 1996 ("Predecessor"), and for the three months ended
(unaudited) August 31, 1999 and 1998
NOTE L (CONTINUED)
$18,481,958 in new debt. Interest expense on these notes was $2,307,467,
$3,635,891 and $419,942 for the years ended May 31, 1999, 1998 and 1997,
respectively. On May 29, 1999, JLB, in lieu of payment of $5,000,000 of
interest on these subordinated notes, received 4,000,000 warrants with an
exercise price of $3.25 per share, expiring on May 29, 2004 and the
Company's assumption of equipment and related lease obligations from a
company affiliated with JLB. Accrued interest related to subordinated notes
payable to JLB were approximately $1.5, $1.3 and $4.0 million,
respectively, at August 31, 1999, May 31, 1999 and 1998. The notes are
secured by substantially all the Company's assets, but subordinated to the
Company's revolving credit line.
On February 27, 1998, the Company issued a subordinated promissory note
payable to Botchman in the amount of $350,000 payable on demand with
interest at 12% per annum. Interest expense for the three months ended
August 31, 1999 and 1998 and for the years ended May 31, 1999 and May 31,
1998 was $10,733, $10,733, $42,583 and $10,733, respectively. This note was
issued per an agreement dated February 27, 1998 between Botchman and the
Company. As part of the terms of the agreement, the Company agreed to
purchase an interest in certain investment securities, owned by Botchman,
of a subprime mortgage banking company. The Company has fully written off
this investment in the amount of $350,000 as of May 31, 1998. In addition,
the Company had a receivable due from this company of approximately
$189,000, which has also been written off as of May 31, 1998.
The Company, through its wholly-owned subsidiary, American Credit Alliance,
Inc., has an $880,000 note payable to JLB with an interest rate of 10% per
annum. Interest expense for the three months ended August 31, 1999 and 1998
and for the years ended May 31, 1999 and May 31, 1998 was $22,489, $22,489,
$89,222 and $85,195, respectively.
The Company made a series of investments, during the period May 1997
through December 1997, amounting to $508,600 in a subprime mortgage banking
company affiliated with JLB. At May 31, 1998, there was substantial doubt
regarding this company's ability to continue as a going concern. The
Company had fully written off its investment in this company. In addition,
the Company had a receivable due from this company of approximately
$183,000, which has also been written off as of May 31, 1998.
F-32
88
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996 to
October 8, 1996 ("Predecessor"), and for the three months ended
(unaudited) August 31, 1999 and 1998
NOTE L (CONTINUED)
The Series A and B Preferred Shares were issued at $1.00 per share (total
of $2,000.00) for all of Taxter's shares of Holdings described in Note A.
The Series A Preferred Stock, as a class, has 80% of the voting rights in
the Company. The Series B Preferred Stock has one vote per share. The
Series A and B Preferred Stock have a liquidation preference of $1.00 per
share and will earn cumulative dividends at a rate of 5% per annum. At
any time after December 31, 2001, (i) the Series A and B Preferred Stock
will be redeemable at the option of the Company, and (ii) while the Series
B Preferred Stock is outstanding will be convertible at the option of the
holder into Series A Preferred Stock on a share-for-share basis.
On December 31, 1996, the Company issued 5,000 shares of Series C Preferred
Stock to Taxter for $5,000,000. The Series C Preferred Stock is non-voting
and will earn cumulative dividends at 6% per annum. The shares have a
liquidation preference of $1,000 per share. The Series A and B Preferred
Stock rank senior to the Series C with respect to dividend and liquidation
rights.
On May 29, 1998, the Company issued 10,000 shares of Series D Preferred
Stock to JLB in exchange for cancellation of the $10,000,000 Promissory
Note dated August 1, 1997 payable by the Company to JLB. The Series D
Preferred Stock is non-voting and will earn a dividend of 8% per annum
payable annually on December 31. The series has a par value of $.001 per
share and a stated value of $1,000 per share. The shares have a liquidation
preference of $1,000 per share. The Series D Preferred Stock ranks senior
to the Series A, B and C with respect to dividend and liquidation rights.
Each share of Series D Preferred Stock is convertible into 380 shares of
common stock. The agreement grants JLB piggyback registration rights with
respect to the Common Stock issuable upon conversion of the shares of
Series D Preferred Stock.
On August 31, 1998, the Company issued 10,000 shares of Series E Preferred
Stock to JLB in exchange for JLB agreeing to cancel the principal
outstanding under a $10,000,000 subordinated promissory note dated August
1, 1997. The Series E Preferred Stock is non-voting and will earn a
dividend of 8% per annum payable annually on December 31. Each share of
Series E Preferred Stock is convertible into 285 shares of common stock at
any time prior to August 31, 2001.
As of August 31, 1999, May 31, 1999, 1998 and 1997, accumulated preferred
dividends undeclared and unpaid on preferred stock amounted to
approximately $2.7 million, $2.2 million, $.4 million, and $7 thousand,
respectively.
F-33
89
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996 to
October 8, 1996 ("Predecessor"), and for the three months ended
(unaudited) August 31, 1999 and 1998
NOTE M - COMMITMENTS AND CONTINGENCIES
1. Operating Leases
The Company leases certain properties, vehicles and equipment under
noncancelable operating leases. Total lease rentals charged to
operations were approximately $184,920 and $203,265 for the three
months ended August 31, 1999 and 1998, respectively, and $766,832,
$776,615, and $349,383, for the years ended May 31, 1999, 1998 and
1997, respectively. Future minimum lease payments under the
noncancelable operating leases are as follows at May 31:
Year ending May 31, Amount
------------------- ------------
2000 $ 587,641
2001 361,697
2002 348,533
2003 295,103
2004 285,000
Thereafter 2,272,875
----------
$4,150,849
==========
2. Contingencies and Litigation
The Company, in the ordinary course of business, receives notices of
consumer complaints from regulatory agencies and is named as a
defendant in legal actions filed by those who have been solicited to
participate in its credit card programs. Currently pending against the
Company are: (i) three class actions on behalf of persons solicited by
the Company to open credit card accounts and voluntarily to repay debt
that had been discharged in bankruptcy, and (ii) two class actions
alleging violation of the Fair Debt Collection Practices Act and state
law in connection with mailers sent to prospective customers whose debt
was out-of-statute. The Company is defending itself vigorously in these
lawsuits. The Company does not believe that pending litigation and
regulatory complaints involving the Company will have a material
adverse effect on the consolidated financial position and results of
operations.
F-34
90
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996 to
October 8, 1996 ("Predecessor"), and for the three months ended
(unaudited) August 31, 1999 and 1998
NOTE N - FAIR VALUE OF FINANCIAL INSTRUMENTS
The accompanying financial statements include various estimated fair value
information as of May 31, 1999, 1998 and 1997. As required by SFAS No. 107,
"Disclosures About Fair Value of Financial Instruments," such information,
which pertains to the Company's financial instruments, is based on the
requirements set forth in the statement and does not purport to represent
the aggregate net fair value of the Company. None of the Company's
financial instruments are held for trading purposes.
The following methods and assumptions were used to estimate the fair value
of each class of financial instrument for which it is practicable to
estimate fair value.
Cash
The carrying amount approximates fair value.
Trade Receivables
The carrying amount approximates fair value.
Investment in Nonperforming Consumer Debt
The Company records investments in nonperforming consumer debt at the cost
of the purchased portfolios, net of costs recovered. As the debt was
purchased at a significant discount, it is likely that the value of these
portfolios may be significantly higher than presented in these financial
statements. It was not possible to estimate a fair value of these
portfolios at May 31, 1998. However, given the expanded market to trade
these portfolios and the Company's recent experience, the fair value at May
31, 1999 was estimated using a net present value calculation of the cash
flows the Company expects to generate from these portfolios. The fair value
at August 31, 1999 and May 31, 1999 was approximately $14.9 million and
$14.4 million in comparison to its carrying value of approximately $2.4
million and $3.2 million, respectively.
Credit Card Receivables
Credit card loans are originated with an initial interest rate of 18.9%. As
discussed in Note C, the settlement amount of the receivables exceeds the
credit card receivables reflected on the consolidated
F-35
91
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996 to
October 8, 1996 ("Predecessor"), and for the three months ended
(unaudited) August 31, 1999 and 1998
NOTE N (CONTINUED)
balance sheet. The Company did not feel it was possible to estimate the
fair value of the credit card receivables at May 31, 1998. Fair values at
August 31, 1999 and May 31, 1999 have been established based on a net
present value of the cash flows expected to be generated by the credit
cards for the Company. The Company applied its actual static pool
experience of repayment rates and defaults to estimate fair value. The fair
value at August 31, 1999 and May 31, 1999 was approximately $36.0 million
and $27.5 million in comparison to its carrying value of approximately
$24.5 million and $18.6 million, respectively.
Retained Interest in Securitized Credit Card Receivables
The carrying amount approximates fair value. Fair value is estimated by
discounting anticipated future cash flows using a discount rate based on
specific factors. The anticipated future cash flows are projected on a
"cash out" basis to reflect the restriction of cash flows until the
investors have been fully paid. At August 31, 1999 and May 31, 1999, the
carrying value of $6.2 million and $5.1 million, respectively, approximated
fair value.
Notes Payable
The carrying amount approximates fair value. Rates currently available to
the Company for debt with similar terms and remaining maturities are used
to estimate the fair value of existing debt.
Subordinated Notes Payable
Due to the related party relationship of these notes, it is not practical
to estimate fair value.
Accounts Payable and Accrued Expenses
The carrying amount approximates fair value.
F-36
92
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996 to
October 8, 1996 ("Predecessor"), and for the three months ended
(unaudited) August 31, 1999 and 1998
NOTE O - EARNINGS PER SHARE
The weighted-average shares used in computing earnings per share were
34,761,965, 34,761,965, 34,761,965, 33,109,781, 25,912,465 and 5,000,000,
for the three months ended August 31, 1999 and 1998, and for the years
ended May 31, 1999, 1998, and 1997 and for the period January 1, 1996 to
October 8, 1996, respectively.
January 1,
1996 to
August 31, May 31, October 8,
-------------------------- ----------------------------------------- 1996
1999 1998 1999 1998 1997 ("Predecessor")
----------- ----------- ----------- ------------ ----------- -----------
Basic earnings per share
Income (loss)
Income (loss)
available
to common
stockholders $(3,011,573) $ (91,217) $ 1,833,698 $(29,551,326) $14,253,656 $(1,512,488)
=========== =========== =========== ============ =========== ===========
Weighted-average 34,761,965 34,761,965 34,761,965 33,109,781 25,912,465 5,000,000
=========== =========== =========== ============ =========== ===========
shares outstanding
Basic earnings
(loss)
per share $ (.09) $ .00 $ .05 $ (.89) $ (.55) $ (.30)
=========== =========== =========== ============ =========== ===========
Diluted earnings per share
Income (loss)
Income (loss) avail-
able to common
stockholders $(2,684,668) $ (91,217) $ 1,833,698 $(29,551,326) $14,253,656 $(1,512,488)
=========== =========== =========== ============ =========== ===========
Weighted-average
shares outstanding 34,761,965 34,761,965 34,761,965 33,109,781 25,912,465 5,000,000
Effective of diluted
securities options * * 3,674,154 * * *
----------- ----------- ----------- ------------ ----------- -----------
Weighted-average
of diluted
shares
outstanding 34,761,965 34,761,965 38,436,119 33,109,781 25,912,465 5,000,000
=========== =========== =========== ============ =========== ===========
Diluted earnings (loss)
per share $ (.09) $ .00 $ .05 $ (.89) $ (.55) $ (.30)
=========== =========== =========== ============ =========== ===========
*Antidilutive.
F-37
93
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996 to
October 8, 1996 ("Predecessor"), and for the three months ended
(unaudited) August 31, 1999 and 1998
NOTE P - RESTATEMENT OF 1997 ACCOUNTING FOR INVESTMENTS IN NONPER-
FORMING CONSUMER DEBT AND CREDIT CARD RECEIVABLES
The 1997 revenue and the investments in nonperforming consumer debt and
credit card receivable balances, have been restated in accordance with
Practice Bulletin No. 6, "Amortization of Discounts on Certain Acquired
Loans." The accounting under this method is described in Note B, Revenue
Recognition. The 1997 method of revenue recognition, before restatement,
applied cash collections on investments in nonperforming consumer debt and
credit card receivable balances on a pro rata basis between cost recovery
and interest and fee income. The restatement resulted in an increase in the
net loss of approximately $3,100,000 ($0.12 per share) for the year ended
May 31, 1997.
NOTE Q - SUBSEQUENT EVENTS (UNAUDITED)
In November 1999, the Company sold the stock of its three SPE's to the
Lender for approximately $8.4 million. The fair value of the three SPE's
was approximately $6.2 million at August 31, 1999.
F-38