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 March 31, 2002
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
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(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
3401 North Louise Avenue
Sioux Falls, South Dakota 57107
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(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 May 1, 2002.
THE CREDIT STORE, INC.
FORM 10-Q
For the Quarter Ended March 31, 2002
INDEX
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (Unaudited):
Condensed Consolidated Balance Sheets as of March 31, 2002
and June 30, 2001 3
Condensed Consolidated Statements of Operations
for the three months ended March 31, 2002 and
March 31, 2001 4
Condensed Consolidated Statements of Operations
for the nine months ended March 31, 2002 and
March 31, 2001 5
Condensed Consolidated Statements of Cash Flows
for the nine months ended March 31, 2002 and
March 31, 2001 6
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 14
Item 3. Quantitative and Qualitative Disclosures About Market Risk 25
PART II. OTHER INFORMATION 26
Item 1. Legal Proceedings 26
Item 2. Changes in Securities 26
Item 3. Defaults under Senior Securities 26
Item 4. Submission of Matters to Vote of Security Holders 26
Item 5. Other Information 26
Item 6. Exhibits and Reports on Form 8-K 27
SIGNATURES S-1
2
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THE CREDIT STORE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
March 31, June 30,
2002 2001
------------ ------------
ASSETS
Cash and cash equivalents $ 2,971,444 $ 1,853,454
Restricted cash 1,000,000 1,250,000
Accounts and notes receivable, net 2,592,559 5,392,845
Prepaid expenses 1,229,572 1,073,283
Amounts due from special purpose entities 427,619 617,737
Investments in receivable portfolios, net 43,442,845 32,948,042
Investment in unconsolidated affiliates -- 1,000,750
Retained interest in securitized receivables 7,026,065 7,249,204
Property and equipment, net of accumulated depreciation 4,655,331 5,512,853
Goodwill, net 2,123,558 2,123,558
Deferred tax 2,700,000 2,700,000
Other assets 1,439,025 985,931
------------ ------------
Total assets $ 69,608,018 $ 62,707,657
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Accounts payable and accrued expenses $ 10,742,476 $ 7,537,895
Senior secured debt 9,937,395 15,186,134
Non-recourse debt 13,767,891 --
Repurchase obligations 8,393,554 8,000,000
Capitalized lease obligations 3,496,407 4,247,093
Subordinated notes and accrued interest payable -
related party 20,469,125 19,970,834
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Total liabilities 66,806,848 54,941,956
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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 March 31, 2002 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 -- 1,603,350
Accumulated deficit (48,206,102) (44,844,921)
------------ ------------
Total liabilities and stockholders' equity $ 69,608,018 $ 62,707,657
============ ============
The accompanying notes are an integral part of these statements.
3
THE CREDIT STORE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended
-----------------------------
March 31, March 31,
2002 2001
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Revenue
Income from investment in receivable portfolios $ 11,986,975 $ 10,557,163
Securitization income and asset sales 357,926 1,046,104
Servicing fees and other income 1,368,605 1,446,425
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Total revenue 13,713,506 13,049,692
Provision for losses 3,980,103 690,235
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Net revenue 9,733,403 12,359,457
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Expenses
Salaries and employee benefits 3,223,162 3,868,786
Professional and financing fees 647,614 933,670
Credit card servicing 1,520,047 2,299,633
Occupancy and equipment expense 806,360 1,052,683
Other 510,490 357,104
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Total expenses 6,707,673 8,511,876
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Operating income 3,025,730 3,847,581
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Interest expense 1,506,064 1,002,432
Interest expense - related party 259,874 446,374
Lender participation expense 1,228,369 --
------------ ------------
Income before income taxes 31,423 2,398,775
Income tax expense (220,217) (54,582)
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Net income (loss) (188,794) 2,344,193
Dividends on preferred stock 500,000 500,000
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Net income (loss), applicable to
common shareholders $ (688,794) $ 1,844,193
============ ============
Net income (loss) per common share
Basic $ (0.02) $ 0.05
============ ============
Diluted $ (0.02) $ 0.05
============ ============
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.
4
THE CREDIT STORE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Nine Months Ended
-----------------------------
March 31, March 31,
2002 2001
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Revenue
Income from investment in receivable portfolios $ 27,141,361 $ 30,496,834
Securitization income and asset sales 2,910,289 1,985,675
Servicing fees and other income 6,058,073 3,214,806
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Total revenue 36,109,723 35,697,315
Provision for losses 11,878,851 6,364,572
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Net revenue 24,230,872 29,332,743
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Expenses
Salaries and employee benefits 9,344,207 10,590,028
Professional and financing fees 2,451,768 3,121,773
Credit card servicing 5,011,093 6,873,393
Occupancy and equipment expense 2,541,194 3,013,353
Other 1,152,246 2,888,199
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Total expenses 20,500,508 26,486,746
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Operating income 3,730,364 2,845,997
Interest expense 3,287,507 2,702,737
Interest expense - related party 1,498,290 1,568,949
Lender participation expense 1,476,961 --
------------ ------------
Loss before income taxes (2,532,394) (1,425,689)
Income tax (expense) benefit (828,786) 225,353
------------ ------------
Net loss (3,361,180) (1,200,336)
Dividends on preferred stock 1,500,000 1,500,000
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Net loss, applicable to
common shareholders $ (4,861,180) $ (2,700,336)
============ ============
Net loss per common share
Basic $ (0.14) $ (0.08)
============ ============
Diluted $ (0.14) $ (0.08)
============ ============
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 CASH FLOWS
(UNAUDITED)
Nine Months Ended
-----------------------------
March 31, March 31,
2002 2001
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Cash flows from operating activities:
Net loss $ (3,361,180) $ (1,200,336)
Adjustments to reconcile net loss to
net cash provided by (used in) operating activities -
Provision for credit card losses 11,878,851 6,364,572
Amortization of receivable portfolios discount (19,822,489) (15,649,597)
Depreciation and amortization 1,311,078 1,469,501
Amortization of retained interest in securitized credit cards (2,433,239) (720,321)
Lender participation 1,446,843 --
Gain from unconsolidated affiliates (29,154) (21,709)
Gain on sale of portfolios and retained interests (477,051) (1,265,354)
Other 619,538 (479,267)
Tax expense (benefit) 828,786 (225,353)
Change in operating assets and liabilities 196,837 3,689,485
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Net cash used in
operating activities (9,841,180) (8,038,379)
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Cash flows from investing activities:
Collection of consumer debt and funds advanced 28,349,142 29,519,073
Retained interest in securitized credit card receivables (1,012,768) (356,686)
Funds advanced on credit cards (16,824,446) (21,493,982)
Purchase of consumer receivables (3,941,584) (4,164,180)
Proceeds from sale of portfolios 11,088,301 1,151,707
Acquisition of property and equipment (453,865) (2,452,769)
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Net cash provided by
investing activities 17,204,780 2,203,163
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Cash flows from financing activities:
Net proceeds (payments) from debt (5,575,555) 3,637,268
Borrowings from capital leases 850,882 3,828,948
Payments on capital lease obligations (1,601,568) (2,251,079)
Partner distributions from unconsolidated affiliates 80,631 198,022
Investment in unconsolidated affiliates -- (10)
Proceeds from exercises of stock options -- 210,350
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Net cash provided by (used in)
financing activities (6,245,610) 5,623,499
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Net increase (decrease) in cash and cash equivalents 1,117,990 (211,717)
Cash and cash equivalents at beginning of period 1,853,454 2,236,630
------------ ------------
Cash and cash equivalents at end of period $ 2,971,444 $ 2,024,913
============ ============
The accompanying notes are an integral part of these statements.
6
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, and transfer the agreed settlement
amount to a newly issued unsecured MasterCard(R) or Visa(R) credit card. 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 March 31, 2002, 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 - Senior Secured Debt, Non-Resource Debt, and Repurchase Obligations.
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 -Senior Secured Debt,
Non-Recourse Debt, and Repurchase Obligations.
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-KA for the year ended June 30, 2001.
7
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.
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 March 31,
2002, the results of operations for the three months ended March 31, 2002 and
March 31, 2001, and the results of operations and cash flows for the nine months
ended March 31, 2002 and March 31, 2001. The results of operations for the nine
months ended March 31, 2002 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 the Form 10-Q for the
quarter ending 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. The error resulted in the restatement of the
consolidated financial statements for the year ended June 30, 2001 and the
quarter ended September 30, 2001. As a result the Company filed amendments to
its Annual Report for the year ended June 30, 2001 and the quarter ended
September 30, 2001. Please refer to those previously filed documents. The
effects of those restatements have been included in the nine months ended March
31, 2002.
NOTE D - NET INCOME (LOSS) PER COMMON SHARE
The Company's basic net income (loss) per common share is computed by dividing
net income (loss) applicable to common stockholders by the weighted average
number of common shares outstanding during the period. Net income (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 income (loss) per common share is computed by dividing net income
(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 (FASB) issued
Statement of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations" and SFAS No. 142 "Goodwill and Other Intangible Assets." SFAS No.
141 is effective for all business combinations completed after June 30, 2001.
SFAS No. 142 is effective for fiscal years beginning after December 15, 2001;
however, certain provisions of this Statement apply to goodwill and other
intangible assets acquired between July 1, 2001, and the effective date of SFAS
No. 142. The Company has chosen to adopt the provisions of SFAS No. 142 as of
July 1, 2001.
As a result of adopting SFAS No. 141 and SFAS No. 142, the Company's accounting
policies for goodwill and other intangibles changed as described below:
Goodwill and Intangibles with Indefinite Lives: The Company recognizes
the excess cost of an acquired entity over the net amount assigned to
assets acquired and liabilities assumed as goodwill. Goodwill will be
tested for impairment on an annual basis and between annual tests
whenever there is an impairment indicated. Impairment losses will be
recognized whenever the implied fair value of goodwill is less than its
carrying value. Prior to July 1, 2001, goodwill was amortized over
periods of up to 15 years. Beginning July 1, 2001, goodwill is no
longer amortized.
For the three and nine month period ended March 31, 2001, the Company would have
reported an increase in net income and a decrease in net loss of $52,000 and
$155,000 respectively if SFAS 142 had been adopted. There would have been no
change in net income (loss) per common share for each period.
8
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. D-98,
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 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.
Impairment or Disposal of Long-Live Assets
- ------------------------------------------
The FASB also recently issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." SFAS No. 144 is effective for financial
statements issued for fiscal years beginning after December 15, 2001. The
company does not believe this pronouncement will have a material effect on its
financial statements.
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 at $18.4 million which was
based on the fair value of the assumed liabilities on December 1, 2001. The
assumed liabilities included $14.5 million of CSSI's outstanding notes to its
lender and additional liabilities of $3.9 million. The transaction also removed
$2.2 million of investment in retained interest from the Company's financial
statements.
The Company has established two wholly owned qualified special purpose entities
for the purpose of purchasing performing credit card receivables from the
Company. These entities are not consolidated in the Company's financial
statements.
- TCS Funding IV, Inc. ("TCS IV"), established in May 2000, has
a secured credit facility with a MM&S Investments Corporation
("MM&S") to finance the purchase of credit card receivables.
MM&S has a senior secured interest in the pool of performing
credit card receivables owned by TCS IV. These receivables
constitute all the assets owned by TCS IV. The initial sale of
credit card receivables to TCS IV on May 31, 2000 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. An
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
sale, TCS IV purchased additional performing credit card
receivables from the Company that were recorded similar to the
initial sale. As of March 31, 2002, no new advances are
available under the facility. The facility was amended March
31, 2002, so that through September 30, 2002, collections on
the receivables held by TCS IV less servicing fees and
interest (currently 9.75%) are applied to fund new credit card
purchases and advances with any excess funds applied to the
principal balance. After October 1, 2002, the TCS IV, credit
facility requires that all collections on receivables held by
TCS IV less servicing fees and interest at prime plus 2.5% be
applied to the principal balance. After October 1, 2002, the
Company will be required to fund all new charges on the credit
card accounts held by TCS IV until the outstanding balance is
repaid. At March 31, 2002, the outstanding balance under this
credit facility was $8.6 million, TCS IV owned $13.7 million
principal face value of credit card receivables and had a cash
reserve of $0.9 million.
9
- TCS Funding V, Inc. ("TCS V"), established in May 2001,
entered into a $4.0 million secured credit facility with MM&S
to finance the purchase of credit card receivables. MM&S has a
senior security interest in the pool of performing credit card
receivables owned by TCS V. These receivables constitute all
the assets owned by TCS V. 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. As of March 31, 2002, no
advances are available under the facility. The facility was
amended on May 13, 2002 to allow collections on the
receivables held by TCS V, less servicing fees and interest
(currently 9.75%), to be applied to fund new credit card
purchases and advances with any excess funds applied to the
principal balance. As of November 1, 2002, the TCS V credit
facility requires that collections on the receivables held by
TCS V, less servicing fees and interest at prime plus 2.5% are
applied to the principal balance. As of November 1, 2002, the
Company is required to fund all new charges and advances on
the credit card accounts held by TCS V until the outstanding
balance is repaid. At March 31, 2002, the outstanding balance
under this credit facility was $3.2 million principal, TCS V
owned $5.0 million principal face amount in credit card
receivables and had a $0.2 million cash reserve account.
The following summarizes the changes in the balance of the Company's retained
interest for the nine months ended March 31, 2002:
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 895,386 -- 895,386
Interest accrued 2,433,239 -- 2,433,239
Retained interests transferred* (1,119,631) (1,051,303) (2,170,934)
Change in unrealized gain -- (1,380,830) (1,380,830)
----------- ----------- -----------
Balance at March 31, 2002 $ 7,026,065 $ -- $ 7,026,065
=========== =========== ===========
* 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.
NOTE G - SENIOR SECURED DEBT, NON-RECOURSE DEBT, AND REPURCHASE OBLIGATIONS
On December 1, 2001, CSFI entered into a $25.0 million credit facility with The
Varde Fund, L.P. ("Varde") to finance purchases of non-performing consumer debt
portfolios. Varde has a senior security interest in the portfolios purchased and
the debt is nonrecourse. Under the facility, Varde finances 95% of the
acquisition price of the non-performing consumer debt portfolios and the Company
finances the remaining 5% of the acquisition price. The facility expires in
October 2003 and future borrowings under the facility are subject to Varde's
sole discretion. As of March 31, 2002, the outstanding principal and interest
balance owed to Varde under this $25 million non-revolving facility was $3.4
million, with $21.4 million remaining available. Additionally, the Company's
outstanding principal and interest owed to Varde under a previous facility
established in CSSI and transferred to CSFI as of March 31, 2002, was $10.4
million. Amounts loaned by Varde bear interest at an annual rate of 15% per
year. Varde is also entitled to share in cash flows in excess of servicing fees
and new funding requirements on the credit card accounts after principal has
been paid. The Company accrues, on a discounted basis, an estimate of the
amounts to be paid to Varde as a lender participation liability on a discounted
basis. On March 31, 2002, this estimated liability was $3.8 million.
10
CSFI also established a $1.0 million secured working capital credit line with
Varde in December 2001 which was fully drawn as of March 31, 2002. This line of
credit had an initial maturity date of April 15, 2002, was repaid on that date,
and subsequently was increased to $1.5 million and maturity extended to June 25,
2002. Advances in excess of $1.0 million are at the sole discretion of Varde.
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 and Recovery Partners II
("Thornton/Recovery"). In accordance with the repurchase agreement, on January
4, 2002, Thornton/Recovery purchased $10.5 million principal face value of
receivables for $8.0 million. The Company used the proceeds of this sale to
exercise the Plains Commerce Bank repurchase option. The Company may repurchase
the receivables at any time and is required to repurchase the receivables upon
an insolvent event. As of May 1, 2002, on 60 days notice, Thornton/Recovery can
require the Company to repurchase the portfolio for the remaining purchase
price. If the Company is unable to repurchase the portfolio, Thornton/Recovery
could sell the receivables and would have recourse to the Company for any
amounts due, subject to the restrictions in the intercreditor and subordination
agreement with Coast. The Company's obligations under this agreement are secured
by a second lien on substantially all its assets, subordinated to Coast Business
Credit. Under the Repurchase Agreement, Thornton/Recovery receives a required
return of the amounts collected on the receivables. The percentage was 12% at
closing and increased to 37.5% as of March 5, 2002. After Thornton/Recovery has
been paid its percentage, collections are applied to the repurchase price of the
portfolio. The Company is required to maintain receivables coverage of 125% of
the repurchase price. As of March 31, 2002, the repurchase price was $7.4
million and the principal face value of the receivables was $9.3 million.
The Company entered into a credit card receivables repurchase agreement in
September 2001 with North Division Associates ("NDA") whereby NDA purchased
credit card receivables in the principal face amount of $2.2 million from the
Company for $0.5 million. The repurchase option expires July 31, 2002. As of
March 31, 2002, the repurchase price was $0.4 million and the principal face
amount of the receivables was $1.8 million. If the Company does not exercise its
option to repurchase, upon 30 days notice, NDA can require the Company to
repurchase the portfolio. 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 based on a formula that is dependent primarily on the performance
and maturity of 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. Amounts borrowed under the line of credit bear
interest at an annual rate equal to prime plus 2.5% with a minimum of 9%. The
agreement requires the Company to maintain a tangible net worth of $20.0
million. 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 card receivable portfolios. The maximum credit line
was $9.6 million as of March 31, 2002. The amount available at March 31, 2002,
based on the borrowing base under the credit line was $9.1 million, of which
$8.9 million was drawn.
The Company received secured financing from a related party, JLB of Nevada. The
notes are payable on demand but are subordinated to the Company's senior secured
revolving credit lines and its obligations under the repurchase agreement with
Thornton Capital Advisors/Recovery Partners II. At March 31, 2002, the principal
amount outstanding on these notes totaled $17.3 million and accrued but unpaid
interest totaled $3.1 million. Effective January 1, 2002 the interest rate on
these notes was changed from a fixed rate of 12% to a variable rate of prime
plus 1 1/4%, with a minimum rate of 6% and a maximum rate of 12% and payment of
interest was deferred until July 15, 2003 provided JLB of Nevada continues to
hold the notes. A subsequent holder may demand payment of up to 20% of the
accrued interest, if any, on or prior to July 15, 2003.
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 of a sale of non-performing consumer debt accounts.
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) two class action
lawsuits and (ii) one suit concerning a Development Agreement. The Company has
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 the Company 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
majority of this amount was accrued during the fourth quarter of fiscal 2001 and
the entire amount is included in accrued expenses at March 31, 2002 and June 30,
2001. No additional amounts have been accrued in the three and nine months ended
March 31, 2002.
12
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.
March 31, 2002 reflects the consolidation of CSFI as of December 1, 2001. The
following summarizes the components in the balance of the investments in
receivable portfolios for the following periods:
March 31, June 30,
2002 2001
----------- -----------
Cost and amortization of
receivable portfolios discount $20,875,042 $ 9,281,048
----------- -----------
Principal funded on new advances and purchases $29,289,330 $27,456,560
Accrued interest on principal funded 431,730 376,749
Accrued fees 364,936 339,517
----------- -----------
30,085,996 28,172,826
----------- -----------
Less
Provision for losses on credit card receivables 7,060,442 3,856,882
Unearned fees 457,751 648,950
----------- -----------
7,518,193 4,505,832
----------- -----------
Investments in receivable portfolios - net $43,442,845 $32,948,042
=========== ===========
Total credit card balances (1) $97,846,448 $66,184,418
=========== ===========
Investment in receivables portfolios as a percentage
of total credit card balances 44.4% 49.8%
Available credit (2) $ 9,323,752 $ 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, and transfer the agreed settlement amount to a newly issued unsecured
MasterCard(R) or Visa(R) credit card. 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.
Critical Accounting Policies
- -----------------------------
Our accounting policies are provided on pages F-9 through F-14 of our June 30,
2001 Form 10-KA. We believe the most critical accounting policies are
securitization accounting, retained interest in securitized credit card
receivables, income from investments in receivable portfolios and allowance for
credit card losses. Our financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America ("US
GAAP"). The application of US GAAP relative to our critical accounting policies
requires us to make estimates and assumptions that affect the reported amount of
assets and liabilities, financial statement disclosure concerning contingent
assets and liabilities and revenue and expenses during the reporting period. We
review estimates and assumptions used in the application of US GAAP on a regular
basis. However it is possible that these estimates and assumptions may change
and this change could be material to our financial position.
Securitization Accounting
- -------------------------
We apply Statement of Financial Accounting Standards No. 140 ("SFAS No. 140"),
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities," to securitized financial asset transactions. SFAS No. 140
requires us to recognize the financial and servicing assets we control and the
liabilities we incur and to derecognize financial assets when control has been
surrendered. The proceeds of securitized financial asset transactions are
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.
14
Retained Interest in Securitized Credit Card Receivables
- --------------------------------------------------------
We account for our retained interest in securitized credit card receivables as a
debt security classified as available-for-sale in accordance with Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments in
Debt and Equity Securities," and carry the retained interest at fair value. We
use a "cash-out" basis in determining fair value based on a discounted expected
future net cash flow perspective. The cash out method projects cash collections
to be received only after all amounts owed to investors have been paid. 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, and adjusts the asset value accordingly. We provide for losses
immediately when the recorded fair value is greater than the present value of
expected future net cash flows.
We accrue income on the retained interest in securitized credit card receivables
based on the effective interest rate applied to its original cost basis,
adjusted for previously accrued interest and cash payments. The effective
interest rate is the rate of return determined based on the timing and amounts
of expected future net cash flows for the underlying pool of securitized credit
card receivables.
Income from Investment in Receivable Portfolios
- -----------------------------------------------
We recognize income from investment in receivable portfolios based on the
accrual method within the provisions of AICPA's Practice Bulletin No. 6
"Amortization of Discounts on Certain Acquired Loans." Prior to June 1, 2000, we
recognized income from investment in receivable portfolios in accordance with
Practice Bulletin No. 6 under the cost recovery method. We believe our cash flow
projection models, based on historical portfolio data, provide reasonable
information relative to the probability of the timing and amount of cash flows
from our investments in receivable portfolios to be used in the determination of
recognized income.
Under the accrual basis of accounting, amortization of receivable portfolios
discount is accrued based on the effective interest rate determined for each
pool applied to each pool's carrying value as of June 1, 2000, adjusted for
previously accrued interest and cash payments, or its cost if purchased after
June 1, 2000. The effective interest rate is the rate of return determined based
on the timing and amounts of actual cash received since the date of adoption of
accrual accounting or since the pool's purchase date, if purchased after June 1,
2000, and anticipated future cash flow projections for each pool. The amount of
discount accrued involves numerous estimates and assumptions principally
relating to the current market environment, provision for expected losses, and
each pool's underlying characteristics.
Allowance for Credit Card Losses
- --------------------------------
The Company's provision for credit card losses includes current period losses
and an amount which, in the judgment of management, is necessary to maintain the
allowance for possible credit card losses at a level that reflects known and
inherent risks in the credit card portfolio. The overall allowance for credit
card losses evaluation requires management consideration of several factors,
including: historical trends of charge-off activity for each credit card
portfolio as well as current economic conditions and the impact that such
conditions might have on a borrowers' ability to repay. Significant changes in
these factors could affect the adequacy of the allowance for credit card losses
in the near term.
15
RESULTS OF OPERATIONS
REVENUES. Total revenue for the three months and nine months ended March 31,
2002 was $13.7 million and $36.1 million, respectively, reflecting 5.0% and 1.2%
increases from the $13.0 million and $35.7 million recorded during the prior
fiscal year comparable periods. Core revenues (revenue from all activities other
than portfolio sales and interest in affiliate revenues) increased 8.6% from
$12.5 million in the third quarter of fiscal 2001 to $13.6 million in the third
quarter of fiscal 2002 and increased 3.5% from $34.4 million in the first nine
months of fiscal 2001 to $35.6 million in the first nine 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 prior to
December 1, 2001 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 continued decreased
servicing fees and increased income from investment in receivable portfolios as
was experienced in the present quarter. Specifically, servicing fees and other
income decreased 5.4% from $1.446 million in the third quarter of fiscal 2001 to
$1.369 million in the present quarter while income from credit card receivables
increased 13.5% from $10.6 million in the third quarter of fiscal 2001 to $12.0
million in the present quarter.
Period to period new originations of credit card accounts increased 16.1% to
$26.5 million during the third quarter of fiscal 2002 from $22.9 million during
the third quarter of fiscal 2001 and decreased 5.4% from $71.4 million during
the first nine months of fiscal 2001 to $67.6 million in the first nine months
of fiscal 2002. Approximately $17.3 million and $30.3 million of the new
accounts originated in the first three and nine months of fiscal 2002 were
booked in CSSI.
Net revenue decreased to $9.7 million in the third quarter of fiscal 2002 from
$12.4 million in the third quarter of fiscal 2001 and decreased to $24.2 million
in the first nine months of fiscal 2002 from $29.3 in the first nine months of
fiscal 2001 primarily due to an increase in the provision for losses. The
provision reported for the third quarter of fiscal 2002 was $4.0 million or
29.3% of core revenues as compared to $0.7 million, or 5.5% of core revenues for
the third quarter of fiscal 2001. The provision for the first nine months of
fiscal 2002 was $11.9 million or 33.3% of core revenues as compared to $6.4
million or 18.5% of core revenues for the first nine months of 2001. The
provision for losses is directly related to the new credit activity of our
cardholders (new funding, interest and fees) recorded on our balance sheet and
general economic conditions. The provision for losses increased from prior
fiscal periods as a result of the inclusion of $11.5 million of new credit
activity balances in CSFI effective December 1, 2001 (in the prior year
comparable periods these balances were in the unconsolidated subsidiary CSSI).
The incremental provision for losses included for CSFI in the three and nine
month periods ending March 31, 2002 was $1.3 million and $1.8 million. The
provision for losses also increased as a result of a higher level of charge-offs
in the third quarter of fiscal 2002 due to economic conditions.
THREE MONTHS ENDED THREE MONTHS ENDED NINE MONTHS ENDED NINE MONTHS ENDED
REVENUES MARCH 31, 2002 MARCH 31, 2001 MARCH 31, 2002 MARCH 31, 2001
-------- ----------------- ------------------ ----------------- -----------------
Income from investment in
receivable portfolios $11,986,975 $10,557,163 $27,141,361 $30,496,834
Securitization income 228,116 500,024 2,433,239 720,321
Servicing fees and other income 1,368,605 1,446,425 6,058,073 3,214,806
----------- ----------- ----------- -----------
Core Revenue 13,583,696 12,503,612 35,632,673 34,431,961
Gains on Sales 129,810 546,080 477,050 1,265,354
----------- ----------- ----------- -----------
Total Revenue 13,713,506 13,049,692 36,109,723 35,697,315
Provision for Losses 3,980,103 690,235 11,878,851 6,364,572
----------- ----------- ----------- -----------
Net Revenue $ 9,733,403 $12,359,457 $24,230,872 $29,332,743
16
EXPENSES. Total operating expenses for the third quarter and first nine months
of fiscal 2002 were $6.7 million and $20.5 million, a 21.2% decrease from $8.5
million in the third quarter of fiscal 2001 and a 22.6% decrease from $26.5
million in the first nine months of fiscal 2001. Operating expenses were 49.4%
and 57.5% of core revenues in the third quarter and first nine months of fiscal
2002 compared to 68.1% and 76.9% in the third quarter and first nine months 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 2.6% increase in the
aggregate balance of credit card receivables we owned and managed from $117.4
million as of March 31, 2001 to $120.4 million as of March 31, 2002.
Originations of new credit card accounts for the third quarter and first nine
months of fiscal 2002 were $26.5 million and $67.6 million compared to $22.9
million in the first quarter of fiscal 2001 and $71.4 million in the first nine
months of fiscal 2001.
Salaries and employee benefits expense was 16.7% lower in the third quarter of
fiscal 2002 than in the third quarter of fiscal 2001 and 11.8% lower in the
first nine 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 326 at March 31, 2001 to 269 at March 31, 2002 resulting from
technological enhancements and operational efficiencies. As disclosed in our
Form 8K filing on April 19, 2002, we also recently reduced our work force by 15
employees, or approximately 5.6% of the total number of employees, in an effort
to further capitalize on operating efficiencies and lower our operating costs.
Professional and financing fees decreased $0.6 million, or 21.5%, from $3.1
million in the first nine months of fiscal 2001 to $2.5 million in the first
nine months of fiscal 2002 and decreased $0.3 million, or 30.6% from $0.9
million in the third quarter of fiscal 2001 to $0.6 million in the third 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 33.9% from $2.3 million in the third quarter of fiscal 2001 to $1.5
million in the third quarter of fiscal 2002 and decreased as a percentage of
core revenue from 18.4% to 11.2%. Credit card servicing fees of $5.0 million in
the first nine months of fiscal 2002 were 27.1% less than the $6.9 million in
credit card servicing fees recorded in the first nine months of fiscal 2001.
This reduction is due, in part, to a reduced volume of receivables acquired by
CSSI and us. We, along with CSSI, acquired $423.4 million principal face amount
of non-performing consumer receivables in the third quarter of fiscal 2001
compared to $202.8 million in the third quarter of fiscal 2002, and $1.1 billion
principal face amount of non-performing consumer receivables in the first nine
months of fiscal 2001 compared to $658.3 million in the first nine months of
fiscal 2002. Additionally, technological enhancements and operating efficiencies
have lowered our cost per account.
Other expenses for the nine month comparative periods 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 March 31,
2002 and June 30, 2001. No additional amounts have been accrued in the three and
nine months ended March 31, 2002.
17
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
EXPENSES MARCH 31, 2002 MARCH 31, 2001 MARCH 31, 2002 MARCH 31, 2001
-------- -------------- -------------- -------------- --------------
Salaries and employee $ 3,223,162 $ 3,868,786 $ 9,344,207 $10,590,028
benefits
Professional and financing 647,614 933,670 2,451,768 3,121,773
fees
Credit card servicing 1,520,047 2,299,633 5,011,093 6,873,393
Occupancy and equipment 806,360 1,052,683 2,541,194 3,013,353
expense
Other 510,490 357,104 1,152,246 2,888,199
----------- ----------- ----------- -----------
Total expenses $ 6,707,673 $ 8,511,876 $20,500,508 $26,486,746
INTEREST AND LENDER PARTICIPATION EXPENSE. Interest expense increased from $1.4
million in the third quarter of fiscal 2001 to $1.8 million in the third quarter
of fiscal 2002, and increased from $4.3 million in the first nine months of
fiscal 2001 to $4.8 million in the first nine months of fiscal 2002. These
increases reflect the assumption by CFSI of CSSI's liabilities as of December 1,
2001. The lender participation expense related to Varde's estimated
participation in future excess cash flows was $1.2 million for the third quarter
of fiscal 2002 and $1.5 million for the first nine months of fiscal 2002 (these
liabilities were included in the books of CSSI an unconsolidated subsidiary
prior to December 1, 2001). Interest expense, as a percentage of core revenue,
for the third quarter and first nine months of fiscal 2002 was 13.0% and 13.4%,
compared to 11.6% and 12.4% in the comparable periods of fiscal 2001.
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
MARCH 31, 2002 MARCH 31, 2001 MARCH 31, 2002 MARCH 31, 2001
-------------- -------------- -------------- --------------
Interest expense $1,765,938 $1,448,806 $4,785,797 $4,271,686
Lender participation $1,228,369 -- $1,476,961 --
expense
INCOME TAX EXPENSE/BENEFIT. Income tax expense or benefit was recorded in the
third quarter and first nine months 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 also 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 if factors
indicate that it is more likely than not that additional future tax benefits
will be realized.
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
MARCH 31, 2002 MARCH 31, 2001 MARCH 31, 2002 MARCH 31, 2001
-------------- -------------- -------------- --------------
Income tax (expense) $(220,217) $(54,582) $(828,784) $225,353
benefit
NET INCOME (LOSS). Net loss was $0.2 million in the third quarter of fiscal 2002
compared to net income of $2.3 million in the third quarter of fiscal 2001. Net
loss was $3.4 million in the first nine months of fiscal 2002 compared to net
loss of $1.2 million in the first nine months 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 income (loss) applicable to common shareholders. After the
effect of preferred dividends of $0.5 million in each of the third fiscal
quarters, the net loss applicable to common shareholders was $0.7 million, or
$0.02 per basic and diluted common share, in the third quarter of fiscal 2002
compared to net income applicable to common shareholders of $1.8 million, or
$0.05 per basic and diluted common share in the third quarter of fiscal 2001.
After the effect of preferred dividends of $1.5 million in each of the first
nine months of the fiscal years, the net loss applicable to common shareholders
was $4.9 million, or $0.14 per basic and diluted common share, in the first nine
months of fiscal 2002; and $2.7 million, or $0.08 per basic and diluted common
share, in the first nine months of fiscal 2001. The amount of undeclared
dividends was $7.7 million at March 31, 2002.
18
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
MARCH 31, 2002 MARCH 31, 2001 MARCH 31, 2002 MARCH 31, 2001
-------------- -------------- -------------- --------------
Net income (loss) $ (188,794) $ 2,344,193 $(3,361,180) $(1,200,336)
Dividends on preferred stock 500,000 500,000 1,500,000 1,500,000
----------- ----------- ----------- -----------
Net income (loss) applicable to
common shareholders $ (688,794) $ 1,844,193 $(4,861,180) $(2,700,336)
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. We tend to experience our highest
delinquency rates during the holiday season, which falls within our second
fiscal quarter. The delinquency rates typically fall during the third fiscal
quarter, as cardholders make payments on their holiday season purchases and
receive tax refunds.
DELINQUENCIES AS A PERCENTAGE OF OWNED AND MANAGED CREDIT CARD RECEIVABLES
AS OF
MAR. 31, 2001 JUNE 30, 2001 SEPT 30, 2001 DEC. 31, 2001 MAR. 31, 2002
------------- ------------- ------------ ------------- -------------
Owned
Receivables
Amount $ 72,775,407 $ 54,936,629 $ 50,278,337 $ 77,353,508 $ 84,984,530
Managed
Receivables
Amount $ 31,671,150 $ 49,843,613 $ 54,665,516 $ 25,871,840 $ 23,740,285
Total
Receivables
Amount $104,446,557 $ 104,7870,242 $104,943,853 $103,225,348 $108,724,816
------------ -------------- ------------ ------------ ------------
(PERCENT OF TOTAL)
Loans
Delinquent:
30 to 59
days 10.11% 11.36% 10.78% 11.39% 9.38%
60 to 89
days 4.59% 6.30% 5.69% 6.30% 3.75%
90 to 119
days 4.18% 4.98% 5.23% 5.14% 3.92%
Total 60 or more 8.76% 11.28% 10.92% 11.44% 7.67%
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.
19
CASH FLOWS FROM OPERATING ACTIVITIES
Our operating activities used $9.8 million of cash in the first nine months of
fiscal 2002, compared to $8.0 million in the first nine months of fiscal 2001.
At March 31, 2002, we had $3.0 million of cash and cash equivalents, compared to
$1.9 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 March 31, 2002 and $1.3
million at June 30, 2001.
CASH FLOWS FROM INVESTING ACTIVITIES
We use cash to purchase non-performing consumer debt portfolios and to fund new
charges and advances incurred by the holders of credit cards we originate from
these portfolios. Our primary source of cash is proceeds of the debt payments
from consumers either from collection based activities or cardholder payments on
originated credit card accounts. Another significant source of cash is the
proceeds of resale of non-performing consumer debt portfolios and sales and/or
securitizations of credit card receivable portfolios.
During the nine months ended March 31, 2002, investing activities supplied $17.2
million in cash flow compared to $2.2 million in the first nine months of fiscal
2001. This increase is due primarily to the excess of cardholder cash payments
over new cardholder charges on the credit cards, the resale of accounts, and the
consolidation effective December 1, 2001 of portfolios that were previously held
in our unconsolidated subsidiary CSSI. We received $28.3 million from collection
activities and credit card payments, an excess of $11.5 million over credit card
funding activity in the first nine months of fiscal 2002, compared to an excess
of $8.0 million in the first nine months of fiscal 2001. Resale proceeds
generated $11.1 million during the period compared to $1.2 million in the prior
comparable period. Cash flows were used to fund the purchase of portfolios of
non-performing consumer debt of $3.9 million in the nine months ended March 31,
2002 compared to $4.2 million in the prior comparable period and to fund the
retained interests in securitizations and acquire property and equipment of $1.5
million in the nine months ended March 31, 2002 compared to $2.8 million in the
prior comparable period.
Although credit card and collection activities are classified as cash flows from
investing activities according to GAAP, this source of cash is the primary
source of cash for our operating activities.
CASH FLOWS FROM FINANCING ACTIVITIES
On March 15, 2002 we established a $3.0 million senior secured revolving credit
line with Plains Commerce Bank. The bank has a senior security interest in a
designated pool of performing credit card receivables. Amounts borrowed under
the new facility bear interest at an annual rate equal to prime plus 2%. The
facility was available for funding on April 4, 2002. The maximum amount which
may be drawn at any time under the credit line commitment is equal to 60% of the
dollar amount of credit card receivables in the pool. At April 30, 2002 the
amount available under the borrowing base formula was $3.0 million, of which
$2.8 million was outstanding. The credit facility has an expiration date of, and
the outstanding balance matures on, April 4, 2003. We expect to use the facility
for general corporate purposes including working capital and the repayment of
certain maturing debt obligations. Plains Commerce is also one of our two credit
card issuing banks. As of March 31, 2002 we had 66,663 or approximately 70% of
our credit cards issued through Plains Commerce. A default under this facility
would constitute a default under our issuing agreement with Plains Commerce
Bank.
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 from Plains Commerce Bank for $8.0 on
January 4, 2002.
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 borrowing base is
composed primarily of performing credit cards, with a graduated advance rate
which cannot exceed 50% of the face value of the performing credit cards. 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. Amounts borrowed under the Coast credit line bear interest at an
20
annual rate equal to prime plus 2.5% with a minimum of 9%. The agreement
requires us to maintain a tangible net worth of not less that $20 million. 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 receivable portfolios. The maximum credit line was $9.6 million as of March
31, 2002. The amount available at March 31, 2002, based on the borrowing base
under the credit line was $9.1 million, of which $8.9 million was drawn. We are
actively seeking a replacement lender for Coast, but cannot guarantee that one
will be in place by July 31, 2002. Alternatively, we may need to sell portfolios
of our performing credit card receivables to retire the debt. We cannot assure
you we will be able to effect sales of portfolios of performing credit card
receivables or to do so on favorable terms.
We have received secured financing from a related party, JLB of Nevada. The
notes are payable on demand but are subordinated to our senior secured revolving
credit lines and our obligations under the repurchase agreement with Thornton
Capital Advisors/Recovery Partners II discussed below. At March 31, 2002, the
principal amount outstanding on these notes totaled $17.3 million and accrued
but unpaid interest totaled $3.1 million. Effective January 1, 2002 the interest
rate on these notes was changed from a fixed rate of 12% to a variable rate of
prime plus 1 1/4%, with a minimum rate of 6% and a maximum rate of 12% and
payment of interest was deferred until July 15, 2003 provided JLB of Nevada
continues to hold the notes. A subsequent holder may demand payment of up to 20%
of the accrued interest, if any, on or prior to July 15, 2003. Under the terms
of our revolving credit line from Coast and certain other outstanding senior
debt, we are not permitted to make interest payments on notes held by JLB of
Nevada, unless our quarterly ratio of EBITDA to principal and interest payments
is at least 1.30:1. We do not expect such ratio to exceed 1.30:1 in the short
term, and therefore we do not expect to be permitted to pay interest on these
notes prior to fiscal year end.
Jay Botchman wholly owns JLB of Nevada. Mr. Botchman is the beneficial owner of
40.3% of our fully diluted outstanding shares of common stock. In addition, Mr.
Botchman beneficially owns all of our Series A, C, D and E Preferred Stock. As
of March 31, 2002 accumulated, undeclared and unpaid dividends on preferred
stock (including dividends on our Series B Preferred Stock which is held by two
independent parties) totaled $7.7 million. Should we be called on to pay these
dividends in the future, our payment would reduce net worth and limit the amount
of cash available for operations. To the extent the preferred stock remains
outstanding, additional cash dividends will accumulate. However, restrictions in
our debt and securitization servicing agreements prohibit us from paying cash
dividends at this time.
In March 2002, we entered into a consulting contract with JLB of Nevada. Under
the terms of this contract we pay a fee of $25,000 a month and receive up to 50
hours of consulting services each month.
On December 31, 2001, we entered into a repurchase agreement with Thornton
Capital Advisors & Recovery Partners II ("Thornton/Recovery"). In accordance
with the repurchase agreement on January 4, 2002, Thornton/Recovery purchased
$10.5 million principal face value of receivables for $8.0 million. We used the
proceeds of this sale to exercise the Plains Commerce Bank repurchase option
described above. We may repurchase the receivables at any time and are required
to repurchase the receivables upon an insolvent event. As of May 1, 2002, on 60
days notice, Thornton/Recovery can require us to repurchase the portfolio for
the remaining repurchase price. If we were required to repurchase the portfolio
and were unable to do so within the required period, Thornton/Recovery could
sell the receivables and would have recourse to us for any amounts due, subject
to the restrictions in the intercreditor and subordination agreement with Coast.
Our obligations under this agreement are secured by a second lien on
substantially all our assets, subordinated to Coast's lien. Under the Repurchase
Agreement, Thornton/Recovery receives a required return of the amounts collected
on the receivables. The percentage was 12% at closing, and increased to 37.5% as
of March 5, 2002. After Thornton/Recovery has been paid its percentage,
collections are applied to the repurchase price of the portfolio. We are
required to maintain receivables coverage of 125% of the repurchase price. As of
March 31, 2002, the repurchase price was $7.4 million and the principal face
value of the receivables was $9.3 million. We are actively seeking the sale or
refinancing of these receivables. However, we cannot assure you that we will be
able to effect the sale or refinancing of these portfolios or do so on favorable
terms.
21
We entered into a credit card receivables repurchase agreement in September 2001
with North Division Associates ("NDA") whereby NDA purchased credit card
receivables in principal face amount of $2.2 million from us for $0.5 million.
Our repurchase option expires on July 31, 2002. As of March 31, 2002, the
repurchase price was $0.4 million and the principal face amount of the
receivables was $1.8 million. If we do not exercise our option to repurchase,
NDA can require us to repurchase the portfolio upon 30 days notice. If we were
unable to repurchase the portfolio after notice from NDA, NDA would have the
right to sell the portfolio of receivables. We intend to sell or refinance these
receivables prior to expiration of the repurchase option, but we can make no
assurances that we will exercise our repurchase option, sell or refinance the
receivables.
For financial statement purposes, we treat these repurchase agreements as
financing transactions.
Our wholly owned qualified special purpose entity, TCS Funding IV, has a secured
credit facility with MM&S to finance the purchase of credit card receivables.
MM&S has a senior security interest in a pool of performing credit card
receivables owned by TCS Funding IV. These receivables constitute all the assets
owned by TCS Funding IV. On May 31, 2000, $10.0 million of the facility was used
by TCS Funding IV to purchase credit card receivables with a principal face
value of $14.2 million from us at a purchase price of $12.1 million. We recorded
the balance of the sale price, $2.1 million, as a retained interest. No other
advances have been made under the facility. The credit facility is now in its
amortization stage and no new advances are available under the facility. The
facility was amended effective March 31, 2002, so that through September 30,
2002, collections on the receivables held by TCS Funding IV, less servicing fees
and interest payments (currently fixed at 9.75%), are applied to fund new credit
card purchases and advances with any excess funds applied to the principal
balance. After October 1, 2002, the TCS Funding IV credit facility requires that
all collections on the receivables held by TCS Funding IV, less servicing fees
and interest at prime plus 2.5%, be applied to the principal balance. After
October 1, 2002 we will be required to fund all new charges on the credit card
accounts held by TCS Funding IV until the principal balance is paid. If we do
not fund the new charges on the accounts, in addition to any contract claims
MM&S might have, MM&S would be entitled to retain an alternate provider to
service the accounts and would be entitled to exercise its rights as a secured
party, including selling the receivables. We are in discussions with a financial
institution to refinance or acquire TCS Funding IV prior to October 2002. At
March 31, 2002, the outstanding balance under this credit facility was $8.6
million, TCS Funding IV owned $13.7 million principal face value in credit card
receivables and had a cash reserve of $0.9 million.
Our wholly owned qualified special purpose entity, TCS Funding V, has a $4.0
million secured credit facility with MM&S to finance the purchase of credit card
receivables. MM&S has a senior security interest in a pool of performing credit
card receivables owned by TCS Funding V. These receivables constitute all the
assets owned by TCS Funding V. On May 1, 2001 all of the funds available under
the facility were used by TCS Funding V to purchase credit card receivables with
a principal face value of $5.7 million from us for $4.9 million. We recorded the
balance of the sale price, $0.9 million, as a retained interest. Through October
31, 2002 collections on the receivables held by TCS Funding V, less servicing
fees and interest payments (currently fixed at 9.75%), are applied to fund new
credit card purchases and advances with any excess funds applied to the
principal balance. After November 1, 2002, the TCS Funding V credit facility
requires that collections on the receivables held by TCS Funding V, less
servicing fees and interest at prime plus 2.5%, be applied to the principal
balance. After November 1, 2002, we will be required to fund all new charges on
the credit card accounts held by TCS Funding V until the principal balance is
paid. If we do not fund the new charges on the accounts, in addition to any
contract claims MM&S might have, MM&S would be entitled to retain an alternate
provider to service the accounts and would be entitled to exercise its rights as
a secured party, including selling the receivables. We are in discussion with a
financial institution to refinance or acquire TCS Funding V prior to November
2002. At March 31, 2002, the outstanding balance under this credit facility was
$3.2 million, TCS Funding V owned $5.0 million principal face value in credit
card receivables and had a $0.2 million cash reserve account.
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. During
22
October 2000, CSSI entered into a $25.0 million credit facility with The Varde
Fund, 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. The liabilities
assumed included $14.5 million of outstanding notes due to Varde. At that time,
the CSSI facility was extinguished and CSFI entered into a similar credit
facility with Varde for an additional $25.0 million. Varde has a senior security
interest in the portfolios purchased by CSSI and CSFI and the debt is
non-recourse to us. 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 retained 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 fiscal 2002. In
addition, our subsidiaries pay interest at a rate of 15% per year on the loans
advanced by Varde and by us. Varde is also entitled to share in cash flows in
excess of servicing fees and new funding requirements on the credit card
accounts after principal has been repaid. As of March 31, 2002, the outstanding
principal and interest balance owed to Varde under this $25 million
non-revolving facility was $3.4 million, with $21.4 million remaining available.
Additionally, the outstanding principal and interest owed to Varde as of March
31, 2002 under a previous facility established in CSSI and transferred to CSFI
was $10.4 million. Future borrowings under the facility are subject to Varde's
sole discretion.
In December 2001, we also established a $1.0 million secured working capital
line of credit with Varde through our CSFI subsidiary. This line of credit had
an initial maturity date of April 15, 2002, was repaid on that date, and was
subsequently extended to July 25, 2002, and increased to $1.5 million, with
advances in excess of $1 million being at the sole discretion of Varde.
CONTRACTUAL OBLIGATIONS: PAYMENT DUE BY PERIOD
Total Amount Less than 1 Year 1-3 Years
------------ ---------------- -----------
Senior Secured Debt $ 9,937,395 $ 9,937,395
Non-Recourse Debt 13,767,891 2,442,644 $11,325,247
Related Party Debt 20,469,125 20,469,125
Repurchase Obligations 8,393,554 8,393,554
Capital leases 3,496,407 261,564 3,234,843
----------- ----------- -----------
Total Contractual Cash Obligations $56,064,372 $21,035,157 $35,029,215
OTHER COMMERCIAL COMMITMENTS Total Amount Less than 1 Year 1-3 Years 4-5 Years
------------ ---------------- ----------- ----------
Estimated Funding Commitments on
Securitizations $ 5,861,616 $ 4,101,301 $ 1,760,315
Estimated Lender Participation Payments 3,792,394 1,462,944 2,329,450
Customer Available Credit 9,323,752 9,323,752
Rents and Other 3,918,498 1,143,577 $ 909,265 $1,865,656
----------- ----------- ----------- ----------
Total Commercial Commitments $22,896,260 $16,031,574 $ 4,999,030 $1,865,656
23
We continue to explore alternate financing and receivable sale 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 continue to have discussions with other
financial institutions regarding the possible purchases of 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 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 consumate, and credit card collection
activities will be sufficient to fund our operations through the end of the
fiscal year.
CERTAIN FACTORS AFFECTING LIQUIDITY
- -----------------------------------
WE MAY NOT ACHIEVE POSITIVE CASH FLOW FROM OPERATIONS OR PROFITABILITY. We have
incurred significant expenditures 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. As a
result, we have historically experienced negative cash flow from operations
before our investing activities. Cash flow from our investing activities
includes our cash flow from credit cards and collections. Our negative cash flow
from operations was $9.8 million for the nine months ended March 31, 2002, and
$8.0 million for the nine months ended March 31, 2001. We may continue to
generate negative cash flow from operations. Until we generate sufficient cash
flows from operations, we will need to use our available capital, including any
proceeds from the sale or securitization of receivables and any future issuances
of debt or equity securities to fund our cash flow requirements.
IF WE CANNOT REPLACE OUR SENIOR CREDIT FACILITY AND OBTAIN ADDITIONAL WORKING
CAPITAL AS NEEDED TO FINANCE OUR OPERATIONS AND GROW OUR BUSINESS, WE MAY BE
REQUIRED TO SELL PORTFOLIOS OF RECEIVABLES ON TERMS LESS FAVORABLE TO US THAN
THOSE OF PAST SALES, LIMIT OUR OPERATIONS AND RESTRICT OUR GROWTH. ANY OF THESE
ACTIONS COULD HURT OUR ABILITY TO GENERATE CASH FLOW FROM OUR INVESTMENT IN
RECEIVABLE PORTFOLIOS AND COULD HAVE A MATERIAL AND ADVERSE IMPACT ON OUR
BUSINESS OPERATIONS. We have a substantial ongoing need for capital to finance
our operations. This need is expected to increase along with the growth of our
business. We fund our cash requirements through a combination of:
o cash flow from operations;
o asset sales and securitizations; and
o loans and other financing transactions.
Our senior credit facility currently has an expiration date of, and the
outstanding balance matures on, July 31, 2002. In addition, Thornton/Recovery
can require us to purchase the portfolios of receivables subject to the
repurchase agreement on sixty days notice.
If we cannot refinance the senior credit facility and the repurchase option,
obtain additional working capital when needed and additional receivable sales
and securitizations are not completed, our ability to operate and grow our
business will be limited. In addition, we may be required to complete receivable
sales or securitizations on less favorable terms than in the past in order to
raise the working capital needed to repay maturing obligations and operate our
business. We cannot assure you we will be successful in obtaining additional
financing when needed to meet our working capital requirements.
BECAUSE WE HAVE PLEDGED ALL OF OUR ASSETS, WE MAY HAVE DIFFICULTY SECURING
FUTURE FINANCING. Our principal lender, Coast Business Credit, has a security
interest in all of our assets, including all receivables, inventory and
equipment, to secure our payment and performance under our senior secured
facility. Thornton Capital Advisors and Recovery Partners II have a subordinated
lien on our assets to secure payment of notes held by them. Our controlling
stockholder, Jay L. Botchman, also has a subordinated lien on our assets to
secure payment of notes held by him. While both our senior secured lender and
our controlling stockholder have in the past voluntarily released their liens on
assets we wanted to sell or securitize, the terms of our loan agreements do not
require them or Thornton Capital and Recovery Partners II to release their
liens. We cannot assure you they will be willing to do so in the future. As a
result, we may find it more difficult to sell certain of our assets or to secure
additional financing in the future.
BECAUSE WE ARE LEVERAGED OUR ABILITY TO SUCCESSFULLY OPERATE OUR BUSINESS MAY BE
LIMITED. As of March 31, 2002, we had approximately $52.9 million of debt
outstanding and we may incur substantial additional debt in the future. Our
level of debt could have important consequences to you, including:
24
o a substantial portion of our cash flow from operations will be
dedicated to paying principal and interest on our debt,
reducing funds available for expansion or other purposes;
o our significant amount of debt could make us more vulnerable
to changes in general economic conditions or increases in
prevailing interest rates;
o our failure to comply with the restrictions contained in any
of our financing arrangements could lead to a default which
could result in our being required to repay all of our
outstanding debt; and
o we may be more leveraged than some of our competitors, which
may result in a competitive disadvantage.
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
This Form 10-Q for the period ended March 31, 2002 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-KA 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-KA 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.
25
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 or decrease, and income (loss) before
income taxes would not change by a material amount. We have not entered into
derivative transactions to hedge the interest rate risk.
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Our collection practices, business operations and credit card receivables are
subject to numerous federal and state consumer protection laws and regulations.
While our policy is to comply with the provisions of all applicable statutes, in
the ordinary course of business, we receive notices from regulatory agencies
regarding alleged failures to comply with applicable laws and regulations and
are named as a defendant in legal actions filed by those who have been solicited
to participate in our credit card programs.
On May 21, 1999, we were sued on behalf of a class of Arizona debtors in the
United States District Court for the District of Arizona in an action titled
Bingham v. The Credit Store, Inc. Our motion to dismiss this case was granted
and the period for appealing the dismissal has expired.
We recently received notice from one state regulatory authority alleging
applicability of the state's credit services organizations statute, a statute
similar to the federal Credit Repair Organizations Act ("CROA"). We do not
believe the statute was intended to apply to our operations and intend to
vigorously contest the allegation. However, if it is determined that the CROA
and similar state statutes are applicable it might require us to change how we
conduct our business which could have a material adverse effect on our
consolidated results of operations or consolidated financial condition.
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
Not applicable.
ITEM 5. OTHER INFORMATION
Not applicable.
26
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 as of December 17, 2001.
10.10.8 Eighth Amendment to the Strategic Modeling Agreement dated January 26, 2002
between the Company and Business Transactions Express, Inc.
10.18.7 Twelfth Amendment to Loan and Security Agreement dated as of December 1, 2001,
between the Company and Coast Business Credit, a division of Southern Pacific
Bank.
10.18.8 Thirteenth Amendment to Loan and Security Agreement dated as of March 28, 2002,
between the Company and Coast Business Credit, a division of Southern
Pacific Bank.
10.32.1 First Amendment To Bankcard Marketing Agreement as of March 15, 2002, by and
between Plains Commerce Bank and the Company.
10.43.4 Amendment No. 1 to Master Credit and Security Agreement dated as of November 30,
2001 among TCS Funding IV, Inc., the Company, and MM&S Investments Corporation.
10.43.5 Amendment No. 2 to Master Credit and Security Agreement dated as of March 31,
2002, among TCS Funding IV, Inc., the Company, and MM&S Investments Corporation.
10.43.6 Amendment No. 1 to Master Credit and Security Agreement dated as of May 12, 2002
among TCS Funding V, Inc., the Company, and MM&S Investments Corporation.
10.50.1 Amendment to Subordinated Grid Promissory Notes, dated January 1, 2002, made by
The Credit Store, Inc., to the order of J.L.B. Nevada, Inc. in the respective
original principal amounts of $20,000,000, $5,000,000 and $5,000,000 dated
respectively August 1, 1997, October 23, 1997 and November 21, 1997 and Secured
Promissory Note made by American Credit Alliance, Inc., to the order of J.L.B.
of Nevada, Inc. in the original principal amount of $880,000 dated August 16,
1996.
10.51 Consulting Agreement dated as of March 1, 2002 between JLB Equities, Inc. and
the Company.
10.52 Revolving Credit Agreement dated as of March 15, 2002 between Plains Commerce
Bank and the Company.
27
10.53 Repurchase Agreement dated as of December 31, 2001, by and among Thornton
Capital Advisors, Inc. and/or Recovery Partners II, LLC, Plains Commerce Bank
and the Company.
10.54 Master Loan And Servicing Agreement dated as of December 1, 2001, by and among
Credit Store Financial, Inc., the Company, and The Varde Fund IV-A, L.P.**
** Denotes confidential information that has been omitted from the exhibit and
filed separately, accompanied by a confidential treatment request, with the
Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities
Exchange Act of 1934.
(B) REPORTS ON FORM 8-K
The issuer filed a current report on Form 8-K dated April 19, 2002, reporting
certain other material events under Item 5.
28
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: May 15, 2002 By: /s/ Kevin T. Riordan
----- ------------ --------------------
President and Chief Operating Officer
DATE: May 15, 2002 By: /s/ Michael J. Philippe
----- ------------ -----------------------
Chief Financial Officer
S-1