U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
|X| Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the Quarterly Period Ended December 31, 2001
or
| | Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the Transition Period From _______ to _______.
Commission file number 000-28709
THE CREDIT STORE, INC.
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(Exact name of registrant as specified in its charter)
Delaware 87-0296990
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
3401 North Louise Avenue
Sioux Falls, South Dakota 57107
(Address of principal executive offices) (Zip code)
(800) 240-1855
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Registrant's telephone number
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Not Applicable
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(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No | |
State the number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practical date: Common Stock, $.001 par value --
34,851,465 issued and outstanding as of February 1, 2002.
THE CREDIT STORE, INC.
FORM 10-Q
For the Quarter Ended December 31, 2001
INDEX
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (Unaudited):
Condensed Consolidated Balance Sheets as of December 31, 2001
and June 30, 2001 4
Condensed Consolidated Statements of Operations
for the three months ended December 31, 2001 and
December 31, 2000 5
Condensed Consolidated Statements of Operations
for the six months ended December 31, 2001 and
December 31, 2000 6
Condensed Consolidated Statements of Cash Flows
for the six months ended December 31, 2001 and
December 31, 2000 7
Notes to Condensed Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 14
Item 3. Quantitative and Qualitative Disclosures About Market Risk 20
PART II. OTHER INFORMATION 21
Item 1. Legal Proceedings 21
Item 2. Changes in Securities 21
Item 3. Defaults under Senior Securities 21
Item 4. Submission of Matters to Vote of Security Holders 21
Item 5. Other Information 21
Item 6. Exhibits and Reports on Form 8-K 22
SIGNATURES 23
2
PART I. FINANCIAL INFORMATION
Subsequent to June 30, 2001 and prior to the filing of this Form 10-Q
as of and for the six months ended December 31, 2001, the Company
discovered an error in its calculation of the fair market value of its
retained interests associated with two securitization transactions.
This Form 10-Q includes certain revisions to historical financial data
but is not intended to update other information presented in the
Company's Annual Report on Form 10-K as originally filed on October 15,
2001 or the Company's Quarterly Report on Form 10-Q as of and for the
three months ended September 30, 2001 as originally filed on November
14, 2001. The Company expects to file amendments to its Form 10-K for
the year ended June 30, 2001 and Form 10-Q as of and for the three
months ended September 30, 2001 as expeditiously as possible. See Note
C of this Form 10-Q for further discussion on this matter.
3
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THE CREDIT STORE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
December 31, June 30,
2001 2001
---- ----
ASSETS
Cash and cash equivalents $ 2,589,823 $ 1,853,454
Restricted cash 1,000,000 1,250,000
Accounts and notes receivable, net 2,177,696 5,392,845
Prepaid expenses 724,460 1,073,283
Amounts due from special purpose entities 657,172 617,737
Investments in receivable portfolios, net 47,840,136 32,948,042
Investment in unconsolidated affiliates -- 1,000,750
Retained interest in securitized receivables 7,148,528 7,249,204
Property and equipment, net of accumulated depreciation 4,774,903 5,512,853
Goodwill, net 2,123,558 2,123,558
Deferred tax 2,700,000 2,700,000
Other assets 1,016,397 985,931
------------ ------------
Total assets $ 72,752,673 $ 62,707,657
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Accounts payable and accrued expenses $ 9,457,686 $ 7,537,895
Notes payable 35,937,062 23,186,134
Capitalized lease obligations 3,731,227 4,247,093
Subordinated notes and accrued interest payable -
related party 20,209,250 19,970,834
------------ ------------
Total liabilities 69,335,225 54,941,956
------------ ------------
REDEEMABLE PREFERRED STOCK, Series A, C, D and E 26,200,000 26,200,000
PREFERRED STOCK, Series B 800,000 800,000
COMMON STOCK, $.001 par value, 65,000,000 authorized,
34,851,465 outstanding at December 31, 2001 and June 30, 2001 34,851 34,851
OTHER STOCKHOLDERS' EQUITY
Additional paid-in capital 23,972,421 23,972,421
Unrealized gain from retained interest in securitized
receivables, net of tax 427,480 1,603,350
Accumulated deficit (48,017,304) (44,844,921)
------------ ------------
Total liabilities and stockholders' equity $ 72,752,673 $ 62,707,657
============ ============
The accompanying notes are an integral part of these statements.
4
THE CREDIT STORE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended
------------------
December 31, December 31,
2001 2000
---- ----
Revenue
Income from investment in receivable portfolios $ 7,645,337 $ 9,702,169
Securitization income and asset sales 1,211,655 486,496
Servicing fees and other income 2,040,575 1,019,865
------------ ------------
Total revenue 10,897,567 11,208,530
Provision for losses (4,601,705) (3,412,198)
------------ ------------
Net revenue 6,295,862 7,796,332
------------ ------------
Expenses
Salaries and employee benefits 2,824,708 3,157,164
Professional and financing fees 1,030,647 1,293,886
Credit card servicing 1,812,746 2,341,349
Occupancy and equipment expense 856,650 987,161
Other 137,821 734,020
------------ ------------
Total expenses 6,662,572 8,513,580
------------ ------------
Operating loss (366,710) (717,248)
Interest expense 983,807 891,869
Interest expense - related party 602,884 585,108
Lender participation expense 248,592 --
------------ ------------
Loss before income taxes (2,201,993) (2,194,225)
Income tax expense (464,801) (21,642)
------------ ------------
Net loss (2,666,794) (2,215,867)
Dividends on preferred stock (500,000) (500,000)
------------ ------------
Net loss, applicable to
common shareholders $ (3,166,794) $ (2,715,867)
============ ============
Net loss per share
Basic $ (.09) $ (.08)
============ ============
Diluted $ (.09) $ (.08)
============ ============
Weighted-average common shares outstanding
Basic 34,851,465 34,851,465
============ ============
Diluted 34,851,465 34,851,465
============ ============
The accompanying notes are an integral part of these statements.
5
THE CREDIT STORE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Six Months Ended
----------------
December 31, December 31,
2001 2000
---- ----
Revenue
Income from investment in receivable portfolios $ 15,154,386 $ 19,939,671
Securitization income and asset sales 2,552,364 939,571
Servicing fees and other income 4,689,467 1,768,381
------------ ------------
Total revenue 22,396,217 22,647,623
Provision for losses (7,898,748) (5,674,337)
------------ ------------
Net revenue 14,497,469 16,973,286
------------ ------------
Expenses
Salaries and employee benefits 6,121,045 6,721,242
Professional and financing fees 1,804,154 2,188,103
Credit card servicing 3,491,046 4,573,760
Occupancy and equipment expense 1,734,834 1,960,670
Other 641,756 2,531,095
------------ ------------
Total expenses 13,792,835 17,974,870
------------ ------------
Operating income (loss) 704,634 (1,001,584)
Interest expense 1,781,443 1,700,305
Interest expense - related party 1,238,416 1,122,576
Lender participation expense 248,592 --
------------ ------------
Loss before income taxes (2,563,817) (3,824,465)
Income tax (expense) benefit (608,566) 279,935
------------ ------------
Net loss (3,172,383) (3,544,530)
Dividends on preferred stock (1,000,000) (1,000,000)
------------ ------------
Net loss, applicable to
common shareholders $ (4,172,383) $ (4,544,530)
============ ============
Net loss per share
Basic $ (.12) $ (.13)
============ ============
Diluted $ (.12) $ (.13)
============ ============
Weighted-average common shares outstanding
Basic 34,851,465 34,851,465
============ ============
Diluted 34,851,465 34,851,465
============ ============
The accompanying notes are an integral part of these statements
6
THE CREDIT STORE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Six Months Ended
----------------
December 31, December 31,
2001 2000
---- ----
Cash flows from operating activities:
Net loss $ (3,172,383) $ (3,544,530)
Adjustments to reconcile net loss to
net cash provided by (used in) operating activities -
Provision for credit card losses 7,898,748 5,674,337
Amortization of receivable portfolios discount (9,843,784) (9,611,576)
Depreciation and amortization 928,965 999,853
Amortization of retained interest in securitized credit cards (2,205,123) (175,809)
Lender participation 248,592 --
Loss from unconsolidated affiliates (29,154) (38,550)
Gain on sale of portfolios and retained interests (347,241) (719,274)
Other (399,260) 23,406
Tax expense (benefit) 608,566 (279,935)
Change in operating assets and liabilities 2,213,736 4,680,811
------------ ------------
Net cash used in
operating activities (4,098,338) (2,991,267)
------------ ------------
Cash flows from investing activities:
Collection of consumer debt and funds advanced 15,078,333 17,941,050
Retained interest in securitized credit card receivables (598,267) (210,264)
Funds advanced on credit cards (10,419,240) (14,550,081)
Purchase of consumer receivables (2,883,076) (3,575,328)
Proceeds from sale of portfolios 6,021,215 706,503
Acquisition of property and equipment (191,690) (2,253,416)
------------ ------------
Net cash provided by (used in)
investing activities 7,007,275 (1,941,536)
------------ ------------
Cash flows from financing activities:
Net proceeds (payments) from debt (1,737,333) 2,655,084
Borrowings from capital leases 611,463 1,746,488
Payments on capital lease obligations (1,127,329) (787,575)
Partner distributions from unconsolidated affiliates 80,631 133,470
Investment in unconsolidated affiliates -- (10)
Proceeds from exercises of stock options -- 210,350
------------ ------------
Net cash provided by (used in)
financing activities (2,172,568) 3,957,807
------------ ------------
Net increase in cash and cash equivalents 736,369 (974,996)
Cash and cash equivalents at beginning of period 1,853,454 2,236,630
------------ ------------
Cash and cash equivalents at end of period $ 2,589,823 $ 1,261,634
============ ============
The accompanying notes are an integral part of these statements.
7
THE CREDIT STORE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE A - ORGANIZATION
The Credit Store (the "Company") is a technology and information based financial
services company that provides credit card products to consumers who may
otherwise fail to qualify for a traditional unsecured bank credit card. Unlike
traditional credit card companies, the Company focuses on consumers who have
previously defaulted on debt. The Company reaches these consumers by acquiring
their defaulted debt from the lender or subsequent debt owner. Through direct
mail and telemarketing operations, these consumers are offered an opportunity to
settle their debt, typically at a discount, transfer the agreed settlement
amount to a newly issued unsecured MasterCard(R) or Visa(R) credit card, and
establish a positive credit history on their newly issued card by making timely
and consistent payments. The Company accepts lump sum settlements and
installment payment plans from those consumers who do not accept the credit card
offer and also resells defaulted debt in the secondary market to other debt
buyers.
As of December 31, 2001, the Company had three active subsidiaries, Credit Store
Financial, Inc., TCS Funding IV, Inc., and TCS Funding V, Inc. These
subsidiaries are wholly owned by the Company; however, only Credit Store
Financial, Inc. is consolidated in the enclosed financial statements. Credit
Store Financial, Inc. acquires non-performing consumer receivables and contracts
with the Company to offer consumers a credit card under the Company's program or
to accept settlements or payment plans. TCS Funding IV, Inc. and TCS Funding V,
Inc. are qualified special purpose entities and were established for the purpose
of purchasing performing credit card receivables from the Company. See Note F -
Securitization of Receivable Portfolios.
In December 2001, the Company dissolved its subsidiary American Credit Alliance,
Inc. ("ACA"). Prior to dissolution of ACA, the Company purchased a 50% interest
in Dakota Card Fund II, LLC ("DCF"), which combined with the 50% ownership
interest ACA had in DCF, resulted in DCF being wholly owned by the Company. The
Company then dissolved DCF, concurrent with the dissolution of ACA.
In December 2001, at the direction of its lender, the Company's wholly owned
subsidiary Credit Store Financial, Inc. ("CSFI"), a special purpose entity,
purchased all of the assets and assumed all of the liabilities of the Company's
wholly owned subsidiary Credit Store Services, Inc. ("CSSI"), a qualified
special purpose entity. Prior to this transaction, CSFI was an inactive
subsidiary of the Company. See Note F - Securitization of Receivable Portfolios
and Note G - Notes Payable.
On December 31, 2001, Credit Store Capital Corp. ("CSCC"), a subsidiary of the
Company, paid the outstanding balance of its revolving credit line with proceeds
from a portfolio sale. Concurrently with the portfolio sale and debt repayment,
the Company inactivated CSCC by direct assumption of its assets and liabilities
other than its regulatory licenses. See Note G - Notes Payable.
NOTE B - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared pursuant to the rules and regulations of the Securities and Exchange
Commission. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with accounting principles generally
accepted in the United States of America have been condensed or omitted pursuant
to such rules and regulations, although management believes that the disclosures
are adequate to make the information presented not misleading. These financial
statements and notes thereto should be read in conjunction with financial
statements and notes thereto included in the Company's audited consolidated
financial statements for the year ended June 30, 2001 contained in the Company's
annual report on Form 10-K for the year ended June 30, 2001.
Preparation of the Company's consolidated financial statements requires
management to make estimates and assumptions that affect reported amounts of
assets and liabilities and related revenues and expenses. Actual results could
differ from the estimates used by management.
8
In the opinion of management, the unaudited condensed consolidated financial
statements contain all adjustments (consisting of only normal recurring
adjustments) necessary to present fairly the financial position as of December
31, 2001, the results of operations for the three months ended December 31, 2001
and December 31, 2000, and the results of operations and cash flows for the six
months ended December 31, 2001 and December 31, 2000. The results of operations
for the six months ended December 31, 2001 are not necessarily indicative of the
results for the full year.
NOTE C - FINANCIAL RESTATEMENT
Subsequent to June 30, 2001 and prior to the filing of this Form 10-Q as of and
for the six months ended December 31, 2001, the Company discovered an error in
its calculation of the fair market value of its retained interests associated
with two securitization transactions, resulting in an overstatement of assets,
unrealized gain from retained interests in securitized credit card receivables
and the resulting income tax benefit at June 30, 2001. The adjustments result in
a write down to the June 30, 2001 fair market valuation of the retained
interests of $4.1 million, a decrease in the unrealized gain from retained
interests in securitized credit card receivables recorded within other
comprehensive income net of income tax of $2.7 million, and a reduction in
income tax benefit of $1.4 million from the original valuation. The adjustment
did not impact operating earnings or cash flows for fiscal 2001.
The restatement increases net revenue by $268,165 and income tax expense by
$143,765 for the six months ended December 31, 2001. These changes resulted in
no change to net loss per share for the period. The restatement does not impact
the loss before income taxes for the three and six months ended December 31,
2000. Income tax expense has increased $21,462 for the three months ended
December 31, 2000 and decreased $279,935 for the six months ended December 31,
2000. These changes result in no change in net loss per share for the three
months ended December 31, 2000 and result in a decrease of $.01 to net loss per
share for the six months ended December 31, 2000. The changes to income tax
expense are related to changes in the Company's other comprehensive income and
are offset by equal amounts of tax benefit, which is recorded in other
comprehensive income.
As a result, the Company expects to file an amended Form 10-K as of June 30,
2001 and Form 10-Q as of and for the three months ended September 30, 2001, as
expeditiously as possible.
NOTE D - NET LOSS PER SHARE
The Company's basic net loss per share is computed by dividing net loss
applicable to common stockholders by the weighted average number of common
shares outstanding during the period. Net loss applicable to common stockholders
is computed by deducting or adding dividends on preferred stock from net income
or net loss, respectively. The Company's diluted net loss per share is computed
by dividing net loss applicable to common stockholders by the weighted average
number of outstanding common shares and common share equivalents relating to
stock options, when dilutive.
NOTE E - ACCOUNTING PRONOUNCEMENTS
Accounting Method Change for Goodwill and Intangible Assets
- -----------------------------------------------------------
On July 20, 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") 141, Business Combinations, and SFAS
142, Goodwill and Intangible Assets. SFAS 141 is effective for all business
combinations completed after June 30, 2001. SFAS 142 is effective for fiscal
years beginning after December 15, 2001. Major provisions of these Statements
and their effective dates for the Company are as follows:
o all business combinations initiated after June 30, 2001 must use the
purchase method of accounting. The pooling of interest method of
accounting is prohibited except for transactions initiated before July 1,
2001.
o intangible assets acquired in a business combination must be recorded
separately from goodwill if they arise from contractual or other legal
rights or are separable from the acquired entity and can be sold,
transferred, licensed, rented or exchanged, either individually or as
part of a related contract, asset or liability.
o goodwill, as well as intangible assets with indefinite lives, acquired
after June 30, 2001, will not be amortized. Effective July 1, 2001, all
previously recognized goodwill and intangible assets with indefinite
lives will no longer be subject to amortization.
9
o effective July 1, 2001, goodwill and intangible assets with indefinite
lives will be tested for impairment annually and whenever there is an
impairment indicated, an impairment loss will be recognized.
The Company adopted the provisions of SFAS 142 as of July 1, 2001. Therefore,
acquired goodwill is no longer amortized. The Company has determined its
goodwill relates to one reporting unit for purposes of impairment testing and an
impairment of goodwill does not exist at December 31, 2001.
Reclassification of Preferred Stock
- -----------------------------------
The Securities and Exchange Commission issued Staff Topic No. D-98 which
provides clarification on the balance sheet classification and measurement of
redeemable equity securities subject to either mandatory redemption features or
whose redemption is outside the control of the issuer. The Company's majority
shareholder and former director is the beneficial owner of approximately 40% of
the Company's fully diluted outstanding shares of common stock and owns all of
the Company's Series A, C, D and E Preferred stock. The Series A Preferred stock
contains preferential voting rights giving this shareholder approximately 80% of
all votes entitled to be voted. Based on the guidance in Staff Topic No. 98,
because the Series A, C, D and E Preferred Stock is owned by the Company's
majority shareholder, the redemption of the Series A, C, D and E is deemed to be
outside the control of the Company. Therefore, the Company has reclassified
these securities outside of permanent equity as of December 31, 2001, as well as
for all periods presented. The Company does not expect this reclassification
will have a material effect on the liquidity or capital resources of the
Company.
NOTE F - SECURITIZATION OF RECEIVABLE PORTFOLIOS
On December 1, 2001, at the direction of its lender, CSSI sold its assets to
CSFI in exchange for CSFI's assumption of CSSI's liabilities. CSSI is a
qualified SPE, therefore it was not consolidated in the Company's financial
statements. CSFI is not a qualified SPE and is consolidated in the Company's
financial statements. The acquired assets were valued based on the fair value of
the assumed liabilities on December 1, 2001. The effect of this transaction on
the Company's consolidated financial statements removed $3.2 million of
investment in retained interest and recorded $18.4 million of assets and
liabilities on December 1, 2001.
The Company has established two wholly owned qualified special purpose entities
for the purpose of purchasing performing credit card receivables from the
Company.
- TCS Funding IV, Inc. ("TCS IV"), established in May 2000, has
a $40.0 million credit facility with a lending institution to
finance the purchase of credit card receivables. The initial
sale of credit card receivables to TCS IV was for
approximately $12.1 million. TCS IV provided $10.0 million of
the purchase price and the remaining approximately $2.1
million was recorded as retained interest by the Company. The
unrealized gain of approximately $0.6 million, included in the
retained interest, was recorded net of tax as a separate
component of stockholders equity. Subsequent to the initial
sales, TCS IV purchased additional performing credit card
receivables from the Company that were recorded similar to the
initial sale. Future borrowings are at the lender's sole
discretion and a number of other conditions. At December 31,
2001, borrowings of $9.6 million were outstanding on this
credit facility.
- TCS Funding V, Inc. ("TCS V"), established in May 2001,
entered into a $4.0 million term loan with a lending
institution to finance the purchase of credit card
receivables. The initial $4.9 million sale of credit card
receivables to TCS V included receivables with a principal
balance of approximately $5.7 million. TCS V paid $4.0 million
of the sale price and the remaining $0.9 million of the sale
was recorded as a retained interest. The unrealized gain of
approximately $0.1 million, included in retained interest, was
recorded net of tax as a separate component of stockholders
equity. At December 31, 2001, $3.6 million principal amount
was outstanding on this credit facility.
10
The following summarizes the changes in the balance of the Company's retained
interest for the six months ended December 31, 2001:
Gross Estimated
Amortized unrealized fair
cost gains value
---- ----- -----
Balance at July 1, 2001 $ 4,817,071 $ 2,432,133 $ 7,249,204
Retained interests in portfolios sold 598,267 -- 598,267
Interest accrued 2,205,123 -- 2,205,123
Retained interests transferred* (1,119,631) (1,051,303) (2,170,934)
Change in unrealized gain -- (733,132) (733,132)
----------- ----------- -----------
Balance at December 31, 2001 $ 6,500,830 $ 647,698 $ 7,148,528
=========== =========== ===========
* CSFI's acquisition of CSSI's assets resulted in the transfer of retained
interests as of December 1, 2001. These retained interests are eliminated in the
consolidation of CSFI with the Company as the related assets are reflected in
investments in receivable portfolios.
As of December 31, 2001, the gross unrealized gain has been offset by a deferred
tax expense of approximately $0.2 million resulting in a net unrealized gain of
approximately $0.4 million.
NOTE G - NOTES PAYABLE
On December 1, 2001, CSFI entered into a $25.0 million credit facility with The
Varde Fund IV-A, L.P. ("Varde") to finance purchases of non-performing consumer
debt portfolios. The facility expires in October 2003 and future borrowings to
fund the purchases of portfolios are at Varde's discretion. As of December 31,
2001, the outstanding balance under CSFI's credit facility was $2.5 million,
with $22.5 million available for future borrowings. Additionally, CSFI has an
outstanding balance of $14.3 million to Varde for notes assumed from CSSI (see
Note F). Each portfolio financed for CSFI by Varde is documented by a separate
note which is non-recourse to the Company and which carries a fixed interest
rate of 15%. The terms of the credit facility also provide that a percentage of
the future cash flows generated by the purchased accounts be paid to Varde after
Varde has earned an internal rate of return of 25% (inclusive of the monies
earned as a result of interest on each note). At the time CSFI assumed the
liabilities of CSSI, the estimated amount of Varde's participation liability was
$2.3 million. On December 31, 2001, this liability was $2.6 million.
CSFI also established a $1.0 million working capital credit line with Varde in
December 2001. This line matures on April 15, 2002 and was fully drawn by CSFI
as of December 31, 2001.
On November 30, 2000 the Company entered into a credit card receivables
repurchase agreement with Plains Commerce Bank. Under the agreement, Plains
Commerce Bank purchased credit card receivables from the Company for $8.0
million. The Company exercised its option to repurchase the receivables on
January 4, 2002. On December 31, 2001 the Company entered into a repurchase
agreement with Thornton Capital Advisors. In accordance with the repurchase
agreement, Thornton Capital Advisors purchased $10.5 million principal value of
receivables for $8.0 million on January 4, 2002. The Company used the proceeds
of this sale to exercise the Plains Commerce Bank repurchase option. The
repurchase option under the Thornton Capital agreement expires on May 1, 2002.
If the Company does not exercise its option, Thornton Capital Advisors may sell
the assets and has recourse to the Company for any deficiency of the repurchase
price including interest. The Company's obligations under this agreement are
secured by a lien on its assets which is subordinated to Coast Business Credit.
In addition, the Company entered into a credit card receivables repurchase
agreement in September 2001 with North Divisions, Associates whereby the lender
purchased credit card receivables from the Company for $0.5 million. The
repurchase agreement expires July 31, 2002. For financial statement purposes,
the Company treats these repurchase agreements as financing transactions.
Since April 1998, the Company has maintained a financing arrangement with Coast
Business Credit. This revolving line of credit is collateralized by
substantially all the Company's assets and may not exceed a monthly borrowing
base computed using the Company's eligible receivables as defined by the
agreement. The credit facility currently has an expiration date of, and the
outstanding balance matures on July 31, 2002. Prior to the maturity date, the
Company is required to permanently reduce the credit line by 60% of net cash
proceeds derived by it from sales or securitizations of credit cards. At
December 31, 2001, the maximum credit line was $11.0 million and the amount
available based on the borrowing base under the credit line was $10.2 million,
of which the Company had $9.8 million outstanding.
11
On December 31, 2001, the $17.5 million credit facility CSCC had with General
Electric Capital Corporation was cancelled. CSCC paid the outstanding balance of
$1.3 million with proceeds from a sale of non-performing consumer debt accounts.
The Company expensed amortized loan fees of $163,634.
NOTE H - COMMITMENTS AND CONTINGENCIES
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 action
lawsuits and (ii) one suit concerning a Development Agreement. We have been
informed by O. Pappalimberis Trust that they intend to file suit against the
Company alleging breach of a Development Agreement. The Development Agreements
are discussed in Note I. The Company does not believe that pending litigation
and regulatory complaints involving the Company will have a material adverse
effect on the Company's consolidated financial position and results of
operations. However, a significant judgment against the Company in one or more
of the lawsuits could subject the Company to a monetary judgment and /or require
the Company to modify its methods of operation, either of which could have a
material adverse effect on the Company's results of operations or financial
condition.
NOTE I - DEVELOPMENT AGREEMENTS
In October 1996, the Company's predecessor entered into two Mutual Business
Development Agreements ("Development Agreements"), one with O. Pappalimberis
Trust and one with Renaissance Trust I.
The Development Agreements call for a royalty equal to 5% of any newly
established receivable originated or acquired by the Company by way of certain
accounts held which: (i) is delivered to a pre-securitization credit facility,
(ii) becomes a qualifying receivable, or (iii) meets 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 Development Agreements provide for
royalties equal to 5% of all principal cash collections on specified accounts
that are not converted to credit cards. If earned, the total royalty payable
under the Development Agreements, after deductions and exclusions, will not
exceed $25.0 million for Renaissance Trust I and $24.0 million for O.
Pappalimberis Trust.
The Development Agreement with the O. Pappalimberis Trust was amended on
September 1, 1998 to alter the amount and timing of payments, give the Company a
buyout option, alternate royalty payment options and extend the term of the
agreement to May 31, 2005. The Development Agreement with Renaissance Trust I
expires October 7, 2002 and has not been amended.
Both Development Agreements are currently in dispute. In February 2001, the
Company discontinued payment of royalties under both Development Agreements.
The Company has been informed by O. Pappalimberis Trust that they intend to file
suit against us alleging breach of the Development Agreement.
On April 23, 2001, the Company was sued by Renaissance Trust I in the United
States District Court for the Southern District of New York in an action titled
Renaissance Trust I v. The Credit Store, Inc. The plaintiffs allege breach of
the Development Agreement and conversion and seek enforcement of the contract,
compensatory damages alleged to be in excess of $5.0 million, and punitive
damages of $25.0 million. Renaissance Trust I owns 4.0 million shares of the
Company's common stock and 400,000 shares of the Company's Series B Preferred
Stock. On June 29, 2001, the Court dismissed the conversion claim and dismissed
the demand for punitive damages.
The Company has estimated that it is probable that at least $2.8 million will be
required to settle the contract disputes and terminate the agreements. The
12
majority of this amount was accrued during the fourth quarter of fiscal 2001 and
is included in accrued expenses at December 31, 2001 and June 30, 2001. No
additional amounts have been accrued in the six months ended December 31, 2001.
NOTE J - INVESTMENTS IN RECEIVABLE PORTFOLIOS
The Company acquires portfolios of non-performing consumer debt. These debts are
acquired at a substantial discount from the actual outstanding consumer balance.
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. Any debt that consumers do not settle remains uncollected by
the Company and may be sold to a third party. The Company expenses origination
costs, including direct mail and telemarketing costs, as incurred.
The following summarizes the components in the balance of the investments in
receivable portfolios for the following periods:
December 31, June 30,
2001 2001
---- ----
Cost and amortization of
receivable portfolios discount $26,082,394 $ 9,281,048
----------- -----------
Principal funded on new advances and purchases $28,431,497 $27,456,560
Accrued interest on principal funded 377,149 376,749
Accrued fees 364,807 339,517
----------- -----------
29,173,453 28,172,826
----------- -----------
Less
Provision for losses on credit card receivables 6,903,227 3,856,882
Unearned fees 512,484 648,950
----------- -----------
7,415,711 4,505,832
----------- -----------
Investments in receivable portfolios $47,840,136 $32,948,042
=========== ===========
Total credit card balances (1) $90,906,468 $66,184,418
=========== ===========
Investment in receivables portfolios as a percentage
of Total credit card balances 52.6% 49.8%
Available credit (2) $ 8,813,940 $ 9,355,862
=========== ===========
(1) Total credit card balances above represent the total amount owed to the
Company by the cardholders through initial settlement, new charges, interest,
fees and payments.
(2) Available credit represents the amount that the Company would be obligated
to fund if the credit cards were fully utilized by the cardholders.
13
THE CREDIT STORE, INC.
The information presented below in Management's Discussion and Analysis of
Financial Condition and Results of Operations contains forward-looking
statements within the meaning of the safe harbor provisions of Section 21E of
the Securities Exchange Act of 1934, as amended. Such statements are subject to
risks and uncertainties, including those discussed under "Disclosure Regarding
Forward-Looking Statements" below that could cause actual results to differ
materially from those projected. Because actual results may differ, readers are
cautioned not to place undue reliance on these forward-looking statements.
Except as required by law, we assume no obligation to publicly release the
results of any revisions or updates to these forward-looking statements to
reflect future events or unanticipated occurrences.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
OVERVIEW
The Credit Store, Inc. is a technology and information based, financial services
company that provides credit card products to consumers who may otherwise fail
to qualify for a traditional unsecured bank credit card. Unlike traditional
credit card companies, we focus on consumers who have previously defaulted on
debt. We reach the consumers by acquiring their defaulted debt from the lender
or subsequent debt owner. Through direct mail and telemarketing operations, we
offer these consumers an opportunity to settle their debt, typically at a
discount, transfer the agreed settlement amount to a newly issued unsecured
MasterCard(R) or Visa(R) credit card, and establish a positive credit history on
their newly issued card by making timely and consistent payments. The new card
is issued with an initial balance and credit line equal to the agreed repayment
amount. We accept lump sum settlements and installment payment plans from those
consumers who do not accept our credit card offer and also resell defaulted debt
in the secondary market. After six or more on-time payments have been made on a
consumer's outstanding credit card balance we consider the account seasoned and
available to sell or securitize. The cash flows, interest and fee income from
our performing credit cards, collection activities, and sales activities combine
to generate a return on our investment in receivables portfolios.
RESULTS OF OPERATIONS
REVENUES. Total revenue for the three months and six months ended December 31,
2001 was $10.9 million and $22.4 million, respectively, reflecting 2.8% and 1.1%
decreases from the $11.2 million and $22.6 million recorded during the prior
fiscal year comparable periods. Core revenues (income from all activities other
than portfolio sales and interest in affiliate revenues) decreased 0.8% from
$10.9 million in the second quarter of fiscal 2001 to $10.8 million in the
second quarter of fiscal 2002 and increased 0.6% from $21.9 million in the first
six months of fiscal 2001 to $22.0 million in the first six months of fiscal
2002. While total and core revenues increased slightly, the mix of core revenues
changed due to the fact that the majority of new credit card accounts were being
originated in our unconsolidated subsidiary, Credit Store Services, Inc.
("CSSI"), a wholly owned qualified special purpose entity, established by us in
July 2000 and which began booking accounts in the second quarter of fiscal 2001.
As an unconsolidated subsidiary, the primary revenue we derived from business
conducted in CSSI was the servicing fees we earned, as opposed to income from
investment in receivables portfolios that we record for business that is
consolidated in our financial statements. On December 1, 2001, the assets and
liabilities of CSSI were sold to our consolidated subsidiary, Credit Store
Financial, Inc. ("CSFI"), a wholly owned special purpose entity that is
consolidated for financial statement purposes. For future periods, we anticipate
the consolidation of CSFI will result in decreased servicing revenues and
increased income from investment in receivable portfolios.
Period to period new originations of credit card accounts remained stable at
$21.0 million during the second quarter of fiscal 2002 compared to $20.9 million
during the second quarter of fiscal 2001 and decreased 15.5% from $48.6 million
during the first half of fiscal 2001 to $41.0 million in the first half of
fiscal 2002. $24.4 million of the new accounts originated in the first half of
fiscal 2002 were booked in CSSI. As indicated above, this has the impact of
increasing servicing revenue and reducing income from investment in receivables
portfolios. Servicing fees and other income has increased 253.9% from $0.7
million in the first quarter of fiscal 2001 to $2.6 million in the first quarter
of fiscal 2002 and increased 170.6% from $1.8 million in the first half of
fiscal 2001 to $4.7 million in the first half of fiscal 2002. This increase
reflects the increased number of accounts serviced by us for third parties and
unconsolidated subsidiaries formed in connection with securitizations, including
CSSI.
14
Net revenue decreased to $6.3 million in the second quarter of fiscal 2002 from
$7.8 million in the second quarter of fiscal 2001 and decreased to $14.5 million
in the first half of fiscal 2002 from $17.0 in the first half of fiscal 2001
primarily due to an increase in the provision for losses. The provision reported
for the second quarter of fiscal 2002 and 2001 was $4.6 million and $3.4
million, 42.7% and 31.4% of core revenues. The provision for the first half of
fiscal 2002 and 2001 was $7.9 million and $5.7 million, 35.8% and 25.9% of core
revenues. Because the provision for losses is directly related to the aggregate
investment in receivable portfolios recorded on our balance sheet, the provision
for losses increased as a result of the adoption of accrual accounting which
increased the percentage of our credit card receivables on our balance sheet and
a higher level of charge-off in the second quarter. The percentage of credit
card receivables on our balance sheet increased from 41% of total credit card
balances at December 31, 2000 to 53% at December 31, 2001. The increase was also
partially due to higher levels of charged off accounts during the second
quarter.
THREE MONTHS ENDED THREE MONTHS ENDED SIX MONTHS ENDED SIX MONTHS ENDED
REVENUES DECEMBER 31, 2001 DECEMBER 31, 2000 DECEMBER 31, 2001 DECEMBER 31, 2000
-------- ----------------- ----------------- ----------------- -----------------
Income from investment $7,645,337 $9,702,169 $15,154,386 $19,939,671
in receivable portfolios
Securitization income 1,211,655 132,765 2,205,123 220,297
Servicing fees and 2,040,575 1,019,865 4,689,467 1,768,381
---------- ---------- ----------- -----------
other income
Core Revenue 10,769,817 10,854,799 22,048,976 21,928,349
---------- ---------- ----------- -----------
Gains on Sales 127,750 353,731 347,241 719,274
---------- ---------- ----------- -----------
Total Revenue 10,897,567 11,208,530 22,396,217 22,647,623
---------- ---------- ----------- -----------
Provision for Losses (4,601,705) (3,412,198) (7,898,748) (5,674,337)
---------- ---------- ----------- -----------
Net Revenue $6,295,862 $7,796,332 $14,497,469 $16,973,286
========== ========== =========== ===========
EXPENSES. Total operating expenses for the second quarter and first half of
fiscal 2002 were $6.7 million and $13.8 million, a 21.7% decrease from $8.5
million in the second quarter of fiscal 2001 and a 23.3% decrease from $18.0
million in the first half of fiscal 2001. Operating expenses were 61.9% and
62.6% of core revenues in the second quarter and first half of fiscal 2002
versus 78.4% and 82.0% in the second quarter and first half of fiscal 2001. Our
operating expenses and our operating expenses as a percentage of core revenues
decreased as a result of a reduction in royalty payments, an increase in the
number of accounts owned, and increased efficiencies in our servicing and
marketing operations. We experienced a 2.3% increase in the aggregate balance of
credit card receivables we owned and managed from $115.0 million as of December
31, 2000 to $117.7 million as of December 31, 2001.
Salaries and employee benefits expense was 10.5% lower in the second quarter of
fiscal 2002 than in the second quarter of fiscal 2001 and 8.9% lower in the
first six months of fiscal 2002 than in the comparable period of fiscal 2001.
Salaries and employee benefit expense also decreased as a percentage of core
revenue in all comparable periods. This decrease is mainly due to a personnel
reduction from 343 at December 31, 2000 to 258 at December 31, 2001 resulting
from technological enhancements and operational efficiencies.
Professional and financing fees decreased $0.4 million, or 17.5%, from $2.2
million in the first half of fiscal 2001 to $1.8 million in the first half of
fiscal 2002 and decreased $0.3 million, or 20.3% from $1.3 million in the second
quarter of fiscal 2001 to $1.0 million in the second quarter of 2002. This
decrease is primarily due to less legal expenses paid by us for class action
litigations.
Credit card servicing fees (consisting of telephone expense, marketing mailers
cost, postage, and third party credit card services and scrubbing fees)
decreased 22.6% from $2.3 million in the second quarter of fiscal 2001 to $1.8
million in the second quarter of fiscal 2002 and decreased as a percentage of
core revenue from 21.6% to 16.8%. Credit card servicing fees of $3.5 million in
the first half of fiscal 2002 were 23.7% less than the $4.6 million in credit
card servicing fees recorded in the first half of fiscal 2001. This reduction is
due, in part, to fewer new credit cards and a reduced volume of receivables
acquired by CSSI and us. We, along with CSSI, acquired $303.3 million face
amount of non-performing consumer receivables in the second quarter of fiscal
2001 compared to $215.8 million in the second quarter of fiscal 2002, and $707.7
million face amount of receivables in the first half of fiscal 2001
compared to $545.7 in the first half of fiscal 2002. Additionally, technological
enhancements and operating efficiencies have lowered our cost per account.
15
Other expenses declined primarily due to our decision to discontinue the accrual
of payments on two mutual business development agreements after November 2000.
The mutual business development agreements are currently in dispute. See "Legal
Proceedings". We believe that at least $2.8 million will be required to settle
the contract disputes and terminate the agreements. The majority of this amount
was accrued during the fourth quarter of fiscal 2001 and is included in accrued
expenses at December 31, 2001 and June 30, 2001. No additional amounts have been
accrued in the six months ended December 31, 2001.
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS
ENDED ENDED ENDED ENDED
Expenses DECEMBER 31, 2001 DECEMBER 31, 2000 DECEMBER 31, 2001 DECEMBER 31, 2000
-------- ----------------- ----------------- ----------------- -----------------
Salaries and employee $2,824,708 $3,157,164 $6,121,045 $6,721,242
benefits
Professional and financing 1,030,647 1,293,886 1,804,154 2,188,103
fees
Credit card servicing 1,812,746 2,341,349 3,491,046 4,573,760
Occupancy and equipment 856,650 987,161 1,734,834 1,960,670
expense
Other 137,821 734,020 641,756 2,531,095
---------- ---------- ----------- -----------
Total expenses $6,662,572 $8,513,580 $13,792,835 $17,974,870
INTEREST EXPENSE. Interest expense increased from $1.5 million in the second
quarter of fiscal 2001 to $1.8 million in the second quarter of fiscal 2002, and
increased from $2.8 million in the first half of fiscal 2001 to $3.3 million in
the first half of fiscal 2002. These increases reflect the assumption by CFSI of
CSSI's liabilities as of December 1, 2001. The liabilities assumed included
notes and a lenders' participation for which monthly accruals and expense are
recorded. The expense related to these liabilities for the month of December
2001 (the liabilities were acquired on December 1, 2001) was $473,228. Interest
expense, as a percentage of core revenue, for the second quarter and first half
of fiscal 2002 was 17.0% and 14.8%, compared to 13.6% and 12.9% in the
comparable periods of fiscal 2001.
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS
ENDED ENDED ENDED ENDED
DECEMBER 31, 2001 DECEMBER 31, 2000 DECEMBER 31, 2001 DECEMBER 31, 2000
----------------- ----------------- ----------------- -----------------
Interest Expense $1,835,283 $1,476,976 $3,268,451 $2,822,881
INCOME TAX EXPENSE/BENEFIT. Income tax expense or benefit was recorded in the
second quarter and first half of fiscal 2002 and 2001. These amounts are related
to changes in our other comprehensive income and are offset by equal amounts of
tax expense or tax benefit, which is recorded in other comprehensive income.
Income tax benefits during the periods relating to losses before income taxes
have been offset by a valuation allowance. We will continue to evaluate the
valuation allowance and will recognize tax benefits as factors indicate that it
is more likely than not that additional future tax benefits will be realized.
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS
ENDED ENDED ENDED ENDED
DECEMBER 31, 2001 DECEMBER 31, 2000 DECEMBER 31, 2001 DECEMBER 31, 2000
----------------- ----------------- ----------------- -----------------
Income tax (expense) $(464,801) $(21,642) $(608,566) $279,935
benefit
NET LOSS. Net loss was $2.7 million in the second quarter of fiscal 2002
compared to $2.2 million in the first quarter of fiscal 2001 and $3.2 million in
the first half of fiscal 2002 compared to $3.5 million in the first half of
fiscal 2001. Dividends on preferred stock have accumulated but have not been
declared and are not yet payable. However, we treat the dividends as declared
and payable for the purpose of calculating net loss applicable to common
shareholders. After the effect of preferred dividends of $0.5 million in each of
the second fiscal quarters, the net loss applicable to common shareholders was
$3.2 million, or $0.09 per basic and diluted common share, in the second quarter
of fiscal 2002; and $2.7 million, or $0.08 per basic and diluted common share,
in second quarter of fiscal 2001. After the effect of preferred dividends of
$1.0 million in each of the first six months of the fiscal years, the net loss
applicable to common shareholders was $4.2 million, or $0.12 per basic and
diluted common share, in the first six months of fiscal 2002; and $4.5 million,
or $0.13 per basic and diluted common share, in the first six months of fiscal
2001.
16
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS
ENDED ENDED ENDED ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
2001 2000 2001 2000
---- ---- ---- ----
Net loss $(2,666,794) $(2,215,867) $(3,172,383) $(3,544,530)
Dividends on preferred stock (500,000) (500,000) (1,000,000) (1,000,000)
Net loss applicable to common
shareholders $(3,166,794) $(2,715,867) $(4,172,383) $(4,544,530)
CREDIT CARD RECEIVABLE QUALITY
The delinquency chart below includes all our owned and managed credit card
receivables but does not include receivables in accounts that have not yet made
a first payment. Because these accounts are not yet performing and may be
closed, including them would distort the reporting of actual delinquencies on
our performing portfolio of accounts.
DELINQUENCIES AS A PERCENTAGE OF OWNED AND MANAGED CREDIT CARD RECEIVABLES
FOR THE THREE MONTHS ENDED
SEPT. 30, 2000 DEC. 31, 2000 MAR. 31, 2001 JUNE 30, 2001 SEPT. 30, 2001 DEC. 31, 2001*
-------------- ------------- ------------- ------------- -------------- --------------
Owned Receivables $82,932,303 $80,674,251 $72,775,407 $54,936,629 $50,278,337 $77,353,508
Managed Receivables $16,919,113 $19,401,550 $31,671,150 $49,843,613 $54,665,516 $25,871,840
Total Receivables $99,851,416 $100,075,801 $104,446,557 $104,780,242 $104,943,853 $103,225,348
Loans Delinquent:
30 to 59 days 11.6% 13.5% 10.1% 11.4% 10.8% 11.4%
60 to 89 days 6.6% 6.0% 4.6% 6.3% 5.7% 6.3%
90 to 119 days 4.7% 4.8% 4.2% 5.0% 5.2% 5.1%
Total 60 to 119 days 11.3% 10.8% 8.8% 11.3% 10.9% 11.4%
* Reflects sale of accounts from CSSI to CSFI in December 2001 (see cash flows
from financing activities).
LIQUIDITY AND CAPITAL RESOURCES
We seek to maintain an adequate level of liquidity through active management of
assets and liabilities, through sales or securitizations of credit card
receivables, and through debt and equity financing. Because the characteristics
of our assets and liabilities change, liquidity management is a dynamic process
affected significantly by the maturity of our assets and the seasonality of the
credit card business.
CASH FLOWS FROM OPERATING ACTIVITIES
Our operating activities used $4.1 million of cash in the first six months of
fiscal 2002, compared to a deficit of $3.0 million in the first six months of
fiscal 2001. At December 31, 2001, we had $3.6 million of cash and cash
equivalents, compared to $3.1 million at June 30, 2001. We maintain restricted
cash reserves at our banks to facilitate the funding of new charges and advances
on our customers' credit cards. These restricted balances were $1.0 million at
December 31, 2001 and $1.3 million at June 30, 2001. This decrease was due to
the required restricted cash balance decreasing $250,000 in July 2001.
17
CASH FLOWS FROM INVESTING ACTIVITIES
We use cash to purchase non-performing consumer debt portfolios and fund new
charges and advances transacted by the credit card customers we originate from
these portfolios. Primary sources of cash are debt payments from the consumers
whose debt we acquired and sales or securitizations of receivables. Debt
payments from consumers result either from collection based activities or
cardholder payments on originated credit card accounts. Although credit card and
collection activities are classified in the investment section of our financial
statements, they comprise the primary source of cash flow for our ongoing
operations.
During the six months ended December 31, 2001, investing activities supplied
$7.0 million in cash flow compared to a use of $1.9 million in the first six
months of fiscal 2001. This is due primarily to the excess of cardholder cash
payments over new cardholder charges on the credit cards and the resale of
accounts. We received $15.1 million from collection activities and credit card
payments that exceeded credit card funding activity by $4.7 million, compared to
an excess of $3.4 million in the first six months of fiscal 2001. Resale
proceeds generated $6.0 million during the period compared to $0.7 million in
fiscal 2001.
CASH FLOWS FROM FINANCING ACTIVITIES
We have entered into multiple financing facilities as described below.
We maintain a senior secured revolving credit line with Coast Business Credit
("Coast"), a division of Southern Pacific Bank. The maximum amount under the
credit line commitment is based on a formula that is dependent primarily on the
performance and maturity of our credit card receivables. The credit line is
secured by substantially all of our assets. The credit facility currently has an
expiration date of, and the outstanding balance matures on, July 31, 2002. Prior
to the maturity date, we are required to permanently reduce the credit line by
60% of net cash proceeds derived by us from sales or securitizations of credit
card. At December 31, 2001, the maximum credit line was $11.0 million and the
amount available based on the borrowing base under the credit line was $10.2
million, of which we had $9.8 million outstanding.
We have received secured financing from a related party, JLB of Nevada. The
notes are payable on demand but are subordinated to the senior secured revolving
credit line and our obligations under the repurchase agreement with Thornton
Capital Advisors discussed below. At December 31, 2001, the principal amount
outstanding on these notes totaled $17.3 million and accrued but unpaid interest
totaled $2.9 million. No payments of interest are required until at least May 4,
2002 if JLB of Nevada holds the notes. A subsequent holder may demand payment of
up to 20% of the accrued interest, if any, prior to May 4, 2002.
In October 1999, through Credit Store Capital Corp. ("CSCC"), a bankruptcy
remote special purpose subsidiary, we established a $17.5 million secured
revolving credit line with General Electric Capital Corporation. The line was
used to finance the acquisition of non-performing consumer debt portfolios and
was set to expire in August 2002. In December 2001, CSCC repaid the $1.3 million
outstanding balance on the credit line and cancelled the credit line.
On November 30, 2000 we entered into a credit card receivables repurchase
agreement with Plains Commerce Bank. Under the agreement, Plains Commerce Bank
purchased credit card receivables from us for $8.0 million. We exercised our
option to repurchase the receivables on January 4, 2002. On December 31, 2001,
we entered into a repurchase agreement with Thornton Capital Advisors. In
accordance with the repurchase agreement, Thornton Capital Advisors purchased
$10.5 million principal value of receivables for $8.0 million on January 4,
2002. We used the proceeds of this sale to exercise the Plains Commerce Bank
repurchase option. Our repurchase option under the Thornton Capital agreement
expires on May 1, 2002. If we do not exercise our option, Thornton Capital
Advisors may sell the assets and has recourse to us for any deficiency. Our
obligations under this agreement are secured by a second lien on our assets,
subordinated to Coast's lien. We intend to sell or refinance these receivables
prior to expiration of the repurchase option. In addition, we entered into a
credit card receivables repurchase agreement in September 2001 with North
Divisions, Associates whereby the lender purchased credit card receivables from
us for $0.5 million. The repurchase agreement expires July 31, 2002. We can make
no assurances that we will exercise our repurchase option. For financial
statement purposes, we treat these repurchase agreements as financing
transactions.
Our wholly owned qualified special purpose entity, TCS Funding IV, has a $40.0
million credit facility with a lending institution to finance the purchase of
credit card receivables. On May 31, 2000, $10.0 million of the facility was used
18
to purchase credit card receivables with a principal balance of $14.2 million at
a purchase price of $12.1 million. We recorded the balance of the sale price,
$2.1 million, as a retained interest. Future borrowings under the facility are
subject to the lender's discretion and a number of other conditions. The credit
facility was amended in November 2001 to extend the expiration of the revolving
period from December 1, 2001 to April 1, 2002. Through March 31, 2002, the
credit facility requires payments of interest only. After April 1, 2002, the TCS
Funding IV credit facility requires that all cash collections received relating
to the senior debt interest in the receivables be used to repay principal, after
payment-related servicing fees and interest are paid. All net new charges on the
sold accounts are to be funded by us and contributed in exchange for a retained
interest until such time as the senior debt interest is paid down. At December
31, 2001, the outstanding debt under this credit facility was $9.6 million. We
are currently in discussion with the lender to restructure the amortization
period, and are also in discussion with a credit card bank that may purchase
these accounts prior to amortization. We cannot make any assurances that these
discussions will be successful. Should TCS be required to fund the new charges
during amortization, we project these new charges would require approximately
$5.3 million of cash over a 14 month period, at which time we would own 100% of
the receivables pool. If we do not fund the new charges on the accounts, the
lender would be entitled to retain an alternate provider to service the
accounts.
Our wholly owned qualified special purpose entity, TCS Funding V, entered into a
$4.0 million credit facility to finance the purchase of $5.7 million in face
value credit card receivables from us for $4.9 million. We recorded the balance
of the sale price, $0.9 million, as a retained interest. At December 31, 2001,
the outstanding debt under this credit facility was $3.6 million. After April 1,
2002, the TCS Funding V credit facility requires that all cash collections
received relating to the senior debt interest in the receivables be used to
repay principal, after payment-related servicing fees and interest are paid. All
net new charges on the sold accounts are to be funded by us and contributed in
exchange for a retained interest until such time as the senior debt interest is
paid down. We are currently in discussion with the lender to restructure the
amortization period and with a bank to acquire the accounts prior to
amortization. We cannot guarantee that we will be successful in restructuring
the amortization period or selling the accounts. Should TCS V be required to
fund the new charges during amortization, we project these new charges would
require approximately $1.7 million of cash over a 16 month period, at which
time, we would own 100% of the receivables pool. If we do not fund the new
charges on the accounts, the lender would be entitled to retain an alternate
provider to service the accounts.
During July 2000, we established Credit Store Services, Inc. ("CSSI"), a wholly
owned, unconsolidated qualified special purpose entity and Credit Store
Financial, Inc. ("CSFI"), a wholly owned, consolidated special purpose entity.
These entities were created to purchase non-performing debt portfolios from us
on the same date and terms that we purchase them from third parties at a price
equal to our book value, which is the acquisition price of the portfolio. During
October 2000, CSSI entered into a $25.0 million credit facility with The Varde
Fund IV-A, L.P. ("Varde") to finance a portion of the purchase price of these
portfolios. At Varde's direction, on December 1, 2001, CSSI sold its assets to
CSFI in exchange for CSFI's assumption of CSSI's liabilities. This assumption
included $14.5 million of CSSI's outstanding notes to Varde. At that time, the
CSSI facility was extinguished and CSFI entered into a similar credit facility
with Varde. CSFI will use this facility to purchase non-performing debt
portfolios. Under the facility, Varde finances 95% of the acquisition price of
the non-performing consumer debt portfolios and we finance the remaining 5% of
the acquisition price. Each loan from Varde to CSFI is evidenced by a note, the
principal and interest of which are due twenty-four months after the date of the
note. The notes assumed by CSFI retain their original maturity dates. Our
subsidiaries pay us all applicable servicing fees in connection with the
acquired portfolios. Prior to the December 1, 2001 transaction, we received
servicing fees from CSSI of approximately $3.1 million during the first six
months of fiscal 2002. In addition, our subsidiaries pay interest on the loans
advanced by Varde and by us. Varde earns a fixed interest rate of 15% and may
share in cash flows after principal has been repaid and Varde has earned an
internal rate of return of 25% (inclusive of monies earned as a result of
interest on the loans.) Future borrowings under the facility are subject to
Varde's discretion and a number of other conditions. At December 31, 2001,
outstanding debt to Varde was $16.8 million, $2.5 million of which is under the
new facility, with $22.5 million availability remaining.
We also established a $1.0 million secured working capital line of credit with
Varde through our CSFI subsidiary. This line of credit matures on April 15, 2002
and was fully drawn at December 31, 2001.
We continue to explore alternate financing vehicles, including replacing our
Coast credit facility, bringing additional equity capital into the Company, and
entering into agreements to sell performing accounts to financial institutions.
We signed a non-binding letter of intent to sell up to $20 million of performing
credit card receivables with six or more consecutive payments to a financial
institution and are in discussions with other institutions interested in
purchasing receivables from us. We cannot guaranty that these sales will take
place, if we will be able to obtain a new credit facility, or if the timing of
19
the sales and the terms of the credit facility will allow us to meet our working
capital needs as they arise. However, management believes that cash on hand
together with the proceeds of these or other transactions it expects to
consummate will be sufficient to fund our operations through the end of the
fiscal year.
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
This Form 10-Q for the period ended December 31, 2001 contains forward-looking
statements within the meaning of the safe harbor provisions of Section 21E of
the Securities Exchange Act of 1934. These forward-looking statements are based
on the beliefs of our management as well as on assumptions made by and
information currently available to us at the time the statements were made. When
used in this Form 10-Q, the words "anticipate", "believe", "estimate", "expect",
"intend" and similar expressions, as they relate to us, are intended to identify
the forward-looking statements. Although we believe that these statements are
reasonable, you should be aware that actual results could differ materially from
those projected by the forward-looking statements. Because actual results may
differ, readers are cautioned not to place undue reliance on forward-looking
statements. Factors that may cause our actual results to differ from those
projected include our ability to achieve positive cash flow from operations; our
ability to obtain additional capital to finance our operations; our ability to
sell or securitize performing credit card receivables; and general economic
conditions. These and other risk factors are more fully discussed in our Annual
Report on Form 10-K for the year ended June 30, 2001. We caution you, however,
that the risk factors mentioned above and in our Annual Report on Form 10-K may
not be exhaustive and that those or other factors, many of which are outside of
our control, could have a material adverse effect on us and our results of
operations. All forward-looking statements attributable to persons acting on our
behalf or us are expressly qualified in their entirety by the cautionary
statements set forth here. Except as required by law, we assume no obligation to
publicly release the results of any revision or updates to these forward-looking
statements to reflect future events or unanticipated occurrences.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and rates.
Our principal market risk is due to changes in interest rates. These changes
affect us directly in our lending and borrowing activities, as well as
indirectly as interest rates may impact the payment performance of our credit
card holders.
To manage our direct risk to market interest rates, management actively monitors
the interest rates and the interest sensitive components of our balance sheet to
minimize the impact changes in interest rates have on the fair value of assets,
operations and cash flow. Management seeks to minimize the impact of changes in
interest rates primarily by matching asset and liability repricings.
Our credit card receivables earn interest at a fixed annual percentage rate. Our
fixed annual percentage rate credit card receivables have no stated maturity or
repricing period. However, we may reprice our credit card receivables upon
providing the required prior notice to the customer, which is generally no more
than 60 days. The interest rates on our liabilities are generally indexed to the
prime rate. The characteristics of our receivables and liabilities expose us to
repricing risk, which results from differences between the timing of rate
changes and the timing of cash flows, which could impact net interest income if
liabilities reprice more often than assets. The principal objective of our
asset/liability risk management activities is to monitor and control our
exposure to adverse effects resulting from movements of interest rates over
time. We have not entered into derivative transactions to hedge repricing risk.
The retained interest in securitized receivables is treated as a debt security
similar to an available-for-sale security and is carried at fair value. At the
time of securitization, the retained interest was initially recorded at the
basis allocated in accordance with SFAS No. 140. The original cost basis is
adjusted to fair value, which is based on the discounted anticipated future cash
flows on a "cash out" basis, with any 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. On a monthly basis, management reviews the fair
value assumptions, which are based on the expected cash flow projections
discounted at an effective rate that reflects a current risk-adjusted rate of
return that a knowledgeable investor would require.
The interest rates on our notes payable are generally indexed to the prime rate.
Changes in short-term interest rates will affect our earnings. If the market
interest rates for variable rate agreements increase or decrease at an average
of 10%, interest expense would increase, and income before income taxes would
not change by a material amount. We have not entered into derivative
transactions to hedge the interest rate risk.
20
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not Applicable.
ITEM 2. CHANGES IN SECURITIES
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of the Stockholders of the Company was held on December 17,
2001. At such meeting, the following matters were voted on:
1. The six individuals listed below were elected to the Company's Board of
Directors, with each receiving the number of shares set forth opposite his name
(shares "for" and "against" represent shares of the Company's Common Stock, all
of the shares of the Company's outstanding Series A and Series B Preferred Stock
were voted in favor of the following):
For: Against: Withheld:
---- -------- ---------
Barry E. Breeman 25,541,632 -- 3,900
J. Richard Budd, III 25,541,632 -- 3,900
Peter J. Mansbach 25,541,632 -- 3,900
Kevin T. Riordan 25,520,567 -- 24,965
Geoffrey A. Thompson 25,541,632 -- 3,900
Salvatore J. Zizza 25,541,632 -- 3,900
2. The appointment of Grant Thornton LLP as independent public accountants of
the Company for the fiscal year ending June 30, 2002 was ratified with
25,542,382 votes cast for the motion, no votes cast against the motion, and
3,150 votes abstaining (shares "for", "against" and "abstaining" represent
shares of the Company's Common Stock, all of the shares of the Company's
outstanding Series A and Series B Preferred Stock were voted in favor of the
motion).
For further information respecting all such matters reference is made to the
Company's definitive proxy statement dated October 29, 2001 (File No.
001-16083).
ITEM 5. OTHER INFORMATION
Not applicable.
21
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
3.1 Amended and Restated Certificate of Incorporation.
(Filed with the Securities and Exchange Commission as
an exhibit to the issuer's registration statement on
Form 10 filed February 24, 2000 (File No. 000-28709)
and incorporated herein by reference.)
3.2 Amended and Restated By-Laws. (Filed with the
Securities and Exchange Commission as an exhibit to
the issuer's quarterly report on Form 10-Q for the
period ended November 30, 2000 (File No. 001-16083)
and incorporated herein by reference.)
10.10.6 Sixth Amendment to the Strategic Modeling Agreement
dated November 12, 2001, between the Company and
Business Transactions Express, Inc.
10.10.7 Seventh Amendment to the Strategic Modeling Agreement
dated December 14, 2001, between the Company and
Business Transactions Express, Inc.
10.33.1 Second Amendment to the Purchase Agreement between
Bank of Hoven and the Company dated November 14,
2001.
(B) REPORTS ON FORM 8-K
None.
22
>
THE CREDIT STORE, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
THE CREDIT STORE, INC.
DATE: February 19, 2002 By: /s/ Kevin T. Riordan
----- ----------------- --------------------
President and Chief Operating Officer
DATE: February 19, 2002 By: /s/ Michael J. Philippe
----- ----------------- -----------------------
Chief Financial Officer