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 February 28, 2001
or
| | Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the Transition Period From _______ to _______.
Commission file number __________
THE CREDIT STORE, INC.
- --------------------------------------------------------------------------------
(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
----------------------
Registrant's telephone number
Not Applicable
- --------------------------------------------------------------------------------
(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 March 31, 2001.
THE CREDIT STORE, INC.
FORM 10-Q
For the Quarter Ended February 28, 2001
INDEX
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (Unaudited):
Condensed Consolidated Balance Sheets as of February 28, 2001
and May 31, 2000 3
Condensed Consolidated Statements of Operations
for the three months ended February 28, 2001 and
February 29, 2000 4
Condensed Consolidated Statements of Operations
for the nine months ended February 28, 2001 and
February 29, 2000 5
Condensed Consolidated Statements of Cash Flows
for the nine months ended February 28, 2001 and
February 29, 2000 6
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk 13
PART II. OTHER INFORMATION 14
Item 1. Legal Proceedings 14
Item 2. Changes in Securities 14
Item 3. Defaults under Senior Securities 14
Item 4. Submission of Matters to Vote of Security Holders 14
Item 5. Other Information 15
Item 6. Exhibits and Reports on Form 8-K 15
SIGNATURES 17
2
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THE CREDIT STORE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
February 28, May 31,
2001 2000
--------------- --------------
(Unaudited)
ASSETS
Cash and cash equivalents $ 3,212,608 $ 1,423,248
Restricted cash 1,250,000 1,025,631
Accounts and notes receivable, net 4,018,713 2,765,882
Prepaid expenses 1,177,328 1,341,516
Amounts due from special purpose entities 669,121 9,332,890
Investments in receivable portfolios, net 40,209,594 33,892,290
Investment in unconsolidated affiliates 1,161,897 1,279,888
Retained interest in securitized receivables 4,825,011 2,142,846
Property and equipment, net of accumulated depreciation 5,952,272 4,790,060
Goodwill, net 2,192,616 2,347,999
Deferred tax asset 2,700,000 2,700,000
Other assets 1,072,119 1,345,942
-------------- --------------
Total assets $ 68,441,279 $ 64,388,192
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Accounts payable and accrued expenses $ 6,135,620 $ 4,499,142
Notes payable 25,856,004 23,609,326
Capitalized lease obligations 4,259,906 2,766,228
Subordinated notes and accrued interest payable -
related party 20,002,251 19,139,028
-------------- --------------
Total liabilities 56,253,781 50,013,724
-------------- --------------
STOCKHOLDERS' EQUITY
Preferred Stock, Series A, B, C, D and E 27,000,000 27,000,000
Common Stock, $.001 par value, 65,000,000 authorized, 34,851,465 and
34,761,965 outstanding at February 28, 2001 and May 31, 2000 34,851 34,762
Additional paid-in capital 23,972,421 23,743,260
Unrealized gain from retained interest in securitized
receivables, net of tax 2,020,606 638,227
Accumulated deficit (40,840,380) (37,041,781)
-------------- --------------
Total stockholders' equity 12,187,498 14,374,468
-------------- --------------
Total liabilities and stockholders' equity $ 68,441,279 $ 64,388,192
============== ==============
The accompanying notes are an integral part of these statements.
3
THE CREDIT STORE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended
-------------------------------
February 28, February 29,
2001 2000
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Revenue
Income from receivables $ 10,168,433 $ 7,816,171
Gain on sales of portfolios and retained interests 577,985 555,411
Servicing fees and other income 1,062,546 398,071
Provision for losses (1,457,485) (1,007,602)
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Net revenue 10,351,479 7,692,051
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Expenses
Salaries and employee benefits 3,511,971 3,281,893
Professional and financing fees 939,127 808,058
Credit card servicing 1,928,483 1,946,384
Occupancy and equipment expense 801,891 816,388
Other 1,034,066 1,508,558
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Total expenses 8,215,538 8,361,281
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Operating income (loss) 2,135,941 (669,230)
Interest expense 1,460,334 1,166,698
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Income (loss) before income taxes 675,607 (1,835,928)
Income tax expense -- --
------------- -------------
Net income (loss) 675,607 (1,835,928)
Dividends on preferred stock (500,000) (500,000)
------------- -------------
Net income (loss), applicable to
common shareholders $ 175,607 $ (2,335,928)
============= =============
Net income (loss) per share
Basic $ .01 $ (.07)
============= =============
Diluted $ .00 $ (.07)
============= =============
Weighted-average common shares outstanding
Basic 34,851,042 34,761,965
============= =============
Diluted 35,491,342 34,761,965
============= =============
The accompanying notes are an integral part of these statements.
4
THE CREDIT STORE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Nine Months Ended
--------------------------------
February 28, February 29,
2001 2000
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Revenue
Income from receivables $ 30,605,069 $ 22,987,854
Gain on sales of portfolios and retained interests 1,146,367 6,891,632
Servicing fees and other income 2,845,127 1,744,132
Provision for losses (7,063,454) (4,815,469)
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Net revenue 27,533,109 26,808,149
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Expenses
Salaries and employee benefits 10,435,176 9,897,670
Professional and financing fees 3,573,816 2,675,516
Credit card servicing 6,155,714 5,134,976
Occupancy and equipment expense 2,331,328 2,542,404
Other 4,574,055 3,274,408
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Total expenses 27,070,089 23,524,974
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Operating income 463,020 3,283,175
Interest expense 4,261,618 3,306,152
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Loss before income taxes (3,798,598) (22,977)
Income tax expense -- (1,286,409)
------------- --------------
Net loss (3,798,598) (1,309,386)
Dividends on preferred stock (1,500,000) (1,500,000)
------------- -------------
Net loss, applicable to
common shareholders $ (5,298,598) $ (2,809,386)
============= =============
Net loss per share
Basic $ (.15) $ (.08)
============= =============
Diluted $ (.15) $ (.08)
============= =============
Weighted-average common shares outstanding
Basic 34,823,124 34,761,965
============= =============
Diluted 34,823,124 34,761,965
============= =============
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
---------------------------------------
February 28, February 29,
2001 2000
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Cash flows from operating activities:
Net loss $ (3,798,598) $ (1,309,386)
Adjustments to reconcile net loss to
net cash used in operating activities -
Provision for credit card losses 7,063,454 4,815,469
Amortization of receivable portfolios discount (14,567,567) (969,743)
Depreciation and amortization 1,454,894 1,930,680
(Gain) loss from unconsolidated affiliates (29,873) 362,789
Gain on sale of portfolios and retained interests (1,146,367) (5,260,358)
Other 25,534 --
Deferred tax expense -- 1,286,409
Changes in operating assets and liabilities:
Restricted cash (224,369) (75,029)
Accounts and notes receivable (753,311) (1,696,167)
Prepaid expenses 166,052 (619,668)
Receivable from unconsolidated affiliate 8,663,769 1,230,700
Accrued interest and fees receivable (1,015,947) (1,314,620)
Other assets (67,123) 74,551
Unearned fees (150,886) 170,813
Accounts payable and accrued expenses 2,499,701 (895,114)
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Net cash used in
operating activities (1,880,637) (2,268,674)
-------------- --------------
Cash flows from investing activities:
Collection of investments in receivable portfolios 27,246,904 16,864,934
Funds advanced on securitized credit card receivables (960,206) (2,036,060)
Funds advanced on credit cards (21,343,444) (21,999,736)
Purchase of consumer debt portfolios (4,055,708) (12,120,658)
Proceeds from sale of portfolios and retained interests 1,146,367 8,643,233
Acquisition of property and equipment (2,462,486) (267,395)
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Net cash used in
investing activities (428,573) (10,915,682)
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Cash flows from financing activities:
Net proceeds (payments) from debt 2,246,678 13,745,342
Borrowings from sale/leaseback transactions 2,739,234 539,438
Payments on capital lease obligations (1,245,556) (1,604,606)
Partner distributions from unconsolidated affiliates 147,864 --
Proceeds from exercises of stock options 210,350 --
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Net cash provided by
financing activities 4,098,570 12,680,174
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Net increase (decrease) in cash and cash equivalents 1,789,360 (504,182)
Cash and cash equivalents at beginning of period 1,423,248 3,533,930
------------- -------------
Cash and cash equivalents at end of period $ 3,212,608 $ 3,029,748
============= =============
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, Inc. is a technology based, financial services company that
provides credit card products to consumers who may otherwise fail to qualify for
a traditional unsecured bank credit card. The Company reaches these consumers by
acquiring portfolios of non-performing consumer receivables and offering a new
credit card to those consumers who agree to pay all or a portion of the
outstanding amount due on their debt and who meet the Company's underwriting
guidelines. The new card is issued with an initial balance and credit line equal
to the agreed repayment amount. After the consumers have made a certain number
of on-time payments on their outstanding credit card balance, the Company seeks
to finance, sell or securitize the credit card receivables generated by this
business strategy. To those consumers who do not accept the credit card offer,
the Company will accept lump sum settlements and installment payment plans.
The Company has four subsidiaries, Credit Store Services, Inc., Credit Store
Capital Corp., American Card Alliance, Inc. and TCS Funding IV, Inc. These
subsidiaries are wholly owned by the Company; however, only Credit Store Capital
Corp. and American Credit Alliance, Inc. are consolidated in the enclosed
financial statements. Credit Store Services, Inc. and Credit Store Capital Corp.
acquire non-performing consumer receivables and contract with the Company to
offer consumers a credit card under the Company's program or to accept
settlements or payment plans. See Note E - Securitization of Receivable
Portfolios. American Credit Alliance owns a 50% interest in Dakota Card Fund II,
LLC, a limited liability company that contracts with the Company to service
non-performing receivables and credit card receivables that it owns. TCS Funding
IV, Inc. was established for the purpose of purchasing performing credit card
receivables from the Company. See Note E - Securitization of Receivable
Portfolios.
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 generally accepted accounting
principles 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 May 31, 2000 contained in the Company's annual report on Form
10-K/A for the year ended May 31, 2000.
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 February
28, 2001, the results of operations for the three months ended February 28, 2001
and February 29, 2000, and the results of operations and cash flows for the nine
months ended February 28, 2001 and February 29, 2000. The results of operations
for the nine months ended February 28, 2001 are not necessarily indicative of
the results for the full year.
NOTE C - NET INCOME (LOSS) PER SHARE
The Company's basic net income (loss) per 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 dividends on preferred stock from
net income or net loss. The Company's diluted net income (loss) per share is
computed by dividing net income (loss) by the weighted average number of
outstanding common shares and common share equivalents relating to stock
options, when dilutive.
7
NOTE D - ACCOUNTING METHODOLOGY CHANGE FOR INVESTMENTS IN RECEIVABLE PORTFOLIOS
Effective June 1, 2000, the Company accounts for its investment in receivable
portfolios on the accrual basis of accounting in accordance with the provisions
of the AICPA's Practice Bulletin 6, "Amortization of Discounts on Certain
Acquired Loans." Prior to June 1, 2000, the Company used the cost recovery
method of accounting. Practice Bulletin 6 requires that the accrual basis of
accounting be used at the time the amount and timing of portfolio projected cash
flows can be reasonably estimated and collection is probable. The Company has
established projection models from historical portfolio data that it believes
provides appropriate information to reasonably estimate future cash flows.
Under the accrual basis of accounting, static pools are established with
accounts having similar attributes, based on the specific seller and the timing
of the acquisition. Once a static pool is established, the receivables are
permanently assigned to the pool. The discount (i.e., the difference between the
cost of each static pool and the related aggregate contractual receivable
balance) is not recorded because the Company expects to collect a relatively
small percentage of each static pool's contractual receivable balance.
The Company accounts for each static pool as a unit for the economic life of the
pool for recognition of income from receivable portfolios, for collections
applied to principal of receivable portfolios and for provision for loss or
impairment. Income from receivable portfolios is accrued based on the effective
interest rate determined for each pool applied to each pool's carrying value as
of June 1, 2000 or its cost if purchased after June 1, 2000, adjusted for unpaid
accrued income and principal paydowns. The effective interest rate is the
internal rate of return determined based on the timing and amounts of actual
cash received since the date of adoption or since inception if purchased after
June 1, 2000 and anticipated future cash flow projections for each pool.
The Company monitors impairment of receivable portfolios based on discounted
projected future cash flows of each portfolio compared to each portfolio's
carrying amount. The receivable portfolios are evaluated for impairment
periodically based on current market and cash flow assumptions. Provisions for
losses are charged to earnings when it is determined that the investment in a
receivable portfolio is greater than the present value of expected future cash
flows. No such provision for losses was recorded in the three or nine months
ended February 28, 2001.
The change to the accrual method resulted in an increase of $10.6 million in
income from credit card receivables during the first nine months of fiscal 2001,
compared to the amount that would have been reported under the cost recovery
method previously used, and an increase of $3.29 million in provision for losses
on credit card receivables. Prior periods are not required to be restated.
NOTE E - SECURITIZATION OF RECEIVABLE PORTFOLIOS
During the year ended May 31, 2000, the Company established a wholly-owned
qualified special purpose entity (SPE), TCS Funding IV, Inc. (TCS IV), for the
purpose of purchasing performing credit card receivables from the Company. TCS
IV entered into a $40.0 million credit facility with a lending institution to
finance the purchase of credit card receivables. The initial sale of credit card
receivables to the SPE was for approximately $12.1 million. TCS IV provided
$10.0 million of the purchase price and the remaining approximately $2.1 million
was recorded as retained interest by the Company. The unrealized gain of
approximately $638 thousand, included in the retained interest, was recorded net
of tax as a separate component of stockholders equity.
During October 2000, the Company established a new wholly-owned qualified
special purpose entity (SPE), Credit Store Services, Inc. (CSSI), for the
purpose of purchasing non-performing consumer debt portfolios from the Company.
The Company contracts with CSSI to offer consumers credit cards under the
Company's program or to accept settlements or payment plans. Non-performing
consumer debt portfolio sales to CSSI are equal to the Company's book value.
CSSI entered into a $25.0 million credit facility with a lending institution to
finance a portion of acquired portfolios at the lender's discretion, which
facility expires in October 2003. During the three months ended February 28,
2001, the Company sold approximately $396.5 million of face value at a sales
price of $5.4 million to CSSI. As of February 28, 2001, the outstanding balance
under CSSI's credit facility was $6.2 million, with $18.8 million available for
future borrowings. The terms of the credit facility also provide that a
percentage of the future cash flow of the purchased accounts be paid to the
lender after the payment of principal and interest for amounts borrowed.
The following summarizes the changes in the balance of the Company's retained
interest for the nine months ended February 28, 2001:
Gross Estimated
Amortized unrealized fair
cost gains value
---------- ---------- ----------
Balance at beginning of period $1,175,837 $ 967,011 $2,142,848
Retained interests in portfolios sold 684,217 - 684,217
Interest accrued 615,567 - 615,567
Change in unrealized gain - 1,382,379 1,382,379
---------- ---------- ----------
Balance at end of period $2,475,621 $2,349,390 $4,825,011
========== ========== ==========
As of February 28, 2001, retained interest with an amortized cost of $2,475,621
and an estimated fair value of $4,825,011 were "available-for-sale." This
resulted in a net unrealized gain of $2,349,390, net of a deferred tax expense
of $328,784.
8
NOTE F - 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 actions
alleging violation of the Fair Debt Collection Practices Act ("FDCPA") and/or
state law in connection with mailers sent to prospective customers whose debt
was out-of-statute, and (ii) one class action alleging RICO and FDCPA claims
arising out of the reporting of credit information. The Company is defending
itself vigorously in these lawsuits. The Company does not believe that pending
litigation and regulatory complaints involving the Company will have a material
adverse effect on the consolidated financial position and results of operations.
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 G - DEVELOPMENT AGREEMENTS
In October 1996, the Company's predecessor entered into two Business Development
Agreements (the "Development Agreements"). The party to one of the Development
Agreements is a beneficial owner of 4 million shares of the Company's common
stock and 400 thousand shares of the Company's Series B Preferred Stock. Both
agreements are currently in dispute. The Company has questioned whether the
Development Agreements provide adequately for consideration to the Company, and
if so, whether such consideration has been provided to the Company. Payments of
royalties under both Development Agreements were discontinued in February 2001.
The issue of the Company's continuing obligation is under discussion among the
contracting parties.
NOTE H - 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 remaining outstanding balance of the debt acquired by the Company at
February 28, 2001 and May 31, 2000 was approximately $3.5 billion and $3.1
billion, respectively. The Company's objective is to offer the consumer an
opportunity to settle these debts, typically at a discount, and transfer the
settled amount to a newly issued credit card. 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.
9
The following summarizes the components in the balance of the investments in
receivable portfolios for the following periods:
February 28, May 31,
2001 2000
------------- --------------
(unaudited)
Cost and accretion $ 12,866,828 $ 9,648,090
------------- -------------
Principal funded on new advances and purchases $ 31,661,047 $ 26,536,055
Accrued interest on principal funded 389,016 420,383
Accrued fees 342,274 429,727
------------- -------------
32,392,337 27,386,165
------------- -------------
Less
Provision for losses on credit card receivables 4,534,330 2,475,838
Unearned fees 515,241 666,127
------------- -------------
5,049,571 3,141,965
------------- -------------
Investments in receivable portfolios $ 40,209,594 $ 33,892,290
============= =============
Total credit card balances (1) $ 88,717,391 $ 77,832,562
============= =============
Available credit (2) $ 9,616,502 $ 7,837,918
============= =============
(1) Total credit card balances in the chart 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.
10
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. 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. (the "Company", "us" and "our") is a technology based,
financial services company that provides credit card products to consumers who
may otherwise fail to qualify for a traditional unsecured bank credit card. The
Company reaches these consumers by acquiring portfolios of non-performing
consumer receivables and offering a new credit card to those consumers who agree
to pay all or a portion of the outstanding amount due on their debt and who meet
the Company's underwriting guidelines. The new card is issued with an initial
balance and credit line equal to the agreed repayment amount. After the
consumers have made a certain number of on-time payments on their outstanding
credit card balance, the Company seeks to finance, sell or securitize the credit
card receivables generated by this business strategy. The Company offers other
forms of settlement to those consumers who do not accept the credit card offer.
RESULTS OF OPERATIONS
THREE MONTHS ENDED FEBRUARY 28, 2001 COMPARED TO THREE MONTHS ENDED FEBRUARY 29,
2000:
REVENUES. Net revenue for the quarter ended February 28, 2001 was $10.35
million, a 34.6% increase from the $7.69 million recorded during the quarter
ended February 29, 2000. Core revenue, defined as income from receivables and
servicing fees and other income, increased 36.7% during the third quarter of
fiscal year 2001 as compared to the third quarter of fiscal year 2000 impacted
positively by the adoption of accrual accounting for receivable portfolios.
Gains from sales of portfolios and retained interests in securitized receivables
increased 4.1% from $0.56 million in the quarter ended February 29, 2000 to
$0.58 million in the quarter ended February 28, 2001. The provision for losses
increased 35.3% from $1.01 million in the quarter ended February 29, 2000 to
$1.46 million in the quarter ended February 28, 2001 and remained stable as a
percentage of core revenue at 13.1% in the quarter ended February 29, 2000 and
13.0% in the quarter ended February 28, 2001.
During the first quarter of Fiscal 2001, the Company adopted the accrual method
of accounting for its investment in receivable portfolios. Prior to June 1,
2000, the Company used the cost recovery method of accounting. Under cost
recovery all cash receipts relating to individual portfolios of nonperforming
consumer debt are applied first to recover the cost of the portfolios, prior to
recognizing any revenue. The accrual method recognizes the discount on acquired
portfolios over the period in which the payments are probably of collection. The
recognition of this disount is based on the effective interest rate of each
portfolio. The accrual method accelerates the recognition of revenue as compared
to the cost recovery method. For the third quarter of fiscal 2001, the adoption
of the accrual method of accounting resulted in an increase of $2.95 million in
income from credit card receivables, and an increase of $937 thousand in
provision for losses on credit card receivables.
EXPENSES. Total operating expenses for the quarter ended February 28, 2001 were
$8.22 million, a 1.7% decrease from $8.36 million in the quarter ended February
29, 2000. Salaries and employee benefits increased 7.0% from $3.28 million in
the quarter ended February 29, 2000 to $3.51 million in the quarter ended
February 28, 2001, and decreased as a percentage of core revenue from 40.0% in
the quarter ended February 29, 2000 to 31.3% in the quarter ended February 28,
2001. Professional and financing fees increased 16.2% from $0.81 million in the
quarter ended February 29, 2000 to $0.94 million in the quarter ended February
28, 2001 and as a percentage of core revenue decreased from 9.8% in the quarter
ended February 29, 2000 to 8.4% in the quarter ended February 28, 2001. Credit
card servicing remained constant at $1.95 million in the quarter ended February
29, 2000 and $1.93 million in the quarter ended February 28, 2001 and as a
percentage of core revenue decreased from 23.7% in the quarter ended February
29, 2000 to 17.2% in the quarter ended February 28, 2001. Other expenses
decreased 31.5% from $1.51 million in the quarter ended February 29, 2000 to
$1.03 million in the quarter ended February 28, 2001 and decreased as a percent
of core revenues from 18.4% in the quarter ended February 29, 2000 to 9.2% in
the quarter ended February 28, 2001.
11
INTEREST EXPENSE. Interest expense increased 25.2% from $1.17 million in the
quarter ended February 29, 2000 to $1.46 million in the quarter ended
February 28, 2001, based on a higher average amount of debt outstanding. As a
percentage of core revenue, interest expense decreased from 14.2% in the quarter
ended February 29, 2000 to 13.0% in the quarter ended February 28, 2001.
INCOME TAX EXPENSE. No income tax expense was recorded the third quarters of
fiscal year 2001 and 2000 as the fiscal year to date corresponding periods
reflect net losses.
NET INCOME (LOSS). Net income was $0.68 million for the quarter ended February
28, 2001 compared to a net loss of $1.84 million in the quarter ended February
29, 2000. Dividends on preferred stock have accumulated but have not been
declared and are not yet payable. The Company, however, treats 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 $0.50 million
in both quarters, the net income applicable to common shareholders was $0.18
million, or $.01 and $.00 per basic and diluted common share, in third quarter
of fiscal year 2001, compared to a net loss of $2.34 million, or ($.07) per
basic and diluted common share, in the third quarter of fiscal year 2000.
NINE MONTHS ENDED FEBRUARY 28, 2001 COMPARED TO NINE MONTHS ENDED FEBRUARY 29,
2000:
REVENUES. Net revenue for the nine months ended February 28, 2001 was $27.53
million, a 2.7% increase from the $26.81 million recorded during the nine months
ended February 29, 2000. Core revenue, defined as income from receivables and
servicing fees and other income, increased 35.3% during the first nine months of
fiscal year 2001 as compared to the first nine months of fiscal year 2000, and
was impacted positively by the adoption of accrual accounting for receivable
portfolios. Gains from sales of portfolios and retained interests in securitized
receivables decreased 83.4% from $6.89 million in the nine months ended February
29, 2000 to $1.15 million in the nine months ended February 28, 2001 due to the
sale of three special purpose entities in November 1999 with no similar event
during the first nine months of fiscal year 2001. The provision for losses
increased 46.7% from $4.82 million in the nine months ended February 29, 2000 to
$7.06 million in the nine months ended February 28, 2001 and increased as a
percentage of core revenue from 19.5% in the nine months ended February 29, 2000
to 21.1% in the nine months ended February 28, 2001.
During the first quarter of Fiscal 2001, the Company adopted the accrual method
of accounting for its investment in receivable portfolios. Prior to June 1,
2000, the Company used the cost recovery method of accounting. Under cost
recovery all cash receipts relating to individual portfolios of nonperforming
consumer debt are applied first to recover the cost of the portfolios, prior to
recognizing any revenue. The accrual method recognizes the discount on acquired
portfolios over the period in which the payments are probably of collection. The
recognition of this disount is based on the effective interest rate of each
portfolio. The accrual method accelerates the recognition of revenue as compared
to the cost recovery method. For the first nine months of fiscal 2001, the
adoption of the accrual method of accounting resulted in an increase of $10.56
million in income from credit card receivables, and an increase of $3.29 million
in provision for losses on credit card receivables.
EXPENSES. Total operating expenses for the nine months ended February 28, 2001
were $27.07 million, a 15.1% increase from $23.53 million in the nine months
ended February 29, 2000. Increased expenses were largely related to a 20.3%
increase in credit card receivables owned and managed from $96.50 million for
the nine months ended February 29, 2000 to $116.06 million for the nine months
ended February 28, 2001. Salaries and employee benefits increased 5.4% from
$9.90 million in the nine months ended February 29, 2000 to $10.44 million in
the nine months ended February 28, 2001and decreased as a percentage of core
revenue from 40.0% in the nine months ended February 29, 2000 to 31.2% in the
nine months ended February 28, 2001. Professional and financing fees increased
33.6% from $2.68 million in the nine months ended February 29, 2000 to $3.57
million in the nine months ended February 28, 2001 and as a percentage of core
revenue remained constant at 10.8% in the nine months ended February 29, 2000
compared to 10.7% in the nine months ended February 28, 2001. Credit card
servicing increased 19.9% from $5.13 million in the nine months ended February
29, 2000 to $6.16 million in the nine months ended February 28, 2001 and as a
percentage of core revenue decreased from 20.8% in the nine months ended
February 29, 2000 to 18.4% in the nine months ended February 28, 2001. Other
expenses increased 39.7% from $3.27 million in the nine months ended February
29, 2000 to $4.57 million in the nine months ended February 28, 2001. Other
expenses increased slightly as a percent of core revenues from 13.2% in the nine
months ended February 29, 2000 to 13.7% in the nine months ended February 28,
2001.
INTEREST EXPENSE. Interest expense increased 28.9% from $3.31 million in the
nine months ended February 29, 2000 to $4.26 million in the nine months ended
February 28, 2001, based on a higher average amount of debt outstanding. As a
percentage of core revenue, interest expense decreased from 13.4% in the nine
months ended February 29, 2000 to 12.7% in the nine months ended February 28,
2001.
12
INCOME TAX EXPENSE. The company recorded a $1.29 million tax expense during the
nine months ended February 29, 2000 as a result of the gain from sale of the
retained interests in its securitizations. No income tax benefits related to the
net loss were recorded in the nine months ended February 28, 2001 due to the
uncertainty as to the recognition of these future tax benefits.
In prior years, the Company has recognized a tax benefit and deferred tax asset
for a portion of its net operating loss carryforward that had been previously
offset by a valuation allowance. This tax benefit was recorded due to the
achievement of net income in fiscal 2000 and 1999 and the projection of net
income in future years at levels greater than 2000 and 1999. The recognition of
net income for fiscal 2001 is dependent on the sale of seasoned credit card
accounts in the fourth quarter as planned in the forecast. No additional tax
benefit has been recognized in the quarter ending February 28, 2001 pending the
execution of these planned transactions.
NET LOSS. Net loss was $1.31 million of rate nine months ended February 29, 2000
compared to a net loss of $3.80 million in the nine months ended February 28,
2001. Dividends on preferred stock have accumulated but have not been declared
and are not yet payable. The Company, however, treats 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 $1.5 million in
each none month period, the net loss applicable to common shareholders was $2.81
million, or ($.08) per basic and diluted common share, in the first nine months
of fiscal year 2000, compared to a net loss of $5.30 million, or ($.15) per
basic and diluted common share, in the first nine months of fiscal year 2001.
LIQUIDITY AND CAPITAL RESOURCES
The Company seeks 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 its assets and liabilities change, liquidity management is a
dynamic process affected significantly by the maturity of the Company's assets
and the seasonality of the credit card business. At February 28, 2001, the
Company had $3.21 million of cash and cash equivalents, compared to $1.42
million at May 31, 2000. The Company maintains restricted cash reserves at its
banks to facilitate the funding of new charges and advances on its customer's
credit cards. These restricted balances were $1.25 million at February 28, 2001,
and $1.03 million at May 31, 2000.
The Company maintains a senior secured revolving credit line with Coast Business
Credit, a division of Southern Pacific Bank. The credit line is for $15 million
and is secured by substantially all of the Company's assets. Borrowings under
the credit line are based on a formula, which is dependent primarily upon the
performance and maturity of the Company's credit card receivables. There was
$14.31 million outstanding under the credit line at February 28, 2001, with
$0.69 million available for future borrowings. The Company has entered into an
amendment with Coast Business Credit to extend the credit line from July 7, 2001
through May 31, 2002. The amendment reduces the amount available to the Company
to $13 million after June 30, 2001, $10 million after September 30, 2001, $7.5
million after December 31, 2001, and $5.0 million by March 31. The Company may
add participating lenders to the Coast credit line to increase the amounts
available to the Company. The Company is in discussion with potential
participants and replacement lenders to increase the amounts available to the
Company for working capital purposes. There can be no assurance that the Company
will be successful in obtaining participants in or a replacement for the Coast
credit line. The Company believes the existing credit facility, as extended,
together with amounts expected to be received by the Company from
securitizations and credit card portfolio sales, will be adequate to meet its
working capital needs through the Company's third fiscal quarter of 2002.
The Company has also received secured financing from a related party, J.L.B. of
Nevada, Inc., which is subordinated to the senior secured revolving credit line.
The principal amount outstanding on these notes totaled $17.32 million and
accrued but unpaid interest totaled $2.68 million at February 28, 2001.
The Company has a $17.5 million secured revolving credit line with General
Electric Capital Corporation to finance the acquisition of non-performing
consumer debt portfolios. The borrower is a wholly owned, bankruptcy remote
special purpose entity established by the Company for this transaction and is
fully consolidated with the Company's financial results. Borrowings are
non-recourse to the Company and based on the age of the non-performing consumer
debt portfolios acquired by the Company coupled with contracts that the
subsidiary enters into to resell portfolios to other debt buyers. There was
$2.74 million outstanding under the credit line at February 28, 2001 with $0.09
million available for future borrowings.
13
The Company entered into a credit card receivables repurchase agreement with a
bank in December 2000, whereby the bank purchased credit card receivables from
the Company for a purchase price of $8.0 million. This agreement was used to
repay an existing $6.0 million repurchase agreement.
The Company's wholly-owned qualified special purpose entity TCS Funding IV, Inc.
has a $40.0 million credit facility with a lending institution to finance the
purchase of credit card receivables. On May 31, 2000, $10.0 million of the
facility was used to purchase credit card receivables with a principal balance
of $14.2 million at a purchase price of $12.1 million with $2.1 million of the
purchase price recorded by the Company as a retained interest. Future borrowings
under the facility are subject to the lender's discretion and a number of other
conditions.
During the second quarter of fiscal 2001, the Company established a new
wholly-owned qualified special purpose entity, Credit Store Services, Inc.
("CSSI"), for the purpose of purchasing non-performing consumer debt portfolios
from the Company. Non-performing consumer debt portfolio sales to CSSI are equal
to the Company's book value. CSSI entered into a $25.0 million credit facility
with a lending institution to finance a portion of non-performing consumer debt
portfolio acquisitions at the lender's discretion. As of February 28, 2001, the
outstanding balance under CSSI's credit facility was $6.25 million, with $18.75
million available for future borrowings at the lender's discretion. The terms of
the credit facility also provide that a percentage of the future cash flow of
the purchased accounts be paid to the lender after the payment of principal and
interest for amounts borrowed.
INFLATION
The Company believes that inflation has not had a material impact on its results
of operations for the nine months ended February 28, 2001.
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
This Form 10-Q for the third quarter ended February 28, 2001 contains
forward-looking statements within the meaning of the safe harbor provisions of
Section 21E of the Securities Exchange Act of 1934. These forward-looking
statements are based on the beliefs of our management as well as on assumptions
made by and information currently available to us at the time the statements
were made. When used in this Form 10-Q, the words "anticipate", "believe",
"estimate", "expect", "intend" and similar expressions, as they relate to us,
are intended to identify the forward-looking statements. Although we believe
that these statements are reasonable, you should be aware that actual results
could differ materially from those projected by the forward-looking statements.
Because actual results may differ, readers are cautioned not to place undue
reliance on forward-looking statements. Factors that may cause our actual
results to differ from those projected include, among others, the following: Our
credit card portfolio may not perform as well as we expect and may not generate
sufficient cash flows to fund our operations. We may not be able to finance our
operations if we are unable to sell our credit card receivables, if we are
unable to secure future financing, including credit line increases, or if we are
unable to control our expenses. The market for the sale or securitization of our
credit card receivables is limited and could be further limited if there is an
increase in competition or regulatory burdens on the industry or if the economy
declines. Our operations could be adversely affected if our suppliers and
vendors on which we rely to issue and service our credit card products fail to
perform or discontinue their agreements with us. If competition increases or if
the economy fluctuates, we may not be able to acquire enough credit card
receivables on favorable terms to operate profitably. In addition, we could
experience a shortfall in revenue if our customers do not pay on their
outstanding card balances. We may also be subject to adverse legal
determinations in lawsuits pending against us or filed in the future. Additional
factors that could cause actual results to differ include: risks associated with
future growth; fluctuations in operating results; the need for additional
capital; risks associated with consumer acceptance of our products; inability to
compete with competitors; potential labor shortages; and our failure to comply
with consumer and debtor protection laws and regulations. Certain of these risk
factors are more fully discussed in the Company's Amended Annual Report on Form
10-K/A filed with the Securities and Exchange Commission on September 28, 2000.
We caution you, however, that the list of factors above 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. 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.
14
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and rates.
The Company's principal market risk is due to changes in interest rates. These
changes affect the Company directly in its lending and borrowing activities, as
well as indirectly as interest rates may impact the payment performance of the
Company's credit card holders.
To manage the Company's direct risk to market interest rates, management
actively monitors the interest rates and the interest sensitive components of
the Company's balance sheet to minimize the impact changes in interest rates
have on the fair value of assets, net income and cash flow. Management seeks to
minimize the impact of changes in interest rates on the Company primarily by
matching asset and liability repricings.
The Company's credit card receivables earn interest at a fixed annual percentage
rate. The Company's fixed annual percentage rate credit card receivables have no
stated maturity or repricing period. However, the Company may reprice its credit
card receivables upon providing the required prior notice to the customer, which
is generally no more than 60 days.
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. 125. This original cost basis is
adjusted to fair value, which is based on the discounted anticipated future cash
flows on a "cash out" basis, with such adjustment (net of related deferred
income taxes) recorded as a component of other comprehensive income. The cash
out method projects cash collections to be received only after all amounts owed
to investors have been remitted. On a quarterly basis, management reviews the
fair value assumptions which are based on the current cash flow projections
discounted at an effective rate that reflects a current risk-adjusted rate of
return that a knowledgeable investor would require.
If the annual effective interest rate for the retained interest averages 10%
more in 2002 than the effective interest rate as of February 28, 2001, the
increase in the unrealized gain would be approximately $250,000 greater during
the next 12 month period. Conversely, if the annual effective rate for the
retained interest averages 10% less, the decrease in the unrealized gain would
be approximately $250,000 lower during the next 12 month period.
The interest rates on our notes payable are generally indexed to the prime rate.
Changes in short-term interest rates will affect our earnings. If the market
interest rates for variable rate agreements increase or decrease at an average
of 10%, interest expense would increase, and income before income taxes would
not change by a material amount. The Company has not entered into derivative
transactions to hedge the interest rate risk.
15
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
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. The Company is defending itself vigorously in these lawsuits. The
Company does not believe that these suits will have a material adverse effect on
the 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.
On May 27, 1999, the Company was sued on behalf of a class of Florida debtors in
the United States District Court for the District of Florida in an action
entitled McIntyre v. Credit Store Inc. On May 21, 1999, the Company was sued on
behalf of a class of Arizona debtors in the United States District Court for the
District of Arizona in an action entitled Bingham v. The Credit Store, Inc. The
Company's motions to dismiss these cases were granted and the suits have been
dismissed. The time for appeal of the ruling in McIntyre has expired and , while
the ruling in Bingham is subject to a motion for reconsideration which is
pending. For more information, see the Company's Quarterly Report on Form 10-Q
for the quarterly period ended November 30, 2000 (File No. 001-16083).
On August 25, 2000, we were named as a co-defendant in an action brought on
behalf of a class of debtors in the United States District Court for the Eastern
District of Texas in an action entitled Barnett v. Experian Information
Solutions, et al. The plaintiffs claim that their debt was improperly reported
as a bad debt on a credit-reporting bureau, Experian Information Solutions,
Inc., which was also named as a defendant. On February 13, 2001 Plaintiffs
amended their complaint which asserts claims against the Company under the Fair
Debt Collection Practices Act and RICO and seeks unspecified actual damages. For
more information, see the Company's Quarterly Report on Form 10-Q for the
quarterly period ended November 30, 2000 (File No. 001-16083).
The Court has granted final approval of the Settlement Agreement to resolve,
without admitting any liability or wrongdoing, Apostol, as Administrator for the
Estate of Curtis Kim v. M. Reza Fayazi, et al., McGlynn v. The Credit Store,
Inc., et al., and Le v. The Credit Store, Inc., et al. The Company is obligated
to pay $370,000 plus the costs of mailing and publication. Of this settlement
amount, the Company anticipates that its insurance will cover $230,000, plus 65%
of the costs of mailing and publication. For more information, see the Company's
Quarterly Report on Form 10-Q for the quarterly period ended August 31, 2000
(File No. 000-28709).
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.
16
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
The following exhibits are filed as part of this Quarterly Report on Form 10-Q
for the third quarter ended February 28, 2001:
Exhibit Description
------- -----------------------------------------
3.1 Amended and Restated Certificate of Incorporation.*
3.2 Amended and Restated By-Laws of the Company.**
4 Specimen certificate representing shares of Common Stock.*
10.23 Amended and Restated 1997 Stock Option Plan***
10.48 Letter Agreement dated February 27, 2001 amending that certain
Repurchase Agreement dated November 30, 2000 by and
between Bank of Hoven and The Credit Store, Inc.
10.49 Amendment Number Nine to Loan and Security Agreement dated as of
April 16, 2001 by and between The Credit Store, Inc. and Coast
Business Credit.
* Incorporated by reference to the like numbered Exhibit to the Company's
Registration Statement on Form 10 filed February 24, 2000 (File No. 000-28709).
** Incorporated by reference to the like numbered Exhibit to the Company's
Quarterly Report on Form 10-Q for the quarterly period ended November 30, 2000
(File No. 001-16083).
*** Incorporated by reference to Exhibit 4 to the Company's Registration
Statement on Form S-8 filed July 26, 2000 (File No. 333-42278).
# 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.
Copies of Exhibits will be furnished upon request and payment of the
Company's reasonable expenses in furnishing the Exhibits.
(B) REPORTS ON FORM 8-K
Not applicable.
17
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: April 16, 2001 By Kevin T. Riordan
-------------- ----------------
President and Chief Operating Officer
DATE: April 16, 2001 By Michael J. Philippe
-------------- -------------------
Chief Financial Officer
18
INDEX TO EXHIBITS
Exhibit Description
------- -----------------------------------------
3.1 Amended and Restated Certificate of Incorporation.*
3.2 Amended and Restated By-Laws of the Company.**
4 Specimen certificate representing shares of Common Stock.*
10.23 Amended and Restated 1997 Stock Option Plan***
10.48 Letter Agreement dated February 27, 2001 amending that certain
Repurchase Agreement dated November 30, 2000 by and
between Bank of Hoven and The Credit Store, Inc.
10.49 Amendment Number Nine to Loan and Security Agreement dated as of
April 16, 2001 by and between The Credit Store, Inc. and Coast
Business Credit.
* Incorporated by reference to the like numbered Exhibit to the Company's
Registration Statement on Form 10 filed February 24, 2000 (File No. 000-28709).
** Incorporated by reference to the like numbered Exhibit to the Company's
Quarterly Report on Form 10-Q for the quarterly period ended November 30, 2000
(File No. 001-16083).
*** Incorporated by reference to Exhibit 4 to the Company's Registration
Statement on Form S-8 filed July 26, 2000 (File No. 333-42278).
# 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.
19