UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended SEPTEMBER 30, 2006
------------------
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from__________ to __________
Commission file number: 0 - 50235
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PERFORMANCE CAPITAL MANAGEMENT, LLC
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(Exact name of small business issuer as specified in its charter)
California 03-0375751
----------------------------- ---------------------------------
State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization
222 South Harbor Blvd., Suite 400, Anaheim, California 92805
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(Address of principal executive offices)
(714) 502-3780
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(Issuer's telephone number)
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(Former name, former address and former fiscal year,
if changed since last report.)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the issuer was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
Check whether the issuer has filed documents and reports required to be filed by
Section 12, 13 or 15(d) of the Exchange Act after the distribution of securities
under a plan confirmed by a court. Yes [X] No [ ]
As of November 1, 2006, the issuer had 564,125 LLC Units issued and outstanding.
Transitional Small Business Disclosure Format (Check one): Yes [ ] No [X]
PERFORMANCE CAPITAL MANAGEMENT, LLC
INDEX TO
QUARTERLY REPORT ON FORM 10-QSB
FOR THE QUARTER ENDED SEPTEMBER 30, 2006
PART I - FINANCIAL INFORMATION PAGE
Item 1 Consolidated Financial Statements
Review Report of Independent Registered Public Accounting Firm . . . . . . . . . . . . 1
Consolidated Balance Sheets as of September 30, 2006 (unaudited) and
December 31, 2005. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Consolidated Statements of Operations for the quarters and nine months ended
September 30, 2006 and 2005 (unaudited). . . . . . . . . . . . . . . . . . . . . . . . 3
Consolidated Statements of Members' Equity for the nine months ended
September 30, 2006 (unaudited) and the year ended December 31, 2005. . . . . . . . . . 4
Consolidated Statements of Cash Flows for the nine months ended
September 30, 2006 and 2005 (unaudited). . . . . . . . . . . . . . . . . . . . . . . . 5
Condensed Notes to the Consolidated Financial Statements (unaudited) . . . . . . . . . 6
Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations. 17
Item 3 Controls and Procedures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
PART II - OTHER INFORMATION
Item 6 Exhibits. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
SIGNATURES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
[MOORE STEPHENS WURTH FRAZER AND TORBET, LLP LETTERHEAD]
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
- -------------------------------------------------------
To the Board of Directors
Performance Capital Management, LLC
Anaheim, California
We have reviewed the accompanying consolidated balance sheet of Performance
Capital Management, LLC as of September 30, 2006, and the related consolidated
statements of operations for the quarters and nine month periods ended September
30, 2006 and 2005, and members' equity and cash flows for the nine month periods
ended September 30, 2006 and 2005. All information included in these
consolidated financial statements is the representation of the management of
Performance Capital Management, LLC.
We conducted our review in accordance with the standards of the Public Company
Accounting Oversight Board (United States). A review of interim financial
information consists principally of applying analytical procedures and making
inquiries of persons responsible for financial and accounting matters. It is
substantially less in scope than an audit conducted in accordance with the
standards of the Public Company Accounting Oversight Board, the objective of
which is the expression of an opinion regarding the financial statements taken
as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the accompanying consolidated financial statements referred to above
for them to be in conformity with accounting principles generally accepted in
the United States of America.
We have previously audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated balance
sheet of Performance Capital Management, LLC as of December 31, 2005, and the
related consolidated statements of operations, members' equity and cash flows
for the year ended December 31, 2005 (not presented herein); and in our report
dated March 20, 2006, we expressed an unqualified opinion on those consolidated
financial statements. In our opinion, the information set forth in the
accompanying consolidated balance sheet as of December 31, 2005, is fairly
stated, in all material respects, in relation to the balance sheet from which it
has been derived.
/s/ Moore Stephens Wurth Frazer And Torbet, LLP
November 9, 2006
Orange, California
PERFORMANCE CAPITAL MANAGEMENT, LLC AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
AS OF SEPTEMBER 30, 2006 AND DECEMBER 31, 2005
September 30, 2006 December 31, 2005
(unaudited)
--------------------- ------------------
ASSETS
------
Cash and cash equivalents $ 1,179,528 $ 1,810,677
Restricted cash 555,830 380,352
Other receivables 259,442 25,678
Purchased loan portfolios, net 6,287,499 8,446,724
Property and equipment, net 253,024 141,169
Deposits 119,511 57,746
Prepaid expenses and other assets 83,235 90,843
--------------------- ------------------
Total assets $ 8,738,069 $ 10,953,189
===================== ==================
LIABILITIES AND MEMBERS' EQUITY
-------------------------------
LIABILITIES:
Accounts payable $ 67,097 $ 78,644
Accrued liabilities 421,776 346,554
Accrued interest 58,788 30,225
Notes payable 5,878,753 7,336,505
Income taxes payable 27,580 27,580
--------------------- ------------------
Total liabilities 6,453,994 7,819,508
COMMITMENTS AND CONTINGENCIES - -
MEMBERS' EQUITY 2,284,075 3,133,681
--------------------- ------------------
Total liabilities and members'
equity $ 8,738,069 $ 10,953,189
===================== ==================
The accompanying notes are an integral part of these consolidated financial
statements.
See Review Report of Independent Registered Public Accounting Firm.
2
PERFORMANCE CAPITAL MANAGEMENT, LLC AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
For the For the For the nine For the nine
quarter ended quarter ended months ended months ended
September 30, September 30, September 30, September 30,
2006 2005 2006 2005
(unaudited) (unaudited) (unaudited) (unaudited)
-------------- -------------- -------------- ---------------
REVENUES:
Portfolio collections $ 3,222,036 $ 3,384,709 $ 10,459,125 $ 9,993,896
Portfolio sales 20,000 66,133 1,552,610 572,142
-------------- -------------- -------------- ---------------
Total revenues 3,242,036 3,450,842 12,011,735 10,566,038
Less portfolio basis recovery 1,691,488 1,457,947 6,216,356 4,729,367
-------------- -------------- -------------- ---------------
NET REVENUES 1,550,548 1,992,895 5,795,379 5,836,671
-------------- -------------- -------------- ---------------
OPERATING COSTS AND EXPENSES:
Salaries and benefits 1,021,897 1,020,669 3,214,974 3,171,233
General and administrative 695,382 704,041 2,205,027 2,258,360
Depreciation 27,456 38,263 79,934 123,256
-------------- -------------- -------------- ---------------
Total operating costs and expenses 1,744,735 1,762,973 5,499,935 5,552,849
-------------- -------------- -------------- ---------------
INCOME (LOSS) FROM OPERATIONS (194,187) 229,922 295,444 283,822
-------------- -------------- -------------- ---------------
OTHER INCOME (EXPENSE):
Interest expense and other financing costs (219,178) (113,637) (629,439) (285,230)
Reorganization costs - - - (440)
Interest income 5,508 4,553 12,101 9,544
Other income - 3,301 - 5,415
-------------- -------------- -------------- ---------------
Total other expense, net (213,670) (105,783) (617,338) (270,711)
-------------- -------------- -------------- ---------------
INCOME (LOSS) BEFORE INCOME TAX
PROVISION (407,857) 124,139 (321,894) 13,111
INCOME TAX PROVISION 2,790 5,790 29,180 23,390
-------------- -------------- -------------- ---------------
NET INCOME (LOSS) $ (410,647) $ 118,349 $ (351,074) $ (10,279)
============== ============== ============== ===============
NET INCOME (LOSS) PER MEMBER
UNIT - BASIC AND DILUTED $ (.73) $ .21 $ (.62) $ (.02)
============== ============== ============== ===============
The accompanying notes are an integral part of these consolidated financial
statements.
See Review Report of Independent Registered Public Accounting Firm.
3
PERFORMANCE CAPITAL MANAGEMENT, LLC AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF MEMBERS' EQUITY
Total
Member Unreturned Abandoned Accumulated Members'
Units Capital Capital Deficit Equity
------- ------------ ----------- ------------- -----------
Balance, December 31, 2004 563,861 $24,633,642 $ 489,244 $(21,536,538) $3,586,348
Reinstatement of units to investor 65 3,503 (3,503) -
Distributions to investors (494,338) (494,338)
Net loss (10,279) (10,279)
------- ------------ ----------- ------------- -----------
Balance, September 30, 2005 563,926 24,142,807 485,741 (21,546,817) 3,081,731
Distributions to investors (163,765) (163,765)
Net income 215,715 215,715
------- ------------ ----------- ------------- -----------
Balance, December 31, 2005 563,926 23,979,042 485,741 (21,331,102) 3,133,681
Reinstatement of units to investor 199 11,938 (11,938) -
Distributions to investors (498,532) (498,532)
Net loss (351,074) (351,074)
------- ------------ ----------- ------------- -----------
Balance, September 30, 2006 564,125 $23,492,448 $ 473,803 $(21,682,176) $2,284,075
======= ============ =========== ============= ===========
The accompanying notes are an integral part of these consolidated financial
statements.
See Review Report of Independent Registered Public Accounting Firm.
4
PERFORMANCE CAPITAL MANAGEMENT, LLC AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the nine months For the nine months
ended ended
September 30, 2006 September 30, 2005
(unaudited) (unaudited)
--------------------- ---------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (351,074) $ (10,279)
Adjustments to reconcile net (loss) to net cash
provided by (used in) operating activities:
Depreciation 79,934 123,256
(Increase) decrease in assets:
Other receivables (233,764) (5,346)
Prepaid expenses and other assets 7,608 15,732
Loan portfolios 2,159,225 (1,270,895)
Deposits (61,765) -
Increase (decrease) in liabilities:
Accounts payable (11,547) (8,920)
Accrued liabilities 75,222 31,917
Accrued interest 28,563 27,048
Income taxes payable - 3,500
--------------------- ---------------------
Net cash provided by (used in) operating activities 1,692,402 (1,093,987)
--------------------- ---------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment (191,789) (28,030)
--------------------- ---------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Loan proceeds from borrowing 2,379,418 3,975,022
Repayment of loans (3,837,170) (1,879,723)
Distributions to investors (498,532) (494,338)
--------------------- ---------------------
Net cash (used in) provided by financing activities (1,956,284) 1,600,961
--------------------- ---------------------
NET CHANGE IN CASH AND CASH EQUIVALENTS (455,671) 478,944
CASH AND CASH EQUIVALENTS, beginning of period 2,191,029 2,042,360
--------------------- ---------------------
CASH AND CASH EQUIVALENTS, end of period $ 1,735,358 $ 2,521,304
===================== =====================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Income taxes paid $ 29,180 $ 19,890
===================== =====================
Interest paid $ 510,314 $ 258,182
===================== =====================
The accompanying notes are an integral part of these consolidated financial
statements.
See Review Report of Independent Registered Public Accounting Firm.
5
PERFORMANCE CAPITAL MANAGEMENT, LLC AND SUBSIDIARY
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND DESCRIPTION OF BUSINESS
Performance Capital Management, LLC ("PCM LLC") and its wholly-owned subsidiary,
Matterhorn Financial Services, LLC ("Matterhorn") (collectively the "Company",
unless stated otherwise) are engaged in the business of acquiring assets
originated by federal and state banks and other sources, for the purpose of
generating income and cash flow from managing, collecting, or selling those
assets. These assets consist primarily of non-performing credit card loan
portfolios and are purchased and sold as portfolios ("portfolios").
Additionally, some of the loan portfolios are assigned to third party agencies
for collection.
Reorganization under Bankruptcy
- -------------------------------
PCM LLC was formed under a Chapter 11 Bankruptcy Reorganization Plan and
operating agreement. The plan called for the consolidation of five California
limited partnerships and a California corporation into the new California
limited liability company. The five California limited partnerships were formed
for the purpose of acquiring investments in or direct ownership of
non-performing credit card loan portfolios from financial institutions and other
sources. The assets of the five limited partnerships consisted primarily of
non-performing credit card loans, as well as cash. In late December 1998, these
six entities voluntarily filed bankruptcy petitions, which were later
consolidated into one case. PCM LLC was formed on January 14, 2002 and commenced
operations upon the confirmation of its Bankruptcy Reorganization Plan
("Reorganization Plan") on February 4, 2002. The entities that were consolidated
under the Reorganization Plan are as follows:
Performance Asset Management Fund, Ltd., - (PAM), a California limited
partnership, formed in 1991. Units in PAM were sold in a private placement
offering. PAM raised $5,205,000 in gross proceeds from the sale of its
partnership units. PAM was not subject to the reporting requirements of the
Securities and Exchange Commission.
Performance Asset Management Fund II, Ltd., - (PAMII), a California limited
partnership, formed in 1992. Units in PAMII were sold in a private placement
offering. PAMII raised $7,670,000 in gross proceeds from the sale of its
partnership units. PAMII was not subject to the reporting requirements of the
Securities and Exchange Commission.
Performance Asset Management Fund III, Ltd., - (PAMIII), a California limited
partnership, formed in 1992. Units in PAMIII were sold in a private placement
offering. PAMIII raised $9,990,000 in gross proceeds from the sale of its
partnership units. PAMIII was a public limited partnership that was subject to
the reporting requirements of the Securities and Exchange Commission.
Performance Asset Management Fund IV, Ltd., - (PAMIV), a California limited
partnership, formed in 1992. Units in PAMIV were sold in an intrastate offering
to residents of California. PAMIV raised $28,595,000 in gross proceeds from the
sale of its partnership units. PAMIV was a public limited partnership that was
subject to the reporting requirements of the Securities and Exchange Commission.
Performance Asset Management Fund V, Ltd., - (PAMV), a California limited
partnership, formed in 1994. Units in PAMV were sold in a private placement
offering. PAMV raised $5,965,000 in gross proceeds from the sale of its
partnership units. PAMV was not subject to the reporting requirements of the
Securities and Exchange Commission.
Performance Capital Management, Inc. - (PCM INC), a California corporation
incorporated in January 1993. PCM INC identified potential portfolio
acquisitions, performed due diligence in conjunction with potential portfolio
acquisitions, acquired portfolios, and through joint ventures with the limited
partnerships (PAM, PAMII, PAMIII, PAMIV, and PAMV) collected and sold acquired
portfolios. The limited partnerships (PAM, PAMII, PAMIII, PAMIV, and PAMV)
collectively obtained 98.5% of the outstanding shares of PCM INC. The minority
interest of 1.5% was effectively eliminated in the bankruptcy plan.
6
PERFORMANCE CAPITAL MANAGEMENT, LLC AND SUBSIDIARY
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND DESCRIPTION OF BUSINESS (CONTINUED)
Pre-petition Operations
- -----------------------
A total of approximately $57,450,000 was raised over the period 1991 to 1994 by
selling limited partnership interests in PAM, PAMII, PAMIII, PAMIV, and PAMV.
Approximately $8.7 million was deducted for brokerage and organizational
expenses. Approximately $49 million was used to purchase non-performing credit
card loan portfolios. These portfolios were typically purchased by the limited
partnerships from PCM INC. PCM INC also collected the portfolios under joint
venture agreements between itself and the limited partnerships.
In the normal course of business, loan portfolios would be purchased,
collections would be made and in some cases the portfolios were sold. PCM INC
was in the business of managing these loan portfolios.
PCM INC generally charged a "mark-up" to the limited partnerships for portfolios
purchased for the limited partnerships. This markup averaged 35% above the price
PCM INC paid for the portfolios on the open market. PCM INC was also
contractually entitled to receive 45% of all monies collected on the portfolios.
Reorganization Plan
- -------------------
The following is a summary of the ownership interest of PCM LLC pursuant to the
terms of the Reorganization Plan:
Original Number of Number of Percentage
Fund's Name Unit Holders PCM LLC Units Interest in PCM LLC
- ----------- ------------ ------------- -------------------
PAM 370 52,050 9
PAMII 459 76,700 13
PAMIII 595 99,900 18
PAMIV 1553 285,950 50
PAMV 327 56,950 10
------------- -------------------
Totals 571,550 100
============= ===================
The following is a summary of the ownership interest of Performance Capital
Management, LLC as of September 30, 2006:
Fund's Number of Percentage
Name PCM LLC Units Interest in PCM LLC
- ---------- ------------- -------------------
PAM 51,565 9
PAMII 76,101 14
PAMIII 97,759 17
PAMIV 282,179 50
PAMV 56,521 10
------------- -------------------
Totals 564,125 100
============= ===================
The Reorganization Plan calls for distributions to be made first to the LLC
Members to the extent of and in proportion to their unreturned Capital
Contributions; and thereafter to the LLC Members in proportion to their
respective percentage ownership interest. The combination of the Partnerships
and PCM INC is summarized as follows (in thousands):
7
PERFORMANCE CAPITAL MANAGEMENT, LLC AND SUBSIDIARY
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND DESCRIPTION OF BUSINESS (CONTINUED)
PAM PAMII PAMIII PAMIV PAMV PCM INC Total
----------------------------------------------------------------------
Sale of Limited Partnership Units $ 5,205 $ 7,670 $ 9,990 $28,595 $ 5,965 $ - $ 57,425
Distributions to Investors (3,704) (4,137) (3,719) (6,920) (829) - (19,309)
----------------------------------------------------------------------
Unreturned Capital 1,501 3,533 6,271 21,675 5,136 - 38,116
Accumulated Deficit (288) (1,333) (2,424) (9,330) (2,561) (2,302) (18,238)
----------------------------------------------------------------------
Cash and Net Assets
Transferred to PCM LLC $ 1,213 $ 2,200 $ 3,847 $12,345 $ 2,575 $ (2,302) 19,878
===========================================================
Cumulative Distributions For The
Period February 4, 2002
Through December 31, 2004 (13,146)
Cumulative Net Loss For The
Period February 4, 2002
Through December 31, 2004 (3,298)
Distributions Forfeited 152
Members' Equity PCM, LLC ---------
at December 31, 2004 3,586
2005 Distributions to Investors (329)
Net Loss For The Six Months
Ended June 30, 2005 (129)
Members' Equity PCM, LLC ---------
at June 30, 2005 3,128
2005 Distributions to Investors (329)
Net Income For The Six Months
Ended December 31, 2005 334
Members' Equity PCM, LLC ---------
at December 31, 2005 3,133
2006 Distributions to Investors (498)
Net Loss For The Nine Months
Ended September 30, 2006 (351)
Members' Equity PCM, LLC ---------
at September 30, 2006 $ 2,284
=========
8
PERFORMANCE CAPITAL MANAGEMENT, LLC AND SUBSIDIARY
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND DESCRIPTION OF BUSINESS (CONTINUED)
PAM III and PAM IV were reporting entities under the Securities Exchange Act of
1934. PAM, PAMII, PAMV, and PCM INC were not reporting entities. It was
determined that PCM LLC is a "successor company" under rule 12g-3 of the
Securities Exchange Act of 1934, and therefore is subject to the reporting
requirements of the Securities Exchange Act of 1934. PCM LLC's LLC units are not
publicly traded securities. The Reorganization Plan placed certain restrictions
on the transfer of members' interests.
On August 2, 2004, an order of the United States Bankruptcy Court was entered
closing the Chapter 11 case. The order acts as a discharge and termination of
any and all liabilities and debts of, and claims against, PCM INC, PAM, PAM II,
PAM III, PAM IV and PAM V that arose at any time before the confirmation order
became effective on February 4, 2002.
Wholly-owned Subsidiary
- -----------------------
In July, 2004, the Company completed a credit facility (effective June 10, 2004)
with Varde Investment Partners, L.P. ("Varde"), a participant in the debt
collection industry, to augment portfolio purchasing capacity using capital
provided by Varde. To implement the agreement, PCM LLC created a wholly-owned
subsidiary, Matterhorn. The facility provides for up to $25 million of capital
(counting each dollar loaned on a cumulative basis) over a five-year term. Varde
is not under any obligation to make a loan to Matterhorn and Varde must agree on
the terms for each specific advance under the loan facility. Under the terms of
the facility, Varde will receive both interest and a portion of any residual
collections on the portfolios acquired with a loan, after repayment of the
purchase price (plus interest) to Varde and the Company and payment of servicing
fees. Portfolios purchased using the facility will be owned by PCM LLC's
subsidiary, Matterhorn. Varde has a first priority security interest in
Matterhorn's assets securing repayment of its loans.
NOTE 2 - BASIS OF PRESENTATION
Interim Condensed Financial Statements
- --------------------------------------
These interim condensed consolidated financial statements have been prepared
using generally accepted accounting principles in the United States. The interim
consolidated financial statements include all adjustments, consisting solely of
normal recurring adjustments, which in management's opinion are necessary for
fair presentation of the financial results for interim periods. The consolidated
financial statements have been prepared consistent with the accounting policies
described in the Company's annual audited consolidated financial statements.
Reference should be made to those statements included with the Company's annual
report filed on Form 10-KSB.
Reporting Entity
- ----------------
PCM LLC is a successor entity of six companies emerging from bankruptcy (see
Note 1). The accompanying balance sheets, statements of operations, members'
equity, and cash flows include balances and transactions since the emergence
from bankruptcy. Matterhorn was consolidated in the financial statements as a
wholly-owned subsidiary starting in the third quarter of 2004.
Fresh Start Accounting
- ----------------------
Statement of Position 90-7 issued by the American Institute of Certified Public
Accountants ("SOP 90-7") addresses accounting for companies in reorganization
under the bankruptcy code. For certain entities, SOP 90-7 requires "fresh start
accounting" which records a revaluation of assets to fair values and an
adjustment of liabilities to present values.
SOP 90-7 also requires the following procedures for entities that adopt fresh
start accounting:
1. The reorganization value of the entity should be allocated to the entity's
assets following FAS 141;
2. Liabilities other than deferred taxes should be stated at present values of
amounts to be paid using current interest rates;
9
PERFORMANCE CAPITAL MANAGEMENT, LLC AND SUBSIDIARY
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - BASIS OF PRESENTATION (CONTINUED)
3. Deferred taxes should be presented in conformity with generally accepted
accounting principles. Benefits realized from preconfirmation net operating
loss carryforwards should reduce reorganization value in excess of amounts
allocable to identifiable assets and other intangibles until exhausted and
be reported as a direct addition to paid-in capital thereafter;
4. Changes in accounting principles that will be required for the emerging
entity within the twelve months following the adoption of fresh start
accounting should be adopted at the same time fresh start accounting is
adopted.
SOP 90-7 also requires the following disclosure in the initial financial
statements after fresh start accounting has been adopted:
1. Adjustments to the historical amounts of individual assets and liabilities;
2. The amount of debt forgiveness;
3. The amount of prior retained earnings or deficit eliminated; and
4. Other important matters in determining reorganization value.
Management reviewed these requirements and determined that fresh start
accounting was not applicable because assets exceeded liabilities prior to
confirmation of the plan and existing limited partners retained a majority
interest in the successor entity.
For entities that do not meet the requirements for fresh start accounting, SOP
90-7 requires that liabilities compromised by a confirmed bankruptcy plan be
stated at present value of amounts to be paid, using current interest rates.
Debt forgiveness, if any, should be reported as an extraordinary item.
As part of the Reorganization Plan, no debt forgiveness existed and all
liabilities subject to compromise were presented on the face of the balance
sheet as pre-petition claims with disclosures required by SOP 90-7. These claims
have been paid or settled by December 31, 2003.
Transfer of Assets to Successor Company
- --------------------------------------------
Assets were transferred at historical carrying values and liabilities were
assumed as required by the bankruptcy confirmation plan.
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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 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 non-performing credit card
loan portfolios. Among other things, the estimated future cash flows of the
portfolios are used to recognize impairment in the purchased loan portfolios.
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 to the financial statements.
10
PERFORMANCE CAPITAL MANAGEMENT, LLC AND SUBSIDIARY
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Purchased Loan Portfolios
- ---------------------------
Purchased loan portfolios consisted primarily of non-performing credit card
accounts. For substantially all the Company's acquired portfolios, future cash
flows cannot be reasonably estimated in order to record an accretable yield
consistently. Therefore, the Company utilizes the cost recovery method as
required by AICPA Practice Bulletin 6. Application of the cost recovery method
requires that any amounts received be applied first against the recorded amount
of the portfolios; when that amount has been reduced to zero, any additional
amounts received are recognized as net revenue. Acquired portfolios are
initially recorded at their respective costs, and no accretable yield is
recorded on the accompanying balance sheets.
The Company provides a valuation allowance for an acquired loan portfolio when
the present value of expected future cash flows does not exceed the carrying
value of the portfolio.
Over the life of the portfolio, the Company's management continues to review the
carrying values of each loan for impairment. If net present value of expected
future cash flows falls below the carrying value of the related portfolio, the
valuation allowance is adjusted accordingly.
Cash and Cash Equivalents
- --------------------------
The Company defines cash equivalents as cash, money market investments, and
overnight deposits with original maturities of less than three months. Cash
equivalents are valued at cost, which approximates market. The Company maintains
cash balances, which exceeded federally insured limits by approximately $1.5
million as of September 30, 2006. The Company has not experienced any losses in
such accounts. Management believes it is not exposed to any significant risks on
cash in bank accounts.
Restricted cash consists principally of cash held in a segregated account
pursuant to the Company's credit facility with Varde. The Company and Varde
settle the status of these funds on a monthly basis pursuant to the credit
facility. The proportion of the restricted cash ultimately disbursed by
Matterhorn to Varde and PCM LLC depends upon a variety of factors, including the
portfolios from which the cash is collected, the size of servicing fees on the
portfolios that generated the cash, and the priority of payments due on the
portfolios that generated the cash.
Property and Equipment
- -----------------------
Property and equipment are carried at cost and depreciation is computed over the
estimated useful lives of the assets ranging from 3 to 7 years. The Company uses
the straight-line method of depreciation. Property and equipment transferred
under the reorganization plan were transferred at net book value. Depreciation
is computed on the remaining useful life at the time of transfer.
The related cost and accumulated depreciation of assets retired or otherwise
disposed of are removed from the accounts and the resultant gain or loss is
reflected in earnings. Maintenance and repairs are expensed currently while
major betterments are capitalized.
Long-term assets of the Company are reviewed annually as to whether their
carrying value has become impaired. Management considers assets to be impaired
if the carrying value exceeds the future projected cash flows from related
operations. Management also re-evaluates the periods of amortization to
determine whether subsequent events and circumstances warrant revised estimates
of useful lives. As of September 30, 2006, management expects these assets to be
fully recoverable.
11
PERFORMANCE CAPITAL MANAGEMENT, LLC AND SUBSIDIARY
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Revenue Recognition
- --------------------
Revenue is accounted for 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 loan portfolios are applied first to recover the cost of
the portfolios, prior to recognizing any revenue. Cash receipts in excess of
cost of purchased loan portfolios are then recognized as net revenue.
Loan portfolio sales occur after the initial portfolio analysis is performed and
the loan portfolio is acquired. Portions of portfolios sold typically do not
meet the Company's targeted collection characteristics. Loan portfolios sold are
valued at the lower of cost or market.
Proceeds from strategic sales of purchased loan portfolios are recorded as
revenue when received.
Income Taxes
- -------------
PCM LLC is treated as a partnership for Federal income tax purposes and does not
incur Federal income taxes. Instead, its earnings and losses are included in the
personal returns of its members.
PCM LLC is also treated as a partnership for state income tax purposes. The
State of California imposes an annual corporation filing fee and an annual
limited liability company fee.
Members' Equity
- ----------------
Members' equity includes voting LLC units held by members and non-voting LLC
units held by one economic interest owner. As of September 30, 2006, PCM LLC had
540,403 voting LLC units (540,204 LLC units as of December 31, 2005) and 23,722
non-voting LLC units (23,722 LLC units as of December 31, 2005). Abandoned
capital represents LLC units that are either voluntarily returned to the Company
by a member or LLC units that are redeemed and cancelled following a procedure
authorized by PCM LLC's plan of reorganization to eliminate the interests of
members the Company has not been able to locate. In the first quarter of 2006,
199 units of previously cancelled units were reinstated due to a beneficiary
heir establishing ownership.
NOTE 4 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value and the methods and assumptions used to estimate the
fair values of the financial instruments of the Company as of September 30, 2006
and December 31, 2005 are as follows. The carrying amount of cash and cash
equivalents, restricted cash and liabilities approximate their fair values. The
total and retained fair values of purchased loan portfolios were determined
based on both market pricing and discounted expected cash flows. The total fair
value of the Company's portfolios includes fair value attributable to the
residual interests of third parties in collections once all funds (including
funds invested by the Company) invested in a portfolio have been repaid (with
interest) and all servicing fees have been paid. The retained fair value of the
Company's portfolios excludes fair value attributable to these residual
interests. The discount rate is based on an acceptable rate of return adjusted
for the risk inherent in the loan portfolios. The discount rate utilized at
September 30, 2006 and December 31, 2005 was 20%. The estimated total fair value
of loan portfolios was $24.2 million and $28.0 million at September 30, 2006,
and December 31, 2005, respectively, and the estimated retained fair value of
loan portfolios was $23.6 million and $27.5 million at September 30, 2006, and
December 31, 2005, respectively.
NOTE 5 - PURCHASED LOAN PORTFOLIOS
The Company acquires portfolios of non-performing credit card loans from federal
and state banks and other sources. These loans are acquired at a substantial
discount from the actual outstanding balance. The aggregate outstanding
contractual loan balances at September 30, 2006 and December 31, 2005 totaled
approximately $814 million and $749 million, respectively.
12
PERFORMANCE CAPITAL MANAGEMENT, LLC AND SUBSIDIARY
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 - PURCHASED LOAN PORTFOLIOS (CONTINUED)
The Company initially records acquired loans at cost. To the extent that the
cost of a particular loan portfolio exceeds the net present value of estimated
future cash flows expected to be collected, a valuation allowance is recognized
in the amount of such impairment.
The carrying amount of loans included in the accompanying balance sheets are as
follows:
As of As of
Sept. 30, 2006 Dec. 31, 2005
---------------- ---------------
Unrecovered cost balance,
beginning of period $ 8,505,065 $ 3,003,642
Valuation allowance,
beginning of period (58,341) (12,000)
---------------- ---------------
Net balance, beginning of period 8,446,724 2,991,642
Net portfolio activity (2,159,225) 5,455,082
---------------- ---------------
Net balance, end of period $ 6,287,499 $ 8,446,724
================ ===============
he activity in the loan portfolios in the accompanying financial statements is
as follows:
Quarter Quarter Nine Months Nine Months
Ended Ended Ended Ended
Sept. 30, 2006 Sept. 30, 2005 Sept. 30, 2006 Sept. 30, 2005
---------------- ---------------- ---------------- ----------------
Purchased loan portfolios - net $ 367,388 $ 247,597 $ 4,057,131 $ 6,000,262
Collections on loan portfolios (3,222,036) (3,384,709) (10,459,125) (9,993,896)
Sales of loan portfolios (20,000) (66,133) (1,552,610) (572,142)
Revenue recognized on collections 1,530,548 1,926,762 5,243,651 5,500,154
Revenue recognized on sales 20,000 66,133 551,728 382,858
Increase in valuation allowance
due to portfolio impairment - - - (46,341)
---------------- ---------------- ---------------- ----------------
Net portfolio activity $ (1,324,100) $ (1,210,350) $ (2,159,225) $ 1,270,895
================ ================ ================ ================
The valuation allowance related to the loan portfolios had a balance of $58,341
at September 30, 2006 and December 31, 2005.
In April 2006, the Company entered into a joint purchase of $2.8 million of loan
portfolios, of which the Company's portion totaled $276,000. Only the Company's
portion was included in the accompanying financial statements. The Company has
assumed the normal risk associated with any portfolio purchase or sale for the
entire transaction.
NOTE 6 - OTHER RECEIVABLES
Other receivables consist of collections on portfolios received by third party
collection agencies and amounts to be refunded to the Company for ineligible
accounts purchased in recent portfolio acquisitions.
13
PERFORMANCE CAPITAL MANAGEMENT, LLC AND SUBSIDIARY
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 - PROPERTY AND EQUIPMENT
Property and equipment is as follows:
As of As of
September 30, 2006 Dec. 31, 2005
------------------- --------------
Office furniture and equipment $ 287,142 $ 286,822
Computer equipment 604,940 525,427
Leasehold improvements 36,982 36,982
Construction in progress (new leasehold) 111,956 -
------------------- --------------
Totals 1,041,020 849,231
Less accumulated depreciation 787,996 708,062
------------------- --------------
Property and equipment, net $ 253,024 $ 141,169
=================== ==============
Depreciation expense for the three months ended September 30, 2006 and 2005
amounted to $27,456 and $38,263, respectively. Depreciation expense for the
nine months ended September 30, 2006 and 2005 amounted to $79,834 and $123,256,
respectively.
NOTE 8 - NOTES PAYABLE
The Company has entered into an agreement for a credit facility with Varde that
provides for up to $25 million of capital (counting each dollar loaned on a
cumulative basis) over a five-year term ending in July 2009. PCM LLC's
wholly-owned subsidiary Matterhorn owed approximately $5.9 million and $7.3
million at September 30, 2006, and December 31, 2005, respectively, under the
facility in connection with its purchase of certain charged-off loan portfolios.
The total amount borrowed was approximately $12.6 million and $10.2 million at
September 30, 2006, and December 31, 2005, respectively. Each advance has
minimum payment threshold points. Each advance has a term of two years and bears
interest at the rate of 12% per annum. These obligations are scheduled to be
paid in full on dates ranging from April 2007 to June 2008, with the approximate
following principal payments due:
Twelve months
ending
September 30,
-------------
2007 $2.4 million
2008 $3.5 million
Once all funds (including funds invested by the Company) invested in a
portfolio financed by Varde have been repaid (with interest) and all servicing
fees have been paid, Varde will begin to receive a residual interest in
collections of that portfolio. Depending on the performance of the portfolio,
these residual interests may never be paid, they may begin being paid a
significant time later than Varde's loan is repaid (i.e., after the funds
invested by the Company are repaid with interest), or, in circumstances where
the portfolio performs extremely well, the loan could be repaid early and Varde
could conceivably begin to receive its residual interest on or before the date
that the loan obligation was originally scheduled to be paid in full. Varde has
a first priority security interest in all the assets of Matterhorn, securing
repayment of its loans and payment of its residual interest. PCM LLC, our parent
operating company, has guarantied certain of Matterhorn's operational
obligations under the loan documents. The amount of remaining available credit
under the facility was approximately $12.4 million at September 30, 2006 and
$14.8 million at December 31, 2005. The assets of Matterhorn that provide
security for Varde's loan were carried at a cost of approximately $5.0 million
at September 30, 2006.
14
PERFORMANCE CAPITAL MANAGEMENT, LLC AND SUBSIDIARY
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9 - COMMITMENTS AND CONTINGENCIES
Lease Commitments
- ------------------
The Company currently leases office space in Anaheim, California under a
non-cancelable five year operating lease that expires on November 30, 2006.
Under the lease agreement, PCM LLC must pay a basic monthly rental charge plus a
portion of the building's common area expenses.
Future minimum lease commitments under the Anaheim lease as of September 30,
2006 are as follows:
Twelve months
ending
September 30,
-------------
2007 $52,000
Thereafter -
Rental expense for the three months ended September 30, 2006 and 2005 amounted
to $84,295 and $81,857, respectively. Rental expense for the nine months ended
September 30, 2006 and 2005 amounted to approximately $252,146 and $245,431,
respectively. The Company has decided not to execute its option to renew the
lease on its existing office space. The Company currently expects to hold over
the current Anaheim lease for an additional minimum rent of approximately
$38,000. The Company is obligated under a five year equipment lease, expiring in
2009, for minimum payments of $4,800 per year.
On July 17, 2006, the Company entered into an Office Lease Agreement to lease
office space in Buena Park, California. The Company intends to use the leased
premises as its principal executive offices and operating facility. The Company
believes that the lease agreement will provide adequate space for its operations
as currently conducted and as it expects to conduct them for the foreseeable
future.
The term of the lease is 87 months and is expected to commence on or around
December 1, 2006, and will expire on February 28, 2014. The Company has an
option to renew the lease for one additional five-year term at the then
prevailing "fair market rental rate" at the end of the term.
The base rent will increase on a yearly basis throughout the term. Future
minimum lease commitments under the Buena Park lease for the calendar years
ended December 31, will be:
Approximate Annual
Year Lease Commitments
---------- -------------------
2006 $ 29,000
2007 $ 173,000
2008 $ 345,000
2009 $ 348,000
Thereafter $ 1,496,000
In addition to the base rent, the Company must pay its pro rata share of the
increase in operating expenses, property taxes and property insurance for the
building above the total dollar amount of operating expenses, property taxes and
property insurance for the 2006 base calendar year.
NOTE 10 - EARNINGS PER MEMBER UNIT
Basic and diluted earnings per member unit are calculated based on the weighted
average number of member units issued and outstanding, 564,125 for the quarter
ended September 30, 2006 and 563,926 for the quarter ended September 30, 2005.
15
PERFORMANCE CAPITAL MANAGEMENT, LLC AND SUBSIDIARY
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11 - EMPLOYEE BENEFIT PLANS
The Company has a defined contribution plan covering all eligible full-time
employees of Performance Capital Management (the Plan Sponsor) who are currently
employed by the Company and have completed six months of service from the time
of enrollment. The Plan was established by the Plan Sponsor to provide
retirement income for its employees and is subject to the provisions of the
Employee Retirement Income Security Act of 1974, as amended (ERISA).
The Plan is a contributory plan whereby participants may contribute a percentage
of pre-tax annual compensation as outlined in the Plan agreement and as limited
by Federal statute. Participants may also contribute amounts representing
distributions from other qualified defined benefit or contribution plans. The
Plan Sponsor does not make matching contributions.
NOTE 12 - SUBSEQUENT EVENTS
On November 10, 2006, PCM LLC commenced a Voluntary Sale Program offering to its
unit holders who own a total of 99 or fewer LLC units the option to sell all
(but not less than all) of their LLC units back to PCM LLC at a price of $4.75
per unit. The Program will expire at 5:00 PM Eastern Time on December 22, 2006,
unless extended. Approximately 1,100 unit holders of PCM LLC's 2,500 record unit
holders are believed by PCM LLC to own in aggregate 99 or fewer LLC units and
such unit holders beneficially own a total of approximately 78,000 LLC units out
of 564,125 LLC units outstanding. The potential outlay could total $370,000. The
amount of capital paid out to the unit holders is dependent upon the number of
LLC units repurchased by PCM LLC.
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Except for the historical information presented in this document, the matters
discussed in this Form 10-QSB, and specifically in "Management's Discussion and
Analysis of Financial Condition and Results of Operations," or otherwise
incorporated by reference into this document contain "forward-looking
statements" (as such term is defined in the Private Securities Litigation Reform
Act of 1995). These statements can be identified by the use of forward-looking
terminology such as "believes," "plans," "expects," "may," "will," "intends,"
"should," "plan," or "anticipates" or the negative thereof or other variations
thereon or comparable terminology, or by discussions of strategy that involve
risks and uncertainties. The safe harbor provisions of Section 21E of the
Securities Exchange Act of 1934, as amended, and Section 27A of the Securities
Act of 1933, as amended, apply to forward-looking statements made by Performance
Capital Management, LLC. You should not place undue reliance on forward-looking
statements due to their inherent uncertainty. Forward-looking statements involve
risks and uncertainties. The actual results that we achieve may differ
materially from any forward-looking statements due to such risks and
uncertainties. These forward-looking statements are based on current
expectations, and we assume no obligation to update this information. Readers
are urged to carefully review and consider the various disclosures made by us in
this report on Form 10-QSB and in our other reports filed with the Securities
and Exchange Commission that attempt to advise interested parties of the risks
and factors that may affect our business.
The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with the unaudited financial statements
and accompanying notes and the other financial information appearing elsewhere
in this report and with the financial information contained in our Form 10-KSB
filed with the Securities and Exchange Commission on March 31, 2006.
OVERVIEW
We acquire assets originated by federal and state banking and savings
institutions, loan agencies, and other sources, for the purpose of generating
income and cash flow from collecting or selling those assets. Typically, these
assets consist of charged-off credit card contracts. These assets are typically
purchased and sold as portfolios. We purchase portfolios using our own cash
resources and funds borrowed from a third party.
Before purchasing a portfolio, we conduct due diligence to assess the value of
the portfolio. We try to purchase portfolios at a substantial discount to the
actual amount of money that they will ultimately produce, so that we can recover
the cost we pay for portfolios, repay funds borrowed to purchase portfolios, pay
our collection and operating costs and still have a profit. We believe that
market conditions currently make it difficult, although not impossible, to
purchase portfolios at prices that will permit us to accomplish these
objectives. We record our portfolios at cost based on the purchase price. We
reduce the cost bases of our portfolios on a portfolio-by-portfolio basis based
on collections, sales of some or all of the portfolio and impairment of net
realizable value.
We frequently sell certain portions of portfolios we purchase, in many instances
to retain those accounts that best fit our collection profile and to reduce our
purchase commitment by reselling the others. We then collect those accounts we
retain as a distinct portfolio. We do not generally purchase loan portfolios
solely with a view to their resale, and for this reason we generally do not show
portfolios on our balance sheet as "held for investment". From time to time we
sell some of our portfolios either to capitalize on market conditions, to
dispose of a portfolio that is not performing or to dispose of a portfolio whose
collection life, from our perspective, has run its course. When we engage in
these sales, we continue collecting the portfolio right up until the closing of
the sale.
We earn revenues from collecting our portfolios and from selling our portfolios
or portions of our portfolios. We recognize gross revenue when we collect an
account and when we sell a portfolio or a portion of it. On our statement of
operations we reduce our total revenues by the cost basis recovery of our
portfolios to arrive at net revenue. For collections, we reduce the cost basis
of the portfolio dollar-for-dollar until we have completely recovered the cost
basis of the portfolio. When we sell a portfolio or a portion of it, to the
extent of remaining cost basis for the portfolio, we reduce the cost
basis of the portfolio by a percentage of the original portfolio cost.
17
Our net revenues from portfolio collections may vary from quarter to quarter
because the number and magnitude of portfolios where we are still recovering
costs may vary, and because the return rates of portfolios whose costs we have
already recovered in full may vary. Similarly, our net revenues from portfolio
sales may vary from quarter to quarter depending on the number and magnitude of
portfolios (or portions) we decide to sell and the market values of the sold
portfolios (or portions) relative to their cost bases.
We refer to the discounted present value of the actual amount of money that we
believe a portfolio will ultimately produce as the "fair value" of the
portfolio. If we conduct our business successfully, the aggregate fair value of
our portfolios should be substantially greater than the aggregate cost basis of
our portfolios presented on our balance sheet. We must make assumptions to
determine fair value, the most significant of which are the magnitude and timing
of future collections and the discount rate used to determine present value.
Because of the inherent uncertainty associated with predicting future events,
our determinations of fair value at any particular point in time are only
estimates, and actual fair value could ultimately vary significantly from our
estimate.
In general, we expect increases in the cost basis of our portfolios presented on
our balance sheet to accompany increases in portfolio fair value. The magnitude
and timing of our collections could cause cost basis to decline in some quarters
when fair value actually increases, however, because we "front-load" our cost
basis recovery instead of matching portfolio cost basis recovery to revenue on a
proportionate basis over the life of the portfolio. Our purchasing patterns
could reinforce this divergence. A decrease in the magnitude of new portfolio
acquisitions (i.e., failing to reinvest all of cash collections representing
cost basis recovery) may still result in a fair value increase because new
portfolios generally have a fair value that exceeds their purchase price.
We plan to realize the difference between fair value and cost basis over time as
we collect our portfolios. We generally collect our portfolios over periods of
time ranging from three to seven years, with the bulk of a portfolio's yield
coming in the first three years we collect it. If we succeed in collecting our
portfolios and realize the difference between fair value and cost basis of our
portfolios, we will recover the cost we paid for them, repay the loans used to
purchase them, pay our collection and operating costs, and still have excess
cash.
Our statement of operations generally will report proportionately low net
revenues in periods that have substantial collections of recently purchased
portfolios, due to the "front-loaded" cost basis recovery associated with new
portfolios. As a result, during times of rapid growth in our portfolio purchases
(and probably for several quarters thereafter), our statement of operations will
likely show a net loss. As purchases slow and more collections come from older
portfolios whose cost bases have been completely recovered, our statement of
operations will begin to report net income, assuming our portfolios perform over
time as anticipated and we collect them in an efficient manner. For the
foreseeable future, we intend to continue seeking new large dollar-volume
portfolio purchases using our loan facility with Varde Investment Partners, L.P.
("Varde").
Our operating costs and expenses consist principally of salaries and benefits
and general and administrative expenses. Fluctuations in our salaries and
benefits correspond roughly to fluctuations in our headcount. Our general and
administrative expenses include non-salaried collection costs, telephone, rent
and professional expenses. Fluctuations in telephone and collection costs
generally correspond to the volume of accounts we are attempting to collect.
Professional expenses tend to vary based on specific issues we must resolve.
BASIS OF PRESENTATION
We present our financial statements based on our February 4, 2002, emergence
from bankruptcy being treated as the inception of our business. In our emergence
from bankruptcy, we succeeded to the assets and liabilities of six entities that
were in bankruptcy. The equity owners of these entities approved a
reorganization plan under which the owners of these six entities agreed to
receive ownership interests in Performance Capital Management, LLC, in exchange
for their ownership interests in the predecessor entities. Our consolidated
financial statements include the accounts of our parent operating company,
Performance Capital Management, LLC, and its wholly-owned special purpose
subsidiary Matterhorn Financial Services LLC, a California limited liability
company ("Matterhorn"). All significant intercompany balances and transactions
have been eliminated.
18
CRITICAL ACCOUNTING ESTIMATES
We present investments in portfolios on our balance sheet at the lower of cost,
market, or estimated net realizable value. As discussed above, we reduce the
cost basis of a portfolio on a proportionate basis when we sell a portion of the
portfolio, and we treat amounts collected on a portfolio as a reduction to the
carrying basis of the portfolio on an individual portfolio basis. When we
present financial statements we assess the estimated net realizable value of our
portfolios on a portfolio-by-portfolio basis, and we reduce the value of any
portfolio that has suffered impairment because its cost basis exceeds its
estimated net realizable value. Estimated net realizable value represents
management's estimates, based upon present plans and intentions, of the
discounted present value of future collections. We must make assumptions to
determine estimated net realizable value, the most significant of which are the
magnitude and timing of future collections and the discount rate used to
determine present value. Once we write down a particular portfolio, we do not
increase it in subsequent periods if our plans and intentions or our assumptions
change.
We present the fair value of our portfolios only in the notes to our financial
statements, not in the basic financial statements themselves. In order to
understand our financial statements the reader must understand the concepts
involved in estimation of the fair value of our portfolios, as discussed in the
section above entitled "Overview". Because of the inherent uncertainty
associated with predicting future events, our determinations of fair value at
any particular point in time are only estimates, and actual fair value could
ultimately vary significantly from our estimate.
When we collect an account in a portfolio, we reduce the cost basis of the
portfolio dollar-for-dollar until we have completely recovered the cost basis of
the portfolio. We believe this method of accounting for the amortization of the
purchase price of our portfolios is conservative and minimizes the effect of
estimation on our results of operations. This policy has the effect of
"front-loading" expenses, however, and may result in a portfolio initially
showing no net revenue for a period of time and then showing only net revenue
once we have recovered its entire cost basis. We believe a policy grounded in
conservatism is preferable to a policy of attempting to match portfolio cost
basis to revenue on a proportionate basis over the life of the portfolio, due to
the distressed nature of the portfolio assets and the lack of assurance that
projected collections will actually occur.
When we sell a portfolio or a portion of it, to the extent of remaining cost
basis for the portfolio, we reduce the cost basis of the portfolio by a
percentage of the original portfolio cost. Our policy does not take into account
whether the portion of the portfolio we are selling may be more or less valuable
than the remaining accounts that comprise the portfolio. We believe our policy,
which is grounded in this objective measure for cost basis recovery, is
preferable to a policy that would attempt to estimate whether a portion of a
portfolio being sold is more or less valuable than the remaining accounts that
comprise the portfolio, because our policy minimizes the effect of estimation on
our results of operations.
As discussed in greater detail below, our credit facility with Varde provides
for up to $25 million of capital (counting each dollar loaned on a cumulative
basis) over a five-year term ending in July 2009. The facility provides for
Varde to receive a residual interest in portfolio collections after all funds
invested in the portfolio have been repaid (with interest) and all servicing
fees have been paid. We do not record a liability for contingent future payments
of residual interests due to the distressed nature of the portfolio assets and
the lack of assurance that collections sufficient to result in a liability will
actually occur. When such payments actually occur, we reflect them in our
statement of operations as other financing costs.
For ease of presentation in the following discussions of "Operating Results" and
"Liquidity and Capital Resources", we round amounts less than one million
dollars to the nearest thousand dollars and amounts greater than one million
dollars to the nearest hundred thousand dollars.
19
OPERATING RESULTS
COMPARISON OF RESULTS FOR THE QUARTERS ENDED SEPTEMBER 30, 2006 AND 2005
The following discussion compares our results for the quarter ended September
30, 2006, to the quarter ended September 30, 2005. We had a net loss of $411,000
for the quarter ended September 30, 2006, as compared to net income of $118,000
for the quarter ended September 30, 2005.
Revenue
- -------
Our net revenues decreased to $1.6 million for the quarter ended September 30,
2006, from $2.0 million for the quarter ended September 30, 2005. The following
table presents a comparison of the components of our revenues for the quarter
ended September 30, 2006, to the quarter ended September 30, 2005, as well as
presenting net revenue as a percentage of the corresponding total revenue
(approximate amounts due to rounding):
Total Collections Sales
----------------------- -------------------------- ----------------------
For the Quarter For the Quarter For the Quarter
Ended Sept. 30, Ended Sept. 30, Ended Sept. 30,
2006 2005 2006 2005 2006 2005
--------- ------------ ------------- ----------- -------- ------------
($in millions) ($in millions) ($in millions)
Total revenues $ 3.2 $ 3.5 $ 3.2 $ 3.4 $ - $ 0.1
Less basis recovery (1.7) (1.5) (1.7) (1.5) - (0.0)
--------- ------------ ------------- ----------- -------- ------------
Net revenues $ 1.6 $ 2.0 $ 1.5 $ 1.9 $ - $ 0.1
========= ============ ============= =========== ======== ============
Net revenue percentage 47.8% 57.8% 47.5% 56.9% - 100.0%
Portfolio collections provided substantially all of our total revenues for the
quarter ended September 30, 2006 and 98.1% of our total revenues for the quarter
ended September 30, 2005. Our total revenues from portfolio collections for the
quarter ended September 30, 2006 decreased by $163,000 over the comparable
quarter in 2005. Our net revenues from portfolio collections decreased by
$396,000 and the percentage of net revenues to total revenues decreased 9.4% to
47.5% for the quarter ended September 30, 2006 from 56.9% in the prior year.
These results reflect the fact that recently purchased portfolios (which provide
no net revenues because of front-loaded cost basis recovery) continue to provide
a substantial portion of our total collection revenues. During 2005, we acquired
$11.5 million of new portfolios (net of returns; $11.0 million after adjusting
for a January 2006 sale of a $461,000 portion of a portfolio purchased in
December 2005). During the nine months ended September 30, 2006, we acquired
$4.1 million of new portfolios (net of returns). We have seen our total revenue
from collections increase as we begin to exploit the large purchases we made in
2005 and continued to make in 2006. We expect to continue to have strong total
collection revenue as we collect these recent portfolio purchases, but we do not
expect our total collection revenue increases in 2006 to be as large as our 2005
increases were in comparison to 2004. The third quarter of 2006 collection
revenue was actually down from the quarter of the prior year but was up by
$466,000 for the nine months of 2006 compared to the same period in the prior
year. The cost basis recovery associated with collecting recently purchased 2005
portfolios, combined with the portfolios that we have already acquired in 2006
and additional portfolios we plan to acquire in 2006, could continue to offset
the increase in net revenue percentage we would otherwise expect our older
portfolios (whose cost bases we have completely recovered) to generate and
actually result in a further decline in our net revenue percentage.
The quarters ended September 30, 2005 and 2006, had portfolio sales revenue of
$66,000 and $20,000, respectively. This revenue consisted of adjustments to
reserve accounts made in the second quarter of 2005 and in the first quarter of
2006. We anticipate continuing to sell portions of newly acquired portfolios
from time to time, but we do not expect to generate substantial net revenues
from these sales.
If we exclude the effect of portfolio sales, our net loss of $431,000 for the
quarter ended September 30, 2006, exceeded the comparable net income (i.e.,
excluding the effect of portfolio sales) of $52,000 for the quarter ended
Septmeber 30, 2006. As long as we succeed at using the Varde facility to
increase portfolio purchases on a year-to-year basis, we do not expect our
collection activity to show net income, due to front-loaded cost basis recovery.
If our purchasing patterns slow, we believe that our collection activity will
begin to show net income. The increase in our net loss
20
excluding the effect of portfolio sales is essentially due to proportionately
greater cost basis recovery (i.e., the decrease in net revenue percentage
discussed above) and to increased interest expense and other financing costs.
Operating Expenses
- -------------------
Our total operating costs and expenses of $1.8 million was comparable for the
quarters ended September 30, 2006 and 2005. Our ratio of operating costs and
expenses to total revenues from collections (i.e., excluding the effect of
portfolio sales), a measure of collection efficiency, increased to 54.2% for the
quarter ended September 30, 2006, from 52.1% for the quarter ended September 30,
2005. We plan to continue following our strategy of increasing total revenues
(while holding infrastructure costs down) and reducing variable costs required
to collect each dollar of revenue, but we believe we may be nearing the point
where it may not be possible to achieve further material decreases in the ratio
of operating costs and expenses to total revenues from collections as reflected
by the increase from the same period in the prior year.
Our interest expense and other financing costs increased to $219,000 for the
quarter ended September 30, 2006 from $114,000 for the quarter ended September
30, 2005. The increase from the same quarter in the prior year reflects the
relatively larger portfolio purchases that were made and financed in 2006. We
intend to continue monitoring the magnitude of the change in the margin by which
our total collection revenues exceed our operating costs and expenses relative
to the principal and interest we pay to Varde under the credit facility to
ensure that the Varde facility provides additional liquidity to us and does not
result in loan payments that will deplete our cash balances. In order to
maintain the working capital necessary to run our operations, we anticipate
maintaining a careful balance between portfolios we purchase using our own cash
(where collection revenues are immediately available to us in full) and
portfolios we purchase using the Varde credit facility (where we must
immediately apply a substantial portion of collections to debt service).
Our general and administration expenses decreased by $9,000 to $695,000 for the
quarter ended September 30, 2006, from $704,000 for the quarter ended September
30, 2005. Our salaries and benefits expenses remained relatively stable at $1.0
million for the quarters ended September 30, 2006 and 2005. Our headcount has
remained relatively stable, although we still experience significant employee
turnover among our collectors. Our operating expenses may increase in 2006 as we
increase the volume of accounts we collect, but we expect increases in total
revenues to continue to outpace any material increases in costs associated with
our collection efforts. Our ability to sustain revenue increases that outpace
cost increases depends on our ability to continue to identify and make large
dollar-volume purchases of portfolios at prices we believe are reasonable. We
are experiencing a greater challenge in obtaining portfolio purchases at a price
that we can make a reasonable return. We are currently considering other
alternatives such as third party collections to offset the effects of the
difficulty in obtaining portfolios at reasonable prices.
COMPARISON OF RESULTS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005
The following discussion compares our results for the nine months ended
September 30, 2006, to the nine months ended September 30, 2005. We had a net
loss of $351,000 for the nine months ended September 30, 2006, compared to a net
1oss of $10,000 for the nine months ended September 30, 2005.
Revenue
- -------
Our net revenues of $5.8 million were comparable for the nine months ended
September 30, 2006 and 2005. The following table presents a comparison of the
components of our revenues for the nine months ended September 30, 2006 and
2005, as well as presenting net revenue as a percentage of the corresponding
total revenue (approximate amounts due to rounding):
21
Total Collections Sales
------------------- ------------------- -------------------
For the Nine For the Nine For the Nine
Months Ended Months Ended Months Ended
Sept., 30 Sept. 30, Sept. 30,
2006 2005 2006 2005 2006 2005
---------- ------- ---------- ------- ---------- -------
($in millions) ($in millions) ($in millions)
Total revenues $ 12.0 $ 10.6 $ 10.5 $ 10.0 $ 1.6 $ 0.6
Less basis recovery (6.2) (4.7) (5.2) (4.5) (1.0) (0.2)
---------- ------- ---------- ------- ---------- -------
Net revenues $ 5.8 $ 5.8 $ 5.2 $ 5.5 $ 0.6 $ 0.4
========== ======= ========== ======= ========== =======
Net Revenue
Percentage 48.3% 55.2% 50.1% 54.6% 35.5% 66.9%
Portfolio collections provided 87.1% of our total revenues for the nine months
ended September 30, 2006, and 94.5% of our total revenues for the nine months
ended September 30, 2005. Our total revenues from portfolio collections
increased by $465,000 substantially due to collections from recently purchased
portfolios and increased efficiency in collection procedures for both recently
purchased and older portfolios. Our net revenues from portfolio collections
decreased by $210,000 and the percentage of net revenues to total revenues
decreased 4.5% to 50.1% for the nine months ended September 30, 2006 from 54.6%
for the nine months ended September 30, 2005. These results reflect the fact
that recently purchased portfolios (which provide no net revenues because of
front-loaded cost basis recovery) continue to provide a substantial portion of
our increased total collection revenues. During the nine months ended September
30, 2006, we acquired $4.1 million of new portfolios (net of returns). During
2005, we acquired $11.5 million of new portfolios (net of returns; $11.0 million
after adjusting for a January 2006 sale of a $461,000 portion of a portfolio
purchased in December 2005). We have seen our total revenue from collections
increase as we begin to exploit the large purchases we made in 2005 and expect
to continue to make in 2006. We expect to continue to have strong total
collection revenue as we collect these recent portfolio purchases, but we do not
expect our total collection revenue increases in 2006 to be as large as our 2005
increases were in comparison to 2004. As previously pointed out, total revenues
from collections in the third quarter of 2006 were down from the comparable
period in 2005. We expect to continue to have strong total collection revenue as
we collect these recent portfolio purchases. The cost basis recovery associated
with collecting recently purchased 2005 portfolios, combined with the portfolios
that we have already acquired in 2006 and additional portfolios we plan to
acquire in 2006 could continue to offset the increase in net revenue percentage
we would otherwise expect our older portfolios (whose cost bases we have
completely recovered) to generate and actually result in a further decline in
our net revenue percentage.
Both our total and net revenues from portfolio sales showed increases. As part
of our program to emphasize efforts to continue to collect and realize a
reasonable return on our portfolios, we identified one larger portfolio that was
not performing to our expectations. We sold this portfolio for $1.1 million
with Varde's consent in the first quarter of 2006 on terms we considered
acceptable. We also sold a $461,000 portion of a portfolio purchased in December
2005. We may engage in further sales if we identify portfolios that are not
performing to our expectations and we believe market conditions are acceptable.
We continue collection efforts for certain accounts in these portfolios right up
until the point of sale. We also anticipate continuing to sell portions of newly
acquired portfolios from time to time, but we do not expect to generate
substantial net revenues from these sales.
Net revenues from sales of $552,000 for the nine months ended September 30,
2006, exceeded net revenues from sales of $383,000 for the nine months ended
September 30, 2005, by $169,000. If we exclude the effect of portfolio sales,
our net loss for the nine months ended September 30, 2006, increases to a net
loss of $903,000, and our net loss for the nine months ended September 30, 2005
widened to $393,000. Our net loss excluding the effect of portfolio sales did
increase substantially, despite increased total revenues from collections, due
to proportionately greater cost basis recovery (i.e., the decrease in net
revenue percentage discussed above) and to increased interest expense and other
financing costs.
During the nine months ended September 30, 2006, we generated positive cash flow
from operating activities of $1.7 million, enabling us to make distributions to
the Company's investors and pay down third party loans. Members' equity,
however, decreased by $850,000 during the nine months ended September 30, 2006.
This significant decline in members' equity is attributed to distributions made
to investors of $499,000, as well as a net loss from operations of
22
$351,000, which resulted in part from the rising cost of portfolios and the
rising interest expenses and other costs associated with the increased use of
financing to purchase portfolios.
Operating Expenses
- -------------------
Our total operating costs and expenses remained relatively stable at $5.5
million for the nine months ended September 30, 2006, compared to $5.6 million
for the nine months ended September 30, 2005. Our ratio of operating costs and
expenses to total revenues from collections (i.e., excluding the effect of
portfolio sales), a measure of collection efficiency, decreased to 52.6% for the
nine months ended September 30, 2006, from 55.6% for the nine months ended
September 30, 2005. This percentage does not include the effects of interest
expense and other financing costs increasing from $285,000 for the nine months
ended September 30, 2005, to $629,000 for the same period in 2006. If interest
and other financing costs are added to total operating cost and expenses to
calculate the ratio of operating expenses to total revenue from collections the
percentages would be 58.6% for the nine months ended September 30, 2006 compared
to 58.4% for the nine months ended September 30, 2005. We plan to continue
following our strategy of increasing total revenues (while holding
infrastructure costs down) and reducing variable costs required to collect each
dollar of revenue, but we believe we may be nearing the point where it may not
be possible to achieve further material decreases in the ratio of operating
costs and expenses to total revenues from collections. We believe that our
agreement with Varde has played, and will continue to play, a significant role
in enabling us to increase the volume of accounts we have available to collect.
As provided above, our interest expense and other financing costs increased by
$344,000 to $629,000 in the nine months ended September 30, 2006, as compared to
$285,000 in the nine months ended September 30, 2005. We intend to continue
monitoring the magnitude of the change in the margin by which our total
collection revenues exceed our operating costs and expenses relative to the
principal and interest we pay to Varde under the credit facility to ensure that
the Varde facility provides additional liquidity to us and does not result in
loan payments that will deplete our cash balances. In order to maintain the
working capital necessary to run our operations, we anticipate maintaining a
careful balance between portfolios we purchase using our own cash (where
collection revenues are immediately available to us in full) and portfolios we
purchase using the Varde credit facility (where we must immediately apply a
substantial portion of collections to debt service).
Our salaries and benefits expenses have remained relatively constant at $3.2
million for the nine month periods ended September 30, 2006 and 2005. Our
operating expenses remained relatively constant at $5.5 million for the nine
months ended September 30, 2006 and 2005. This occurred while our total
collection revenues increased by $465,000 in the nine months ended September 30,
2006, as compared to the same nine month period in 2005.
LIQUIDITY AND CAPITAL RESOURCES
Our cash and cash equivalents decreased $456,000 in the first nine months of
2006 to a balance of $1.7 million at September 30, 2006. During the nine months
ended September 30, 2006, our portfolio collections and sales generated $12
million of cash, we borrowed $2.4 million and we used $6.4 million for operating
and other activities, $4.1 million to purchase new portfolios (net of returns),
$3.8 million to repay loans, and $499,000 for distributions to unit holders.
The large cost basis recovery associated with the recent rapid growth in our
portfolios has made it difficult to generate the profit called for in our
business plan: to recover the cost we pay for our portfolios, repay funds
borrowed to purchase portfolios, pay our collecting and operating costs and
still have a profit. Excluding the results from portfolio sales in the nine
months ended September 30, 2006, our cost basis recovery of $5.2 million plus
our operating, interest and other expenses of $5.5 million exceeded our total
revenues from collections of $10.5 million. We generated sufficient cash to
repay the portion of borrowed funds that came due in the first nine months of
2006. We believe these results reflect the steady progress we have made to focus
on collecting the right portfolios in an efficient manner. We believe our
future results will continue to reflect this progress, although the
"front-loading" of cost basis recovery from our recent large portfolio purchases
could cause our statement of operations to show a net loss.
During 2005 we believe we continued to improve the balance between our new and
old portfolios by purchasing the largest dollar amount of portfolios in one year
since inception ($11.5 million in 2005; $11.0 million after adjusting for the
January 2006 sale described above). We may not match that level of activity in
2006, but we plan to continue
23
adding new portfolios if we can purchase them at reasonable prices. We have
added $4.1 million of portfolios (net of returns) thus far in 2006. The current
market conditions make it doubtful that we will continue to acquire portfolios
at the same pace as in 2005. We will continue to depend on our assessment of
market conditions, as well as the amount of liquid cash and other financial
resources available to us.
We believe that our procedures to ensure that our collectors continue to focus
collection efforts on older portfolios that still have returns to yield, rather
than focusing just on the most recently acquired portfolios, continue to show
results. We have used our dialer to ensure that our collectors continue to focus
on portfolios other than those we have most recently acquired. By monitoring the
results of calls originated through our dialer, we identify portfolios that
require more cost to collect than others. As a result of these procedures, we
identified a larger portfolio that was not performing as well as we wanted, and
we sold it during the first quarter of 2006. We believe this process of
constantly evaluating portfolio returns against costs of collection should
continue to improve the balance between our new and old portfolios. Current
plans for 2006 do not call for the sale of a large number of older portfolios or
underperforming portfolios, but we may engage in further sales if we believe
market conditions are acceptable or portfolio performance is not up to our
expectations.
Our portfolios provide our principal long-term source of liquidity. Over time,
we expect to convert our portfolios to cash in an amount that equals or exceeds
the cost basis of our portfolios. In addition, some portfolios whose cost bases
we have completely recovered will continue to return collections to us. The
total fair value of our portfolios includes fair value attributable to the
residual interests of third parties in collections once all funds (including
funds invested by us) invested in a portfolio have been repaid (with interest)
and all servicing fees have been paid. The retained fair value of our
portfolios excludes fair value attributable to these residual interests. Our
estimate of the total fair value of our portfolios at September 30, 2006,
decreased $3.8 million to $24.2 million from $28 million at December 31, 2005.
At the same time, the cost basis of our portfolios decreased to $6.3 million at
September 30, 2006, from $8.4 million at December 31, 2005. Our estimate of the
retained fair value of our portfolios at Septmeber 30, 2006, decreased $3.9
million to $23.6 million from $27.5 million at December 31, 2005.
Our estimates of fair value decreased due principally to our collections and
portfolio sales exceeding the fair value of the $4.1 million of portfolio
purchases (net of returns) made thus far in 2006. Our portfolio cost basis also
decreased, due principally to the cost basis recovery associated with our
collections and sales exceeding the $4.1 million of portfolio purchases (net of
returns) made thus far in 2006. Whether the fair value and cost basis of our
portfolios will resume the growth established in 2005 will depend on our ability
to find portfolios at a reasonable price in a very competitive market. If we can
find reasonably priced portfolios, we believe our portfolio fair value and cost
basis will increase in the near term because we can use the Varde credit
facility as well as reinvest some cash proceeds from collections to purchase new
portfolios. Long-term growth in portfolio fair value and cost basis will depend
on whether market conditions continue to permit us to purchase portfolios at
reasonable prices and on our financial resources.
We used a discount rate of 20% to determine the fair values of our portfolios at
June 30, 2006 and December 31, 2005. The following table sets forth alternative
estimates of total fair value, retained fair value, and the portion of fair
value attributable to residual interests of third parties in collections, if we
assessed collection risk as higher (using a discount rate of 25%) or lower
(using a discount rate of 15%).
Total Retained Fair Value of
Fair Value Fair Value Residual Interests
------------------- ------------------- ----------------------
Sep 30 Dec 31 Sep 30 Dec 31 Sep 30 Dec 31
2006 2005 2006 2005 2006 2005
--------- -------- --------- -------- --------- -----------
($in millions) ($in millions) ($in millions)
Higher collection risk (25% discount rate) $ 22.6 $ 26.2 $ 22.0 $ 25.7 $ 0.6 $ 0.5
Assumed collection risk (20% discount rate) $ 24.2 $ 28.0 $ 23.6 $ 27.5 $ 0.6 $ 0.5
Lower collection risk (15% discount rate) $ 26.2 $ 30.3 $ 25.5 $ 29.7 $ 0.7 $ 0.6
Our estimates of fair values also would change if we revised our projections of
the magnitude and timing of future collections. Because of the inherent
uncertainty associated with predicting future events, our determinations of fair
24
value at any particular point in time are only estimates, and actual fair value
could ultimately vary significantly from our estimate.
We do not present the portion of fair value attributable to residual interests
of third parties in collections as a liability in our financial statements,
although it does represent a contingent obligation to make payments to a third
party. Because we will receive a servicing fee and our share of residual
collections, we believe collections of the specified portfolios will generate
funds sufficient to pay these residual interests to third parties as they come
due and cover our operating costs, with the potential for some profit on our
part. If our collection efficiency declines significantly, however, we might
have to use some of our own capital to cover operating costs.
In the near term, we plan to reinvest some of our cash collections representing
cost basis recovery to acquire additional portfolios and use the Varde facility
to acquire additional portfolios to continue growing the fair value of our
portfolios on a quarter to quarter basis. Ultimately we plan to reinvest all of
the cash representing cost basis recovery, plus a portion of excess cash, to
acquire additional portfolios.
Our Board of Directors has described this strategy as having two parts:
- Provide an annuity without impairing the value of the
business; and
- Grow the business to increase the annuity.
Due to factors such as the availability of new portfolios, market pricing
conditions for new portfolios, the timing of loan repayments and residual
interest payments to Varde, and the timing of distributions to our members, we
may not achieve increases in fair value each quarter.
In the near term, we plan to use some of our cash collections representing cost
basis recovery to make distributions to our members and interest holders.
Ultimately we plan to generate cash in excess of our collection and operating
costs and our cost basis recovery and to use some of the excess cash to make
distributions to our members and interest holders. Beginning in April 2003, we
began making quarterly distributions. During 2005, we made distributions
totaling $658,000. We made distributions of $166,000 in each of January 2006,
April 2006, July 2006 and October 2006 relating to the quarters ended December
31, 2005, March 31, 2006, June 30, 2006, and September 30, 2006 respectively.
During the nine months ended September 30, 2006, we generated positive cash flow
from operating activities of $1.7 million, enabling us to make distributions to
the Company's investors and pay down third party loans. Members' equity,
however, decreased by $850,000 during the nine months ended September 30, 2006.
This significant decline in members' equity is attributed to distributions made
to investors of $499,000, as well as a net loss from operations of $351,000,
which resulted in part from the rising cost of portfolios and the rising
interest expenses and other costs associated with increased use of financing to
purchase portfolios.
Our agreement with Varde provides us with a source of capital to purchase new
portfolios. The agreement provides up to $25 million of capital (counting each
dollar loaned on a cumulative basis) over a five-year term. We will never have
outstanding indebtedness approaching the full $25 million at any one time, due
to the cumulative nature of the facility. At September 30, 2006, Matterhorn owed
$5.9 million under the facility in connection with purchases of certain
charged-off loan portfolios. Under the credit facility, Varde has a first
priority security interest in Matterhorn's assets. The assets of Matterhorn that
provide security for Varde's loan were carried at a cost of $5.0 million at
September 30, 2006. The loan advances have minimum payment threshold points with
terms of two years and bear interest at the rate of 12% per annum. These
obligations are scheduled to be repaid in full on dates ranging from April 2007
to June 2008. Once all funds (including those invested by us) invested in a
portfolio financed by Varde have been repaid (with interest) and all servicing
fees have been paid, Varde will begin to receive a residual interest in
collections of that portfolio. Depending on the performance of the portfolio,
these residual interests may never be paid, they may begin being paid a
significant time later than Varde's loan is repaid (i.e., after the funds
invested by us are repaid with interest), or, in circumstances where the
portfolio performs extremely well, the loan could be repaid early and Varde
could conceivably begin to receive its residual interest on or before the date
that the loan obligation was originally scheduled to be paid in full. The
amount of remaining available credit under the facility at September 30, 2006
was $12.4 million.
25
There can be no assurance that Varde will advance any new money under the
facility, because in each instance Varde must approve of the portfolio(s) we
propose to acquire and the terms of the acquisition. We do not have any plans to
raise equity capital. Based on our cash position and current financial
resources, and assuming our operating results continue to increase at projected
levels, we believe we have adequate capital resources to continue our business
as presently conducted for the foreseeable future. We plan to continue to use
the Varde credit facility to maximize the return on our infrastructure and to
continue to reduce variable costs required to collect each dollar of revenue. We
will continue to consider other alternatives to increase the volume of accounts
we service other than through new portfolio acquisitions using only our cash
resources, however, if the economic returns to us seem reasonable.
We have continued a project begun in 2004 to obtain authority to collect in each
state where a license, exemption or other such registration is required to
collect on behalf of a third party. We have made progress with this project
during 2006 and will consider collecting accounts for third parties on a
case-by-case basis as such opportunities present themselves.
We do not have any contractual commitments to make capital expenditures, and we
have not budgeted any capital expenditures for the coming year. We may from time
to time acquire capital assets on an as needed basis, such as the $80,000 of
computer equipment and office furniture we acquired during the nine months of
2006. Our most significant capital assets are our dialer and our telephone
switch, which we do not anticipate having to replace within the next year.
We timely exercised our option to renew the lease on our existing office space,
but we could not reach agreement with our landlord on terms for the renewal. As
a result, we continued to explore other alternatives, which resulted in us
entering into a new lease for office space on July 17, 2006 with LBA Realty
Fund-Holding Co. II, LLC in Buena Park, California. The term of the lease is 87
months and is expected to commence on or around December 1, 2006, and will
expire on February 28, 2014. We have an option to renew the lease for one
additional five-year term at the then prevailing "fair market rental rate" at
the end of the term. We intend to use the leased premises as our principal
executive offices and operating facility. We believe that the lease agreement
will provide adequate space for our operations as currently conducted and as we
expect to conduct them for the foreseeable future. A breakout of the approximate
annual lease commitments is contained in Note 9 to the Condensed Notes to the
Consolidated Financial Statements on page 15 of this Form 10-QSB. In addition to
the base rent, the Company must pay its pro rata share of the increase in
operating expenses, property taxes and property insurance for the building above
the total dollar amount of operating expenses, property taxes and property
insurance for the 2006 base calendar year.
On November 10, 2006, we commenced a Voluntary Sale Program offering to our unit
holders who own a total of 99 or fewer units the option to sell all (but not
less than all) of their units back to us at a price of $4.75 per unit. The
Program will expire at 5:00 PM Eastern Time on December 22, 2006, unless
extended. We believe that approximately 1,100 unit holders out of a total of
2,500 record unit holders own in aggregate 99 or fewer units and such unit
holders beneficially own a total of approximately 78,000 units out of 564,125
units outstanding. The potential outlay could total $370,000. The amount of
capital paid out to the unit holders is dependent upon the number of units we
repurchase.
ITEM 3. CONTROLS AND PROCEDURES
In accordance with the Exchange Act, we carried out an evaluation, under the
supervision and with the participation of management, including our Chief
Operations Officer and our Accounting Manager, of the effectiveness of our
disclosure controls and procedures as of the end of the period covered by this
report. In designing and evaluating disclosure controls and procedures,
management recognized that any controls and procedures, no matter how well
designed and operated, can provide only reasonable assurance of achieving the
desired control objectives. Further, the design of a control system must reflect
the fact that there are resource constraints. Because of the inherent
limitations in all control systems, no evaluation of controls can provide
absolute assurance that all control issues and instances of fraud, if any, may
be detected. Based on this evaluation, our Chief Operations Officer and our
Accounting Manager concluded that our disclosure controls and procedures were
effective as of September 30, 2006, to provide reasonable assurance that
information required to be disclosed in our reports filed or submitted under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange
26
Commission's rules and forms. As noted below, however, we previously identified
a weakness in our disclosure controls and procedures that existed during the
period ended September 30, 2004.
During the process of evaluating and testing the effectiveness of our disclosure
controls and procedures for the period ended September 30, 2004, management
identified a potential deficiency involving the Company's failure to timely
disclose an event that was reportable under new Form 8-K Item 2.03. Disclosure
of this event was included in our Form 10-QSB for the quarter ended September
30, 2004, under Part II, Item 5. Since identifying this potential deficiency,
management monitored this potential deficiency to determine whether any further
mitigating controls are necessary. On December 30, 2005, we had a closing under
the Varde credit facility, which we disclosed in a Form 8-K under Item 2.03
dated December 30, 2005 and filed on February 1, 2006. The Form 8-K was filed 28
days late. We closed this transaction on a tight time line to accommodate the
seller's desire to consummate the transaction in 2005, and we then rebalanced
this purchase in January 2006, with Varde's consent, by transferring
approximately $750,000 of the portfolio to Performance Capital Management and by
selling approximately $461,000 of the portfolio to a third party. During the
several weeks over which we rebalanced this purchase, we overlooked our
obligation to file the required Form 8-K. We have since filed all of our
required reports on Form 8-K on a timely basis.
There has been no change in our internal controls over financial reporting that
occurred during the third quarter of 2006 that has materially affected, or is
reasonably likely to materially affect, our internal controls over financial
reporting.
27
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
- ------- --------------------------------------------------------------------------------------------------
2.1 Joint Chapter 11 Plan of Reorganization Proposed by Chapter 11 Trustee and the Official Committee
of Equity Security Holders effective February 4, 2002 (1)
2.2 First Amended Disclosure Statement Describing Joint Chapter 11 Plan Proposed by Chapter 11
Trustee and the Official Committee of Equity Security Holders approved on October 12, 2001 (1)
3.1 Performance Capital Management, LLC Articles of Organization (1)
3.2 Operating Agreement for Performance Capital Management, LLC (1)
3.3 First Amendment to Operating Agreement for Performance Capital Management, LLC (1)
3.4 Second Amendment to Operating Agreement for Performance Capital Management, LLC (2)
3.5 Third Amendment to Operating Agreement for Performance Capital Management, LLC (3)
4.1 Specimen Performance Capital Management, LLC Unit Certificate (1)
4.2 Specimen Performance Capital Management, LLC Economic Interest Unit Certificate (1)
4.3 Provisions in the Operating Agreement for Performance Capital Management, LLC pertaining to the
rights of LLC Unit holders (see Exhibits 3.2 and 3.3) (1)
10.1 Office Lease Agreement by and between LBA Realty Fund-Holding Co. II, LLC and Performance
Capital Management, LLC dated July 17, 2006 *
31.1 Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)
31.2 Certification of Principal Financial Officer Pursuant to Rule 13a-14(a)
32.1 Certification of Principal Executive Officer and Principal Financial Officer Pursuant to 18 U.S.C
.Sec. 1350 **
* Portions of this exhibit have been omitted and filed separately with the
Securities and Exchange Commision pursuant to a request for confidential
treatment.
** The certifications filed under Exhibit 32.1 are not deemed "filed" for
purposes of Section 18 of the Securities Exchange Act of 1934 and are not to be
incorporated by reference into any filing of Performance Capital Management, LLC
under the Securities Exchange Act of 1933, as amended, or the Securities
Exchange Act of 1934, as amended, whether made before or after the date hereof
irrespective of any general incorporation by reference language contained in any
such filing, except to the extent that Performance Capital Management, LLC
specifically incorporates it by reference.
(1) Filed on April 2, 2003 as an exhibit to our report on Form 8-K dated
February 4, 2002, and incorporated herein by reference.
(2) Filed on November 14, 2003 as an exhibit to our report on Form 10-QSB for
the period ended September 30, 2003, and incorporated herein by reference.
(3) Filed on August 14, 2006 as an exhibit to our report on Form 10-QSB for the
period ended June 30, 2006, and incorporated herein by reference.
28
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
PERFORMANCE CAPITAL MANAGEMENT, LLC
November 13, 2006 By: /s/ David J. Caldwell
- ----------------- --------------------------------
(Date) Name: David J. Caldwell
Its: Chief Operations Officer
29
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
- ------- --------------------------------------------------------------------------------------------------
2.1 Joint Chapter 11 Plan of Reorganization Proposed by Chapter 11 Trustee and the Official Committee
of Equity Security Holders effective February 4, 2002 (1)
2.2 First Amended Disclosure Statement Describing Joint Chapter 11 Plan Proposed by Chapter 11
Trustee and the Official Committee of Equity Security Holders approved on October 12, 2001 (1)
3.1 Performance Capital Management, LLC Articles of Organization (1)
3.2 Operating Agreement for Performance Capital Management, LLC (1)
3.3 First Amendment to Operating Agreement for Performance Capital Management, LLC (1)
3.4 Second Amendment to Operating Agreement for Performance Capital Management, LLC (2)
3.5 Third Amendment to Operating Agreement for Performance Capital Management, LLC (3)
4.1 Specimen Performance Capital Management, LLC Unit Certificate (1)
4.2 Specimen Performance Capital Management, LLC Economic Interest Unit Certificate (1)
4.3 Provisions in the Operating Agreement for Performance Capital Management, LLC pertaining to the
rights of LLC Unit holders (see Exhibits 3.2 and 3.3) (1)
10.1 Office Lease Agreement by and between LBA Realty Fund-Holding Co. II, LLC and Performance
Capital Management, LLC dated July 17, 2006 *
31.1 Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)
31.2 Certification of Principal Financial Officer Pursuant to Rule 13a-14(a)
32.1 Certification of Principal Executive Officer and Principal Financial Officer Pursuant to 18 U.S.C
.Sec. 1350 **
* Portions of this exhibit have been omitted and filed separately with the
Securities and Exchanged Commission pursuant to a request for confidential
treatment.
** The certifications filed under Exhibit 32.1 are not deemed "filed" for
purposes of Section 18 of the Securities Exchange Act of 1934 and are not to be
incorporated by reference into any filing of Performance Capital Management, LLC
under the Securities Exchange Act of 1933, as amended, or the Securities
Exchange Act of 1934, as amended, whether made before or after the date hereof
irrespective of any general incorporation by reference language contained in any
such filing, except to the extent that Performance Capital Management, LLC
specifically incorporates it by reference.
(1) Filed on April 2, 2003 as an exhibit to our report on Form 8-K dated
February 4, 2002 and incorporated herein by reference.
(2) Filed on November 14, 2003 as an exhibit to our report on Form 10-QSB for
the period ended September 30, 2003 and incorporated herein by reference.
(3) Filed on August 14, 2006 as an exhibit to our report on Form 10-QSB for the
period ended June 30, 2006, and incorporated herein by reference.