As filed with the Securities and Exchange Commission on June 19, 2001
Registration No. 333-56456
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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AMENDMENT NO. 1
FORM S-1
REGISTRATION STATEMENT
Under The Securities Act of 1933
--------------------
THE CREDIT STORE, INC.
(Exact name of Registrant as specified in its charter)
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Delaware 6199 87-0296990
(State or other (Primary Standard (I.R.S. Employer
jurisdiction of Industrial Classification Identification No.)
incorporation or Code Number)
organization)
3401 North Louise Avenue
Sioux Falls, South Dakota 57107
(800) 240-1855
(Address, including zip code, and telephone number,
including area code, of Registrant's principal executive offices)
--------------------
Richard S. Angel, Esq.
The Credit Store, Inc.
3401 North Louise Avenue
Sioux Falls, South Dakota 57107
(800) 240-1855
(Name, address, including zip code, and telephone number,
including area code, of agent for service)
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Copy to:
Ralph J. Sutcliffe, Esq.
Kronish Lieb Weiner & Hellman LLP
1114 Avenue of the Americas
New York, New York 10036-7798
(212) 479 - 6000
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Approximate date of commencement of proposed sale to public: As soon as
practicable after this Registration Statement becomes effective.
If any of the securities being registered on this Form are to be offered
on a delayed or continuous basis pursuant to Rule 415 under the Securities Act
of 1933, check the following box: |X|
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering: |_|
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering: |_|
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering: |_|
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box: |_|
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CALCULATION OF REGISTRATION FEE
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Proposed
Title of Securities Amount to be Proposed Maximum Amount of
to be Registered Registered Maximum Aggregate Registration Fee
Offering Price (1) Offering Price
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Senior Subordinated Renewable Notes $100,000,000 100% $100,000,000 $25,000(2)
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Common Stock 8,000,000 shares(3) $1.65(4) $13,200,000 $3,300
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(1) Estimated solely for purposes of calculating the registration fee.
(2) Previously paid.
(3) Pursuant to Rule 416, an indeterminate number of additional shares of
common stock are registered hereunder which may be issued with respect to
the registered shares in the event of a stock split or stock dividend.
(4) Average of the high and low prices on June 14, 2001, pursuant to Rule
457(c).
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The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant shall
file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until the Registration Statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
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EXPLANATORY NOTE
This registration statement contains two prospectuses. The first
prospectus relates to a primary offering of subordinated renewable notes and is
produced in its entirety. The second prospectus relates to a secondary offering
of common stock and is created by substituting the pages numbered "S-" for
corresponding pages in the subordinated renewable notes prospectus.
The information in this prospectus is not complete and may be changed without
notice. We may not sell these securities until the registration statement filed
with the Securities and Exchange Commission is effective. This prospectus is not
an offer to sell these securities, and we are not soliciting offers to buy these
securities in any state where the offer or sale of these securities is not
permitted.
Subject to Completion, Dated June 19, 2001
[COMPANY LOGO]
$100,000,000 Principal Amount of Subordinated Renewable Notes
The Credit Store, Inc.
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The following terms apply to the subordinated renewable notes we are
offering. For a more detailed description, see "Description of Subordinated
Renewable Notes Offered and the Indenture. "
o Each subordinated renewable note will accrue interest at a rate
based on its maturity and the aggregate principal amount of the
portfolio of notes owned by you and your immediate family members.
The rate for each note will be fixed at issuance. We will provide
interest rates offered from time to time through supplements to this
prospectus.
o Interest will be paid monthly, quarterly, semi-annually, annually or
at maturity, at your election.
o You may redeem your subordinated renewable notes without penalty on
death or disability, or otherwise before maturity with penalty, up
to the maximum redemption cap.
o We may redeem the subordinated renewable notes without penalty on 30
days notice.
o Subordinated renewable notes will be offered with terms ranging from
three months to 120 months. You may select the term of your
subordinated renewable note at the time of purchase.
o The maturity of the subordinated renewable notes will automatically
be renewed for a period equal to the original term unless we or you
elect not to have them renewed.
o The subordinated renewable notes are unsecured and will be
subordinated to all of our existing debt and all of our future debt
other than debt that is specifically designated as ranking equal or
subordinate to the subordinated renewable notes.
o The subordinated renewable notes will not be transferable without
our consent.
The subordinated renewable notes will be offered on a best efforts basis
by us and by any placement agents or underwriters we engage from time to time.
There is no minimum offering amount we must reach before accepting subscriptions
and using the proceeds from the sale of any subordinated renewable notes.
There is no public trading market for the subordinated renewable notes and
it is unlikely that an active trading market will develop.
You should consider carefully the risk factors and the other information in this
prospectus before you decide to purchase any subordinated renewable notes. See
"Risk Factors" beginning on page 10.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed on the
adequacy or accuracy of this prospectus. Any representation to the contrary is a
criminal offense.
The date of this prospectus is __________, 2001
You should rely only on the information contained in this prospectus. We
have not authorized any other person to provide you with different information.
This prospectus is not an offer to sell, nor is it seeking an offer to buy,
these securities in any state where the offer or sale is not permitted. The
information in this prospectus is complete and accurate as of the date on the
front cover, but the information may have changed since that date.
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TABLE OF CONTENTS
Page
----
Summary........................................................................1
Risk Factors..................................................................10
Cautionary Note Regarding Forward - Looking Statements........................16
Use of Proceeds...............................................................17
Description of Subordinated Renewable Notes Offered and The Indenture.........18
Material United States Federal Income Tax Considerations......................27
Capitalization................................................................32
Selected Consolidated Financial and Other Data................................33
Management's Discussion and Analysis of Financial Condition and Results
of Operations.................................................................37
Business......................................................................51
Management....................................................................63
Security Ownership of Principal Stockholders and Management...................70
Certain Relationships and Related Transactions................................72
Market Price of and Dividends on Our Common Stock and Related Stockholder
Matters.......................................................................74
Description of Capital Stock..................................................75
Plan of Distribution..........................................................80
Legal Matters.................................................................81
Experts.......................................................................81
Where You Can Find More Information...........................................81
Index to Consolidated Financial Statements...................................F-1
Form of Subscription Agreement...............................................A-1
SUMMARY
This summary contains selected key information about us and the offering.
Because it is a summary, it does not contain all of the information you should
consider before investing. You should carefully read the more detailed
information set out in this prospectus, including the risk factors, our
consolidated financial statements and the notes related to our consolidated
financial statements.
General Information Regarding Our Business
The Credit Store 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 these consumers by acquiring their defaulted debt. Through our
direct mail and telemarketing operations, these consumers are offered an
opportunity to:
o settle their debt, typically at a discount negotiated between our
sales agent and the consumer which is based primarily on the
consumer's ability to repay the settlement amount,
o transfer the agreed settlement amount to a newly issued unsecured
MasterCard(R) or Visa(R) credit card, and
o establish a positive credit history on their newly issued card by
making timely and consistent payments.
We believe this credit card offer is attractive to our target consumers
who, given the non-performing status of their debt, are typically receiving few
or no solicitations from traditional credit card companies. We accept lump sum
settlements or installment payment plans from those consumers who do not accept
the credit card offer.
After making principal payments on the transferred balance, the consumer
can begin using the credit card for new purchases or cash advances and may be
granted increased credit limits over time based on the consumer's payment
performance. After a consumer has made eight or more consecutive monthly
payments on the consumer's outstanding credit card balance we consider the
account seasoned and available to sell or securitize. Because the focus of our
business is to convert defaulted debt into seasoned credit cards, we
periodically sell portfolios of seasoned accounts in the ordinary course of our
business. We typically sell a portfolio either to an unrelated third party or to
a newly created wholly owned subsidiary, which we refer to as a qualifying
special purpose entity. When we sell the portfolio to a qualifying special
purpose entity, the new subsidiary typically obtains a loan, secured only by the
portfolio, to pay a portion of the purchase price. The balance of the purchase
price represents our equity investment in the portfolio sold to the subsidiary.
We refer to the entire process of selling the portfolio of receivables to the
qualifying special purpose entity and obtaining financing of the portfolio as a
securitization. Generally, we continue to hold the equity investment in the
portfolio sold to the qualifying special purpose entity after the securitization
is complete, and we refer to this investment as our retained interest. We have
from time to time sold and may in the future sell our retained interest in a
qualifying special purpose entity.
We have incurred significant expenditures to build the infrastructure
necessary to acquire portfolios of defaulted debt, 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 generated negative cash flows
from operations. We cannot assure you we will be able to generate positive cash
flow from operations. We expect to continue to generate negative cash flow from
operations for the foreseeable future while we expand our operations and develop
our customer base. For the last two completed fiscal years our negative cash
flow from operations has been offset by gains on sales of portfolios of
receivables and/or securitizations. We expect our available credit facilities,
together with the amount we expect to receive from securitizations and credit
card portfolio sales, will be adequate to meet our working capital needs through
February 2002. Until we can generate sufficient cash flow from operations, we
will need to use
-1-
our available capital, including any proceeds from the sale of the subordinated
renewable notes and any future issuances of debt or equity securities, to fund
our cash flow requirements. This may impair our ability to make principal and
interest payments on our outstanding debt, including the subordinated renewable
notes.
Office Location
Our principal executive offices are located at 3401 North Louise Avenue,
Sioux Falls, South Dakota 57107 and our telephone number is 800-240-1855. We
maintain a website at www.creditstore.com.
-2-
Summary of the Offering
Security Offered .................... Up to $100 million of unsecured, fixed
term subordinated renewable notes. There
is no minimum amount of subordinated
renewable notes that must be sold in the
offering. We may withdraw or cancel the
offering at any time. If we withdraw or
cancel the offering, the subordinated
renewable notes previously sold will
remain outstanding until maturity or
earlier redemption. See "Plan of
Distribution."
Denomination of Initial Purchase
and Additional Purchases ............ Minimum purchase: $1,000 per note. No
fixed denominations. Subordinated
renewable notes will be issued for the
exact investment amount.
Interest Rate ....................... The interest rate for each subordinated
renewable note will be fixed on the date
it is issued. The rate will be set based
on the maturity you elect and the total
principal amount of your note portfolio.
The amount of your note portfolio will
be determined at the time a subordinated
renewable note is purchased or
automatically renewed by aggregating the
principal amount of all subordinated
renewable notes currently owned by you
and your immediate family members.
Interest will be compounded daily.
Payment of Interest ................. At your election, interest will be paid
monthly, quarterly, semi-annually,
annually or at maturity. If you select
the monthly payment option, you can also
choose the day of the month on which you
want your interest to be paid. You can
change this election one time only
during the term of a subordinated
renewable note.
Maturity ............................ Subordinated renewable notes are offered
with maturities ranging from three to
120 months. You must select the term of
your subordinated renewable note at the
time of purchase. If the subordinated
renewable note is not automatically
renewed as discussed below, we will pay
principal, together with accrued and
unpaid interest through the maturity
date:
-3-
o within 5 days of the maturity date,
if we receive notice on or before the
maturity date of your intent not to
renew the subordinated renewable
note, or if we notify you that we
will not renew the subordinated
renewable note; or
o within 5 days of the date we receive
notice of your intent not to renew
the subordinated renewable note, if
the notice is received within 15 days
after the maturity date.
Automatic Renewals .................. Subordinated renewable notes will be
automatically renewed for a period equal
to the original term unless:
o we notify you at least seven days
before the maturity date that a
renewal will not be provided; or
o you notify us, before the 15th day
following the maturity date, of your
intention not to renew your note.
Subordinated renewable notes to be
renewed will be renewed at a fixed rate
equal to the interest rate then being
offered on newly issued subordinated
renewable notes of the same term and
principal amount of your note portfolio.
If your subordinated renewable note pays
interest only at maturity, unless you
request to receive the accrued interest,
all accrued interest will be added to
the principal amount on renewal.
We will notify you of the maturity of
your subordinated renewable note
approximately 20 days before the
maturity date. The renewal notice will
include a copy of the current supplement
to the prospectus which lists all of the
rates applicable to each term then
offered by us.
-4-
Subordination ....................... The subordinated renewable notes will be
subordinate to all of our existing debt
and all of our future debt other than
debt which is specifically designated as
ranking equal or subordinate to the
subordinated renewable notes. As of
February 28, 2001, we had:
o approximately $50.1 million of senior
debt outstanding, including
approximately $4.3 million of capital
lease obligations, and
o no debt ranking equal or subordinate
to the subordinated renewable notes.
We can incur substantial additional
debt, including senior debt, under the
terms of the subordinated renewable
notes. See "Description of Subordinated
Renewable Notes Offered and the
Indenture--Subordination."
Unsecured Obligations ............... The subordinated renewable notes are not
insured, guaranteed or secured by any
lien on any of our assets. We do not
contribute funds to a separate fund,
commonly referred to as a sinking fund,
to provide funds to repay the
subordinated renewable notes at
maturity.
We intend to rely on our income from
operations, the proceeds from the sale
or securitization of receivables, our
working capital and the proceeds of
sales of additional subordinated
renewable notes or other debt or equity
securities for the cash we need to make
principal and interest payments on the
subordinated renewable notes. See "Risk
Factors - Since we will not set aside
funds to repay the subordinated
renewable notes offered, you must rely
on our cash flow from operations and
other sources for repayment" and " -
Because the subordinated renewable notes
are not insured by the FDIC or any other
government agency, you could lose your
entire investment."
-5-
Redemption at Your Request .......... You may redeem your subordinated
renewable notes:
o without penalty, on death or
total disability; or
o at any time, on 30 days written
notice to us, with a penalty
equal to simple interest on the
principal amount at the stated
interest rate for a period equal
to the lesser of six months or
the remaining term of the note.
Redemptions of subordinated renewable
notes at your request prior to maturity
are limited to an aggregate principal
amount for all holders of $1 million in
any calendar quarter.
For purposes of the $1 million limit,
redemption requests will be honored in
the order in which they are received.
Any redemption request not honored in a
calendar quarter will be honored in the
next calendar quarter; however,
redemptions in the next calendar quarter
will also be limited to an aggregate
principal amount of $1 million.
Redemption by Us .................... We may redeem any subordinated renewable
note at any time without penalty on 30
days written notice for a redemption
price equal to the principal amount plus
accrued and unpaid interest up to the
date of redemption.
Form/Transferability ................ Subordinated renewable notes will be
issued in book-entry form and you will
receive a book-entry receipt, not an
individual promissory note. The
subordinated renewable notes are not
transferable without our written
consent.
Periodic Statements ................. You will receive a quarterly statement
detailing the current balance and
interest paid on each subordinated
renewable note held by you no later than
the 10th business day after the end of
each calendar quarter.
-6-
Use of Proceeds ..................... We intend to use the net proceeds for
general corporate purposes, including
funding acquisitions of non-performing
consumer debt, capital expenditures, and
general operating activities. Proceeds
may also be used to pay, redeem and
refinance existing debt, repurchase our
outstanding capital stock, in particular
preferred stock held by our controlling
stockholder, pay interest on outstanding
subordinated renewable notes or retire
subordinated renewable notes. See "Use
of Proceeds."
Subscription Procedures ............. To subscribe for subordinated renewable
notes you must complete a subscription
in the form attached to this prospectus
as Annex A and return it to the address
indicated on the subscription form,
together with the purchase price. Your
subscription for subordinated renewable
notes will be irrevocable after the
expiration of the rescission period. We
may reject your subscription, in whole
or in part, for any reason. If your
subscription is not accepted by us, we
will promptly refund your purchase price
without deduction of any costs and
without interest.
Rescission Right .................... You have the right to rescind your
investment without penalty within three
business days of your submission of a
subscription. If you rescind your
investment, you will not earn any
interest on the subscription amount.
The preceding terms of the subordinated renewable notes may be modified or
supplemented by us from time to time, in our sole discretion, in a prospectus
supplement to this prospectus. Any modification will not affect any subordinated
renewable notes then outstanding.
Risk Factors
You should carefully consider all the information in this prospectus. In
particular, you should evaluate the specific risk factors set forth under "Risk
Factors," beginning on page 10, for a discussion of the risks involved in making
an investment in the subordinated renewable notes.
-7-
Summary Consolidated Financial and Other Data
We have five subsidiaries: Credit Store Services, Credit Store Capital,
American Credit Alliance, TCS Funding IV and TCS Funding V. All of these
subsidiaries are wholly owned by us; however, only Credit Store Capital and
American Credit Alliance are consolidated on our financial statements. Credit
Store Services, TCS Funding IV and TCS Funding V are qualifying special purpose
entities that are not required to be consolidated.
Credit Store Services and Credit Store Capital acquire non-performing
consumer receivables and contract with us to offer consumers a credit card under
our program or to accept settlements or payment plans.
American Credit Alliance owns a 50% interest in Dakota Card Fund II, a
limited liability company that contracts with us to service non-performing
receivables and credit card receivables that it owns.
TCS Funding IV and TCS Funding V were created in connection with
securitizations for the purpose of purchasing performing credit card receivables
from us.
PREDECESSOR(1) THE CREDIT STORE, INC.
------------------------ ----------------------------------------------------------------------
FOR THE NINE
FOR THE YEAR JANUARY 1, MONTHS ENDED
ENDED 1996 TO FOR THE YEAR ENDED MAY 31 FEBRUARY 29 FEBRUARY 28
DECEMBER OCTOBER -------------------------------------------- -----------------------
31, 1995 8, 1996 1997 1998 1999 2000 2000 2001
-------- -------- -------- -------- -------- -------- -------- --------
(dollars in thousands, except per share data)
CONSOLIDATED STATEMENT
OF OPERATIONS DATA:
Income from receivables(2) $ 975 $ 12,090 $ 28,747 $ 31,103 $ 22,988 $ 30,605
Securitization income and
asset sales(2) -- -- 11,851 12,599 6,892 1,146
Servicing fees and other
income $ 6,529 $ 2,079 1,601 1,293 1,564 2,685 1,744 2,845
-------- -------- -------- -------- -------- -------- -------- --------
Total revenue 6,259 2,079 2,576 13,382 42,163 46,387 31,624 34,597
Provision for losses -- -- 1,494 6,484 4,607 5,681 4,815 7,063
-------- -------- -------- -------- -------- -------- -------- --------
Net revenue 6,259 2,079 1,082 6,899 37,556 40,706 26,808 27,533
Income (loss)
before
income taxes 2,703 (1,933) (14,406) (29,445) 1,889 2,030 (23) (3,799)
Income tax benefit (expense) 24 420 -- -- 1,986 1,042 (1,286) --
-------- -------- -------- -------- -------- -------- -------- --------
Net income (loss) 2,728 (1,512) (14,406) (29,445) 3,876 3,072 (1,309) (3,799)
Dividends on preferred
stock(2)(3) (7) (400) (1,800) (2,000) (1,500) (1,500)
-------- -------- -------- -------- -------- -------- -------- --------
Net income (loss) applicable
to common stockholders $ 2,728 $ (1,512) $(14,413) $(29,845) $ 2,076 $ 1,072 $ (2,809) $ (5,299)
Net income (loss) per share,
basic $ 0.55 $ (0.30) $ (0.56) $ (0.90) $ 0.06 $ 0.03 $ (0.08) $ (0.15)
Net income (loss) per share,
diluted $ 0.55 $ (0.30) $ (0.56) $ (0.90) $ 0.06 $ 0.03 $ (0.08) $ (0.15)
-8-
PREDECESSOR(1) THE CREDIT STORE, INC.
----------------------- ---------------------------------------------------------------------------
AS OF AS OF AS OF MAY 31 AS OF
DECEMBER 31, OCTOBER 8, ----------------------------------------------------------- FEBRUARY 28,
1995 1996 1997 1998 1999 2000 2001
------------ ---------- -------------- ------------ ------------ ------------- --------------
(dollars in thousands, except other data)
CONSOLIDATED
BALANCE SHEET DATA:
Cash and cash equivalents
and restricted cash $ 279 $ 58 $ 2,686 $ 8,205 $ 4,284 $ 2,449 $ 4,463
Investments in receivable
portfolios, net(2) 10,760 18,592 21,648 33,892 40,210
Total assets 525 2,885 24,744 39,723 45,781 64,388 68,441
Notes payable -- 1,158 429 5,902 6,087 23,609 25,856
Senior subordinated notes
and accrued interest
payable-related party -- 880 10,446 31,807 19,247 19,139 20,002
Total liabilities 280 4,007 18,118 47,367 33,692 50,014 56,254
Accumulated earnings
(deficit) 240 (1,512) (14,545) (43,990) (40,014) (37,042) (40,840)
Total stockholders' equity
(deficit) 244 (1,122) 6,625 (7,643) 12,089 14,374 12,187
SELECTED CONSOLIDATED
OPERATING DATA:
Face value of non-performing
debt acquired during the
period(2) $1,067,579,343 $890,634,206 $891,904,454 $1,771,707,748 $1,208,506,429
Credit card receivables
owned and managed(2) 35,709,395 84,830,552 89,149,715 96,127,819 116,061,733
Number of accounts owned and
managed(2) 26,803 84,351 94,278 76,732 85,209
Total employees, end of
period(2) 233 292 305 305 334
Ratio of earnings to fixed
charges (4) N/A N/A -- -- 1.4x 1.4x --
Deficiency of earnings to
fixed charges(4) -- -- 14,415,861 29,722,190 -- -- 3,532,733
- ----------
(1) The information for the fiscal year ended December 31, 1995 and for the
period from January 1, 1996 to October 8, 1996 relates to Service One
International, our predecessor. See "Business - General Development of
Business."
(2) Information not applicable for predecessor company.
(3) We have not paid dividends on our capital stock during the periods
presented. See "Description of Capital Stock."
(4) The ratios of earnings to fixed charges have been computed by dividing
earnings available for fixed charges by fixed charges. Earnings available for
fixed charges includes income or loss before income taxes, plus fixed charges
and adjustments for equity interests in qualifying special purpose entities.
Fixed charges consist of interest expenses and a portion of rental expense that
is estimated to be interest. No premiums, discounts, or capitalized expenses
related to our debt exist.
-9-
RISK FACTORS
Risk Factors related to this Offering
Since the subordinated renewable notes are unsecured and subordinated to
our senior debt, in an insolvency proceeding, you would be repaid only if
sufficient funds remain after we repay our senior debt. As of February 28, 2001,
there was approximately $50.1 million of senior debt outstanding, including
approximately $4.3 million of capital lease obligations. We may incur
substantial additional senior debt in the future. If we were to become
insolvent, our senior debt would have to be paid in full before we could repay
the subordinated renewable notes. In addition, we may have significant debt,
other than senior debt, that has rights on our liquidation or dissolution equal
to the rights of the subordinated renewable notes being offered. There may not
be adequate funds remaining to pay the principal and interest on the
subordinated renewable notes. See "Description of Subordinated Renewable Notes
Offered and the Indenture --Subordination."
Since we will not set aside funds to repay the subordinated renewable
notes offered, you must rely on our cash flow from operations and other sources
for repayment. If these sources are not adequate we may be unable to repay the
subordinated renewable notes at maturity. We will not contribute funds to a
separate account, commonly known as a sinking fund, to repay the subordinated
renewable notes at maturity. As a result, you must rely on our cash flow from
operations, proceeds from the sale or securitization of receivables, our working
capital and the proceeds of sales of subordinated renewable notes or other debt
or equity securities. We have historically experienced operating losses and
generated negative cash flows from operations. We cannot assure you we will be
able to generate positive cash flow from operations. To the extent our cash flow
from operations is not sufficient to repay the debt, you may lose all or part of
your investment. See "Description of Subordinated Renewable Notes Offered and
the Indenture."
Because the indenture covenants place very limited restrictions on us,
they may not provide adequate protections if we suffer a material adverse change
in our financial condition or results of operations. Under the covenants in the
indenture our ability to incur additional debt and pay dividends on our capital
stock is limited only by the requirement that we maintain positive tangible net
worth, which includes stockholder's equity and subordinated debt. If we borrow
significant amounts or use our available cash to pay dividends, our ability to
meet our obligations under the subordinated renewable notes will be limited if
we do not generate sufficient positive cash flow from operations and financing
activities or if having done so we suffer cash flow problems due to a material
adverse change in our financial condition. See "Description of Subordinated
Renewable Notes Offered and the Indenture - Covenants Contained in Indenture."
Because the subordinated renewable notes are not insured by the FDIC or
any other government agency, you could lose your entire investment. No
governmental or private agency insures the debt securities offered by this
prospectus. Therefore you must depend solely on our cash flow from operations,
proceeds from the sale or securitization of receivables and other financing
activities, and our working capital for repayment of principal at maturity and
the ongoing payment of interest on the subordinated renewable notes.
Because of transfer restrictions, the lack of a trading market and the
limitation on early redemptions, your ability to liquidate your investment is
limited. The subordinated renewable notes may not be transferred without our
written consent. There is also no established trading market for the
subordinated renewable notes. Therefore, even if we permitted a transfer, you
would likely be unable to sell your subordinated renewable notes. In addition,
unless we elect to redeem subordinated renewable notes, early redemptions by you
are limited to an aggregate principal amount of $1 million during each calendar
quarter. See "Description of Subordinated Renewable Notes Offered and the
Indenture."
-10-
Our management has broad discretion over how to use the proceeds from the
offering and could use the funds in a manner contrary to the interests of
noteholders. Since no specific allocation of the proceeds has been determined as
of the date of this prospectus, our management will have broad discretion in
determining how the proceeds of the offering will be used. As a result,
management could use the funds in a manner contrary to the best interests of the
noteholders. See "Use of Proceeds."
Because this is a best efforts offering with no firm underwriting
commitment, we may not receive sufficient proceeds from the offering to finance
our anticipated growth. The subordinated renewable notes are initially being
offered by us, although we may engage placement agents or underwriters to offer
the subordinated renewable notes from time to time in the future. We currently
do not have any agreements with any placement agents or underwriters to assist
in the offering. We have not established a minimum amount of proceeds that we
must receive in the offering before any proceeds may be accepted. We may not
sell all of the subordinated renewable notes offered and we may sell only a
limited amount of notes. As a result, we may not receive sufficient proceeds
from the offering to finance our anticipated growth.
Risk Factors related to Us
If we are unable to achieve positive cash flow from operations or maintain
profitability, our ability to repay the subordinated renewable notes may be
impaired. 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. We expect to continue to generate negative cash flow from operations
for the foreseeable future while we expand our operations and develop our
customer base. For the last two completed fiscal years our negative cash flow
from operations has been offset by gains on sales of portfolios of receivables
and/or securitizations. We expect our available credit facilities, together with
the amount we expect to receive from securitizations and credit card portfolio
sales, will be adequate to meet our working capital needs through February 2002.
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, the sale of the subordinated renewable notes and any future
issuances of debt or equity securities to fund our cash flow requirements. This
may impair our ability to make principal and interest payments on the
subordinated renewable notes.
Because our quarterly operating results and cash requirements may
fluctuate from period to period, we may have insufficient cash to meet our
obligations under the subordinated renewable notes. The timing of portfolio
acquisitions and credit card receivable sales and securitizations affects the
timing of recorded income and results in periodic fluctuations in our quarterly
operating results and cash requirements. The timing of any sale or
securitization transaction is affected by a number of factors beyond our control
including market conditions and the presence of investors and lenders interested
in our credit card accounts. We may also experience seasonal fluctuations in
cash requirements due to other factors beyond our control including the rate at
which customers pay down their credit card balances, make new purchases and take
cash advances. We may experience higher cash requirements during the year-end
holiday season and at other times during the year when customers make new credit
card purchases at a faster rate than they pay their debts. Because of these
fluctuations in income and cash requirements, we may experience periods when we
have insufficient cash available after funding our operating expenses to meet
our obligations under the subordinated renewable notes.
If we cannot obtain additional capital when needed to finance our
operations and grow our business, we may need to limit our operations and
restrict our growth which could hurt our profitability and restrict our ability
to repay the subordinated renewable notes at maturity. 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:
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o cash flow from operations;
o asset sales and securitizations; and
o loans and other financing transactions.
If additional financing is unavailable and additional receivable sales and
securitizations are not completed, our ability to operate and grow our business
will be limited. If we fail to grow our business we may have difficulty
maintaining profitability and repaying the subordinated renewable notes at
maturity. We cannot assure you we will be successful in obtaining additional
financing when needed.
Because we have pledged all of our assets, we may have difficulty in
securing future financings. Our principal lender 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. Our controlling
stockholder 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 released their liens on assets we wanted to sell or
securitize, we cannot assure you they will be willing to do so in the future. As
a result, we may find it more difficult to secure additional financing in the
future.
If we are not successful in converting the defaulted debt we acquire
to credit card accounts, we may not be able to generate sufficient cash flow to
fund our operations and repay the subordinated renewable notes. We are primarily
in the business of providing credit card products to consumers who have
previously defaulted on a debt. Before our acquisition of the receivables, the
originating institutions and intermediary owners, if any, have generally made
numerous attempts to collect on the non-performing accounts. Before buying
receivables we project the amount we expect to collect on those receivables. If:
o we collect less on the receivables than expected;
o we convert fewer of the non-performing accounts than expected into
credit card accounts; or
o the new credit card accounts have a higher default rate than we
anticipated
we may not be able to generate sufficient cash to cover the costs associated
with purchasing receivables and operating our business or to repay the
subordinated renewable notes.
Lack of maturity of our credit card portfolio may result in increased
delinquencies and defaults reducing our profit and limiting our ability to repay
the subordinated renewable notes at maturity. A portfolio of older accounts
generally behaves more predictably than a portfolio of newly originated
accounts. As a result, the average age of a credit card issuer's portfolio is
generally used as an indicator of the stability of the delinquency and default
levels of that portfolio. As of May 31, 2001, the majority of the credit card
accounts owned by us were less than three years old. As a result there can be no
assurance as to the levels of delinquencies and defaults, which may result in
charge-offs which would affect our earnings over time. Any material increase in
delinquencies and defaults above management's expectations would decrease our
cash inflows and could affect our ability to repay the subordinated renewable
notes.
Our failure to manage growth could result in increased costs and decreased
profits making it more difficult for us to repay the subordinated renewable
notes. We may be unable to manage our growth effectively and maintain our
historical level of cash flows from the portfolios we purchase. This would
increase the cost of expansion and impair our ability to fully implement our
expansion plans. The development and expansion of our business will depend on,
among other things, our ability to:
o maintain our relationships with third-party credit card issuers;
o acquire non-performing debt on favorable terms;
o convert acquired non-performing debt to credit cards accounts and
collect on these new credit card accounts;
o obtain adequate financing on favorable terms; and
o profitably securitize or sell our receivables on a regular basis.
-12-
Our inability to achieve any or all of these factors could result in
reduced income and cash flow and impair our ability to repay the subordinated
renewable notes.
Because we have accumulated but not paid cash dividends on our preferred
stock, if we were required to pay these dividends it would decrease our
liquidity and could make it more difficult for us to repay the subordinated
renewable notes. As of February 28, 2001, we had accumulated approximately $5.6
million in undeclared and unpaid dividends on our preferred stock. Although our
board of directors has not declared, and therefore we have not paid, the
accumulated dividends to date, we may be called on to pay the accumulated
dividends in the future. To the extent the preferred stock remains outstanding,
additional cash dividends will accumulate. If we are required to pay the
dividends, the payments would limit the amount of cash available to use for
operations or for repaying outstanding subordinated renewable notes.
Jay L. Botchman controls a majority of our voting power and his interests
in us may conflict with your interests. Jay L. Botchman is the beneficial owner
of 40.3% of our outstanding shares of common stock. In addition, Mr. Botchman,
individually and through his control of Taxter One and J.L.B. of Nevada,
beneficially owns all of our Series A, C, D and E Preferred Stock. The Series A
Preferred Stock contains preferential voting rights. As a result, Mr. Botchman
controls approximately 74% of all votes entitled to be voted at any meeting of
our stockholders and is able to control our management and affairs and the
outcome of all matters submitted to our stockholders for approval, including the
election and removal of directors, any merger, consolidation or sale of all or
substantially all of our assets and any charter amendments.
Since we are dependent on the continued contributions of our key
personnel, the loss of the services of one or more of our key employees could
disrupt our operations causing our income to decrease and impairing our ability
to repay the subordinated renewable notes. We have entered into employment
agreements with Kevin T. Riordan, our President and Chief Operating Officer, and
Michael J. Philippe, our Executive Vice President and Chief Financial Officer.
Although our written agreement with Richard Angel, our Executive Vice President
and General Counsel, has expired, we have an oral employment agreement with Mr.
Angel with no fixed term. The loss of the services of any of these individuals
or the services of other officers or key employees could cause us to incur costs
for recruiting replacements, result in the loss of the valuable expertise and
business relationships, and affect our business and prospects. Any resulting
decrease in our cash flow would impair our ability to repay the subordinated
renewable notes.
Labor shortages and high employee turnover rates could increase costs
significantly and adversely impact revenue making it more difficult for us to
repay the subordinated renewable notes. The credit card industry is labor
intensive and generally experiences a high rate of turnover in personnel. Growth
in our business will also require us to continue to recruit and train
significant numbers of additional qualified personnel. A high turnover rate
among our employees would increase our recruiting and training costs and could
adversely impact the overall recovery of our receivables. In addition, Sioux
Falls, South Dakota experiences a low incidence of unemployment. There can be no
assurance we will be able to hire, train and retain a sufficient number of
qualified employees. If we were unable to recruit and retain a sufficient number
of employees, we would be forced to limit our growth or possibly curtail our
operations. If we were required to take these actions it would likely reduce our
ability to operate profitably and make it more difficult for us to repay the
subordinated renewable notes.
Because we cannot issue our own credit cards, the failure of our
third-party credit card issuers to continue to provide credit cards to our
accounts could severely disrupt our business. We are not licensed to nor do we
currently have the ability to independently issue credit cards. As a result, we
are dependent on the two banks we use to issue credit cards to our customers.
These banks operate under extensive governmental regulation. If additional
regulations or restrictions were imposed on issuing credit cards, the new
regulations or restrictions could increase our costs or limit our operations. In
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addition, if our existing credit card issuers discontinue offering credit cards
to our accounts and we cannot find a new credit card issuer willing to issue
cards to consumers with impaired credit histories, we would be unable to operate
our business as it is currently conducted. We cannot assure you we could find an
alternate provider willing to issue credit cards to our accounts on terms we
consider favorable in a timely manner without disruption of our business.
Because we do not have backup arrangements for all of our operations, we
may incur significant losses if an outage occurs. Through the issuing bank's
arrangement with First Data Resources, we use First Data Resources for
third-party processing of credit card data and services. We provide credit card
data to First Data Resources on a daily basis and this data is backed up and
stored by First Data Resources. While we are currently evaluating a back-up
servicer for our portfolio of credit cards, to date we have not arranged for a
back-up. In addition, we do not have a back-up telemarketer for our marketing
programs. If a disaster or other event closed our main facility or shut down our
primary and redundant data connections to First Data Resources our business
would be interrupted until we could repair our data lines and/or facilities or
relocate to temporary facilities. Any interruption in our operations could have
a material adverse impact on our business and revenues.
If we cannot protect our proprietary information, we may lose a
competitive advantage and suffer decreased cash flow and ability to repay the
subordinated renewable notes. We are dependent, in part, on proprietary data,
analytical computer programs and methods and related know-how for our day-to-day
operations. We rely on a combination of confidentiality agreements, contract
provisions and trade secret laws to protect our proprietary rights. Although we
intend to protect our rights vigorously, there can be no assurance we will be
successful in protecting our proprietary rights. If we are not able to protect
our proprietary rights, or if the proprietary information and methods become
widely available, we may lose a competitive advantage within our market niche.
The loss of this competitive advantage could result in decreased revenues and
cash flow and decrease our ability to repay the subordinated renewable notes.
If we fail to successfully anticipate, invest in or adopt technological
advances within our industry, we may lose market share which could result in
decreased cash flow and ability to repay the subordinated renewable notes. Our
success is dependent in large part on our continued investment in sophisticated
telecommunications and computer systems, including predictive dialers, automated
call distribution systems and digital switching equipment. We have invested
significantly in technology in an effort to remain competitive and anticipate it
will be necessary to continue to do so. Moreover, computer and
telecommunications technologies are evolving rapidly and are characterized by
short product life cycles, which require us to anticipate and stay current with
technological developments. There can be no assurance we will be successful in
anticipating, managing or adopting technological changes on a timely basis or
that we will have the capital resources available to invest in new technologies.
Our failure to anticipate or adopt technological changes may affect our ability
to maintain our customers and may affect our cash flow.
We are developing new products and services which may not be successful.
While we may, from time to time, develop additional products and services, there
can be no assurance the development of these products and services will be
completed or that any new products or services will be successfully marketed and
implemented. Consumer preferences for credit card and credit related products
are difficult to predict, especially where consumers have experienced past
credit difficulties. Failure to obtain significant customer satisfaction or
market share for our products and services would impact our ability to attract
new customers and adversely affect our growth potential and our ability to repay
the subordinated renewable notes.
Pending and future litigation may interrupt our business operations and
adversely affect our liquidity or profitability and ability to repay the
subordinated renewable notes. From time to time we have been named as a
defendant in class action lawsuits. Two class action lawsuits are pending
against us. If we were required to pay a significant judgment in one or more of
the lawsuits, or in a future
-14-
lawsuit, it would affect our liquidity. In addition, a loss might also require
us to change how we conduct our business if our operations were found to not
comply with applicable legal standards. Any required changes might affect our
ability to operate the business profitably and to repay the subordinated
renewable notes at maturity. See "Business - Legal Proceedings."
Because we use estimates in our accounting, differences between actual and
expected performance may cause fluctuations in our reported revenue and reported
income. Income from credit card receivables and securitization income and asset
sales have constituted, and are likely to continue to constitute, a significant
portion of our revenue. Portions of this revenue are reported based on the cash
flow we expect to receive from the credit cards we originate or own and from the
credit cards that have been securitized and in which we hold a retained
interest. The expected cash flows are based on our estimates of interest rates,
default rates, new account origination rates, repayment rates, and new charges
made by cardholders. These estimates are based on a variety of factors, many of
which are not within our control. Differences between actual and expected
performance of the receivables may cause us to adjust our estimates and result
in fluctuations in our reported revenue and reported income.
Risk Factors related to the Non-Performing Debt and Sub-Prime Credit Card
Industries
Because the market for our credit card receivables is limited, we may be
unable to sell or securitize our portfolios to generate the cash required to
operate our business and repay the subordinated renewable notes. Our future is
highly dependent on our ability to sell or securitize the portfolios of credit
cards we generate from the non-performing debt we acquire. Although we have sold
several portfolios and completed several securitizations, no assurance can be
given we will be able to sell or securitize future portfolios. Our ability to
complete securitizations or asset sales depends on several factors including
interest rates, general market conditions and the quality of our portfolios. If
we are unable to sell or securitize our credit card receivables it will be
difficult for us to raise enough capital to repay the subordinated renewable
notes.
We may not be able to acquire enough receivables on favorable terms to
operate profitably or generate sufficient cash flow to repay the subordinated
renewable notes at maturity. To obtain additional credit card customers, we
depend on the continued availability of non-performing portfolios that meet our
requirements. The availability of portfolios of receivables for future purchase
at prices favorable to us depends on a number of factors outside of our control.
These factors include:
o continuation of the current growth trend in credit card and consumer
installment debt;
o the ability of consumers to obtain credit, especially unsecured
credit cards;
o the overall default rates on consumer debt;
o the ability of traditional credit card lenders to rehabilitate their
own non-performing credit card receivables;
o overly aggressive pricing by competitors bidding on available
non-performing receivables; and
o the entry of new competitors.
If we cannot purchase a sufficient amount of non-performing receivables at
favorable prices it will reduce our profitability and liquidity, affecting our
ability to repay the subordinated renewable notes.
Fluctuations in economic conditions could increase payment delinquencies
and defaults and reduce our cash flow impairing our ability to repay the
subordinated renewable notes. During strong economic cycles, available credit,
including consumer credit, generally increases and payment delinquencies and
defaults generally decrease. During periods of economic slowdown and recession,
delinquencies and defaults generally increase. No assurances can be given that
our credit card losses and delinquencies would not worsen in a weak economic
cycle. Significant increases in credit card losses would reduce our cash flow
and impair our ability to repay the subordinated renewable notes.
-15-
Adverse publicity or increased regulation may impair acceptance of our
products and our ability to generate sufficient cash to repay the subordinated
renewable notes. Critics of the credit card industry have in the past focused on
marketing practices they claim encourage consumers to borrow more money than
they should and on pricing practices they claim are either confusing or result
in prices that are too high. Increased criticism of the industry or us could
hurt client acceptance of our products or lead to adverse changes in the law or
regulatory environment. In addition, increased regulation of financial
institutions that buy credit card receivables or invest in securitizations could
affect the pricing or the size of the market for credit card sales or
securitizations. These changes could adversely affect our ability to generate
cash from our operations or complete sales or securitizations of credit card
receivables and our ability to repay the subordinated renewable notes.
Failure to comply with consumer and debtor protection laws and regulations
could adversely affect our business. Our collection practices, business
operations and credit card receivables are subject to numerous federal and state
consumer protection laws and regulations imposing licensing and other
requirements with respect to purchasing, collecting, making and enforcing
consumer loans. Our failure to comply with these statutes or regulations could
cause adverse publicity which could make it more difficult to collect our
receivables reducing the funds available to repay the subordinated renewable
notes. See "Business -- Government Regulation."
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains "forward-looking statements" which you can
generally identify by our use of forward-looking words including "believe,"
"expect," "may," "will," "could," "should," "seek," "look for," "project,"
"anticipate," or "plan" or the negative or other variations of these terms or
similar expressions or by discussions of strategies that involve risk or
uncertainty. Forward-looking statements are inherently uncertain as they are
based on current expectations and assumptions concerning future events and are
subject to numerous known and unknown risks and uncertainties. We caution you
not to place undue reliance on these forward-looking statements, which are only
predictions and speak only as of the date of this prospectus. Actual results
could differ materially from those currently anticipated due to a number of
factors, including those identified in the "Risk Factors" above or discussed
elsewhere in this prospectus. Except as required by law, we undertake no
obligation to update or publicly announce revisions to any forward-looking
statements to reflect future events or developments.
-16-
USE OF PROCEEDS
The primary purposes of this offering are to provide additional financing
for our anticipated growth and to increase our financial flexibility. Net
proceeds from the sale of the subordinated renewable notes, including any
interest earned on the proceeds, will be used for general corporate purposes,
including:
o funding acquisitions of non-performing consumer debt;
o capital expenditures; and
o general operating activities.
We may also use a portion of the proceeds to:
o pay, redeem or refinance existing debt, including debt subordinated
or senior to the subordinated renewable notes;
o repurchase outstanding capital stock, in particular preferred stock
held by our controlling stockholder;
o pay interest on existing subordinated renewable notes;
o retire subordinated renewable notes; or
o fund future acquisitions of related businesses or assets, although
we have no present commitments, agreements or understandings with
respect to any acquisitions.
As of May 31, 2001, the aggregate outstanding amount of principal and
accrued interest on our outstanding debt was approximately $43.1 million. The
interest rate on the debt ranged from 6.5% to 12% and the debt had maturities
ranging from being payable on demand to August 2002.
We are not required to sell a minimum number or principal amount of
subordinated renewable notes before we can deposit and use the proceeds from any
sale. There can be no assurance that all or any portion of the subordinated
renewable notes will be sold. We currently estimate that no more than $35.0
million principal amount of subordinated renewable notes will be outstanding at
any one time.
The precise amount, timing and allocation of the use of proceeds will
depend on many factors, including:
o the dollar amount of subordinated renewable notes actually sold;
o the term and interest rates of the subordinated renewable notes
sold;
o the timing of the receipt of the proceeds from any sales;
o our operating cash requirements; and
o the availability of other sources of funding.
-17-
DESCRIPTION OF SUBORDINATED RENEWABLE NOTES OFFERED
AND THE INDENTURE
General. We are offering up to $100 million of subordinated renewable
notes. The subordinated renewable notes will represent unsecured debt
obligations. The subordinated renewable notes will be issued under an indenture
between U.S. Bank Trust National Association, as trustee, and us. The terms of
the subordinated renewable notes include those stated in the indenture and those
made part of the indenture by reference to the Trust Indenture Act of 1939, as
amended.
The following discussion is a summary of the important terms of the
indenture. It does not restate the indenture in its entirety. We urge you to
read the indenture because it, and not this description, defines your rights as
a holder of the subordinated renewable notes. We will provide a copy of the
indenture on request.
Maturity. We are offering subordinated renewable notes with terms ranging
from three to 120 months. You will select the term of each subordinated
renewable note at the time of your subscription.
If the subordinated renewable note is not automatically renewed as
discussed below under the caption "Automatic Renewal," we will pay principal,
together with accrued and unpaid interest through the maturity date:
o within 5 days of the maturity date, if we receive notice on or
before the maturity date of your intent not to renew the
subordinated renewable note, or if we notify you that we will not
renew the subordinated renewable note;
o within 5 days of the date we receive notice of your intent not to
renew the subordinated renewable note, if the notice is received
within 15 days after the maturity date.
Automatic Renewal. Each subordinated renewable note will be automatically
renewed for a term identical to its original term unless:
o we notify you at least seven days before the maturity date that a
renewal will not be provided; or
o you notify us in writing, before the 15th day following the maturity
date, of your intention not to renew.
The subordinated renewable notes will continue to renew in this manner
until redemption. Interest will continue to accrue from the first day of each
renewed term. The terms of the renewal note will be the same as the terms of the
original subordinated renewable note except:
o the interest rate payable during the renewal term will be the
interest rate which is then being offered to holders with similar
portfolios of similar subordinated renewable notes or, if none are
then offered, the rate specified by us in the renewal notice
described below;
o if the subordinated renewable note pays interest only at maturity,
unless you request to receive the accrued interest, the principal
amount of the renewal note will be increased by the accrued
interest; and
o the renewal note will be bound by any amendment to the indenture
adopted before the renewal date, with the consent of the holders of
at least a majority of the principal amount of the subordinated
renewable notes, whether or not the holder consented to the
amendment.
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We will notify you of the maturity of your subordinated renewable note
approximately 20 days before the maturity date. The renewal notice will include
a copy of the current supplement to the prospectus which lists all of the rates
applicable to each term then offered by us.
Interest. The interest rate payable on a subordinated renewable note will
be determined at the time of subscription or renewal based on market conditions,
the maturity date and term established for the subordinated renewable note and
the total principal amount of the note portfolio of the holder. Once determined,
the rate of interest payable on a subordinated renewable note will remain fixed
for the term of the note.
The amount of the note portfolio of the holder is determined at the time a
note is purchased by aggregating the principal amount of all notes currently
owned by the holder and the holder's immediate family members. Immediate family
members include parents, children, siblings, grandparents and grandchildren.
Immediate family members of sibling families are also considered immediate
family members if two or more siblings are note holders. A holder will have the
ability to identify his or her immediate family members in the subscription
documents.
We will compute interest on subordinated renewable notes on the basis of
an actual calendar year and interest will compound daily. Holders of
subordinated renewable notes may elect at the time a subscription agreement is
completed to have interest paid either monthly, quarterly, semi-annually,
annually or at maturity. If no payment frequency is elected, interest will be
paid at maturity. A holder electing the monthly payment option may also select
the day of the month on which interest will be paid. If you select a day of the
month other than the issue date of your subordinated renewable note, your first
interest payment period will be longer than one month. The first interest
payment will include all of the interest accrued from the issue date. For all
other frequencies, the payment date will be determined based on the issue date
of the subordinated renewable note. If an interest payment date falls on a day
which is not a business day, interest will be paid on the next business day. Any
interest not otherwise paid on an interest payment date will be paid at
maturity.
The frequency of interest payments and/or the interest payment date may be
changed by the holder one time only during the term of the subordinated
renewable note. Requests to change the election must be made in writing to us
and will be effective on the 45th day following the date we receive the
election. No specific change in election form is required.
We reserve the right to vary from time to time, at our discretion, the
interest rates we offer on the subordinated renewable notes based on numerous
factors in addition to length of term and aggregate principal amount. These
factors may include:
o whether the holder has previously purchased subordinated renewable
notes;
o whether subordinated renewable notes are being purchased for an IRA
and/or Keogh account;
o whether the investment is a renewal or a new purchase; and
o the geographic locality of the holder.
Interest Accrual Date. Interest on the subordinated renewable notes will
accrue from the date of purchase. The date of purchase will be deemed to be, for
accepted subscriptions, the date we receive funds, if the funds are received on
or before 12:01 p.m. central time on a business day, or the next business day if
the funds are received on a non-business day or after 12:01 p.m. central time on
a business day. For this purpose, our business days will be deemed to be each
Monday through Friday, except for legal holidays in the State of South Dakota.
Place and Method of Payment. Principal and interest on the subordinated
renewable notes will be paid to the holders through electronic deposits to
accounts specified by each holder in the subscription documents or, if requested
by a holder, by check mailed to the holder at his/her address as it appears in a
register maintained for that purpose.
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Optional Redemption by Us. We have the right to redeem any subordinated
renewable note, in whole or in part, at any time, on 30 days written notice to
the holder of the note, at a redemption price equal to the principal amount of
the note plus accrued and unpaid interest up to the redemption date, without any
penalty or premium. The holder has no right to require us to prepay any
subordinated renewable note before its maturity date as originally stated or as
it may be renewed, except as indicated below.
Redemption at the Election of the Holder on Death or Total Permanent
Disability. Subordinated renewable notes may be redeemed at the election of a
holder who is a natural person under the circumstances described below. For
purposes of this redemption provision, we consider an individual retirement
account that holds the subordinated renewable notes a natural person. If two or
more persons are joint registered holders of a subordinated renewable note, the
election to redeem will apply when either registered holder dies or becomes
permanently disabled. If the subordinated renewable note is held by a person who
is not a natural person, such as a trust, partnership, corporation or other
similar entity, the right to require redemption on death or disability does not
apply.
A qualified holder can require us to redeem his/her subordinated renewable
notes, in whole but not in part, by giving us written notice within 45 days
following his/her total permanent disability, as established to our
satisfaction, or by his/her estate following his/her death. We will redeem the
notes on a date no more than 15 days after we receive the notice at a redemption
price equal to:
o the principal amount of the subordinated renewable note; plus
o accrued and unpaid interest up to the date of redemption.
We may modify our policy on redemptions after death or disability in the
future. However, no modification will affect the right of redemption applicable
to any outstanding subordinated renewable note.
Redemption at the Holder's Election. A holder may also elect to require us
to redeem subordinated renewable notes at any time, in whole but not in part, by
giving us 30 days written notice. We will redeem the subordinated renewable
note(s) specified on a date no more than 30 days after we receive the notice at
a redemption price equal to:
o the principal amount of subordinated renewable note(s), plus
o accrued and unpaid interest up to the date of redemption, less
o a redemption penalty equal to simple interest on the principal
amount at the stated interest rate for a period equal to the lesser
of the remaining term or six months.
We may modify our policy on redemptions at the holder's election in the
future. However, no modification will affect the right of redemption applicable
to any outstanding subordinated renewable note.
Limitation on Aggregate Redemptions at the Holder's Election. Redemptions
of subordinated renewable notes at the request of holders, whether as a result
of death or total permanent disability or otherwise, are limited to an aggregate
principal amount for all holders of $1 million in any calendar quarter.
For purposes of the $1 million limit, redemption requests will be honored
in the order in which they are received. Any redemption request not honored in a
calendar quarter will be honored in the next calendar quarter; however,
redemptions in the next calendar quarter will also be limited to an aggregate
principal amount of $1 million.
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Book-Entry. On acceptance of a subscription, the trustee or its agent will
credit on a book-entry registration and transfer system, to your account, the
principal amount of the security purchased by you. You will also receive a
book-entry receipt which will indicate the acceptance of your subscription. You
will have three business days after the date on which you send your subscription
to us to rescind your subscription. If we reject your subscription or you
rescind it during the three-day revocation period, all funds deposited, without
any interest, will be promptly returned to you.
Holders of subordinated renewable notes will receive a book-entry receipt
but will not receive or be entitled to receive physical delivery of a note or
certificate evidencing the debt. The holders of the accounts established on the
book-entry registration and transfer system will be deemed to be the owners of
the subordinated renewable notes under the indenture for all purposes. The
holder must rely on the procedures established by the trustee to exercise any
rights of a holder under the indenture.
Interest due on each account will be credited on the book-entry
registration and transfer system on each interest payment date. The trustee or
its agent will calculate the interest payments to be credited to the book-entry
accounts and maintain, supervise and review any records relating to book-entry
beneficial interests in the subordinated renewable notes.
Form and Denominations/Transfers. The subordinated renewable notes are not
negotiable debt instruments and will be issued only in book-entry form. On
acceptance of a subscription, a book-entry receipt reflecting the ownership of a
subordinated renewable note will be issued for the exact subscription amount.
Except as described below, book-entry interests in subordinated renewable
notes will not be exchangeable for registered notes. Book-entry interests will
be exchangeable for actual notes registered in the names of the holders only if:
o we, at our option, advise the trustee in writing of our election to
terminate the book-entry system, or
o after the occurrence of an event of default under the indenture,
holders of the subordinated renewable notes aggregating more than
50% of the aggregate outstanding amount of the subordinated
renewable notes advise the trustee in writing that the continuation
of a book-entry system is no longer in the best interests of the
holders of subordinated renewable notes and the trustee notifies all
registered holders of the occurrence of any event of default and the
availability of definitive notes.
Ownership of subordinated renewable notes may be transferred on our
register only by written notice to us signed by the owner(s) or the owner's duly
authorized representative on a form to be supplied by us and with our written
consent, which consent will not be unreasonably withheld. We may also, in our
discretion, require an opinion from the holder's counsel that the proposed
transfer will not violate any applicable securities laws and a signature
guarantee in connection with the transfer. On transfer of a subordinated
renewable note, we will provide the new owner of the note with a book-entry
receipt which will evidence the transfer of the account on our records.
Rescission Right. The holder has the right to rescind his or her
investment without penalty within the first three business days after submission
of his/her subscription. We will promptly return any funds sent with a
subscription that is properly rescinded. No interest will be earned on the
subscription amount if the subscription is rescinded.
Statements. Holders of subordinated renewable notes will receive quarterly
statements, which will indicate, among other things, the current account balance
and interest paid. These statements will be mailed not later than the tenth
business day following the end of each calendar quarter. Each holder of a
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subordinated renewable note will also receive a periodic statement indicating
any transactions in the holder's account, as well as interest credited.
Subordination. The debt evidenced by the subordinated renewable notes, and
any interest thereon, will be subordinated to the prior payment in full of all
of our senior debt. "Senior debt" means any of our debt, whether outstanding on
the date of this prospectus or incurred by us after the date of this prospectus,
unless the debt is specifically designated as ranking equal or subordinate to
the subordinated renewable notes in its defining instruments.
As of February 28, 2001, we had:
o approximately $50.1 million of senior debt outstanding, including
approximately $4.3 million of capital lease obligations, and
o no debt ranking equal or subordinate to the subordinated renewable
notes.
The subordinated renewable notes are not guaranteed by any of our
subsidiaries or affiliates. If we liquidate or dissolve one of our subsidiaries,
the law requires that creditors of that subsidiary be paid in full, or provision
for payment be made, from the assets of that subsidiary before distributing any
remaining assets to us as a stockholder of that subsidiary. Therefore, on a
liquidation or dissolution of a subsidiary, no assets of that subsidiary may be
used to make payment to the holders of the subordinated renewable notes until
the creditors of that subsidiary are paid in full from the assets of that
subsidiary.
The indenture does not prevent holders of senior debt from disposing of,
or exercising any other rights with respect to, any or all of the collateral
securing the senior debt. In addition, as long as we make required payments on
the subordinated renewable notes and there is no default under the indenture, we
may also make required payments and pre-payments on, and complete payment of,
debt held by our affiliates and subsidiaries.
Until all senior debt has been paid in full, we will not make any payment
on the subordinated renewable notes, other than a payment made in securities
which rank equal or junior to the subordinated renewable notes, if we experience
any of the following events:
o any liquidation, dissolution or any other winding up of us;
o any receivership, insolvency, bankruptcy, reorganization or similar
proceeding under the U.S. Bankruptcy Code or any other applicable
federal or state law relating to bankruptcy or insolvency;
o the continuation of any default in the payment of the senior debt;
or
o the continuation of any other default on the senior debt which
permits the holders to accelerate the maturity of the senior debt
provided we and the trustee receive notice of the default from the
holders of the senior debt.
Payments on the subordinated renewable notes will not be resumed unless
and until the default has been cured or waived or has ceased to exist or the
holders of the senior debt have been paid in full.
If any distribution is made to holders of the subordinated renewable notes
at a time when it is prohibited by the subordination provisions of the
subordinated renewable notes, the money or property distributed to them must be
paid over to the holders of the senior debt to the extent necessary to pay
senior debt in full.
As a result of the subordination provisions described above, in a
bankruptcy, liquidation or reorganization, holders of subordinated renewable
notes may recover less ratably than holders of senior debt. See "Risk
Factors--Since the subordinated renewable notes are unsecured and subordinate to
our senior debt, in an insolvency proceeding, you would be repaid only if
sufficient funds remain after we repay our senior debt."
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Covenants Contained in Indenture
Maintenance of Positive Tangible Net Worth
The indenture provides that so long as any subordinated renewable notes
are outstanding we will maintain a positive tangible net worth, which includes
stockholder's equity and subordinated debt.
Reports
The indenture requires us to file with the trustee, within 15 days after
we are required to file with the Securities and Exchange Commission, copies of
the annual reports and the information, documents, and other reports that we may
be required to file with the Securities and Exchange Commission under Section 13
or 15(d) of the Exchange Act. If we are not required to file these reports we
will nevertheless continue to file them with the Securities and Exchange
Commission and the trustee so long as any subordinated renewable notes are
outstanding. So long as any subordinated renewable notes are outstanding, we
will make the reports available to investors who request them in writing.
Consolidation, Merger or Sale
The indenture generally permits a consolidation or merger between us and
another entity. It also permits the sale or transfer by us of all or
substantially all of our property and assets. These transactions are permitted
if:
o the resulting or acquiring entity, if other than us, is organized
and existing under the laws of a domestic jurisdiction and assumes
all of our responsibilities and liabilities under the indenture,
including the payment of all amounts due on the subordinated
renewable notes and performance of the covenants in the indenture;
and
o immediately after the transaction, and after giving effect to the
transaction, no default or event of default under the indenture
exists.
If we consolidate or merge with or into any other entity or sell or lease
all or substantially all of our assets according to the terms and conditions of
the indenture, the resulting or acquiring entity will be substituted for us in
the indenture with the same effect as if it had been an original party to the
indenture. As a result, a successor entity may exercise our rights and powers
under the indenture, in our name and, except in the case of a lease, we will be
released from all our liabilities and obligations under the indenture and under
the subordinated renewable notes.
Events of Default. Each of the following constitutes an event of default:
o default for 5 days in the payment of interest when due on any
subordinated renewable note, whether or not prohibited by the
subordination provisions of the indenture;
o default in payment of principal when due on any subordinated
renewable note, whether or not prohibited by the subordination
provisions of the indenture, and continuation of the default for 2
days;
o our failure to observe or perform any material covenant in the
indenture; but only if we have not cured the failure within 60 days
after we have been given notice of the failure by the trustee or the
holders of at least a majority of the principal amount of the
subordinated renewable notes then outstanding; and
o certain events of bankruptcy or insolvency with respect to us.
If any event of default occurs and is continuing, the trustee or the
holders of at least a majority in principal amount of the then outstanding
subordinated renewable notes may declare the unpaid principal of and any accrued
interest on the subordinated renewable notes to be due and payable immediately.
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However, so long as any senior debt is outstanding, a declaration of this kind
will not become effective until the earlier of:
o the day which is five business days after the receipt by us and the
holders of any senior debt of the written notice of acceleration; or
o the date of acceleration of any senior debt.
In the case of an event of default arising from events of bankruptcy or
insolvency, with respect to us, all outstanding subordinated renewable notes
will become due and payable without further action or notice. Holders of the
subordinated renewable notes may not enforce the indenture or the subordinated
renewable notes except as provided in the indenture. Subject to certain
limitations, holders of a majority in principal amount of the then outstanding
subordinated renewable notes may direct the trustee in its exercise of any trust
or power. If the trustee determines that withholding notice is in the interest
of the holders, the trustee may withhold from the holders notice of any
continuing default or event of default, except a default or event of default
relating to the payment of principal or interest.
The holders of a majority in aggregate principal amount of the
subordinated renewable notes then outstanding by notice to the trustee may, on
behalf of the holders of all of the subordinated renewable notes, waive any
existing default or event of default and its consequences under the indenture,
except a continuing default or event of default in the payment of interest on,
or the principal of, the subordinated renewable notes.
We are required to deliver to the trustee annually a statement regarding
compliance with the indenture, and we are required on becoming aware of any
default or event of default, to deliver to the trustee a statement specifying
the default or event of default.
Amendment, Supplement and Waiver. Except as provided in the next
paragraph, the terms of the subordinated renewable notes may be amended or
supplemented with the consent of the holders of at least a majority in principal
amount of the subordinated renewable notes then outstanding, and any existing
default or compliance with any provision of the indenture or the subordinated
renewable notes may be waived with the consent of the holders of a majority in
principal amount of the then outstanding subordinated renewable notes.
Without the consent of each holder affected, an amendment or waiver may
not, with respect to any outstanding subordinated renewable notes held by a
nonconsenting holder:
o reduce the principal amount of subordinated renewable notes whose
holders must consent to an amendment, supplement or waiver;
o reduce the principal of or change the stated maturity of any
subordinated renewable note or alter the redemption provisions or
the price at which we may redeem the note;
o reduce the rate of or change the time for payment of interest,
including default interest, if any, on any note;
o waive a default or event of default in the payment of principal or
interest on, or redemption payment with respect to, the subordinated
renewable notes except a rescission of acceleration of the
subordinated renewable notes by the holders of at least a majority
in aggregate principal amount of the subordinated renewable notes
and a waiver of the payment default that resulted from the
acceleration;
o make any subordinated renewable note payable in money other than
that stated in the subordinated renewable notes;
o make any change in the provisions of the indenture relating to
waivers of past defaults or the rights of holders of subordinated
renewable notes to receive payments of principal of or interest on
the subordinated renewable notes;
o make any change to the subordination provisions of the indenture
that has a material adverse effect on holders of subordinated
renewable notes;
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o modify or eliminate holders' redemption rights; or
o make any change in the foregoing amendment and waiver provisions.
Notwithstanding the foregoing, without the consent of any holder of
subordinated renewable notes, we and the trustee may amend or supplement the
indenture or the notes:
o to cure any ambiguity, defect or inconsistency;
o to provide for the assumption of our obligations to holders of the
subordinated renewable notes in the case of a merger or
consolidation;
o to provide for additional uncertificated subordinated renewable
notes or certificated subordinated renewable notes;
o to make any change that would provide any additional rights or
benefits to the holders of the subordinated renewable notes or that
does not materially adversely affect the legal rights under the
indenture of any holder, including an increase in the aggregate
dollar amount of subordinated renewable notes which may be
outstanding under the indenture;
o to change or eliminate any provision of the indenture, including
those relating to redemptions elected by a holder of subordinated
renewable notes and redemptions on the death or disability of any
holder, but any modifications will not apply to any then outstanding
senior subordinated renewable notes; or
o to comply with requirements of the Securities and Exchange
Commission to effect or maintain the qualification of the indenture
under the Trust Indenture Act.
The Trustee. The indenture contains limitations on the rights of the
trustee, should it become one of our creditors, to obtain payment of claims in
certain cases, or to realize on certain property received in respect of any
claim as security or otherwise. The trustee will be permitted to engage in other
transactions with us.
Subject to certain exceptions, the holders of a majority in principal
amount of the then outstanding subordinated renewable notes will have the right
to direct the time, method and place of conducting any proceeding for exercising
any remedy available to the trustee. The indenture provides that if an event of
default specified in the indenture occurs and is not cured, the trustee will be
required, in the exercise of its power, to use the degree of care of a
reasonable person in the conduct of his own affairs. Subject to these
provisions, the trustee will be under no obligation to exercise any of its
rights or powers under the indenture at the request of any holder of
subordinated renewable notes, unless the holder has offered to the trustee
security and indemnity satisfactory to it against any loss, liability or
expense.
Except as specified below, no holder of any subordinated renewable note
will have any right to institute any proceeding with respect to the subordinated
renewable notes or the indenture or for any remedy under the indenture, unless:
o the holder gives to the trustee written notice of a continuing event
of default;
o holders of at least a majority in principal amount of the then
outstanding subordinated renewable notes make a written request to
the trustee to pursue the remedy;
o the holders provide to the trustee satisfactory indemnity; and
o the trustee does not comply within 60 days.
A holder of a subordinated renewable note may institute suit for
enforcement of payment of the principal of or interest on any subordinated
renewable note on or after the due date of the principal or interest payment.
Reports to Trustee. We will provide the trustee with quarterly reports
which will contain the information reasonably requested by the trustee. These
quarterly reports will include information regarding the outstanding balance,
interest credited, and interest paid on each account.
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No Personal Liability of Directors, Officers, Employees and Stockholders.
No director, officer, employee, incorporator or stockholder of ours will have
any liability for:
o any obligations of ours under the subordinated renewable notes or
the indenture; or
o any claim based on, in respect of, or by reason of, these
obligations or their creation.
Each holder of the subordinated renewable notes waives and releases these
persons from any liability. The waiver and release are part of the consideration
for issuance of the subordinated renewable notes. We have been advised that the
waiver may not be effective to waive liabilities under the federal securities
laws and it is the view of the Securities and Exchange Commission that a waiver
of liabilities under the federal securities laws is against public policy.
Service Charges. We reserve the right to assess service charges for
changing the registration of any subordinated renewable note to reflect a change
in name of the holder, or a transfer by operation of law or otherwise, of a note
by the holder to another person.
Additional Securities. We may offer from time to time additional classes
of securities with terms and conditions different from the subordinated
renewable notes being offered. We will amend or supplement this prospectus if
and when we decide to offer to the public any additional class of security under
this prospectus.
Variations by State. We reserve the right to offer different securities
and to vary the terms and conditions of the offer depending on the state where
the purchaser resides. Examples of these variations include, but are not limited
to, additional interest payments and service charges.
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MATERIAL UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS
Introduction
The following is a summary of the material United States federal income
tax considerations that may be relevant to a holder of a subordinated renewable
note. The summary is based on:
o laws;
o regulations;
o rulings; and
o judicial decisions,
all of which may change, possibly with retroactive effect. This summary deals
only with holders that purchase subordinated renewable notes at original
issuance and will hold the subordinated renewable notes as capital assets. This
summary does not address tax considerations applicable to holders subject to
special tax rules, including, without limitation:
o banks;
o tax-exempt entities;
o insurance companies;
o regulated investment companies;
o common trust funds;
o dealers in securities or currencies;
o traders in securities that elect mark to market;
o persons that will hold subordinated renewable notes as part of an
integrated investment, including a straddle, a synthetic security or
hedge or a conversion transaction, consisting of a subordinated
renewable note and one or more other positions; or
o United States holders, as defined below, that have a functional
currency other than the U.S. dollar.
Investors should consult their tax advisors in determining the tax
consequences to them of holding subordinated renewable notes, including the
application to their particular situation of the United States federal income
tax considerations discussed below, as well as the application of state, local,
foreign or other tax laws.
As used in this prospectus, the term "United States holder" means a holder
that is:
o a citizen or resident of the United States;
o a corporation, partnership or other entity created or organized in
the United States or under the laws of the United States or any
political subdivision of the United States;
o an estate, if United States federal income taxation is applicable to
the income of the estate regardless of its source; or
o a trust, if a United States court is able to exercise primary
supervision over the trust's administration and one or more United
States persons have the authority to control all of the trust's
substantial decisions, or, in certain cases, a trust in existence on
August 19, 1996, electing to continue being treated as a domestic
trust.
The term "non-United States holder" means a holder that is not a United States
holder.
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United States Holders
Original Issue Discount and Qualified Stated Interest
In general, a debt instrument has original issue discount ("OID") for
United States federal income tax purposes if its stated redemption price at
maturity exceeds its issue price by an amount equal to or greater than 0.25% of
the instrument's stated redemption price at maturity multiplied by the number of
complete years to maturity. The issue price of a debt instrument issued for
money is the first price at which a substantial amount of instruments of the
same issue is sold, other than to bond houses, brokers or similar persons or
organizations acting in the capacity of underwriters, placement agents or
wholesalers. The stated redemption price at maturity of a debt instrument is the
sum of all payments due under the instrument, other than payments of qualified
stated interest. Qualified stated interest includes stated interest that is
unconditionally payable in cash at least annually during the entire term of a
debt instrument at a single fixed rate of interest.
We will not offer subordinated renewable notes at a discount.
Nevertheless, a subordinated renewable note with a term greater than one year
will be issued with OID for United States federal income tax purposes if the
purchaser elects to have all interest paid at maturity. A subordinated renewable
note with a term greater than one year and all interest payable at maturity is
called an "OID note" in this prospectus. If a holder elects to receive interest
on a subordinated renewable note with a term greater than one year on a monthly,
quarterly, semi-annual or annual basis, all of the interest will be qualified
stated interest. A subordinated renewable note with a term greater than one year
and interest payable annually or more frequently is called a "non-OID note" in
this prospectus. Subordinated renewable notes with terms that do not exceed one
year are discussed below under "Short-Term Renewable Notes."
For United States federal income tax purposes, if a holder of a non-OID
note elects to switch from monthly, quarterly, semi-annual or annual interest
payments to a payment at maturity and the period between the last payment of
qualified stated interest and the maturity date of the non-OID note exceeds one
year, the non-OID note will be deemed to have been retired and a new OID note
issued for an amount equal to the issue price of the non-OID note. Conversely,
if a holder of an OID note elects to switch from a payment of interest at
maturity to monthly, quarterly, semi-annual or annual payments and the remaining
term of the OID note exceeds one year, the original OID note will be deemed to
have been retired and a new non-OID note issued at an issue price equal to the
adjusted issue price of the OID note, that is, the issue price increased by OID
previously includible in income. Payments of interest on the non-OID note will
be qualified stated interest. If the remaining term of the OID note does not
exceed one year, a new short-term subordinated renewable note will be deemed to
have been issued. See "Short-Term Renewable Notes" below.
Payments of Qualified Stated Interest on Non-OID Notes
Payments of qualified stated interest on a non-OID note will be taxable to
a United States holder as ordinary interest income at the time the payments are
accrued or are received, in accordance with the United States holder's method of
tax accounting.
Accrual of OID on OID Notes
In general, United States holders of OID notes must include the OID in
gross income over the term of the OID notes on a constant yield basis,
regardless of their regular method of tax accounting. As a result, United States
holders generally will recognize taxable income in respect of OID notes in
advance of the receipt of cash attributable to the income.
For each taxable year of a United States holder, the amount of OID that
must be included in gross income in respect of an OID note will be the sum of
the daily portions of OID for each day during that
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taxable year on which the United States holder held the OID note. These daily
portions are determined by allocating to each day in an accrual period a pro
rata portion of the OID allocable to that accrual period. Accrual periods may be
of any length that does not exceed one year and may vary in length over the term
of an OID note.
The amount of OID allocable to any accrual period will equal the OID
note's adjusted issue price at the beginning of the accrual period multiplied by
its yield to maturity as adjusted to take into account the length of the accrual
period. The adjusted issue price of an OID note at the beginning of any accrual
period will equal the issue price of the OID note, increased by previously
accrued OID from prior accrual periods.
Purchase, Sale and Retirement of Subordinated Renewable Notes
A United States holder's tax basis in a subordinated renewable note
generally will equal the cost of that note to the holder increased by any
amounts includible in income by the holder as OID.
On the sale, exchange, retirement or other taxable disposition of a
subordinated renewable note, a United States holder generally will recognize
gain or loss equal to the difference between (a) the amount realized on the
disposition, less any accrued qualified stated interest, which will be taxable
as ordinary income, and (b) the United States holder's adjusted tax basis in the
subordinated renewable note.
Except as discussed below in connection with short-term subordinated
renewable notes, gain or loss recognized by a United States holder on the sale,
exchange, retirement or other taxable disposition of a subordinated renewable
note will generally be long-term capital gain or loss if the United States
holder's holding period for the subordinated renewable note exceeded one year at
the time of disposition.
Renewal at Maturity
For United States federal income tax purposes, if a subordinated renewable
note is renewed at maturity, the subordinated renewable note will be considered
to have been retired and a new subordinated renewable note issued.
Short-Term Renewable Notes
The general rules discussed above are subject to certain modifications in
the case of subordinated renewable notes having maturities of not more than one
year from the date of issuance. Subordinated renewable notes with these
maturities are called "short-term renewable notes" in this prospectus.
None of the interest payments on short-term renewable notes will be
qualified stated interest. A United States holder of a short-term renewable note
that uses the accrual method of tax accounting will be required to include the
OID in respect of the subordinated renewable note in income as it accrues. The
OID will be treated as accruing ratably or, at the holder's election, under a
constant yield method based on daily compounding.
A United States holder of a short-term renewable note that uses the cash
method of tax accounting generally will be entitled to take the interest into
income when received and will not be required to include OID in respect of the
renewable note in income on a current basis. A United States holder using the
cash method of tax accounting may also not be allowed to deduct all of the
interest paid or accrued on any indebtedness incurred or maintained to purchase
or carry the short-term renewable note until the maturity of the subordinated
renewable note or its earlier disposition in a taxable transaction. In addition,
a United States holder using the cash method of tax accounting will be required
to treat any gain on a disposition of the short-term renewable note as ordinary
income to the extent of the holder's accrued OID with respect to the
subordinated renewable note. Alternatively, a United States holder of a
short-term renewable note using the cash method of tax accounting may elect to
accrue OID into income on a
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current basis. Any election will apply to all short-term debt instruments
acquired by the United States holder on or after the first day of the first
taxable year to which the election applies and may be revoked only with the
consent of the Internal Revenue Service. If the election is made, ordinary
income treatment on disposition and the limitation on the deductibility of
interest will not apply.
Information Reporting and Backup Withholding
Information returns may be required to be filed with the Internal Revenue
Service relating to payments made to particular United States holders of
subordinated renewable notes. In addition, United States holders may be subject
to a 31% backup withholding tax on these payments if they do not provide their
taxpayer identification numbers in the manner required, fail to certify that
they are not subject to backup withholding tax, or otherwise fail to comply with
applicable backup withholding tax rules. United States holders may also be
subject to information reporting and backup withholding tax with respect to the
proceeds from a sale, exchange, retirement or other taxable disposition of the
subordinated renewable notes. Any amount paid as backup withholding tax would be
creditable against a United States holder's United States federal income tax
liability, provided that the required information was furnished to the Internal
Revenue Service.
Non-United States Holders
Under United States federal income tax law:
o withholding of United States federal income tax will not apply to a
payment on a subordinated renewable note to a non-United States
holder, provided that:
o the holder does not actually or constructively own 10% or more
of the total combined voting power of all classes of our stock
entitled to vote and is not a controlled foreign corporation
related to us through stock ownership; and
o the beneficial owner provides a statement signed under
penalties of perjury that includes its name and address and
certifies that it is a non-United States person in compliance
with applicable requirements, or satisfies documentary
evidence requirements for establishing that it is a non-United
States person; and
o a non-United States holder will not be subject to United States
federal income tax on gain realized on the sale, exchange,
retirement or other taxable disposition of a subordinated renewable
note, unless, in the case of an individual, the holder is present in
the United States for 183 days or more in the taxable year of the
retirement or disposition and certain other conditions are met.
Despite the above, a non-United States holder that is subject to United
States federal income taxation on a net income basis generally will be taxable
under the same rules that govern the taxation of a United States holder
receiving or accruing interest on a subordinated renewable note or recognizing
gain or loss on the sale, exchange, retirement or other taxable disposition of a
subordinated renewable note. Special rules might also apply to a non-United
States holder that is a qualified resident of a country with which the United
States has an income tax treaty.
United States information reporting requirements and backup withholding
tax will not apply to payments on a subordinated renewable note if the
beneficial owner (a) certifies its non-United States status under penalties of
perjury or satisfies documentary evidence requirements for establishing that it
is a non-United States person, or (b) otherwise establishes an exemption.
Information reporting requirements will not apply to any payment of the
proceeds of the sale of a subordinated renewable note effected outside the
United States by a foreign office of a foreign broker, provided that the broker:
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o derives less than 50% of its gross income for particular periods
from the conduct of a trade or business in the United States;
o is not a controlled foreign corporation for United States federal
income tax purposes; and
o is not a foreign partnership that, at any time during its taxable
year, is 50% or more, by income or capital interest, owned by United
States persons or is engaged in the conduct of a United States trade
or business.
Furthermore, information reporting requirements will not apply to any
payment of the proceeds of the sale of a subordinated renewable note effected
outside the United States by a foreign office of any broker if (a) the broker
has documentary evidence in its records that the beneficial owner is a
non-United States person and other conditions are met or (b) the beneficial
owner otherwise establishes an exemption.
Backup withholding tax will not apply to the payment of the proceeds of
the sale of a subordinated renewable note effected outside the United States by
a foreign office of any broker.
Information reporting requirements and backup withholding tax will apply
to the payment of the proceeds of a sale of a subordinated renewable note by the
U.S. office of a broker, unless the beneficial owner certifies its non-United
States person status under penalties of perjury or otherwise establishes an
exemption.
For purposes of applying the above rules for non-United States holders to
an entity that is treated as fiscally transparent, such as a partnership or
trust, the beneficial owner means each of the ultimate beneficial owners of the
entity.
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CAPITALIZATION
The following table shows our historical consolidated capitalization as of
February 28, 2001 and our capitalization as of February 28, 2001 as adjusted to
give effect to the offering of subordinated renewable notes. The as adjusted
capitalization reflects our estimate that no more than $35.0 million principal
amount of subordinated renewable notes will be outstanding at any one time.
Because the offering of subordinated renewable notes is a best efforts-no
minimum offering, we cannot assure you that all or any portion of the
subordinated renewable notes will be sold.
This table should be read in conjunction with our consolidated financial
statements included elsewhere in this prospectus.
As of
February 28, 2001
-----------------
As adjusted
Historical for the offering
---------- ----------------
(dollars in thousands)
Cash and cash equivalents and
restricted cash ......................... $ 4,463 $ 39,463
======== ========
Notes payable .............................. $ 25,856 $ 25,856
Senior subordinated notes and accrued
interest payable--related party ......... 20,002 20,002
Subordinated renewable notes ............... -- 35,000
Capital lease obligations .................. 4,260 4,260
-------- --------
Total long-term debt ................... 50,118 85,118
Series A, B, C, D and E Preferred Stock .... 27,000 27,000
Common Stock, $.001 par value, 65,000,000
authorized, 34,851,465 outstanding at
February 28, 2001 ....................... 35 35
Additional paid-in capital ................. 23,972 23,972
Unrealized gain from retained interest in
securitized receivables, net of tax ..... 2,020 2,020
Accumulated deficit ........................ (40,840) (40,840)
-------- --------
Total stockholders' equity .............. 12,187 12,187
Total capitalization .................... $ 62,305 $ 97,305
======== ========
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SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
The selected consolidated financial data presented below should be read in
conjunction with our consolidated financial statements, the notes to our
consolidated financial statements and "Management's Discussion and Analysis of
Financial Condition and Results of Operations." The selected consolidated
statement of operations data with respect to the year ended December 31, 1995
and the period from January 1, 1996 to October 8, 1996 and the selected
consolidated balance sheet data at December 31, 1995 and at October 8, 1996 are
derived from the audited consolidated financial statements of our predecessor.
The consolidated statement of operations data with respect to the years ended
May 31, 1997, 1998, 1999, and 2000 and the consolidated balance sheet data at
May 31, 1997, 1998, 1999, and 2000 are derived from, and are qualified by
reference to, our audited consolidated financial statements. The consolidated
financial statements as of and for the years ended May 31, 1998, 1999 and 2000
were audited by Grant Thornton LLP, independent certified public accountants,
and the consolidated financial statements as of and for the year ended May 31,
1997 were audited by Tanner & Co., independent auditors. We derived our selected
financial data as of February 28, 2001 and for the nine months ended February
28, 2001 and February 29, 2000 from our unaudited condensed, consolidated
financial statements included elsewhere in the prospectus and this financial
data reflects all normal recurring adjustments necessary for a fair presentation
of results for such periods. The results for the nine months ended February 28,
2001 are not necessarily indicative of the results to be expected for the entire
year.
PREDECESSOR(1) THE CREDIT STORE, INC.
------------------------ ----------------------------------------------------------------------
FOR THE NINE
FOR THE YEAR JANUARY 1, MONTHS ENDED
ENDED 1996 TO FOR THE YEAR ENDED MAY 31 FEBRUARY 29 FEBRUARY 28
DECEMBER OCTOBER -------------------------------------------- -----------------------
31, 1995 8, 1996 1997 1998 1999 2000 2000 2001
-------- -------- -------- -------- -------- -------- -------- --------
(dollars in thousands, except per share data)
CONSOLIDATED STATEMENT
OF OPERATIONS DATA:
Income from receivables(2) $ 975 $ 12,090 $ 28,747 $ 31,103 $ 22,988 $ 30,605
Securitization income and
asset sales(2) -- -- 11,851 12,599 6,892 1,146
Servicing fees and other
income $ 6,529 $ 2,079 1,601 1,293 1,564 2,685 1,744 2,845
-------- -------- -------- -------- -------- -------- -------- --------
Total revenue 6,259 2,079 2,576 13,382 42,163 46,387 31,624 34,597
Provision for losses -- -- 1,494 6,484 4,607 5,681 4,815 7,063
-------- -------- -------- -------- -------- -------- -------- --------
Net revenue 6,259 2,079 1,082 6,899 37,556 40,706 26,808 27,533
Income (loss) before
income taxes 2,703 (1,933) (14,406) (29,445) 1,889 2,030 (23) (3,799)
Income tax benefit (expense) 24 420 -- -- 1,986 1,042 (1,286) --
-------- -------- -------- -------- -------- -------- -------- --------
Net income (loss) 2,728 (1,512) (14,406) (29,445) 3,876 3,072 (1,309) (3,799)
Dividends on preferred
stock(2)(3) (7) (400) (1,800) (2,000) (1,500) (1,500)
-------- -------- -------- -------- -------- -------- -------- --------
Net income (loss) applicable
to common stockholders $ 2,728 $ (1,512) $(14,413) $(29,845) $ 2,076 $ 1,072 $ (2,809) $ (5,299)
Net income (loss) per share,
basic $ 0.55 $ (0.30) $ (0.56) $ (0.90) $ 0.06 $ 0.03 $ (0.08) $ (0.15)
Net income (loss) per share,
diluted $ 0.55 $ (0.30) $ (0.56) $ (0.90) $ 0.06 $ 0.03 $ (0.08) $ (0.15)
-33-
PREDECESSOR(1) THE CREDIT STORE, INC.
------------------------ ---------------------------------------------------------------------------
AS OF AS OF AS OF MAY 31 AS OF
DECEMBER 31, OCTOBER 8, --------------------------------------------------------- FEBRUARY 28,
1995 1996 1997 1998 1999 2000 2001
------------ ---------- -------------- ------------ ------------ ------------- --------------
(dollars in thousands, except other data)
CONSOLIDATED
BALANCE SHEET DATA:
Cash and cash equivalents
and restricted cash $ 279 $ 58 $ 2,686 $ 8,205 $ 4,284 $ 2,449 $ 4,463
Investments in receivable
portfolios, net(2) 10,760 18,592 21,648 33,892 40,210
Total assets 525 2,885 24,744 39,723 45,781 64,388 68,441
Notes payable -- 1,158 429 5,902 6,087 23,609 25,856
Senior subordinated notes
and accrued interest
payable-related party -- 880 10,446 31,807 19,247 19,139 20,002
Total liabilities 280 4,007 18,118 47,367 33,692 50,014 56,254
Accumulated earnings
(deficit) 240 (1,512) (14,545) (43,990) (40,014) (37,042) (40,840)
Total stockholders' equity
(deficit) 244 (1,122) 6,625 (7,643) 12,089 14,374 12,187
SELECTED CONSOLIDATED
OPERATING DATA:
Face value of non-performing
debt acquired during the
period(2) $1,067,579,343 $890,634,206 $891,904,454 $1,771,707,748 $1,208,506,429
Credit card receivables
owned and managed(2) 35,709,395 84,830,552 89,149,715 96,127,819 116,061,733
Number of accounts owned and
managed(2) 26,803 84,351 94,278 76,732 85,209
Total employees, end of
period(2) 233 292 305 305 334
Ratio of earnings to fixed
charges (4) N/A N/A -- -- 1.4x 1.4x --
Deficiency of earnings to
fixed charges(4) -- -- 14,415,861 29,722,190 -- -- 4,013,513
- ----------
(1) The information for the fiscal year ended December 31, 1995 and for the
period from January 1, 1996 to October 8, 1996 relates to Service One
International, our predecessor. See "Business - General Development of
Business."
(2) Information not applicable for predecessor company.
(3) We have not paid dividends on our capital stock during the periods
presented. See "Description of Capital Stock.
(4) The ratios of earnings to fixed charges have been computed by dividing
earnings available for fixed charges by fixed charges. Earnings available for
fixed charges includes income or loss before income taxes, plus fixed charges
and adjustments for equity interests in qualifying special purpose entities.
Fixed charges consist of interest expenses and a portion of rental expense that
is estimated to be interest. No premiums, discounts, or capitalized expenses
related to our debt exist.
-34-
Quarterly Financial Information
The following table presents certain unaudited consolidated statements of
operations data for our most recent 11 quarters. This information has been
derived from our audited and unaudited consolidated financial statements. In our
opinion, this information has been prepared on the same basis as our annual
consolidated financial statements and includes all adjustments (consisting only
of normal recurring adjustments) necessary for a fair presentation of the
information for the quarters presented. This information should be read in
conjunction with our consolidated financial statements and related notes
included elsewhere in this prospectus. The operating results for any quarter are
not indicative of results for any future period.
Fiscal year 2001
Total for nine
months ended Third Second First
February 28, 2001 quarter quarter quarter
----------------- ------- ------- -------
(dollars in thousands, except per share data)
Summary of operations
Revenue $ 34,596 $ 11,809 $ 11,675 $ 11,113
Provision for losses (7,063) (1,457) (2,724) (2,882)
-------- -------- -------- --------
Net revenue 27,533 10,351 8,951 8,231
Operating income (loss) 463 2,136 (154) (1,519)
Net income (loss) (3,799) 676 (1,579) (2,895)
Dividends on preferred stock (1,500) (500) (500) (500)
-------- -------- -------- --------
Net income (loss) applicable to $ (5,299) $ 176 $ (2,080) $ (3,395)
common shareholders ======== ======== ======== ========
Net income (loss) per share
Basic $ (.15) $ .01 $ (.06) $ (.10)
Diluted $ (.15) $ .00 $ (.06) $ (.10)
Fiscal year 2000
Total for
year ended Fourth Third Second First
May 31, 2000 quarter quarter quarter quarter
------------ ------- ------- ------- -------
(dollars in thousands, except per share data)
Summary of operations
Revenue $ 46,387 $ 14,763 $ 8,770 $ 14,621 $ 8,233
Provision for losses (5,681) (866) (1,078) (1,703) (2,035)
-------- -------- -------- -------- --------
Net revenue 40,706 13,898 7,692 12,918 6,198
Operating income (loss) 7,012 3,729 (669) 5,553 (1,600)
Net income (loss) 3,072 4,382 (1,836) 3,135 (2,608)
Dividends on preferred stock (2,000) (500) (500) (500) (500)
-------- -------- -------- -------- --------
Net income (loss) applicable to $ 1,072 $ 3,882 $ (2,336) $ 2,635 $ (3,108)
common shareholders ======== ======== ======== ======== ========
Net income (loss) per share
Basic $ .03 $ .11 $ (.07) $ .07 $ (.09)
Diluted $ .03 $ .10 $ (.07) $ .07 $ (.09)
-35-
Fiscal year 1999
Total for
year ended Fourth Third Second First
May 31, 1999 quarter quarter quarter quarter
------------ ------- ------- ------- -------
(dollars in thousands, except per share data)
Summary of operations
Revenue $ 42,162 $ 11,378 $ 10,600 $ 9,852 $ 10,332
Provision for losses (4,607) (1,125) (923) (1,170) (1,389)
-------- -------- -------- -------- --------
Net revenue 37,556 10,252 9,678 8,682 8,943
Operating income (loss) 5,919 1,939 1,187 1,220 1,573
Net income (loss) 3,876 3,007 295 283 290
Dividends on preferred stock (1,800) (500) (500) (500) (300)
-------- -------- -------- -------- --------
Net income (loss) applicable to $ 2,076 $ 2,507 $ (205) $ (217) $ (10)
common shareholders ======== ======== ======== ======== ========
Net income (loss) per share
Basic $ .06 $ .07 $ (.01) $ (.01) $ .00
Diluted $ .06 $ .07 $ (.01) $ (.01) $ .00
-36-
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of our financial condition and results of
operations should be read in connection with our consolidated financial
statements and the related notes to the consolidated financial statements
appearing elsewhere in this prospectus. The following discussion contains
forward-looking statements that involve risk and uncertainties. Our actual
results could differ materially from those discussed herein. Factors that could
cause or contribute to such differences include risks and uncertainties related
to:
o the need for additional funds;
o the rapid growth of our operations; and
o our ability to continue to operate profitably.
For a more extensive discussion of these risks and uncertainties, see
"Risk Factors."
Overview
The Credit Store 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 these consumers by acquiring their defaulted debt. We purchase
portfolios for prices typically ranging from 0.50% to 3.00% of the receivable
balance. An increasing amount of our acquisitions come from our "cash for
conversions" or "CFC" program, through which we pay the debt owner an agreed on
price for each account we convert to a credit card. Under a CFC, we typically
pay a higher price per account, but we only pay for the accounts we convert to a
credit card.
Through our direct mail and telemarketing operations, these consumers are
offered an opportunity to:
o settle their debt, typically at a discount,
o transfer the agreed settlement amount to a newly issued unsecured
MasterCard(R) or Visa(R) credit card, and
o establish a positive credit history on their newly issued card by
making timely and consistent payments.
We accept lump sum settlements or installment payment plans from those
consumers who do not accept the credit card offer.
After the consumers have made eight or more consecutive monthly payments
on their outstanding credit card balance we consider the account seasoned and
available to sell or securitize. Because the focus of our business is to convert
defaulted debt into seasoned credit cards, we periodically sell or securitize
portfolios of these seasoned accounts. We also periodically sell into the
secondary market for non-performing consumer debt portfolios of accounts we
acquired but were unable to convert.
We have five subsidiaries, Credit Store Services, Credit Store Capital,
American Credit Alliance, TCS Funding IV and TCS Funding V. All of these
subsidiaries are wholly owned by us; however, only Credit Store Capital and
American Credit Alliance are consolidated on our financial statements. Credit
Store Services, TCS Funding IV and TCS Funding V are qualifying special purpose
entities that are not required to be consolidated.
Credit Store Services and Credit Store Capital acquire non-performing
consumer receivables and contract with us to offer consumers a credit card under
our program or to accept settlements or payment
-37-
plans. American Credit Alliance owns a 50% interest in Dakota Card Fund II, a
limited liability company that contracts with us to service non-performing
receivables and credit card receivables that it owns. TCS Funding IV and TCS
Funding V were created in connection with securitizations for the purpose of
purchasing performing credit card receivables from us. See Note D to our audited
consolidated financial statements.
Our business is highly dependant on the amount of non-performing consumer
debt we acquire, the cost to acquire these accounts, and the cash flows we
generate from these accounts. The marketing cycle for and useful life of a new
credit card account extends over several years. Therefore, we measure our
operating results on both a traditional fiscal period basis and on a "vintage
basis." When analyzing our performance on a vintage basis, we track each
acquired portfolio over the entire period we own the accounts. We store
statistics for each portfolio of accounts in our data warehouse and use these
statistics to develop our portfolio acquisition models, marketing models,
account servicing models, and accounting methodology. Since 1996, we have
acquired approximately $6.0 billion in non-performing consumer debt through
approximately 110 separate portfolio acquisitions.
The charts below summarize the performance of the portfolios we acquired
in each fiscal period on a vintage basis. For fiscal 2001, the charts include
portfolios of receivables owned by The Credit Store and by Credit Store
Services, our unconsolidated subsidiary.
Vintage Basis Analysis of Non-Performing Debt Acquired and Resold
Receivables
Receivable Total Settled through Receivables
Purchased Acquired Receivables CFC Returned to Credit Card or Resold into Remaining
Receivables* through CFC's Acquired Seller Cash Secondary Market Receivables
------------ ------------- -------- ------ ---- ---------------- -----------
Nine months ended
February 28, 2001 $ 786,984,637 $404,382,594 $1,191,367,231 $ 379,035,351 $ 45,524,070 $ 14,805,402 $ 752,002,408
Year ended May 31,
2000 1,401,699,121 328,797,101 1,730,496,222 315,424,851 81,721,524 190,767,788 1,142,582,059
Year ended May 31,
1999 925,541,081 -- 925,541,081 -- 66,147,351 686,876,331 172,517,399
Year ended May 31,
1998 846,868,197 -- 846,868,197 -- 131,744,556 513,434,996 201,688,645
*Net of qualifying accounts returned to seller.
Vintage Basis Analysis of Settled Balances Transferred to Credit Cards
Settlement
Amounts Net New Charges Payments Credit Card
Transferred to Closed Credit Settlement Interest and Received on Credit Card Balances Remaining
Credit Card Card Amounts Fees on Credit Card Balances Sold or Credit Card
Accounts Accounts* Transferred Credit Cards Balances Charged Off Securitized Balances
-------- --------- ----------- ------------ -------- ----------- ----------- --------
Nine months ended
February 28, 2001 $41,113,730 $ 9,130,512 $31,983,218 $ 3,075,835 $ 3,292,974 $ 470,879 $ -- $31,295,200
Year ended
May 31, 2000 66,047,067 19,196,046 46,851,021 16,865,046 17,286,481 11,816,243 252,386 34,360,957
Year ended
May 31, 1999 50,084,301 11,195,051 38,889,250 26,886,235 28,552,468 17,753,473 8,586,366 10,883,177
Year ended
May 31, 1998 84,927,895 14,530,532 70,397,363 43,810,209 45,306,929 44,644,066 17,413,200 6,843,378
* Accounts where the first required payment was never made and
accounts closed at the request of customers before any significant
activity occurred. When this occurs we close the account and return
the original receivable balance to the status of non-performing
debt.
-38-
Vintage Basis Analysis of Balances Settled for Cash
Cash Collections
Receivables on Settled
Settled Receivables
------- -----------
Nine months ended February 28, 2001 $ 4,410,340 $ 880,834
Year ended May 31, 2000 15,674,457 3,848,213
Year ended May 31, 1999 16,063,050 3,573,228
Year ended May 31, 1998 46,816,661 5,969,455
In addition to vintage analysis, we track performance on a traditional
fiscal period basis. Performance during a fiscal period forms the basis for the
numbers that appear in our consolidated financial statements for the fiscal
period.
The charts below summarize the results of our portfolio acquisition
activity and subsequent account performance by fiscal period. For fiscal 2001,
the charts include portfolios of receivables owned by The Credit Store and by
Credit Store Services, our unconsolidated subsidiary.
Fiscal Period Analysis of Non-Performing Debt Acquired and Resold
Year Ended May 31
----------------- Nine Months Ended
1997 1998 1999 2000 February 28, 2001
---- ---- ---- ---- -----------------
Acquisition method
Cash acquisition* $1,063,886,911 $ 899,367,399 $ 956,043,213 $1,483,921,605 $ 792,229,023
Cash for conversion* -- -- -- $ 328,797,100 $ 404,382,594
-------------- -------------- -------------- -------------- --------------
Total acquisition cost $ 12,323,387 $ 15,723,045 $ 8,282,140 $ 14,308,164 $ 10,555,840
Acquisition cost as a 1.16% 1.75% 0.87% 0.78% 0.88%
percent of face value
Number of accounts 525,217 363,191 566,208 808,813 467,767
Cost per account $23.46 $43.29 $14.63 $17.84 $22.57
* Face value of receivables acquired.
Fiscal Period Analysis of Balances Settled by Transfers to Credit Cards
and Balances Settled for Cash
Year Ended May 31
----------------- Nine Months Ended
1998 1999 2000 February 28, 2001
---- ---- ---- -----------------
Settlement amount transferred
to new credit card accounts $ 99,521,065 $ 55,210,412 $ 66,811,969 $ 71,041,209
Cash collections on settled receivables $ 1,511,267 $ 4,420,029 $ 3,989,271 $ 3,479,483
ACCOUNTING FOR INVESTMENTS IN RECEIVABLE PORTFOLIOS.
Effective June 1, 2000, we account for our investments 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." Before June 1, 2000, we used the cost recovery method of
accounting for the portfolios of non-performing consumer debt that we acquired.
Practice Bulletin 6
-39-
requires that the accrual basis of accounting be used at the time the amount and
timing of cash flows from an acquired portfolio can be reasonably estimated and
collection is probable. As of June 1, 2001, we had accumulated statistics in our
data warehouse on approximately $5 billion of non-performing debt acquired since
1996. At that point, we determined that our models provided us with reliable
estimates of the amounts and timing of cash flows that portfolios of acquired
debt would generate in future periods. As required by Practice Bulletin 6, we
then converted on a prospective basis to accrual accounting. As part of our
ongoing commitment to data analysis and statistical modeling, we update and
evaluate our models on a monthly basis to facilitate the application of
appropriate accounting treatment and internal valuation of our portfolios.
Under the accrual method of accounting, static pools are typically
established for each portfolio acquired. Once a static pool is established, the
receivables are permanently assigned to the pool. We account 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.
For financial statement purposes, the cost of a portfolio is the purchase
price paid to the seller plus costs directly related to the acquisition of the
portfolio. All direct mail, telemarketing, and scrubbing costs are expensed as
incurred. At the time a settlement has been reached with a consumer, whether
through the credit card product or other form of settlement, no incremental
asset is recorded to the financial statements. Financial statement entries are
recorded to reflect the new assets as a cardholder begins to make new charges on
an account and through accretion under yield accounting. For other forms of
settlement, financial statement entries are recorded as an account holder makes
payments.
We monitor impairment of non-performing receivable portfolios based on the
current market environment and discounted projected future cash flows of each
portfolio compared to each portfolio's carrying amount. Provisions for losses
are charged to earnings when it is determined that the investment in a
non-performing receivable portfolio is greater than the present value of
expected future cash flows. No provision for losses on non-performing receivable
portfolios was recorded in the nine months ended February 28, 2001.
Our provision for possible credit card losses includes current period
losses and an amount which, in our judgment, 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. In evaluating the adequacy of the
allowance for credit card losses, we consider several factors, including:
historical trends of charge-off activity for each credit card portfolio, current
economic conditions and the impact current economic 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. Credit
card accounts are generally charged off at the end of the month during which the
credit card receivable becomes contractually 180 days past due. Bankrupt
accounts and accounts of deceased cardholders without a surviving, contractually
liable individual, are charged off immediately on receipt of formal notification
of bankruptcy or death, as the case may be.
Under the cost recovery method, we record the purchase price of a
portfolio and any costs directly related to the purchase as an investment in
non-performing consumer debt on the balance sheet. We apply cash flows related
to the acquired portfolio as a reduction of the investment on the balance sheet.
Once the cost of a portfolio has been recovered, the remaining cash flow is
recorded as excess of revenue over cost recovered. The application of cost
recovery can have a material impact on revenue and net income during periods of
increasing or decreasing portfolio acquisitions. We made significant
-40-
investments in portfolio acquisitions during fiscal 1998 totaling $15.6 million,
and the application of cost of recovery resulted in decreased revenue during the
period. The decreases occurred because cash flows from an acquired portfolio are
applied first to reduce the investment in that portfolio to zero, which takes
between 9 and 13 months on the average, depending on the performance of the
acquired portfolio. During the same period, we expensed, as incurred, all costs
to market and service the portfolios which, when, combined with the effects of
cost recovery on revenue, contributed to the large losses experienced in fiscal
1998. During fiscal 1999 and 2000, the majority of the portfolios acquired
during the two preceding years experienced full cost recovery, leading to a
significant increase in revenue in excess of cost recovered. In addition,
portions of our performing credit card receivables had matured to the point
where we were able to sell and securitize them at prices well in excess of the
cost basis of those receivables, generating gains on the sale of those
portfolios. The above factors contributed to the net income of $3.1 million in
fiscal 2000 and $3.9 million in fiscal 1999 and a net loss of $29.4 million in
fiscal 1998.
Results of Operations
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 2001 as compared to the first nine months of fiscal 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 qualifying special purpose entities in November 1999 with no
similar event during the first nine months of fiscal 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, we adopted the accrual method of
accounting for our investment in receivable portfolios. Before June 1, 2000, we
used the cost recovery method of accounting. Under the cost recovery method 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 as revenue the discount on acquired
portfolios over the period in which the payments are probable of collection. The
recognition of this discount 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, 2001 and 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
-41-
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 percentage of core revenue from 13.2% in the
nine months ended February 29, 2000 to 13.7% in the nine months ended February
28, 2001. Within this category, royalty expense increased from $0.59 million in
the nine months ended February 29, 2000 to $1.28 million in the nine months
ended February 28, 2001. As indicated in Note G to our interim financial
statements, we are disputing our obligation to continue making royalty payments
under the agreements and suspended both payment and accrual of royalty expense
in February 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.
INCOME TAX EXPENSE. We recorded a $1.29 million tax expense during the
nine months ended February 29, 2000 as a result of the gain from the sale of the
retained interests in securitizations. No income tax benefits related to the net
loss were recorded in the nine months ended February 28, 2001. The net loss is
expected to be offset against fourth quarter net income. The recognition of net
income for the fourth quarter and fiscal 2001 is dependent on the sale of
seasoned credit card accounts in the fourth quarter as planned in the forecast.
In prior years, we recognized a tax benefit and deferred tax asset for a
portion of our 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, the projection of net income in future
years at levels greater than fiscal 2000 and 1999 and the level of
securitization and sale activity we experienced. We will continue to evaluate
the remaining valuation allowance and will recognize tax benefits as factors
indicate that it is more likely than not that future tax benefits will be
realized.
NET LOSS. Net loss was $1.31 million for the 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. However, we treat the dividends as
declared and payable for the purpose of calculating net income (loss) applicable
to common stockholders. After the effect of preferred dividends of $1.5 million
in each nine month period, the net loss applicable to common stockholders was
$2.81 million, or $.08 per basic and diluted common share, in the first nine
months of fiscal 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 2001.
FISCAL YEAR ENDED MAY 31, 2000 COMPARED TO FISCAL YEAR ENDED MAY 31, 1999:
REVENUES. Total revenue for the fiscal year ended May 31, 2000 was $46.4
million a 10% increase from $42.2 million during the year ended May 31, 1999.
Income from credit card receivables increased 51% from $6.4 million to $9.7
million due to a higher amount of funded credit card receivables during the
period. Income from credit card receivables represents interest and fees on new
advances or purchases made by holders of our credit cards on an accrual basis.
Revenue in excess of costs recovered decreased 4% from $22.3 million to $21.4
million. Securitization income and asset sales increased 6% from $11.9 million
to $12.6 million primarily due to entrance into the re-sale market of
nonperforming consumer accounts. Securitization income and asset sales
represents the excess of cash proceeds over the cost basis in those assets.
During fiscal 2000, we sold our retained interests in three qualifying
special purpose entities, completed a securitization of $14.3 million in
receivables, sold $1.4 million of receivables to an
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unaffiliated bank, and sold non-performing assets in the market. Servicing fees
and other income increased 72% from $1.6 million to $2.7 million due to the
increased number of accounts serviced. Core revenue, defined as income from
credit card receivables, revenue in excess of cost recovered and servicing fees
and other income, increased 11% from $30.3 million in fiscal 1999 to $33.8
million in fiscal 2000 due to higher amount of funded credit card receivables
and increased number of accounts serviced. The provision for losses increased
23% from $4.6 million to $5.7 million based on increasing volume of new charges
funded. The above combined to produce net revenue of $40.7 million for the
fiscal year ended May 31, 2000, an 8% increase over $37.6 million recorded for
the year ended May 31, 1999.
EXPENSES. Total operating expenses increased 7% from $31.6 million in
fiscal 1999 to $33.7 million in fiscal 2000 but decreased as a percentage of
core revenues from 104% to 100%. Salaries and employee benefits increased 8% to
$13.5 million from $12.5 million based on an average higher number of full time
personnel but decreased as percentage of core revenues from 41% to 40%.
Professional fees decreased 4% from $2.7 million in fiscal 1999 to $2.6 million
in fiscal 2000. Depreciation and amortization decreased 5% from $2.6 million in
fiscal 1999 to $2.5 million in fiscal 2000. Third party service fees decreased
2% from $4.7 million in fiscal 1999 to $4.6 million in fiscal 2000 and decreased
as a percentage of core revenues from 16% to 14% as our cost per account
declined. Communication expense increased 18% from $2.3 million in fiscal 1999
to $2.8 million in fiscal 2000 in line with increased portfolio acquisition
activity. Royalty expense, under two mutual business development agreements,
increased 12% from $1.5 million in fiscal 1999 to $1.7 million in fiscal 2000.
The royalty expense is accrued when new credit card accounts make their third
payment according to the terms of the cardholder agreement or when cash from
non-card accounts is collected. Increased royalty expense is due to a higher
percentage of cards reaching a third payment due to increased portfolio
acquisition activity in fiscal 2000. The mutual business development agreements
are currently in dispute. See "Certain Relationships and Related Transactions."
Financing fees increased 416% from $0.2 million to $1.1 million reflecting
our ability to obtain two additional financing sources in fiscal 2000. Interest
expense increased 15% from $4.0 million in fiscal 1999 to $4.6 million in fiscal
2000 based on a higher average amount of debt outstanding resulting from
increased portfolio acquisition activity.
INCOME TAX BENEFIT. Revenues and expenses combined for income before
income taxes of $2.0 million in fiscal 2000 compared to income before income
taxes of $1.9 million in fiscal 1999. We recognized a tax benefit of $1.0
million in fiscal 2000 resulting in net income of $3.1 million compared to a tax
benefit of $2.0 million in fiscal 1999 resulting in net income of $3.9 million.
The tax benefit in fiscal 2000 consisted of the recognition of $1.0 million of
tax expenses related to the reclassification of comprehensive income and the
reduction of $2.0 million of a valuation allowance related to net operating loss
carryforward.
We have reviewed the adequacy of our valuation allowance and determined
that based on fiscal 2000 and 1999 pretax income, the projection of net income
in future years at levels greater than fiscal 2000 and 1999 and the level of
securitization and sale activity we experienced, it was more likely than not
that a portion of our net operating loss carryforward would be utilized. We will
continue to evaluate the remaining valuation allowance and will recognize tax
benefits as factors indicate that it is more likely than not that future tax
benefits will be realized.
NET INCOME (LOSS). Dividends on preferred stock have accumulated but have
not been declared and are not yet payable. We, however, treat the preferred
dividends as declared and payable for the purpose of calculating net income
applicable to common stockholders and earnings per share. Preferred dividends
for fiscal 2000 increased 11% from $1.8 million in fiscal 1999 to $2.0 million.
After the effect of preferred dividends, net income applicable to common
stockholders in fiscal 2000 was $1.1 million compared to net income applicable
to common stockholders of $2.1 million for fiscal 1999.
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FISCAL YEAR ENDED MAY 31, 1999 COMPARED TO FISCAL YEAR ENDED MAY 31, 1998:
REVENUES. During the fiscal year ended May 31, 1999, total revenue
increased from $13.4 million to $42.2 million, or 215%. The increase was
primarily due to a combination of increased revenues from a maturing credit card
portfolio, portfolio securitizations and portfolio sales. Income from credit
card receivables increased 63% from $4.0 million to $6.4 million due to an
increase in the weighted average credit card receivables funded. Revenue in
excess of costs recovered increased 174% from $8.1 million to $22.3 million due
to increased cash flow related to acquired portfolios and the effect of fully
recovering the acquisition costs on the majority of the portfolios acquired
during the two previous fiscal years. Our performing credit card receivables had
matured to the stage where we achieved the sale or securitization of
approximately $27.4 million in receivables. Our securitization income and asset
sales resulted in an $11.9 million gain which represents the excess of cash
proceeds over the cost basis in those assets. There were no such sales in the
previous fiscal year. Servicing fees and other income increased 21% from $1.3
million to $1.6 million due to a higher average number of accounts under
management subject to a servicing fee. Core revenue, defined as income from
credit card receivables, revenue in excess of cost recovered and servicing fees
and other income, increased 127% to $30.3 million, in fiscal 1999 from $13.4
million in fiscal 1998 due to the effect of fully recovering the acquisition
costs of the majority of portfolios in the two previous years through the cost
recovery methodology of applying payments received. The provision for losses
decreased 29% from $6.5 million to $4.6 million based on the experience of a
more matured portfolio. The above combined to produce net revenue of $37.6
million for the fiscal year ended May 31, 1999, a 445% increase over the $6.9
million recorded for the year ended May 31, 1998.
EXPENSES. During the fiscal year ended May 31, 1999, salaries and employee
benefits decreased 6% from $13.3 million to $12.5 million based on an average
lower number of full-time personnel. Professional fees decreased 36% from $4.2
million in fiscal 1998 to $2.7 million in fiscal 1999 as we moved beyond our
startup period requiring fewer outside professional services. Depreciation and
amortization decreased 19% from $3.2 million in fiscal 1998 to $2.6 million in
fiscal 1999. Fiscal 1998 included an $0.8 million writedown of existing software
systems. Third party card service fees increased 36% from $3.5 million in fiscal
1998 to $4.7 million in fiscal 1999, in line with the increase in the average
number of accounts under management. Communication expense increased 12% from
$2.0 million in fiscal 1998 to $2.3 million in fiscal 1999 largely in line with
increased marketing campaigns on existing portfolios of non-performing debt.
Royalty expense, under two mutual business development agreements, increased
644% from $0.2 million in fiscal 1998 to $1.5 million in fiscal 1999. The
royalty expense increased because a higher percentage of cards reached a third
payment as a result of to a more thorough sales process and better account
retention in the early months of a new account. The mutual business development
agreements are currently in dispute. See "Certain Relationships and Related
Transactions."
Interest expense decreased 15% from $4.8 million in fiscal 1998 to $4.0
million in fiscal 1999 for two reasons. We had a lower average amount of debt
outstanding due to the conversion of $10.0 million of subordinated debt to
preferred stock in May 1998 and the conversion of $10.0 million of subordinated
debt in August 1998. Second, we benefited from a reduction in the interest rate
on senior debt.
INCOME TAX BENEFIT. Revenues and expenses combined for income before
income taxes of $1.9 million in fiscal 1999 compared to a loss before income
taxes of $29.4 million in fiscal 1998. We recognized a tax benefit of $2.0
million for the year ended May 31, 1999 due to the reduction of a valuation
allowance related to net operating loss carryforwards. We did not recognize a
tax benefit for the year ended May 31, 1998.
We have reviewed the adequacy of our valuation allowance and determined
that based on fiscal 1999 pretax income, the projection of net income in future
years at levels greater than fiscal 1999 and the level of securitization and
sale activity we experienced, it was more likely than not that a portion of our
net operating loss carryforward would be utilized.
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NET INCOME (LOSS). Dividends on preferred stock have accumulated but have
not been declared and are not yet payable. We, however, treat the preferred
dividends as declared and payable for the purpose of calculating net income
applicable to common stockholders and earnings per share. Preferred dividends
for fiscal 1999 increased 350% from $0.4 million in fiscal 1998 to $1.8 million
due to the previously discussed conversion of debt to preferred stock. After the
effect of preferred dividends, net income applicable to common stockholders in
fiscal 1999 was $2.1 million compared to a net loss applicable to common
stockholders of $29.8 million for fiscal 1998.
Credit Card Receivable Quality
Once a receivable is settled and the settlement amount is transferred to a
credit card, we employ traditional credit card measurements to track
delinquencies and charge-offs in our portfolio of performing credit cards. We
experience the majority of defaults and delinquencies during the first few
months after the settlement amount is transferred to a new credit card. In
general, if a customer does not make the first required payment on an account,
we close the account and restore the account balance to non-performing status.
We follow the same policy if the customer closes the account voluntarily before
making the first required payment. We track these closed accounts separately.
The delinquency chart below includes all our owned and managed credit card
receivables but does not include receivables in accounts that have not yet made
a first payment. Because these accounts are not yet performing and may be
closed, including them would distort the reporting of actual delinquencies on
our performing portfolio of accounts.
Delinquencies as a Percentage of Owned and Managed Credit Card Receivables
For the Three Months Ended
May 31 Aug. 31, Nov. 30, Feb. 29, May 31, Aug. 31, Nov. 30, Feb. 28,
1999 1999 1999 2000 2000 2000 2000 2001
---- ---- ---- ---- ---- ---- ---- ----
(percent of total)
Loans Delinquent:
30 to 59 days 10.9% 9.6% 9.3% 8.2% 9.6% 10.5% 11.0% 9.7%
60 to 89 days 4.9% 5.5% 4.5% 3.6% 4.7% 6.2% 5.8% 5.5%
90 or more 3.4% 4.1% 3.5% 3.1% 3.2% 4.2% 4.7% 5.0%
Total 60 or more 8.3% 9.6% 8.0% 6.7% 7.9% 10.4% 10.5% 10.5%
We track the performance of securitized receivables as separate pools and
have summarized the delinquency history of securitized credit card receivables
in the chart below. The three month periods ended May 31, 1999 through May 31,
2000 reflect the performance of receivables held by the three qualifying special
purpose entities created in connection with our first three securitizations. We
sold our retained interest in all three of these entities in May 2000. Removing
these seasoned receivables from our portfolio of owned and managed credit card
receivables and our portfolio of securitized receivables had the effect of
increasing reported delinquencies during the subsequent reporting periods. The
three month periods ended May 31, 2000 through February 28, 2001 reflect the
performance of receivables held by TCS IV which was created in connection with
our May 2000 securitization. See "--Liquidity and Capital Resources."
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Delinquencies as a Percentage of Securitized Credit Card Receivables
For the Three Months Ended
May 31, Aug. 31, Nov. 30, Feb. 29, May 31, Aug. 31, Nov. 30, Feb. 28,
1999 1999 1999 2000 2000 2000 2000 2001
---- ---- ---- ---- ---- ---- ---- ----
(percent of total)
Loans Delinquent:
30 to 59 days 6.6% 6.1% 5.8% 5.8% 2.0% 7.0% 7.6% 7.1%
60 to 89 days 1.8% 2.2% 2.0% 2.2% 0.0% 2.5% 2.7% 2.8%
90 or more 1.0% 1.7% 1.6% 1.7% 0.0% 2.3% 4.2% 5.3%
Total 60 or more 2.9% 3.9% 3.7% 3.9% 0.0% 4.8% 7.0% 8.1%
Under our program, when a new credit card is issued to the consumer, the
opening balance and credit line equal the agreed settlement amount of the debt
obligation we purchased. However, for financial statement purposes, we record as
credit card receivables only:
o amounts funded as a result of cash advances and new cardholder
purchases made after the cardholder makes the first payment on the
credit card account,
o the accrued interest on these cash advances and new purchases, and
o the accrued fees on the account.
We do not record any credit card asset until after the cardholder makes
payments and begins to make new charges on the account. As a result,
historically, the amount owed by our cardholders exceeds the amount of
receivables recorded on our balance sheet as summarized in the following chart.
Actual Cardholder Balances Compared to Credit Card Receivables
Recorded on Balance Sheet
Year Ended May 31
----------------- Nine Months Ended
1998 1999 2000 February 28, 2001
---- ---- ---- -----------------
Owned credit card receivables $75,019,451 $66,745,515 $77,912,670 $89,220,685
Unused credit $ 6,090,362 $ 4,456,019 $ 7,864,138 $ 9,845,894
Utilization rate 92% 94% 91% 90%
Credit card receivables on balance sheet $16,824,782 $21,879,209 $27,386,165 $32,392,337
Credit card receivables on balance sheet
as a percentage of owned credit card receivables 22% 33% 35% 36%
We reserve for credit card losses on our balance sheet and charge against
the reserve based on the amounts funded as a result of cash advances and new
cardholder purchases made after the cardholder makes the first payment on the
credit card account, the accrued interest on these cash advances and new
purchases, and the accrued fees on the account. The following table presents our
charge-offs for the periods indicated and our provision for losses on our owned
credit card receivables:
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Charge Offs and Provision for Losses on Credit Card Receivables
Recorded on Balance Sheet
Year Ended May 31
----------------- Nine Months Ended
1998 1999 2000 February 28, 2001
---- ---- ---- -----------------
Average credit card receivables on balance sheet $10,043,983 $19,906,367 $34,476,497 $26,387,249
Charge-offs* $ 4,721,858 $ 5,448,783 $ 6,051,670 $ 5,104,920
Charge-offs as a percentage of average credit 47.0% 27.4% 17.6% 19.3%
card receivables on balance sheet
Provision for credit card losses $ 6,483,737 $ 4,607,081 $ 5,680,975 $ 7,063,455
Provision as a percentage of charge-offs 137.3% 84.6% 93.9% 138.4%
* Charge-offs are not net of recoveries.
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.
At February 28, 2001, we had $4.5 million of cash and cash equivalents and
restricted cash, compared to $8.2 million at May 31, 1998, $4.2 million at May
31, 1999 and $2.4 million at May 31, 2000. We maintain restricted cash reserves
at two banks to facilitate the funding of new charges and advances on our
customer's credit cards. These restricted balances were $1.3 million at February
28, 2001, $1.0 million at May 31, 2000, $0.8 million at May 31, 1999 and $1.0
million at May 31, 1998.
A significant source of liquidity for us has been the sale and
securitization of credit card receivables. In May 2001, we completed a
securitization of approximately $4.86 million in seasoned credit card
receivables which had a principal balance of approximately $5.72 million with an
unconsolidated wholly-owned qualifying special purpose entity. The qualifying
special purpose entity provided $4.0 million for the purchase and the remaining
$0.86 million of the purchase price was recorded by us as retained interest.
During the fiscal year ended May 31, 2000, we sold our retained interest
in three qualifying special purpose entities to the senior beneficial interest
holder for approximately $8.6 million in cash, realizing a pretax gain of
approximately $6.5 million.
During the fiscal year ended May 31, 1999, we sold approximately $7.0
million in face amount of receivables to an unaffiliated bank for $5.0 million
and raised approximately $13.0 million from three securitizations of credit card
receivables totaling $20.4 million. We intend to securitize receivables in the
capital markets and sell receivables to unaffiliated credit card banks in the
ordinary course of business.
We also maintain a senior secured revolving credit line with Coast
Business Credit, a division of Southern Pacific Bank. The credit line is for
$15.0 million and is secured by substantially all of our assets. Borrowings
under the credit line are based on a formula, which is dependent primarily on
the performance and maturity of our 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. We entered into an amendment with Coast
Business Credit in May 2001 to extend the credit line until May 31, 2002. The
amendment reduces the amount available to us to $13.0 million after June 30,
2001, $10.0 million after September 30, 2001, $7.5 million after December 31,
2001, and $5.0 million by March 31, 2002. We may add participating lenders to
the Coast credit line to increase the amounts available to us. We are in
discussion with potential participants and replacement lenders to increase the
amounts available to us for working capital purposes. There can be no assurance
we will be successful in obtaining participants in or a replacement for the
Coast credit line. We believe the existing credit facility, as extended,
together with
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amounts expected to be received by us from securitizations and credit card
portfolio sales, will be adequate to meet our working capital needs through our
third fiscal quarter of 2002.
We have also received secured financing from a related party, J.L.B. of
Nevada. The notes are payable on demand but are subordinated to the senior
secured revolving credit line. The holder of the notes cannot demand repayment
prior to repayment of the senior secured revolving credit line. In August 1998,
we converted $10.0 million of this debt into Series E preferred stock. At
February 28, 2001, the principal amount outstanding on these notes totaled $17.3
million and accrued but unpaid interest totaled $2.7 million.
On September 20, 1999, we entered into a repurchase agreement with Bank of
Hoven. Under the agreement, the bank purchased credit card receivables from us.
The initial agreement had a purchase price of $3.0 million which was increased
to $6.0 million in March 2000. The agreement was replaced by a new repurchase
agreement for $8.0 million in December 2000. For accounting purposes, we treat
the repurchase agreement as a financing transaction. We anticipate renewing this
repurchase agreement on a quarterly basis until we include the receivables in a
securitization or portfolio sale.
In October 1999, through a bankruptcy remote special purpose entity, we
established a $17.5 million secured revolving credit line with General Electric
Capital Corporation to finance the acquisition of non-performing consumer debt
portfolios, which credit line expires in August 2002. There was $2.7 million
outstanding under the credit line at February 28, 2001 with $0.09 million
available under the borrowing base formula for future borrowings. The transfer
of receivables to this special purpose entity by us does not qualify for sale
treatment under SFAS 140. The special purpose entity is fully consolidated in
our financial results.
During the fiscal year ended May 31, 2000, we established a new
wholly-owned qualifying special purpose entity, TCS Funding IV, for the purpose
of purchasing performing credit card receivables from us. TCS Funding IV entered
into a $40.0 million credit facility with a lending institution to finance the
purchase of credit card receivables. The initial $12.1 million sale of credit
card receivables to the qualifying special purpose entity included receivables
with a principal balance of approximately $14.2 million. TCS Funding IV provided
$10.0 million for the purchase and the remaining $2.1 million of the purchase
price was recorded by us as retained interest. We recognized a pretax gain of
approximately $3.8 million. Future borrowings under the facility are subject to
the lender's discretion and a number of other conditions.
The TCS Funding IV credit facility requires interest payments only during
the first 18 months and allows for multiple advances during this period up to
$40.0 million. Borrowings in excess of $10.0 million are governed by a borrowing
base and are contingent on the senior beneficial interests receiving a minimum
BBB- rating from a nationally recognized rating agency. The credit facility
advances 70% of the receivables balance, of which 5% must be deposited in a
reserve account. We are in the process of attaining a rating on behalf of TCS
Funding IV. The terms of the credit facility require that all credit card
receivables purchased by TCS Funding IV must be current with a minimum of eight
payments made on each account and must meet specified other eligibility
requirements.
During the first 18 months of the credit facility, after new charges are
funded and fees and interest are paid, excess cash collections can be used by
the qualifying special purpose entity to purchase additional accounts from us or
pay down the senior beneficial interest. Following the first 18 months, all cash
collections relating to the senior debt interest in the receivables are used to
repay principal, after payment of the related servicing fees and interest. All
new charges on the sold accounts are either sold to the qualifying special
purpose entity or contributed in exchange for a retained interest until the
senior debt interest is paid down. While the senior debt interest is in place,
there are restrictions on our ability to pay dividends and to pay interest on or
the principal of the notes held by our controlling stockholder.
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During October 2000, we established a new wholly-owned qualifying special
purpose entity, Credit Store Services, Inc. ("CSSI"), for the purpose of
purchasing non-performing consumer debt portfolios from us. Non-performing
consumer debt portfolios are sold to CSSI at a price equal to our book value.
CSSI entered into a $25.0 million credit facility with a lending institution to
finance a portion of the purchase price of these non-performing consumer debt
portfolio acquisitions. The facility expires in October 2003. 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 flows generated by the purchased accounts be paid to the lender in addition
to the payment of principal of and interest on amounts borrowed.
Capital Expenditures and Portfolio Acquisitions
During the first nine months of fiscal 2001, we invested $4.1 million to
acquire portfolios of non-performing consumer debt, a decrease of 67% from the
$12.1 million invested in the first nine months of fiscal 2000. The decrease in
the first nine months of fiscal 2001 was due to the increased use of our cash
for conversions program which significantly decreases the amount of cash
investment required to acquire a portfolio. During fiscal 2000, we invested
$13.8 million to acquire portfolios of non-performing consumer debt, an increase
of 60% over the $8.6 million invested in fiscal 1999, which was a 45% decrease
from the $15.6 million invested in fiscal 1998. The decrease in fiscal 1999 was
due in part to a shortage of available financing for the industry in general and
a shortage of available portfolios for purchase that met our requirements and
were available for acceptable prices. During fiscal 2000 we also invested $4.1
million to acquire a portfolio of fully performing credit card receivables, at a
discount.
We invested $2.5 million in property and equipment during the first nine
months of fiscal 2001 compared to $0.7 million during fiscal 2000, $0.7 million
in fiscal 1999, and $4.2 million in fiscal 1998. A large portion of the hardware
commitments required to build our business platform were made in fiscal 1998.
We plan to make continued investments in technology and non-performing
portfolios, the amount of which will depend on the amount of financing and new
capital available.
Inflation
We believe inflation has not had a material impact on our results of
operations for the nine months ended February 28, 2001 or for the fiscal years
ended May 31, 1998, 1999 and 2000.
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, we actively monitor
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,
net income and cash flow. We seek 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 after providing the required notice to the customer, which is
generally no more than 60 days.
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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 is initially recorded at
the basis allocated in accordance with SFAS No. 140. This original cost basis is
adjusted to fair value, which is based on the discounted anticipated future cash
flows on a "cash out" basis. Any adjustment, net of related deferred income
taxes, is 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, we review 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 on our variable rate loans increase or decrease an average
of 10%, interest expense and income before income taxes would not change by a
material amount. We have not entered into derivative transactions to hedge the
interest rate risk.
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BUSINESS
General Development of Business
The Credit Store 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 these consumers by acquiring their defaulted debt. Through our
direct mail and telemarketing operations, these consumers are offered an
opportunity to:
o settle their debt, typically at a discount,
o transfer the agreed settlement amount to a newly issued unsecured
MasterCard(R) or Visa(R) credit card, and
o establish a positive credit history on their newly issued card by
making timely and consistent payments.
After the consumers have made eight or more consecutive monthly payments
on their outstanding credit card balance we consider the account seasoned and
available to sell or securitize. Because the focus of our business is to convert
defaulted debt into seasoned credit cards, we periodically sell or securitize
portfolios of these seasoned accounts.
In December, 1996, we acquired from Taxter One all the capital stock of a
company which had been engaged through a subsidiary, Service One International,
since January 1996 in the business of acquiring non-performing consumer debt
portfolios and marketing and servicing credit cards generated from these
portfolios. In connection with the acquisition we changed our name to Credit
Store, Inc. Prior to the acquisition, we discontinued operations of our prior
line of business, which was unrelated to our current operations. In February
1998, we merged the acquired subsidiary and another wholly owned subsidiary,
Credit Store Mortgage, Inc., into us. In March 1998, we merged with Service One
International and changed our name to The Credit Store, Inc.
We have five wholly owned subsidiaries: Credit Store Services, Credit
Store Capital, American Credit Alliance, TCS Funding IV and TCS Funding V.
Credit Store Services, a qualifying special purpose entity established in July
2000, and Credit Store Capital, established in July 2000, acquire non-performing
consumer receivables and contract with us to offer consumers a credit card under
our program or to accept settlements or payment plans. American Credit Alliance,
established in June 1995, owns a 50% interest in Dakota Card Fund II, a limited
liability company that contracts with us to service non-performing receivables
and credit card receivables that it owns. TCS Funding IV, established in May
2000, and TCS Funding V, established in May 2001, are qualifying special purpose
entities created in connection with securitizations for the purpose of
purchasing performing credit card receivables from us.
Industry Overview
We operate in the consumer finance industry, competing with issuers of
revolving credit products and other buyers of non-performing consumer debt.
The United States Federal Reserve reported that American consumers owed an
aggregate of $1.53 trillion of debt as of February 2001, and that the size of
the revolving credit market in the United States was in excess of $681 billion
as of February 2001, up from $609 billion in February 2000. The United States
Federal Reserve also reported that pools of securitized revolving credit assets
totaled $363 billion as of February 2001, up from $317 billion in November 1999.
We believe that the purchasing convenience associated with unsecured credit
cards has driven the growth of credit cards and has made them the preferred
consumer credit vehicle. In addition, we believe that the purchase of consumer
goods and services over the Internet will continue to fuel the demand for credit
cards. We also believe that the
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relative liquidity and predictability of these assets has fostered the
widespread acceptance of revolving credit securitizations by investors.
While traditional banking organizations have enjoyed significant
advantages in consumer lending compared to non-bank providers of consumer loans,
greater access to capital and the emergence of securitization markets, coupled
with technological advances, has allowed non-banks to compete effectively with
banks in this arena. We believe that future success in the credit card industry
will continue to be experienced primarily by highly focused organizations that
are adept at using information and technology to market their products and
manage risk within their portfolios.
Credit card issuers make credit cards available to their clients in a
variety of ways. Many issuers offer cards as a convenience to existing clients,
a strategy to create greater affinity and client loyalty. This is generally the
case with credit cards offered by department stores, who offer private label
credit cards, as well as smaller banks and credit unions. In contrast, the
larger credit card issuers, who control the vast majority of the market, use
mass mailing of credit card offers to consumers as the most cost-effective means
of achieving the growth rates they seek. Often this process is accomplished by
obtaining a list of names of individuals who meet the issuer's credit guidelines
from one of the national credit bureaus.
We, however, source our customers by purchasing charged-off consumer debt
from banks and finance companies. We believe the purchase of charged-off debt is
an efficient means to source new credit card customers in our target market. We
believe the market for buying and selling non-performing consumer debt
portfolios has expanded due to a steadily increasing volume of charged-off
consumer debt coupled with a shift by originating institutions toward selling
their portfolios of non-performing consumer loans. Historically, originating
institutions had relied on large internal collection staffs for their initial
collection efforts and outside collection agencies for accounts delinquent more
than 180 days. As buyers emerged to purchase non-performing debt, originating
institutions have increasingly sold these portfolios for cash. Institutions will
usually sell accounts when the market prices exceed the net present value of
retaining and working the accounts. In deciding whether to sell accounts,
sellers also evaluate the potential return on investment from reinvesting the
cash proceeds from portfolio sales in the core operations of originating and
servicing new loans.
According to Faulkner & Gray, a leading receivables management publisher,
the sales volume of charged-off debt by initial credit grantors grew from $2.5
billion in 1990 to an estimated $52.0 billion in 2000. The 2000 estimate
includes resale volume. Sellers have developed a variety of ways to sell
non-performing receivables. Some originating institutions pursue auction type
sales by constructing a portfolio of receivables and seeking bids from specially
invited competing parties. This approach has resulted in an increase in the
number of receivables portfolios offered for sale by account brokers. Other
means of selling receivables include privately negotiated direct sales when the
originating institution contacts known, reputable purchasers. Originating
institutions have also entered into "forward flow" sales contracts. These
contracts require an originating institution to sell some or all of its
receivables that meet specified criteria, such as balance size and elapsed time
since delinquency, to a single purchaser during a specified period of time for
an agreed on price.
Business Operations
Our operations integrate the following disciplines: (1) portfolio
acquisitions and divestitures; (2) scrubbing and modeling; (3) marketing,
settlement and card origination; (4) cardholder services; and (5) receivables
sales and securitizations.
PORTFOLIO ACQUISITIONS AND DIVESTITURES:
We acquire non-performing credit card receivables, consumer installment
loans, and automobile deficiencies on a nationwide basis, from a wide range of
originating institutions, including banks and
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finance companies. We have acquired in excess of $6.0 billion in receivables. A
typical portfolio contains between 5,000 and 150,000 consumer accounts that
typically were charged-off by the original lending institution and passed
through various stages of collection efforts. Usually, the size of each account
was between $1,000 and $6,000, with an average balance of approximately $2,100.
We purchase portfolios for prices typically ranging from 0.50% to 3.00% of the
receivable balance.
After acquiring a portfolio, we conduct an analysis to determine which
accounts in the acquired portfolio should be returned to the seller because they
do not meet the criteria established under the terms of the portfolio
acquisition agreement. Although the terms of each portfolio acquisition
agreement differ, examples of accounts that may be returned under the typical
portfolio acquisition agreement include debts paid off prior to our acquisition,
debts in which the consumer filed bankruptcy prior to our acquisition and debts
in which the consumer was deceased prior to our acquisition. Typically, the
agreement with the seller of the portfolio allows us to return these
non-qualifying accounts for a specified period of time, which is generally
between 120 and 180 days from the date of purchase. Under the typical portfolio
acquisition agreement, the seller either replaces a returned account or refunds
the portion of the purchase price attributable to the account.
An increasing amount of our acquisitions come from our CFC program,
through which we pay the debt owner an agreed on price for each account we
convert to a credit card. Under a CFC, we typically pay a higher price per
account, but we only pay for the accounts we convert to a credit card. The price
paid per account under a CFC is negotiated with the seller and depends on many
factors including the market demand for the portfolio under consideration. At
the end of the CFC term, unconverted accounts are returned to the seller.
The consumer debt and credit card industries generally categorize
delinquent and charged-off accounts into three groups: primary, secondary and
tertiary. Primary accounts are typically 120 to 270 days past due and are in the
process of being placed with collection agencies or collection attorneys for the
first time. Secondary accounts are 270 to 360 days past due and may have already
been placed with one collection agency. Tertiary accounts have already been
placed unsuccessfully with more than two collection agencies. Most of the
accounts we acquire are tertiary accounts that have been non-performing for
several years. We focus on these older charged-off accounts because our target
customer is someone who has had sufficient time to recover from the financial
setback which caused them to default on the account.
We have also purchased tertiary accounts which are "out of statute." An
"out of statute account" is one in which the statute of limitations for
collection of the debt has expired. Debt that is "out of statute" will not be
enforced by a court of law. Accordingly, the likelihood of recoveries from such
accounts is lower than on accounts that are currently enforceable by a court of
law. These accounts are generally less attractive to buyers who employ a
collection strategy and, consequently, we pay less for out of statute accounts
than for in statute accounts. We actively purchase out of statute accounts
because we believe our approach which offers the consumer the utility of a
credit card, is attractive to these target consumers who have typically been
unable to qualify for a traditional bank credit card. We market to out of
statute accounts in a fashion similar to the way we market to other potential
consumers, but provide specific and detailed disclosure to the customer on the
legal status of an out of statute account.
We continually seek new non-performing portfolios for purchase. Once new
portfolios are located, an acquisition team is responsible for:
o coordinating due diligence;
o stratifying and analyzing the portfolio characteristics;
o projecting conversions to new credit cards and the total cash
collections on the account;
o preparing bid proposals for review and approval by our senior
management;
o processing and tracking the bids;
o documenting and closing the purchase; and
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o coordinating the receipt of account documentation for the acquired
portfolios.
We use our proprietary analytical methodology and database to evaluate a
potential portfolio purchase. We have developed a large and valuable database of
performance characteristics from the over $6.0 billion of receivables we
purchased since inception that enables us to estimate future portfolio
performance. We build a financial model for each portfolio we seek to acquire
that projects all cash inflows and outflows associated with an acquisition,
including:
o the number and dollar amount of credit cards that we will originate;
o the cost to originate these accounts;
o the amount of net cash flows that these cards will generate during
the time we own the receivables;
o the cost to service these accounts;
o the amount of cash received from non-card accounts and the cost to
collect this cash; and
o the amount of cash we project to receive from the securitization and
sale of receivables.
The net present value of these cash flows are used to establish the price
we offer to pay for the portfolio.
We have developed a discipline of reselling unconverted accounts into the
secondary market. In general, we resell portfolios of unconverted accounts when
the price that other debt buyers are willing to pay exceeds the net present
value of the cash flows that we expect to generate over the remaining life of
the portfolio. We calculate the net present value of each portfolio on a monthly
basis.
To date, we have resold over $1.9 billion of non-performing debt into the
secondary market through auctions and directly negotiated transactions.
Unconverted accounts resold into the secondary market were $517 million for the
nine months ended February 28, 2001, $599 million for fiscal 2000, and $452
million for fiscal 1999.
SCRUBBING AND MODELING:
In our experience, much of the account information contained in the
portfolios we acquire is stale. Accordingly, once a particular portfolio has
been purchased, a "scrubbing" process begins. Scrubbing describes the process of
electronically updating phone numbers and addresses on each account purchased
and searching for bankrupt and deceased accounts. We have a scrubbing contract
with Riskwise, a subsidiary of Lexis-Nexis specializing in locating consumers
with little or no credit history. We believe using third-party scrubbing
services produces quality results and allows us to efficiently focus our
resources on marketing and servicing our customers.
We have also developed proprietary scoring models in conjunction with
Riskwise using our data on the over $6 billion in accounts we have acquired to
date. These models allow us to focus on accounts with the best marketing
potential. As we continue to develop and deploy these models, we believe they
will allow us to refine our marketing campaigns and underwriting procedures
lowering our cost to originate and service our credit card accounts.
MARKETING, SETTLEMENT AND CARD ORIGINATION:
Once a portfolio acquisition is completed and the portfolio has been
scrubbed, the receivables and accounts in the acquired portfolio are processed
by our marketing, settlement and card origination departments. We believe that
our consumer friendly and hands-on approach to the consumer is a key component
of our business strategy. Many of the receivables we acquire represent
obligations of individuals who have, in the past several years, experienced some
life-altering event, such as divorce, career displacement or major medical
illness, and have recovered or currently are recovering financially from their
setback. We contact potential customers through direct mail and by telephone and
offer them
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the opportunity to settle their debt and obtain an unsecured credit card which
they can use to make new purchases.
We operate a 25,000 square foot mail center in Sioux Falls, South Dakota.
Our mail center is equipped with high-speed printing, folding, inserting, zip
sorting and mailing equipment capable of sending 180,000 pieces of mail a day.
Having our direct mail operations in-house allows us to manage high quality
direct mail campaigns in a cost-effective manner. Our mail center is linked
electronically with our operation center, allowing our mail center to receive
database information to print and mail specific mail campaigns. We also maintain
a trained sales force that operates from our Sioux Falls, South Dakota
headquarters. The group is supported by a state-of-the-art auto-dialer, which
enables sales agents to effectively manage their large inventory of accounts. We
employ approximately 45 sales agents and we currently have space and system
capacity to expand our telemarketing sales force. The auto-dialer enhances
productivity via high-speed dialing coupled with a screening process to detect
no-answers, nonexistent numbers and answering machines. This technology allows
our sales agents to concentrate their efforts on actual customers. In addition
to outgoing calls, we receive incoming calls that are prompted by mailings.
Incoming calls are routed directly to the telemarketing department where sales
agents service the inquiry. Our sales agents are trained to understand our
customer base, keeping in mind that the individual has experienced the
collection efforts of several agencies.
A customer who accepts our offer, and meets our underwriting guidelines,
is issued a new unsecured credit card by one of our unaffiliated issuing banks.
The card has an outstanding balance and credit limit equal to the agreed
settlement amount. The settlement amount is negotiated between our sales agent
and the consumer. Historically, the average discount ranges between 20% and 30%
per account. The discount offered to a particular account will depend on several
factors including the customer's ability, based on their income, to make the
minimum monthly payments.
As the customer makes principal payments on the outstanding balance, the
customer frees up the credit limit for new purchases. We report the payment
history on the credit card to the major credit bureaus. We believe that our
credit card product provides our customers with an opportunity to establish a
positive payment history on their credit record by making timely and consistent
payments on their new credit cards.
We believe our credit card product affords us more flexibility in working
with the consumer than the originating institution or third-party collection
agency who are simply attempting to recover all or a portion of the amount owed.
Factors that contribute to this increased flexibility include:
o our ability to settle the account for an amount that fits within the
consumer's budget because we typically acquire accounts for between
0.50% and 3.00% of the actual outstanding balance;
o our ability to offer a new unsecured credit card which has utility
to the consumer due to its revolving nature;
o our freedom from many of the cultural and regulatory constraints
that influence account resolution decisions of banks, savings and
loan and other financial institutions; and
o our ownership of the accounts which frees us from the time
limitations on collecting funds generally faced by third-party
collection agencies.
The table below summarizes our standard credit card program as currently
offered:
Initial Credit Line: Settlement amount
Annual Fee: $0 the 1st year; $35 annual
thereafter
Interest Rate: 18.9% or 19.9%
Grace Period: 25 Days
Late Fee: $10.00 - $19.00
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Over Limit Fee: $10.00 - $19.00
Cash Advance Fee: Greater of 2% or $10.00
Minimum Payment: Greater of 3% or $10.00
Applicants failing to meet our underwriting or exception criteria are
notified of denial in accordance with the Equal Credit Opportunity Act. We offer
these applicants, as well as any customer who does not wish to establish a new
credit card account installment and lump sum payment options to settle their
debt. Applicants who meet our underwriting guidelines or exception criteria are
notified of acceptance into the program and issued a card. Although the initial
credit limit of the credit card is fully utilized when issued, an applicant
regains availability of credit on the card as and to the extent the applicant
makes principal payments. After establishing a positive payment history a
customer may request a credit increase. Guidelines change periodically and
depend on the customer's payment history but in general, a customer can request
a credit line increase after their first payment, sixth payment, and annually
thereafter. Our primary underwriting guidelines center on reported annual income
and validation of contact information supplied by the customer. Historically,
over 90% of applicants have qualified for a credit card.
Once a customer has accepted our offer and has cleared the underwriting
process, the relevant data is transmitted to First Data Resources to establish a
new account on First Data Resources' credit card processing system. We have
arranged, through two unaffiliated banks, to issue the credit cards and for
First Data Resources to provide some of our cardholder services including:
o data processing;
o card issuance;
o monthly customer statement processing; and
o customer correspondence.
First Data Resources is a subsidiary of First Data Corporation, a provider
of information processing and related services, including cardholder processing
and merchant processing, for major financial institutions throughout the United
States. We believe that outsourcing these services to First Data Resources gives
us operational efficiencies and the flexibility to handle additional growth.
We also offer the convenience of an Automatic Payment Program to our
customers. Under this program, the customer authorizes us to withdraw from the
customer's bank account the monthly minimum credit card payment. Approximately
18% of our customers are currently using the Automatic Payment Program. Accounts
on the Automatic Payment Program have a lower incidence of delinquency than
those accounts that are not on the Automatic Payment Program.
CARDHOLDER SERVICES:
We believe that to maximize the customer's payment performance, it is
imperative to have a sophisticated, highly structured hands-on approach to
educating and servicing the customers and addressing situations that would
result in default without our attention and assistance. Our cardholder services
group conducts our "Welcome Aboard" program verifying the customer has received
the credit card, thoroughly understands the program and knows how to use the
credit card. In addition, they place calls to customers at other critical
junctures, including approximately fifteen days before the first payment is due.
These calls are a part of our educational approach with customers that stresses
the importance and benefits of making timely and consistent payments.
The cardholder services group handles calls from customers regarding their
accounts, including:
o balance inquiries,
o billing inquires and disputes,
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o requests for replacement cards,
o requests for temporary credit line increases and requests for
evidence of account activity.
Cardholder services representatives counsel the customer on use of the
card and continue the process of instilling the importance and benefits of
making timely and consistent payments.
Our cardholder services group is also responsible for collection of
delinquent credit card accounts in a prompt, professional and thorough manner in
order to reduce net credit losses. We use state of the art predictive and power
dialing technology to maximize collector productivity, and heavily emphasize the
"instant payment" products such as Western Union Quick Collect. Collection calls
are prioritized using a special scoring model implemented through the First Data
Resources servicing platform and are based on models developed by us for our
specific customer base. We maintain a strict re-age policy which allows accounts
to be re-aged if the cardholder displays a desire to correct the status of the
account as well as an ability to continue making monthly payments on the
account. We have systemic restrictions in place which prevent customer service
representatives from performing unauthorized re-aging of accounts. In an effort
to maximize cash flow, the settlement of an account may be negotiated in cases
where we have determined that the account is destined to become a charge-off and
there is no potential to retain the customer. Accounts are charged off and taken
as a loss either after formal notification of bankruptcy or when they become
contractually 180 days past due. Accounts identified as fraud losses are
immediately reserved for and charged off no later than 90 days after the last
activity. Charged-off accounts are referred to our Resolutions Department for
further recovery efforts.
RECEIVABLE SALES AND SECURITIZATIONS:
An important piece of our business strategy is to securitize seasoned
receivables and/or sell seasoned receivables to third parties for cash. When we
complete a sale or securitization we typically realize a gain in an amount equal
to the excess of the cash proceeds from the sale or securitization over our cost
basis in the receivables.
As part of the securitization process, we sell receivables in a pool of
designated credit card accounts to a wholly owned bankruptcy remote qualifying
special purpose entity. In the securitizations completed to date, the qualifying
special purpose entity entered into a financing agreement with a lender under
which the lender made one or more non-recourse loans to the qualifying special
purpose entity, secured by all credit card receivables owned by the qualifying
special purpose entity, and we agreed to provide servicing on the pledged
receivables for a market rate servicing fee.
We currently consider an account seasoned and available to sell or
securitize when the consumer has made eight or more consecutive monthly payments
on the outstanding credit card balance. The number of payments we require a
consumer to make before an account is considered seasoned is based on conditions
in the market for securitizations and sales of receivables. If the purchasers of
receivables, or the lenders who finance our securitizations, were to change the
criteria they use to evaluate if a receivable may be purchased or securitized,
we would likely adjust the number of payments required.
We use a variety of debt instruments to fund our operations and portfolio
acquisitions including subordinated debt, senior secured debt, and non-recourse
debt. The ability to borrow based on the collateral value of our asset base is
integral to our operations and growth plans.
We have significant ongoing cash needs to fund our operations and to fund
the purchase of non-performing consumer debt portfolios. Our ability to sell or
securitize the receivables and/or finance these receivables on-balance sheet is
critical to the future and growth of the business. To finance, sell or
securitize our receivables, we maintain a detailed database concerning the
status and performance of each receivable in our portfolios. We must maintain
this database to provide historical performance information to potential lenders
and purchasers of our receivables. Potential lenders and purchasers
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assess our portfolio of receivables according to a variety of factors including
monthly repayment rates by the cardholders and annualized default rates.
To date we have completed six securitizations. In each case, we
established a new wholly-owned qualifying special purpose entity which is
unconsolidated on our financial statements. Five of the qualifying special
purpose entities were established for the purpose of purchasing performing
credit card receivables from us and one was established for the purpose of
purchasing non-performing receivable portfolios. We currently hold retained
interests in three of these qualifying special purpose entities. We sold our
retained interests in three of our qualifying special purpose entities during
fiscal 1999 resulting in a pre-tax gain of approximately $6.5 million.
The activities of the qualifying special purpose entities are
significantly limited. Qualifying special purpose entities may only hold passive
assets and cannot be dissolved by us. These restrictions on qualifying special
purpose entities are required so that these securitizations may be accounted for
as sales under the provisions of SFAS no.140. The retained interest in the
securitized credit card receivables is treated as a debt security classified as
available-for-sale in accordance with SFAS No. 115.
Summarized data on the two qualifying special purpose entities in which we
held a retained interest on February 28, 2001 is as follows:
Amount of Retained
Total Outstanding Converted Beneficial
Name Asset Type Credit Line Debt Receivables Interest
---- ---------- ----------- ---- ----------- --------
TCS Funding IV Performing receivables $40,000,000 $10,000,000 $15,131,165 15%
Credit Store Services Non-performing receivables $25,000,000 $ 6,266,132 $ 9,466,137 5%
In May 2001, we established a new wholly-owned qualifying special purpose
entity, TCS Funding V, for the purpose of purchasing performing credit card
receivables from us. TCS Funding V entered into a $4.0 million credit facility
with a lending institution to finance the purchase of credit card receivables.
We sold approximately $5.72 million of credit card receivables to the qualifying
special purpose entity for approximately $4.86 million. TCS Funding V provided
$4.0 million for the purchase and the remaining $0.86 million of the purchase
price was recorded by us as retained interest.
Competitive Conditions
We experience competition in all aspects of our business operations. We
compete with a wide range of third-party collection companies and other
financial services companies seeking to purchase portfolios of non-performing
consumer debt and with traditional collection companies seeking consignments of
non-performing debt for collection. We also compete with companies that provide
financing to consumers that have previously defaulted on a debt obligation.
As more buyers enter the market to purchase portfolios of non-performing
consumer debt, the price for the purchase of these portfolios may increase and
our business strategy may become less profitable or viable. Some of these
competitors may have substantially greater personnel and financial resources
than we do. In addition, to the extent consumers with negative credit history
have less difficulty obtaining credit, especially obtaining unsecured credit
cards, there may be less consumer demand for our product.
We believe we compete effectively based on what we believe are superior
information technology capabilities, which enable us to evaluate and purchase
receivables more effectively than some of our competitors. We are unaware of any
competitors that have a database like ours that contains
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information on over $6 billion in defaulted debt and how these accounts convert
and subsequently perform on a new credit card. Further, we believe we
differentiate ourselves from most of our competitors through our innovative
credit card program, which allows the consumer to resolve a prior obligation in
a positive manner and gain the utility of a new credit card. Virtually all our
competitors who buy non-performing debt employ a collection strategy.
We anticipate that additional competitors will seek to enter our niche
within the financial services market. Because of the high costs in developing
and servicing a credit card program and the high costs of acquiring
non-performing consumer debt, we believe that new competitors will likely be
large, established finance companies.
Government Regulation
Our collection practices, business operations and credit card receivables
are subject to numerous federal and state consumer protection laws and
regulations imposing licensing and other requirements with respect to
purchasing, collecting, making and enforcing consumer loans. We conduct periodic
internal compliance tests on a sample of accounts and, if necessary, implement
procedures to bring us into compliance with all applicable state and federal
regulatory requirements. Additionally, we contract with an external firm to
perform an annual compliance audit, the findings of which, if any, are addressed
through procedure and process enhancements. Our failure to comply with such
statutes or regulations could have a material adverse effect on our results of
operations or financial condition.
The federal Fair Debt Collection Practices Act and comparable state
statutes establish specific guidelines and procedures that debt collectors must
follow to communicate with consumer debtors, including the time, place and
manner of such communications. Our policy is to comply with the provisions of
the Fair Debt Collection Practices Act and comparable state statutes in all of
our collection activities, although we may not be specifically subject to these
laws. If these laws apply to some or all of our collection activities, our
failure to comply with such laws could have a material adverse effect on our
results of operations and financial condition.
As a purchaser of consumer receivables, we may acquire as part of a
portfolio receivables subject to legitimate claims, defenses or rights of offset
on the part of the consumer. As a result, we may not be able to collect on these
receivables. For example, as previously described, we acquire "out of statute"
accounts which are subject to a statute of limitations defense, and may also
acquire some credit card accounts where customers cannot be held liable for, or
their liability may be limited with respect to, charges to a credit card account
that were a result of an unauthorized use of a credit card.
While we are not a credit card issuer ourselves, portions of our
operations are affected by federal and state consumer protection and related
laws and regulations that apply to the marketing and extension of credit by a
credit card issuer because many of our receivables are originated through credit
card transactions. Significant laws include:
o the Truth-In-Lending Act,
o the Fair Credit Billing Act,
o the Equal Credit Opportunity Act,
o the Fair Credit Reporting Act,
o the Credit Repair Organization Act and the Electronic Funds Transfer
Act and the Federal Reserve Board's regulations which relate to
these Acts, and
o comparable statutes in those states in which customers reside or in
which the originating institutions are located.
State laws may also limit the interest rate and the fees that a credit
card issuer or other consumer lender may impose on its customers. Among other
things, the laws and regulations applicable to credit card issuers impose
disclosure requirements when a credit card account is advertised, when it is
applied
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for and when it is opened, at the end of monthly billing cycles and at year end.
Federal law requires credit card issuers to disclose to consumers the interest
rates, fees, grace periods and balance calculation methods associated with their
credit card accounts, among other things. In addition, customers are entitled
under current laws to have payments and credits applied to their credit card
accounts promptly, to receive prescribed notices and to require billing errors
to be resolved promptly. In addition, some laws prohibit discriminatory
practices in connection with the extension of credit. Failure by the originating
institutions or by us to comply with applicable statutes, rules and regulations
could create claims and/or rights of offset by the customers which could have a
material adverse effect on us.
Changes in these laws or regulations, or in their interpretation or
application, could have a material adverse effect on us. Various proposals which
could affect our business have been introduced in Congress in recent years,
including proposals relating to:
o imposing a statutory cap on credit card interest rates,
o substantially revising the laws governing consumer bankruptcy,
o limiting the use of social security numbers,
o permitting affiliations between banks and commercial, insurance or
securities firms, and
o other regulatory restructuring proposals.
There have also been proposals in state legislatures in recent years to:
o restrict telemarketing activities,
o impose statutory caps on consumer interest rates,
o limit the use of social security numbers, and
o expand consumer protection laws.
It is impossible to determine whether any of these proposals will become
law and, if so, what impact they might have on us and our operations.
Due to the consumer-oriented nature of the collections and credit card
industry, there is a risk that we or other industry participants may be named as
defendants in litigation involving alleged violations of federal and state laws
and regulations, including consumer protection laws and consumer law torts
including fraud. A significant judgment against us or within the industry could
have a material adverse effect on our consolidated results of operations or
consolidated financial condition. See "Business -- Legal Proceedings."
Employees
As of May 31, 2001, we had 300 employees. No employee group is covered
under a collective bargaining agreement. We believe our relationship with our
employees is good.
Technology and Systems
We utilize a variety of management information and telecommunications
systems to enhance productivity in all areas of our business. We utilize the
latest technology in our operations and employ multiple levels of backup to
minimize the risk of systemic breakdown. We believe that advanced technology is
key to maintaining a competitive advantage and we seek to maximize the use of
technology. New technologies are continually evaluated for business
appropriateness and cost effectiveness.
We use a proprietary credit card origination and servicing system ("NOCS")
which incorporates all aspects of our operation on a seamless platform from the
time a new portfolio is purchased until an account is converted to a new credit
card and set up on the First Data Resources credit card servicing platform. NOCS
includes specialized applications for telesales, underwriting, non-card
collections, payment processing, account scrubbing, portfolio stratification,
and customer service.
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The overall computing platform is client-server, Windows NT/SQL based, and
is scaleable to accommodate our growth plans. We employ the latest technology in
telephony, including a predictive auto-dialer and voice recognition technology.
The telephony platform is capable of supporting in excess of 2,000 workstations
and we believe it is easily expandable to accommodate our growth plans.
We use image-based technology and processing to minimize paper flow
wherever possible. We have also invested in the latest electronic data
warehousing technologies to support our data mining strategies. We believe data
warehousing gives us a distinct competitive advantage in the portfolio analysis
and acquisitions aspect of our business. In addition, we believe data
warehousing will give us an advantage in the securitization markets through our
ability to provide a sophisticated level of performance detail to investors.
We employ several layers of security to prevent unauthorized access to our
data and to protect our proprietary systems and methodologies. We also have
non-compete agreements with key employees who develop and manage our proprietary
models.
We maintain a website at www.creditstore.com and we own the domain name.
We use the website to attract potential employees and provide information to our
business partners. In addition, credit card customers can access information
about their account through our website.
Third-Party Servicing
At February 28, 2001, we serviced over 20,000 accounts under third party
servicing agreements. Almost all of these accounts are held by our
unconsolidated qualifying special purpose entities. We receive a market rate fee
on a monthly basis for servicing these accounts. In addition, we service the
accounts related to the repurchase agreement with Bank of Hoven and receive the
net cash proceeds of the receivables in excess of the yield and fees owing to
the bank. We intend to concentrate on servicing our own accounts and accounts
that we have either securitized or sold to third party purchasers.
Properties
Our headquarters consist of a 30,000 square foot leased facility in Sioux
Falls, South Dakota. The lease expires on September 30, 2011. We own an
additional five acres of undeveloped property adjacent to this site that can be
utilized for expansion purposes.
Our mail center consists of a separate 25,000 square foot leased facility
in Sioux Falls, South Dakota. The lease was renewed to extend the terms of the
lease for one year commencing on March 1, 2001 and ending on February 28, 2002.
Legal Proceedings
In the ordinary course of business, we receive notices of consumer
complaints from regulatory agencies and are named as a defendant in legal
actions filed by those who have been solicited to participate in our credit card
programs. Except as described below, we do not believe any of these ordinary
course of business claims will have a material effect on our consolidated
financial condition or consolidated results of operations. We believe we have
meritorious factual and legal defenses in each of these cases and are defending
these lawsuits vigorously. Because we have been successful in defending
ourselves in other similar proceedings arising in the ordinary course of our
business, we do not believe that these suits will have a material adverse effect
on our consolidated financial position and results of operations. However, a
significant judgment against us in one or more of the lawsuits could subject us
to a monetary judgment and/or require us to modify our methods of operation,
either of which could have a material adverse effect on our consolidated results
of operations or consolidated financial condition.
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On May 27, 1999, we were sued on behalf of a class of Florida debtors in
the United States District Court for the District of Florida in an action titled
McIntyre v. The Credit Store, Inc. 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 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 the ruling in Bingham is
subject to a motion for reconsideration which is pending.
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 titled 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 to assert claims against us under the Fair Debt
Collection Practices Act and RICO and seek unspecified actual damages, treble
damages under RICO, punitive damages, and statutory damages of up to $500,000
under the Fair Debt Collection Practices Act.
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. The Credit Store, Inc., et al., Le
v. The Credit Store, Inc., et al., Marshall-Harris v. The Credit Store, Inc., et
al. and McGlynn and Levesque v. The Credit Store, Inc. We are obligated to pay
$370,000 plus the costs of mailing and publication. Of this settlement amount,
we anticipate that our insurance will cover $240,500, plus 65% of the costs of
mailing and publication.
In addition, during the past twelve months we have settled or have
obtained the dismissal of three other actions, including one class action that
was the consolidation of three separate class actions.
On April 23, 2001, we were 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 Mutual Business Development Agreement and conversion and seek enforcement of
the contract, compensatory damages alleged to be in excess of $5 million, and
punitive damages of $25 million. Renaissance Trust I owns 4,000,000 shares of
our common stock and 400,000 shares of our Series B Preferred Stock. On May 23,
2001, we made a motion to dismiss the conversion claim, to strike the demand for
punitive damages and to compel mediation under the Mutual Business Development
Agreement. This case is in a very early stage and no assurance can be given as
to its ultimate outcome. For a description of the Mutual Business Development
Agreement see "Certain Relationships and Related Party Transactions."
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MANAGEMENT
Directors
The following sets forth information as to each of our directors.
Name Age Position
- ------------------------------ ---------- --------------------------------------------------------
Barry E. Breeman 52 Director
J. Richard Budd, III 48 Director
Peter J. Mansbach 64 Director
Kevin T. Riordan 49 President, Chief Operating Officer and Director
Geoffrey A. Thompson 60 Interim Chairman of the Board of Directors
Salvatore J. Zizza 55 Director
Barry E. Breeman. Mr. Breeman joined our board of directors in September
1998. Since April 1998, Mr. Breeman has been Vice Chairman and Chief Investment
Officer of Manley-Berenson Realty & Development, LLC. From January 1991 to the
present, Mr. Breeman has been the managing member of Cambridge Real Estate
Services, LLC, and predecessor entities, a real estate investment banking
services business.
J. Richard Budd, III. Mr. Budd joined our board of directors in September
1998. Mr. Budd serves as a consultant to troubled companies and to creditors of
troubled companies. Mr. Budd served as Senior Vice President of Metallurg, Inc.,
an international specialty metals producer, from July 1996 to October 1998. From
July 1994 to January 1996, Mr. Budd served as Vice President of Cityscape Corp.
Peter J. Mansbach. Mr. Mansbach joined our board of directors in May 2001.
Mr. Mansbach is currently of counsel at the firm of Kronish Lieb Weiner &
Hellman LLP. Mr. Mansbach is engaged in a general business law practice and
advises business clients with respect to a variety of complex legal issues. He
served as chairman of the executive committee of Republic New York Corporation
and of Republic National Bank of New York from 1994 until 1998. From 1991
through 1999, Mr. Mansbach was chairman of the board of Van Cleef & Arpels and a
member of its European Directoire. Kronish Lieb Weiner & Hellman LLP is
providing legal advice concerning this offering.
Kevin T. Riordan. Mr. Riordan has been our President and Chief Operating
Officer since April 1997 and a director since September 2000. From February 1995
to March 1997, Mr. Riordan served as President and Chief Executive Officer of
Long Beach Acceptance Corp., a subsidiary of Long Beach Mortgage Corp. From
February 1985 to February 1995, Mr. Riordan was President and Chief Executive
Officer of Alliance Funding Company and its successor in interest Alliance
Funding Company, a division of Superior Bank FSB.
Geoffrey A. Thompson. Mr. Thompson joined our board of directors in April
1999. Mr. Thompson has served as interim Chairman of the Board of Directors
since September 22, 2000. Mr. Thompson retired from Marine Midland Bank, Inc.,
Buffalo, New York in October 1992, where he had served as President and Chief
Executive Officer. In addition, he serves on the boards of four privately held
corporations and four not-for-profit corporations.
Salvatore J. Zizza. Mr. Zizza joined our board of directors in May 2001.
Since 1997, Mr. Zizza has been the Chairman of HallMark Electrical Supplies
Corp., a supplier of electrical supplies and lighting to electrical contractors.
From 1985 until 1997, Mr. Zizza was chairman and CEO of the LVI Group, Inc., a
company primarily engaged in interior construction. Mr. Zizza was President and
Chief Financial Officer of NICO, Inc., an interior construction company, from
1978 until 1985, when NICO merged with the LVI Group. Mr. Zizza currently serves
on the boards of eight public companies: The Gabelli Asset Fund, The Gabelli
Convertible Securities Fund, The Gabelli Equity Trust, The Gabelli
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Global Multimedia Trust, The Gabelli Growth Fund, The Gabelli Utility Fund,
Hollis Eden Pharmaceuticals, and Bion Environmental Technologies Inc.
None of our directors are related to any other director or to any of our
executive officers.
Compensation of Directors
Directors J. Richard Budd, III, Barry E. Breeman, Geoffrey A. Thompson,
Peter J. Mansbach, and Salvatore J. Zizza each receive $50,000 as annual
compensation for their services on our board of directors. In addition, we
granted Mr. Budd and Mr. Breeman options to purchase 75,000 shares with an
exercise price of $2.00 per share and 75,000 shares with an exercise price of
$1.80 per share. Mr. Thompson received options to purchase 75,000 shares with an
exercise price of $2.19 per share and 75,000 shares with an exercise price of
$1.80 per share. Mr. Mansbach and Mr. Zizza each received options to purchase
150,000 shares with an exercise price of $1.80 per share. The board of directors
may authorize the payment of compensation to directors for their attendance at
regular and special meetings of the board of directors and for attendance at
meetings of committees of the board of directors as is customary for similar
companies. Directors are reimbursed for their reasonable out-of-pocket expenses
incurred in connection with their duties as directors or officers. The board of
directors determines compensation for directors, including those serving on the
Compensation Committee.
Committees of the Board of Directors and Meeting Attendance
Audit Committee. We have an audit committee consisting of Barry E.
Breeman, J. Richard Budd, III, and Geoffrey A. Thompson. The audit committee had
eight meetings in fiscal 2000. The audit committee meets with the Chief
Financial Officer, the Controller and the independent public accountants, and
monitors and reviews our accounting, auditing and reporting practices and system
of internal controls, approves the scope and timing of the independent public
accountants' audit and discusses the meaning and significance of the audited
financial results.
Compensation Committee. We have a compensation committee consisting of
Barry E. Breeman, J. Richard Budd, III, and Geoffrey A. Thompson, which grants
or makes recommendations to our board of directors concerning employee stock
options, bonuses and other compensation.
Executive Officers
The following table provides information about our current executive
officers other than Kevin T. Riordan.
Name Age Position
- ------------------------- ----------- -------------------------------------------------------------------
Michael J. Philippe 43 Executive Vice President, Chief Financial Officer and Treasurer
Richard S. Angel 43 Executive Vice President and General Counsel
William Buriak 47 Senior Vice President and Chief Information Officer
Cynthia D. Hassoun 50 Senior Vice President and Corporate Secretary
Michael L. Neher 36 Senior Vice President
Patrick Steffl 35 Senior Vice President
Michael J. Philippe. Mr. Philippe joined us in June 1997 as Vice President
of Finance and became Chief Financial Officer in September 1997. In June 1999,
Mr. Philippe was elected Executive Vice President, Chief Financial Officer and
Treasurer. Before joining us, Mr. Philippe served as a Vice President and
Manager for The Sumitomo Bank, Ltd. and its predecessors for 13 years.
Richard S. Angel. Mr. Angel joined us in August 1997 as Vice President,
Secretary and Corporate Counsel. In June 1999, Mr. Angel was elected Executive
Vice President and General Counsel.
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From January 1992 to August 1997, Mr. Angel was a stockholder in the law firm of
Buchalter, Nemer, Fields & Younger in Los Angeles, California.
William G. Buriak. Mr. Buriak joined us as Chief Information Officer in
July 1999. In September 1999, Mr. Buriak was elected Senior Vice President and
Chief Information Officer. From November 1996 to July 1999, Mr. Buriak was
Director of Management Information Services and Director of Business Office
Operations for CCDM, a non-profit healthcare system in Perth Amboy, New Jersey.
From June 1986 to November 1996, Mr. Buriak was Assistant Vice President at
Beneficial Finance Corporation in Peapack, New Jersey.
Cynthia D. Hassoun. Ms. Hassoun joined us in October 1997 as Chief
Coordinating Officer. In April 1999, Ms. Hassoun was elected Corporate Secretary
and she was elected Senior Vice President in June 1999. From April 1997 to
September 1997, Ms. Hassoun served as a consultant to us. From January 1992 to
November 1996, Ms. Hassoun was Vice President of Customer Service for Superior
Bank FSB, a savings bank.
Michael L. Neher. Mr. Neher joined us as Senior Vice President responsible
for Non-Card Resolutions and Portfolio Divestitures in November 1999. In
February 2001, Mr. Neher was named Senior Vice President responsible for
Business Development. From September 1998 to October 1999, Mr. Neher was the
Assistant Vice President for Outsourcing-Card Services/Consumer Products of the
Atlanta, Georgia operation of the Bank of Hawaii. From December 1995 to
September 1998, he was the Regional Sales Manager for Primus Automotive
Financial Services, Atlanta, Georgia. From June 1993 to November 1995, Mr. Neher
served as the Business Line Supervisor, Collections and Recovery-Consumer Loans
for Ocwen Federal Bank & Trust FSB, West Palm Beach, Florida.
Patrick Steffl. Mr. Steffl joined us in August 1997 as Vice President of
Marketing. Mr. Steffl was elected Senior Vice President in June 1999. Before
joining us, Mr. Steffl had been with Fingerhut Companies, Inc. in Minnetonka,
Minnesota since 1989, managing mail and telemarketing media of six phone centers
throughout the country.
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Executive Compensation
Summary Compensation Table. The following table shows, for our former
Chief Executive Officer and each of our four most highly compensated executive
officers (collectively, the "Named Executive Officers"), information concerning
compensation earned for services in all capacities during the fiscal year ended
May 31, 2000, as well as compensation earned by each person for the two previous
fiscal years.
Long-Term
Compensation
Annual Compensation Awards
------------------------------------------------ -----------------
Number of
Securities
Name and Principal Fiscal Other Underlying
Position Year Salary Bonus Compensation Option
- --------------------------------- ---------- ---------------- ------------- ---------------- -----------------
Martin J. Burke, III (1) 2000 $61,304 $60,505 -- --
1999 60,000 -- -- --
1998 62,518 -- -- 1,000,000
Kevin Riordan 2000 $305,919 -- -- 200,000
President and Chief 1999 305,769 -- -- 100,000
Operating Officer 1998 305,968 -- -- 300,000
Michael J. Philippe 2000 $214,188 $50,000 -- 200,000
Executive Vice President, 1999 184,951 5,000 -- 100,000
Chief Financial Officer and 1998 161,233 -- -- 100,000
Treasurer
Richard S. Angel 2000 $244,765 $60,000 $43,956 100,000
Executive Vice President 1999 220,154 -- -- 100,000
and General Counsel 1998 153,989 -- -- 100,000
Cynthia D. Hassoun 2000 $162,698 -- -- 15,000
Senior Vice President and 1999 152,884 -- -- --
Corporate Secretary 1998 92,223 $50,000 -- 75,000
- ----------
(1) Mr. Burke resigned his position as Chairman of our board of directors and
Chief Executive Officer effective September 22, 2000. We entered into a
Separation Agreement and Release with Mr. Burke, which is described below
under "Employment Agreements."
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Stock Option Tables
The following tables summarize stock option grants to and exercises by the
Named Executive Officers during the fiscal year ended May 31, 2000, and other
related information.
Option Grants In Last Fiscal Year
The following table contains information concerning the grant of stock
options to the Named Executive Officers during our fiscal year ended May 31,
2000. These grants are also reflected in the Summary Compensation Table, above.
Potential Realizable
Number of Percentage of Value at Assumed
Securities Total Options Annual Rates of Stock
Underlying Granted to Price Appreciation for
Options Employees Exercise Price Option Term(2)
Name Granted(1) in Fiscal Year Per Share Expiration Date 5% 10%
- ---------------------- ------------- -------------- -------------- ----------------- --------------------------
Kevin Riordan 200,000 22% $2.40 June 1, 2004 $132,000 $294,000
Michael J. Philippe 200,000 22% $2.40 June 1, 2004 $132,000 $294,000
Richard S. Angel 100,000 11% $2.40 June 1, 2004 $ 66,000 $147,000
Cynthia D. Hassoun 15,000 2% $3.44 November 19, $ 14,250 $ 31,500
2004
- ----------
(1) Options granted under our 1997 Stock Option Plan.
(2) Potential realized values shown above represent the potential gains
based on compound price appreciation of 5% and 10% from the date of
grant through the full option term. The actual value realized, if
any, on stock option exercises will be dependent on overall market
conditions and our future performance. There is no assurance that
the actual value will approximate the amounts reflected in this
table.
Aggregate Option Exercises in Fiscal 2000 and Fiscal Year-End Option Values
Shares
Acquired Number of Shares Value of Unexercised
On Value Underlying Unexercised In-The-Money Options
Name Exercise Realized Options at Fiscal Year-End At Fiscal Year-End(1)
- ---------------------- -------------- ---------- --------------------------------- ---------------------------------
Exercisable Unexercisable Exercisable Unexercisable
--------------- ---------------- ---------------- ---------------
Martin J. Burke -- -- 1,000,000(2) -- $2,812,000 $ --
Kevin Riordan -- -- 600,000 -- $1,537,200 $ --
Michael J. Philippe -- -- 350,000 50,000 $ 834,200 $140,600
Richard S. Angel -- -- 250,000 50,000 $ 593,000 $140,600
Cynthia D. Hassoun -- -- 57,500 32,500 $ 150,890 $ 80,590
- ----------
(1) Value is based on the closing price of our common stock on May 31,
2000, the last trading day of fiscal 2000, which was $4.812.
(2) The shares of common stock which may be issued on the exercise of
this option and the proceeds, if any, received from any sale of
these shares are subject to a Security Agreement between Mr. Burke
and us and secure Mr. Burke's obligations to us under the secured
promissory note described under "Employment Agreements" below.
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Employment Agreements
Before his resignation, Mr. Burke was employed as our Chief Executive
Officer under a five-year agreement dated March 27, 1997. Mr. Burke was paid an
annual salary of $60,000. Mr. Burke received a bonus of (a) 1.5% of our annual
net earnings before taxes and (b) options to purchase 1,000,000 shares of our
common stock, at an exercise price of $2.00 per share. We also extended a
$450,000 line of credit to Mr. Burke. Mr. Burke resigned as a director, officer,
and employee effective September 22, 2000.
In connection with his resignation, a Separation Agreement and Release was
executed in February 2001, effective as of December 11, 2000. Under the
separation agreement, the parties agreed to terminate Mr. Burke's existing
employment agreement, along with the compensation, benefits and other
obligations under the employment agreement. In the separation agreement, we
agreed to pay Mr. Burke $2,500 every other week from September 29, 2000 through
March 26, 2002 and to pay Mr. Burke's health insurance premiums during the
period. We also agreed to pay Mr. Burke a bonus of 1.5% of our annual pre-tax
net earnings for both the 2001 and 2002 fiscal years, with the 2002 payment
being pro-rated over 10 months. We also agreed that Mr. Burke may retain his
option to purchase 1,000,000 shares of our common stock. These options are
exercisable until December 15, 2002. Finally, we agreed to loan Mr. Burke
$25,000 to pay his legal fees in connection with the separation agreement. In
the separation agreement, Mr. Burke agreed to pay the credit line debt he owes
to us, which was $504,801 on December 11, 2000, and to repay the $25,000 loan
for his legal fees, for a total of $529,801. This debt is evidenced by a secured
promissory note, which bears interest at 8% per year, is payable monthly and
matures on December 1, 2002. Mr. Burke's obligations under the separation
agreement and the promissory note are secured by the amounts payable to him
under the agreement and by his stock options. The separation agreement also
contains mutual releases of the parties.
On April 1, 1997, we entered into a five year employment agreement with
Kevin Riordan, our President and Chief Operating Officer. Mr. Riordan receives
an annual base salary of $300,000. In addition to the base salary, we paid Mr.
Riordan a signing bonus of $2 million. Mr. Riordan was granted options to
purchase 300,000 shares of common stock at an exercise price of $2.00 per share.
The options will expire on the earlier of March 31, 2002, or the termination of
Mr. Riordan's employment. The employment agreement also entitles Mr. Riordan to
participate in all of our employee benefit plans. Under the employment
agreement, employment terminates on death or total disability of Mr. Riordan and
we may terminate his employment for cause which is defined as (a) misconduct,
(b) disregard of instructions from the board of directors, (c) commission of
specified crimes or acts or (d) a material breach of the terms of the employment
agreement. On September 22, 2000, Mr. Riordan was appointed to our board of
directors to fill the open directorship resulting from Mr. Burke's resignation.
On June 17, 1997, we entered into an employment agreement with Michael J.
Philippe, our Chief Financial Officer and an Executive Vice President, which was
amended effective June 1, 1999 to extend the term of the agreement to June 20,
2002. Mr. Philippe receives an annual base salary of $210,000. In addition, Mr.
Philippe received options to purchase 100,000 shares of common stock at an
exercise price of $2.00 per share. The options are exercisable until December
15, 2002. The employment agreement also entitles Mr. Philippe to participate in
all of our employee benefit plans. Under the terms of the employment agreement,
employment terminates on death or total disability of Mr. Philippe and we may
terminate his employment for cause which is defined as (a) misconduct, (b)
disregard of instructions from the board of directors, (c) commission of
specified crimes or acts or (d) a material breach of the terms of the employment
agreement. The employment agreement contains a change in control provision that
provides Mr. Philippe with the right to terminate his employment within 60 days
of the date of a change in control and have the termination treated by us as a
termination without cause, meaning that Mr. Philippe would have the right to
continue to be compensated through the term of the employment agreement. For
purposes of the employment agreement, a change of control is deemed to have
occurred when either (a) Taxter One owns directly or indirectly less than 10% of
our common stock and less than
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50% of each other outstanding class of securities the majority vote of which is
required for stockholder action, or (b) Jay Botchman owns less than 50% of the
membership interests in Taxter One.
On August 1, 1997, we entered into an employment agreement with Richard S.
Angel, our General Counsel and an Executive Vice President, which was amended
effective June 1, 1999 to extend the term of the agreement to September 30,
2000. Mr. Angel's agreement has not been renewed in writing but Mr. Angel's
employment continues under an oral agreement with us providing for the same
terms as his expired written agreement but with no fixed term. Mr. Angel
receives an annual base salary of $240,000. In addition, Mr. Angel received
options to purchase 100,000 shares of common stock at an exercise price of $2.00
per share. The options are exercisable until December 15, 2002. The employment
agreement also entitles Mr. Angel to participate in all of our employee benefit
plans. Under the terms of the employment agreement, employment terminates on
death or total disability of Mr. Angel and we may terminate his employment for
cause which is defined as (a) misconduct, (b) disregard of instructions from the
board of directors, (c) commission of specified crimes or acts or (d) a material
breach of the terms of the employment agreement. The employment agreement
contains a change in control provision that provides Mr. Angel with the right to
terminate his employment within 60 days of the date of a change in control and
have the termination treated as a termination without cause by us, meaning that
Mr. Angel would have the right to continue to be compensated through the term of
the employment agreement. For purposes of the employment agreement, a change of
control is deemed to have occurred when either (a) Taxter One owns directly or
indirectly less than 10% of our common stock and less than 50% of each other
outstanding class of securities the majority vote of which is required for
stockholder action, or (b) Jay Botchman owns less than 50% of the membership
interests in Taxter One.
On October 15, 1997, we entered into a three-year agreement with Cynthia
Hassoun, our Corporate Secretary and a Senior Vice President. The agreement
renews automatically for successive one-year terms unless terminated by either
party 90 days before the renewal date. The current term expires October 15,
2001. Ms. Hassoun receives an annual base salary of $165,000. In addition, Ms.
Hassoun received options to purchase 75,000 shares of common stock at an
exercise price of $2.00 per share. The options are exercisable until December
15, 2002. The agreement also entitles Ms. Hassoun to participate in all of our
employee benefit plans. Under the terms of the employment agreement, employment
terminates on death or total disability of Ms. Hassoun and we may terminate her
employment for cause which is defined as (a) misconduct, (b) disregard of
instructions from the board of directors, (c) commission of specified crimes or
acts or (d) a material breach of the terms of the employment agreement.
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SECURITY OWNERSHIP OF PRINCIPAL STOCKHOLDERS AND MANAGEMENT
The following table sets forth, as of May 31, 2001, the ownership of our
common and preferred stock by each stockholder who is known by us to own
beneficially more than 5% of our outstanding common or preferred stock, each
director, each Named Executive Officer, and all executive officers and directors
as a group. At May 31, 2001 there were 34,851,465 shares of common stock, par
value $.001, issued and outstanding, each of which is entitled to one vote.
Common Stock Preferred Stock (1)
------------ ---------------
Number Percentage Number Percentage
of Shares of Shares of Shares of Shares
--------- --------- --------- ---------
Principal Stockholders:
Taxter One LLC(2) 7,678,000 22.0% 1,200,000(3) 100%(3)
565 Taxter Road
Elmsford, NY 10523
J.L.B. of Nevada, Inc. (2) 4,000,000(4) 10.3% -- --
1500 E. Tropicana Ave.
Suite 100
Las Vegas, NV 89119
Jay L. Botchman 18,328,000(5) 40.3% 1,225,000(6) 100%(6)
133 Quail Run Road
Henderson, Nevada 89014
Blum Family Trust 4,000,000 11.5% 400,000(7) 50%(7)
c/o Silverman Perlstein &
Acampora, LLP
100 Jericho Quadrangle, Suite 300
Jericho, NY 11753
Renaissance Trust I 4,000,000 11.5% 400,000(8) 50%(8)
James B. Panther and Marie Panther,
Trustees
1635 South Pacific Street
Oceanside, CA 92054.
Michael Lauer, Lancer Partners, 8,252,500(9) 23.7% -- --
L.P., and Lancer Offshore, Inc.
375 Park Avenue, Suite 2006
New York, NY 10166
Directors and Named Executive Officers:
Kevin T. Riordan 865,000(10) 2.4% -- --
Michael J. Philippe 435,334(11) 1.2% -- --
Richard S. Angel 330,000(12) 1.0% -- --
Cynthia D. Hassoun 102,833(13) * -- --
Barry E. Breeman 150,000(14) * -- --
J. Richard Budd, III 166,300(15) * -- --
Peter J. Mansbach 150,000(16) * -- --
Geoffrey A. Thompson 170,000(17) * -- --
Salvatore J. Zizza 150,000(16) * -- --
All directors and executive officers
as a group (12 persons)
2,675,465(18)
- ----------
* Less than 1%
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(1) We currently have outstanding 1,200,000 shares of Series A Preferred
Stock, 800,000 shares of Series B Preferred Stock, 5,000 shares of Series
C Preferred Stock, 10,000 shares of Series D Preferred Stock, and 10,000
shares of Series E Preferred Stock. All percentages indicated are for each
separate class of preferred stock, rather than for all preferred stock
classes as a whole.
(2) Mr. Botchman owns 100% of the membership interests in Taxter One and owns
100% of the outstanding capital stock of J.L.B. of Nevada.
(3) Consists of 1,200,000 shares of Series A Preferred Stock.
(4) Consists of 4,000,000 shares of common stock issuable on the exercise of a
warrant with an exercise price of $3.25 per share.
(5) Includes the shares beneficially owned by Taxter One and J.L.B. of Nevada,
3,800,000 shares of common stock issuable on conversion of 10,000 shares
of Series D Preferred Stock and 2,850,000 shares of common stock issuable
on conversion of 10,000 shares of Series E Preferred Stock.
(6) Includes 5,000 shares of Series C Preferred Stock, 10,000 shares of Series
D Preferred Stock and 10,000 shares of Series E Preferred Stock held of
record by Jay L. Botchman and 1,200,000 shares of Series A Preferred Stock
held by Taxter One.
(7) Consists of 400,000 shares of Series B Preferred Stock.
(8) Consists of 400,000 shares of Series B Preferred Stock.
(9) Consists of 2,987,500 shares of common stock owned by Lancer Partners,
L.P., 4,730,000 shares of common stock owned by Lancer Offshore, Inc., and
535,000 shares of common stock owned by Michael Lauer. Mr. Lauer is the
investment manager for Lancer Partners, L.P. and Lancer Offshore, Inc. and
has the authority to vote and dispose of all shares of common stock owned
by these entities. Based on information as of February 27, 2000 contained
in a Form 3 filed with the Securities and Exchange Commission.
(10) Consists of shares issuable on the exercise of options exercisable as
follows: 300,000 shares at $2.00 per share, 100,000 shares at $2.70 per
share, 200,000 shares at $2.40 per share, and 50,000 shares at $6.47 per
share. Includes 215,000 shares owned by Mr. Riordan's wife, as to which
shares Mr. Riordan disclaims beneficial ownership.
(11) Consists of 5,334 shares of common stock held by Mr. Philippe and shares
issuable on the exercise of options exercisable as follows: 100,000 shares
at $2.00 per share, 100,000 shares at $2.70 per share, 200,000 shares at
$2.40 per share, and 30,000 shares at $6.47 per share.
(12) Consists of shares issuable on the exercise of options exercisable as
follows: 100,000 shares at $2.00 per share, 100,000 shares at $2.70 per
share, 100,000 shares at $2.40 per share, and 30,000 shares at $6.47 per
share.
(13) Consists of shares issuable on the exercise of options exercisable as
follows: 75,000 shares at $2.00 per share, 15,000 shares at $3.44 per
share, and 12,833 shares at $6.47 per share.
(14) Consists of shares issuable on the exercise of options exercisable as
follows: 75,000 shares at $2.00 per share, and 75,000 shares at $1.80 per
share.
(15) Consists of 16,300 shares of common stock held by Mr. Budd and 75,000
shares issuable on the exercise of options with an exercise price of $2.00
per share and 75,000 shares issuable on the exercise of options with an
exercise price of $1.80 per share.
(16) Consists of 150,000 shares issuable on the exercise of options with an
exercise price of $1.80 per share.
(17) Consists of 20,000 shares of common stock held by Mr. Thompson and shares
issuable on the exercise of options as follows: 75,000 shares at $2.19 per
share and 75,000 shares at $1.80 per share.
(18) Includes 155,498 shares issuable on the exercise of options in addition to
the shares and options listed in footnotes 10 through 16. Also includes
500 shares owned by William Buriak's wife.
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CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Mr. Botchman, our controlling stockholder, owns and controls J.L.B. of
Nevada and Taxter One.
In fiscal 1998, we issued subordinated promissory grid notes to J.L.B. of
Nevada, with a maximum principal amount of $40 million which are payable on
demand and bear interest at a rate of 12% per year. $30 million principal amount
of grid notes were issued in exchange for outstanding notes totaling $11,518,042
which accrued interest at a rate of 12% per year and $18,481,958 in new debt.
Interest expense on these notes was $2,006,283 for the year ended May 31, 2000,
$2,307,467 for the year ended May 31, 1999 and $3,635,891 for the year ended May
31, 1998. On May 29, 1999, J.L.B. of Nevada forgave $5 million of accrued
interest on these subordinated notes in return for warrants to purchase
4,000,000 shares of our common stock and our assumption of the payment
obligations under personal property lease agreements of entities affiliated with
J.L.B. of Nevada. J.L.B. of Nevada had previously guaranteed the payment of
these obligations on behalf of the entities. On the date of the assumption of
the obligations, the fair value of the obligations was $1.7 million and the
warrants had a fair market value of $3.3 million. The warrants may be exercised
at any time until June 30, 2004. The current exercise price of the warrants is
$3.25 per share, but the price may be adjusted as a result of stock splits,
stock dividends and other issuances of additional stock. At February 28, 2001
accrued interest related to subordinated notes payable to J.L.B. of Nevada, was
approximately $2.3 million.
On February 27, 1998, we issued a subordinated promissory note payable to
Mr. Botchman in the amount of $350,000. The note was payable on demand and
accrued interest at a rate of 12% per year. The note was paid off during fiscal
2000. Interest expense for the year ended May 31, 2000 was $18,200.
We made a series of investments totaling $508,600 during the period May
1997 through December 1997 in a subprime mortgage banking company affiliated
with J.L.B. of Nevada. The mortgage company had subsequent financial
difficulties and ceased operations. We wrote off this investment and a
receivable due from this company of approximately $189,000 during the fiscal
year ended May 31, 1998.
As of May 31, 2000, our wholly-owned subsidiary, American Credit Alliance,
had an $880,000 note payable to J.L.B. of Nevada. The note is payable on demand
and accrues interest at a rate of 10% per year. Interest expense for the year
ended May 31, 2000 was $89,467. The note was issued as of August 16, 1996 as
evidence of a series of loans to American Credit Alliance. American Credit
Alliance is the managing member and owner of 50% of the membership interests in
Dakota Card Fund II, an entity that owns performing credit card receivables.
We acquired all of the capital stock of Service One Holdings from Taxter
One on December 4, 1996. As consideration for the capital stock, we issued
1,200,000 shares of Series A Preferred Stock and 800,000 shares of Series B
Preferred Stock to Taxter One. For a description of the Series A Preferred
Stock, see "Description of Capital Stock--Series A Preferred Stock." For a
description of the Series B Preferred Stock, see "Description of Capital
Stock--Series B Preferred Stock."
In connection with Taxter One's acquisition of Service One Holdings,
Taxter One granted each of Renaissance Trust I and the O. Pappolimberis Trust an
option to repurchase part of the capital stock of Service One Holdings.
Following our acquisition of Service One Holdings, these options were exchanged
for options to purchase from Taxter One 4,000,000 shares of our common stock and
400,000 shares of our Series B Preferred Stock. On the same date as the
exchange, the O. Pappolimberis Trust sold the option to the Blum Family Trust.
In connection with the exchange, we granted Renaissance Trust I and the Blum
Family Trust registration rights. These options were exercised in October 2000.
This transaction did not affect the number of outstanding shares of common stock
or preferred stock.
Renaissance Trust I and the Blum Family Trust have exercised their
registration rights and we have filed a registration statement covering the sale
of up to 8,000,000 shares of common stock.
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On December 31, 1996, we issued 5,000 shares of Series C Preferred Stock
to Mr. Botchman for $5 million. For a description of the Series C Preferred
Stock, see "Description of Capital Stock--Series C Preferred Stock."
On May 29, 1998, we issued 10,000 shares of Series D Preferred Stock to
J.L.B. of Nevada in exchange for the cancellation of an outstanding $10 million
promissory note dated August 1, 1997. We granted piggyback registration rights
for any common stock issued on conversion of the shares of Series D Preferred
Stock. For a description of the Series D Preferred Stock, see "Description of
Capital Stock--Series D Preferred Stock."
On August 31, 1998, we issued 10,000 shares of Series E Preferred Stock to
J.L.B. of Nevada in exchange for J.L.B. of Nevada agreeing to cancel $10 million
of the principal amount outstanding under a subordinated promissory note dated
August 1, 1997 in the original principal amount of $20 million. We also granted
piggyback registration rights for any common stock issued on conversion of the
shares of Series E Preferred Stock. For a description of the Series E Preferred
Stock, see "Description of Capital Stock--Series E Preferred Stock."
On May 4, 2001, in consideration of J.L.B. of Nevada agreeing to amend the
payment terms of several promissory notes, we extended the expiration date of
the conversion feature of the Series D Preferred Stock until May 30, 2006 and
the Series E Preferred Stock until August 30, 2006. See "Description of Capital
Stock--Series D Preferred Stock" and "Description of Capital Stock--Series E
Preferred Stock."
On October 8, 1996, Service One International, which at the time was a
subsidiary of Service One Holdings but which was subsequently merged into us,
entered into two substantially similar Mutual Business Development Agreements,
one with Renaissance Trust I and one with the O. Pappolimberis Trust.
The Development Agreements call for a royalty equal to 5% of any newly
established receivable originated or acquired by us by way of a converted credit
card account held which: (a) is delivered to a pre-securitization credit
facility, (b) becomes a qualifying receivable, or (c) meets other account age
and payment parameters. A qualifying receivable is defined as any converted
account on which the cardholder has made three consecutive payments during
specified 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. The total royalty, if earned, payable
under each of the two Development Agreements, after deductions and exclusions,
will not exceed $25 million.
The Development Agreement with the O. Pappolimberis Trust was amended on
September 1, 1998 to alter the amount and timing of payments, give us 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.
We incurred royalty expenses of $1,733,412 for the year ended May 31,
2000, $1,541,944 for the year ended May 31, 1999 and $207,238 for the year ended
May 31, 1998. At May 31, 2000 we had accrued but unpaid royalty expenses of
$740,487.
Both Development Agreements are currently in dispute. In February 2001 we
discontinued our payment of royalties under both Development Agreements. We are
discussing the rights and obligations of the parties under the Development
Agreements with the O. Pappolimberis Trust. On April 23, 2001 Renaissance Trust
I filed suit in the Southern District of New York seeking to enforce the
Development Agreement and monetary damages. See "Business--Legal Proceedings."
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MARKET PRICE OF AND DIVIDENDS ON OUR COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
Since August 28, 2000, our common stock has traded on the American Stock
Exchange under the trading symbol "CDS". Before August 28, 2000, our common
stock was traded on the Over The Counter Bulletin Board under the trading symbol
"PLCR".
The high and low bid prices for the our common stock for each quarter for
the past three fiscal years were as follows:
Fiscal
Period High Low
------ ---- ---
1999 First Quarter $ 3 7/8 $ 1 7/8
Second Quarter 2 3/4 1 3/4
Third Quarter 2 15/16 1 7/8
Fourth Quarter 2 5/8 1 15/16
2000 First Quarter $ 3 13/16 $ 2 1/4
Second Quarter 5 3/4 2 1/2
Third Quarter 5 1/4 3 15/16
Fourth Quarter 5 1/2 3 1/4
2001 First Quarter $ 4 7/8 $ 3 11/16
Second Quarter 4 11/16 2 3/16
Third Quarter 3.438 1.85
As of May 31, 2001, there were approximately 230 holders of record of our
common stock.
We have not paid any dividends on our common stock and do not anticipate
paying dividends on our common stock in the foreseeable future.
As of February 28, 2001, accumulated but undeclared and unpaid dividends
on preferred stock amounted to approximately $5.6 million. These dividends have
not been declared by our board or paid by us, so they remain outstanding
obligations. Dividends have not been paid because we believe it to be in our
best interest at this time to retain our earnings to reinvest in our operations.
Our board of directors will review our dividend policy from time to time
to determine the feasibility and desirability of paying dividends, after giving
consideration to our results of operations, financial condition, capital
requirements and such other factors as the board of directors deems relevant. In
addition, the terms of our senior secured revolving credit facility with Coast
Business Credit, the terms of our agreement, as servicer and originator of the
accounts owned by TCS Funding IV, with TCS Funding IV's lender, and the terms of
our agreement, as servicer and originator of the accounts owned by TCS Funding
V, with TCS Funding V's lender restrict our ability to pay dividends on our
common and preferred stock.
There can be no assurance that dividends of any kind will ever be paid.
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DESCRIPTION OF CAPITAL STOCK
The following description is a summary of the material terms of our
capital stock. It is not a complete description of all of the terms of our
capital stock. You should read this description of our capital stock as well as
the Delaware General Corporation Law, our certificate of incorporation, and our
bylaws.
Common Stock
We have authorized 65,000,000 shares of common stock, par value $.001 per
share. As of the date of this prospectus, we had 34,851,465 shares of common
stock outstanding. On May 31, 2001 there were outstanding warrants and options
to purchase 12,763,147 shares of common stock and shares of convertible
preferred stock convertible into 6,650,000 shares of common stock. If all our
warrants and options were exercised and all of our convertible preferred stock
converted, we would have outstanding 54,264,612 shares of common stock. All of
our outstanding shares of common stock are fully paid and non-assessable.
Voting, Stockholders' Meetings and Resolutions. Each holder of common
stock is entitled to one vote for each share held on all matters submitted to a
vote of stockholders.
Dividend and Liquidation Rights. Subject to the prior rights of any series
of preferred stock, holders of common stock will receive dividends out of
legally available assets at the times and in the amounts as the board of
directors from time to time may determine. On our liquidation, the holders of
common stock are entitled to share ratably in all assets remaining after payment
of liabilities and payment of accrued dividends and liquidation preferences on
the preferred stock.
No Conversion, Redemption or Preemptive Rights. Our common stock is not
convertible. Holders of the shares of common stock have no right to require us
to redeem the common stock and have no preemptive rights.
Preferred Stock
We currently issue the following series of preferred stock. All of our
outstanding shares of preferred stock are fully paid and non-assessable.
Series A Preferred Stock
We have authorized 2,000,000 shares of Series A Preferred Stock, par value
$.001 per share. As of the date of this prospectus, we had 1,200,000 shares of
Series A Preferred Stock outstanding, all of which are held by Taxter One.
The Series A Preferred Stock has the following rights and preferences.
Dividends. Dividends accrue at the rate of $.05 per share per year and are
cumulative. While we are not required to pay the dividends at any specific time,
any accumulated dividends must be paid (a) before any dividends may be paid on
our common stock or on our Series C Preferred Stock and (b) ratably with the
Series B Preferred Stock. Dividends accumulate on each share of Series A
Preferred Stock from December 31, 1996, whether or not declared. As of February
28, 2001 we had approximately $250,000 of accumulated, undeclared and unpaid
dividends on outstanding shares of Series A Preferred Stock.
Voting Rights. Except as otherwise required by law, as long as at least
one share of Series A Preferred Stock is outstanding, the holders of the Series
A Preferred Stock are entitled to vote approximately 74% of all votes entitled
to be voted at any annual or special meeting of the stockholders. This
percentage may be adjusted to reflect subsequently issued capital stock. Each
share of Series A Preferred Stock represents its proportionate share of the
votes allocated to the outstanding shares of Series A Preferred Stock.
Accordingly, except on matters requiring a separate class vote, the
holders of the Series A Preferred Stock effectively control all matters that may
be put to a stockholder vote, including the election of directors and
fundamental corporate changes and, therefore, effectively control us.
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Redemption. At any time after December 31, 2001, on 20 days written notice
to the holders of the Series A Preferred Stock and Series B Preferred Stock, we
may redeem all or part of the outstanding shares of Series A Preferred Stock and
Series B Preferred Stock. If we elect to redeem these shares, we will pay a
redemption price of $1.00 per share plus accumulated and unpaid dividends, if
any, to the redemption date.
Liquidation. On our liquidation, the holders of shares of Series A and
Series B Preferred Stock, will be entitled to be paid, out of the assets
available for distribution to our stockholders, before any payment is made to
the holders of our common stock or Series C Preferred Stock, $1.00 per share
plus accumulated and unpaid dividends, if any, to the distribution date.
Series B Preferred Stock
We have authorized 800,000 shares of Series B Preferred Stock, par value
$.001 per share. As of the date of this prospectus, we had 800,000 shares of
Series B Preferred Stock outstanding, which are held by two holders.
The Series B Preferred Stock has the following rights and preferences.
Dividends. Dividends accrue at the rate of $.05 per share per year and are
cumulative. While we are not required to pay the dividends at any specific time,
any accumulated dividends must be paid (a) before any dividends may be paid on
our common stock or Series C Preferred Stock and (b) ratably with the Series A
Preferred Stock. Dividends accumulate on each share of Series B Preferred Stock
from December 31, 1996, whether or not declared. As of February 28, 2001 we had
approximately $166,667 of accumulated, undeclared and unpaid dividends on
outstanding shares of Series B Preferred Stock.
Voting Rights. Each holder of Series B Preferred Stock is entitled to one
vote per share, voting together with common and the Series A Preferred Stock,
except as required by law.
Redemption. At any time after December 31, 2001, on 20 days written notice
to the holders of the Series A Preferred Stock and Series B Preferred Stock, we
may redeem all or part of the outstanding shares of Series A Preferred Stock and
Series B Preferred Stock. If we elect to redeem these shares, we will pay a
redemption price of $1.00 per share plus accumulated and unpaid dividends, if
any, to the redemption date.
Liquidation. On our liquidation, the holders of shares of Series A and
Series B Preferred Stock, will be entitled to be paid, out of the assets
available for distribution to our stockholders, before any payment is made to
the holders of our common stock or Series C Preferred Stock, $1.00 per share
plus accumulated and unpaid dividends, if any, to the distribution date.
Conversion. At any time after December 31, 2001, a holder of shares of
Series B Preferred Stock may convert those shares into shares of Series A
Preferred Stock. Initially, each share of Series B Preferred Stock may be
converted into one share of Series A Preferred Stock. The number of shares of
Series A Preferred Stock into which each share of Series B Preferred Stock can
be converted may be adjusted as a result of stock splits, stock dividends and
specified other issuances of additional stock.
Series C Preferred Stock
We have authorized 5,000 shares of Series C Preferred Stock, par value
$.001 per share. As of the date of this prospectus, we had 5,000 shares of
Series C Preferred Stock outstanding, all of which are held by Mr. Botchman.
The Series C Preferred Stock has the following rights and preferences.
Dividends. Dividends accrue at the rate of 6% of $1,000 per share each
year and are cumulative. While we are not required to pay the dividends at any
specific time, any accumulated dividends must be paid before any dividends may
be paid on our common stock. Dividends accumulate on each share of Series C
Preferred Stock from December 31, 1997, whether or not declared. As of February
28, 2001 we had approximately $950,000 of accumulated, undeclared and unpaid
dividends on outstanding shares of Series C Preferred Stock
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Voting Rights. Except as required by law, the holders of the Series C
Preferred Stock do not have the right to vote on matters presented to our
stockholders. In any matter on which the holders of the Series C Preferred Stock
are entitled to vote as a matter of law, each holder of Series C Preferred Stock
will have one vote per share.
Redemption. We may redeem all or part of the outstanding shares of Series
C Preferred Stock at any time on 20 days written notice. If we elect to redeem
these shares, we will pay a redemption price of $1,000 per share plus
accumulated and unpaid dividends, if any, to the redemption date.
Liquidation. On our liquidation, the holders of shares of Series C
Preferred Stock, will be entitled to be paid, out of the assets available for
distribution to our stockholders, before any payment is made to the holders of
our common stock, $1,000 per share plus accumulated and unpaid dividends, if
any, to the distribution date.
Series D Preferred Stock
We have authorized 10,000 shares of Series D Preferred Stock, par value
$.001 per share. As of the date of this prospectus, we had 10,000 shares of
Series D Preferred Stock outstanding, all of which are held by Mr. Botchman.
The Series D Preferred Stock has the following rights and preferences.
Dividends. Dividends accrue at the rate of 8% of the stated value of
$1,000 per share each year and are cumulative. While we are not required to pay
the dividends at any specific time, any accumulated dividends must be paid
before any dividends may be paid on our common stock, Series A Preferred Stock,
Series B Preferred Stock or Series C Preferred Stock. Dividends accumulate on
each share of Series D Preferred Stock from December 31, 1998, whether or not
declared. As of February 28, 2001 we had approximately $2,200,000 of
accumulated, undeclared and unpaid dividends on outstanding shares of Series D
Preferred Stock.
Voting Rights. Except as required by law, the holders of the Series D
Preferred Stock do not have the right to vote on matters presented to our
stockholders. In any matter on which the holders of the Series D Preferred Stock
are entitled to vote as a matter of law, each holder of Series D Preferred Stock
will have one vote per share.
Redemption. We may redeem all or part of the outstanding shares of Series
D Preferred Stock at any time on 20 days written notice. If we elect to redeem
these shares, we will pay a redemption price of $1,000 per share plus
accumulated and unpaid dividends, if any, to the redemption date.
Exchange. At any time before May 31, 2006, a holder of shares of Series D
Preferred Stock may exchange those shares for shares of common stock. Initially
each share of Series D Preferred Stock may be exchanged for 380 shares of common
stock. The number of shares of common stock into which each share of Series D
Preferred Stock can be exchanged may be adjusted as a result of stock splits,
stock dividends and other issuances of additional stock. Holders of shares of
Series D Preferred Stock have piggyback registration rights covering any common
stock issued in exchange for the shares of Series D Preferred Stock.
Liquidation. On our liquidation, the holders of shares of Series D
Preferred Stock, will be entitled to be paid, out of the assets available for
distribution to our stockholders, before any payment is made to the holders of
our common stock, Series A Preferred Stock, Series B Preferred Stock or Series C
Preferred Stock, $1,000 per share plus accumulated and unpaid dividends, if any,
to the distribution date.
Series E Preferred Stock
We have authorized 20,000 shares of Series E Preferred Stock, par value
$.001 per share. The stated value is $1,000 per share. As of the date of this
prospectus, we have 10,000 shares of Series E Preferred Stock outstanding, all
of which are held by Mr. Botchman.
The Series E Preferred Stock has the following rights and preferences.
Dividends. Dividends accrue at the rate of 8% of the stated value of
$1,000 per share each year
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and are cumulative. While we are not required to pay dividends at any specific
time, any accumulated dividends must be paid before any dividends may be paid on
our common stock, Series A Preferred Stock, Series B Preferred Stock, Series C
Preferred Stock or Series D Preferred Stock. Dividends accumulate on each share
of Series E Preferred Stock from December 31, 1998, whether or not declared. As
of February 28, 2001 we had approximately $2,000,000 of accumulated, undeclared
and unpaid dividends on outstanding shares of Series E Preferred Stock.
Voting Rights. Except as required by law, the holders of the Series E
Preferred Stock do not have the right to vote on matters presented to our
stockholders. In any matter on which the holders of the Series E Preferred Stock
are entitled to vote as a matter of law, each holder of Series E Preferred Stock
will have one vote per share
Redemption. We may redeem all or part of the outstanding shares of Series
E Preferred Stock at any time on 20 days written notice. If we elect to redeem
these shares, we will pay a redemption price of $1,000 per share plus
accumulated and unpaid dividends, if any, to the redemption date.
Exchange. At any time before August 31, 2006, a holder of shares of Series
E Preferred Stock may exchange those shares for shares of common stock.
Initially, each share of Series E Preferred Stock may be exchanged for 285
shares of common stock. The number of shares of common stock into which each
share of Series E Preferred Stock can be exchanged may be adjusted as a result
of stock splits, stock dividends and other issuances of additional stock. Holder
of shares of Series E Preferred Stock have piggyback registration rights
covering any common stock issued in exchange for the shares of Series E
Preferred Stock.
Liquidation. On our liquidation, the holders of shares of Series E
Preferred Stock, will be entitled to be paid, out of the assets available for
distribution to our stockholders, before any payment is made to the holders of
our common stock, Series A Preferred Stock, Series B Preferred Stock, Series C
Preferred Stock or Series D Preferred Stock, $1,000 per share plus accumulated
and unpaid dividends, if any, to the distribution date.
Undesignated Preferred Stock
As of the date of this prospectus, we had 965,000 shares, par value $.001
per share, of unissued, undesignated preferred stock. If we issue preferred
stock in the future, the preferred stock will have the rights, terms and
preferences specified by our board of directors in a certificate filed with the
Secretary of State of Delaware. The issuance of preferred stock by the board of
directors in the future could adversely affect the rights of holders of common
stock. For example, an issuance of preferred stock could result in an additional
class of securities outstanding with preferences over the common stock with
respect to dividends and liquidations and/or an additional class of securities
with voting rights equal to or greater than those of the common stock. We have
no present plan to issue any additional series of preferred stock.
Outstanding Warrants
As of the date of this prospectus we had outstanding warrants to purchase
a total of 5,675,247 shares of common stock with a weighted average exercise
price of $2.94 per share. The number of shares of common and the exercise price
of the warrants may be adjusted as a result of stock splits, stock dividends and
specified other issuances of additional stock.
Registration Rights of Security Holders
The holders of shares of common stock which may be issued on the
conversion of our Series D Preferred Stock, Series E Preferred Stock and certain
of our warrants have the right to demand that we register the common stock. In
addition, these holders may include their shares of common stock in any
registration statements filed by us in connection with an underwritten offering
of securities. These demand and piggyback registration rights are subject to
customary blackout periods and cut back provisions.
Stock Options
We have adopted a stock option plan to attract and retain employees,
directors and consultants.
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We have reserved 8,000,000 shares of common stock to issue under the plan of
which 2,462,100 shares remain available for issuance as of May 31, 2001.
As of May 31, 2001, we had outstanding options to purchase 6,581,000
shares of our common stock.
Anti-Takeover Provisions
We are subject to the provisions of Section 203 of the Delaware General
Corporation Law concerning corporate takeovers. This section prevents Delaware
corporations from engaging in a "business combination" which includes a merger
with or sale of more than 10% of the corporation's assets to any "interested
stockholder," or a stockholder who owns 15% or more of the corporation's
outstanding voting stock, as well as affiliates and associates of any these
persons, for three years following the date that the stockholder became an
"interested stockholder" unless:
o the transaction in which the stockholder became an "interested
stockholder" is approved by the board of directors before the date
the "interested stockholder" attained that status;
o on completion of the transaction that resulted in the stockholder's
becoming an "interested stockholder," the "interested stockholder"
owned at least 85% of the voting stock of the corporation
outstanding at the time the transaction commenced, excluding those
shares owned by persons who are directors and also officers; or
o on or after the date the "interested stockholder" became an
"interested stockholder," the "business combination" is approved by
the board of directors and authorized at an annual or special
meeting of stockholders by the affirmative vote of at least
two-thirds of the outstanding voting stock that is not owned by the
"interested stockholder."
This statute could prohibit or delay any proposed merger or change in
control attempt and may discourage attempts to acquire us.
Stockholder Action and Special Meetings
Our bylaws provide that:
o the number of directors is set by resolution of our board of
directors; and
o special meetings of stockholders may be called only by our board of
directors, the chairman of our board of directors, or the President.
These provisions may have the effect of deterring hostile takeovers or
delaying a change in control.
Transfer Agent and Registrar
The transfer agent and registrar for the shares of common stock is Wells
Fargo Shareowner Services.
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PLAN OF DISTRIBUTION
We do not currently use a broker-dealer or agent to assist in the sale of
the subordinated renewable notes. We may employ the services of a National
Association of Securities Dealers, Inc. member broker-dealer in the future for
purposes of offering the subordinated renewable notes on a "best-efforts" or
agency basis. If an agreement concerning the use of the services of any
broker-dealer is reached, we may pay any such broker-dealer a commission which
we estimate will range from .5% to 10% of the sale price of any subordinated
renewable notes sold through the broker-dealer, depending on numerous factors.
We may also agree to indemnify the broker-dealer against certain liabilities,
including liabilities under the Securities Act and to reimburse the
broker-dealer for its costs and expenses, up to a maximum to be determined,
based on the total dollar value of the securities sold. We will otherwise offer
the subordinated renewable notes through our employees in accordance with Rule
3a4-1 under the Securities Exchange Act of 1934.
We may reject any order, in whole or in part, for any reason. In the event
your order is not accepted, we will promptly refund your subscription, without
deduction of any costs and without interest. We expect that orders that are not
accepted will be refunded within 48 hours after receipt. No minimum number of
subordinated renewable notes must be sold in the offering. You will not know at
the time of order whether we will be successful in completing the sale of any or
all of the subordinated renewable notes being offered. We reserve the right to
withdraw or cancel the offering at any time. In the event of a withdrawal or
cancellation, orders previously received will be irrevocable after the
expiration of the rescission period, and no funds will be refunded. You may
rescind your subscription by sending a notice of rescission to us within three
business days of sending us your subscription.
We may from time to time offer investment incentives to investors. These
incentives could take the form of favorable interest rates or other rate term,
or other incentives which would be awarded to investors who satisfy total
investment, length of investment or other criteria. There are no specific
incentive programs in place on the date of this prospectus. Any specific
incentive program would be disclosed in an amended prospectus. Investors must
consider that they will recognize income for income tax purposes based on the
value of any incentive received.
-80-
LEGAL MATTERS
Various legal matters regarding the validity of the subordinated renewable
notes we are offering will be passed on by Kronish Lieb Weiner & Hellman LLP,
New York. Peter J. Mansbach, who is currently of counsel to Kronish Lieb Weiner
& Hellman LLP, serves on our board of directors. Kronish Lieb Weiner & Hellman
LLP will receive a portion of the compensation received by Mr. Mansbach.
EXPERTS
Our consolidated financial statements as of May 31, 2000, 1999, and 1998
and for the years then ended, included in this prospectus, have been audited by
Grant Thornton LLP, independent certified public accountants, as indicated in
their report thereon, and are included herein in reliance on the authority of
such firm as experts in giving said report.
WHERE YOU CAN FIND MORE INFORMATION
We have filed a registration statement on Form S-1 with the Securities and
Exchange Commission for the securities we are offering by this prospectus. This
prospectus does not include all of the information contained in the registration
statement. You should refer to the registration statement and its exhibits for
additional information. We also file annual, quarterly and special reports,
proxy statements and other information with the Securities and Exchange
Commission.
You can read our Securities and Exchange Commission filings, including the
registration statement, over the Internet at the Securities and Exchange
Commission's web site at http://www.sec.gov. You may also read and copy any
document we file with the Securities and Exchange Commission at its public
reference facilities at 450 Fifth Street, NW, Washington, DC 20549, 7 World
Trade Center, Suite 1300, New York, New York 10048 and Citicorp Center, 500 West
Madison Street, Suite 1400, Chicago, Illinois 60661-2511. You may also obtain
copies of the documents at prescribed rates by writing to the Public Reference
Section of the Securities and Exchange Commission at 450 Fifth Street, NW,
Washington, DC 20549. Please call the Securities and Exchange Commission at
1-800-SEC-0330 for further information on the operation of the public reference
facilities. Our Securities and Exchange Commission filings are also available at
the offices of the American Stock Exchange at 86 Trinity Place, New York, New
York 10006.
-81-
THE CREDIT STORE, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Report of Independent Certified Public Accountants F-2
Consolidated Balance Sheets (audited) as of May 31, 1999 and 2000 F-3
Consolidated Statements of Operations (audited) for the years ended May F-4
31, 1998, 1999 and 2000
Consolidated Statements of Stockholders' Equity (audited) for the years F-5
ended May 31, 1998, 1999 and 2000
Consolidated Statements of Cash Flows (audited) for the years ended May F-7
31, 1998, 1999 and 2000
Notes to Consolidated Financial Statements (audited) F-9
Condensed Consolidated Balance Sheets as of February 28, 2001 F-25
(unaudited) and May 31, 2000
Condensed Consolidated Statement of Operations (unaudited) for the nine F-26
months ended February 28, 2001 and February 29, 2000
Condensed Consolidated Statements of Cash Flows (unaudited) for the nine F-27
months ended February 28, 2001 and February 29, 2000
Notes to Condensed Consolidated Financial Statements (unaudited) F-28
F-1
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
The Credit Store, Inc.
We have audited the accompanying consolidated balance sheets of The Credit
Store, Inc. (a Delaware corporation) and subsidiaries as of May 31, 2000 and
1999, and the related consolidated statements of operations, stockholders'
equity and cash flows for each of the three years in the period ended May 31,
2000. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of The Credit
Store, Inc. and subsidiaries as of May 31, 2000 and 1999, and the consolidated
results of their operations and their consolidated cash flows for each of the
three years in the period ended May 31, 2000 in conformity with accounting
principles generally accepted in the United States of America.
/s/ GRANT THORNTON LLP
Minneapolis, Minnesota
July 24, 2000
F-2
THE CREDIT STORE, INC.
CONSOLIDATED BALANCE SHEETS
MAY 31,
ASSETS 2000 1999
------------- -------------
Cash and cash equivalents $ 1,423,248 $ 3,533,930
Restricted cash 1,025,631 750,000
Accounts and notes receivable, net 2,765,882 1,150,207
Prepaid expenses 1,341,516 618,198
Amounts due from special purpose entities 9,332,890 1,230,700
Investments
Investments in nonperforming consumer debt, net 9,648,090 3,016,697
Credit card receivables, net 24,244,200 18,631,403
Investment in unconsolidated affiliate 1,279,888 1,612,648
Retained interest in securitized credit card 2,142,846 5,130,372
receivables
Property and equipment, net 4,790,060 6,132,612
Goodwill, net 2,347,999 2,555,175
Deferred tax asset 2,700,000 700,000
Other assets 1,345,942 719,014
------------ ------------
$ 64,388,192 $ 45,780,956
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Accounts payable and accrued expenses $ 4,499,142 $ 4,313,409
Notes payable 23,609,326 6,086,766
Capitalized lease obligations 2,766,228 4,045,541
Subordinated notes and accrued interest payable
- related party 19,139,028 19,246,595
------------ ------------
Total liabilities 50,013,724 33,692,311
------------ ------------
COMMITMENTS AND CONTINGENCIES -- --
------------ ------------
STOCKHOLDERS' EQUITY
Series A, B, C, D and E Preferred Stock 27,000,000 27,000,000
Common stock, $.001 par value; 65,000,000 shares
authorized at May 31, 2000 and 50,000,000
shares authorized at May 31, 1999; 34,761,965
shares issued and outstanding at May 31, 2000
and 1999 34,762 34,762
Additional paid-in capital 23,743,260 22,670,711
Unrealized gain from retained interest in
securitized credit card receivables, net of
tax 638,227 2,497,148
Accumulated deficit (37,041,781) (40,113,976)
------------ ------------
Total stockholders' equity 14,374,468 12,088,645
------------ ------------
Total liabilities and stockholders' equity $ 64,388,192 $ 45,780,956
The accompanying notes are an integral part of these statements.
F-3
THE CREDIT STORE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED MAY 31,
2000 1999 1998
------------ ------------ ------------
Revenue
Income from credit card receivables $ 9,706,247 $ 6,438,460 $ 3,951,602
Revenue in excess of cost recovered 21,396,561 22,308,908 8,138,122
Securitization income and asset sales 12,599,265 11,851,080 --
Servicing fees and other income 2,684,554 1,564,356 1,292,596
------------ ------------ ------------
Total revenue 46,386,627 42,162,804 13,382,320
Provision for losses 5,680,975 4,607,081 6,483,736
------------ ------------ ------------
Net revenue 40,705,652 37,555,723 6,898,584
Expenses
Salaries and employee benefits 13,502,074 12,484,582 13,268,863
Professional fees 2,604,992 2,701,016 4,215,891
Depreciation and amortization 2,494,489 2,614,216 3,223,620
Third-party credit card services 3,972,785 4,468,992 3,486,915
Third-party scrubbing services 665,078 264,536 --
Communication expense 2,769,077 2,272,513 2,035,380
Occupancy and equipment rental 858,325 766,832 825,517
Royalty expense 1,733,412 1,541,944 207,238
Financing fees 1,092,286 211,864 90,182
Other 4,001,365 4,310,466 4,229,104
------------ ------------ ------------
Total expenses 33,693,883 31,636,961 31,582,710
------------ ------------ ------------
Operating income (loss) 7,011,769 5,918,762 (24,684,126)
Interest expense 4,981,949 4,029,491 4,760,905
------------ ------------ ------------
Income (loss) before income taxes 2,029,820 1,889,271 (29,445,031)
Income tax benefit 1,042,375 1,986,409 --
------------ ------------ ------------
NET INCOME (LOSS) 3,072,195 3,875,680 (29,445,031)
Dividends on preferred stock (2,000,000) (1,799,999) (399,996)
------------ ------------ ------------
Net income (loss), applicable to common
stockholders $ 1,072,195 $ 2,075,681 $(29,845,027)
Net income (loss) per share
Basic $ 0.03 $ 0.06 $ (0.90)
Diluted $ 0.03 $ 0.06 $ (0.90)
Weighted-average common shares outstanding
Basic 34,761,965 34,761,965 33,109,781
Diluted 36,924,208 35,091,550 33,109,781
The accompanying notes are an integral part of these statements.
F-4
THE CREDIT STORE, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED MAY 31,
Common stock
------------------------ Series A Series B Series C Series D
Shares Amount Preferred Preferred Preferred Preferred
---------- -------- ---------- --------- ---------- -----------
Balance at June 1, 1997 32,207,465 $ 32,208 $1,200,000 $800,000 $5,000,000 $ --
Net loss -- -- -- -- -- --
Issuance of Series D Preferred
Stock in exchange for $10
million subordinated note -- -- -- -- -- 10,000,000
Issuance of common stock 2,554,500 2,554 -- -- -- --
---------- -------- ---------- -------- ---------- -----------
Balance at May 31, 1998 34,761,965 34,762 1,200,000 800,000 5,000,000 10,000,000
Net income -- -- -- -- -- --
Unrealized gain and accretion on
retained interest in
securitization, net of tax -- -- -- -- -- --
Comprehensive income -- -- -- -- -- --
Issuance of Series E Preferred
Stock in exchange for $10
million subordinated note -- -- -- -- -- --
Issuance of warrants in lieu of
payment of accrued interest on
subordinated debt -- -- -- -- -- --
---------- -------- ---------- -------- ---------- -----------
Balance at May 31, 1999 34,761,965 34,762 1,200,000 800,000 5,000,000 10,000,000
Net income -- -- -- -- -- --
Unrealized gain and accretion on
retained interest in
securitization, net of tax -- -- -- -- -- --
Sale of retained interest in
securitized receivables, net of
tax -- -- -- -- -- --
Comprehensive income -- -- -- -- -- --
Issuance of warrants and stock
options in lieu of payment for
services and assets -- -- -- -- -- --
---------- -------- ---------- -------- ---------- -----------
Balance at May 31, 2000 34,761,965 $ 34,762 $1,200,000 $800,000 $5,000,000 $10,000,000
The accompanying notes are an integral part of these statements.
F-5
THE CREDIT STORE, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY - CONTINUED
YEARS ENDED MAY 31,
Additional Other Total
Series E paid-in Accumulated comprehensive stockholders'
Preferred capital deficit income equity
----------- ----------- ------------- -------------- --------------
Balance at June 1, 1997 $ -- $14,137,892 $(14,544,625) $ -- $ 6,625,475
Net loss -- -- (29,445,031) -- (29,445,031)
Issuance of Series D Preferred Stock
in exchange for $10 million
subordinated note -- -- -- -- 10,000,000
Issuance of common stock -- 5,173,890 -- -- 5,176,444
----------- ----------- ------------ ----------- ------------
Balance at May 31, 1998 -- 19,311,782 (43,989,656) -- (7,643,112)
Net income -- -- 3,875,680 -- 3,875,680
Unrealized gain and accretion on
retained interest in
securitization, net of tax -- -- -- 2,497,148 2,497,148
------------
Comprehensive income -- -- -- -- 6,372,828
Issuance of Series E Preferred Stock
in exchange for $10 million
subordinated note 10,000,000 -- -- -- 10,000,000
Issuance of warrants in lieu of
payment of accrued interest on
subordinated debt -- 3,358,929 -- -- 3,358,929
----------- ----------- ------------ ----------- ------------
Balance at May 31, 1999 10,000,000 22,670,711 (40,113,976) 2,497,148 12,088,645
Net income -- -- 3,072,195 -- 3,072,195
Unrealized gain and accretion on
retained interest in
securitization, net of tax -- -- -- 2,062,292 2,062,292
Sale of retained interest in
securitized receivables, net of tax -- -- -- (3,921,213) (3,921,213)
------------
Comprehensive income -- -- -- -- 1,213,274
Issuance of warrants and stock
options in lieu of payment for
services and assets -- 1,072,549 -- -- 1,072,549
----------- ----------- ------------ ----------- ------------
Balance at May 31, 2000 $10,000,000 $23,743,260 $(37,041,781) $ 638,227 $ 14,374,468
The accompanying notes are an integral part of these statements.
F-6
THE CREDIT STORE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED MAY 31,
2000 1999 1998
------------- ------------- -------------
Cash flows from operating activities:
Net income (loss) $ 3,072,195 $ 3,875,680 $(29,445,031)
Adjustments to reconcile net income (loss) to net
cash used in operating activities
Provision for credit card losses 5,680,975 4,607,081 6,483,736
Amortization of discount on performing credit
card portfolio (1,344,418) -- --
Provision for losses on accounts and notes
receivable 100,000 768,860 780,027
Depreciation and amortization 2,494,489 2,614,216 3,223,620
Deferred tax benefit (1,042,375) (1,986,409) --
Gain on sale of interest in affiliates (5,260,358) -- --
(Gain)loss from unconsolidated affiliates 332,760 (325,183) (277,159)
Gain on sale of credit card receivable
portfolios (5,771,007) (11,851,080) --
Services received for stock options granted 38,500 -- 176,444
Changes in operating assets and liabilities:
Restricted cash (275,631) 250,000 --
Accounts and notes receivable (1,715,675) (1,426,401) (473,436)
Receivable from unconsolidated affiliate (8,102,190) (1,230,700) --
Prepaid expenses (723,318) (173,362) (327,177)
Accrued interest on funds advanced on
credit cards (511,096) 82,488 (263,255)
Accrued fees (1,197,790) 291,161 (48,382)
Other assets 407,121 (177,085) (383,338)
Unearned fees 264,855 184,551 216,721
Accounts payable and accrued expenses 185,733 (193,277) 1,230,841
Accrued interest payable on subordinated
notes 242,433 2,439,273 3,675,381
------------ ------------ ------------
Net cash used in operating activities (13,124,797) (2,250,187) (15,431,008)
Cash flows from investing activities:
Collection of funds advanced on credit cards 18,581,055 13,305,543 1,887,306
Collection of consumer debt 7,180,106 11,278,295 18,162,596
Funds advanced on securitized credit card
receivables (1,840,282) (1,346,815) --
Proceeds from sale of credit card receivable
portfolios 12,244,229 17,129,109 --
Funds advanced on credit cards (30,849,101) (29,460,286) (18,629,185)
Purchase of nonperforming consumer debt portfolios (13,811,499) (8,622,478) (15,641,657)
Proceeds from sale of beneficial interest in
affiliates 8,643,233 -- --
Purchase of performing consumer debt portfolios (4,082,114) -- --
Development of proprietary software (207,587) (460,497) --
Purchase of property and equipment (737,172) (682,539) (4,170,472)
------------ ------------ ------------
Net cash provided by (used in) investing
activities (4,879,132) 1,140,332 (18,391,412)
------------ ------------ ------------
The accompanying notes are an integral part of these statements.
F-7
THE CREDIT STORE, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS - CONTINUED
FOR THE YEARS ENDED MAY 31,
2000 1999 1998
------------ ------------ --------------
Cash flows from financing activities:
Proceeds from debt $ 19,128,881 $ 576,643 $ 33,240,887
Payments on debt (1,956,321) (2,032,989) (101,921)
Borrowings from sale/leaseback transactions 896,018 559,713 3,146,275
Payments on capital lease obligations (2,175,331) (1,664,653) (1,943,331)
Proceeds from issuance of stock -- -- 5,000,000
------------ ------------ ------------
Net cash provided by (used in) financing
activities 15,893,247 (2,561,286) 39,341,910
------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH (2,110,682) (3,671,141) 5,519,490
Cash and cash equivalents at beginning of period 3,533,930 7,205,071 1,685,581
------------ ------------ ------------
Cash and cash equivalents at end of period $ 1,423,248 $ 3,533,930 $ 7,205,071
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest $ 4,178,571 $ 1,592,864 $ 1,006,663
Noncash financing activities:
Series D and E preferred stock issued in
exchange for subordinated note -- 10,000,000 10,000,000
Obligations assumed in lieu of payment of
accrued interest on subordinated debt -- 1,641,071 --
Issuance of warrants in lieu of payment of
accrued interest on subordinated debt -- 3,358,929 --
Issuance of warrants and stock options in
lieu of payment for services and assets 1,072,549 -- --
The accompanying notes are an integral part of these statements.
F-8
THE CREDIT STORE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2000, 1999 AND 1998
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. Through direct mail and
telemarketing operations, these consumers are offered an opportunity to
settle their debt, typically at a discount, transfer the agreed settlement
amount to a newly issued unsecured MasterCard(R) or Visa(R) credit card,
and establish a positive credit history on their newly issued card by
making timely and consistent payments. The Company accepts lump sum
settlements or installment payment plans from those consumers who do not
accept the credit card offer.
After the consumers have made eight or more consecutive monthly payments
on their outstanding credit card balance the Company considers the account
seasoned and available to sell or securitize. Because the focus of the
Company's business is to convert defaulted debt into seasoned credit
cards, the Company periodically sells or securitizes portfolios of these
seasoned accounts. The Company also periodically sells into the secondary
market for non-performing consumer debt portfolios of accounts it acquired
but was unable to convert.
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The Company has four subsidiaries, Credit Store Services, Credit Store
Capital, American Credit Alliance and TCS Funding IV. All of these
subsidiaries are wholly owned by the Company; however, only Credit Store
Capital and American Credit Alliance are consolidated in the financial
statements. Credit Store Services and TCS Funding IV are qualifying
special purpose entities that are not required to be consolidated. Credit
Store Services and Credit Store Capital acquire non-performing consumer
receivables and contract with the Company to offer consumers a credit card
or to accept settlements or payment plans. American Credit Alliance owns a
50% interest in Dakota Card Fund II, a limited liability company that
contracts with the Company to service non-performing receivables and
credit card receivables that it owns. TCS Funding IV was created in
connection with securitizations for the purpose of purchasing performing
credit card receivables from the Company. All significant inter-company
transactions have been eliminated.
Cash and Cash Equivalents
For purposes of the statements of cash flows, cash includes all cash and
investments with original maturities of three months or less when
purchased, except restricted cash. The Company's restricted cash is on
deposit with two banks to facilitate funding of credit card loans. The
Company maintains its cash in bank deposit accounts, which at times may
exceed federally insured limits.
Investments
Investments in nonperforming consumer debt consist of portfolios of
consumer debt purchased by the Company, which are recorded at cost, less
cost recovered. Cost is substantially less than the remaining outstanding
balance on these portfolios. To the extent that the cost of a particular
portfolio
F-9
of debt purchased exceeds the present value of the estimated amount of
cash expected to be collected, a valuation allowance would be recognized
in the amount of such impairment.
Credit card receivables consist of amounts funded by the Company for new
purchases or advances, accrued interest on new purchases and advances, and
accrued fees, less a provision for losses and unearned fees.
Investment in unconsolidated affiliate represents the Company's 50%
ownership interest in an entity involved in substantially the same
business as the Company and is recorded on the equity method of
accounting.
Securitization Accounting
Statement of Financial Accounting Standards No. 125 ("SFAS No. 125"),
"Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities," requires an entity to recognize the
financial and servicing assets it controls and the liabilities it has
incurred and to derecognize financial assets when control has been
surrendered. The proceeds of securitized financial assets 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.
SFAS No. 125 requires an entity to recognize a servicing asset or
servicing liability each time it undertakes an obligation to service
financial assets that have been securitized and amortize it over the
period of estimated net servicing income or loss. The Company received
adequate compensation for the servicing of securitized credit card
receivables and therefore no servicing asset or liability was recorded.
Retained Interest in Securitized Credit Card Receivables
The retained interest in securitized credit card receivables is treated as
a debt security classified as available-for-sale in accordance with
Statement of Financial Accounting Standards No. 115, "Accounting for
Certain Investments in Debt and Equity Securities," and is carried at fair
value. Fair value is based on the discounted anticipated future cash flows
on a "cash out" basis. The cash out method projects cash collections to be
received only after all amounts owed to investors have been remitted.
Adjustments to fair value (net of related income taxes) are recorded as a
component of other comprehensive income.
Income on the retained interest is accrued based on the effective interest
rate applied to its original cost basis, adjusted for accrued interest and
principal payments. The effective interest rate is the internal rate of
return determined based on the timing and amounts of anticipated future
cash flows for the underlying pool of securitized credit card receivables.
The retained interest is evaluated for impairment by management monthly
based on current market and cash flow assumptions applied to the
underlying receivables. Provisions for losses are charged to earnings when
it is determined that the retained interest's original cost basis,
adjusted for accrued interest and principal payments, is greater than the
present value of expected future cash flows. No provision for losses was
recorded during the fiscal years ended May 31, 2000, 1999 and 1998.
Property and Equipment
Property and equipment are recorded at cost, less accumulated depreciation
and amortization. Depreciation and amortization are determined using the
straight-line method over the estimated useful lives of the assets or
terms of the capital lease. Expenditures for maintenance and repairs are
expensed when incurred.
F-10
Goodwill
Goodwill originating from the acquisition of companies acquired in
purchase transactions is being amortized using the straight-line method
over fifteen years. The Company evaluates the impairment of goodwill based
on expectations of future non-discounted cash flows and operating income
related to purchased businesses. As of May 31, 2000 and 1999, accumulated
amortization was $759,646 and $552,470.
Revenue Recognition
Income from credit cards receivable represents interest and fees on new
advances or purchases made by holders of the Company's credit cards on an
accrual basis.
For the portfolios of nonperforming consumer debt, revenue in excess of
cost recovery is accounted for on a pool basis using the cost recovery
method of accounting in accordance with Practice Bulletin No. 6,
"Amortization of Discounts on Certain Acquired Loans." Under the cost
recovery method of accounting, all cash receipts relating to individual
portfolios of nonperforming consumer debt are applied first to recover the
cost of the portfolios, prior to recognizing any revenue. Cash receipts in
excess of cost of acquired portfolios are then recognized as revenue. The
cost of the portfolio includes the purchase price paid to the seller plus
costs directly related to the acquisition of the portfolio. All direct
mail, telemarketing, and scrubbing costs are expensed as incurred.
Servicing revenues are fees related to processing and managing credit
cards for third parties. These revenues are recognized when the related
services are provided.
The Company's policy is to accrue fee income and interest on new advances
on all credit card accounts including delinquent accounts, until the
account is charged off. A credit card is contractually delinquent if the
minimum payment is not received on the specified payment due date on the
customer's statement.
For performing credit card portfolios purchased, the Company uses models
to estimate the amount and timing of future cash flows. These models are
based on historical cash collection data from performing receivable
portfolios and are used to compute an effective interest rate for income
recognition. For these portfolios the fair value of credit card
receivables is based upon discounted expected cash flows. The discount
rate is based upon an acceptable rate of return adjusted for specific risk
factors inherent in each individual portfolio.
Allowance for Credit Card Losses
The provision for possible 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. In
evaluating the adequacy of the allowance for credit card losses,
management considers 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. Credit card accounts are generally charged off at the end of the
month during which the credit card receivable becomes contractually 120
days past due, with the exception of bankrupt accounts, which are charged
off immediately upon formal notification of bankruptcy, and accounts of
deceased cardholders without a surviving, contractually liable individual,
which are also charged off immediately upon notification.
F-11
The following table summarizes information about the Company's allowance
for credit card losses.
For the years ended May 31,
-----------------------------
2000 1999
------------- --------------
Balance at beginning of period $ 2,846,533 $ 3,688,091
Provision for credit card losses 5,680,975 4,607,081
Credit card receivables charged-off (6,051,670) (5,448,639)
----------- -----------
Balance at end of period $ 2,475,838 $ 2,846,533
Accounts and Notes Receivable
As of May 31, 2000 and 1999, the accounts and notes receivable allowance
for doubtful accounts was $584,029 and $746,463.
Stock Based Compensation
The Company utilizes the intrinsic value method of accounting for its
stock-based employee compensation plans. Stock based awards granted to
non-employees are expensed over the time the services are rendered based
upon the fair value of the award or services. Pro-forma information
related to the fair value based method of accounting is contained in note
H.
Deferred Income Taxes
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes.
Net Income (Loss) Per Share
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 (loss). Diluted net income (loss) per share is based
on the weighted-average number of common and common equivalent shares
outstanding. The calculation takes into account the shares that may be
issued upon exercise of stock options, reduced by the shares that may be
repurchased with the funds received from the exercise, based on the
average price during the period. In computing diluted net income (loss)
per share, only potential common shares that are dilutive (those that
reduce net income per share) are included. Exercise of stock options is
not assumed if the result would be antidilutive, such as when a net loss
is reported.
Comprehensive Income
Comprehensive income, as defined by SFAS No. 130, "Reporting Comprehensive
Income," includes net income (loss) and items defined as other
comprehensive income. SFAS No. 130 requires that items defined as other
comprehensive income (loss), such as unrealized gains and losses on
certain investments in debt securities, be separately classified in the
financial statements. Such disclosures are included in the consolidated
statements of stockholders' equity.
Reclassifications
Certain reclassifications have been made to prior period amounts to
conform to the current period presentation.
Use of Estimates
In preparing financial statements in conformity with accounting principles
generally accepted in the United States of America, management is required
to make estimates and assumptions that affect the
F-12
reported amounts of assets and liabilities, the disclosure of contingent
assets and liabilities at the date of the financial statements, and the
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Significant estimates have been made by management with respect to the
timing and amount of collection of future cash flows from nonperforming
consumer debt and credit card receivables ("portfolios"). Among other
things, the estimated future cash flows of the portfolios are used to
recognize impairment in investment in nonperforming consumer debt,
provision for losses on credit card receivables and fair value of retained
interest in securitized credit card receivables. On a periodic basis,
management reviews the estimate of future collections, and it is
reasonably possible that these estimates may change based on actual
results and other factors. A change could be material.
New Accounting Pronouncements
FASB Interpretation 44, Interpretation of APB Opinion 25 ("FIN 44"), was
issued in March 2000. FIN 44 provides an interpretation of APB Opinion 25
on accounting for employee stock compensation and describes its
application to certain transactions. FIN 44 is effective on July 1, 2000.
It applies on a prospective basis to events occurring after that date,
except for certain transactions involving options granted to nonemployees,
repriced fixed options, and modifications to add reload option features,
which apply to awards granted after December 31, 1998. The provisions of
FIN 44 are not expected to have a material effect on transactions entered
into through May 31, 2000.
NOTE C - INVESTMENTS IN NONPERFORMING CONSUMER DEBT AND CREDIT CARD RECEIVABLES
Investments in Nonperforming Consumer Debt
The Company acquires portfolios of nonperforming consumer installment
debt, credit card receivables, and automobile deficiency debt from
originating financial institutions. These debts are acquired at a
substantial discount from the actual consumer outstanding balance. A
portion of these debts may be subject to legitimate claims, defenses or
rights of offset on the part of the consumer. As a result, the Company may
not be able to collect on these receivables. For example, the Company
acquires "out of statute" accounts which are subject to a statute of
limitations defense, and may also acquire some credit card accounts where
customers cannot be held liable for, or their liability may be limited
with respect to, charges to a credit card account that were a result of an
unauthorized use of a credit card.
The outstanding balance of the debt acquired by the Company at May 31,
2000 and 1999 was approximately $3.1 billion and $2.0 billion. The
Company's objective is to offer the consumer an opportunity to settle
these debts, typically at a discount, and transfer the settled amount to a
newly issued credit card. (See Credit Card Receivables below.)
Investments in nonperforming consumer debt consist of the following at May
31:
2000 1999
------------- -------------
Cost of portfolios purchased including
capitalized acquisition costs of $2,109,937
and $2,079,897 $ 51,907,168 $ 38,574,174
Cost recovered (42,259,078) (35,557,477)
------------ ------------
Investment in nonperforming consumer debt $ 9,648,090 $ 3,016,697
Credit Card Receivables
Upon settlement of the debt, a credit card is issued to the consumer with
the opening balance and credit line equal to the settlement amount. The
Company expenses origination costs including direct mail and telemarketing
costs as incurred. The Company does not record a credit card asset until
the cardholder begins to make new charges on the account. For financial
statement purposes the Company
F-13
records as credit card receivables the amount funded on new advances and
purchases, accrued interest on new advances and accrued fees, less
provision for losses on credit card receivables and unearned fees. After
making principal payments on the settlement amount, the customer may use
the credit card for new purchases and cash advances up to their available
credit limit, which may be increased from time to time based on their
payment history.
May 31,
--------------------------
2000 1999
------------ ------------
Principal funded on new advances and purchases $ 26,536,055 $21,303,274
Accrued interest on principal funded 420,383 243,489
Accrued fees 429,727 332,446
------------ -----------
27,386,165 21,879,209
Less:
Provision for losses on credit card
receivables $ 2,475,838 $ 2,846,533
Unearned fees 666,127 401,273
------------ -----------
3,141,965 3,247,806
Credit card receivables $ 24,244,200 $18,631,403
============ ===========
Total credit card balances (1) $ 77,832,562 $55,184,540
Available credit (2) $ 7,837,918 $ 4,296,364
(1) Total credit card balances 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 additional amount that the Company
would be obligated to fund if the credit cards were fully utilized
by the cardholders.
NOTE D - SECURITIZATION AND GAIN ON SALES OF CREDIT CARD RECEIVABLE PORTFOLIOS
During the year ended May 31, 2000, the Company established a new
wholly-owned qualified special purpose entity, TCS Funding IV, Inc. ("TCS
IV"), for the purpose of purchasing performing credit card receivables
from the Company. TCS IV entered into a $40,000,000 credit facility with a
lending institution to finance the purchase of credit card receivables.
The initial approximately $12,100,000 sale of credit card receivables to
the SPE included receivables with a principal balance of approximately
$14,200,000. TCS IV provided $10,000,000 for the purchase and the
remaining approximately $2,100,000 of the purchase price was recorded by
the Company as retained interest. The transaction closed on May 31, 2000.
The Company recognized a pre-tax gain, of approximately $3,800,000. The
unrealized gain of approximately $638,000, included in the retained
interest, was recorded net of tax as a separate component of stockholders'
equity.
At May 31, 2000, the Company recorded a receivable from the SPE for
$9,332,890. This balance represented sales proceeds due to the Company.
The receivable was guaranteed by the lending institution through an
irrevocable commitment to fund. The receivable was collected after May 31,
2000.
The TCS IV credit facility requires interest payments only during the
first 18 months and allows for multiple advances during this period up to
$40 million. Borrowings in excess of $10 million are governed by a
borrowing base and are contingent upon the senior beneficial interests
receiving a minimum BBB- rating from a nationally recognized rating
agency. The credit facility advances 70% of the receivables balance, of
which 5% must be deposited into a reserve account. The Company is in the
process of attaining a rating on behalf of TCS IV. The terms of the credit
facility require that all credit card receivables purchased by TCS IV must
be current with a minimum of eight payments made on each account and must
meet certain other eligibility requirements.
During the first 18 months of the credit facility, after new charges are
funded and fees and interest are paid, excess cash collections can be used
by TCS IV to purchase additional accounts from the
F-14
Company or pay down the senior beneficial interest. Following the first 18
months, all cash collections relating to the senior debt interest in the
receivables are used to repay principal, after the payment-related
servicing fees and interest are made. All new charges on the sold accounts
are either sold to TCS IV or contributed in exchange for a residual
interest until such time as the senior debt interest is paid down. While
the senior debt interest is in place, there are restrictions on payments
that can be made by the Company to certain related parties.
During the year ended May 31, 2000, the Company also sold a portfolio of
receivables totaling approximately $1,400,000, with a carrying value of
approximately $644,000, for approximately $1,100,000 to an unrelated party
without recourse.
During the year ended May 31, 1999, the Company completed three
securitizations of seasoned credit card receivables ("Receivables") of
approximately $20,400,000 with three unconsolidated wholly-owned qualified
special purpose entities ("SPE's"). All receivables sold in these
transactions were current with a minimum of eight payments made on each
account. The SPEs purchased the Receivables from the Company for
approximately $17,300,000, which was funded with the sale of senior debt
interests. The remaining approximately $4,300,000 represented interest
retained by the Company.
Under the provisions of SFAS No. 125, the securitizations are accounted
for as sales. As a result, the Company recognized a pre-tax gain of
approximately $8,000,000 and recorded a retained interest in securitized
credit card receivables on an allocated basis in the amount of
approximately $1,300,000 based on its relative fair value as discussed in
Note B.
At May 31, 1999, the allocated basis amount was adjusted to a fair value
of approximately $5,100,000, resulting in approximately $3,800,000 of
unrealized gain on the retained interest in securitized credit card
receivables. The unrealized gain was recorded net of tax of approximately
$1,300,000, resulting in approximately $2,500,000, as a component of
comprehensive income. The fair value of the retained interest was
estimated using a discount rate of 23% to calculate the present value of
all projected net cash flows from the credit cards reduced by servicing
costs and an annualized default rate of 12%. The discount rate was arrived
at by comparison to the market rate on investments of similar risk and
term that are available for the company to invest in. During November
1999, the Company sold its retained interest in the three SPE's to the
lender for approximately $8,600,000, resulting in a pre-tax gain of
approximately $6,500,000.
As of May 31, 1999, the Company included $1,230,700 in amounts due from
SPE's representing funds advanced with respect to revolving period
requirements and servicing fee income which are paid to the Company on a
monthly basis.
During the year ended May 31, 1999, The Company also sold a portfolio of
credit card receivables with a total credit card balance of approximately
$7,000,000 and a carrying value of approximately $2,250,000 for $5,000,000
to an unrelated party without recourse.
The following summarizes the changes in the balance sheet of the Company's
retained interest for the years ended May 31, 2000 and 1999:
F-15
Gross Estimated
Amortized Unrealized Fair
Cost Gains Value
---- ----- -----
Balance at 6/1/98 $ -- $ -- $ --
Retained interests in portfolios sold 1,083,191 3,643,332 4,726,523
Retained Interest sold to 3rd Party -- -- --
Interest accrued 263,624 -- 263,624
Change in unrealized gain -- 140,225 140,225
----------------------------------------
Balance at 5/31/99 1,346,815 3,783,557 5,130,372
Retained interests in portfolios sold 1,175,837 967,011 2,142,848
Retained Interest sold to 3rd Party (2,096,466) (5,207,622) (7,304,088)
Interest accrued 749,649 -- 749,649
Change in unrealized gain -- 1,424,065 1,424,065
----------------------------------------
Balance at 5/31/00 $ 1,175,835 $ 967,011 $ 2,142,846
========================================
NOTE E - PROPERTY AND EQUIPMENT
Property and equipment consist of the following at May 31:
Useful
life
(in years) 2000 1999
------------ ------------ -------------
Computer equipment and software 3 - 5 $ 7,289,750 $ 6,631,043
Office equipment 5 - 7 2,280,037 2,275,037
Furniture and fixtures 5 - 7 1,241,458 1,183,400
Proprietary software 5 668,084 460,497
Leasehold improvements Life of leases
669,884 654,475
------------ ------------
12,149,213 11,204,452
Less accumulated depreciation and
amortization (7,489,579) (5,202,266)
------------ ------------
4,659,634 6,002,186
Land 130,426 130,426
------------ ------------
$ 4,790,060 $ 6,132,612
NOTE F - NOTES PAYABLE
Notes payable consist of the following at May 31:
2000 1999
------------ ----------
Note payable - bank $ 13,442,597 $3,644,776
Note payable - other lenders 10,065,808 2,217,714
Note payable - other 100,921 224,276
------------ ----------
$ 23,609,326 $6,086,766
Note Payable - Bank
On April 30, 1998, the Company entered into a financing agreement with a
bank. The revolving line of credit, may not exceed an established dollar
amount or 50% of the Company's eligible receivables as defined by the
agreement and is used for general working capital purposes. The originally
established dollar amount, which was $5,000,000, was increased to
$10,000,000 on June 25, 1999 and increased to $15,000,000 on December 6,
1999. The line is collateralized by substantially all of the Company's
assets. The interest rate, which was originally at the prime rate plus
2.75% per annum, was reduced to prime rate plus 2.5% per annum on June 25,
1999. The agreement expires July 29, 2001. Interest expense for the years
ended May 31, 2000, 1999 and 1998 was $1,501,047, $617,249, and $27,936.
F-16
Note Payable - Other Lenders
The Company has uncollateralized installment notes issued in connection
with purchases of nonperforming consumer debt in addition to installment
obligations assumed in connection with the closing of certain affiliated
mortgage companies (see Note L). The notes have various maturity dates
through May 2002, with interest rates ranging up to 23.7% per annum. The
amount outstanding as of May 31, 2000 and 1999 was $2,292,920 and
$2,217,714. Interest expense for the years ended May 31, 2000, 1999 and
1998 was $145,763, $65,353, and $51,925.
On October 15, 1999, the Company, through a bankruptcy remote special
purpose entity, entered into a revolving line of credit ("revolving line")
with a financial institution. The revolving line, which may not exceed
$17,500,000, is non-recourse to the Company and is secured by all assets
of the SPE. The revolving line is used to acquire non-performing consumer
debt portfolios. The Company services the portfolios subject to an
agreement with the SPE and purchases all new credit card receivables for a
pre-determined price. The SPE is not a qualified SPE for accounting
purposes and is fully consolidated with the Company in the accompanying
consolidated financial statements. Interest is charged at a floating daily
rate and is equal to the reference rate plus 2.5% per annum. The agreement
is in effect until August 31, 2002. The amount outstanding as of May 31,
2000 was $1,772,888. Interest expense for the year ended May 31, 2000 was
$151,547.
On September 20, 1999, the Company entered into a repurchase agreement
with a bank. Under the agreement the bank purchased credit card
receivables from the Company for $3,000,000. The agreement had an initial
repurchase date of December 20, 1999, which has been extended to September
15, 2000. In addition, the agreement was increased to $6,000,000 effective
March 17, 2000. Interest is charged at a rate of 15% per annum. Interest
expense for the year ended May 31, 2000 was $378,750.
At May 31, 2000, future minimum principal payments for all notes payable
were as follows:
Year Amount
---- -----------
2001 $ 8,156,058
2002 13,680,381
2003 1,772,887
-----------
$23,609,326
NOTE G - CAPITAL LEASE OBLIGATIONS
The Company leases computer equipment and furniture and fixtures under
long-term leases and has the option to purchase the equipment for a
nominal cost at the termination of the lease. Assets under capital leases
have been capitalized at a cost of $6,953,160 and $6,526,915, and have
accumulated amortization of $5,023,793 and $3,646,314 at May 31, 2000 and
1999.
Future minimum lease payments for capitalized leases are as follows at May
31, 2000:
Amount
-----------
Year
2001 $ 1,695,728
2002 1,325,048
2003 328,479
2004 27,282
-----------
3,376,537
Less amount representing interest (610,309)
-----------
$ 2,766,228
F-17
Amortization expense for assets under capital leases for the years ended
May 31, 2000, 1999 and 1998 was $1,377,479, $1,645,705 and $1,535,029.
NOTE H - STOCK OPTIONS
The Board of Directors of the Company approved the Company's 1997 Stock
Option Plan (the "Plan"). The Plan authorizes the grant of stock options
covering 8,000,000 shares of the Company's common stock. In addition, the
Board of Directors has granted stock options outside the Plan covering a
total of 1,550,000 shares of common stock. The Board of Directors has the
authority to determine the key employees, consultants, and directors who
shall be granted options as well as the number of options granted and the
nature of each grant. The options granted under the Plan may be either
incentive stock options or nonqualified stock options.
Transactions during each of the three years in the period ended May 31,
2000 are summarized as follows:
Number of Weighted
shares under average
option exercise price
------------ --------------
Outstanding at June 1, 1997 2,550,000 $ 5.76
Granted 3,021,000 2.45
Cancelled (1,915,000) 5.93
----------
Outstanding at May 31, 1998 3,656,000 2.93
Granted 690,500 2.35
----------
Outstanding at May 31, 1999 4,346,500 2.84
Granted 942,500 2.90
Cancelled (156,000) 2.08
----------
Outstanding at May 31, 2000 5,133,000 $ 2.88
Options exercisable at May 31 are as follows:
1998 2,395,000 $ 3.39
1999 3,305,500 3.08
2000 4,750,000 2.88
The following table summarizes information about stock options outstanding
at May 31, 2000:
Options outstanding
--------------------------------------------
Weighted
average Weighted
Range of remaining average
exercise Number life exercise
prices outstanding (years) price
----------- -------------- -------------- -------------
$2.00 - $2.50 3,433,500 3.12 $ 2.09
$2.69 - $4.03 720,500 3.97 3.10
$4.50 - $5.50 979,000 1.90 5.48
---------
5,133,000 $ 2.88
Options exercisable
---------------------------------
Number Weighted
Range of exercisable at average
exercise May 31, exercise
prices 2000 price
----------- ----------------- -----------
$2.00 - $2.50 3,250,500 $ 2.09
$2.69 - $4.03 532,500 2.96
$4.50 - $5.50 967,000 5.49
---------
4,750,000 $ 2.88
On April 30, 1998, the Company granted warrants to purchase 650,247 shares
of the Company's common stock for $2.50 per share to a bank with which it
has a financing agreement. Warrants to purchase 278,677 shares were
exercisable immediately, while the remaining 371,570 warrants were
exercisable on June 25, 1999, when the Company's line of credit increased
to $10,000,000 (see Note
F-18
F). The fair value of the warrants was $1.01 at the date of grant. For the
year ended May 31, 2000, $357,182 of amortization was included in interest
expense.
On March 18, 1999, the Company granted a five-year warrant to a vendor to
purchase 1,000,000 shares of the Company's common stock at $2.00 per
share. The fair value was $0.85 per warrant. For the year ended May 31,
2000, expense was $72,262.
The Company's proforma net income (loss) applicable to common stockholders
and basic and diluted net income (loss) per share would have been as
follows had the fair value method been used for valuing stock options
granted to employees for the year ended May 31 are as follows:
2000 1999 1998
---------- -------- ------------
Net income (loss) applicable to $ (506,953) $50,109 $(30,214,556)
common stockholders
Net income (loss) per share basic $ (0.01) $ 0.00 $ (0.91)
and diluted
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option pricing model with the following
assumptions:
For the years ended May 31,
-------------------------------------------------
2000 1999 1998
-------------------------------------------------
Fair value of options granted $2.12 $1.73 $1.52
Assumptions:
Dividend yield $ 0 $ 0 $ 0
Volatility 90% 90% 120%
Average term 5 or 10 years 5 or 10 years 5 or 10 years
Risk-free rate of return 6.05% - 6.47% 5.75% - 5.81% 4.50%
The Company determines the fair value of stock based awards granted to
non-employees for services and expenses these awards over the time period
the services are rendered.
NOTE I - INCOME TAXES
Deferred income tax assets (liabilities) consist of the following at May
31:
2000 1999
------------- -------------
Deferred tax assets
Net operating loss carryforward $ 14,291,477 $ 17,065,146
Allowance for doubtful accounts 1,389,759 1,221,619
------------ ------------
Total deferred tax assets 15,681,206 18,286,765
Less valuation allowance (10,327,461) (12,270,988)
------------ ------------
5,353,745 6,015,777
Deferred tax liabilities
Gain on sales of portfolios (2,324,961) (4,029,368)
Unrealized gain on retained interest in
securitization (328,784) (1,286,409)
------------ ------------
Total deferred tax liabilities (2,653,745) (5,315,777)
------------ ------------
Net deferred tax asset $ 2,700,000 $ 700,000
The difference between the total income tax benefit and the income tax
expense computed using the applicable Federal income tax rate was as
follows for the years ended May 31:
2000 1999 1998
----------- ----------- ------------
Computed Federal income taxes at 34% $ 690,139 $ 642,352 $(10,011,311)
Increase (decrease) of deferred tax
asset valuation allowance (1,732,514) (2,628,761) 10,011,311
----------- ----------- ------------
Income tax benefit $(1,042,375) $(1,986,409) $ --
At May 31, 2000, the Company has a net operating loss carryforward
available to offset future taxable income of approximately $42,000,000,
which will begin to expire in 2012. The benefit of the net operating loss
carryforwards is dependent upon the tax laws in effect at the time the net
operating loss carryforwards are to be utilized and the change of control
rules.
F-19
The Company continually reviews the adequacy of the valuation allowance
and recognizes those benefits only as the Company's assessment indicates
that it is more likely than not that future tax benefits will be realized.
Based upon actual pretax income and projected future earnings, the Company
has reduced the valuation allowance by $2,000,000 and $700,000 for the
years ended May 31, 2000 and 1999, respectively. The Company maintains a
valuation allowance for the remaining amount of deferred tax assets
created by net operating losses and the allowance for doubtful accounts.
NOTE J - EMPLOYEE BENEFIT PLANS
In January 1998, the Company adopted a defined contribution 401(k)
profit-sharing plan for its employees. All employees working at least
1,000 hours per year are eligible to participate in the plan. Employees
can contribute up to 15% of their salary up to $10,000 and $9,500 for the
calendar years 1999 and 1998. The plan requires the employer to match 100%
of the first 3% of compensation contributed to the plan by the employees.
Employer contributions vest at a rate of 20% per year. Additional employer
contributions are allowable at the discretion of the Board of Directors.
The Company expensed $217,271, $173,479 and $84,573 in 2000, 1999 and 1998
relating to this plan.
NOTE K - MUTUAL BUSINESS DEVELOPMENT AGREEMENTS
The Company is obligated to pay royalties to previous owners under the
terms of Mutual Business Development Agreements ("Development
Agreements").
The royalty is equal to five percent of the balance transfer amount, as
defined, on all converted credit card accounts which: (i) are delivered to
a pre-securitization credit facility, (ii) become a qualifying receivable,
or (iii) meet other specified account age and payment parameters. A
qualifying receivable is defined as any converted account on which the
cardholder has made three consecutive payments within certain time
restrictions. In addition, the Development Agreements provide for
royalties equal to 5% of all principal cash collections on specified
accounts that are not converted to credit cards. The term of the
Development Agreements expires in 2002 and the total royalty, if earned,
payable to each of the previous owners, after certain deductions and
exclusions, will not exceed $25,000,000. For the years ended May 31, 2000,
1999, and 1998, $1,733,412, $1,541,944, and $207,238 of royalty expenses
were incurred with $740,487, $702,075, and $261,667 accrued at May 31,
2000, 1999, and 1998. One of the Development Agreements was amended on
September 1, 1998. The amendment clarifies the amount and timing of
payments, gives the Company a buyout option, alternate royalty payment
options, and extends the term of the agreement to May 31, 2005.
NOTE L - RELATED PARTY TRANSACTIONS
At May 31, 2000 and 1999, the Company owed amounts under subordinated
promissory notes to J.L.B. of Nevada, Inc., an entity wholly owned by Jay
L. Botchman ("Botchman"), a director, totaling $16,444,940 payable on
demand with interest at 12% per annum. Interest expense on these notes was
$2,006,283, $2,307,467, and $3,635,891 for the years ended May 31, 2000,
1999, and 1998. Accrued interest related to subordinated promissory notes
was approximately $1,500,000, $1,300,000, and $4,000,000 at May 31, 2000,
1999, and 1998. The notes are collateralized by substantially all the
Company's assets, but subordinated to the Company's revolving credit
lines.
On May 29, 1999, J.L.B. of Nevada, Inc., forgave $5,000,000 of interest on
the subordinated promissory notes, in exchange for warrants to purchase
4,000,000 shares of the Company's common stock with an exercise price of
$3.25 per share, expiring on June 30, 2004, and the Company's assumption
of equipment and related lease obligations from a company affiliated with
J.L.B. of Nevada, Inc. in the amount of approximately $1,700,000. The fair
value of the warrant was approximately $3,300,000.
F-20
On February 27, 1998, the Company issued a subordinated promissory note to
Botchman in the amount of $350,000 payable on demand with interest at 12%
per annum. The note was paid during fiscal 2000. Interest expense for the
years ended May 31, 2000, 1999 and 1998 was $18,200, $42,583, and $10,733.
The Company, through its wholly-owned subsidiary, American Credit
Alliance, Inc., has an $880,000 note payable to J.L.B. of Nevada, Inc.
with an interest rate of 10% per annum. American Credit Alliance Inc. is
the managing member and 50% owner of Dakota Card Fund II, LLC, an entity
that owns performing credit card receivables. Interest expense for the
years ended May 31, 2000, 1999, and 1998 was $89,467, $89,222 and $85,195.
Accrued interest related to this note payable was approximately $327,000,
$238,000 and $152,649 at May 31, 2000, 1999 and 1998.
The Company made a series of investments during the period May 1997
through December 1997 totaling $508,600 in a subprime mortgage banking
company affiliated with J.L.B. of Nevada, Inc. At May 31, 1998, the
investment was written off due to the substantial doubt regarding the
mortgage banking company's ability to continue as a going concern. In
addition, the Company had a receivable due from this company of
approximately $183,000, which was also written off as of May 31, 1998.
The Series A and B Preferred Shares were issued at $1.00 per share (total
of $2,000,000) on December 4, 1996 to a related party. The Series A
Preferred Stock, as a class, was granted 80% of the voting rights in the
Company but the percentage is subject to adjustment on certain issuances
of capital stock. The Series B Preferred Stock has one vote per share. The
shares of Series A and B Preferred Stock have a liquidation preference of
$1.00 per share and earn cumulative dividends at a rate of $.05 per share
per annum. At any time after December 31, 2001, the Series A and B
Preferred Stock will be redeemable at the option of the Company. The
Series B Preferred Stock is convertible at the option of the holder into
Series A Preferred Stock on a share-for-share basis.
On December 31, 1996, the Company issued 5,000 shares of Series C
Preferred Stock to a related party for $5,000,000. The shares of Series C
Preferred Stock are non-voting and earn cumulative dividends at 6% of
$1,000 per share per annum. The shares have a liquidation preference of
$1,000 per share. The Series A and B Preferred Stock rank senior to the
Series C with respect to dividend and liquidation rights.
On May 29, 1998, the Company issued 10,000 shares of Series D Preferred
Stock to a related party in exchange for cancellation of a $10,000,000
Promissory Note dated August 1, 1997. The shares of Series D Preferred
Stock are non-voting and earn a dividend of 8% of the stated value of
$1,000 per share per annum payable annually on December 31. The shares
have a liquidation preference of $1,000 per share. The Series D Preferred
Stock ranks senior to the Series A, B and C with respect to dividend and
liquidation rights. Each share of Series D Preferred Stock is convertible
into 380 shares of common stock at any time prior to August 31, 2001. The
holders of the Series D Preferred Stock have piggyback registration rights
with respect to the common stock issuable upon conversion of the shares of
Series D Preferred Stock.
On August 31, 1998, the Company issued 10,000 shares of Series E Preferred
Stock to a related party in exchange for agreeing to cancel a $10,000,000
subordinated promissory note. The shares of Series E Preferred Stock are
non-voting and earn a dividend of 8% of the stated value of $1,000 per
share per annum payable annually on December 31. The shares have a
liquidation preference of $1,000 per share. The Series E Preferred Stock
ranks senior to the Series A, B, C and D with respect to dividend and
liquidation rights. Each share of Series E Preferred Stock is convertible
into 285 shares of common stock at any time prior to August 31, 2001. The
holders of the Series E Preferred Stock have piggyback registration rights
with respect to the common stock issuable upon conversion of the shares of
Series E Preferred Stock.
As of May 31, 2000, 1999, and 1998, accumulated preferred dividends
undeclared and unpaid on preferred stock amounted to approximately
$4,200,000, $2,200,000, and $400,000, respectively.
F-21
NOTE M - COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company leases certain properties, vehicles and equipment under
noncancelable operating leases. Total lease rentals charged to operations
were approximately $858,000, $766,000 and $776,000, for the years ended
May 31, 2000, 1999 and 1998. Future minimum lease payments under the
noncancelable operating leases are as follows:
Year ending May 31, Amount
------------------- ----------
2001 $ 644,000
2002 370,000
2003 311,000
2004 290,000
2005 285,000
Thereafter 2,019,000
----------
$3,919,000
Contingencies and Litigation
The Company, in the ordinary course of business, receives notices of
consumer complaints from regulatory agencies and is named as a defendant
in legal actions filed by those who have been solicited to participate in
its credit card programs. Currently pending against the Company are: (i)
three class actions on behalf of persons purportedly solicited by the
Company to voluntarily repay debt that had been discharged in bankruptcy,
alleging that the Company had violated provisions of federal or state law,
including violations of the Bankruptcy Code, the Fair Debt Collection
Practices Act, the Truth in Lending Act, various state consumer protection
laws and, in one case, RICO, and (ii) three class actions alleging
violation of the Fair Debt Collection Practices Act and similar state laws
in connection with mailers sent to prospective customers to collect
out-of-statute debt. The Company is defending itself vigorously in these
lawsuits. The Company does not believe that pending litigation and
consumer complaints involving the Company will have a material adverse
effect on the consolidated financial position and consolidated 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 consolidated
results of operations or consolidated financial condition.
NOTE N - FAIR VALUE OF FINANCIAL INSTRUMENTS
The accompanying financial statements include various estimated fair value
information as of May 31, 2000, 1999 and 1998. As required by SFAS No.
107, "Disclosures About Fair Value of Financial Instruments," such
information, which pertains to the Company's financial instruments, is
based on the requirements set forth in the statement and does not purport
to represent the aggregate net fair value of the Company. None of the
Company's financial instruments are held for trading purposes.
The following methods and assumptions were used to estimate the fair value
of each class of financial instrument for which it is practicable to
estimate fair value.
Cash, Cash Equivalents and Restricted Cash
The carrying amount approximates fair value.
Accounts and Notes Receivables
The carrying amount approximates fair value.
F-22
Amounts Due from Special Purpose Entities
The carrying amount approximates fair value.
Investments in Nonperforming Consumer Debt
The Company records investments in nonperforming consumer debt at the cost
of the purchased portfolios, net of costs recovered. As the debt was
purchased at a significant discount, the fair value of these portfolios
may be significantly higher than presented in the financial statements.
The fair value at May 31, 2000 and 1999 was estimated using a net present
value calculation of the cash flows the Company expects to generate from
these portfolios.
Credit Card Receivables
Credit card receivables are originated with an initial interest rate of
19.9% or 18.9%. As discussed in Note C, the settlement amount of the
receivables exceeds the credit card receivables reflected on the
consolidated balance sheet. Fair values at May 31, 2000 and 1999 have been
estimated based on a net present value of the cash flows expected to be
generated by the credit cards. The Company applied its actual static pool
experience of repayment rates and defaults to estimate fair value.
Retained Interest in Securitized Credit Card Receivables
The carrying amount approximates fair value. Fair value is estimated by
discounting anticipated future cash flows using a discount rate based on
specific factors. The anticipated future cash flows are projected on a
"cash out" basis to reflect the restriction of cash flows until the
investors have been fully paid.
Notes Payable
The carrying amount approximates fair value. Rates currently available to
the Company for debt with similar terms and remaining maturities are used
to estimate the fair value of existing debt.
Subordinated Notes and Accrued Interest Payable
Due to the related party relationship of these notes, it is not practical
to estimate fair value.
Accounts Payable and Accrued Expenses
The carrying amount approximates fair value.
The carrying amounts and estimated fair values of the Company's financial
instruments consisted of the following:
May 31,
-----------------------------------------------------
2000 1999
------------------------- -------------------------
Carrying Estimated Carrying Estimated
Value fair value value fair value
----------- ----------- ----------- -----------
Cash, Cash Equivalents and
Restricted Cash $ 2,448,879 $ 2,448,879 $ 4,283,930 $ 4,283,930
Accounts and Notes Receivable $ 2,765,882 $ 2,765,882 $ 1,150,207 $ 1,150,207
Amounts Due from Special Purpose
Entities $ 9,332,890 $ 9,332,890 $ 1,230,700 $ 1,230,700
Investments in Nonperforming
Consumer Debt $ 9,648,090 $21,000,000 $ 3,016,697 $14,400,000
Credit Card Receivables $24,244,200 $42,900,000 $18,631,403 $27,500,000
Retained Interest in Securitized
Credit Card Receivables $ 2,142,846 $ 2,142,846 $ 5,130,372 $ 5,130,372
Notes Payable $23,609,326 $23,609,326 $ 6,086,766 $ 6,086,766
Accounts Payable and Accrued
Expenses $ 4,499,142 $ 4,499,142 $ 4,313,409 $ 4,313,409
F-23
Financial Accounting Standards Board Statement No. 107 excludes certain
financial instruments and all non-financial instruments from its
disclosure requirements. Accordingly, the aggregate estimated net fair
value amount does not represent, and should not be interpreted to
represent, the fair value of the Company.
NOTE O - NET INCOME (LOSS) PER SHARE
Years ended May 31,
------------------------------------------------
2000 1999 1998
------------- ------------- ---------------
Basic net income (loss) per share
Net income (loss) available to common
stockholders $ 1,072,195 $ 2,075,681 $ (29,845,027)
Weighted-average shares outstanding 34,761,965 34,761,965 33,109,781
Basic net income (loss) per share $ 0.03 $ 0.06 $ (0.90)
Diluted net income (loss) per share
Net income (loss) available to common
stockholders $ 1,072,195 $ 2,075,681 $ (29,845,027)
Weighted-average shares outstanding 34,761,965 34,761,965 33,109,781
Effect of diluted securities options 2,162,243 329,585 *
------------- ------------- --------------
Weighted-average of diluted shares
outstanding 36,924,208 35,091,550 33,109,781
Diluted net income (loss) per share $ 0.03 $ 0.06 $ (0.90)
*Antidilutive.
NOTE P - PREFERRED STOCK
As of May 31, 2000 and 1999, Preferred Stock consists of the following:
2000 1999
----------- -----------
Series A Preferred Stock, $.001 par value; 2,000,000 shares authorized;
1,200,000 shares issued and outstanding; stated at
liquidation value of $1 per share $ 1,200,000 $ 1,200,000
Series B Preferred Stock, $.001 par value; 800,000 shares authorized,
issued, and outstanding; stated at liquidation value of $1 per share 800,000 800,000
Series C Preferred Stock, 5,000 shares authorized, issued, and
outstanding; stated at liquidation value of $1,000 per share $ 5,000,000 $ 5,000,000
Series D Preferred Stock, $.001 par value; 10,000 shares authorized,
issued, and outstanding, convertible into 3,800,000 shares of common
stock; stated at liquidation value of $1,000 per share 10,000,000 10,000,000
Series E Preferred Stock, $.001 par value; 20,000 shares authorized
convertible into 5,700,000 shares of common stock; 10,000 shares
issued and outstanding; stated at liquidation value of $1,000 per share 10,000,000 10,000,000
----------- -----------
Total $27,000,000 $27,000,000
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.
F-24
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.
F-25
THE CREDIT STORE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Nine Months Ended
-----------------------------
February 28, February 29,
2001 2000
------------- -------------
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)
------------ ------------
Net revenue 27,533,109 26,808,149
------------ ------------
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
------------ ------------
Total expenses 27,070,089 23,524,974
------------ ------------
Operating income 463,020 3,283,175
Interest expense 4,261,618 3,306,152
------------ ------------
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 stockholders $ (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.
F-26
THE CREDIT STORE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine Months Ended
-----------------------------
February 28, February 29,
2001 2000
------------- -------------
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)
------------ ------------
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)
------------ ------------
Net cash used in
investing activities (428,573) (10,915,682)
------------ ------------
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 --
------------ ------------
Net cash provided by
financing activities 4,098,570 12,680,174
------------ ------------
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.
F-27
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. Through direct mail and
telemarketing operations, these consumers are offered an opportunity to
settle their debt, typically at a discount, transfer the agreed settlement
amount to a newly issued unsecured MasterCard(R) or Visa(R) credit card,
and establish a positive credit history on their newly issued card by
making timely and consistent payments. The Company accepts lump sum
settlements or installment payment plans from those consumers who do not
accept the credit card offer.
After the consumers have made eight or more consecutive monthly payments
on their outstanding credit card balance the Company considers the account
seasoned and available to sell or securitize. Because the focus of the
Company's business is to convert defaulted debt into seasoned credit
cards, the Company periodically sells or securitizes portfolios of these
seasoned accounts. The Company also periodically sells into the secondary
market for non-performing consumer debt portfolios of accounts it acquired
but was unable to convert.
The Company has four subsidiaries, Credit Store Services, Credit Store
Capital, American Credit Alliance and TCS Funding IV. All of these
subsidiaries are wholly owned by the Company; however, only Credit Store
Capital and American Credit Alliance are consolidated on the financial
statements. Credit Store Services and TCS Funding IV are qualifying
special purpose entities that are not required to be consolidated. Credit
Store Services and Credit Store Capital acquire non-performing consumer
receivables and contract with the Company to offer consumers a credit card
or to accept settlements or payment plans. American Credit Alliance owns a
50% interest in Dakota Card Fund II, a limited liability company that
contracts with the Company to service non-performing receivables and
credit card receivables that it owns. TCS Funding IV was created in
connection with securitizations for the purpose of purchasing performing
credit card receivables from us. See Note E.
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.
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
F-28
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.
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 non-performing receivable portfolios
based on the current market environment and the discounted projected
future cash flow of each portfolio compared to the portfolio's carrying
amount. Provisions for losses are charged to earnings when the Company has
determined that the investment in a non-performing receivable portfolio is
greater than the present value of expected future cash flows. No such
provision for losses was recorded in the 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, 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
F-29
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, 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 portfolios are sold to CSSI at a price 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 the purchase
price of the acquired portfolios. The 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 at the lender's discretion. The terms of the credit
facility also provide that a percentage of the future cash flow generated
by the purchased accounts be paid to the lender in addition to the payment
of principal and interest on 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.
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
consumer 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
F-30
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.
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 amortization of receivable portfolios discount $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.
F-31
Annex A
[The Credit Store and logo]
Subordinated Renewable Note Subscription Agreement
- --------------------------------------------------------------------------------
To purchase a Subordinated Renewable Note, please complete this form and write a
check made payable to The Credit Store, Inc. Send the white copy of this form
along with your check and any other documents requested below to
[________________________________________]. Keep the yellow copy of this form
for your records. If you have any questions, please call
[________________________________].
- --------------------------------------------------------------------------------
Note Selection
I would like to purchase the following note(s) from The Credit Store. Enclosed
is my check for $____________:
Investment Amount Interest Payment Option (please check one per note)
($1,000 minimum per note) Note Term Monthly Quarterly Semiannually Annually At Maturity
$ 3 Month
- ----------------------------------
$ 6 Month
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$ 1 Year
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$ 2 Year
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$ 3 Year
- ----------------------------------
$ 4 Year
- ----------------------------------
$ 5 Year
- ----------------------------------
$ 10 Year
- ----------------------------------
If you choose the monthly payment option, you can also select the day on which
you want your interest paid.
Please pay my monthly interest on the ____ day of each month.
- --------------------------------------------------------------------------------
Note Ownership (Please select one)
A. I am purchasing my note(s) as an individual investor. (Naming a beneficiary
is optional.)
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Individual Investor
- --------------------------------------------------------------------------------
First Name Middle Name Last Name Social Security Number Date of Birth
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Optional Beneficiary
- --------------------------------------------------------------------------------
First Name Middle Name Last Name Social Security Number Date of Birth
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
A-1
B. We are purchasing our note(s) as Joint Tenants with Right of Survivorship.
- --------------------------------------------------------------------------------
First Joint Tenant
- --------------------------------------------------------------------------------
First Name Middle Name Last Name Social Security Number Date of Birth
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Second Joint Tenant
- --------------------------------------------------------------------------------
First Name Middle Name Last Name Social Security Number Date of Birth
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
C. I am purchasing the note(s) as a custodian for a minor under the Uniform
Gifts to Minors Act.
- --------------------------------------------------------------------------------
Minor
- --------------------------------------------------------------------------------
First Name Middle Name Last Name Social Security Number Date of Birth
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Custodian
- --------------------------------------------------------------------------------
First Name Middle Name Last Name
- ---------------------------------------
- ---------------------------------------
- --------------------------------------------------------------------------------
D. I am purchasing the note(s) through another entity that I control, e.g. IRA,
SEP, 401(k), 403(b), Keogh, trust account, corporation, partnership, etc. (If
you are investing through a trust account, corporation or partnership, please
include the appropriate documents that authorize you to control this entity with
this form.)
- --------------------------------------------------------------------------------
Legal Entity
- --------------------------------------------------------------------------------
Name: Tax ID Number:
- --------------------------------------------------------------------------------
Attention:
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Address Information
Please send all official correspondence regarding the notes to the following
address:
Primary Mailing Address (investor, IRA administrator, trustee, custodian, etc.)
Address: ________________________________________
City: ___________________________________________
State:___________________________________________
Zip Code: _______________________________________
Daytime Phone: __________________________________
Evening Phone:___________________________________
A-2
Please send copies of this correspondence to the following address (OPTIONAL)
Additional Mailing Address (IRA owner, second joint tenant, partner, etc.)
Address: ________________________________________
City: ___________________________________________
State:___________________________________________
Zip Code: _______________________________________
Daytime Phone: __________________________________
Evening Phone:___________________________________
- --------------------------------------------------------------------------------
Password
When you call [______________] to discuss your note, you will be asked the
following question to help verify your identification. Please fill in the
correct answer.
What is your mother's maiden name? ________________________________
- --------------------------------------------------------------------------------
Interest and Principal Payments (Please select one)
______ Please deposit my principal and interest payments directly into the
following bank account:
______ The same checking account that I used to purchase my note(s).
______ A different account that is listed below:
- --------------------------------------------------------------------------------
Bank Name Address . ABA Routing Number Account Number
______ Please send a check for my principal and interest payments to me at the
address listed above for official correspondence.
A-3
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Certification
I hereby certify that: (i) I am a bona fide resident of the state listed in the
primary mailing address; (ii) I have received and read the prospectus provided
by The Credit Store and understand the risks associated with this investment;
(iii) my aggregate investment in Subordinated Renewable Notes issued by The
Credit Store represents less than 30% of my net worth; (iv) this investment is
strictly an obligation of The Credit Store and is not insured or guaranteed by
the FDIC or any other governmental agency; [(v)________________ is an agent of
the issuer and is not responsible for making any interest or principal
payments]; (vi) the social security number or tax identification number listed
above is correct; and (vii) I am not subject to backup withholding, either
because the Internal Revenue Service (IRS) has not notified me that I am subject
to backup withholding as a result of a failure to report all interest or
dividends or the IRS has notified me that I am no longer subject to backup
withholding. I understand that my offer to purchase the note(s) may be rejected
in whole or in part and that my purchase offer will not become effective until
accepted by The Credit Store or its agent.
- --------------------------------------------------------------------------------
___________________________________________________ Date:_____________________
Signature of owner, first joint tenant or custodian
___________________________________________________ Date:_____________________
Signature of second joint tenant, if applicable
- --------------------------------------------------------------------------------
Office Use Only
ISDT_____ (investment date)
INTR_____ (applicable interest rate)
CBON_____ (cash bonus amount)
COMM_____ (commission earned)
ABAR_____ (ABA routing number for the bank on which the note purchase funds
were drawn)
ACTN_____ (account number from which the note purchase funds were drawn)
CHKN_____ (check number used to purchase the note)
ADVR_____ (advertising code)
BNUS_____ (bonus offer code)
[_______]_____ ([_______________] database number)
FAML_____ (family code)
TRAN_____ (transition note number)
PNLT_____ (penalty)
SALU_____ (salutation for correspondence)
A-4
The information in this prospectus is not complete and may be changed without
notice. The selling stockholders may not sell these securities until the
registration statement filed with the Securities and Exchange Commission is
effective. This prospectus is not an offer to sell these securities, and the
selling stockholders are not soliciting offers to buy these securities in any
state where the offer or sale of these securities is not permitted.
Subject to Completion, Dated June 19, 2001
[COMPANY LOGO]
8,000,000 SHARES
COMMON STOCK
The Credit Store, Inc.
The selling stockholders identified in this prospectus are selling up to
8,000,000 shares of common stock.
We issued the shares to the selling stockholders in a private transaction.
The selling stockholders, Renaissance Trust I and Blum Family Trust, or
pledgees, donees, transferees or other successors-in-interest selling shares
received from the selling stockholders as a gift, distribution or other non-sale
related transfer after the date of this prospectus (collectively, the selling
stockholders) may sell the shares from time to time. The selling stockholders
will act independently of us in making decisions regarding the timing, manner
and size of each sale. The sales may be made on the American Stock Exchange or
in the over-the-counter market or otherwise, at prices and at terms then
prevailing or at prices related to the then current market price, or in
negotiated transactions. The selling stockholders may effect these transactions
by selling the shares to or through broker-dealers. See "Plan of Distribution."
This prospectus also covers any additional shares of common stock which
may be issued in connection with the shares registered for sale by reason of any
stock dividend or stock split.
We will not receive any proceeds from the sale of the shares by the
selling stockholders.
We have agreed to pay substantially all the expenses incidental to the
registration, offering and sale of the shares to the public other than
commissions, fees and discounts of underwriters, brokers, dealers and agents.
The common stock is quoted on the American Stock Exchange under the symbol
"CDS". The last reported sale price of the common stock on the American Stock
Exchange on , 2001, was $ per share.
You should consider carefully the risk factors and the other information
in this prospectus before you decide to purchase our common stock. See "Risk
Factors" beginning on page 10.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed on the
adequacy or accuracy of this prospectus. Any representation to the contrary is a
criminal offense.
The date of this prospectus is __________, 2001
S-
You should rely only on the information contained in this prospectus. We
have not authorized any other person to provide you with different information.
This prospectus is not an offer to sell, nor is it seeking an offer to buy,
these securities in any state where the offer or sale is not permitted. The
information in this prospectus is complete and accurate as of the date on the
front cover, but the information may have changed since that date.
----------
TABLE OF CONTENTS
Page
----
Summary.......................................................................1
Risk Factors.................................................................10
Cautionary Note Regarding Forward - Looking Statements.......................17
Use of Proceeds..............................................................17
Description of Subordinated Renewable Notes Offered in the Concurrent
Offering...................................................................18
Capitalization...............................................................32
Selected Consolidated Financial and Other Data...............................33
Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................................37
Business.....................................................................51
Management...................................................................63
Security Ownership of Principal Stockholders and Management..................70
Certain Relationships and Related Transactions...............................72
Market Price of and Dividends on Our Common Stock
and Related Stockholder Matters............................................74
Description of Capital Stock.................................................75
Plan of Distribution.........................................................80
Legal Matters................................................................81
Experts......................................................................81
Where You Can Find More Information..........................................81
Index to Consolidated Financial Statements...................................F-1
S-
Summary of the Offering
Common stock offered by the
selling stockholders...... 8,000,000 shares
Common stock outstanding
after this offering....... 34,851,465 shares (1)
Use of Proceeds............. We will not receive any proceeds from the sale of
the shares by the selling stockholders.
Symbol on the American
Stock Exchange............ CDS
Concurrent Offering......... Concurrently with this offering, and by a separate
prospectus, we are offering up to $100,000,000
principal amount of subordinated renewable notes.
This offering is not dependent on the completion
of the concurrent offering.
- ----------
(1) Excludes: 6,650,000 shares of common stock which may be issued on
conversion of our preferred stock, 6,581,000 shares of common stock which
may be issued on the exercise of outstanding stock options, and 5,675,247
shares of common stock which may be issued on the exercise of outstanding
warrants. See "Description of Capital Stock".
Risk Factors
You should carefully consider all the information in this prospectus. In
particular, you should evaluate the specific risk factors set forth under "Risk
Factors," beginning on page 10, for a discussion of the risks involved in making
an investment in our common stock.
S-3
Intentionally Left Blank
S-4, S-5, S-6, S-7
RISK FACTORS
Risk Factors related to Us
If we are unable to achieve positive cash flow from operations or maintain
profitability, the price of our common stock may decline. 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. We expect
to continue to generate negative cash flow from operations for the foreseeable
future while we expand our operations and develop our customer base. For the
last two completed fiscal years our negative cash flow from operations has been
offset by gains on sales of portfolios of receivable and securitizations. We
expect our available credit facilities, together with the amount we expect to
receive from securitizations and credit card portfolio sales, will be adequate
to meet our working capital needs through February 2002. 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 issuances of debt or equity securities to fund our cash flow
requirements.
Because we are leveraged our ability to successfully operate our business
may be limited. As of May 31, 2001, we had approximately $43.1 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:
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.
If we cannot obtain additional capital when needed to finance our
operations and grow our business, we may need to limit our operations and
restrict our growth which could hurt our profitability. 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.
If additional financing is unavailable and additional receivable sales and
securitizations are not completed, our ability to operate and grow our business
will be limited. If we fail to grow our business we may have difficulty
maintaining profitability. We cannot assure you we will be successful in
obtaining additional financing when needed.
S-10
Because we have pledged all of our assets, we may have difficulty in
securing future financings. Our principal lender 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. Our controlling
stockholder 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 released their liens on assets we wanted to sell or
securitize, we cannot assure you they will be willing to do so in the future. As
a result, we may find it more difficult to secure additional financing in the
future.
If we are not successful in converting the defaulted debt we acquire to
credit card accounts, we may not be able to generate sufficient cash flow to
fund our operations. We are primarily in the business of providing credit card
products to consumers who have previously defaulted on a debt. Before our
acquisition of the receivables, the originating institutions and intermediary
owners, if any, have generally made numerous attempts to collect on the
non-performing accounts. Before buying receivables we project the amount we
expect to collect on those receivables. If:
o we collect less on the receivables than expected;
o we convert fewer of the non-performing accounts than expected into
credit card accounts; or
o the new credit card accounts have a higher default rate than we
anticipated
we may not be able to generate sufficient cash to cover the costs associated
with purchasing receivables and operating our business.
Lack of maturity of our credit card portfolio may result in increased
delinquencies and defaults reducing our profit and adversely affecting the price
of our common stock. A portfolio of older accounts generally behaves more
predictably than a portfolio of newly originated accounts. As a result, the
average age of a credit card issuer's portfolio is generally used as an
indicator of the stability of the delinquency and default levels of that
portfolio. As of May 31, 2001, the majority of the credit card accounts owned by
us were less than three years old. As a result there can be no assurance as to
the levels of delinquencies and defaults, which may result in charge-offs which
would affect our earnings over time. Any material increase in delinquencies and
defaults above management's expectations would decrease our cash inflows and
could adversely affect the price of our common stock.
Our failure to manage growth could result in increased costs and decreased
profits and adversely affect the price of our common stock. We may be unable to
manage our growth effectively and maintain our historical level of cash flows
from the portfolios we purchase. This would increase the cost of expansion and
impair our ability to fully implement our expansion plans. The development and
expansion of our business will depend on, among other things, our ability to:
o maintain our relationships with third-party credit card issuers;
o acquire non-performing debt on favorable terms;
o convert acquired non-performing debt to credit cards accounts and
collect on these new credit card accounts;
o obtain adequate financing on favorable terms; and
o profitably securitize or sell our receivables on a regular basis.
Our inability to achieve any or all of these factors could result in
reduced income and adversely affect the price of our common stock.
Because we have accumulated but not paid cash dividends on our preferred
stock, if we were required to pay these dividends it would decrease our
liquidity and could adversely affect the
S-11
growth of our business. As of February 28, 2001, we had accumulated
approximately $5.6 million in undeclared and unpaid dividends on our preferred
stock. Although our board of directors has not declared, and therefore we have
not paid, the accumulated dividends to date, we may be called on to pay the
accumulated dividends in the future. To the extent the preferred stock remains
outstanding, additional cash dividends will accumulate. If we are required to
pay the dividends, the payments would limit the amount of cash available to use
for operations which could adversely affect the growth of our business.
Since we are dependent on the continued contributions of our key
personnel, the loss of the services of one or more of our key employees could
disrupt our operations causing our income to decrease. We have entered into
employment agreements with Kevin T. Riordan, our President and Chief Operating
Officer, and Michael J. Philippe, our Executive Vice President and Chief
Financial Officer. Although our written agreement with Richard Angel, our
Executive Vice President and General Counsel, has expired, we have an oral
employment agreement with Mr. Angel with no fixed term. The loss of the services
of any of these individuals or the services of other officers or key employees
could cause us to incur costs for recruiting replacements, result in the loss of
the valuable expertise and business relationships, and affect our business and
prospects.
Labor shortages and high employee turnover rates could increase costs
significantly and adversely impact revenue. The credit card industry is labor
intensive and generally experiences a high rate of turnover in personnel. Growth
in our business will also require us to continue to recruit and train
significant numbers of additional qualified personnel. A high turnover rate
among our employees would increase our recruiting and training costs and could
adversely impact the overall recovery of our receivables. In addition, Sioux
Falls, South Dakota experiences a low incidence of unemployment. There can be no
assurance we will be able to hire, train and retain a sufficient number of
qualified employees. If we were unable to recruit and retain a sufficient number
of employees, we would be forced to limit our growth or possibly curtail our
operations. If we were required to take these actions it would likely reduce our
ability to operate profitably.
Because we cannot issue our own credit cards, the failure of our
third-party credit card issuers to continue to provide credit cards to our
accounts could severely disrupt our business. We are not licensed to nor do we
currently have the ability to independently issue credit cards. As a result, we
are dependent on the two banks we use to issue credit cards to our customers.
These banks operate under extensive governmental regulation. If additional
regulations or restrictions were imposed on issuing credit cards, the new
regulations or restrictions could increase our costs or limit our operations. In
addition, if our existing credit card issuers discontinue offering credit cards
to our accounts and we cannot find a new credit card issuer willing to issue
cards to consumers with impaired credit history, we would be unable to operate
our business as it is currently conducted. We cannot assure you we could find an
alternate provider willing to issue credit cards to our accounts on terms we
consider favorable in a timely manner without disruption of our business.
Because we do not have backup arrangements for all of our operations, we
may incur significant losses if an outage occurs. Through the issuing bank's
arrangement with First Data Resources, we use First Data Resources for
third-party processing of credit card data and services. We provide credit card
data to First Data Resources on a daily basis and this data is backed up and
stored by First Data Resources. While we are currently evaluating a back-up
servicer for our portfolio of credit cards, to date we have not arranged for a
back-up. In addition, we do not have a back-up telemarketer for our marketing
programs. If a disaster or other event closed our main facility or shut down our
primary and redundant data connections to First Data Resources our business
would be interrupted until we could repair our data lines and/or facilities or
relocate to temporary facilities. Any interruption in our operations could have
a material adverse impact on our business and revenues.
S-12
If we cannot protect our proprietary information, we may lose a
competitive advantage and suffer decreased receivables. We are dependent, in
part, on proprietary data, analytical computer programs and methods and related
know-how for our day-to-day operations. We rely on a combination of
confidentiality agreements, contract provisions and trade secret laws to protect
our proprietary rights. Although we intend to protect our rights vigorously,
there can be no assurance we will be successful in protecting our proprietary
rights. If we are not able to protect our proprietary rights, or if the
proprietary information and methods become widely available, we may lose a
competitive advantage within our market niche. The loss of this competitive
advantage could result in decreased revenues.
If we fail to successfully anticipate, invest in or adopt technological
advances within our industry, we may lose market share which could adversely
affect our ability to operate profitably. Our success is dependent in large part
on our continued investment in sophisticated telecommunications and computer
systems, including predictive dialers, automated call distribution systems and
digital switching equipment. We have invested significantly in technology in an
effort to remain competitive and anticipate it will be necessary to continue to
do so. Moreover, computer and telecommunications technologies are evolving
rapidly and are characterized by short product life cycles, which require us to
anticipate and stay current with technological developments. There can be no
assurance we will be successful in anticipating, managing or adopting
technological changes on a timely basis or that we will have the capital
resources available to invest in new technologies. Our failure to anticipate or
adopt technological changes may affect our ability to maintain our customers and
operate profitably.
We are developing new products and services which may not be successful.
While we may, from time to time, develop additional products and services, there
can be no assurance the development of these products and services will be
completed or that any new products or services will be successfully marketed and
implemented. Consumer preferences for credit card and credit related products
are difficult to predict, especially where consumers have experienced past
credit difficulties. Failure to obtain significant customer satisfaction or
market share for our products and services would impact our ability to attract
new customers and adversely affect our growth potential.
Pending and future litigation may interrupt our business operations and
adversely affect our liquidity or profitability and the price of our common
stock. From time to time we have been named as a defendant in class action
lawsuits. Two class action lawsuits are pending against us. If we were required
to pay a significant judgment in one or more of the lawsuits, or in a future
lawsuit, it would affect our liquidity. In addition, a loss might also require
us to change how we conduct our business if our operations were found to not
comply with applicable legal standards. Any required changes might affect our
ability to operate the business profitably and the price of our common stock.
See "Business - Legal Proceedings."
Because we use estimates in our accounting, differences between actual and
expected performance may cause fluctuations in our reported revenue and reported
income. Income from credit card receivables and securitization income and asset
sales have constituted, and are likely to continue to constitute, a significant
portion of our revenue. Portions of this revenue are reported based on the cash
flow we expect to receive from the credit cards we originate or own and from the
credit cards that have been securitized and in which we hold a retained
interest. The expected cash flows are based on our estimates of interest rates,
default rates, new account origination rates, repayment rates, and new charges
made by cardholders. These estimates are based on a variety of factors, many of
which are not within our control. Differences between actual and expected
performance of the receivables may cause us to adjust our estimates and result
in fluctuations in our reported revenue and reported income.
Risk Factors related to the Non-Performing Debt and Sub-Prime Credit Card
Industries
S-13
Because the market for our credit card receivables is limited, we may be
unable to sell or securitize our portfolios to generate the cash required to
operate our business. Our future is highly dependent on our ability to sell or
securitize the portfolios of credit cards we generate from the non-performing
debt we acquire. Although we have sold several portfolios and completed several
securitizations, no assurance can be given we will be able to sell or securitize
future portfolios. Our ability to complete securitizations or asset sales
depends on several factors including interest rates, general market conditions
and the quality of our portfolios. If we are unable to sell or securitize our
credit card receivables it will be difficult for us to raise enough capital to
operate our business and repay our outstanding debt.
We may not be able to acquire enough receivables on favorable terms to
operate profitably. To obtain additional credit card customers, we depend on the
continued availability of non-performing portfolios that meet our requirements.
The availability of portfolios of receivables for future purchase at prices
favorable to us depends on a number of factors outside of our control. These
factors include:
o continuation of the current growth trend in credit card and consumer
installment debt;
o the ability of consumers to obtain credit, especially unsecured
credit cards;
o the overall default rates on consumer debt;
o the ability of traditional credit card lenders to rehabilitate their
own non-performing credit card receivables;
o overly aggressive pricing by competitors bidding on available
non-performing receivables; and
o the entry of new competitors.
If we cannot purchase a sufficient amount of non-performing receivables at
favorable prices it will reduce our profitability.
Fluctuations in economic conditions could increase payment delinquencies
and defaults and reduce our cash flow from operations. During strong economic
cycles, available credit, including consumer credit, generally increases and
payment delinquencies and defaults generally decrease. During periods of
economic slowdown and recession, delinquencies and defaults generally increase.
No assurances can be given that our credit card losses and delinquencies would
not worsen in a weak economic cycle. Significant increases in credit card losses
would reduce our operating cash flow.
Adverse publicity or increased regulation may impair acceptance of our
products and our ability to operate profitably. Critics of the credit card
industry have in the past focused on marketing practices they claim encourage
consumers to borrow more money than they should and on pricing practices they
claim are either confusing or result in prices that are too high. Increased
criticism of the industry or us could hurt client acceptance of our products or
lead to adverse changes in the law or regulatory environment. In addition,
increased regulation of financial institutions that buy credit card receivables
or invest in securitizations could affect the pricing or the size of the market
for credit card sales or securitizations. These changes could adversely affect
our ability to operate profitably.
Failure to comply with consumer and debtor protection laws and regulations
could adversely affect our business. Our collection practices, business
operations and credit card receivables are subject to numerous federal and state
consumer protection laws and regulations imposing licensing and other
requirements with respect to purchasing, collecting, making and enforcing
consumer loans. Our failure to comply with these statutes or regulations could
cause adverse publicity which could make it more difficult to collect our
receivables reducing the funds available to finance our operations. See
"Business -- Government Regulation."
S-14
Risk Factors Relating to the Offering
Because our stock price has been and may continue to be volatile, it is
more difficult for you to evaluate our company or our prospects. The trading
price of our common stock has been and is likely to be highly volatile. Our
stock price could fluctuate widely in response to a variety of factors,
including:
o actual or anticipated variations in quarterly operating results;
o new products or services offered by us or our competitors;
o changes in interest rates;
o changes in economic conditions;
o changes in financial estimates by securities analysts;
o additions or departures of key personnel;
o sales of common stock; and
o other events or factors that may be beyond our control.
In addition, the American Stock Exchange has recently experienced extreme
price and volume fluctuations. These fluctuations often have been unrelated or
disproportionate to the operating performance of the affected companies. Broad
market and industry factors may materially adversely affect the market price of
our common stock, regardless of our actual operating performance.
Fluctuations in our quarterly operating results may cause the market price
of our common stock to fluctuate. The timing of portfolio acquisitions and
credit card receivable sales and securitizations affects the timing of recorded
income and results in periodic fluctuations in our quarterly operating results.
The timing of any sale or securitization transaction is affected by a number of
factors beyond our control including market conditions and the presence of
investors and lenders interested in our credit card accounts. We may also
experience seasonal fluctuations in operating results due to other factors
beyond our control including the rate at which customers pay down their credit
card balances, make new purchases and take cash advances. For example during the
year-end holiday season customers make new credit card purchases at a faster
rate than they pay their debts. For these and other reasons our operating
results may fall below expectations of securities analysts or investors which
may cause the market price of our common stock to fluctuate.
Because we do not intend to pay dividends, your ability to make a profit
from an investment in our common stock will depend solely on an increase in its
market price. We have never paid any dividends on our common stock. We intend to
retain our earnings, if any, to finance the development and expansion of our
business. Payment of any future dividends on our common stock will depend on our
earnings and capital requirements and other factors our board of directors
considers appropriate. In addition, our ability to declare and pay cash
dividends on our common stock is restricted by covenants in our outstanding debt
instruments and our outstanding preferred stock. As of February 28, 2001, we had
accumulated approximately $5.6 million in undeclared and unpaid dividends on our
preferred stock, all of which must be paid before we can pay any dividends on
our common stock. To the extent the preferred stock remains outstanding,
additional cash dividends will accumulate. Because we do not intend to pay
dividends, your ability to make a profit from an investment in our stock will
depend solely on an increase in its market price.
Jay L. Botchman controls a majority of our voting power and his interests
may conflict with your interests. Jay L. Botchman is the beneficial owner of
40.3% of our outstanding shares of common stock. In addition, Mr. Botchman,
individually and through his control of Taxter One and J.L.B. of Nevada,
beneficially owns all of our Series A, C, D and E Preferred Stock. The Series A
Preferred Stock contains preferential voting rights. As a result, Mr. Botchman
controls approximately 74% of all votes
S-15
entitled to be voted at any meeting of our stockholders and is able to control
our management and affairs and the outcome of all matters submitted to our
stockholders for approval, including the election and removal of directors, any
merger, consolidation or sale of all or substantially all of our assets and any
charter amendments.
Our stock price will likely decline if our existing stockholders sell a
significant number of shares on the public market. Our stock price will likely
decline if the supply of our stock being sold in the open market exceeds the
demand for our stock. Substantially all of our common stock, other than shares
held by our "affiliates" as defined by the Securities Act, is currently eligible
for sale in the open market without restriction or registration under the
Securities Act. In addition, any shares of common stock which may be issued on
exercise of stock options registered under our stock option plan will be freely
tradable. See "Description of Capital Stock - Shares Eligible for Future Sale."
The holders of some of our warrants and convertible securities have demand
and/or piggyback registration rights which, if exercised, could result in the
registration of the shares of common stock.
The sale or potential sale of substantial amounts of our common stock in
the open market could cause the price of our common stock to fall.
The restrictions, additional costs, and burdens imposed by penny stock
regulations may decrease the liquidity our common stock. The Securities
Enforcement and Penny Stock Reform Act of 1990 requires additional disclosure
relating to penny stocks. Generally a penny stock is any equity security that
has a market price of less than $5.00 a share. We currently must comply with
regulations which require the delivery of a disclosure schedule explaining the
penny stock market and the associated risks. In addition, broker/dealers who
recommend our common stock to persons other than established customers and
accredited investors must make a determination of the suitability of the
purchaser and receive the purchaser's written agreement to the investment before
a sale. Because the restrictions may limit the pool of purchasers for our common
stock, you may have difficulty selling your shares.
The greater voting power of our Series A Preferred Stock, our unissued,
undesignated preferred stock, some provisions of the Delaware Law and our
certificate of incorporation and bylaws could discourage a takeover of us and
adversely affect the price of our common stock. As of the date of this
prospectus, we had 965,000 shares, of unissued, undesignated preferred stock. If
we issue preferred stock in the future, the preferred stock will have the
rights, terms and preferences specified by our board of directors. The issuance
of preferred stock by the board of directors in the future could adversely
affect the rights of holders of common stock. The issuance of preferred stock
could also make it more difficult for a third party to acquire a majority of our
outstanding voting stock. While we have no present plan to issue any additional
series of preferred stock, no assurances can be given that we will not do so in
the future. We are also subject to provisions of Delaware law which could have
the effect of delaying, deterring or preventing a change of control of our
company. In addition, our certificate of incorporation and bylaws contain
provisions that, together with Jay L. Botchman's voting power and ownership of
Series A Preferred Stock, could discourage potential takeover attempts and make
attempts by stockholders to change management more difficult. See "Description
of Capital Stock - Anti-takeover Provisions," "--Stockholder Action and Special
Meetings."
S-16
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains "forward-looking statements" which you can
generally identify by our use of forward-looking words including "believe,"
"expect," "may," "will," "could," "should," "seek," "look for," "project,"
"anticipate," or "plan" or the negative or other variations of these terms or
similar expressions or by discussions of strategies that involve risk or
uncertainty. Forward-looking statements are inherently uncertain as they are
based on current expectations and assumptions concerning future events and are
subject to numerous known and unknown risks and uncertainties. We caution you
not to place undue reliance on these forward-looking statements, which are only
predictions and speak only as of the date of this prospectus. Actual results
could differ materially from those currently anticipated due to a number of
factors, including those identified in the "Risk Factors" above or discussed
elsewhere in this prospectus. Except as required by law, we undertake no
obligation to update or publicly announce revisions to any forward-looking
statements to reflect future events or developments.
USE OF PROCEEDS
We will not receive any proceeds from this offering.
S-17
DESCRIPTION OF SUBORDINATED RENEWABLE NOTES OFFERED
IN THE CONCURRENT OFFERING
General. In the concurrent offering we are offering up to $100 million of
subordinated renewable notes. The subordinated renewable notes will represent
unsecured debt obligations. The subordinated renewable notes will be issued
under an indenture between U.S. Bank Trust National Association, as trustee, and
us. The terms of the subordinated renewable notes include those stated in the
indenture and those made part of the indenture by reference to the Trust
Indenture Act of 1939, as amended.
The following discussion is a summary of the important terms of the
indenture. It does not restate the indenture in its entirety. We urge you to
read the indenture because it, and not this description, defines your rights as
a holder of the subordinated renewable notes. We will provide a copy of the
indenture on request.
Maturity. We are offering subordinated renewable notes with terms ranging
from three to 120 months. You will select the term of each subordinated
renewable note at the time of your subscription.
If the subordinated renewable note is not automatically renewed as
discussed below under the caption "Automatic Renewal," we will pay principal,
together with accrued and unpaid interest through the maturity date:
o within 5 days of the maturity date, if we receive notice on or
before the maturity date of your intent not to renew the
subordinated renewable note, or if we notify you that we will not
renew the subordinated renewable note;
o within 5 days of the date we receive notice of your intent not to
renew the subordinated renewable note, if the notice is received
within 15 days after the maturity date.
Automatic Renewal. Each subordinated renewable note will be automatically
renewed for a term identical to its original term unless:
o we notify you at least seven days before the maturity date that a
renewal will not be provided; or
o you notify us in writing, before the 15th day following the maturity
date, of your intention not to renew.
The subordinated renewable notes will continue to renew in this manner
until redemption. Interest will continue to accrue from the first day of each
renewed term. The terms of the renewal note will be the same as the terms of the
original subordinated renewable note except:
o the interest rate payable during the renewal term will be the
interest rate which is then being offered to holders with similar
portfolios of similar subordinated renewable notes or, if none are
then offered, the rate specified by us in the renewal notice
described below;
o if the subordinated renewable note pays interest only at maturity,
unless you request to receive the accrued interest, the principal
amount of the renewal note will be increased by the accrued
interest; and
o the renewal note will be bound by any amendment to the indenture
adopted before the renewal date, with the consent of the holders of
at least a majority of the principal amount of the subordinated
renewable notes, whether or not the holder consented to the
amendment.
S-18
SELLING STOCKHOLDERS
The following table lists the number of shares of common stock held of
record by each selling stock holder as of the date of this prospectus and the
number of shares of common stock offered for sale under this prospectus. As of
the date of this prospectus, each selling stockholder also holds 400,000 shares
of Series B Preferred Stock. The shares of Series B Preferred Stock are not
being registered for resale under this prospectus. See "Security Ownership of
Principal Stockholders and Management" and "Description of Capital Stock -
Series B Preferred."
Unless otherwise disclosed in the footnotes to the table, no selling
stockholder has held any position, office or had any other material relationship
with us during the past three years.
Selling Stockholder Shares of Common Stock Maximum Number of Shares Shares of Common Stock Owned
Owned before the Offering of Common Stock Offered after the Offering.
Renaissance Trust I (1) 4,000,000 4,000,000 ------(3)
Blum Family Trust (2) 4,000,000 4,000,000 ------(3)
(1) Renaissance Trust I acquired the shares of common stock in October
2000 when it exercised an option to purchase shares of our common stock granted
by Taxter One. Renaissance Trust I is also a party to a business development
agreement which is currently in dispute. See "Certain Relationships and Related
Transactions."
(2) Blum Family Trust acquired the shares of common stock in October 2000
when it exercised an option to purchase shares of our common stock granted by
Taxter One. Blum Family Trust purchased the option from O. Pappolimberis Trust
in December 1996. See "Certain Relationships and Related Transactions."
(3) Because the selling stockholders may sell all or some of the shares
they hold and because there currently are no agreements, arrangements or
understandings with respect to the sale of any of the shares, we cannot estimate
the number of shares of common stock to be held by each selling stockholder
after completion of the offering. See "Plan of Distribution."
S-71A
Shares Eligible for Future Sale
We have outstanding an aggregate of 34,851,465 shares of common stock.
Substantially all of our common stock and the 5,537,000 shares of common stock
which may be issued on the exercise of options issued under our stock option
plan, are freely tradable without restriction or further registration under the
Securities Act unless those shares are held by our "affiliates" as defined by
the Securities Act.
The 6,650,000 shares of common stock which may be issued on conversion of
our preferred stock, the 5,675,247 shares which may be issued on the exercise of
outstanding warrants, and the 1,550,000 shares of common stock which may be
issued on the exercise of options not issued under our stock option plan are
"restricted securities" under the Securities Act because they were issued and
sold by us in private transactions in reliance on exemptions from registration
under the Securities Act. Restricted Securities may not be sold except in
compliance with the registration requirements of the Securities Act or under an
exemption from registration, such as the exemption provided by Rule 144 of the
Securities Act. After sale under Rule 144 under the Securities Act, these shares
will be freely tradable without restriction or registration under the Securities
Act. Substantially all of our restricted securities currently qualify for sale
under Rule 144.
S-79A
PLAN OF DISTRIBUTION
We are registering eight million shares of our common stock on behalf of
the selling stockholders. The selling stockholders, Renaissance Trust I and Blum
Family Trust, or pledgees, donees, transferees or other successors-in-interest
selling shares received from the selling stockholder as a gift, distribution or
other non-sale related transfer after the date of this prospectus (collectively,
the "selling stockholders") may sell the shares from time to time. The selling
stockholders will act independently of us in making decisions regarding the
timing, manner and size of each sale.
The sales may be made on the American Stock Exchange or in the
over-the-counter market or otherwise, at prices and at terms then prevailing or
at prices related to the then current market price, or in negotiated
transactions. The selling stockholders may effect these transactions by selling
the shares to or through broker-dealers. The shares may be sold by one or more
of, or a combination of, the following methods:
o a block trade in which the broker-dealer will attempt to sell the
shares as agent, but may position and resell a portion of the block
as principal to facilitate the transaction;
o purchases by a broker-dealer as principal and resale by the
broker-dealer for its account under this prospectus;
o an exchange distribution under the rules of the American Stock
Exchange or any other exchange on which they may make a
distribution;
o ordinary brokerage transactions and transactions in which the broker
solicits purchasers; and
o in privately negotiated transactions.
The selling stockholders may enter into hedging transactions with
broker-dealers in connection with distributions of the shares or otherwise. In
these transactions, broker-dealers may engage in short sales of the shares in
the course of hedging the positions they assume with the selling stockholders.
The selling stockholders also may sell shares short and redeliver the shares to
close out the short positions. The selling stockholders may enter into option or
other transactions with broker-dealers which require the delivery to the
broker-dealer of the shares. The broker-dealer may then resell or otherwise
transfer the shares covered by this prospectus. The selling stockholders also
may loan or pledge the shares to a broker-dealer. The broker-dealer may sell the
loaned shares or, on a default, the pledged shares under this prospectus. Any
securities covered by this prospectus which qualify for sale in compliance with
Rule 144 promulgated under the Securities Act may be sold under Rule 144 rather
than under this prospectus.
Broker-dealers or agents may receive compensation in the form of
commissions, discounts or concessions from the selling stockholders.
Broker-dealers or agents may also receive compensation from the purchasers of
the shares for whom they act as agents or to whom they sell as principals.
Compensation as to a particular broker-dealer might be in excess of customary
commissions and will be in amounts to be negotiated in connection with the sale.
Broker-dealers, agents, any other participating broker-dealers or the selling
stockholders may be deemed to be "underwriters" within the meaning of the
Securities Act in connection with sales of the shares. Accordingly, any
commission, discount or concession received by them and any profit on the resale
of the shares purchased by them may be deemed to be underwriting discounts or
commissions under the Securities Act. Because the selling stockholders may be
deemed to be "underwriters" within the meaning of the Securities Act, the
selling stockholders will be subject to the prospectus delivery requirements of
the Securities Act.
S-80
We will make copies of this prospectus available to the selling
stockholders. We have informed the selling stockholders of the need to deliver
copies of this prospectus to purchasers at or before the time of any sale of the
shares.
The selling stockholders have advised us that as of the date of this
prospectus they had not entered into any agreements, understandings or
arrangements with any underwriters or broker-dealers regarding the sale of their
securities and there is no underwriter or coordinating broker acting in
connection with the proposed sale of shares by the selling stockholders. To the
extent required, this prospectus may be amended or supplemented from time to
time to describe a specific plan of distribution. In effecting sales,
broker-dealers engaged by the selling stockholders may arrange for other
broker-dealers to participate in the resales.
Under applicable rules and regulations under the Exchange Act, any person
engaged in the distribution of the shares may not simultaneously engage in
market making activities with respect to our common stock for a specified period
of time before distribution begins. In addition, each selling stockholder will
be subject to applicable provisions of the Exchange Act and the associated rules
and regulations under the Exchange Act, including Regulation M, which provisions
may limit the timing of purchases and sales of shares of our common stock by the
selling stockholders.
The selling stockholders may sell all or part of the shares offered by
this prospectus. We will not receive any proceeds from the sale of the shares
offered by the selling stockholders.
Under the terms of the registration rights agreement which defines our
obligations relating to the registration of the shares of common stock covered
by this prospectus, we are required to pay substantially all the expenses
incidental to the registration, offering and sale of the shares to the public
other than commissions, fees and discounts of underwriters, brokers, dealers and
agents. The selling stockholders will pay all commissions, fees and discounts,
if any, attributable to the sales of the shares.
The selling stockholders may agree to indemnify any broker-dealer or agent
that participates in transactions involving sales of the shares against various
liabilities, including liabilities arising under the Securities Act.
S-80A
LEGAL MATTERS
Certain legal matters regarding the validity of the common stock offered
by this prospectus will be passed on for us by Kronish Lieb Weiner & Hellman
LLP, New York, New York. Peter J. Mansbach, who is currently of counsel to
Kronish Lieb Weiner & Hellman LLP, serves on our board of directors. Kronish
Lieb Weiner & Hellman LLP will receive a portion of the compensation received by
Mr. Mansbach.
EXPERTS
Our consolidated financial statements as of May 31, 2000, 1999, and 1998
and for the years then ended, included in this prospectus, have been audited by
Grant Thornton LLP, independent certified public accountants, as indicated in
their report thereon, and are included herein in reliance on the authority of
such firm as experts in giving said report.
WHERE YOU CAN FIND MORE INFORMATION
We have filed a registration statement on Form S-1 with the Securities and
Exchange Commission covering the securities we offered by this prospectus. This
prospectus does not include all of the information contained in the registration
statement. You should refer to the registration statement and its exhibits for
additional information. We also file annual, quarterly and special reports,
proxy statements and other information with the Securities and Exchange
Commission.
You can read our Securities and Exchange Commission filings, including the
registration statement, over the Internet at the Securities and Exchange
Commission's web site at http://www.sec.gov. You may also read and copy any
document we file with the Securities and Exchange Commission at its public
reference facilities at 450 Fifth Street, NW, Washington, DC 20549, 7 World
Trade Center, Suite 1300, New York, New York 10048 and Citicorp Center, 500 West
Madison Street, Suite 1400, Chicago, Illinois 60661-2511. You may also obtain
copies of the documents at prescribed rates by writing to the Public Reference
Section of the Securities and Exchange Commission at 450 Fifth Street, NW,
Washington, DC 20549. Please call the Securities and Exchange Commission at
1-800-SEC-0330 for further information on the operation of the public reference
facilities. Our Securities and Exchange Commission filings are also available at
the offices of the American Stock Exchange at 86 Trinity Place, New York, New
York 10006.
S-81
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution
Expenses in connection with the issuance and distribution of the
securities being registered hereunder are estimated below.
SEC registration fee ........................................ $ 28,300
Legal fees and expenses ..................................... 75,000
Accounting fees and expenses ................................ 50,000
Printing expenses ........................................... 20,000
Miscellaneous expenses ...................................... 10,000
--------
Total ................................................. $183,300
========
Item 14. Indemnification of Directors and Officers
Limitation on Director's Liability
In accordance with the DGCL, the Company's Certificate of Incorporation
provides that the directors shall not be personally liable to the Company or its
stockholders for monetary damages for breach of duty as a director except (i)
for any breach of the director's duty of loyalty to the Company and its
stockholders; (ii) for acts or omissions not in good faith or which involve
intentional misconduct, or knowing violation of law; (iii) under Section 174 of
the DGCL, which relates to unlawful payments of dividends and unlawful stock
repurchases and redemptions; or (iv) for any transaction from which the director
derived an improper personal benefit. This provision does not eliminate a
director's fiduciary duties; it merely eliminates the possibility of damage
awards against a director personally which may be occasioned by certain
unintentional breaches (including situations that may involve grossly negligent
business decisions) of those duties. The provision has no effect on the
availability of equitable remedies, such as injunctive relief or rescission,
which might be necessitated by a director's breach of his or her fiduciary
duties. However, equitable remedies may not be available as a practical matter
where transactions (such as merger transactions) have already been consummated.
The inclusion of this provision in the Certificate of Incorporation may have the
effect of reducing the likelihood of derivative litigation against directors and
may discourage or deter stockholders or management from bringing a lawsuit
against directors for breach of their duty of care, even though such an action,
if successful, might otherwise have benefited the Company and its stockholders.
Indemnification
The Certificate of Incorporation provides that the Company shall indemnify
its officers, directors, employees and agents to the fullest extent permitted by
the DGCL. Section 145 of the DGCL provides that the Company may indemnify any
person who was or is a party, or is threatened to be made a party, to any
threatened, pending or completed action, suit or proceeding, whether civil,
criminal, administrative or investigative (other than a "derivative" action by
or in the right of the Company) by reason of the fact that such person is or was
a director, officer, employee or agent of the Company, against expenses
(including attorneys' fees), judgments, fines and amounts paid in settlement in
connection with such action, suit or proceeding if such person acted in good
faith and in a manner such person reasonably believed to be in or not opposed to
the best interests of the Company, and, with respect to any criminal action or
proceeding, had no reasonable cause to believe was unlawful. A similar standard
of care is applicable to derivative actions, except that no indemnification
shall be made where the person is adjudged to be liable to the Company, unless
and only to the extent that the Court of Chancery of the State of Delaware or
the court
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in which such action was brought determines that such person is fairly and
reasonably entitled to such indemnity and such expenses.
Item 15. Recent Sales of Unregistered Securities
The Company issued the following securities during the past three years
without registering the securities under the Securities Act:
Issuance of Capital Stock:
1. On May 29, 1998, the Company issued 10,000 shares of Series D
Preferred Stock to J.L.B. of Nevada, Inc. in exchange for J.L.B. of
Nevada, Inc. agreeing to cancel $10.0 million of the principal
outstanding under the $10.0 million Subordinated Promissory Note
dated August 1, 1997. Each share of Series D Preferred Stock may be
exchanged for 380 shares of Common Stock.
2. On August 31, 1998, the Company issued 10,000 shares of Series E
Preferred Stock to J.L.B. of Nevada, Inc. in exchange for J.L.B. of
Nevada, Inc. agreeing to cancel $10.0 million of the principal
outstanding under the $20.0 million Subordinated Promissory Note
dated August 1, 1997. Each share of Series E Preferred Stock may be
exchanged for 285 shares of Common Stock.
Grant of Stock Options and Warrants:
1. On April 30, 1998, the Company issued to Coast Business Credit, a
division of Southern Pacific Bank, a warrant to purchase 650,247
shares of the Common Stock at an exercise price of $2.50. The
warrant was issued in connection with a loan from Coast Business
Credit to the Company.
2. On August 3, 1998, the Company granted options to purchase 10,000
shares of Common Stock under the Amended 1997 Stock Option Plan at
an exercise price of $3.00 per share to employees.
3. On August 10, 1998, the Company granted options to purchase 300,000
shares of Common Stock under the Amended 1997 Stock Option Plan at
an exercise price of $2.70 per share to employees.
4. On September 15, 1998, the Company granted options to purchase
10,000 shares of Common Stock under the Amended 1997 Stock Option
Plan at an exercise price of $2.00 per share to employees.
5. On November 23, 1998, the Company granted options to purchase a
total of 150,000 shares of Common Stock under the Amended 1997 Stock
Option Plan at an exercise price of $2.00 per share to two directors
of the Company.
6. On February 15, 1999, the Company granted options to purchase 13,000
shares of Common Stock under the Amended 1997 Stock Option Plan at
an exercise price of $2.38 per share to employees.
7. On March 17, 1999, the Company granted options to purchase 200,500
shares of Common Stock under the Amended 1997 Stock Option Plan at
an exercise price of $2.00 per share to employees.
8. On March 18, 1999, the Company issued a warrant to purchase
1,000,000 shares of Common Stock to Business Transactions Express,
Inc. at an exercise price of $2.00 per share. The warrant was issued
in connection with the execution of a strategic modeling services
agreement between the Company and Business Transactions Express,
Inc.
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9. On March 22, 1999, the Company granted options to purchase 3,500
shares of Common Stock under the Amended 1997 Stock Option Plan at
an exercise price of $2.30 per share to employees.
10. On March 29, 1999, the Company granted options to purchase 3,500
shares of Common Stock under the Amended 1997 Stock Option Plan at
an exercise price of $2.30 per share to employees.
11. On April 15, 1999, the Company granted options to purchase 75,000
shares of Common Stock under the Amended 1997 Stock Option Plan at
an exercise price of $2.19 per share to a director of the Company.
12. On May 29, 1999, the Company issued a warrant to purchase 4,000,000
shares of Common Stock to J.L.B. of Nevada, Inc. at an exercise
price of $3.25 per share. This warrant was issued as partial
consideration for J.L.B. of Nevada, Inc.'s forgiveness of certain
interest owed to J.L.B. of Nevada, Inc. by the Company.
13. On June 1, 1999, the Company granted options to purchase 503,000
shares of Common Stock under the Amended 1997 Stock Option Plan at
an exercise price of $2.40 per share to employees.
14. On July 26, 1999, the Company granted options to purchase 10,000
shares of Common Stock under the Amended 1997 Stock Option Plan at
an exercise price of $2.88 per share to employees.
15. On August 1, 1999, the Company granted options to purchase 22,000
shares of Common Stock under the Amended 1997 Stock Option Plan at
an exercise price of $3.00 per share to employees.
16. On August 3, 1999, the Company granted options to purchase 10,000
shares of Common Stock under the Amended 1997 Stock Option Plan at
an exercise price of $2.97 per share to employees.
17. On August 27, 1999, the Company granted options to purchase 10,000
shares of Common Stock under the Amended 1997 Stock Option Plan at
an exercise price of $2.69 per share to a consultant.
18. On September 1, 1999, the Company granted options to purchase 1,500
shares of Common Stock under the Amended 1997 Stock Option Plan at
an exercise price of $2.75 per share to employees.
19. On September 10, 1999, the Company issued a warrant to purchase
25,000 shares of Common Stock to Cappello Capital Corp. at an
exercise price of $2.56 per share. The warrant was issued in
connection with Cappello Capital Corp. providing financial advisory
services to the Company.
20. On September 16, 1999, the Company granted options to purchase 8,000
shares of Common Stock under the Amended 1997 Stock Option Plan at
an exercise price of $2.75 per share to employees.
21. On October 18, 1999, the Company granted options to purchase 2,000
shares of Common Stock under the Amended 1997 Stock Option Plan at
an exercise price of $2.75 per share to employees.
22. On October 25, 1999, the Company granted options to purchase 5,000
shares of Common Stock under the Amended 1997 Stock Option Plan at
an exercise price of $3.13 per share to employees.
23. On November 8, 1999, the Company granted options to purchase 10,000
shares of Common Stock under the Amended 1997 Stock Option Plan at
an exercise price of $3.88 per share to employees.
24. On November 19, 1999, the Company granted options to purchase
310,000 shares of Common Stock under the Amended 1997 Stock Option
Plan at an exercise price of $3.44 per share to employees and a
consultant.
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25. On November 29, 1999, the Company granted options to purchase 15,000
shares of Common Stock under the Amended 1997 Stock Option Plan at
an exercise price of $5.00 per share to employees.
26. On December 1, 1999, the Company granted options to purchase 2,000
shares of Common Stock under the Amended 1997 Stock Option Plan at
an exercise price of $4.69 per share to employees.
27. On January 10, 2000, the Company granted options to purchase 3,500
shares of Common Stock under the Amended 1997 Stock Option Plan at
an exercise price of $4.03 per share to employees.
28. On March 1, 2000, the Company granted options to purchase 2,000
shares of Common Stock under the Amended 1997 Stock Option Plan at
an exercise price of $4.00 per share to employees.
29. On March 20, 2000, the Company granted options to purchase 5,500
shares of Common Stock under the Amended 1997 Stock Option Plan at
an exercise price of $4.00 per share to employees.
30. On April 3, 2000, the Company granted options to purchase 2,000
shares of Common Stock under the Amended 1997 Stock Option Plan at
an exercise price of $4.00 per share to employees.
31. On April 17, 2000, the Company granted options to purchase 7,500
shares of Common Stock under the Amended 1997 Stock Option Plan at
an exercise price of $4.00 per share to employees.
32. On April 24, 2000, the Company granted options to purchase 3,500
shares of Common Stock under the Amended 1997 Stock Option Plan at
an exercise price of $3.88 per share to employees.
33. On May 1, 2000, the Company granted options to purchase 2,000 shares
of Common Stock under the Amended 1997 Stock Option Plan at an
exercise price of $4.88 per share to employees.
34. On May 15, 2000, the Company granted options to purchase 10,000
shares of Common Stock under the Amended 1997 Stock Option Plan at
an exercise price of $4.50 per share to employees.
35. On June 1, 2000, the Company granted options to purchase 2,000
shares of Common Stock under the Amended 1997 Stock Option Plan at
an exercise price of $4.50 per share to employees.
36. On June 26, 2000, the Company granted options to purchase 2,000
shares of Common Stock under the Amended 1997 Stock Option Plan at
an exercise price of $4.38 per share to employees.
37. On July 10, 2000, the Company granted options to purchase 2,000
shares of Common Stock under the Amended 1997 Stock Option Plan at
an exercise price of $4.31 per share to employees.
38. On July 17, 2000, the Company granted options to purchase 2,000
shares of Common Stock under the Amended 1997 Stock Option Plan at
an exercise price of $4.31 per share to employees.
39. On July 19, 2000, the Company granted options to purchase 1,016,900
shares of Common Stock under the Amended 1997 Stock Option Plan at
an exercise price of $4.31 per share to certain employees and at an
exercise price of $6.47 to certain officers and employees of the
Company.
40. On July 24, 2000, the Company granted options to purchase 2,000
shares of Common Stock under the Amended 1997 Stock Option Plan at
an exercise price of $4.28 per share to employees.
The sales and issuances described in paragraphs 1 and 2 under "Issuances
of Capital Stock" and in paragraphs 1, 8, 12 and 19 under "Grant of Stock
Options and Warrants" above were exempt from registration under the Securities
Act by virtue of Rule 4(2) and Regulation D promulgated thereunder. The
remaining issuances were exempt from registration under the Securities Act by
virtue of Rule 701.
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The sales and issuances under Rule 4(2) and Regulation D were conducted in a
manner to avoid a public offering, were made to a limited number of financially
sophisticated persons or entities with a high net worth and were not made
pursuant to any general advertising or general solicitation. The sales and
issuances under Rule 701 were offered and sold either pursuant to a written
compensatory benefit plan or pursuant to a written contract relating to
compensation.
Appropriate legends are affixed to the stock certificates issued in the
aforementioned transactions. Similar legends were imposed in connection with any
subsequent sales of any of these securities. All recipients either received
adequate information about the Company or had access, through employment or
other relationships, to such information.
Item 16. Exhibits and Financial Statement Schedules
(a) Index to Financial Statements
The Financial Statements required by this item are submitted in a separate
section beginning on page F-1 of this registration statement
PAGE
Report of Independent Certified Public Accountants F-2
Consolidated Balance Sheets (audited) as of May 31, 1999 F-3
and 2000
Consolidated Statements of Operations (audited) for the F-4
years ended May 31, 1998, 1999 and 2000
Consolidated Statements of Stockholders' Equity (audited) F-5
for the years ended May 31, 1998, 1999 and 2000
Consolidated Statements of Cash Flows (audited) for the F-7
years ended May 31, 1998, 1999 and 2000
Notes to Consolidated Financial Statements (audited) F-9
Condensed Consolidated Balance Sheets as of February 28, F-25
2001 (unaudited) and May 31, 2000
Condensed Consolidated Statement of Operations (unaudited) F-26
for the nine months ended February 28, 2001 and February
29, 2000
Condensed Consolidated Statements of Cash Flows (unaudited) F-27
for the nine months ended February 28, 2001 and February
29, 2000
Notes to Condensed Consolidated Financial Statements F-28
(unaudited)
-5-
(b) Index to Exhibits
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------ -----------------------
3.1(1) Amended and Restated Certificate of Incorporation
3.2(4) Amended and Restated By-Laws
4.1(1) Specimen certificate representing shares of Common Stock
4.2* Form of Indenture
4.3* Form of Renewable Note
4.4 Agreement, dated May 4, 2001, between the Company and
J.L.B. of Nevada, Inc.
4.5 Agreement, dated May 4, 2001, between the Company and
J.L.B. of Nevada, Inc.
5* Opinion and Consent of Legal Counsel to the Company
10.1(1) Amended and Restated Lease Agreement dated December 12,
1996 between Service One International Corporation and
Donald A. Dunham, Jr.
10.2(1) Amendment No. One to the Amended and Restated Lease
Agreement dated June 11, 1997 between Service One
International Corporation and Donald A. Dunham, Jr.
10.3(1) Amendment No. Two to the Amended and Restated Lease
Agreement dated July 31, 1997 between Service One
International Corporation and Donald A. Dunham, Jr.
10.4(1) Lease Agreement dated February 28, 1997 between Service
One International Corporation and Eagle Properties,
L.L.C.
10.5(1) Addendum to Lease Agreement dated November 18, 1997
between Service One International Corporation and Eagle
Properties, L.L.C.
10.6(1) Mutual Business Development Agreement dated as of
October 8, 1996, between Service One International
Corporation and the O. Pappalimberis Trust
10.7(1) Amendment dated as of December 16, 1997 to the Mutual
Business Development Agreement dated as of October 8,
1996, such amendment among O. Pappalimberis Trust,
Taxter One LLC, Service One International Corporation,
Eikos Management, LLC and Thesseus International Asset
Fund
10.8(1) Amendment dated September 1, 1998 to the Mutual Business
Development Agreement dated as of October 8, 1996, as
amended, between the Company and Eikos Management LLC
10.9(1) Mutual Business Development Agreement dated as of
October 8, 1996, between Service One International
Corporation and Renaissance Trust I
-6-
10.10(1) Strategic Modeling Agreement dated March 18, 1999,
between the Company and Business Transactions Express,
Inc.
10.11(1) Warrant to purchase Common Stock of the Company issued
to J.L.B. of Nevada, Inc. on June 22, 1999
10.12(1) Loan and Security Agreement, dated as of April 30, 1998,
between the Company and Coast Business Credit, a
division of Southern Pacific Bank
10.13(1) First Amendment to Loan and Security Agreement, dated as
of September 30, 1998, between the Company and Coast
Business Credit, a division of Southern Pacific Bank
10.14(1) Second Amendment to Loan and Security Agreement, dated
as of December 1, 1998, between the Company and Coast
Business Credit, a division of Southern Pacific Bank
10.15(1) Amendment Number Two to Loan and Security Agreement,
dated as of April 27, 1999, between the Company and
Coast Business Credit, a division of Southern Pacific
Bank
10.16(1) Fourth Amendment to Loan and Security Agreement, dated
as of May 27, 1999, between the Company and Coast
Business Credit, a division of Southern Pacific Bank
10.17(1) Amendment Number Five to Loan and Security Agreement,
dated as of June 25, 1999, between the Company and Coast
Business Credit, a division of Southern Pacific Bank
10.18.1(1) Amendment Number Six to Loan and Security Agreement
Dated as of December 6, 1999 between the Company and
Coast Business Credit, a division of Southern Pacific
Bank
10.18.2 Seventh Amendment to Loan and Security Agreement, dated
as of May 31, 2000, between the Company and Coast
Business Credit, a division of Southern Pacific Bank
10.18.3 Eighth Amendment to Loan and Security Agreement, dated
as of October 31, 2000, between the Company and Coast
Business Credit, a division of Southern Pacific Bank
10.18.4(4) Amendment Number Nine to Loan and Security Agreement,
dated as of April 16, 2001, between the Company and
Coast Business Credit, a division of Southern Pacific
Bank
10.18.5 Tenth Amendment to Loan and Security Agreement, dated
as of May 1, 2001, between the Company and Coast
Business Credit, a division of Southern Pacific Bank
10.19(1) Security Agreement dated as of August 1, 1997, between
J.L.B. of Nevada, Inc., Credit Store Mortgage, Inc., New
Beginnings Corp., Consumer Debt Acquisitions, Inc.,
Sleepy Hollow Associates, Inc., Service One Holdings
Inc., Service One International Corporation, American
Credit Alliance, Inc., Service One Receivables
Acquisition Corporation, the Company, Service One
Commercial Corporation and Soiland Company
-7-
10.20(1) First Amendment to Security Agreement, dated as of
October 23, 1997 between J.L.B. of Nevada, Inc., the
Company and Credit Store Mortgage, Inc., New Beginnings
Corp., Consumer Debt Acquisitions, Inc., Sleepy Hollow
Associates, Inc., Service One Holdings, Inc., Service
One International Corporation, Service One Receivables
Acquisition Corporation, the Company, Service One
Commercial Corporation and Soiland Company
10.21(1) Second Amendment to Security Agreement, dated as of
November 21, 1997 between J.L.B. of Nevada, Inc., the
Company, Sleepy Hollow Associates, Inc., Service One
International Corporation, American Credit Alliance,
Inc. and Service One Receivables Acquisition Corporation
10.22(1) Credit Agreement Dated as of October 15, 1999 among
Credit Store Capital Corp., the Company, The Lenders
Signatory thereto from time to time, and General
Electric Capital Corporation
10.23(2) Amended 1997 Stock Option Plan of the Company
10.24(1) Employment Agreement dated March 27, 1997, between the
Company and Martin Burke
10.25(1) Letter from Martin Burke dated March 27, 1997, regarding
credit card repayment terms
10.26(1) Employment Agreement dated April 1, 1997, between the
Company and Kevin Riordan
10.27(1) Employment Agreement dated June 17, 1997, between the
Company and Michael Philippe
10.28(1) Amendment to Employment Agreement between the Company
and Michael Philippe dated December 15, 1999
10.29(1) Employment Agreement dated August 1, 1997, between the
Company and Richard Angel
10.30(1) Amendment to Employment Agreement between the Company
and Richard Angel dated December 15, 1999
10.31(1) Employment Agreement dated October 15, 1997, between the
Company and Cynthia Hassoun
10.32(1) Bankcard Marketing Agreement between the Company and
Bank of Hoven dated February 9, 1999
10.33(1) Purchase Agreement between Bank of Hoven and the Company
dated February 9, 1999
10.34(1) Bankcard Marketing Agreement between Service One
International Corporation and First National Bank in
Brookings dated October 2, 1997
10.35(1) Purchase Agreement between First National Bank in
Brookings and Service One International Corporation
doing business as TCS Services, Inc. dated October 2,
1997
10.36(1) Amendment to Purchase Agreement by First National Bank
in Brookings and the Company dated August 31, 1998
-8-
10.37(1) Letter Agreement Regarding Bankcard Marketing Agreement
and Purchasing Agreement between the Company and First
National Bank in Brookings dated August 17, 1999
10.38(1) Agreement Regarding Transfer of Accounts between the
Company and First National Bank in Brookings dated
December 14, 1998
10.39(1) Subordinated Grid Promissory Note of the Company in
favor of J.L.B. of Nevada, Inc. dated August 1, 1997 in
the amount of $20,000,000
10.40(1) Subordinated Grid Promissory Note of the Company in
favor of J.L.B. of Nevada, Inc. dated October 23, 1997
in the amount of $5,000,000
10.41(1) Subordinated Grid Promissory Note of the Company in
favor of J.L.B. of Nevada, Inc. dated November 21, 1997
in the amount of $5,000,000
10.42(4) Receivables Purchase Agreement, dated as of May 31,
2000, by and between The Credit Store, Inc. and TCS
Funding IV, Inc.
10.43.1(4) Master Credit and Security Agreement, dated as of May
31, 2000, by and among TCS Funding IV, Inc., The Credit
Store, Inc., and Miller & Schroeder Investments
Corporation.
10.43.2 Credit and Security Agreement, dated as of May 1, 2001,
by and among TCS Funding V, Inc., The Credit Store,
Inc., and Miller & Schroeder Investments Corporation.
10.43.3 Receivables Purchase Agreement dated May 1, 2001, by and
between The Credit Store, Inc. and TCS Funding V, Inc.
10.44(4) Account Purchase Agreement, dated as of October 31,
2000, by and among The Credit Store, Inc. and Credit
Services, Inc.
10.45(4) Converted Accounts/Receivables Sale Agreement, dated as
of October 31, 2000, by and among Credit Store Services,
Inc. and The Credit Store, Inc.
10.46(4) Master Loan and Servicing Agreement, dated October 31,
2000, by and among Credit Store Services, Inc., The
Credit Store, Inc., and The Varde Fund IV-A.**
10.47(4) Repurchase Agreement, dated November 22, 2000, by and
between Bank of Hoven and The Credit Store, Inc.
10.47.1 Amendment dated February 27, 2001 to the Repurchase
Agreement dated November 22, 2000, by and between Bank
of Hoven and The Credit Store, Inc.
10.47.2 Amendment dated May 31, 2001 to the Repurchase Agreement
dated November 22, 2000, by and between Bank of Hoven
and The Credit Store, Inc.
10.48(5) Separation Agreement and Release by and between The
Credit Store, Inc. and Martin Burke dated December 11,
2000.
10.49(5) Secured Promissory Note of American Credit Alliance,
Inc. in favor of J.L.B. of Nevada, Inc. dated August 16,
1996 in the amount of $880,000.
10.50 Amendment to Subordinated Grid Promissory Notes, dated
May 4, 2001, 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.
-9-
12 Computation of Ratios of Earnings to Fixed Charges
21 List of Subsidiaries
23.1 Consent of Grant Thornton LLP
23.2* Consent of Legal Counsel to the Company (contained in
Exhibit 5)
24(5) Powers of Attorney
25* Form T-1, Statement of Eligibility and Qualification of
U.S. Bank Trust National Association, as Trustee
- ----------
(1) 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.
(2) Filed with the Securities and Exchange Commission as an exhibit to the
issuer's registration statement on Form S-8 filed July 26, 2000 (File No.
333-42278) and incorporated herein by reference.
(3) Filed with the Securities and Exchange Commission as an exhibit to the
issuer's annual report on Form 10-K for the period ended May 31, 2000 (File No.
001-16083) and incorporated herein by reference.
(4) Filed with the Securities and Exchange Commission as an exhibit to the
issuer's quarterly report on Form 10-Q for the period ended November 30, 2000
(File No. 001-16083) and incorporated herein by reference.
(5) Filed with the Securities and Exchange Commission as an exhibit to the
issuer's registration statement on Form S-1 filed March 2, 2001 (File No.
333-56456) and incorporated herein by reference.
** 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.
* To be filed by amendment.
Item 17. Undertakings
(a) The undersigned Registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being
made, a post-effective amendment to this Registration Statement:
(i) to include any prospectus required by Section 10(a)(3) of
the Securities Act of 1933;
(ii) to reflect in the prospectus any facts or events arising
after the effective date of the Registration Statement (or the most
recent post-effective amendment thereof) which, individually or in
the aggregate, represent a fundamental change in the information set
forth in the Registration Statement. Notwithstanding the foregoing,
any increase or decrease in volume of securities offered (if the
total dollar value of securities offered would not exceed that which
was registered) and any deviation from the low or high end of the
estimated maximum offering range may be reflected in the form of
prospectus filed with the Commission pursuant to Rule 424(b) if, in
the aggregate, the changes in volume and price represent no more
than a 20% change in the maximum aggregate offering price set forth
in the "Calculation of Registration Fee" table in the effective
Registration Statement;
(iii) to include any material information with respect to the
plan of distribution not previously disclosed in the Registration
Statement or any material change to such information in the
Registration Statement;
-10-
provided, however, that paragraphs (a)(1)(i) and (a)(1)(ii) do not apply
if the Registration Statement is on Form S-3, Form S-8 or Form F-3, and
the information required to be included in a post-effective amendment by
those paragraphs is contained in periodic reports filed with or furnished
to the Securities and Exchange Commission by the Registrant pursuant to
Section 13 or Section 15(d) of the Securities Exchange Act of 1934 that
are incorporated by reference in the Registration Statement.
(2) That, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be deemed
to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed
to be the initial bona fide offering thereof.
(3) To remove from registration by means of a post-effective
amendment any of the securities being registered which remain unsold at
the termination of the offering.
(4) For purposes of determining any liability under the Securities
Act, the information omitted from the form of prospectus filed as part of
this registration statement in reliance upon Rule 430A and contained in a
form of prospectus filed by the Registrant under Rule 424(b)(1) or (4) or
497(h) under the Securities Act shall be deemed to be part of this
registration statement as of the time it was declared effective.
(5) For the purpose of determining any liability under the
Securities Act, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating to
the securities offered therein, and the offering of such securities at
that time shall be deemed to be the initial bona fide offering thereof.
(6) To file an application for the purpose of determining the
eligibility of the trustee to act under subsection (a) of Section 310 of
the Trust Indenture Act in accordance with the rules and regulations
prescribed by the Securities and Exchange Commission under Section
305(b)(2) of the Act.
(b) Insofar as indemnification for liabilities arising under the
Securities Act may be permitted to directors, officers, and controlling persons
of the Registrant pursuant to the provisions summarized in Item 14 above or
otherwise, the Registrant has been advised that, in the opinion of the
Commission, such indemnification is against public policy as expressed in the
Securities Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
Registrant of expenses incurred or paid by a director, officer or controlling
person of the Registrant in the successful defense of any action, suit, or
proceeding) is asserted by such director, officer, or controlling person in
connection with the securities being registered, the Registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Securities
Act, and will be governed by the final adjudication of such issue.
-11-
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Amendment No. 1 to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Sioux Falls, State of
South Dakota, on June 18, 2001.
THE CREDIT STORE INC.
By s/ Kevin T. Riordan
-------------------------------------
Kevin T. Riordan
President
Pursuant to the requirements of the Securities Act of 1933, this Amendment
No. 1 has been signed by the following persons in the capacities indicated on
June 18, 2001.
Signature Capacity
s/ Kevin T. Riordan President and Diretor
- ------------------------------ (Principal Executive Officer)
Kevin T. Riordan
s/ Michael J. Philippe Executive Vice President,
- ------------------------------ Chief Financial Officer and Treasurer
Michael J. Philippe. (Principal Financial and Accounting Officer)
* Director
- ------------------------------
Barry E. Breeman
* Director
- ------------------------------
J. Richard Budd, III
Director
- ------------------------------
Peter J. Mansbach
* Interim Chairman of the Board of Directors
- ------------------------------
Geoffrey A. Thompson
Director
- ------------------------------
Salvatore J. Zizza
*Michael J. Philippe, by signing his name hereto, does hereby sign this document
on behalf of each of the above-named officers and/or directors of the Company
pursuant to powers of attorney duly executed by such persons.
By: s/ Michael J. Philippe
----------------------------------------
Michael J. Philippe, Attorney-in-Fact
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------ -----------------------
3.1(1) Amended and Restated Certificate of Incorporation
3.2(4) Amended and Restated By-Laws
4.1(1) Specimen certificate representing shares of Common Stock
4.2* Form of Indenture
4.3* Form of Renewable Note
4.4 Agreement, dated May 4, 2001, between the Company and
J.L.B. of Nevada, Inc.
4.5 Agreement, dated May 4, 2001, between the Company and
J.L.B. of Nevada, Inc.
5* Opinion and Consent of Legal Counsel to the Company
10.1(1) Amended and Restated Lease Agreement dated December 12,
1996 between Service One International Corporation and
Donald A. Dunham, Jr.
10.2(1) Amendment No. One to the Amended and Restated Lease
Agreement dated June 11, 1997 between Service One
International Corporation and Donald A. Dunham, Jr.
10.3(1) Amendment No. Two to the Amended and Restated Lease
Agreement dated July 31, 1997 between Service One
International Corporation and Donald A. Dunham, Jr.
10.4(1) Lease Agreement dated February 28, 1997 between Service
One International Corporation and Eagle Properties,
L.L.C.
10.5(1) Addendum to Lease Agreement dated November 18, 1997
between Service One International Corporation and Eagle
Properties, L.L.C.
10.6(1) Mutual Business Development Agreement dated as of
October 8, 1996, between Service One International
Corporation and the O. Pappalimberis Trust
10.7(1) Amendment dated as of December 16, 1997 to the Mutual
Business Development Agreement dated as of October 8,
1996, such amendment among O. Pappalimberis Trust,
Taxter One LLC, Service One International Corporation,
Eikos Management, LLC and Thesseus International Asset
Fund
10.8(1) Amendment dated September 1, 1998 to the Mutual Business
Development Agreement dated as of October 8, 1996, as
amended, between the Company and Eikos Management LLC
10.9(1) Mutual Business Development Agreement dated as of
October 8, 1996, between Service One International
Corporation and Renaissance Trust I
10.10(1) Strategic Modeling Agreement dated March 18, 1999,
between the Company and Business Transactions Express,
Inc.
10.11(1) Warrant to purchase Common Stock of the Company issued
to J.L.B. of Nevada, Inc. on June 22, 1999
10.12(1) Loan and Security Agreement, dated as of April 30, 1998,
between the Company and Coast Business Credit, a
division of Southern Pacific Bank
10.13(1) First Amendment to Loan and Security Agreement, dated as
of September 30, 1998, between the Company and Coast
Business Credit, a division of Southern Pacific Bank
10.14(1) Second Amendment to Loan and Security Agreement, dated
as of December 1, 1998, between the Company and Coast
Business Credit, a division of Southern Pacific Bank
10.15(1) Amendment Number Two to Loan and Security Agreement,
dated as of April 27, 1999, between the Company and
Coast Business Credit, a division of Southern Pacific
Bank
10.16(1) Fourth Amendment to Loan and Security Agreement, dated
as of May 27, 1999, between the Company and Coast
Business Credit, a division of Southern Pacific Bank
10.17(1) Amendment Number Five to Loan and Security Agreement,
dated as of June 25, 1999, between the Company and Coast
Business Credit, a division of Southern Pacific Bank
10.18.1(1) Amendment Number Six to Loan and Security Agreement
Dated as of December 6, 1999 between the Company and
Coast Business Credit, a division of Southern Pacific
Bank
10.18.2 Seventh Amendment to Loan and Security Agreement, dated
as of May 31, 2000, between the Company and Coast
Business Credit, a division of Southern Pacific Bank
10.18.3 Eighth Amendment to Loan and Security Agreement, dated
as of October 31, 2000, between the Company and Coast
Business Credit, a division of Southern Pacific Bank
10.18.4(4) Amendment Number Nine to Loan and Security Agreement,
dated as of April 16, 2001, between the Company and
Coast Business Credit, a division of Southern Pacific
Bank
10.18.5 Tenth Amendment to Loan and Security Agreement, dated
as of May 1, 2001, between the Company and Coast
Business Credit, a division of Southern Pacific Bank
10.19(1) Security Agreement dated as of August 1, 1997, between
J.L.B. of Nevada, Inc., Credit Store Mortgage, Inc., New
Beginnings Corp., Consumer Debt Acquisitions, Inc.,
Sleepy Hollow Associates, Inc., Service One Holdings
Inc., Service One International Corporation, American
Credit Alliance, Inc., Service One Receivables
Acquisition Corporation, the Company, Service One
Commercial Corporation and Soiland Company
10.20(1) First Amendment to Security Agreement, dated as of
October 23, 1997 between J.L.B. of Nevada, Inc., the
Company and Credit Store Mortgage, Inc., New Beginnings
Corp., Consumer Debt Acquisitions, Inc., Sleepy Hollow
Associates, Inc., Service One Holdings, Inc., Service
One International Corporation, Service One Receivables
Acquisition Corporation, the Company, Service One
Commercial Corporation and Soiland Company
10.21(1) Second Amendment to Security Agreement, dated as of
November 21, 1997 between J.L.B. of Nevada, Inc., the
Company, Sleepy Hollow Associates, Inc., Service One
International Corporation, American Credit Alliance,
Inc. and Service One Receivables Acquisition Corporation
10.22(1) Credit Agreement Dated as of October 15, 1999 among
Credit Store Capital Corp., the Company, The Lenders
Signatory thereto from time to time, and General
Electric Capital Corporation
10.23(2) Amended 1997 Stock Option Plan of the Company
10.24(1) Employment Agreement dated March 27, 1997, between the
Company and Martin Burke
10.25(1) Letter from Martin Burke dated March 27, 1997, regarding
credit card repayment terms
10.26(1) Employment Agreement dated April 1, 1997, between the
Company and Kevin Riordan
10.27(1) Employment Agreement dated June 17, 1997, between the
Company and Michael Philippe
10.28(1) Amendment to Employment Agreement between the Company
and Michael Philippe dated December 15, 1999
10.29(1) Employment Agreement dated August 1, 1997, between the
Company and Richard Angel
10.30(1) Amendment to Employment Agreement between the Company
and Richard Angel dated December 15, 1999
10.31(1) Employment Agreement dated October 15, 1997, between the
Company and Cynthia Hassoun
10.32(1) Bankcard Marketing Agreement between the Company and
Bank of Hoven dated February 9, 1999
10.33(1) Purchase Agreement between Bank of Hoven and the Company
dated February 9, 1999
10.34(1) Bankcard Marketing Agreement between Service One
International Corporation and First National Bank in
Brookings dated October 2, 1997
10.35(1) Purchase Agreement between First National Bank in
Brookings and Service One International Corporation
doing business as TCS Services, Inc. dated October 2,
1997
10.36(1) Amendment to Purchase Agreement by First National Bank
in Brookings and the Company dated August 31, 1998
10.37(1) Letter Agreement Regarding Bankcard Marketing Agreement
and Purchasing Agreement between the Company and First
National Bank in Brookings dated August 17, 1999
10.38(1) Agreement Regarding Transfer of Accounts between the
Company and First National Bank in Brookings dated
December 14, 1998
10.39(1) Subordinated Grid Promissory Note of the Company in
favor of J.L.B. of Nevada, Inc. dated August 1, 1997 in
the amount of $20,000,000
10.40(1) Subordinated Grid Promissory Note of the Company in
favor of J.L.B. of Nevada, Inc. dated October 23, 1997
in the amount of $5,000,000
10.41(1) Subordinated Grid Promissory Note of the Company in
favor of J.L.B. of Nevada, Inc. dated November 21, 1997
in the amount of $5,000,000
10.42(4) Receivables Purchase Agreement, dated as of May 31,
2000, by and between The Credit Store, Inc. and TCS
Funding IV, Inc.
10.43.1(4) Master Credit and Security Agreement, dated as of May
31, 2000, by and among TCS Funding IV, Inc., The Credit
Store, Inc., and Miller & Schroeder Investments
Corporation.
10.43.2 Credit and Security Agreement, dated as of May 1, 2001,
by and among TCS Funding V, Inc., The Credit Store,
Inc., and Miller & Schroeder Investments Corporation.
10.43.3 Receivables Purchase Agreement dated May 1, 2001, by and
between The Credit Store, Inc. and TCS Funding V, Inc.
10.44(4) Account Purchase Agreement, dated as of October 31,
2000, by and among The Credit Store, Inc. and Credit
Services, Inc.
10.45(4) Converted Accounts/Receivables Sale Agreement, dated as
of October 31, 2000, by and among Credit Store Services,
Inc. and The Credit Store, Inc.
10.46(4) Master Loan and Servicing Agreement, dated October 31,
2000, by and among Credit Store Services, Inc., The
Credit Store, Inc., and The Varde Fund IV-A.**
10.47(4) Repurchase Agreement, dated November 22, 2000, by and
between Bank of Hoven and The Credit Store, Inc.
10.47.1 Amendment dated February 27, 2001 to the Repurchase
Agreement dated November 22, 2000, by and between Bank
of Hoven and The Credit Store, Inc.
10.47.2 Amendment dated May 31, 2001 to the Repurchase Agreement
dated November 22, 2000, by and between Bank of Hoven
and The Credit Store, Inc.
10.48(5) Separation Agreement and Release by and between The
Credit Store, Inc. and Martin Burke dated December 11,
2000.
10.49(5) Secured Promissory Note of American Credit Alliance,
Inc. in favor of J.L.B. of Nevada, Inc. dated August 16,
1996 in the amount of $880,000.
10.50 Amendment to Subordinated Grid Promissory Notes, dated
May 4, 2001, 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.
12 Computation of Ratios of Earnings to Fixed Charges
21 List of Subsidiaries
23.1 Consent of Grant Thornton LLP
23.2* Consent of Legal Counsel to the Company (contained in
Exhibit 5)
24(5) Powers of Attorney
25* Form T-1, Statement of Eligibility and Qualification of
U.S. Bank Trust National Association, as Trustee
- ----------
(1) 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.
(2) Filed with the Securities and Exchange Commission as an exhibit to the
issuer's registration statement on Form S-8 filed July 26, 2000 (File No.
333-42278) and incorporated herein by reference.
(3) Filed with the Securities and Exchange Commission as an exhibit to the
issuer's annual report on Form 10-K for the period ended May 31, 2000 (File No.
001-16083) and incorporated herein by reference.
(4) Filed with the Securities and Exchange Commission as an exhibit to the
issuer's quarterly report on Form 10-Q for the period ended November 30, 2000
(File No. 001-16083) and incorporated herein by reference.
(5) Filed with the Securities and Exchange Commission as an exhibit to the
issuer's registration statement on Form S-1 filed March 2, 2001 (File No.
333-56456) and incorporated herein by reference.
** 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.
* To be filed by amendment.