<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended Commission file number
December 31, 1999 001-12351
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METRIS COMPANIES INC.
(Exact name of registrant as specified in its charter)
Delaware 41-1849591
(State of Incorporation) (I.R.S. Employer Identification No.)
600 South Highway 169, Suite 1800, St. Louis Park, Minnesota 55426
(Address of principal executive offices)
(952) 525-5020
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to section 12(g) of the Act:
Common Stock, $.01 Par Value
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months and (2) has been subject to such filing requirements for
the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
As of February 25, 2000, 38,683,524 shares of the Registrant's Common Stock were
outstanding and the aggregate market value of common stock held by
non-affiliates of the Registrant on that date was approximately $1,006,795,000
based upon the closing price on the New York Stock Exchange on February 25,
2000.
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the Annual Report to Shareholders for the year ended
December 31, 1999, are incorporated by reference in Parts II and IV.
Certain portions of the Proxy Statement for the Annual Meeting of Shareholders
of Metris Companies Inc. to be held on May 9, 2000, which will be filed with the
Securities and Exchange Commission within 120 days after December 31, 1999, are
incorporated by reference in Part III.
<PAGE>
TABLE OF CONTENTS
PART I
Page
Item 1. Business......................................................... 2
Item 2. Properties.......................................................34
Item 3. Legal Proceedings................................................34
Item 4. Submission of Matters to a Vote of Security Holders..............34
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters..........................................34
Item 6. Selected Financial Data..........................................35
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations..........................35
Item 7A.Quantitative and Qualitative Disclosures
About Market Risk............................................35
Item 8. Financial Statements and Supplementary Data......................36
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure..........................75
PART III
Item 10. Directors and Executive Officers of the Registrant..............75
Item 11. Executive Compensation..........................................75
Item 12. Security Ownership of Certain Beneficial
Owners and Management.......................................75
Item 13. Certain Relationships and Related Transactions..................75
PART IV
Item 14. Exhibits, Financial Statement Schedules
and Reports on Form 8-K.....................................76
Signatures...............................................................77
Exhibit Index............................................................79
<PAGE>
PART I
Item 1. Business
Metris Companies Inc. ("MCI" and collectively with its subsidiaries, the
"Company," which may be referred to as "we," "us" and "our") is an
information-based direct marketer of consumer credit products and fee-based
services, primarily to moderate-income consumers. The Company's consumer credit
products are primarily unsecured and secured credit cards issued by its
subsidiary, Direct Merchants Credit Card Bank, National Association ("Direct
Merchants Bank"). Our customers and prospects include individuals for whom
credit bureau information is available ("External Prospects") and other third
party sources including customer lists and databases. We market our fee-based
services, including debt waiver programs, membership clubs, extended service
plans, and third-party insurance, to our credit card customers and customers of
third parties.
MCI was incorporated in Delaware on August 20, 1996. We became a publicly
held company in October 1996 after completing an initial public offering. Our
principal subsidiaries are Direct Merchants Bank, and Metris Direct, Inc. During
the third quarter of 1998, Fingerhut Companies, Inc., which held approximately
83% of our common stock, received written approval from the Internal Revenue
Service to distribute its interest in us to their shareholders in a tax-free
spin off (the "spin off").
Business Segments
We measure performance and operate in two business segments:
Consumer Credit Products, which are primarily unsecured and secured credit
cards issued by Direct Merchants Bank; and
Fee-Based Services, which include debt waiver programs, membership clubs,
extended service plans and third-party insurance offered to our credit card
customers and customers of third parties.
We receive income from our consumer credit products through: interest
charges assessed on outstanding credit card loans; credit card fees (including
annual membership, cash advances, overlimit fees, and past-due fees); and
interchange fees. The primary expenses of this business are the costs of funding
the loans, provisions for loan losses and operating expenses including employee
compensation, account solicitation and marketing expenses and data processing
and servicing expenses. Profitability is affected by response and approval rates
to solicitation efforts, loan growth, interest spreads on loans, credit card
usage, credit quality (delinquencies and charge-offs), card cancellations and
fraud losses.
In addition to selling fee-based services to third parties, our fee-based
services business derives benefits from our consumer credit products business
because we cross-sell these services to our credit card holders. Nonetheless,
our two business segments are different with respect to the factors that affect
profitability, including how income is generated and how expenses are incurred.
These differences require us to manage our operations separately.
We receive revenue from our fee-based services through fees and
commissions. Our expenses include costs of solicitation, underwriting and claims
servicing expenses, fees paid to third parties and other operating expenses. The
primary factors that affect profitability for this business are: response rates
to solicitation efforts, returns or cancel rates, and claims rates.
We primarily target moderate-income consumers whom we believe have
historically been overlooked by other credit card companies. We target and
evaluate prospective customers in this market by using our proprietary scoring
techniques, together with information from credit bureaus and other customer
lists and databases, to determine a potential customer's creditworthiness. We
also use sophisticated modeling techniques to evaluate the expected risk,
responsiveness, and profitability of each prospective customer and to offer and
price the products and services we believe to be appropriate for each customer.
(See more detailed discussion following under "Business Lines.")
Strategy
The principal components of our strategy are the following:
Identify and solicit additional External Prospects for credit cards. We
intend to continue adding moderate-income consumers through the use of our own
internally developed risk models. We have developed our own proprietary credit
risk modeling system (the "Proprietary Modeling System"). By incorporating
individual credit information from the major credit bureaus into this
Proprietary Modeling System and eliminating those individuals contained in the
Fingerhut suppression and bad debt file (the "Suppress File"), we expect to
generate additional customer relationships from External Prospects.
Use risk-based pricing. We determine the specific pricing for an
individual's credit card offer through the prospective customer's risk profile
and expected responsiveness prior to solicitation, a practice known as
"risk-based pricing." We believe the use of risk-based pricing allows us to
maximize the profitability of a customer relationship.
Pursue acquisitions of credit card portfolios. We expect to continue to
pursue acquisitions of credit card portfolios and/or other businesses whose
customers fit our product and target market profile or which otherwise
strategically fit with our business.
Increase the number of third party customers using our products and
services. We will seek to access additional customers for our products and
services by establishing relationships with third parties. Our strategy is to
continue to use our proprietary risk, response and profitability models to
solicit strategic partner's customers for credit cards, and to focus our
cross-selling activities in order to increase the volume of fee-based services
and extended service plans purchased by these customers.
Sell multiple products and services to each customer. We intend to maximize
the profitability of each customer relationship by selling additional products,
thereby leveraging our account acquisition costs and infrastructure. Currently
we focus our efforts on selling fee-based services to our credit card customers
and customers of third parties.
Diversify product offerings to our customers. We intend to segment markets
to expand the success of our existing credit and fee-based products. To do so,
we plan to analyze the data in our proprietary database and the databases of
others to determine the needs of our target markets, then develop, test and
effectively market these new products to our target markets.
Spin Off
During the third quarter of 1998, Fingerhut received formal written
approval from the Internal Revenue Service to complete the tax-free spin off of
their 83% interest in the Company. The Fingerhut Board of Directors approved the
spin off and completed the distribution of Metris shares on September 25, 1998
to Fingerhut shareholders.
Each of the agreements between us and Fingerhut, other than the tax sharing
agreement, remain in effect after the spin off. Although the administrative
services agreement remains in effect, it is expected that the only continuing
administrative services to be provided by Fingerhut to us will be information
systems, and that these services will continue to be provided for no longer than
24 months following the spin off.
Each of the agreements between us and Fingerhut may terminate early due to
a change of control of the Company, as defined in the Risk Factors on page 26.
The spin off itself did not constitute a change of control. However, now that
Fingerhut does not own the stock of the Company, it is possible for a change of
control to occur, thus causing early termination of these agreements.
On November 13, 1998, we entered into agreements with affiliates of the
Thomas H. Lee Company to invest $300 million in the Company. The terms of the
transaction provided that the Lee Company investment would convert into 0.8
million shares of Series C Perpetual Convertible Preferred Stock upon
shareholder approval and receipt of notice that there was no regulatory
objection to the transaction. We determined that this conversion might result in
a change of control as defined in certain agreements between us and Fingerhut,
which would permit Fingerhut to terminate any or all of the agreements.
Therefore, on December 8, 1998, we obtained an agreement (the "Waiver
Agreement") from Fingerhut to waive its right to terminate the agreements if a
change of control occurred as a result of the conversion.
Pursuant to the Waiver Agreement, the Company and Fingerhut amended
certain of their other agreements. The most significant change occurred in the
database access agreement. Our exclusive license to use Fingerhut's customer
database to market financial service products will become non-exclusive after
October 31, 2001.
Currently, no individual holds titles of officer or director at both
Fingerhut and the Company.
Business Lines
We operate primarily through two businesses: consumer credit products and
fee-based services.
Consumer credit products
Products. Our consumer credit products are primarily unsecured and secured
credit cards, including the Direct Merchants Bank MasterCard(R) and Visa(R). We
offer co-branded credit cards and may also offer other consumer credit products
either directly or through alliances with other companies. At December 31, 1999,
we had approximately 3.7 million credit card accounts with approximately $7.3
billion in managed credit card loans. According to the Nilson Report, at
December 31, 1999, we were the 9th largest MasterCard issuer in the United
States based on the number of cards issued, and the 11th largest credit card
issuer based on managed credit card loan balances.
Prospects. Our primary sources of prospects to solicit for credit card
offers are obtained from credit bureau queries and individuals in third-party
customer lists and databases. Currently, our most significant source is the
leads obtained from credit bureau inquiries. Our most significant third party
customer source is a database maintained by Fingerhut, a wholly owned subsidiary
of Federated Department Stores, Inc. Fingerhut is a database marketing firm that
sells a broad range of products and services via catalogs, telemarketing,
television, the Internet and other media. Substantially all of Fingerhut's sales
are made using closed-end and revolving credit card loans. As customers make
payments and order new products, Fingerhut enters a variety of payment,
behavioral, and other data into its database. Fingerhut uses information in its
database, along with sophisticated proprietary credit scoring models, to produce
its proprietary credit scores for its customers. The Fingerhut database also
includes Fingerhut's suppress file, which contains information on individuals
about whom it has information relating to indicators of unacceptably high risk.
Fingerhut periodically updates the information in its database. Fingerhut does
not report its credit information to the credit bureaus, which means this
information is not publicly available. At December 31, 1999, Fingerhut customers
represented approximately 30% of our accounts and managed loans.
Credit Scoring. We use internally and externally developed proprietary
models to enhance our evaluation of prospects. These models help segment these
prospects into narrower ranges within each risk score provided by Fair, Isaac
and Co ("FICO"), allowing us to better evaluate individual credit risk and to
tailor our risk-based pricing accordingly. We also use this segmentation along
with the Fingerhut suppress file to exclude certain individuals from our
marketing solicitations.
We generate External Prospects from lists obtained from the major credit
bureaus based on criteria established by us. We use proprietary models and
additional analysis in conjunction with files obtained from the credit bureaus
to further segment prospects based upon their likelihood of delinquency. We also
eliminate any names which are included in the Fingerhut suppress file. We
currently do not solicit prospects obtained from the credit bureaus who do not
have risk scores calculated by FICO.
We believe that our proprietary models in conjunction with additional
analysis is effective in further segmenting and evaluating risk within risk
score bands. However, for certain campaigns the models and additional analysis
were less effective in doing so than in other campaigns. We have and continue to
use the results of our analysis of prospects to adjust the proprietary models to
determine the pricing for various segments and to exclude certain segments from
subsequent direct marketing efforts. While we believe that the proprietary
models and additional analysis are valuable tools in analyzing relative risks,
it is not possible to accurately predict which consumers will default or the
overall level of defaults, and we cannot assure you as to the levels of actual
delinquencies or losses.
We also use the Fingerhut database to identify potential customers.
Fingerhut uses the information in their database, along with its proprietary
credit scoring models, to create the Fingerhut score. We also acquire credit
bureau information, including FICO scores, for all Fingerhut customers. For
those Fingerhut customers who have FICO scores, we use the Fingerhut score to
further segment Fingerhut customers into narrower ranges within each FICO score
subsegment, allowing us to better evaluate credit risk and to tailor its
risk-based pricing accordingly. Additionally, we use the Fingerhut score to
target individuals who have no credit bureau information, and consequently no
FICO score, allowing us to target Fingerhut customers who would not typically be
solicited by other credit card issuers. The Fingerhut score has been effective
in enhancing our ability to select which Fingerhut customers to solicit and in
rank ordering Fingerhut customers according to their likelihood of delinquency.
We believe that both the proprietary models and the Fingerhut score, in
conjunction with the Fingerhut suppress file, give us a competitive advantage in
evaluating the credit risk of moderate-income consumers. We believe that due to
the amount and type of credit information available in the Fingerhut database,
the Fingerhut score is currently more effective than our proprietary models in
allowing us to evaluate the credit risk of prospects having lower FICO scores.
Therefore, we have been willing to solicit certain consumers who have lower FICO
scores if they also have an appropriate Fingerhut score. As a result, our
Fingerhut-sourced credit card customers generally have lower initial FICO scores
than do other prospects. After every marketing campaign, we monitor the
performance of the proprietary models and continually re-evaluate the
effectiveness of these models in segmenting credit risk, resulting in further
refinements to our selection criteria for prospects. Over time, we believe that
we will capture additional credit information on the behavioral characteristics
of prospects which will allow us to further increase the effectiveness of our
proprietary models.
Solicitation. Prospects for solicitation include both External Prospects
and customers of third parties. Prospects are contacted on a nationwide basis
primarily through pre-screened direct mail and telephone solicitations. We
receive responses to our solicitations, perform fraud screening, verify name and
address changes, and obtain any information which may be missing from the
application. Applications are sent to third party data entry providers, which
key the application information and process the applications based on the
criteria provided by us. We then make the credit decisions and approve, deny or
begin the exception processing. We process exceptions for, among other things,
derogatory credit bureau information and fraud warnings. Exception applications
are processed manually by credit analysts based on policies approved by our
credit committee.
Pricing. Through risk-based pricing, we price credit card offers based upon
a prospect's risk profile prior to solicitation or upon receipt of an
application. We evaluate a prospect to determine credit needs, credit risk, and
existing credit availability and then develop a customized offer that includes
the most appropriate product, brand, pricing and credit line. We currently offer
over 100 different pricing structures on our credit card products, with annual
fees ranging from $0 to $75 and annual interest rates up to 28.99%. After credit
card accounts are opened, we periodically monitor customers' internal and
external credit performance and recalculate delinquency, profitability,
attrition and bankruptcy predictors. As customers evolve through the credit life
cycle and are regularly rescored, the lending relationship may evolve to include
more or less restrictive pricing and product configurations.
Age of Portfolio. The following table sets forth, as of December 31, 1999,
the number of total accounts and amount of outstanding loans based on the age of
the managed accounts. (Accounts in acquired portfolios are presented based on
when the account was originated with the previous issue.)
<TABLE>
Percentage of
Age Since Number Percentage Loans Loans
Origination Of Accounts of Accounts Outstanding Outstanding
- ----------- ----------- ----------- ----------- -----------
(Dollars in
thousands)
<S> <C> <C> <C> <C>
0-6 Months ............. 639,084 17.4% $ 528,100 7.3%
7-12 Months ............ 267,788 7.3% 367,827 5.0%
13-18 Months ........... 394,299 10.7% 889,548 12.2%
19-24 Months ........... 265,667 7.2% 544,849 7.5%
25-36 Months ........... 575,557 15.6% 1,336,775 18.4%
37+ Months ............. 1,537,183 41.8% 3,614,223 49.6%
--------- ----- ---------- -----
Total ............. 3,679,578 100.0% $7,281,322 100.0%
========= ===== ========== =====
</TABLE>
Geographic Distribution. We solicit credit card customers on a national
basis and, therefore, maintain a geographically diversified portfolio. The
following table shows the distribution of total accounts and amount of
outstanding loans by state, as of December 31, 1999.
Percentage of
Number Percentage Loans Loans
State Of Accounts of Accounts Outstanding Outstanding
- ----- ----------- ----------- ----------- -----------
(Dollars in
thousands)
California ............. 457,308 12.4% $ 926,613 12.7%
Texas .................. 334,153 9.1% 655,687 9.0%
New York ............... 273,917 7.4% 553,787 7.6%
Florida ................ 264,762 7.2% 545,003 7.5%
Ohio ................... 151,142 4.1% 302,786 4.2%
Illinois ............... 140,309 3.8% 276,493 3.8%
Pennsylvania ........... 116,823 3.2% 231,388 3.2%
Michigan ............... 100,769 2.7% 198,064 2.7%
Georgia ................ 96,713 2.6% 195,845 2.7%
Virginia ............... 96,543 2.6% 193,400 2.6%
North Carolina ......... 98,416 2.7% 187,146 2.6%
All others (1) ......... 1,548,723 42.2% 3,015,110 41.4%
---------- ----- ---------- -----
Total ............. 3,679,578 100.0% $7,281,322 100.0%
========== ===== ========== =====
(1) No other state accounts for more than 2.5% of loans outstanding.
Credit Lines. Once we approve an account we use automated screening and
credit scoring techniques to establish an initial credit line based on the
individual's risk profile. Excluding the portfolios that were purchased from
other companies, our credit lines are below the industry average, due to our
risk assessment methods and the higher average risk inherent in our target
market. We may elect, at any time and without prior notice to a cardholder, to
prevent or restrict further credit card use by the cardholder, usually as a
result of poor payment performance or our concern over the creditworthiness of
the cardholder. We manage credit lines based on the results of the behavioral
scoring analysis, and in accordance with our internally established criteria.
These analysis models automatically and regularly assign credit line increases
and decreases to individual customers, as well as determine the systematic
collection steps to be taken at the various stages of delinquency. We use these
models to manage the authorization of each transaction, as well as the
collections strategies used for non-delinquent accounts with balances above
their assigned credit lines.
<PAGE>
The following table sets forth information with respect to account balance
and credit limit ranges of our managed loan portfolio, as of December 31, 1999.
Percentage
Credit Number Percentage of
Limit of of Loans Loans
Range Accounts Accounts Outstanding Outstanding
- ----- -------- -------- ----------- -----------
(Dollars in
thousands)
$1,000 or Less 457,657 12.4% $ 237,307 3.3%
$1,001-$2,000 . 546,815 14.9% 654,971 9.0%
$2,001-$3,500 . 722,561 19.6% 1,274,394 17.4%
$3,501-$5,000 . 666,347 18.1% 1,564,087 21.5%
Over $5,000 ... 1,286,198 35.0% 3,550,563 48.8%
--------- ----- ---------- -----
Total .... 3,679,578 100.0% $7,281,322 100.0%
========= ===== ========== =====
Percentage
Number Percentage of
Account of of Loans Loans
Balance Range Accounts Accounts Outstanding Outstanding
- ------------- -------- -------- ----------- -----------
(Dollars in
thousands)
Credit Balance .. 59,807 1.6% $ (5,790) (.1%)
No Balance ...... 668,361 18.2% -- --
$1,000 or Less .. 948,063 25.8% 423,452 5.8%
$1,001-$2,000 ... 601,480 16.3% 942,125 13.0%
$2,001-$3,500 ... 668,151 18.2% 1,863,690 25.6%
Over $3,500 ..... 733,716 19.9% 4,057,845 55.7%
--------- ----- ----------- -----
Total .... 3,679,578 100.0% $ 7,281,322 100.0%
========= ===== =========== =====
Servicing, Billing and Payment. We have established a relationship with
First Data Resources, Inc. ("FDR") for cardholder processing services. FDR is a
subsidiary of First Data Corporation, a provider of information processing and
related services including cardholder processing (services for financial
institutions which issue credit cards to cardholders), and merchant processing
(services for financial institutions which make arrangements with merchants for
the acceptance of credit cards as methods of payment). FDR provides the
following services for us:
* data processing;
* credit card reissuance;
* monthly statements; and
* interbank settlement.
<PAGE>
Our processing services agreement with FDR expires in 2006. We handle the
following functions internally:
* applications processing; and
* back office support for mail inquiries and fraud management.
In addition, we handle most in-bound customer service telephone calls for
our customer base.
We generally assess periodic finance charges on an account if the
cardholder has not paid the balance in full from the previous billing cycle. We
base these finance charges on the average daily balance outstanding on the
account during the monthly billing cycle. The servicer applies payments in the
following order: first to any billed and unpaid fees, next to billed and unpaid
finance charges and then to billed and unpaid transactions in the order
determined by us. If we are not paid in full prior to the due date, which is 25
days after the statement cycle date, we impose finance charges on all purchases
from the date of the transaction to the statement cycle date. We also impose
finance charges on each cash advance from the day we make the advance until the
cardholder pays the advance in full. The finance charge is applied to the
average daily balance. For most cardholders, if they pay the entire balance on
the account by the due date, we do not impose a finance charge on purchases.
We assess an annual fee on some credit card accounts. We may waive the
annual fee, or a portion thereof, in connection with the solicitation of new
accounts depending on the credit terms offered, which we determined based on the
prospect's risk profile prior to solicitation, or when we determine a waiver to
be appropriate considering the account's overall profitability. In addition to
the annual fee, we charge accounts other fees, including:
* a late fee with respect to any unpaid monthly balance if we do not
receive the required minimum monthly payment by the due date;
* a cash advance fee for each cash advance;
* a fee with respect to each check submitted by a cardholder in payment of
an account, which the cardholder's bank does not honor;
* an overlimit charge if, at any time during the billing cycle, the total
amount owed exceeds the cardholder's credit line by at least $30; and
* card processing or application fees for some card offers.
Each cardholder is subject to an agreement governing the terms and
conditions of the accounts. Pursuant to the agreement, we reserve the right to
change or terminate certain terms, conditions, services and features of the
account (including periodic finance charges, late fees, returned check charges
and any other charges or the minimum payment), subject to the conditions set
forth in the account agreement.
FDR sends monthly billing statements to cardholders on our behalf. When we
establish an account, we assign a billing cycle. Currently, there are 20 billing
cycles. Each of the cycles has a separate monthly billing date based on the
respective business day the cycle represents in each calendar month. Each month,
we send a statement to all accounts with an outstanding balance greater than $1.
All cardholders with open accounts must make a minimum monthly payment,
generally of the greater of: $15, 2.5% of the outstanding balance, the finance
charge or the balance of the account if the balance is less than $15. If we do
not receive the minimum payment by the due date, we consider the account
delinquent.
Most merchant transactions by cardholders are authorized online. The
remaining transactions generally are low dollar amounts, typically below $50.
All authorizations are handled through FDR's adaptive control system.
Delinquency, Collections and Charge-offs. We consider an account delinquent
if we do not receive a payment due within 25 days from the closing date of the
statement. We manage the collections work internally. We determine the
collection actions to take by using the adaptive control system, which
continually monitors all delinquent accounts. We close accounts that become 60
days contractually delinquent, but do not necessarily charge them off. We charge
off and take accounts as a loss either within 60 days after formal notification
of bankruptcy or at the end of the month during which they become contractually
180 days past due. We immediately reserve for and charge off accounts that we
identify as fraud losses no later than 90 days after the last activity. We refer
charged-off accounts to our recovery unit for coordination of collection efforts
to recover the amounts owed. When appropriate, we place accounts with external
collection agencies or attorneys. Periodically, we sell a portion of our
charged-off portfolio to third-parties.
Fee-Based Services
We sell or offer fee-based services, including:
* debt waiver protection for unemployment, disability, and death;
* membership programs such as card registration, purchase protection and
other club memberships; and
* third-party insurance, directly to our credit card customers and
customers of third parties.
We currently administer the extended service plans that we sell through a
third-party retailer, and our customers pay the retailer directly. In addition,
we develop customized targeted mailing lists from information contained in both
our and Fingerhut's databases for use by unaffiliated companies in their own
financial services product solicitation efforts that do not directly compete
with ours.
We currently market the following programs:
Account Protection Plus(SM). Account Protection Plus is a program we have
developed that protects customers from interest charges on our credit cards in
the event that they become disabled or unemployed. The customer's account is
"frozen" for six months, with no payments due or interest accruing during this
time. In the event of death, the amount due, up to the credit limit, is waived
and the account is closed. Because this is an internally administered program,
we are responsible for all of the program's associated costs. We also offer
Account Benefit PlanSM which forgives the customer's balance due in the event of
death but offers no protection in the event of disability or unemployment.
Accidental Death Insurance. Beginning in May 1999, we began reinsuring the
risk associated with underwriting accidental death insurance. Under an
arrangement with a third-party insurance provider, this carrier sells accidental
death policies to our customers for a fee. Our captive insurance company, ICOM
Limited, then reinsures these policies from the third-party insurance provider.
When these policies are reinsured by us, we assume all risk of loss and incur
all administrative expenses related to servicing these policyholders. Prior to
May 1999 we earned a fee from a third-party insurance administrator for the
marketing and billing of the third-party's accidental death insurance program.
Credit Life. Credit Life is a program that we have developed to provide the
cardholder various coverage options. Depending on which coverage has been
selected, the program will make the minimum payment on the cardholders credit
card balance in the event of disability or unemployment for a period of six
months, pay off the entire balance in the event of death, and provide a death
benefit in the event of accidental death. A third party insurance company
underwrites the policy and then reinsures those policies with ICOM Limited, our
captive insurance subsidiary. We market this insurance program to our credit
card customers only.
Cash Benefit. Cash Benefit is a fee-based service launched in September
1999 that pays a set amount per month in the event of disability or unemployment
and has a death benefit. A third-party insurance company markets, fulfills and
underwrites the policies. We currently market Cash Benefit to our credit card
customers only.
PurchaseShield(R). PurchaseShield is a membership program that offers
various levels of purchase protection to its members. Eligible purchases made on
members' credit cards are protected with the following benefits:
* warranty extension;
* sale price protection; and
* product return guarantee.
In addition, PurchaseShield offers its members a household repair rebate
that can be used on certain existing in-home electro-mechanical item repairs.
Because we administer the program ourselves, we receive all revenues and are
responsible for all of the program's associated costs. We currently offer
PurchaseShield to our credit card customers and credit card customers of third
parties.
Card Registration. Card registration protects members from fraudulent
charges if their credit cards are lost or stolen and provides emergency cash and
airline tickets, change of address notification and lost or stolen card
notification, valuable property and document registration, a messaging service
and car rental discounts. We currently offer card registration service under the
names Fraud Alert Services(SM) and SafeKeeper(SM) to our credit card customers
and customers of third parties. We are responsible for all of its associated
costs and revenues.
DirectAlert(SM). DirectAlert is a fee-based service launched in April 1999
to help members monitor and review their credit report. Members of DirectAlert
receive the following benefits:
* access to their credit report in an easy to read format;
* quarterly updates detailing any changes in their credit report and the
names of anyone who has requested or received a copy of their credit
report;
* toll-free access to credit experts who are ready to answer questions and
assist with any disputes; and
* retirement information verification which can help members examine
their financial future by giving them an idea of what they will
receive from social security after they retire.
We currently offer DirectAlert to our credit card customers, credit card
customers of third parties and the Internet market.
Travel Club. TripSaver(SM) is a fee-based service launched in September
1999 that offers discounted travel services through the Metris travel agency.
Members of TripSaver receive benefits of airline, hotel and car rental
discounts, lowest price guarantee, 5% cash back on services booked through the
Metris travel agency and other travel related discounts. We currently offer
TripSaver to our credit card customers only.
Extended Service Plans. We administer extended service plans sold by
retailers. Extended service plans provide warranty coverage beyond the
manufacturer's warranty. In general, the extended service plans that we
administer provide customers with the right to have their covered purchases
repaired, replaced, or in certain circumstances, the purchase price of the
product refunded, within certain limits that we determine. Within the warranty
industry, extended service plans are available for a wide variety of products,
including consumer electronics and appliances, furniture, jewelry, automotives,
and household mechanical systems such as heating, plumbing and electrical
systems. We currently administer extended service plans for consumer
electronics, appliances, furniture and jewelry purchased from third-party
retailers.
ServiceEdge(R) is our extended service plan administered by the Company for
consumer electronics and all other electro-mechanical items. ServiceEdge
customers have the right to have their purchases repaired or replaced in the
event of electrical or mechanical failure or defects in materials and
workmanship for coverable events after the manufacturer's warranty expires.
Quality Furniture Care(SM) is our extended service plan program for
furniture. The services provided to Quality Furniture Care customers include
stain cleaning, structural defect or damage repair, or replacement if the
merchandise cannot be repaired.
Quality Jewelry Care(SM) is our extended service plan for jewelry. The
services provided to Quality Jewelry Care customers include repair, soldering,
ring sizing, prong re-tipping, and cleaning. We contract with third-party
jewelers to perform the services to our customers.
Most of the extended service plans that we administer continue for two
years from the date of the product purchase (three to five years in limited
cases). The customer pays the retail company a one-time fee for this coverage
based on the price of the product, the term of coverage and the loss risk of the
product. Customers may also be offered the opportunity to renew their coverage
in one-year extensions, presently up to six years from the date of purchase,
upon payment of an additional fee for each renewal. We are responsible for
claims risk and claims processing for all extended service plans sold.
Home ServiceEdge(SM). Home ServiceEdge is a fee-based service launched in
September 1999 that covers repairs for a number of major appliances in the home.
The plan will assist the customer in locating and arranging for service and, in
the event the appliance cannot be fixed, will pay a fixed dollar amount towards
the replacement of the appliance. We currently offer Home ServiceEdge to our
credit card customers only.
Tailored List Development. We currently work with several companies to
develop targeted mailing lists. We earn revenue for each name that is solicited
by these companies from our customer databases. We also earn revenue from the
sale of advertising space included in our monthly billing statements.
Other Membership Clubs. We have cooperative marketing arrangements with
several third parties to market the third party's memberships in clubs that do
not compete with our services or clubs. Additionally, we have other arrangements
with third parties, which we assumed from acquired credit card portfolios, that
provide us with revenue from ongoing membership fees billed to our acquired
credit card holders.
<PAGE>
Liquidity, Funding and Capital Resources
One of our primary financial goals is to maintain an adequate level of
liquidity through active management of assets and liabilities. Because the
pricing and maturity characteristics of our assets and liabilities change,
liquidity management is a dynamic process, affected by changes in short- and
long-term interest rates. We use a variety of financing sources to manage
liquidity, refunding and interest rate risks.
Metris Companies Inc. Year-End Funding Mix*
-------------------------------------------
1999 1998
---- ----
Total Year-End Funding $ 7.3 billion $ 5.3 billion
Bank Loans 1.4% 2.1%
Long-term Debt 3.4% 3.8%
Equity 8.6% 8.1%
Bank Conduit Securitizations 10.3% 17.6%
Deposits 10.7% --
Metris Master Trust 65.6% 68.4%
------------- -------------
100.0% 100.0%
============= =============
(*Chart replaces graph in 1999 Annual Report.)
We finance the growth of our credit card loan portfolio through asset
securitization, subsidiary bank deposits, bank loans, long-term debt issuance,
cash flow from operations and equity issuance.
Asset Securitization
A significant source of our funding is the securitization of our credit
card loans. Securitization involves packaging and selling both current and
future receivable balances of pools of credit card accounts, while retaining the
servicing of such receivables. Our securitizations are treated as sales under
generally accepted accounting principles. As a result, the securitized
receivables are removed from our balance sheet and treated as managed loans.
We primarily securitize receivables by selling the receivables either to
our proprietary trust, the Metris Master Trust, or to bank-sponsored
multi-seller conduits.
The Metris Master Trust. The Metris Master Trust was formed in May 1995
pursuant to a pooling and servicing agreement, which was amended on July 30,
1998. Metris Receivables, Inc., one of our subsidiaries, transfers receivables
in designated accounts to the trust in exchange for proceeds and an interest in
the trust. Metris Receivables, Inc. may then exchange portions of this interest
for one or more series of securities which it may then sell publicly or
privately to third-party investors. The securities each represent undivided
interests in all of the receivables in the trust, and may be split into separate
classes which have different terms. The different classes of an individual
series are structured to obtain specific credit ratings. As of December 31,
1999, ten series of securities have been issued by the trust. We currently
retain the most subordinated class of securities in each series and sell all the
other classes.
Generally, each series involves an initial reinvestment period (a
"revolving period") in which principal payments on receivables allocated to such
series are returned to Metris Receivables, Inc. and reinvested in new
receivables arising in the accounts. After the revolving period ends, principal
payments allocated to the series are then used to repay the investors. This
period is referred to as the amortization period. Currently, the trust has one
series which is in a controlled amortization period. The scheduled amortization
period is set in the agreements governing each series. However, all series set
forth certain events by which amortization can be accelerated (early
amortization). Usually, this would occur if the portfolio collections less
charge-offs for bad debt, financing costs and operational costs drop below a
minimum amount. Because new receivables in designated accounts cannot be funded
while a series is in amortization, early amortization would accelerate our
funding requirements for new receivables in the accounts. We do not have any
series that are in early amortization.
Each month, each series is allocated its share of finance charge
collections which are used to pay investors interest on their securities, to
reimburse them for their share of losses due to charge-offs and to pay their
share of servicing fees. Amounts remaining may be deposited in cash accounts of
the trust as additional protection for future losses. Once each of these
obligations is fully met, any remaining finance charge collections, if any, are
returned to us.
Bank-Sponsored Conduit Programs. We maintain flexibility in our current
securitization program by negotiating with bank-sponsored conduits. These
conduits purchase an interest in receivables arising in designated accounts.
These transactions also feature a revolving period in which principal payments
on receivables allocated to the conduits are returned to us and reinvested in
new receivables. These agreements also have early amortization triggers. Finance
charge collections are used to pay certain obligations, including servicing
fees, interest on the principal amount of the conduits investment in the
applicable receivables, and recouping charge-offs. After such allocation,
remaining finance charge collections, if any, are returned to us.
At December 31, 1999 and 1998, we had received cumulative net proceeds of
approximately $5.5 billion and $4.6 billion, respectively, from sales of credit
card loans to the trust and conduits. We used cash generated from these
transactions to reduce borrowings and to fund credit card loan portfolio growth.
We rely upon the securitization of our credit card loans to fund portfolio
growth and, to date, have completed securitization transactions on terms that we
believe are satisfactory. Our ability to securitize our assets depends on the
favorable investor demand and legal, regulatory and tax conditions for
securitization transactions, as well as continued favorable performance of our
securitized portfolio of receivables. Any adverse change could force us to rely
on other potentially more expensive funding sources and, in the worst case
scenario, could create liquidity risks if other funding is unavailable or
significantly limit our ability to grow.
The following table presents the amounts, at December 31, 1999, of investor
principal in securitized receivables scheduled to amortize in future years. We
base the amortization amounts on estimated amortization periods which are
subject to change based on trust and conduit performance.
(Dollars in thousands)
2000 $2,116,040
2001 2,102,273
2002 0
2003 500,000
2004 300,000
Thereafter 500,000
----------
Total Securitized Loans at December 31, 1999 $5,518,313
==========
Subsidiary Bank Deposits
Beginning in the first quarter of 1999, Direct Merchants Bank began issuing
certificates of deposit. These CDs are issued in increments of $100,000. As of
December 31, 1999, $758.5 million of CDs were outstanding with maturities
ranging from three months to two years with fixed interest rates ranging from
5.2% to 6.6%.
Bank Loans
We have a $200 million, three-year revolving credit facility and a $100
million five-year term loan with a syndicate of banks and money market mutual
funds. These credit facilities became effective upon the spin off from Fingerhut
on September 25, 1998, and replaced our $300 million, five-year revolving credit
facility. The credit facilities are secured by receivables and subsidiary stock
and are guaranteed by one of our subsidiaries. Financial covenants in the credit
facilities include, but are not limited to, requirements concerning minimum net
worth, minimum tangible net worth to net managed receivables and tangible net
worth plus reserves to delinquent receivables. At December 31, 1999 and 1998, we
were in compliance with all financial covenants under these credit facilities.
At December 31, 1999 and 1998, we had outstanding borrowings of $100 million and
$110 million, respectively, under these credit facilities.
Long-Term Debt and Equity Issuance
In addition to cash flow from operations, bank loans, subsidiary bank
CDs, and asset securitizations, we use long term debt and equity to fund
continued credit card growth.
On July 15, 1999, we privately issued and sold $150 million of 10.125%
Senior Notes due 2006 pursuant to an exemption from registration under Rule 144A
of the Securities Act of 1933. In October of 1999, we commenced an exchange
offer for the senior notes pursuant to a registration statement. The terms of
the new senior notes are identical in all material respects to the original
private issue. We completed the exchange offer in November of 1999. In November
1997, we issued and sold $100 million of 10% senior notes due 2004. The senior
notes are guaranteed on the same loan basis as the Senior Notes due 2006.
On November 13, 1998, we sold $200 million in Series B Perpetual
Convertible Preferred Stock and $100 million in 12% Senior Notes due 2006 to
affiliates of the Thomas H. Lee Company. We also issued 7.5 million ten-year
warrants to purchase shares of our common stock for $15, subject to adjustment
in certain circumstances. The Series B Preferred had a 12.5% dividend payable in
additional shares of Series B Preferred for 10 years, then converting to payable
in cash.
On March 12, 1999, shareholders approved conversion of the Series B
Preferred and 12% Senior Notes into Series C Perpetual Convertible Preferred
Stock. On May 28, 1999, notice was received that there was no regulatory
objection to the conversion to the Series C Preferred, and the Series B
Preferred and the 12% Senior Notes were converted into 0.8 million shares of
Series C Preferred at a conversion price of $18.63 and the warrants were
canceled. The Series C Preferred has a 9% dividend payable in additional shares
of Series C Preferred and will also receive any dividends paid on our common
stock on an as converted basis. The cumulative payment-in-kind dividends are
effectively guaranteed for a seven-year period. Assuming conversion of the
Series C Preferred into common stock had occurred at December 31, 1999, the Lee
Company would have owned over 30% of the Company on a diluted basis.
Converting to the Series C Preferred caused a one-time, non-cash,
accounting adjustment for extinguishing the Series B Preferred and 12% Senior
Notes. We allocated the excess of the fair value of the Series C Preferred over
the carrying value of the Series B Preferred and the 12% Senior Notes at the
time of the conversion to the 12% Senior Notes and the Series B Preferred Stock
based upon their initial fair values. We recognized the $50.8 million allocated
to the 12% Senior Notes as an extraordinary loss from the early extinguishment
of debt and the $101.6 million allocated to the Series B Preferred as a
reduction of net income applicable to common stockholders. We did not record the
extraordinary loss attributable to the 12% Senior Notes net of taxes. These
adjustments had no impact on total stockholders' equity.
General
The Federal Reserve Act imposes various legal limitations on the extent to
which banks that are members of the Federal Reserve System can finance or
otherwise supply funds to certain of their affiliates. In particular, Direct
Merchants Bank is subject to certain restrictions on any extensions of credit to
us or our subsidiaries. Additionally, Direct Merchants Bank is limited in its
ability to declare dividends to us. Therefore, Direct Merchants Bank's
investments in federal funds sold are generally not available for our general
liquidity needs or the needs of our subsidiaries. These restrictions were not
material to our operations at December 31, 1999 and 1998.
As the portfolio of credit card loans grows, or as the trust and
conduit certificates amortize or are otherwise paid, our funding needs will
increase accordingly. We believe that our asset securitizations, subsidiary bank
deposits, bank loans, long term debt, cash flow from operations and equity
issuance will provide adequate liquidity for meeting anticipated cash needs,
although we cannot give assurance to that effect.
Competition
As a marketer of consumer credit products, we compete with numerous
providers of financial services, many of which have greater resources than we
do. In particular, our credit card business competes with national, regional and
local bank card issuers as well as other general purpose credit and debit card
issuers. In general, customers are attracted to credit card issuers largely on
the basis of price, credit limit and other product features; as a result,
customer loyalty is often limited. However, we believe that our strategy of
focusing on the moderate income sector and our exclusive access to information
from the Fingerhut customer database allows us to compete effectively in the
market for moderate income cardholders to market financial services products.
There are numerous competitors in the fee-based services market, including
insurance companies, financial services institutions and other membership-based
or consumer-enhancement service providers, many of which are larger, better
capitalized and more experienced than we are. However, we believe that our
agreements with Fingerhut, including our exclusive right to use the Fingerhut
customer database to market financial services and our right to be the exclusive
provider of extended service plans to Fingerhut customers, will allow us to
compete effectively in this market. As we continue to expand our business to
market extended service plans to the customers of third-party retailers, we will
also compete with manufacturers, financial institutions, insurance companies and
a number of independent administrators, many of which have greater operating
experience and financial resources than we do.
Regulation
The Company and Direct Merchants Bank
Direct Merchants Bank is a limited purpose credit card bank chartered as a
national banking association. It is a member of the Federal Reserve System. Its
deposits are insured by the Bank Insurance Fund which is administered by the
Federal Deposit Insurance Corporation ("FDIC") and it is subject to
comprehensive regulation and periodic examination by the Office of the
Comptroller of the Currency ("OCC"), its primary regulator. It is also subject
to regulation by the FDIC, as a back-up regulator. Direct Merchants Bank is not
a "bank" as defined under the Bank Holding Company Act of 1956, as amended (the
"BHCA") because it:
* engages only in credit card operations;
* does not accept demand deposits or deposits that the depositor may
withdraw by check or similar means for payment to third parties or others;
* does not accept any savings or time deposits of less than $100,000,
except for deposits pledged as collateral for extensions of credit;
* maintains only one office that accepts deposits; and
* does not engage in the business of making commercial loans.
As a result, we are not a bank holding company under the BHCA. If Direct
Merchants Bank failed to meet the credit card bank criteria described above,
Direct Merchants Bank's status as an insured bank would make us subject to the
provisions of the BHCA. We believe that becoming a bank holding company would
limit our ability to pursue future opportunities.
Exportation of Interest Rates and Fees
Under current judicial interpretations of federal law, national banks such
as Direct Merchants Bank may charge interest at the rate allowed by the laws of
the state where the bank is located and may "export" those interest rates on
loans to borrowers in other states, without regard to the laws of such other
states.
In 1996, the Supreme Court of the United States held that national banks
may also impose late payment fees allowed by the laws of the state where the
national bank is located on borrowers in other states, without regard to the
laws of such other states. The Supreme Court based its opinion largely on its
deference to a regulation adopted by the OCC that includes certain fees,
including late fees, overlimit fees, annual fees, cash advance fees and
membership fees, within the term "interest" under the provision of the National
Bank Act that has been interpreted to permit national banks to export interest
rates. As a result, national banks such as Direct Merchants Bank may export such
fees.
Dividends and Transfers of Funds
There are various federal law limitations on the extent to which Direct
Merchants Bank can finance or otherwise supply funds to the Company and its
affiliates through dividends, loans or otherwise. These limitations include:
minimum regulatory capital requirements; restrictions concerning the payment of
dividends out of net profits or surplus; and Sections 23A and 23B of the Federal
Reserve Act governing transactions between a bank and its affiliates. In
general, Federal law prohibits a national bank such as Direct Merchants Bank
from making dividend distributions on common stock if the dividend would exceed
currently available undistributed profits. In addition, Direct Merchants Bank
must get OCC prior approval for a dividend, if such distribution would exceed
current year net income combined with retained earnings from the prior two
years. Direct Merchants Bank cannot make a dividend if the distribution would
cause the bank to fail to meet applicable capital adequacy standards. Finally,
although not a regulatory restriction, the terms of certain debt agreements
prohibit the payment of dividends in certain circumstances.
Capital Adequacy
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA"), requires the banking agencies to prescribe certain non-capital
standards for safety and soundness relating generally to operations and
management, asset quality and executive compensation. FDICIA also provides that
regulatory action may be taken against a bank that does not meet such standards.
The OCC has adopted regulations that define the five capital categories
(well-capitalized, adequately-capitalized, undercapitalized,
significantly-undercapitalized and critically-undercapitalized) identified by
FDICIA, using the total risk-based capital, Tier 1 risk-based capital and
leveraged capital ratios as the relevant capital measures. Such regulations
establish various degrees of corrective action to be taken when an institution
is considered undercapitalized. Under the regulations, a "well-capitalized"
institution must have a Tier 1 capital ratio of at least 6%, a total capital
ratio of at least 10% and a leverage ratio of at least 5% and not be subject to
a capital directive order. An "adequately- capitalized" institution must have a
Tier 1 capital ratio of at least 4%, a total capital ratio of at least 8% and a
leverage ratio of at least 4% (3% in some cases). Under these guidelines, Direct
Merchants Bank is considered well-capitalized.
The OCC's risk-based capital standards explicitly consider a bank's
exposure to declines in the economic value of its capital due to changes in
interest rates when evaluating a bank's capital adequacy. Interest rate risk is
the exposure of a bank's current and future earnings and equity capital arising
from adverse movements in interest rates. The evaluation will be made as a part
of the institution's regular safety and soundness examination.
The FDICIA requires the FDIC to implement a system of risk-based premiums
for deposit insurance pursuant to which the premiums paid by a depository
institution will be based on the probability that the FDIC will incur a loss in
respect of such institution. The FDIC has adopted a system that imposes
insurance premiums based upon a matrix that takes into account a bank's capital
level and supervisory rating. Direct Merchants Bank pays the lowest rate on
deposit insurance premiums for its capital level and supervisory rating.
Under FDICIA, only "well-capitalized" and "adequately- capitalized" banks
may accept brokered deposits. "Adequately- capitalized" banks, however, must
first obtain a waiver from the FDIC before accepting brokered deposits and such
deposits may not pay rates that significantly exceed the rates paid on deposits
of similar size and maturity accepted from the bank's normal market area or the
national rate on deposits of comparable maturity, as determined by the FDIC, for
deposits from outside the bank's normal market area. Direct Merchants Bank may
accept brokered deposits as part of its funding and began issuing certificates
of deposit in the first quarter of 1999. These CDs are issued through third
party registered deposit brokers in increments of $100,000.
<PAGE>
Lending Activities
Direct Merchants Bank's activities as a credit card lender are also subject
to regulation under various federal consumer protection laws including the
Truth-in-Lending Act, the Equal Credit Opportunity Act, the Fair Credit
Reporting Act, the Community Reinvestment Act (the "CRA") and the Soldiers' and
Sailors' Civil Relief Act. Regulators are authorized to impose penalties for
violations of these statutes and, in certain cases, to order Direct Merchants
Bank to pay restitution to injured cardholders. Cardholders may also bring
actions for certain alleged violations of such regulations. Federal and state
bankruptcy and debtor relief laws also affect Direct Merchants Bank's ability to
collect outstanding balances owed by cardholders who seek relief under these
statutes.
The OCC's CRA regulations subject limited purpose banks, including Direct
Merchants Bank, to a "community development" test for evaluating required CRA
compliance. The community development performance of a limited purpose bank is
evaluated pursuant to various criteria involving community development lending,
qualified investments and community development services.
Legislation
Congress recently passed a financial services modernization law that
includes statutes to protect consumer privacy. Regulations to implement these
privacy provisions could adversely affect us if these changes result in limits
on sharing information.
From time to time legislation has been proposed in Congress to limit
interest rates and fees that could be charged on credit card accounts or
otherwise restrict practices of credit card issuers. If this or similar
legislation is proposed and adopted, our ability to collect on account balances
or maintain previous levels of finance charges and other fees could be adversely
affected.
Additionally, the U.S. Senate and House of Representatives each have passed
legislation that would amend the federal bankruptcy laws. Changes in federal
bankruptcy laws and any changes to state debtor relief and collection laws could
adversely affect us if such changes result in, among other things, accounts
being charged off as uncollectible and additional administrative expenses. It is
unclear at this time whether and in what form any legislation will be adopted
or, if adopted, what its impact on us would be. Congress may in the future
consider other legislation that would materially affect the credit card and
related fee-based services industries.
Consumer and Debtor Protection Laws
Various federal and state consumer protection laws limit our ability to
offer and extend credit. In addition, the U.S. Congress and the States may
decide to regulate further the credit card industry by enacting laws or
amendments to existing laws to reduce finance charges or other fees or charges
applicable to credit card and other consumer revolving loan accounts. These laws
may adversely affect our ability to collect on account balances or maintain
established levels of periodic rate finance charges and other fees and charges
with respect to the accounts. Similarly, Congress and the States may decide to
regulate further our fee-based services.
Investment in the Company and Direct Merchants Bank
Certain acquisitions of capital stock may be subject to regulatory approval
or notice under federal law. Investors are responsible for insuring that they do
not directly or indirectly acquire shares of our capital stock in excess of the
amount which can be acquired without regulatory approval.
Interstate Taxation
Several states have passed legislation which attempts to tax the income
from interstate financial activities, including credit cards, derived from
accounts held by local state residents. We believe that this legislation will
not materially affect us. Our belief is based upon the following: current
interpretations of the enforceability of legislation; prior court decisions; and
the volume of business in states that have passed legislation.
Licensing Requirements
Several state and local government regulators require our subsidiaries to
be licensed in order to offer our fee-based insurance and warranty products in
these states. We are in the process of obtaining licenses for these products in
the remainder of states. Our captive insurance subsidiary, ICOM Limited, is
licensed in Bermuda under The Insurance Act of 1978 as a Class 2 Insurer. We are
restricted from writing any long-term policies or pursuing any unrelated
business in excess of certain limits under Bermuda law.
Fair Credit Reporting Act
The Fair Credit Reporting Act ("FCRA") regulates "consumer reporting
agencies." Under the FCRA, an entity risks becoming a consumer reporting agency
if it furnishes "consumer reports" to third parties. A consumer report is a
communication of information which bears on a consumer's creditworthiness,
credit capacity, credit standing or certain other characteristics and which is
collected or used or expected to be used to determine the consumer's eligibility
for credit, insurance, employment or certain other purposes. The FCRA explicitly
excludes from the definition of consumer report a report containing information
solely as to transactions or experiences between the consumer and the entity
making the report. An entity may share consumer reports with any of its
affiliates so long as that entity provides consumers with an appropriate
disclosure and an opportunity to opt out of such "affiliate sharing."
Our objective is to conduct our operations in a manner that would fall
outside the definition of consumer reporting agency under the FCRA. If we were
to become a consumer reporting agency, however, we would be subject to a number
of complex and burdensome regulatory requirements and restrictions. Such
restrictions could have a significant adverse economic impact on us. Our
agreements with Fingerhut provide that neither of us will provide information
that causes either of us to become a consumer reporting agency. Failure to
comply with this limitation could result in termination of the agreements and
have an adverse impact us.
Employees
As of December 31, 1999, we had approximately 3,100 employees, located in
Arizona, Florida, Illinois, Maryland, Minnesota, and Oklahoma. None of our
employees are represented by a collective bargaining agreement. We consider our
relations with our employees to be good.
Trademarks, Tradenames and Service Marks
Metris Companies Inc. and its subsidiaries have registered and continue to
register, when appropriate, various trademarks, tradenames and service marks
used in connection with its business and for private label marketing of certain
of its products. We consider these trademarks and service marks to be readily
identifiable with, and valuable to, our business.
Executive Officers of the Registrant
The following table sets forth certain information concerning the persons
who currently serve as our executive officers. Each executive officer serves at
the discretion of our Board of Directors.
Name Age Position
---- --- --------
Ronald N. Zebeck 45 President, Chief Executive Officer and Director
Z. Jill Barclift 42 Executive Vice President, General Counsel and
Secretary
Joseph A. Hoffman 42 Executive Vice President, Consumer Credit Card
Marketing
Douglas B. McCoy 52 Executive Vice President, Operations
David R. Reak 41 Executive Vice President, Risk
Management/Recovery
Douglas L. Scaliti 42 Executive Vice President, Fee-Based Products
David D. Wesselink 57 Executive Vice President, Chief Financial Officer
Jean C. Benson 32 Senior Vice President, Finance, Corporate
Controller
Patrick J. Fox 44 Senior Vice President, Business Development
Paul T. Runice 40 Senior Vice President, Treasurer
Benson Woo 45 Senior Vice President, Finance
Ronald N. Zebeck has been our President and Chief Executive Officer and a
director of the Company since our incorporation in August 1996. Mr. Zebeck has
been President of Metris Direct, Inc. since March 1994 and has served as
Chairman of the Board of Direct Merchants Bank since August 1995. Prior to
joining us, Mr. Zebeck was Managing Director, GM Card Operations of General
Motors Corporation from 1991 to 1993, Vice President, Marketing and Strategic
Planning of Advanta Corporation (Colonial National Bank USA) from 1987 to 1991,
Director of Strategic Planning of TSO Financial (later Advanta Corporation) from
1986 to 1987 and held various credit card and credit-related positions at
Citibank affiliates from 1976 to 1986.
Z. Jill Barclift has been our Executive Vice President, General Counsel and
Secretary since November 1998. Ms. Barclift was appointed Vice President,
General Counsel in December 1996 and served as Assistant General Counsel from
April 1996 to December 1996. Prior to joining us, Ms. Barclift held various
positions at Household International, Inc. and Household Credit Services, Inc.
from October 1989 to April 1996, most recently as Associate General Counsel.
Prior to that, she was Senior Counsel at Dean Witter Financial Services, Inc.
from January 1984 to October 1989.
Joseph A. Hoffman has been Executive Vice President, Consumer Credit Card
Marketing since October 1999. Mr. Hoffman previously served as Senior Vice
President, Consumer Credit Marketing from April 1998. Prior to joining us, Mr.
Hoffman was Vice President of Marketing at Advanta Corporation from June 1994 to
April 1998, where he held a variety of positions including Directors of Brand
Management and Affinity and Co-Brand Marketing. Before that, Mr. Hoffman was
Vice President, Area Director, in Citibank's Card Product Group, which he joined
in 1980. During his fourteen-year tenure with Citibank, Mr. Hoffman held a
variety of Marketing and Operations positions with Citibank's Bankcard and
Private Label businesses.
Douglas B. McCoy has been Executive Vice President, Operations since
November 1998. Mr. McCoy was appointed Senior Vice President, Operations in
December 1996. He served as Vice President, Operations of Metris Direct, Inc.
from January 1995 to November 1996. In addition, Mr. McCoy has been President of
Direct Merchants Bank since July 1995. Prior to joining us, he was Vice
President, Credit Administration of USAA Federal Savings Bank from September
1984 to January 1995, Assistant Vice President, Credit Administration of Bank of
Oklahoma from July 1984 to September 1984, Assistant Vice President, Operations
of First National Bank of Tulsa from May 1982 to July 1984 and Assistant Vice
President, Credit Card Marketing of The Bank of New Orleans from April 1978 to
April 1982.
David R. Reak has been Executive Vice President, Risk Management/Recovery
since October 1999. Mr. Reak previously served as Senior Vice President, Credit
Risk since November 1998. Mr. Reak was appointed Vice President, Credit Risk in
October 1996 and previously served as Senior Director, Credit Risk of Metris
Direct, Inc. from December 1995 to October 1996. Prior to joining us, he had
several positions at American Express Travel Related Services Company, including
Senior Manager, Credit Risk Management Europe and Middle East from 1994 to
December 1995, Senior Manager, Credit Risk Management U.S. Consulting Group from
1992 to 1994, and Project Manager, Credit Research and Analysis from 1990 to
1992.
Douglas L. Scaliti has been Executive Vice President, Fee-Based Products
since November 1998. Mr. Scaliti previously held the position of Senior Vice
President, Fee-Based Services from March 1998. Mr. Scaliti was appointed Senior
Vice President, Marketing in December 1996 and served as Vice President,
Marketing from August 1996 to November 1996. He held that same position at
Metris Direct, Inc. since September 1994. Prior to joining us, he held several
positions at Advanta Corporation in its marketing and operations area, including
Senior Marketing Manager, Credit Cards from 1987 to 1994, Operations Consultant,
Profit Improvement from 1985 to 1987 and Credit Operations Manager from 1982 to
1985. Mr. Scaliti also serves on the First Data Resources Market Area Advisory
Group.
David D. Wesselink has been Executive Vice President, Chief Financial
Officer since December 1998. Prior to joining us, Mr. Wesselink was Senior Vice
President and Chief Financial Officer of Advanta Corporation from 1993 to 1998.
Prior to Advanta Corporation, he held several positions at Household Finance
Corp. and Household International, Inc. from 1971 to 1993, including Senior Vice
President from 1986 to 1993 and Chief Financial Officer from 1982 to 1993.
Jean C. Benson has been Senior Vice President, Finance, Corporate
Controller since March 1999. Ms. Benson previously was Vice President, Finance,
Corporate Controller from May 1998 to February 1999 and has been Corporate
Controller since August 1996. In addition, Ms. Benson held various finance
positions at the Company since October 1994. Prior to that, she held various
positions at Deloitte & Touche LLP (public accounting), specializing in the
financial services industry from 1990 to 1994.
Patrick J. Fox has been Senior Vice President, Business Development since
March 1998. Prior to joining us, Mr. Fox held executive positions in the credit
card group of Bank of America from September 1994 to March 1998, Where most
recently he was the Director of Product Management and Business Development.
Prior to Bank of America, Mr. Fox held various marketing and sales management
positions with Bank One, which he joined in 1990, Comerica Bank and Citibank.
Paul T. Runice has been Senior Vice President, Treasurer since November
1998. Mr. Runice previously was Vice President, Treasurer from January 1998 to
October 1998. Prior to joining us, Mr. Runice was with the Bank of America for
nine years, most recently as Vice President in the U.S. Corporate Finance Group.
Prior to Bank of America, he was employed by Grand Metropolitan, Inc. and The
Pillsbury Company as Manager of Treasury Operations, as well as in corporate
development and financial analysis roles.
Benson Woo has been Senior Vice President, Finance since joining the
Company in October of 1999. Prior to joining us, Mr. Woo was Vice President and
Chief Financial Officer of York International Corporation from 1998 to 1999.
Prior to York International Corporation, he was Vice President and Treasurer of
Case Corporation from 1994 to 1998. Prior to that, he held several positions at
General Motors Corporation from 1979 to 1994, including Finance Director, GM
Credit Card Operations from 1992 to 1994.
Our officers are elected by, and hold office at the will of, our Board of
Directors and do not serve a "term of office" as such.
Risk Factors
This annual report on Form 10-K contains certain forward-looking statements
and information relating to the Company that are based on the beliefs of our
management as well as assumptions made by, and information currently available
to, our management. These forward-looking statements involve risks and
uncertainties that could cause our actual results to differ materially from such
statements. You should not place undue reliance on these forward-looking
statements as they speak only of our views as of the date the statement was made
and are not a guarantee of future performance.
Forward-looking statements include statements and information as to our
strategies and objectives, growth in earnings per share, return on equity,
growth in our managed loan portfolio, net interest margins, funding costs,
operating costs and marketing expenses, delinquencies and charge-offs and
industry comparisons or projections. Forward-looking statements may be
identified by the use of terminology such as "may," "will," "believes," "does
not believe," "no reason to believe," "expects," "plans," "intends,"
"estimates," "anticipated," or "anticipates" and similar expressions, as they
relate to the Company or our management. These statements reflect management's
current views with respect to future events and are subject to certain risks,
uncertainties and assumptions.
The factors discussed below, among others, could cause our actual results
to differ materially from those expressed in any forward-looking statements.
Although we have attempted to list comprehensively these important factors, we
caution you that other factors may in the future prove to be important in
affecting our results of operations. New factors emerge from time to time and it
is not possible for us to predict all of these factors, nor can we assess the
impact of each such factor on the business or the extent to which any factor, or
combination of factors, may cause actual results to differ materially from those
contained in any forward-looking statement.
Our Target Market for Consumer Credit Products Has Higher Default and
Bankruptcy Rates
The primary risk associated with secured and unsecured lending to moderate
income consumers is higher default rates than other income classes of consumers,
resulting in more accounts being charged-off as uncollectible. In addition,
general economic factors, such as the rate of inflation, unemployment levels and
interest rates, may result in greater delinquencies and credit losses among
moderate-income consumers than among other income classes of consumers. A
recession or economic downturn may cause an increase in default rates and
delinquencies. We may be unable to successfully identify and evaluate the
creditworthiness of our target customers to minimize the expected higher
delinquencies and losses. We also cannot assure you that our risk-based pricing
system can offset the negative impact on profitability that the expected greater
delinquencies and losses may have.
The Lack of Seasoning of Our Credit Card Portfolio Creates a Risk of
Increasing Loss Levels
Our growth strategy is likely to produce a continued flow of unseasoned
accounts into our portfolio. The average age of a credit card issuer's portfolio
of accounts generally affects the level and stability of delinquency and loss
rates of that portfolio. For example, a portfolio containing mostly older
accounts generally behaves more predictably than a newly originated portfolio.
At December 31, 1999, 58% of our credit card accounts were less than 36 months
old. The delinquency and charge-off ratios for the following periods do not
reflect the favorable impact of purchase accounting related to the portfolio
acquisitions. At December 31, 1999, 7.8% of our managed credit card loans were
30 days or more delinquent, compared to 7.4% at December 31, 1998, and 7.1% at
December 31, 1997. Any material increases in delinquencies and losses beyond our
expectations could have a material adverse impact on us and the value of our net
retained interests in loans securitized, which are subordinated to the interests
sold in such securitizations.
We May Not be Able to Sustain and Manage Growth
In order to meet our strategic objectives, we plan to continue to expand
our credit card loan portfolio. Continued growth in this area depends largely
on:
* our ability to attract new cardholders;
* growth in both existing and new account balances;
* the degree to which we lose accounts and account balances to
competing card issuers;
* levels of delinquencies and losses;
* the availability of funding, including securitizations, on favorable
terms;
* general economic and other factors such as the rate of inflation,
unemployment levels and interest rates, which are beyond our control;
* our ability to acquire and integrate portfolios; and
* stability and growth in management.
Our continued growth also depends on our ability to manage this growth
effectively. Factors that affect our ability to successfully manage growth
include:
* retaining and recruiting experienced management personnel;
* finding and adequately training new employees;
* cost-effectively expanding our facilities;
* growing and updating our management systems; and
* obtaining capital when needed.
<PAGE>
We May Not be Able to Successfully Market Our Fee-Based Services or Sign
Additional Marketing Alliances
We target our fee-based services to our credit card customers and customers
of third parties. Because of the variety of offers provided and the diversity of
the customers targeted, we are uncertain about how many customers will respond
to our offers for these fee-based services. We may experience higher than
anticipated costs in connection with the internal administration and
underwriting of these fee-based services and lower than anticipated response or
retention rates.
Furthermore, we may be unable to expand the fee-based services business or
maintain historical growth and stability levels if:
* we cannot successfully market credit cards to new customers;
* existing credit card customers close accounts voluntarily or
involuntarily;
* existing fee-based services customers cancel their services;
* we cannot form marketing alliances with other third parties; or
* new or restrictive state regulations limit our ability to market
or sell fee-based services.
Our Profitability and Ability to Grow is Dependent on Our Funding Sources
Securitization Markets. We depend heavily upon the securitization of our
credit card loans to fund our operations and growth. As recently as the fourth
quarter of 1998, these markets have undergone disruptions which adversely
affected the ability of companies like us to raise money from these sources.
Furthermore, our ability to securitize our assets depends on the continued
availability of credit enhancements on acceptable terms and the continued
favorable legal, regulatory and tax environment for such transactions.
In addition, even if we are able to securitize our assets consistent with
past practice, poor performance of our securitized assets, including increased
delinquencies and credit losses, could result in a downgrade or withdrawal of
the ratings on the outstanding securities issued in our securitization
transactions, cause early amortization of such securities or result in higher
required credit enhancement levels. As a result, poor performance of our
securitized assets could divert significant amounts of cash that would otherwise
be available to us. This could jeopardize our ability to complete other
securitization transactions on acceptable terms, decrease our liquidity and
force us to rely on other potentially more expensive funding sources, to the
extent available. We cannot assure you that the securitization market will
continue to offer suitable funding alternatives.
Credit Facility. We rely on our credit facilities to fund our operations
and growth. If we breach any of our covenants under our credit facilities,
including various financial covenants, the lenders may terminate the facilities.
Disruptions in the securitization market could negatively affect our ability to
comply with these covenants, and therefore our ability to borrow or replace
these facilities could be adversely affected.
CD Program. Beginning in the first quarter of 1999, Direct Merchants Bank
began issuing certificates of deposit in increments of $100,000. We expect to
use the proceeds of these deposits to fund our operations and growth. To
maintain our current level of access to the certificate of deposit market,
Direct Merchants Bank must maintain a "well-capitalized" rating, as that rating
is defined by the Office of the Comptroller of the Currency. If it does not do
so, Direct Merchants Bank may be required to modify the program and may not be
able to accept additional deposits.
Other Funding Sources. We also expect to obtain financing by selling debt
and equity securities. Our ability to obtain such financing is dependent upon
many factors, including general market conditions. We cannot assure you that we
will be able to obtain this financing on favorable terms or at all. In addition,
restrictions contained in our debt agreements may adversely affect our ability
to finance future operations or capital needs or to engage in other business
activities.
Our ability to obtain financing from the various sources available to us is
dependent upon many factors, including those outside of our control. In
addition, disruptions or unfavorable conditions related to one financing source
may negatively affect our ability to access other financing sources, or may
increase our financing costs.
We Require a High Degree of Liquidity to Operate Our Business
We depend on asset securitization, subsidiary bank deposit program, bank
loans, long-term debt issuance, cash flow from operations, and equity issuance
to fund our operations and growth. The loss or interruption of any of these
sources of funding could adversely affect our ability to operate.
Key elements of our strategy are dependent upon us having adequate
available cash. These cash needs include:
* funding receivable growth through marketing campaigns;
* additional credit enhancement in the case of poor performance of our
securitized assets;
* interest and principal payments under our securitizations, our credit
agreement, our existing senior notes and other indebtedness;
* ongoing operating expenses;
* maintenance of the "well-capitalized" status of our subsidiary, Direct
Merchants Bank, which is necessary to maintain the CD program;
* portfolio and business acquisitions;
* fees and expenses incurred in connection with the securitization of
receivables and the servicing of them; and
* tax payments due on receipt of excess cash flow from securitization trusts.
Given these cash needs, we anticipate that we will need to enter into
financing transactions on a regular basis. We cannot assure you that we will be
able to secure funds to support our cash needs on terms as favorable as past
transactions. Any adverse change in the funding sources we use could force us to
rely on other potentially more expensive funding sources, to the extent
available, and could have other adverse consequences. If any of our funding
sources become limited it may require us to use more expensive sources of
funding. Any material increase in our costs of financing beyond our expectations
could negatively impact us.
Interest Rate Fluctuations Impact the Yield on Our Assets and Funding
Expense
An increase or decrease in market interest rates could have a negative
impact on the net interest spread between the yield on our assets and our cost
of funding. A rise in market interest rates may indirectly impact the payment
performance of our customers. We try to minimize the impact of changes in market
interest rates on our cash flow, asset value and net income primarily by funding
variable-rate assets with variable-rate funding sources and by using interest
rate derivatives to match asset and liability repricings. However, changes in
market interest rates may have a negative impact on us.
We May Not be Able to Successfully Integrate Portfolio Acquisitions
As previously mentioned, our growth depends in part on our ability to
acquire and successfully integrate new portfolios of credit card customers.
Since our risk-based pricing system depends on information regarding customers,
limited or unreliable historical information on customers within an acquired
portfolio may have an impact on our ability to successfully and profitably
integrate that portfolio. Our success also depends on whether the desirable
customers of an acquired portfolio close their accounts after transfer of the
portfolio. A large attrition rate would result in a lower borrowing base upon
which to assess fees, higher costs relating to closing accounts and less
potential for marketing fee-based services. In addition, if customers reduce
their borrowings after the transfer of accounts, the acquired portfolio may be
less profitable than originally expected.
Current and Proposed Regulation and Legislation Limit Our Business
Activities, Product Offerings and Fees Charged
Various federal and state laws and regulations significantly limit the
activities in which we and Direct Merchants Bank are permitted to engage. Such
laws and regulations, among other things, limit the fees and other charges that
we are allowed to charge, limit or prescribe certain other terms of our products
and services, require specified disclosures to consumers, govern the sale and
terms of products and services we offer and require that we maintain certain
licenses, qualifications, or capital requirements (see "Business -
Regulations"). In some cases, the precise application of these statutes and
regulations is not clear. In addition, the regulatory framework at the state and
federal level regarding some of our fee-based products is evolving. The
regulatory framework affects the design or profitability of such products and
our ability to sell certain products. In addition, numerous legislative and
regulatory proposals are advanced each year which, if adopted, could adversely
affect our profitability or further restrict the manner in which we conduct our
activities. The failure to comply with, or adverse changes in, the laws or
regulations to which our business is subject, or adverse changes in the
interpretation thereof, could adversely affect our ability to collect our
receivables and generate fees on the receivables which could have a material
adverse effect on our business.
Other Industry Risks Related to Consumer Credit Products and Fee-Based
Services Could Negatively Impact Us
We face a number of risks associated with unsecured lending. These include
the risk that delinquencies and credit losses will increase because of future
economic downturns; the risk that an increasing number of customers will default
on the payment of their outstanding balances or seek protection under bankruptcy
laws; and the risk that fraud by cardholders and third parties will increase. We
also face the risk that increased criticism from consumer advocates and the
media could hurt consumer acceptance of our products, as well as the risk of
litigation, including class action litigation, challenging our product terms,
rates, disclosures, collections or other practices, under state and federal
consumer protection statutes and other laws.
Due to Intense Competition in Our Consumer Credit Products and Fee-Based
Services Businesses, We May Not be Able to Compete Successfully
We face intense and increasing competition from numerous financial services
providers, many of which have greater resources than we do. In particular, our
credit card business competes with national, regional and local bank card
issuers, as well as other general purpose and private label credit card issuers.
There has been a recent increase in solicitations to moderate income consumers,
as competitors have increasingly focused on this market. Customers are attracted
to credit card issuers largely on the basis of price, credit limit and other
product features; as a result, customer loyalty is often limited. According to
published reports, as of December 1999, the 20 largest issuers accounted for
approximately 90% (based on receivables outstanding) of the market for general
purpose credit cards. Many of these issuers are substantially larger, have more
seasoned credit card portfolios and often compete for customers by offering
lower interest rates and/or fee levels than we do. We cannot assure you that we
will be able to compete successfully in this environment.
We also face competition from numerous fee-based services providers,
including insurance companies, financial services institutions and other
membership-based or consumer services providers, many of which are larger,
better capitalized and more experienced than us. As we continue to expand our
extended service plan business to the customers of third-party retailers, we
compete with manufacturers, financial institutions, insurance companies and a
number of independent administrators, many of which have greater operating
experience and financial resources than we do.
Changes in Our Relationship with Fingerhut Could Materially Impact Our
Business
We have entered into a number of agreements with Fingerhut for the purpose
of defining the ongoing relationship between us, some of which are material to
our business. We rely on our access to the Fingerhut database, including the
Fingerhut suppression and bad debt file, to market financial services products.
As of December 31, 1999, Fingerhut customers in the Fingerhut database
represented approximately 30% of our credit card accounts and all of the
purchasers of our extended service plans. Fingerhut can terminate our
contractual rights to this access in the event a third party acquires control of
our company and, upon termination of the agreement, Fingerhut has the right to
repurchase any then outstanding general purpose credit cards bearing the
Fingerhut name and logo. Any denial or delay of this access or any such
repurchase could have a significant economic impact on us.
Each of the agreements between us and Fingerhut may terminate early due to
a change of control of the Company, as defined below. The spin off itself did
not constitute a change of control. However, now that Fingerhut does not own the
stock of the Company, it is possible for a change of control to occur, thus
causing early terminations of these agreements. Specifically, we have a contract
with Fingerhut to use the information in the Fingerhut database for marketing
our financial services products, including general purpose credit cards. This
contract expires October 2003 and is renewable thereafter upon mutual agreement
between us and Fingerhut unless there has been a change in control of the
Company. A change of control shall be deemed to have occurred if:
* any person or group (within the meaning of Rule 13d-5 of the Securities
Exchange Act of 1934), other than Fingerhut, shall own beneficially or
of record, shares representing more than 25% of the aggregate ordinary
voting power represented by the issued and outstanding capital stock of
the Company;
* a majority of the seats (other than vacant seats) on the Board of
Directors of the Company shall at anytime be occupied by persons who
were neither nominated by Fingerhut, or by the Board of Directors of
the Company, nor appointed by directors so nominated; or
* any person or group other than Fingerhut shall otherwise directly or
indirectly have the power to exercise a controlling influence over
management or policies of the Company.
Potential Volatility in the Stock Market May Negatively Affect Our Stock
Price
The Company, which began as a subsidiary of Fingerhut, was incorporated in
1996 and prior to the spin off was 83% owned by Fingerhut. Factors such as
actual or anticipated fluctuations in our operating results, regulatory
developments, conditions and trends in the consumer credit industry, general
market conditions and other factors beyond our control may significantly affect
the market price of our common stock. In addition, the market has, from time to
time, experienced significant price and volume fluctuations that often have been
unrelated to the operating performance of particular companies. These broad
fluctuations may adversely affect the market price of our common stock.
<PAGE>
Item 2. Properties
We currently lease our principal executive office space in St. Louis Park,
Minnesota, consisting of leases for approximately 75,000, 18,000, and 13,000
square feet. These leases expire in November 2000, May 2001, and August 2000,
respectively. We have also entered into leases for our new corporate office
space in Minnetonka, Minnesota, consisting of approximately 300,000 and 19,000
square feet effective September 2000 and March 2000 and terminating December
2006 and March 2006, respectively. Direct Merchants Bank leases office space in
Phoenix, Arizona, consisting of approximately 26,000 square feet. This lease
expires in June 2004, and may be terminated by us after June 2001. In addition,
Direct Merchants Bank purchased a new 130,000 square foot building in
Scottsdale, Arizona, during the third quarter of 1999 in anticipation of moving
into the new facility in March 2000. The new building serves as western regional
headquarters for us and Direct Merchants Bank's operation center. In addition,
we lease facilities in Tulsa, Oklahoma, White Marsh, Maryland, Jacksonville,
Florida, and Champaign, Illinois, consisting of approximately 100,000, 115,000,
160,000, and 10,000 square feet, respectively. These leases expire in November
2009, September 2007, June 2005, and November 2002, respectively. The leased
properties in Oklahoma, Maryland, and Florida support our collections, customer
service and back office operations. We believe our facilities are suitable to
our businesses and that we will be able to lease or purchase additional
facilities as needed.
Item 3. Legal Proceedings
We are a party to various legal proceedings resulting from the ordinary
business activities relating to our operations. We do not believe that any such
legal proceedings will have a material adverse effect on our financial position
or our operations.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of security holders during the fourth
quarter of our fiscal year ended December 31, 1999.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The information required by Item 201 of Regulation S-K is set forth in the
"Summary of Consolidated Quarterly Financial Information and Stock Data" on
pages 69 and 70 of our Annual Report to Shareholders as of and for the year
ended December 31, 1999, (the "1999 Annual Report"), and is incorporated herein
by reference.
During the period covered by this report, we issued securities that were
not registered under the Securities Act of 1933 (the "1933 Act"), in reliance on
Section 4(2) of the 1933 Act. We exchanged $200 million of Series B Perpetual
Preferred Stock, $100 million Senior Notes and ten year warrants for $300
million of Series C Perpetual Convertible Preferred Stock on June 1, 1999. The
additional information required by this item is set forth in "Note 6 - Private
Equity Placement" on pages 49 of this Form 10-K for the year ended December 31,
1999 and is incorporated herein by reference.
Item 6. Selected Financial Data
The information required by this item is set forth under the caption
"Selected Financial Data" on pages 25 and 26 of the 1999 Annual Report and is
incorporated herein by reference.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The information required by this item is set forth under the captions
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Forward Looking Statements" on pages 27 to 43 of the 1999
Annual Report and is incorporated herein by reference.
Item 7a. Quantitative And Qualitative Disclosures About Market Risk
The information required by this item is set forth under the captions
"Management's Discussion and Analysis-Market Risk" on page 39 of the 1999 Annual
Report and is incorporated herein by reference.
<PAGE>
Item 8. Financial Statements and Supplementary Data
<TABLE>
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(Dollars in thousands, except per-share data)
December 31,
1999 1998
---- ----
Assets:
<S> <C> <C>
Cash and due from banks ........................................................ $ 28,505 $ 22,114
Federal funds sold ............................................................. 118,962 15,060
Short-term investments ......................................................... 46,966 173
---------- --------
Cash and cash equivalents ................................................... 194,433 37,347
---------- --------
Retained interests in loans securitized ........................................ 1,617,226 753,469
Less: Allowance for loan losses ............................................. 606,853 393,283
---------- --------
Net retained interests in loans securitized .................................... 1,010,373 360,186
---------- --------
Credit card loans (net of allowance for loan losses of $12,175) 131,038 --
Loans held for securitization .................................................. 2,570 3,430
Property and equipment, net .................................................... 56,914 21,982
Accrued interest and fees receivable ........................................... 17,704 6,009
Prepaid expenses and deferred charges .......................................... 57,371 59,104
Deferred income taxes .......................................................... 185,613 153,021
Customer base intangible ....................................................... 83,809 81,892
Other receivables due from credit card securitizations, net ................... 243,978 185,935
Other assets ................................................................... 61,279 36,813
---------- --------
Total assets ............................................................. $2,045,082 $945,719
========== ========
Liabilities:
Deposits ....................................................................... $ 775,381 $ --
Debt ........................................................................... 345,012 310,896
Accounts payable ............................................................... 45,850 19,091
Current income taxes payable ................................................... 22,969 31,783
Deferred income ................................................................ 171,666 124,892
Accrued expenses and other liabilities ......................................... 60,403 26,075
---------- --------
Total liabilities ........................................................... $1,421,281 $512,737
---------- --------
Stockholders' Equity:
Preferred stock - Series B, par value $.01 per share; 10,000,000 shares
authorized, 539,866 shares issued and outstanding $ -- $201,100
Convertible preferred stock - Series C, par value $.01 per share; 10,000,000
shares authorized, 885,178 shares issued and outstanding 329,729 --
Common stock, par value $.01 per share; 100,000,000 shares authorized,
38,612,955 and 38,519,500 shares issued and outstanding, respectively 386 193
Paid-in capital ................................................................ 130,772 107,615
Retained earnings .............................................................. 162,914 124,074
---------- --------
Total stockholders' equity .................................................. $ 623,801 $432,982
---------- --------
Total liabilities and stockholders' equity .................................. $2,045,082 $945,719
========== ========
See accompanying Notes to Consolidated Financial Statements.
</TABLE>
<PAGE>
<TABLE>
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Statements of Income
(Dollars in thousands, except per-share data)
Year Ended December 31,
-----------------------
1999 1998 1997
---- ---- ----
Interest Income:
<S> <C> <C> <C>
Credit card loans and retained
interests in loans securitized ....... $ 229,394 $ 111,118 $ 66,695
Federal funds sold ........................ 4,477 1,065 1,636
Other ..................................... 2,298 1,028 863
--------- --------- ---------
Total interest income ................ 236,169 113,211 69,194
Interest expense .......................... 55,841 30,513 11,951
--------- --------- ---------
Net Interest Income ....................... 180,328 82,698 57,243
Provision for loan losses ................. 174,800 77,770 43,989
--------- --------- ---------
Net Interest Income
After Provision for Loan Losses ...... 5,528 4,928 13,254
--------- --------- ---------
Other Operating Income:
Net securitization and credit card
servicing income ..................... 318,873 138,221 79,533
Credit card fees, interchange
and other credit card income ......... 129,808 68,136 43,731
Fee-based services revenues ............... 175,091 109,123 64,532
--------- --------- ---------
623,772 315,480 187,796
--------- --------- ---------
Other Operating Expense:
Credit card account and other product
solicitation and marketing expenses .. 107,726 43,471 31,622
Employee compensation ..................... 122,417 62,627 35,200
Data processing services and
communications ....................... 52,355 35,445 20,087
Third-party servicing expense ............. 13,615 11,074 12,711
Warranty and debt waiver underwriting
and claims servicing expense ......... 21,091 12,279 6,053
Credit card fraud losses .................. 7,384 4,436 3,240
Customer base intangible amortization ..... 31,752 10,051 2,467
Other ..................................... 81,644 47,777 27,787
--------- --------- ---------
437,984 227,160 139,167
--------- --------- ---------
Income Before Income Taxes and
Extraordinary Loss ................... 191,316 93,248 61,883
Income taxes .............................. 75,953 35,900 23,825
--------- --------- ---------
Income Before Extraordinary Loss .......... 115,363 57,348 38,058
Extraordinary loss from early
extinguishment of debt ............... 50,808 -- --
--------- --------- ---------
Net Income ................................ 64,555 57,348 38,058
Preferred stock dividends-Series B ........ 7,506 1,100 --
Convertible preferred stock
dividends-Series C.................... 17,080 -- --
Adjustment for the retirement of
Series B preferred stock.............. 101,615 -- --
--------- --------- ---------
Net (Loss) Income Applicable to
Common Stockholders .................... $ (61,646) $ 56,248 $ 38,058
========= ========= =========
</TABLE>
<PAGE>
Earnings per share:
Basic-(loss) income before
extraordinary loss .......... $ (0.28) $ 1.46 $ 0.99
Basic-extraordinary loss ........ (1.32) -- --
Basic-net (loss) income ......... (1.60) 1.46 0.99
Diluted-(loss) income before
extraordinary loss .......... (0.28) 1.41 0.94
Diluted-extraordinary loss ...... (1.32) -- --
Diluted-net (loss) income ....... (1.60) 1.41 0.94
Shares used to compute earnings
per share:
Basic ................................ 38,570 38,464 38,450
Diluted .............................. 38,570 39,937 40,476
See accompanying Notes to Consolidated Financial Statements.
<PAGE>
<TABLE>
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity
(Dollars in thousands)
Total
Preferred Common Paid-In Retained Stockholders'
Stock Stock Capital Earnings Equity
----- ----- ------- -------- ------
<S> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1996 ............... $ -- $ 192 $ 107,220 $ 31,306 $ 138,718
Net income ............................ -- -- -- 38,058 38,058
Common stock dividends and other - cash -- -- (161) (577) (738)
--------- --------- --------- --------- ---------
BALANCE, DECEMBER 31, 1997 ............... $ -- $ 192 $ 107,059 $ 68,787 $ 176,038
========= ========= ========= ========= =========
Net income ............................ -- -- -- 57,348 57,348
Issuance of preferred stock ........... 200,000 -- -- -- 200,000
Common stock dividends and
other - cash ......................... -- -- -- (961) (961)
Preferred dividends in kind
- Series B ........................... 1,100 -- -- (1,100) --
Issuance of common stock
under employee benefit
plans .............................. -- 1 556 -- 557
--------- --------- --------- --------- ---------
BALANCE, DECEMBER 31, 1998 ............... $ 201,100 $ 193 $ 107,615 $ 124,074 $ 432,982
========= ========= ========= ========= =========
Net income .......................... -- -- -- 64,555 64,555
Retirement of preferred
stock - Series B ................ (208,606) -- (101,615) -- (310,221)
Issuance of preferred
stock - Series C ................ 312,910 -- 122,369 -- 435,279
Cash dividends ...................... -- -- -- (1,390) (1,390)
June 1999 two-for-one
stock split ..................... -- 193 (193) -- --
Preferred dividends in
kind - Series B .................. 7,506 -- -- (7,506) --
Preferred dividends in
kind - Series C ................. 16,819 -- -- (16,819) --
Issuance of common stock
under employee benefit
plans ........................... -- -- 2,596 -- 2,596
--------- --------- --------- --------- ---------
BALANCE, DECEMBER 31, 1999 ............... $ 329,729 $ 386 $ 130,772 $ 162,914 $ 623,801
========= ========= ========= ========= =========
See accompanying Notes to Consolidated Financial Statements.
</TABLE>
<PAGE>
<TABLE>
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Dollars in thousands)
Year Ended December 31,
-----------------------
1999 1998 1997
---- ---- ----
Operating Activities:
<S> <C> <C> <C>
Net income ...................................................... $ 64,555 $ 57,348 $ 38,058
Adjustments to reconcile net income to net cash provided by
operating activities:
Extraordinary loss from early extinguishment of debt.......... 50,808 -- --
Depreciation and amortization ................................ 75,341 48,678 15,942
Change in allowance for loan losses .......................... 225,745 149,199 148,415
Changes in operating assets and liabilities:
Accrued interest and fees receivable ...................... (11,695) (1,699) (1,368)
Prepaid expenses and deferred charges ..................... (46,448) (61,163) (23,150)
Deferred income taxes ..................................... (32,592) (72,234) (49,259)
Other receivables due from credit card securitizations, net (61,144) (112,170) (31,911)
Accounts payable and accrued expenses ..................... 65,337 (14,553) 28,246
Current income taxes payable .............................. (8,814) 22,082 8,241
Deferred income ........................................... 46,774 75,688 26,021
Other ..................................................... (39,983) (26,264) (16,022)
----------- ----------- -----------
Net cash provided by operating activities ....................... 327,884 64,912 143,213
----------- ----------- -----------
Investing Activities:
Proceeds from repayments of securitized loans................... 960,170 1,491,832 1,665,700
Net loans originated or collected ............................... (843,274) (901,740) (1,231,223)
Credit card portfolio acquisitions .............................. (1,156,673) (921,558) (738,104)
Additions to premises and equipment ............................. (41,724) (10,814) (11,705)
----------- ----------- -----------
Net cash used in investing activities ........................... (1,081,501) (342,280) (315,332)
----------- ----------- -----------
Financing Activities:
Net (decrease)/increase in short-term borrowings................. (10,000) (34,000) 88,837
Proceeds from the issuance of long-term debt..................... 144,116 100,896 100,000
Net increase in deposits ........................................ 775,381 -- --
Cash dividends paid ............................................. (1,390) (961) (577)
(Decrease)/Increase in preferred equity ......................... (124) 200,000 --
Increase in common equity ....................................... 2,720 557 --
----------- ----------- -----------
Net cash provided by financing activities ....................... 910,703 266,492 188,260
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents............. 157,086 (10,876) 16,141
Cash and cash equivalents at beginning of year................... 37,347 48,223 32,082
----------- ----------- -----------
Cash and cash equivalents at end of year ........................ $ 194,433 $ 37,347 $ 48,223
=========== =========== ===========
See accompanying Notes to Consolidated Financial Statements.
</TABLE>
<PAGE>
METRIS COMPANIES INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except as noted)
NOTE 1 - ORGANIZATION AND BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Metris
Companies Inc. ("MCI") and its subsidiaries (collectively, the "Company")
including Direct Merchants Credit Card Bank, N.A. ("Direct Merchants Bank")
which may be referred to as "we," "us" and "our." The Company is an
information-based direct marketer of consumer credit products and fee-based
services primarily to moderate-income consumers.
Prior to September 25, 1998, Fingerhut Companies, Inc. owned 83% of the
Company. On September 25, 1998, Fingerhut distributed its remaining shares of
the Company to Fingerhut shareholders in a tax free distribution (the "spin
off").
All significant intercompany balances and transactions have been eliminated
in consolidation. Certain prior year amounts have been reclassified to conform
with the current year's presentation.
Pervasiveness of Estimates
We have prepared the consolidated financial statements in accordance with
generally accepted accounting principles, which require us to make estimates and
assumptions that affect the reported amount of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the consolidated
financial statements as well as the reported amount of revenues and expenses
during the reporting periods. Actual results could differ from these estimates.
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of the significant accounting and reporting
policies used in preparing the consolidated financial statements.
Federal Funds Sold and Short-term Investments
Federal funds sold are short-term loans made to banks through the Federal
Reserve System. It is the Company's policy to make such loans only to banks that
are considered to be in compliance with their regulatory capital requirements.
Short-term investments are investments in commercial paper, money market mutual
funds and certificates of deposits with maturities less than three months.
Loans Held for Securitization and Credit Card Loans
Loans held for securitization are credit card loans we intend to
securitize, generally no later than three months from origination and are
recorded at the lower of aggregate cost or market value. Credit card loans are
receivables from consumers that we do not intend to securitize.
<PAGE>
Securitization, Retained Interests in Loans Securitized and
Securitization Income
We securitize and sell a significant portion of our credit card loans to
both public and private investors through the Metris Master Trust and
third-party bank-sponsored, multi-seller receivables conduits. We retain
participating interests in the credit card loans under "Retained interests in
loans securitized" on the consolidated balance sheets. Our retained interests in
loans securitized are subordinate to the interests of investors in the trust and
conduit portfolios. Although we continue to service the securitized credit card
accounts and maintain the customer relationships, these transactions are treated
as sales for financial reporting purposes and the associated loans are not
reflected on the consolidated balance sheets.
The sales of these loans have been recorded in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities." Upon sale,
the sold credit card loans are removed from the balance sheet and the related
financial and servicing assets controlled and liabilities incurred are initially
measured at fair value, if practicable. SFAS 125 also requires that servicing
assets and other retained interests in the transferred assets be measured by
allocating the previous carrying amount between the assets sold, if any, and
retained interests, if any, based on their relative fair values at the date of
the transfer.
The securitization and sale of credit card loans changes our interest in
such loans from lender to servicer, with a corresponding change in how revenue
is reported in the statements of income. For securitized and sold credit card
loans, amounts that otherwise would have been recorded as interest income,
interest expense, fee income and provision for loan losses are instead reported
in other operating income as "Net securitization and credit card servicing
income." We have various receivables from the trust or conduits and other assets
as a result of securitizations, including: amounts deposited in accounts held by
the trust for the benefit of the trust's security holders; amounts due from
interest rate caps, swaps and floors; accrued interest and fees on the
securitized receivables; servicing fee receivables and various other
receivables. These amounts are reported as "Other receivables due from credit
card securitizations, net" on the consolidated balance sheets. The provision for
loan losses reflected on the statements of income in "Net securitization and
credit card servicing income" was $567.7 million, $456.4 million and $275.3
million for the years ended December 31, 1999, 1998 and 1997, respectively.
Allowance for Loan Losses
Provisions for loan losses are made in amounts necessary to maintain the
allowance at a level estimated to be sufficient to absorb probable future losses
of principal and earned interest, net of recoveries, inherent in the existing
managed loan portfolio, effectively reducing our retained interests in loans
securitized to fair value. In evaluating the adequacy of the allowance for loan
losses, we consider several factors, including: historical charge-off and
recovery activity by age (vintage) of each loan portfolio (noting any particular
trends over recent periods); recent delinquency and collection trends by
vintage; current economic conditions and the impact such conditions might have
on borrowers' ability to repay; the risk characteristics of the portfolios; and
other factors. Significant changes in these factors could affect the adequacy of
the allowance for loan losses in the near term. Credit card accounts are
generally charged off at the end of the month during which the loan becomes
contractually 180 days past due, with the exception of bankrupt accounts, which
are charged off immediately upon formal notification of bankruptcy, and accounts
of deceased cardholders without a surviving, contractually liable individual, or
an estate large enough to pay the debt in full, which are also charged off
immediately upon notification.
Property and Equipment
Property and equipment, and computer hardware and software are stated at
cost and depreciated on a straight-line basis over their estimated economic
useful lives. We capitalize software developed for internal use that represents
major enhancements or replacements of operating and management information
systems. Amortization of such capitalized software begins when the systems are
fully developed and ready for implementation. Repairs and maintenance are
charged to expense as incurred.
Customer Base Intangible
The customer base intangible represents the excess of amounts paid for
portfolio acquisitions over the related credit card loan balances net of
reserves and discounts. The intangible assets are amortized over the estimated
periods of benefit, generally five to seven years, in proportion to the expected
benefits to be recognized. The amounts amortized for 1999, 1998 and 1997 were
$31.8 million, $10.1 million, and $2.5 million, respectively.
Interest Income on Credit Card Loans
Interest income on credit card loans is accrued and earned based on the
principal amount of the loans outstanding using the effective-yield method.
Accrued interest which has been billed to the customer but not yet received is
classified on the balance sheet with the related credit card loans. Accrued
interest which has not yet been billed to the customer is estimated and
classified on the balance sheet separate from the loan balance. Interest income
is generally recognized until a loan is charged off. At that time, the accrued
interest portion of the charged off balance is deducted from current period
interest income.
Fee-Based Services
Debt Waiver Products
Direct Merchants Bank offers various debt waiver products to its credit
card customers for which it retains the claims risk. Revenue for such products
is recognized ratably over the coverage period, generally one month, and
reserves are provided for pending claims based on Direct Merchants Bank's
historical experience with settlement of such claims. Revenues recorded for debt
waiver products are included in the consolidated statements of income under
"Fee-based services revenues" and were $106.0 million, $73.8 million and $47.6
million for the years ended December 31, 1999, 1998 and 1997, respectively.
Unearned revenues and reserves for pending claims are recorded in the
consolidated balance sheets in "Deferred income" and "Accrued expenses and other
liabilities" and combined amounted to $7.1 million and $4.8 million as of
December 31, 1999 and 1998, respectively.
Membership Programs
Membership fees for fee-based product sales are generally billed through
financial institutions, including Direct Merchants Bank, and other
cardholder-based institutions and are recorded as deferred membership income
upon acceptance of membership and pro-rated over the membership period beginning
after the contractual cancellation period is complete. Deferred fee-based
revenues totaled $127.5 million and $72.9 million at December 31, 1999 and 1998,
respectively.
In accordance with the provisions of Statement of Position 93-7, "Reporting
on Advertising Costs," qualifying membership acquisition costs are deferred and
charged to expense as membership fees are recognized. These costs, which relate
directly to membership solicitations (direct response advertising costs),
principally include: postage, printing, mailings and telemarketing costs. Such
costs are amortized on a straight-line basis as revenues are realized over the
membership period. Amortization of membership acquisition costs amounted to $9.9
million, $8.9 million and $2.3 million for the years ended December 31, 1999,
1998 and 1997, respectively. If deferred membership acquisition costs were to
exceed the membership fee, an appropriate adjustment would be made for
impairment. Deferred fee-based membership acquisition costs amounted to $30.6
million and $22.4 million as of December 31, 1999 and 1998, respectively.
During the quarter ended September 30, 1998, we changed our method of
recognizing revenue for certain fee-based services for which a cancellation
period with a full refund exists. This change was made to be consistent with
revenue recognition policy changes made by others in our industry. Previously,
we had recognized a portion of the revenue, net of estimated cancellations,
associated with such services during the refund period. We now defer the
recognition of revenue until the expiration of the cancellation period, at which
time revenue relating to the full refund period is recognized. The remaining
revenue is recognized over the remaining term of the membership. We continue to
defer qualifying direct-response advertising costs and amortize these expenses
in proportion to revenue recognized. This change resulted in a cumulative
one-time reduction in revenues of approximately $3.0 million and a corresponding
reduction in expenses of approximately $3.1 million, or a $68,000 increase in
net income. This cumulative impact is reflected in the consolidated statement of
income for the year ended December 31, 1998.
Extended Service Plans
We coordinate the marketing activities for Fingerhut's sales of extended
service plans. We perform administrative services and retain the claims risk for
all extended service plans sold. As a result, extended service plan revenues and
the incremental direct acquisition costs are deferred and recognized on a
straight-line basis over the life of the related extended service plan contracts
beginning after the expiration of any manufacturers' warranty coverage. The
provision for service contract returns charged against deferred income for the
years ended December 31, 1999, 1998 and 1997, amounted to $5.0 million, $4.8
million and $4.6 million, respectively. Additionally, prior to 1999, we
reimbursed Fingerhut for the cost of its marketing media and other services
utilized in the sales of extended service plans, based on contracts sold and on
media utilization costs as agreed to by us and Fingerhut. Beginning in 1999,
Fingerhut was responsible for paying a majority of the marketing expense and
therefore retained a larger portion of the related revenue.
Credit Card Fees and Origination Costs
Credit card fees include annual membership, late payment, overlimit,
returned check, cash advance transaction fees and other miscellaneous fees.
These fees are assessed according to the terms of the related cardholder
agreements.
We defer direct credit card origination costs associated with successful
credit card solicitations that we incur in transactions with independent third
parties, and certain other costs that we incur in connection with loan
underwriting and the preparation and processing of loan documents. These
deferred credit card origination costs are netted against the related credit
card annual fee, if any, and amortized on a straight-line basis over the
cardholder's privilege period, generally 12 months. Net deferred fees were $11.8
million and $9.6 million as of December 31, 1999 and 1998, respectively.
Solicitation Expenses
Credit card account costs, including printing, credit bureaus, list
processing costs, telemarketing and postage, are generally expensed as incurred
over the two to three month period during which the related responses to such
solicitation are received.
Credit Card Fraud Losses
We experience credit card fraud losses from the unauthorized use of credit
cards. These fraudulent transactions are expensed when identified, through the
establishment of a reserve for the transactions. These amounts are charged off
after 90 days, after all attempts to recover the amounts from such transactions,
including chargebacks to merchants and claims against cardholders, are
exhausted.
Interest Rate Risk Management Contracts
The nature and composition of our assets and liabilities and securitized
loans expose us to interest rate risk. We enter into a variety of interest rate
risk management contracts such as interest rate swap, floor and cap agreements
with highly rated counterparties in order to hedge our interest rate exposure.
The monthly interest rate differential to be paid or received on these contracts
is accrued and included in "Net securitization and credit card servicing income"
on the consolidated statements of income. Premiums paid for such contracts and
the related interest payable or receivable under such contracts are classified
under "Other receivables due from credit card securitization, net," on the
consolidated balance sheets. Premiums paid for interest rate contracts are
recorded at cost and amortized on a straight-line basis over the life of the
contract.
Debt Issuance Costs
Debt issuance costs are the costs related to issuing new debt securities
and establishing new securitizations under the trust or conduits. The costs are
capitalized as incurred and amortized to expense over the term of the new debt
security.
Income Taxes
We determine deferred taxes based on the temporary differences between the
financial statement and the tax bases of assets and liabilities that will result
in future taxable or deductible amounts. The deferred taxes are based on the
enacted rate that is expected to apply when the temporary differences reverse.
For periods prior to the spin off, we were included in the consolidated federal
and certain state income tax returns of Fingerhut Companies, Inc. Based on a tax
sharing agreement between us and Fingerhut Companies, Inc., the provision and
deferred income taxes are computed based only on our financial results as if we
filed our own federal and state tax returns.
Statements of Cash Flows
We prepare our consolidated statements of cash flows using the indirect
method, which requires a reconciliation of net income to net cash from operating
activities. In addition, we net certain cash receipts and cash payments from
credit card loans made to customers, including principal collections on those
loans. For purposes of the consolidated statements of cash flows, cash and cash
equivalents include cash and due from banks, federal funds sold, short-term
investments (mainly commercial paper and money market funds), and all other
highly liquid investments with original maturities of three months or less.
Cash paid for interest during the years ended December 31, 1999, 1998 and
1997, was $29.5 million, $28.4 million and $9.4 million, respectively. Cash paid
for income taxes for the same periods was $117.0 million, $86.1 million and
$64.8 million, respectively.
The statement of cash flows for the year ended December 31, 1999, reflects
the non-cash adjustments related to the conversion of the Series B Perpetual
Preferred Stock and 12% Senior Notes and the cancellation of warrants (see Note
6). The conversion to Series C Perpetual Convertible Preferred Stock resulted in
non-cash reductions in debt and accrued interest of $100 million and $4.3
million, respectively, offset by an increase of $104.3 million in equity.
Earnings Per Share
Basic earnings per share ("EPS") excludes dilution and is computed by
dividing net income applicable to common stockholders by the weighted average
number of common shares outstanding for the period. Diluted EPS reflects the
potential dilution that could occur if securities or other contracts to issue
<PAGE>
common stock were exercised or converted into common stock. The following table
presents the computation of basic and diluted weighted average shares used in
the per-share calculations:
Year Ended December 31,
1999 1998 1997
---- ---- ----
(In thousands, except per-share amounts)
Income before extraordinary loss ........ $ 115,363 $ 57,348 $ 38,058
Preferred dividends - Series B .......... 7,506 1,100 --
Preferred dividends - Series C .......... 17,080 -- --
Adjustment for the retirement of Series B
preferred stock .................... 101,615 -- --
--------- --------- ---------
Net (loss) income applicable to common
stockholders before extraordinary
items .............................. (10,838) 56,248 38,058
Extraordinary loss from the early
extinguishment of debt ............. 50,808 -- --
--------- --------- ---------
Net (loss) income applicable to common
stockholders ....................... $ (61,646) $ 56,248 $ 38,058
========= ========= =========
Weighted average common shares
outstanding ........................ 38,570 38,464 38,450
Adjustments for dilutive securities:
Assumed exercise of outstanding stock
options(1) ........................... -- 1,473 2,026
--------- --------- ---------
Diluted common shares ................... 38,570 39,937 40,476
========= ========= =========
Earnings per share:
Basic - (loss) income before
extraordinary loss ............. $ (0.28) $ 1.46 $ 0.99
Basic - extraordinary loss ......... (1.32) -- --
Basic - net (loss) income .......... (1.60) 1.46 0.99
Diluted - (loss) income before
extraordinary loss ............. (0.28) 1.41 0.94
Diluted - extraordinary loss ....... (1.32) -- --
Diluted - net (loss) income ........ (1.60) 1.41 0.94
(1) For the year ended December 31, 1999, there were options and convertible
preferred stock outstanding to purchase 2.1 million and 10.2 million common
shares. These potential common shares have been excluded from the computation of
diluted earnings per share because their inclusion would have been
anti-dilutive.
Comprehensive Income
During 1998, we adopted SFAS 130, "Reporting Comprehensive Income." This
statement does not apply to our current financial results and therefore, net
income equals comprehensive income.
NOTE 3 - ALLOWANCE FOR LOAN LOSSES
We maintain an allowance for loan losses for both owned loans and the
retained interests in loans securitized. The portion allocated to the retained
interest in loans securitized represents our estimated valuation adjustment to
report this asset in accordance with SFAS 125. For securitized loans,
anticipated losses and related provisions for loan losses are reflected in the
calculations of net securitization and credit card servicing income. We make
provisions for loan losses in amounts necessary to maintain the allowance at a
level estimated to be sufficient to absorb probable future losses of principal
and earned interest, net of recoveries, inherent in the existing loan portfolio.
The activity in the allowance for loan losses is as follows:
Year Ended December 31,
1999 1998 1997
---- ---- ----
Balance at beginning of year ............ $ 393,283 $ 244,084 $ 95,669
Allowance related to assets acquired, net 26,293 20,152 20,246
Provision for loan losses ............... 174,800 77,770 43,989
Provision for loan losses (1) ........... 567,737 456,354 275,310
Loans charged off ....................... (582,637) (420,875) (195,535)
Recoveries .............................. 39,552 15,798 4,405
--------- --------- ---------
Net loans charged off ................... (543,085) (405,077) (191,130)
--------- --------- ---------
Balance at end of year .................. $ 619,028 $ 393,283 $ 244,084
========= ========= =========
(1) Amounts are included in "Net securitizations and credit card servicing
income."
NOTE 4 - PROPERTY AND EQUIPMENT
The carrying value of property and equipment is as follows:
December 31,
1999 1998
---- ----
Furniture and equipment ....................... $12,186 $10,974
Computer software and equipment ............... 24,675 9,077
Construction in progress ...................... 24,500 2,013
Leasehold improvements ........................ 8,631 6,204
------- -------
Total ......................................... $69,992 $28,268
Less: Accumulated depreciation and amortization 13,078 6,286
------- -------
Balance at end of year ........................ $56,914 $21,982
======= =======
Depreciation and amortization expense for the years ended December 31,
1999, 1998 and 1997, was $6.8 million, $4.4 million and $1.4 million,
respectively.
NOTE 5 - PORTFOLIO ACQUISITIONS
On June 30, 1999, Direct Merchants Bank purchased a portion of the consumer
bank card portfolio of GE Capital Consumer Card Co., a unit of General Electric
Company. The acquired credit card portfolio had approximately 485,000 active
accounts, which were converted to the Direct Merchants Bank platform in October
1999, and approximately $1.2 billion in receivables. In December 1998, the
Company acquired an $800 million credit card portfolio from PNC Bank Corp.
representing loans from customers outside of PNC's normal banking relationship.
In October 1997, the Company acquired a $405 million credit card portfolio from
Mercantile Bank National Association. In September 1997, the Company acquired a
$317 million credit card portfolio from Key Bank USA, National Association.
NOTE 6 - PRIVATE EQUITY PLACEMENT
On November 13, 1998, we entered into agreements with affiliates of the
Thomas H. Lee Company, a private equity firm, to make a total private equity
investment of $300 million in the Company. The Lee Company agreed to purchase
0.8 million shares of Series C Perpetual Convertible Preferred Stock, which are
convertible into common shares at a conversion price of $18.63 per common share
subject to adjustment in certain circumstances. The Series C Preferred has a 9%
dividend payable in additional shares of Series C Preferred and will also
receive any dividends paid on our common stock on an as converted basis. The
cumulative payment-in-kind dividends are effectively guaranteed for a seven-year
period. Assuming conversion of the Series C Preferred into common stock, the Lee
Company would own over 30% of the Company on a diluted basis at December 31,
1999. The Series C Preferred entitles the holders to elect four members to our
Board of Directors. The Series C Preferred may be redeemed by us in certain
circumstances after December 31, 2001 by paying 103% of the redemption price of
$372.50 and any accrued dividends at the time of redemption. We also have the
option to redeem the Series C Preferred after December 9, 2008, without
restriction by paying the redemption price of $372.50 and any accrued dividends
at the time of redemption. The conversion to the Series C Preferred would have
resulted in a "change in control" in certain of our agreements with Fingerhut
and our credit facilities. Therefore, prior to closing the transaction, we
increased the change in control ownership percentage from 30 to 35 or otherwise
exempted the Lee Company from the change in control provision in its agreements.
Prior to shareholder approval and the receipt of notice that there was no
regulatory objection to the Series C Preferred investment, the Lee Company
agreed to purchase $200 million in Series B Perpetual Preferred Stock and $100
million in 12% Senior Notes due 2006. We also issued the Lee Company 7.5 million
ten-year warrants to purchase shares of our common stock.
On March 12, 1999, shareholders approved the conversion of the Series B
Preferred and 12% Senior Notes into Series C Preferred. Notice was received on
May 28, 1999, that there was no regulatory objection to the conversion to the
Series C Preferred. On June 1, 1999, the Series B Preferred and the 12% Senior
Notes were extinguished, and the warrants were canceled causing a one-time,
non-cash, accounting adjustment. The excess of the fair value of the Series C
Preferred over the carrying value of the Series B Preferred and the 12% Senior
Notes at the time of the conversion was allocated to the 12% Senior Notes and
the Series B Preferred based upon their initial fair values. To arrive at net
income applicable to common stockholders in the calculation of earnings per
share, the amount allocated to the 12% Senior Notes was recognized as an
extraordinary loss from the early extinguishment of debt in the amount of $50.8
million and the amount allocated to the Series B Preferred was recognized as a
reduction of net income applicable to common stockholders in the amount of
$101.6 million. The extraordinary loss attributable to the 12% Senior Notes is
not recorded net of taxes. These adjustments did not have an impact on total
stockholders' equity.
NOTE 7 - STOCK OPTIONS
We offer the Metris Companies Inc. Long-Term Incentive and Stock Option
Plan, which permits a variety of stock-based grants and awards and gives us
flexibility in tailoring our long-term compensation programs. Originally, this
stock option plan permitted up to 3.7 million shares of common stock for awards
of options, subject to certain adjustments in certain circumstances. In 1998,
the Board of Directors amended the plan to provide 8.0 million shares of common
stock for awards of stock options or other stock-based awards, subject to
adjustment in certain circumstances. As of December 31, 1999 and 1998, 1.5
million and 3.0 million shares, respectively, were available for grant. There
were 0.6 million shares available for grant at December 31, 1997, prior to the
amendment which increased the total number of shares available for awards under
the plan to 8.0 million.
The Compensation Committee has the authority to determine the exercise
prices, vesting dates or conditions, expiration dates and other material
conditions upon which options or awards may be exercised, except that the option
price for Incentive Stock Options ("ISOs") may not be less than 100% of the fair
market value of the common stock on the date of grant (and not less than 110% of
the fair market value in the case of an ISO granted to any employee owning more
than 10% of the common stock) and the terms of nonqualified stock options may
not exceed 15 years from the date of grant (not more than 10 years for ISOs and
five years for ISOs granted to any employee owning more than 10% of the common
stock). Full- or part-time employees, consultants or independent contractors are
eligible to receive nonqualified options and awards. Only full- or part-time
employees are eligible to receive ISOs.
During 1999, 1998 and 1997, we granted 1.8 million, 2.1 million and 0.6
million options, respectively, to officers and employees. Restricted stock
grants are also issued under the stock option plan to our executive officers. A
total of 0.2 million common shares were granted in 1999, with an approximate
aggregate market value of $4.0 million at the time of the grant. The market
value of these restricted shares at the date of grant is amortized into expense
over a period not less than the restriction period. We recognized $0.6 million
in 1999 for these restricted shares. If the restrictions have been removed,
generally upon death, disability or retirement, the remaining unamortized market
value of the restricted shares is expensed.
We also offer the Metris Companies Inc. Non-Employee Director Stock Option
Plan. Originally, such plan permitted up to 40,000 shares of common stock for
awards of options, subject to certain adjustments in certain circumstances. In
1997, the Board of Directors amended the plan to provide up to 200,000 shares of
common stock for awards of options, subject to adjustments in certain
circumstances. This Director Plan was approved by our stockholders at the 1998
annual meeting. In 1999, the Board of Directors amended the plan to provide up
to 500,000 shares of common stock for awards of options, subject to adjustments
in certain circumstances. During 1999, 1998 and 1997, we granted 85,000, 50,000
and 40,000 options, respectively. At December 31, 1999, 1998 and 1997, 305,000,
90,000 and 140,000 shares, respectively, were available for grant.
We have adopted the disclosure-only provisions of SFAS No. 123 "Accounting
for Stock-Based Compensation." Accordingly, we continue to account for
stock-based compensation under the provisions of Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees." Under the guidelines
of Opinion 25, compensation cost for stock-based employee compensation plans is
recognized based on the difference, if any, between the quoted market price of
the stock on the date of grant and the amount an employee must pay to acquire
the stock. Had compensation cost for these plans been determined based on the
fair value methodology prescribed by SFAS 123, our net earnings and earnings per
share would have been reduced to the pro forma amounts indicated below:
Year Ended December 31,
1999 1998 1997
---- ---- ----
Net income as reported ...................... $ 64,555 $ 57,348 $ 38,058
Net income pro forma ........................ 59,733 47,264 36,819
Diluted (loss)/earnings per share as reported (1.60) 1.41 0.94
Diluted (loss)/earnings per share pro forma . (1.72) 1.18 0.91
The above pro forma amounts may not be representative of the effects on
reported net earnings for future years. The fair value of each option grant is
estimated on the date of grant using the Black-Scholes option-pricing model. The
following weighted-average assumptions were used for grants in 1999, 1998 and
1997, respectively: dividend yield of 0.10%, 0.10% and 0.11%; expected
volatility of 55.4%, 71.3% and 68.2%; risk-free interest rate of 5.30%, 4.72%
and 6.34%; and expected lives of six years, seven years, and seven years,
respectively.
<PAGE>
Information regarding our stock option plans for 1999, 1998 and 1997, is as
follows:
<TABLE>
Year Ended December 31,
1999 1998 1997
---- ---- ----
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Options outstanding, beginning of
year .......................... 5,241,400 $12.84 3,364,400 $ 7.52 2,817,400 $ 4.47
Options exercised ................ 74,500 9.60 69,500 8.00 -- --
Options granted .................. 1,907,276 20.20 2,161,000 21.78 677,000 20.29
Options canceled/forfeited....... 321,100 20.68 214,500 20.88 130,000 8.00
--------- ------ --------- ------ --------- ------
Options outstanding,
end of year ................... 6,753,076 $14.58 5,241,400 $12.84 3,364,400 $ 7.52
========= ========= =========
Weighted-average fair value of
options granted during the year $ 9.80 $16.16 $14.15
</TABLE>
The following table summarizes information about stock options outstanding
at December 31, 1999:
<TABLE>
Options Outstanding Options Exercisable
------------------- -------------------
Weighted-
Average Weighted- Weighted-
Number Remaining Average Number Average
Outstanding Contractual Exercise Exercisable Exercise
at 12/31/99 Life Price at 12/31/99 Price
----------- ---- ----- ----------- -----
Exercise Price
<S> <C> <C> <C> <C> <C>
$ 1.38 .............. 1,704,400 5.1 $ 1.22 1,504,400 $ 1.38
$ 8.00-$18.25 .............. 1,905,000 7.8 11.34 1,705,000 10.95
$18.26-$27.75 .............. 2,108,176 8.8 21.03 382,000 21.00
$27.76-$34.69 .............. 1,035,500 8.6 29.41 766,000 29.25
--------- --- ------ --------- ------
6,753,076 7.5 $14.58 4,357,400 $11.74
========= =========
</TABLE>
Employee Stock Purchase Plan
During the third quarter of 1999, we adopted an employee stock purchase
plan (ESPP), whereby eligible employees may authorize payroll deductions of up
to 15% of their salary to purchase shares of our common stock. Under the plan,
shares of our common stock may be purchased at the end of each monthly offering
period at 85% of the lower of the fair market value on the first or last day of
the monthly offering period. Employees contributed $0.7 million to purchase
26,681 shares of common stock under the ESPP for 1999. We are authorized to
issue up to 1.7 million shares of common stock to employees under the plan, and
as of December 31, 1999 there were approximately 1.7 million shares available
for future issuance.
Management Stock Purchase Plan
During the third quarter of 1999, effective January 1, 2000, we adopted a
management stock purchase plan (MSPP), whereby any employee who is a Senior Vice
President or higher and who participates in the Metris Management Incentive
Bonus Plan is eligible to participate in the MSPP. Participants may elect to
defer up to 50% of their bonus received under the Management Bonus Plan, which
is credited to a stock purchase account as restricted stock units. We will make
a match of $1 for every $3 contributed by the participant. The participant's
contributions are vested immediately and our matching contributions vest after
three years (two years for contributions made for the year of adoption). We are
authorized to issue up to 300,000 shares of common stock to employees under the
plan, and as of December 31, 1999, 100% of the authorized shares were available
for future issuance.
Supplemental Executive Retirement Plan
Our funded Supplemental Executive Retirement Plan ("SERP"), established
in 1999, provides officers and other members of senior management with
supplemental retirement benefits in excess of limits imposed on qualified plans
by federal tax law. The SERP is an account balance plan to which we will make
annual contributions targeted to provide 60% of the average of the participant's
final five years of salary and bonus with us. These benefits will be paid in 15
annual installments beginning the year after they become eligible to receive
benefits. Participants are eligible to receive benefits upon leaving our
employment if they are at least 65 years of age or at least age 55 with five
years of plan participation, if a change of control occurs or in the event of
death. We recognized $2.2 million dollars of expense in 1999 related to the SERP
plan. This expense was calculated based on actuarial assumptions regarding years
of participation, future investment returns and participants continuing in the
plan until age 65.
NOTE 8 - EMPLOYEE BENEFIT PLANS
We offer a defined contribution plan that is intended to qualify under
section 401(k) of the Internal Revenue Code. The 401(k) Plan provides retirement
benefits for eligible employees. Eligible employees may elect to contribute to
the 401(k) Plan, and we match a portion of employee contributions and make
discretionary contributions based upon our financial performance. For the years
ended December 31, 1999, 1998 and 1997, we contributed $1.8 million, $0.9
million and $0.9 million to the 401(k), respectively.
<PAGE>
NOTE 9 - INCOME TAXES
The components of the provision for income taxes consisted of the
following:
Year Ended December 31,
1999 1998 1997
---- ---- ----
Current:
Federal .......... $ 94,309 $ 98,428 $ 66,496
State ............ 14,236 8,355 4,663
Deferred ............ (32,592) (70,883) (47,334)
-------- -------- --------
$ 75,953 $ 35,900 $ 23,825
======== ======== ========
A reconciliation of our effective income tax rate compared to the statutory
federal income tax rate is as follows:
Year Ended December 31,
1999 1998 1997
---- ---- ----
Statutory federal income tax rate ............... 35.0% 35.0% 35.0%
State income taxes, net of federal benefit ...... 3.2% 3.2% 3.2%
Other, net ...................................... 1.5% 0.3% 0.3%
---- ---- ----
Effective income tax rate ....................... 39.7% 38.5% 38.5%
---- ---- ----
Our deferred tax assets and liabilities are as follows:
December 31,
1999 1998
---- ----
Deferred income tax assets resulting from
future deductible temporary differences:
Allowance for loan losses ............................ $196,840 $119,518
Deferred revenues .................................... 48,200 32,334
Other ................................................ 19,378 18,199
-------- --------
Total deferred tax assets ............................... $264,418 $170,051
Deferred income tax liabilities resulting from
future taxable temporary differences:
Accrued interest on credit card loans ................ $ 65,260 $ 5,048
Deferred costs ....................................... 11,464 10,672
Other ................................................ 2,081 1,310
-------- --------
Total deferred tax liabilities .......................... $ 78,805 $ 17,030
-------- --------
Net deferred tax assets ................................. $185,613 $153,021
======== ========
We believe, based on our history of operating earnings, expectations for
operating earnings in the future, and the expected reversal of taxable temporary
differences, earnings will be sufficient to fully utilize the deferred tax
assets.
NOTE 10 - RELATED PARTY TRANSACTIONS
Prior to September 1998, Fingerhut owned approximately 83% of our
outstanding common shares. In September 1998, Fingerhut distributed the
remaining shares of the Company to shareholders of Fingerhut in a tax free
distribution.
Information related to transactions with Fingerhut have not been presented
for the year ended December 31, 1999; as Fingerhut is no longer considered a
related party after distributing their remaining shares. Prior to the
distribution of the shares, Fingerhut and its various subsidiaries had
historically provided financial and operational support to us. We believe the
fees paid for the operational support reasonably approximate market rates for
the services performed. The direct and allocated expenses represent charges for
various administrative services. We have also entered into several other
agreements with Fingerhut that detail further business arrangements between the
companies. Each of these agreements was negotiated and we believe they
reasonably approximate contracts between unrelated third parties.
The following table summarizes the amounts of revenues, direct expense
charges, cost allocations (including net interest income or expense), and our
costs of the agreements mentioned above for each of the years reflected in our
financial statements.
Year Ended December 31,
1998 1997
---- ----
Revenues:
Fee-based services ................................... $15,439 $ 9,030
Expenses:
Credit card account and other product solicitation and
marketing expenses ................................ 10,796 9,551
Data processing services and communications .......... 2,344 1,837
Other ................................................ 659 1,336
The Lee Company investment (see Note 6) would have resulted in a "Change of
Control" as defined in certain agreements between us and Fingerhut, which would
have permitted Fingerhut to terminate any or all of the agreements. On December
8, 1998, we obtained a waiver agreement from Fingerhut to waive their rights to
terminate the agreements if a change of control occurred as a result of the
conversion.
Pursuant to the waiver agreement, the Company and Fingerhut amended certain
of their other agreements. The most significant change was made in the database
access agreement. Our exclusive license to use Fingerhut's customer database to
market financial service products will now become non-exclusive after October
31, 2001.
In the ordinary course of business, our executive officers may have credit
card loans issued by us. Pursuant to our policy, such loans are issued on the
same terms as those prevailing at the time for comparable loans with unrelated
persons and do not involve more than the normal risk of collectibility.
NOTE 11 - COMMITMENTS AND CONTINGENCIES
Commitments to extend credit to consumers represent the unused credit
limits on open credit card accounts. These commitments amounted to $9.7 billion,
$5.9 billion and $4.1 billion as of December 31, 1999, 1998 and 1997,
respectively. While these amounts represent the total lines of credit available
to our customers, we have not experienced and do not anticipate all of our
customers will exercise their entire available line at any given point in time.
We also have the right to increase, reduce, cancel, alter or amend the terms of
these available lines of credit at any time.
We lease certain office facilities and equipment under various cancelable
and non-cancelable operating lease agreements that provide for the payment of a
proportionate share of property taxes, insurance and other maintenance expenses.
These leases also may include scheduled rent increases and renewal options.
Rental expense for these operating leases for the years ended December 31, 1999,
1998 and 1997, was $11.1 million, $6.4 million and $3.9 million, respectively.
Future minimum lease commitments at December 31, 1999, under cancelable and
non-cancelable operating leases are as follows:
2000 $14,322
2001 13,870
2002 12,400
2003 10,306
2004 9,865
Thereafter 20,353
-------
Total minimum lease payments $81,116
=======
NOTE 12 - CAPITAL REQUIREMENTS AND RESTRICTED PAYMENTS
In the normal course of business, we enter into agreements, or are subject
to regulatory requirements, that result in cash, debt and dividend or other
capital restrictions.
The Federal Reserve Act imposes various legal limitations on the extent to
which banks can finance or otherwise supply funds to their affiliates. In
particular, Direct Merchants Bank is subject to certain restrictions on any
extensions of credit to or other covered transactions, such as certain purchases
of assets, with us and our affiliates. Such restrictions limit Direct Merchants
Bank's ability to lend to us and our affiliates. Additionally, Direct Merchants
Bank is limited in its ability to declare dividends to us in accordance with the
national bank dividend provisions.
Direct Merchants Bank is subject to certain capital adequacy guidelines
adopted by the OCC. At December 31, 1999 and 1998, Direct Merchants Bank's Tier
1 risk-based capital ratio, risk-based total capital ratio and Tier 1 leverage
ratio exceeded the minimum required capital levels, and Direct Merchants Bank
was considered a "well- capitalized" depository institution under regulations of
the OCC.
We are also bound by restrictions set forth in the indentures related to
the Senior Notes dated November 7, 1997, and July 15, 1999. Pursuant to those
indentures, we may not make dividend payments in the event of a default or if
all such restricted payments would exceed 25% of our aggregate cumulative net
income.
NOTE 13 - CONCENTRATIONS OF CREDIT RISK
A concentration of credit risk is defined as significant credit exposure
with an individual or group engaged in similar activities or affected similarly
by economic conditions. We are active in originating credit card loans
throughout the United States, and no individual or group had a significant
concentration of credit risk at December 31, 1999 or 1998. The following table
details the geographic distribution of our retained, sold and managed credit
card loans:
Retained Sold Managed
-------- ---- -------
December 31, 1999
California ........................ $ 224,359 $ 702,254 $ 926,613
Texas ............................. 158,760 496,927 655,687
New York .......................... 134,087 419,700 553,787
Florida ........................... 131,960 413,043 545,003
Ohio .............................. 73,313 229,473 302,786
Illinois .......................... 66,947 209,546 276,493
Pennsylvania ...................... 56,025 175,363 231,388
All others ........................ 917,558 2,872,007 3,789,565
---------- ---------- ----------
Total .......................... $1,763,009 $5,518,313 $7,281,322
========== ========== ==========
Retained Sold Managed
-------- ---- -------
December 31, 1998
California ........................ $ 94,521 $ 569,205 $ 663,726
Texas ............................. 76,542 460,937 537,479
Florida ........................... 57,138 344,084 401,222
New York .......................... 55,231 332,598 387,829
Ohio .............................. 31,936 192,320 224,256
Illinois .......................... 26,994 162,558 189,552
Pennsylvania ...................... 22,795 137,274 160,069
All others ........................ 391,742 2,359,167 2,750,909
---------- ---------- ----------
Total ....................... $ 756,899 $4,558,143 $5,315,042
========== ========== ==========
We target our consumer credit products primarily to moderate-income
consumers. Primary risks associated with lending to this market are that they
may be more sensitive to future economic downturn, which may make them more
likely to default on their obligations.
<PAGE>
NOTE 14 - FAIR VALUE OF FINANCIAL INSTRUMENTS
We have estimated the fair value of our financial instruments in accordance
with SFAS No. 107, "Disclosures About Fair Value of Financial Instruments."
Financial instruments include both assets and liabilities, whether or not
recognized in our consolidated balance sheets, for which it is practicable to
estimate fair value. Additionally, certain intangible assets recorded on the
consolidated balance sheets, such as purchased credit card relationships, and
other intangible assets not recorded on the consolidated balance sheets (such as
the value of the credit card relationships for originated loans and the
franchise values of our various lines of business) are not considered financial
instruments and, accordingly, are not valued for purposes of this disclosure. We
believe that there is substantial value associated with these assets based on
current market conditions, including the purchase and sale of such assets.
Accordingly, the aggregate estimated fair value amounts presented do not
represent the entire underlying value of the Company.
Quoted market prices generally are not available for all of our financial
instruments. Accordingly, in cases where quoted market prices are not available,
fair values were estimated using present value and other valuation techniques
that are significantly affected by the assumptions used, including the discount
rate and estimated future cash flows. These assumptions are based on historical
experience and assessments regarding the ultimate collectibility of assets and
related interest, and estimates of product lives and repricing characteristics
used in our asset/liability management process. These assumptions involve
uncertainties and matters of judgment, and therefore, cannot be determined with
precision. Thus, changes in these assumptions could significantly affect the
fair-value estimates.
A description of the methods and assumptions used to estimate the fair
value of each class of our financial instruments is as follows:
Cash and cash equivalents and accrued interest and fees receivable
The carrying amounts approximate fair value due to the short-term nature of
these instruments.
Net retained interests in loans securitized, loans held for securitizations and
credit card loans
Currently, credit card loans are originated with variable rates of interest
that adjust with changing market interest rates. Thus, carrying value less the
allowance for loan losses, approximates fair value. However, this valuation does
not include the value that relates to estimated cash flows generated from new
loans from existing customers over the life of the cardholder relationship.
Accordingly, the aggregate fair value of the credit card loans does not
represent the underlying value of the established cardholder relationships.
<PAGE>
Other receivables due from credit card securitizations, net
The following components of this net asset are as follows:
Interest-only strip
The fair value of the interest-only strip is estimated by discounting the
expected future cash flows from the trust and each of the conduits at rates
which we believe to be consistent with those that would be used by an
independent third party. However, because there is no active market for this,
the fair values presented may not be indicative of the value negotiated in an
actual sale. The future cash flows used to estimate fair value are limited to
the securitized receivables that exist at year end and does not reflect the
value associated with future receivables generated by cardholder activity. The
significant assumptions used to estimate fair value include: (i) discount rates;
(ii) customer payment rates; and (iii) anticipated charge-offs over the life of
the loans:
December 31,
1999 1998
---- ----
Discount rate ......... 12% 10%
Payment rate .......... 7% 6%
Default rate .......... 17% 16%
Interest rate cap and floor agreements
The fair values of interest rate cap and floor agreements were obtained
from dealer quoted prices. These values generally represent the estimated
amounts we would receive or pay to terminate the agreements at the reporting
dates, taking into consideration current interest rates and the current
creditworthiness of the counterparties.
Other amounts
For the other components of other receivables due from credit card
securitizations, net, the carrying amount is a reasonable estimate of the fair
value.
Debt
Short-term borrowings are made with variable rates of interest that adjust
with changing market interest rates. Thus, carrying value approximates fair
value.
The fair value of long-term debt was obtained from quoted market prices,
when available.
Deposits
The fair value for fixed rate certificates of deposit are estimated based
on quoted market prices of comparable instruments.
<PAGE>
The estimated fair values of our financial instruments are summarized as
follows:
<TABLE>
December 31,
1999 1998
---- ----
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
------ ---------- ------ ----------
<S> <C> <C> <C> <C>
Cash and cash equivalents ............ $ 194,433 $ 194,433 $ 37,347 $ 37,347
Retained interest in loans
securitized, net .................. 1,010,373 1,010,373 360,186 360,186
Credit card loans .................... 131,038 131,038 -- --
Loans held for
Securitization .................... 2,570 2,570 3,430 3,430
Other receivables due from credit card
securitizations, net:
Interest rate cap agreements ...... 27,113 34,526 2,912 2,925
Interest rate floor agreements .... 23 6 187 3,233
Interest only strip ............... -- -- -- --
Other amounts ..................... 216,842 216,842 182,836 182,836
Debt ................................. 345,012 346,218 310,896 317,666
Deposits ............................. 775,381 775,381 -- --
</TABLE>
NOTE 15 - DERIVATIVE FINANCIAL INSTRUMENTS
We enter into interest rate floor, cap and swap agreements to hedge the
cash flow and earnings impact of fluctuating market interest rates on the spread
between the floating rate loans and the floating and fixed rate securities
issued to fund the loans. In connection with the issuance of term asset-backed
securities by the trust, we enter into term interest rate cap agreements with
highly rated bank counterparties to effectively cap the potentially negative
impact to us of increases in the floating interest rate of the securities. These
interest rate cap agreements are for original terms ranging from three to ten
years and will terminate between February 2002 and January 2010.
<PAGE>
<TABLE>
Notional Amounts of Interest Rate Swap,
Cap and Floor Agreements Purchased and Sold
-------------------------------------------
Weighted Weighted
Year Ended December 31, Average Average
(Dollars in thousands) Interest Interest
1999 Rate 1998 Rate
---- ---------- ---- ----------
Interest rate swap
agreements:
<S> <C> <C> <C> <C>
Beginning Balance ..... $ -- -- $1,328,000 6.5%
Additions ............. -- -- -- --
Maturities/Terminations -- -- 1,328,000 6.5%
---------- ----------
Ending Balance ........ $ -- -- $ -- --
========== ==========
Interest rate caps:
Beginning Balance ..... $2,393,021 8.7% $ -- --
Additions ............. 2,460,000 9.5% 3,393,021 8.8%
Maturities/Terminations 640,000 7.4% 1,000,000 9.3%
---------- ----------
Ending Balance ........ $4,213,021 9.4% $2,393,021 8.7%
========== ==========
Interest rate floor:
Beginning Balance ..... $ 467,367 6.2% $ -- --
Additions ............. -- -- 1,293,467 6.4%
Maturities/Terminations 409,034 6.2% 826,100 6.5%
---------- ----------
Ending Balance ........ $ 58,333 6.2% $ 467,367 6.2%
========== ==========
</TABLE>
Interest rate risk management contracts are generally expressed in notional
principal or contract amounts that are much larger than the amounts potentially
at risk for nonpayment by counterparties. Therefore, in the event of
nonperformance by the counterparties, our credit exposure is limited to the
uncollected interest and contract market value related to the contracts that
have become favorable to us. We manage the credit risk of such contracts through
established risk limits and monitoring of the credit ratings of our
counterparties. We currently have no reason to anticipate nonperformance by any
counterparty.
NOTE 16 - SEGMENTS
We operate in two principal areas: consumer credit products and fee-based
services. Our primary consumer credit products are unsecured and secured credit
cards, including the Direct Merchants Bank MasterCard(R) and Visa(R). Our credit
card accounts include customers obtained from third-party lists and other
customers for whom general credit bureau information is available.
We market our fee-based services, including (i) debt waiver protection for
unemployment, disability and death, (ii) membership programs such as card
registration, purchase protection and other club memberships, and (iii)
third-party insurance, directly to our credit card customers and customers of
third parties. We currently administer our extended service plans sold through a
third-party retailer, and the customer pays the retailer directly. In addition,
we develop customized targeted mailing lists from information contained in our
databases for use by unaffiliated companies in their own product solicitation
efforts that do not directly compete with our efforts.
The segment information reported below is presented on a managed basis. We
use this basis to review segment performance and to make operating decisions. To
do so, the income statement and balance sheet are adjusted to reverse the
effects of securitizations. Presentation on a managed basis is not in conformity
with generally accepted accounting principles. The elimination column in the
segment table includes adjustments to present the information on an owned basis
as reported in the financial statements of this annual report.
The expenses, assets and liabilities attributable to corporate functions
are not allocated to the operating segments, such as employee compensation, data
processing services and communications, third-party servicing expenses, and
other expenses including occupancy, depreciation and amortization, professional
fees, and other general and administrative expenses. These expenses are included
in the reconciliation of the income before income taxes (and extraordinary loss)
for the reported segments to the consolidated total. We do not allocate capital
expenditures for leasehold improvements, capitalized software and furniture and
equipment to operating segments. There were no operating assets located outside
of the United States for the periods presented.
The fee-based services operating segment pays a commission to the consumer
credit products segment for successful marketing efforts to the consumer credit
products segment's cardholders at a rate similar to those paid to our other
third parties. The fee-based services segment reports interest income and the
consumer credit products segment reports interest expense at our weighted
average borrowing rate for the excess cash flow generated by the fee-based
services segment and used by the consumer credit products segment to fund the
growth of cardholder balances.
<TABLE>
1999
----
Consumer
Credit Fee-Based
Products Services Reconciliation (a) Consolidated
-------- -------- ------------------ ------------
<S> <C> <C> <C> <C>
Interest revenue .... $1,163,663 $ 4,649 $ (932,143) (b) $ 236,169
Interest expense .... 340,066 -- (284,225) (c) 55,841
---------- ---------- ------------- ----------
Net interest income . 823,597 4,649 (647,918) 180,328
Other revenue ....... 368,500 175,091 80,181 623,772
Total revenue ....... 1,532,163 179,740 (851,962) 859,941
Income before income .
taxes and extra- ..
ordinary loss .... 392,453(d) 100,646 (d) (301,783) (e) 191,316
Income taxes ........ -- -- 75,953 75,953
Total assets ........ $7,190,903 $ 116,106 $ (5,261,927) (f) $2,045,082
</TABLE>
<TABLE>
1998
----
Consumer
Credit Fee-Based
Products Services Reconciliation (a) Consolidated
-------- -------- ------------------ ------------
<S> <C> <C> <C> <C>
Interest revenue .... $ 740,768 $ 2,754 $ (630,311) (b) $ 113,211
Interest expense .... 237,710 -- (207,197) (c) 30,513
---------- ---------- ------------- -----------
Net interest income . 503,058 2,754 (423,114) 82,698
Other revenue ....... 239,597 109,123 (33,240) 315,480
Total revenue ....... 980,365 111,877 (663,551) 428,691
Income before
income taxes ...... 188,148(d) 73,279 (d) (168,179) (e) 93,248
Income taxes ........ -- -- 35,900 35,900
Total assets ........ $5,375,925 $ 58,052 $ (4,488,258) (f) $ 945,719
</TABLE>
<PAGE>
<TABLE>
1997
----
Consumer
Credit Fee-Based
Products Services Reconciliation (a) Consolidated
-------- -------- ------------------ ------------
<S> <C> <C> <C> <C>
Interest revenue .... $ 435,833 $ 2,484 $ (369,123) (b) $ 69,194
Interest expense .... 131,956 -- (120,005) (c) 11,951
---------- ---------- ------------- --------
Net interest income . 303,877 2,484 (249,118) 57,243
Other revenue ....... 149,456 64,532 (26,192) 187,796
Total revenue ....... 585,289 67,016 (395,315) 256,990
Income before
income taxes ...... 110,973 (d) 49,162(d) (98,252) (e) 61,883
Income taxes ........ -- -- 23,825 23,825
Total assets ........ $3,505,165 $ 30,488 $ (2,996,991) (f) $538,662
</TABLE>
(a) The reconciliation column includes: intercompany eliminations; amounts
not allocated to segments; and adjustments to the amounts reported on a managed
basis to reflect the effects of securitization.
(b) The reconciliation to consolidated owned interest revenue includes the
elimination of $4.6 million, $2.8 million and $2.5 million of intercompany
interest received by the fee-based services segment from the consumer credit
products segment for 1999, 1998 and 1997, respectively.
(c) The reconciliation to consolidated owned interest expense includes the
elimination of $4.6 million, $2.8 million and $2.5 million of intercompany
interest paid by the consumer credit products segment to the fee-based services
segment for 1999, 1998 and 1997, respectively.
(d) Income before income taxes includes intercompany commissions paid by
the fee-based services segment to the consumer credit products segment for
successful marketing efforts to consumer credit products cardholders of $6.7
million, $3.3 million and $4.4 million for 1999, 1998 and 1997, respectively.
(e) The reconciliation to the owned income before income taxes includes:
unallocated costs related to employee compensation; data processing and
communications; third-party servicing expenses; and other expenses. The majority
of these expenses, although not allocated for the internal segment reporting
used by management, relate to the consumer credit products segment.
(f) Total assets include the assets attributable to corporate functions not
allocated to operating segments and the removal of investors interest in
securitized loans to present total assets on an owned basis.
NOTE 17 - DEBT AND DEPOSITS
We have a $200 million, term revolving credit facility and a $100 million
term loan, (collectively, the "credit facilities"), with a syndicate of banks
and money market mutual funds. At December 31, 1999, we were in compliance with
all financial covenants under these agreements. At December 31, 1999 and 1998,
we had outstanding borrowings of $100 million and $110 million, respectively,
under the credit facilities. The weighted average interest rates on the
borrowings at December 31, 1999 and 1998, were 8.7% and 7.9%, respectively.
On July 15, 1999, we privately issued and sold $150 million of 10.125%
Senior Notes due 2006 pursuant to an exemption from registration under rule
144(a) of the Securities Act of 1933. In October 1999, we commenced an exchange
offer for the Senior Notes pursuant to a registration statement. The exchange
offer was completed in November 1999. The terms of the new Senior Notes are
identical in all material respects to the original private issue. The Senior
Notes due 2006 are unconditionally guaranteed on a senior basis, jointly and
severally, by Metris Direct, Inc. (the "Guarantor"), and all of our future
subsidiaries that guarantee any of our indebtedness, including the credit
facilities. The guarantee is an unsecured obligation of the Guarantor and ranks
equally with all existing and future unsubordinated indebtedness. We also have
$100 million of 10% Senior Notes due 2004 outstanding with terms and conditions
substantially similar to the Senior Notes due 2006.
Beginning in the first quarter of 1999, Direct Merchants Bank began issuing
certificates of deposit in increments of $100,000. As of December 31, 1999,
$758.5 million of CDs were outstanding with maturities ranging from three months
to two years with fixed interest rates ranging from 5.2% to 6.6%.
<PAGE>
Our debt and CDs outstanding as of December 31, 1999, mature as follows:
Debt CDs Total
---- --- -----
2000 $ -- $ 543,200 $ 543,200
2001 -- 215,300 215,300
2002 800 -- 800
2003 100,000 -- 100,000
2004 100,000 -- 100,000
Thereafter 144,212 -- 144,212
--------------- --------------- ---------------
Total $ 345,012 $ 758,500 $ 1,103,512
=============== =============== ===============
As part of the initial Lee Company investment, we issued the 12% Senior
Notes (see Note 6) which were similar in all material respects to the Senior
Notes due 2004. These notes were converted into Series C Preferred Stock in the
second quarter of 1999 after shareholders approved the conversion and the
Company received notice that there was no regulatory objection to the
conversion. We also have approximately $0.9 million of debt with local
governments to support growth in those areas.
Metris Direct, Inc., our wholly-owned subsidiary and guarantor, has various
subsidiaries which have not guaranteed the Senior Notes. The following condensed
consolidating financial statements of (a) the Company; (b) the guarantor
subsidiaries; and (c) the non-guarantor subsidiaries are presented for purposes
of complying with SEC reporting requirements. Separate financial statements of
Metris Direct, Inc. and the non-guaranteeing subsidiaries are not presented
because management has determined that the subsidiaries financial statements
would not be material to investors.
<PAGE>
<TABLE>
METRIS COMPANIES INC.
Supplemental Consolidating Balance Sheets
December 31, 1999
(Dollars in thousands)
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
-------------- ------------ ------------ ------------ ------------
Assets:
<S> <C> <C> <C> <C> <C>
Cash and cash equivalents ..... $ 43,619 $ 309 $ 150,505 $ -- $ 194,433
Net retained interests in
loans securitized .......... (228) -- 1,010,601 -- 1,010,373
Loans held for securitization/
credit card loans .......... 2,570 -- 131,038 -- 133,608
Property and equipment, net -- 33,152 23,762 -- 56,914
Prepaid expenses and deferred
charges .................... -- 26,441 30,930 -- 57,371
Deferred income taxes ......... (1,835) 25,241 162,207 -- 185,613
Customer base intangible -- -- 83,809 -- 83,809
Other receivables due from
credit card securitizations,
net ........................ 5 -- 243,973 -- 243,978
Other assets .................. 12,951 8,488 57,544 -- 78,983
Investment in subsidiaries .... 1,184,006 1,105,992 -- (2,289,998) --
----------- ----------- ----------- ----------- -----------
Total assets .................. $ 1,241,088 $ 1,199,623 $ 1,894,369 $(2,289,998) $ 2,045,082
=========== =========== =========== =========== ============
Liabilities:
Deposits ...................... $ (1,000) $ -- $ 776,381 $ -- $ 775,381
Debt .......................... 569,956 (82,779) (142,165) -- 345,012
Accounts payable .............. 494 12,337 33,019 -- 45,850
Current income taxes payable .. 16,183 (10,985) 17,771 -- 22,969
Deferred income ............... 22,231 58,856 90,579 -- 171,666
Accrued expenses and other
liabilities ................ 9,423 38,188 12,792 -- 60,403
----------- ----------- ----------- ----------- -----------
Total liabilities ............. 617,287 15,617 788,377 -- 1,421,281
----------- ----------- ----------- ----------- -----------
Total stockholders' equity .... 623,801 1,184,006 1,105,992 (2,289,998) 623,801
----------- ----------- ----------- ----------- -----------
Total liabilities and
stockholders' equity ....... $ 1,241,088 $ 1,199,623 $ 1,894,369 $(2,289,998) $ 2,045,082
=========== =========== =========== =========== ============
</TABLE>
<PAGE>
<TABLE>
METRIS COMPANIES INC.
Supplemental Consolidating Balance Sheets
December 31, 1998
(Dollars in thousands)
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
-------------- ------------ ------------ ------------ ------------
Assets:
<S> <C> <C> <C> <C> <C>
Cash and cash equivalents ........... $ (5,007) $ (156) $ 42,510 $ -- $ 37,347
Net retained interests in loans
securitized ...................... (97) -- 360,283 -- 360,186
Loans held for securitization/credit
card loans ....................... 1,876 -- 1,554 -- 3,430
Property and equipment, net ......... -- 18,243 3,739 -- 21,982
Prepaid expenses and deferred charges 30,487 17,833 10,784 -- 59,104
Deferred income taxes ............... 1,049 19,427 132,545 -- 153,021
Customer base intangible ............ -- -- 81,892 -- 81,892
Other receivables due from credit
card securitizations, net......... -- -- 185,935 -- 185,935
Other assets ........................ 5,989 6,989 29,844 -- 42,822
Investment in subsidiaries .......... 756,455 774,986 -- (1,531,441) --
----------- ----------- ----------- ----------- -----------
Total assets ........................ $ 790,752 $ 837,322 $ 849,086 $(1,531,441) $ 945,719
=========== =========== =========== =========== ===========
Liabilities:
Interest-bearing deposit from
affiliate ........................ $ (1,000) $ -- $ 1,000 $ -- $ --
Debt ................................ 318,298 15,021 (22,423) -- 310,896
Accounts payable .................... 3,140 3,786 12,165 -- 19,091
Current income taxes payable ........ 3,722 (5,692) 33,753 -- 31,783
Deferred income ..................... 31,753 47,515 45,624 -- 124,892
Accrued expenses and other
liabilities ...................... 1,857 20,237 3,981 -- 26,075
----------- ----------- ----------- ----------- -----------
Total liabilities ................... 357,770 80,867 74,100 -- 512,737
----------- ----------- ----------- ----------- -----------
Total stockholders' equity .......... 432,982 756,455 774,986 (1,531,441) 432,982
----------- ----------- ----------- ----------- -----------
Total liabilities and stockholders'
equity ........................... $ 790,752 $ 837,322 $ 849,086 $(1,531,441) $ 945,719
=========== =========== =========== =========== ===========
</TABLE>
<PAGE>
<TABLE>
METRIS COMPANIES INC.
Supplemental Consolidating Statements of Income
Year Ended December 31, 1999
(Dollars in thousands)
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
-------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Net Interest Income/(Expense) ......... $ (39,529) $ (974) $ 220,831 $ -- $ 180,328
Provision for loan losses ............. 248 -- 174,552 -- 174,800
--------- --------- --------- --------- ---------
Net interest income/(expense) after
provision for loan losses .......... (39,777) (974) 46,279 -- 5,528
--------- --------- --------- --------- ---------
Other Operating Income:
Net securitization and credit card
servicing income ................... 5,601 (4) 313,276 -- 318,873
Credit card fees, interchange and other
credit card income ................. 886 (4,088) 133,010 -- 129,808
Fee-based services revenues ........... -- 51,341 123,750 -- 175,091
--------- --------- --------- --------- ---------
6,487 47,249 570,036 -- 623,772
--------- --------- --------- --------- ---------
Other Operating Expense:
Credit card account and other product
solicitation and marketing expenses -- 36,751 70,975 -- 107,726
Employee compensation ................. -- 110,886 11,531 -- 122,417
Data processing services and
communications ..................... -- 8,726 43,629 -- 52,355
Third-party servicing expense ......... -- (74,999) 88,614 -- 13,615
Warranty and debt waiver underwriting
and claims servicing expense ....... -- 2,755 18,336 -- 21,091
Credit card fraud losses .............. 17 -- 7,367 -- 7,384
Other ................................. 1,071 32,997 79,328 -- 113,396
--------- --------- --------- --------- ---------
1,088 117,116 319,780 -- 437,984
--------- --------- --------- --------- ---------
Income/(Loss) Before Income Taxes
And Equity in Income of
Subsidiaries ....................... (34,378) (70,841) 296,535 -- 191,316
Income taxes .......................... (13,647) (28,471) 118,071 -- 75,953
Equity in income of subsidiaries ...... 136,094 178,464 -- (314,558) --
--------- --------- --------- --------- ---------
Net Income/(Loss) ..................... $ 115,363 $ 136,094 $ 178,464 $(314,558) $ 115,363
========= ========= ========= ========= =========
</TABLE>
<PAGE>
<TABLE>
METRIS COMPANIES INC.
Supplemental Consolidating Statements of Income
Year Ended December 31, 1998
(Dollars in thousands)
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
-------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Net Interest Income/(Expense) ........ $ (6,553) $ (24,444) $ 113,695 $ -- $ 82,698
Provision for loan losses ............ 532 -- 77,238 -- 77,770
--------- --------- --------- --------- ---------
Net interest income/(expense)
after provision for loan
losses ............................ (7,085) (24,444) 36,457 -- 4,928
--------- --------- --------- --------- ---------
Other Operating Income:
Net securitization and credit
card servicing income ............. 9,668 (20) 128,573 -- 138,221
Credit card fees, interchange
and other credit card income ...... 636 -- 67,500 -- 68,136
Fee-based services revenues .......... -- 28,425 80,698 -- 109,123
--------- --------- --------- --------- ---------
10,304 28,405 276,771 -- 315,480
--------- --------- --------- --------- ---------
Other Operating Expense:
Credit card account and other
product solicitation and
marketing expenses ................ -- 14,992 28,479 -- 43,471
Employee compensation ................ -- 55,980 6,647 -- 62,627
Data processing services and
communications .................... -- 5,276 30,169 -- 35,445
Third-party servicing expense ........ -- (51,565) 62,639 -- 11,074
Warranty and debt waiver
underwriting and claims
servicing expense ................. -- 1,875 10,404 -- 12,279
Credit card fraud losses ............. 18 -- 4,418 -- 4,436
Other ................................ 529 18,899 38,400 -- 57,828
--------- --------- --------- --------- ---------
547 45,457 181,156 -- 227,160
--------- --------- --------- --------- ---------
Income/(Loss) Before Income
Taxes and Equity in Income
of Subsidiaries ................... 2,672 (41,496) 132,072 -- 93,248
Income taxes ......................... 1,028 (16,768) 51,640 -- 35,900
Equity in income of
subsidiaries ...................... 55,704 80,432 -- (136,136) --
--------- --------- --------- --------- ---------
Net Income/(Loss) .................... $ 57,348 $ 55,704 $ 80,432 $(136,136) $ 57,348
========= ========= ========= ========= =========
</TABLE>
<PAGE>
<TABLE>
METRIS COMPANIES INC.
Supplemental Consolidating Statements of Income
Year Ended December 31, 1997
(Dollars in thousands)
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
-------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Net Interest Income/(Expense) ........ $ (12,690) $ (432) $ 70,365 $ -- $ 57,243
Provision for Loan Losses ............ 682 -- 43,307 -- 43,989
--------- --------- --------- ----------- ---------
Net interest income/(expense)
after provision for loan losses ... (13,372) (432) 27,058 -- 13,254
--------- --------- --------- ----------- ---------
Other Operating Income:
Net securitization and credit card
servicing income .................. 10,653 -- 68,880 -- 79,533
Credit card fees, interchange and
other credit card income .......... 478 (21) 43,274 -- 43,731
Fee-based services revenues .......... -- 9,655 54,877 -- 64,532
--------- --------- --------- ----------- ---------
11,131 9,634 167,031 -- 187,796
--------- --------- --------- ----------- ---------
Other Operating Expense:
Credit card account and other
product solicitation and
marketing expenses ................ -- 2,902 28,720 -- 31,622
Employee compensation ................ -- 32,735 2,465 -- 35,200
Data processing services and
communications .................... -- 2,883 17,204 -- 20,087
Third-party servicing expense ........ 51 (20,396) 33,056 -- 12,711
Warranty and debt waiver
underwriting and claims
servicing expense ................. -- 549 5,504 -- 6,053
Credit card fraud losses ............. 27 -- 3,213 -- 3,240
Other ................................ 382 12,644 17,228 -- 30,254
--------- --------- --------- ----------- ---------
460 31,317 107,390 -- 139,167
--------- --------- --------- ----------- ---------
Income/(Loss) Before Income Taxes
and Equity in Income of
Subsidiaries ...................... (2,701) (22,115) 86,699 -- 61,883
Income taxes ......................... (1,040) (8,475) 33,340 -- 23,825
Equity in income of subsidiaries ..... 39,719 53,359 -- (93,078) --
--------- --------- --------- ----------- ---------
Net Income/(Loss) .................... $ 38,058 $ 39,719 $ 53,359 $ (93,078) $ 38,058
========= ========= ========= =========== =========
</TABLE>
<PAGE>
<TABLE>
METRIS COMPANIES INC.
Supplemental Condensed Consolidating Statements of Cash Flows
Year Ended December 31,
(Dollars in thousands)
1999
- ----
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Consolidated
-------------- ------------ ------------ ------------
Operating Activities:
<S> <C> <C> <C> <C>
Net cash (used in) provided by
operating activities .......................... $ (12,089) $ (19,710) $ 359,683 $ 327,884
----------- ----------- ----------- -----------
Investing Activities:
Proceeds from repayments of
securitized loans .............................. -- -- 960,170 960,170
Net loans originated or collected .................. (693) -- (842,581) (843,274)
Credit card portfolio acquisitions ................. -- -- (1,156,673) (1,156,673)
Additions to premises and equipment ................ -- (20,944) (20,780) (41,724)
----------- ----------- ----------- -----------
Net cash used in investing activities .............. (693) (20,944) (1,059,864) (1,081,501)
----------- ----------- ----------- -----------
Financing Activities:
Net increase (decrease) in deposits ................ -- -- 775,381 775,381
Net increase (decrease) in debt .................... 351,658 (97,800) (119,742) 134,116
Cash dividends paid ................................ (1,390) (804) 804 (1,390)
Net increase in equity ............................. (288,860) 139,723 151,733 2,596
----------- ----------- ----------- -----------
Net cash provided by financing activities .......... 61,408 41,119 808,176 910,703
----------- ----------- ----------- -----------
Net increase in cash and cash equivalents ......... 48,626 465 107,995 157,086
Cash and cash equivalents at beginning of year ..... (5,007) (156) 42,510 37,347
----------- ----------- ----------- -----------
Cash and cash equivalents at end of year ........... $ 43,619 $ 309 $ 150,505 $ 194,433
=========== =========== =========== ===========
</TABLE>
<TABLE>
1998
- ----
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Consolidated
-------------- ------------ ------------ ------------
Operating Activities:
<S> <C> <C> <C> <C>
Net cash provided by (used in)
operating activities .......................... $ 97,276 $ (22,625) $ (9,739) $ 64,912
----------- ----------- ----------- -----------
Investing Activities:
Proceeds from repayments of securitized loans ..... -- -- 1,491,832 1,491,832
Net loans originated or collected ................. 8,106 -- (909,846) (901,740)
Credit card portfolio acquisitions ................ -- -- (921,558) (921,558)
Additions to premises and equipment ............... -- (8,414) (2,400) (10,814)
----------- ----------- ----------- -----------
Net cash provided by (used in)
investing activities .......................... 8,106 (8,414) (341,972) (342,280)
----------- ----------- ----------- -----------
Financing Activities:
Net increase in debt .............................. 40,700 7,046 19,150 66,896
Cash dividends paid ............................... 20,039 -- (21,000) (961)
Net increase in equity ............................ (171,464) 23,447 348,574 200,557
----------- ----------- ----------- -----------
Net cash (used in) provided by
financing activities .......................... (110,725) 30,493 346,724 266,492
----------- ----------- ----------- -----------
Net decrease in cash and cash equivalents ......... (5,343) (546) (4,987) (10,876)
Cash and cash equivalents at beginning of year .... 336 390 47,497 48,223
----------- ----------- ----------- -----------
Cash and cash equivalents at end of year .......... $ (5,007) $ (156) $ 42,510 $ 37,347
=========== =========== =========== ===========
</TABLE>
<PAGE>
<TABLE>
METRIS COMPANIES INC.
Supplemental Condensed Consolidating Statements of Cash Flows
Year Ended December 31, 1997
(Dollars in thousands)
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Consolidated
-------------- ------------ ------------ ------------
Operating Activities:
<S> <C> <C> <C> <C>
Net cash (used in) provided by
operating activities ........................... $ (51,357) $ (526) $ 195,096 $ 143,213
----------- ----------- ----------- -----------
Investing Activities:
Proceeds from repayments of securitized loans ...... -- -- 1,665,700 1,665,700
Net loans originated or collected .................. 3,357 -- (1,234,580) (1,231,223)
Credit card portfolio acquisitions ................. -- -- (738,104) (738,104)
Additions to premises and equipment ................ -- (10,515) (1,190) (11,705)
----------- ----------- ----------- -----------
Net cash provided by (used in) investing activities 3,357 (10,515) (308,174) (315,332)
----------- ----------- ----------- -----------
Financing Activities:
Net increase in debt ............................... 226,425 11,348 (48,936) 188,837
Cash dividends paid ................................ 15,350 -- (15,927) (577)
Net increase in equity ............................. (197,814) -- 197,814 --
----------- ----------- ----------- -----------
Net cash provided by financing activities .......... 43,961 11,348 132,951 188,260
----------- ----------- ----------- -----------
Net (decrease) increase in cash and
cash equivalents ............................... (4,039) 307 19,873 16,141
Cash and cash equivalents at beginning of year ..... 4,375 83 27,624 32,082
----------- ----------- ----------- -----------
Cash and cash equivalents at end of year ........... $ 336 $ 390 $ 47,497 $ 48,223
=========== =========== =========== ===========
</TABLE>
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Metris Companies Inc.:
We have audited the accompanying consolidated balance sheets of Metris
Companies Inc. and subsidiaries as of December 31, 1999 and 1998, and the
related consolidated statements of income, changes in stockholders' equity and
cash flows for each of the years in the three-year period ended December 31,
1999. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Metris
Companies Inc. and subsidiaries as of December 31, 1999 and 1998, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1999, in conformity with generally accepted
accounting principles.
/s/ KPMG LLP
KPMG LLP
Minneapolis, Minnesota
January 19, 2000
<PAGE>
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None
PART III
Item 10. Directors and Executive Officers of the Registrant
The information required by this item with respect to directors is set
forth under "Proposal One: Election of Directors," in the Company's proxy
statement for the annual meeting of shareholders to be held on May 9, 2000,
which will be filed within 120 days of December 31, 1999 (the "Proxy Statement")
and is incorporated herein by reference. The information required by this item
with respect to executive officers is, pursuant to instruction 3 of Item 401(b)
of Regulation S-K, set forth in Part I of this Form 10-K under "Executive
Officers of the Registrant." The information required by this item with respect
to reports required to be filed under Section 16(a) of the Securities Exchange
Act of 1934 is set forth under "Section 16(a) Beneficial Ownership Reporting
Compliance" in the Proxy Statement and is incorporated herein by reference.
Item 11. Executive Compensation
The information required by this item is set forth under "Compensation
Tables and Compensation Matters" in the Proxy Statement and is incorporated
herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this item is set forth under "Company Stock
Owned by Officers and Directors" and "Persons Owning More Than Five Percent of
Company Common Stock" in the Proxy Statement and is incorporated herein by
reference.
Item 13. Certain Relationships and Related Transactions
The information required by this item is set forth under "Corporate
Governance" in the Proxy Statement and is incorporated herein by reference.
With the exception of the information incorporated by reference in Items
10-13 above, the Proxy Statement is not to be deemed filed as part of this Form
10-K.
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) The following documents are made part of this report:
1. Consolidated Financial Statements - See Item 8 above.
2. Financial Statement Schedules
All schedules to the consolidated financial statements
normally required by Form 10-K are omitted since they
are either not applicable or the required information
is shown in the financial statements or the notes
thereto.
(b) Reports on Form 8-K: On November 15, 1999, the Company filed a
Current Report on Form 8-K to report the extension of its
offer to exchange its 10.125% Senior Notes due 2006 which have
been registered under the Securities Act of 1933 for any and
all of its outstanding unregistered 10.125% Senior Notes due
2006.
(c) Exhibits: See Exhibit Index on page 79 of this Report.
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized on the 21st day of
March, 2000.
METRIS COMPANIES INC.
(Registrant)
By /s/ Ronald N. Zebeck
-----------------------
Ronald N. Zebeck
President and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of Metris Companies
Inc., the Registrant, and in the capacities and on the dates indicated.
Signature Title Date
Principal executive President, March 21, 2000
officer and director: Chief Executive Officer
and Director
/s/ Ronald N. Zebeck
- --------------------
Ronald N. Zebeck
Principal financial officer: Executive Vice March 21, 2000
President,
Chief Financial Officer
/s/ David D. Wesselink
- ----------------------
David D. Wesselink
Principal accounting officer: Senior Vice President, March 21, 2000
Finance,
Corporate Controller
/s/ Jean C. Benson
- ------------------
Jean C. Benson
<PAGE>
Directors:
/s/ Theodore Deikel Director March 21, 2000
- ---------------------------
Theodore Deikel
/s/ Lee R. Anderson, Sr. Director March 21, 2000
- ---------------------------
Lee R. Anderson, Sr.
/s/ C. Hunter Boll Director March 21, 2000
- ---------------------------
C. Hunter Boll
/s/ John A. Cleary Director March 21, 2000
- ---------------------------
John A. Cleary
/s/ Thomas M. Hagerty Director March 21, 2000
- ---------------------------
Thomas M. Hagerty
/s/ David V. Harkins Director March 21, 2000
- ---------------------------
David V. Harkins
/s/ Walter M. Hoff Director March 21, 2000
- ---------------------------
Walter M. Hoff
/s/ Thomas H. Lee Director March 21, 2000
- ---------------------------
Thomas H. Lee
/s/ Derek V. Smith Director March 21, 2000
- ---------------------------
Derek V. Smith
/s/ Frank D. Trestman Director March 21, 2000
- ---------------------------
Frank D. Trestman
<PAGE>
EXHIBIT INDEX
Exhibit
Number Description of Exhibit
Charter Documents:
- -----------------
3.1 Amended and Restated Certificate of Incorporation of the Company
(incorporated by reference to Exhibit 3.1 to the Company's Registration
Statement on Form 8-A (File No. 1-12351)).
3.2 Amended and Restated Bylaws of the Company (incorporated by reference
to Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q, filed on
August 13, 1999 (File No. 1-12351)).
Instruments Defining Rights:
- ---------------------------
4.1 Indenture, dated as of November 7, 1997, among the Company, Metris
Direct, Inc. as the Guarantor, and the First National Bank of Chicago,
as Trustee, including form of 10% Senior Note due 2004 and form of
Guarantee by Metris Direct, Inc. (incorporated by reference to
Exhibit 4.a to the Company's Registration Statement on Form S-4
(File No. 333-43771)).
(i) First Supplemental Indenture, dated as of June 25, 1999, among the
Company, the Guarantors named therein and The First National Bank
of Chicago (incorporated by reference to Exhibit 4.4 to the
Companies Registration Statement on S-4 (File No. 333-86695)).
4.2 Certificate of Designation of Series B Perpetual Preferred Stock
(incorporated by reference to Exhibit 4.1 of the Company's Current
Report on Form 8-K dated December 22, 1998 (File No. 1-12351)).
4.3 Certificate of Designation of Series C Perpetual Preferred Stock
(incorporated by reference to Exhibit 4.2 of the Company's Current
Report on Form 8-K dated December 22, 1998 (File No. 1-12351)).
4.4 Certificate of Designation of Series D Junior Participating
Convertible Preferred Stock (incorporated by reference to Exhibit
4.3 of the Company's Current Report on Form 8-K dated
December 22, 1998 (File No. 1-12351)).
4.5 Securities Purchase Agreement, dated as of November 13, 1998, among
the Company, the Thomas H. Lee Equity Fund IV, L.P. (the "Lee Fund")
and certain affiliates of the Lee Fund (incorporated by reference to
Exhibit 10.2 to the Company's Current Report on Form 8-K dated
December 22, 1998 (File No. 1-12351)).
4.6 Indenture, dated as of December 9, 1998, among the Company, the
Guarantors named therein and The Bank of New York, as Trustee
(incorporated by reference to Exhibit 4.4 to the Company's Current
Report on Form 8-K dated December 22, 1998 (File No. 1-12351)).
4.7 Registration Rights Agreement, dated as of December 9, 1998, between
the Company and the Investors named therein (incorporated by reference
to Exhibit 10.3 to the Company's Current Report on Form 8-K dated
December 22, 1998 (File No. 1-12351)).
4.8 Warrant Agreement, dated as of December 9, 1998, between the Company
and the Purchasers named therein (incorporated by reference to
Exhibit 4.5 to the Company's Current Report on Form 8-K dated
December 22, 1998 (File No. 1-12351)).
4.9 Form of common stock certificate of the Company (incorporated by
reference to Exhibit 4.3 to the Company's Registration Statement on
Form S-8 (File No. 333-91917)).
4.10 Indenture, dated as of July 13, 1999, by and among the Company, Metris
Direct, Inc. and The Bank of New York, including Form of 10 1/8% Senior
Notes due 2006 and Form of Guarantee (incorporated by reference to
Exhibit 4.1 to the Companies Registration Statement on S-4
(File No. 333-86695)).
4.11 Exchange and Registration Rights Agreement, dated as of July 13, 1999,
by and among the Company, Bear, Stearns & Co. Inc., Chase Securities
Inc., Salomon Smith Barney Inc. and Barclays Capital Inc., relating to
the new notes (incorporated by reference to Exhibit 4.2 to the
Companies Registration Statement on S-4 (File No. 333-86695)).
4.12 Registration Rights Agreement dated as of December 9, 1998 between the
Company and the investors named therein. (Incorporated by reference to
Exhibit 10.3 from the Company's Form 8-K, filed on December 22, 1998).
4.13 Registration Rights Agreement dated as of April 23, 1999 between the
Company and Rakesh Kaul. (incorporated by reference to the Company's
Registration Statement on Form S-3 (File No. 333-82007))
Material Contracts
10.1 Amended and Restated Pooling and Servicing Agreement, dated as of
July 30, 1998, among Metris Receivables, Inc. ("MRI"), as Transferor,
Direct Merchants Credit Card Bank, National Association ("DMCCB"),
as Servicer, and The Bank of New York (Delaware), as Trustee
(incorporated by reference to Exhibit 4(a) to MRI's Registration
Statement on Form S-3 (File No. 333-61343)).
10.2 Amended and Restated Bank Receivables Purchase Agreement, dated as of
July 30, 1998, between DMCCB and the Company (incorporated by reference
to Exhibit 4(c) to MRI's Registration Statement on Form S-3
(File No. 333-61343)).
10.3 Amended and Restated Bank Receivables Purchase Agreement, dated as of
July 30, 1998, between the Company and MRI (incorporated by reference
to Exhibit 4(d) to MRI's Registration Statement on Form S-3
(File No. 333-61343)).
10.4 Owner Trust Agreement, dated as of July 30, 1998, among MRI and
Wilmington Trust Company (incorporated by reference to Exhibit 10.1(ii)
to the Company's Quarterly Report on Form 10-Q for the period ended
September 30, 1998 (File No. 1-12351)).
10.5 Liquidity Agreements, each dated July 30, 1998, among Metris Owner
Trust, the Lenders thereto and the Administrative Agent (pursuant to
Instruction 2 to Item 601, only one such agreement has been filed)
(incorporated by reference to Exhibit 10.1(iii) to the Company's
Quarterly Report on Form 10-Q for the period ended September 30, 1998
(File No. 1-12351)).
10.6* Stock Option and Valuation Rights Agreement, dated as of March 21,
1994, between Fingerhut Companies, Inc. and Ronald N. Zebeck
(incorporated by reference to Exhibit 10.l to Fingerhut Companies,
Inc.'s Annual Report on Form 10-K for the fiscal year ended
December 29, 1995 (File No. 1-8668)).
(i)* Amendment, dated October 25, 1996 (incorporated by reference to
Exhibit 10.4(i) to the Company's Annual Report on Form 10-K for
the year ended December 31, 1997 (File No. 1-12351)).
(ii)* Non-Qualified Stock Option Agreement pursuant to Metris
Companies Long-Term Incentive and Stock Option Plan, dated as
of October 25, 1996, by and between the Company and
Ronald N. Zebeck (incorporated by reference to Exhibit 10.4(ii)
to the Company's Annual Report on Form 10-K for the year ended
December 31, 1997 (File No. 1-12351)).
10.7 Change of Control Agreement, dated as of May 15, 1998, by and between
the Company and Ronald Zebeck and a schedule of executive officers of
the Company also having such an agreement with the Company,
indicating the differences from the form of agreement filed (as
permitted by Instruction 2 to Item 601 of regulation S-K)
(incorporated by reference to Exhibit 10.2 to the Company's Quarterly
Report on Form 10-Q for the quarter ended September 30, 1998
(File No. 1-12351)).
(i) Amendment to Change in Control Severance Agreement, dated as
of December 9, 1998.
(ii) Amended Schedule of Officers with Change of Control.
10.8* Co-Brand Credit Card Agreement, dated as of October 31, 1996, between
the Company, Fingerhut Corporation, and Direct Merchants Credit Card
Bank, N.A. (incorporated by reference to Exhibit 10.11 to the
Company's Annual Report on Form 10-K for the year ended
December 31, 1997 (File No. 1-12351)).
10.9* Extended Service Plan Agreement, dated as of October 31, 1996, between
the Company, Fingerhut Corporation, and InfoChoice USA, Inc.
(incorporated by reference to Exhibit 10.12 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1997
(File No. 1-12351)).
10.10 Database Access Agreement, dated as of October 31, 1996, between the
Company and Fingerhut Corporation (incorporated by reference to
Exhibit 10.13 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1997 (File No. 1-12351)).
10.11 Tax Sharing Agreement, dated as of October 31, 1996, between the
Company and Fingerhut Companies, Inc. (incorporated by reference to
Exhibit 10.15 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1997 (File No. 1-12351)).
(i) Amendment to Tax Sharing Agreement, dated January 1, 1998,
between the Company and Fingerhut Companies, Inc.
10.12 Waiver Agreement, dated as of December 8, 1998, between Fingerhut
Corporation, Infochoice USA, Inc., Metris Direct, Inc., DMCCB and
Metris Direct Services, Inc. (incorporated by reference to
Exhibit 10.4 to the Company's Current Report on Form 8-K dated
December 22, 1998 (File No. 1-12351)).
10.13 Data Sharing Agreement, dated as of October 31, 1996, between
Fingerhut Corporation and DMCCB (incorporated by reference to
Exhibit 10.17 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1997 (File No. 1-12351)).
10.14 Amended and Restated Credit Agreement, dated as of June 30, 1998 among
the Company and the lenders named therein (incorporated by reference
to Exhibit 10.18 (a) to the Company's Quarterly Report on Form 10-Q
for the period ended June 30, 1998 (File No. 1-12351)).
(i) Amendment, dated as of December 3, 1998, to the Amended and
Restated Credit Agreement, dated as of June 30, 1998, among
the Company, the lenders named therein, NationsBank, N.A., as
syndication agent, Deutsche Bank, as documentation agent,
U.S. Bank National Association, as documentation agent,
Barclays Bank PLC, as co-agent, Bank of America National
Trust and Savings Association, as co-agent, and The Chase
Manhattan Bank, as administrative agent (incorporated by
reference to Exhibit 10.5 to the Company's Current Report on
Form 8-K dated December 22, 1998 (File No. 1-12351)).
(ii) Amendment, dated as of December 7, 1998, to the Amended and
Restated Credit Agreement, dated as of June 30, 1998, among
the Company, the lenders named therein, NationsBank, N.A., as
syndication agent, Deutsche Bank, as documentation agent,
U.S. Bank National Association, as documentation agent,
Barclays Bank PLC, as co-agent, Bank of America National
Trust and Savings Association, as co-agent, and The Chase
Manhattan Bank, as administrative agent.
(iii) Amendment dated as of May 7, 1999, to (a) the Amended and
Restated Credit Agreement, dated as of June 30, 1998, among
the Company and the lenders named therein, Nationsbank, N.A.,
as syndication agent, Deutsche Bank, as documentation agent,
U.S. Bank National Association, as documentation agent,
Barclays Bank PLC, as co-agent, Bank of America National
Trust and Savings Association, as co-agent, and The Chase
Manhattan Bank, as administrative agent and (b) the Amended
and Restated Pledge Agreement, dated as of June 30, 1998,
among the Company, Metris Direct Inc. and The Chase Manhattan
Bank (incorporated by reference to Exhibit 10.10 to the
Companies Registration Statement on S-4/A
(File No. 333-86695)).
(iv) Amendment dated as of June 10, 1999, to the Amended and
Restated Credit Agreement, dated as of June 30, 1998, among
the Company and the lenders named therein, Nationsbank, N.A.,
as syndication agent, Deutsche Bank, as documentation agent,
U.S. Bank National Association, as documentation agent,
Barclays Bank PLC, as co-agent, Bank of America National
Trust and Savings Association, as co-agent, and The Chase
Manhattan Bank, as administrative agent Bank (incorporated by
reference to Exhibit 10.11 to the Companies Registration
Statement on S-4/A (File No. 333-86695)).
10.15 Transfer and Administration Agreement, dated as of October 23, 1997,
among Kitty Hawk Funding Corporation, Metris Funding Co., as
Transferor, Direct Merchants Credit Card Bank, National Association as
Collection Agent, and NationsBank, N.A., as Agent and Bank Investor
(incorporated by reference to Exhibit 10.18(a) to the Company's
Quarterly Report on Form 10-Q for the period ended September 30, 1998
(File No. 1-12351)).
(i) Amendment No. 4, dated October 22, 1998, to the Transfer and
Administration Agreement, dated as of October 23, 1997, among
Kitty Hawk Funding Corporation, Metris Funding Co., as
Transferor, Direct Merchants Credit Card Bank, National
Association as Collection Agent, and NationsBank, N.A., as
Agent and Bank Investor (incorporated by reference to the
Company's Annual Report on Form 10-K for the year ended
December 31, 1998 (File No. 1-12351)).
10.16 Transfer and Administration Agreement, dated December 9, 1998, among
Enterprise Funding Corporation, Park Avenue Receivables Corporation,
Sheffield Receivables Corporation, Metris Asset Funding Co., Direct
Merchants Credit Card Bank, National Association, N.A. (incorporated by
reference to Exhibit 3.1 to the Company's Annual Report on Form 10-K
the year ended December 31, 1998 (File No. 1-12351)).
10.17* Receivables Purchase Agreement, dated December 9, 1998, between the
Company and Metris Asset Funding Co. (incorporated by reference to
Exhibit 3.1 to the Company's Annual Report on Form 10-K the year ended
December 31, 1998 (File No. 1-12351)).
10.18* Metris Companies Inc. Non-Employee Director Stock Option Plan
(incorporated by reference to Exhibit 10.3 to the Companies
Registration Statement on S-4/A (File No. 333-86695)).
10.19* Metris Companies Inc. Management Stock Purchase Plan (incorporated by
reference to Exhibit 10.4 to the Companies Registration Statement on
S-4/A (File No. 333-86695)).
10.20* Metris Companies Inc. Amended and Restated Annual Incentive Plan for
Designated Corporate Officers (incorporated by reference to
Exhibit 10.5 to the Companies Registration Statement on S-4/A
(File No. 333-86695)).
10.21* Metris Companies Inc. Amended and Restated Long-Term Incentive and
Stock Option Plan (incorporated by reference to Exhibit 10.6 to the
Companies Registration Statement on S-4/A (File No. 333-86695)).
(i)* Form of Non-Qualified Stock Option Agreement (incorporated by
reference to Exhibit 10.8 to the Company's Annual Report on
Form 10-K for the year ended December 31, 1998
(File No. 1-12351)).
10.22* Transfer and Administration Agreement, dated June 30, 1999, among
Direct Merchants Credit Card Bank, N.A. as Transferor and Collection
Agent, Enterprise Funding Corporation, Sheffield Receivables
Corporation as Purchasers, Barclays Bank PLC as Agent and NationsBank,
N.A. as Bank Investor and Agent Bank (incorporated by reference to
Exhibit 10.12 to the Companies Registration Statement on S-4/A
(File No. 333-86695)).
Other Exhibits
11 Computation of Earnings Per Share.
12 (a) Computation of Ratio of Earnings to Fixed Charges.
12 (b) Computation of Ratio of Earnings to Fixed Charges and Preferred
Dividends.
13 Pages 25 to 71 of the 1999 Annual Report to Shareholders. The 1999
Annual Report shall not be deemed to be filed with the Commission
except to the extent that information is specifically incorporated
herein by reference.
21 Subsidiaries of the Company.
23 Independent Auditors' Consent.
27 Financial Data Schedule.
* Management contract or compensatory plan or arrangement required to be filed
as an exhibit pursuant to Item 14(c) of Form 10-K.
Exhibit 11
METRIS COMPANIES INC. AND SUBSIDIARIES
Computation of Earnings Per Share
In thousands, except per share amounts Year Ended December 31,
-----------------------
1999 1998 1997
---- ---- ----
BASIC:
- ------
Net (loss) income applicable to common
stockholders ...................... ($61,646) $56,248 $38,058
======== ======= =======
Weighted average number of common shares
outstanding ........................ 38,570 38,464 38,450
Net (loss) income per share ............ ($ 1.60) $ 1.46 $ 0.99
DILUTED:
- --------
Net (loss) income applicable to common
stockholders ........................... ($61,646) $56,248 $38,058
======== ======= =======
Weighted average number of common shares
outstanding ........................ 38,570 38,464 38,450
Net effect of assumed exercise of stock
options based on treasury stock
method using average market price .. -- 1,473 2,026
-------- ------- -------
38,570 39,937 40,476
======== ======= =======
Net (loss) income per share ............ ($ 1.60) $ 1.41 $ 0.94
EXHIBIT 12 (a)
<TABLE>
METRIS COMPANIES INC.
COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES
(DOLLARS IN THOUSANDS)
Year Ended December 31,
-----------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Earnings before income taxes and extraordinary loss: (1) $191,316 $93,248 $61,883 $32,546 $7,449
Fixed Charges: (1)
Interest on indebtedness, and
amortization of debt expense 55,841 30,513 11,951 4,106 1,217
Interest factor of rental expense 3,706 2,134 1,313 378 50
-------- -------- ------- ------- ------
Total fixed charges 59,547 32,647 13,264 4,484 1,267
-------- -------- ------- ------- ------
Total available earnings $250,863 $125,895 $75,147 $37,030 $8,716
======== ======== ======= ======= ======
Ratio of earnings to fixed charges 4.21 3.86 5.67 8.26 6.88
(1) As defined in Item 503(d) of Regulation S-K.
</TABLE>
EXHIBIT 12 (b)
<TABLE>
METRIS COMPANIES INC.
COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES AND PREFERRED DIVIDENDS
(DOLLARS IN THOUSANDS)
Year Ended December 31,
-----------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Earnings before income taxes and extraordinary loss: (1) $191,316 $93,248 $61,883 $32,546 $7,449
Preferred dividend requirement $24,586 $1,100
Ratio of earnings before tax expense to net income 1.66 1.63
-------- ------- ------- ------- ------
Preferred dividends (2) $40,773 $1,789
Fixed Charges: (1)
Interest on indebtedness, and
amortization of debt expense 55,841 30,513 11,951 4,106 1,217
Interest factor of rental expense 3,706 2,134 1,313 378 50
-------- ------- ------- ------- ------
59,547 32,647 13,264 4,484 1,267
Total fixed charges and preferred dividends 100,320 34,436 13,264 4,484 1,267
-------- ------- ------- ------- ------
Total available earnings $250,863 $125,895 $75,147 $37,030 $8,716
======== ======== ======= ======= ======
Ratio of earnings to fixed charges and preferred dividends 2.50 3.66 5.67 8.26 6.88
</TABLE>
(1) As defined in Item 503(d) of Regulation S-K.
(2) The preferred dividends were increased to amounts representing the pretax
earnings that would be required to cover such dividend requirements.
EXHIBIT 13
METRIS COMPANIES INC.
1999 ANNUAL REPORT, PAGES 25 TO 71
Selected Financial Data
Owned Basis
(In thousands, except EPS, dividends and stock prices)
<TABLE>
Year Ended December 31,
-----------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
Income Statement Data:
<S> <C> <C> <C> <C> <C>
Net Interest Income ............ $ 180,328 $ 82,698 $ 57,243 $ 26,088 $ 6,399
Provision for Loan Losses ...... 174,800 77,770 43,989 18,477 4,393
Other Operating Income ......... 623,772 315,480 187,796 126,222 51,083
Other Operating Expense ........ 437,984 227,160 139,167 101,287 45,640
- -------------------------------- ---------- ---------- ---------- ---------- ----------
Income Before Income Taxes and
Extraordinary Loss .......... 191,316 93,248 61,883 32,546 7,449
Tax Rate ....................... 39.7% 38.5% 38.5% 38.5% 38.5%
Net Income (1) ................. $ 115,363 $ 57,348 $ 38,058 $ 20,016 $ 4,581
- -------------------------------- ---------- ---------- ---------- ---------- ----------
Per Common Share Statistics (2):
EPS - diluted (1)(3) ........... $ 2.12 $ 1.41 $ 0.94 $ 0.58 $ 0.14
Stock Price (year-end) ......... 35.69 25.16 17.13 12.00 --
Dividends Paid ................. 0.025 0.020 0.015 -- --
Shares Outstanding (year-end) .. 38,613 38,520 38,450 38,450 31,934
Shares Used to Compute EPS
(diluted) ..................... 50,883 39,937 40,476 34,258 32,738
- -------------------------------- ---------- ---------- ---------- ---------- ----------
Selected Operating Data:
Total Accounts ................. 3,680 2,972 2,293 1,418 703
Year-end Loans ................. $1,763,009 $ 756,899 $ 480,626 $215,329 $ 95,064
Year-end Assets ................ 2,045,082 945,719 538,662 286,616 174,428
Average Loans .................. 1,167,072 596,380 356,817 149,809 39,832
Average Interest-Earning Assets 1,303,528 636,133 403,375 171,877 49,644
Average Assets ................. 1,449,297 774,167 417,903 209,299 70,921
Average Total Equity ........... 542,050 219,835 158,180 92,852 30,083
Deposits ....................... 775,381 -- -- -- --
Debt ........................... 345,012 310,896 244,000 55,163 64,482
Preferred Stock ................ 329,729 201,100 -- -- --
Return on Average Assets (1) ... 8.0% 7.4% 9.1% 9.6% 6.5%
Return on Average Total
Equity (1) ................... 21.3% 26.1% 24.1% 21.6% 15.2%
Selected Fee-Based Data:
Fee-Based Services Revenues .... $ 175,091 $ 109,123 $ 64,532 $ 50,273 $ 24,441
Deferred Fee-Based Revenues .... 127,541 72,866 35,461 2,060 294
Active Fee-Based Members ....... 4,902 3,619 2,997 1,981 689
</TABLE>
(1) Excluding the one-time, non-cash, accounting impact from the conversion
of the Thomas H. Lee Series B Preferred Stock, 12% Senior Notes and
cancellation of warrants in June 1999. (Refer to Note 6 of the Consolidated
Financial Statements for additional information.)
(2) Amounts adjusted for two-for-one stock split effected on June 1, 1999.
(3) Earnings per share is calculated assuming the Company was incorporated at
the beginning of the first year shown.
<PAGE>
<TABLE>
Managed Basis (1)
(In thousands, except EPS, dividends and stock prices)
Year Ended December 31,
-----------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
Income Statement Data (1):
<S> <C> <C> <C> <C> <C>
Net Interest Income ............ $ 828,246 $ 505,812 $ 306,361 $ 143,491 $ 26,354
Provision for Loan Losses ...... 742,537 534,124 319,299 136,305 26,234
Other Operating Income ......... 543,591 348,720 213,988 126,647 52,969
Other Operating Expense ........ 437,984 227,160 139,167 101,287 45,640
- -------------------------------- ---------- ---------- ---------- ---------- ----------
Income Before Income Taxes and
Extraordinary Loss .......... 191,316 93,248 61,883 32,546 7,449
Tax Rate ....................... 39.7% 38.5% 38.5% 38.5% 38.5%
Net Income (2) ................. $ 115,363 $ 57,348 $ 38,058 $ 20,016 $ 4,581
- -------------------------------- ---------- ---------- ---------- ---------- ----------
Per Common Share Statistics (3)
EPS - diluted (2)(4) ........... $ 2.12 $ 1.41 $ 0.94 $ 0.58 $ 0.14
- -------------------------------- ---------- ---------- ---------- ---------- ----------
Selected Operating Data:
Year-end Loans ................. $7,281,322 $5,315,042 $3,546,936 $1,615,940 $ 543,619
Year-end Assets ................ 7,563,394 5,503,862 3,604,972 1,687,227 622,983
Average Loans .................. 6,003,791 4,000,467 2,294,893 1,018,856 183,274
Average Interest-Earning Assets 6,140,247 4,040,220 2,341,451 1,040,924 193,086
Average Assets ................. 6,269,760 4,159,171 2,355,978 1,078,346 214,363
Return on Average Assets (2) ... 1.8% 1.4% 1.6% 1.9% 2.1%
Net Interest Margin (5) ........ 13.5% 12.5% 13.1% 13.8% 13.6%
Loan Loss Reserves ............. $ 619,028 $ 393,283 $ 244,084 $ 95,669 $ 22,219
Delinquency Ratio (6) .......... 7.6% 6.8% 6.6% 5.5% 4.0%
Loan Loss Reserve Ratio ........ 8.5% 7.4% 6.9% 5.9% 4.1%
Net Charge-off Ratio (7) ....... 9.0% 10.1% 8.3% 6.2% 2.2%
</TABLE>
(1) The Company analyzes its financial performance on a managed loan
portfolio basis whereby the income statement and balance sheet are
adjusted to reverse the effects of securitization.
(2) Excluding the one-time, non-cash, accounting impact from the conversion
of the Thomas H. Lee Series B Preferred Stock, 12% Senior Notes and
cancellation of warrants in June 1999. (Refer to Note 6 of the Consolidated
Financial Statements for additional information.)
(3) Amounts adjusted for two-for-one stock split effected on June 1, 1999.
(4) Earnings per share is calculated assuming the Company was incorporated at
the beginning of the first year shown.
(5) Includes the Company's actual cost of funds plus all costs associated with
asset securitizations, including the interest expense paid to the
certificate holders and amortization of the discount and fees.
(6) Delinquency ratio represents credit card loans that were at least 30 days
contractually past due at year end as a percentage of year-end managed
loans.
(7) Net charge-off ratio reflects actual principal amounts charged off, less
recoveries, as a percentage of average managed credit card loans.
<PAGE>
METRIS COMPANIES INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion and analysis provides information management
believes to be relevant to understanding the financial condition and results of
operations of Metris Companies Inc. and its subsidiaries, the "Company", which
may be referred to as "we", "us" and "our" including Direct Merchants Credit
Card Bank, National Association ("Direct Merchants Bank"). This discussion
should be read in conjunction with the consolidated financial statements and the
related notes thereto.
General
We are an information-based direct marketer and provider of consumer credit
products and fee-based services primarily to moderate-income consumers. We
underwrite and offer credit cards and fee-based services to moderate-income
consumers that have historically been overlooked by other credit card companies
and in doing so provide opportunities for such individuals to establish credit.
Our products are available throughout the United States.
Business Segments
We measure performance and operate in two business segments.
* Consumer Credit Products, which are primarily unsecured and secured
credit cards issued by Direct Merchants Bank; and
* Fee-Based Services, which include debt waiver programs, membership
clubs, extended service plans and third-party insurance offered to our
credit card customers and customers of third parties.
We receive income from our consumer credit products through: interest
charges and other finance charges assessed on outstanding credit card loans;
credit card fees (including annual membership, cash advances, overlimit fees,
and past due fees); and interchange fees. The primary expenses of this business
are the costs of funding the loans, provisions for loan losses and operating
expenses including employee compensation, account solicitation and marketing
expenses and data processing and servicing expenses. Profitability is affected
by response and approval rates to solicitation efforts, loan growth, interest
spreads on loans, credit card usage, credit quality (delinquencies and
charge-offs), card cancellations and fraud losses.
In addition to sales to third parties, the fee-based services business
derives benefits from our consumer credit products business because we
cross-sell these services to our credit card holders. Nonetheless, our two
business segments are different with respect to the factors that affect
profitability, including how income is generated and how expenses are incurred.
These differences require us to manage our operations separately.
We receive revenue from our fee-based services through fees and commissions
for such services. Expenses include costs of solicitation, underwriting and
claims servicing expenses, fees paid to third parties and other operating
expenses. The primary factors that affect profitability for this business are:
response rates to solicitation efforts, returns or cancel rates, and claims
rates.
Spin Off
You will see references in the following discussion of our financial
performance to the "spin off." Prior to September 25, 1998, Fingerhut Companies,
Inc. owned 83% of the Company's common stock. During the third quarter of 1998,
Fingerhut received written approval from the Internal Revenue Service to
distribute its interest in the Company to Fingerhut's shareholders in a tax-free
spin off. Fingerhut executed this spin off on September 25, 1998, and at that
time the Company ceased to be a subsidiary of Fingerhut.
<PAGE>
Results of Operations
Year Ended December 31, 1999, Compared to Year Ended December 31, 1998
Net loss applicable to common stockholders for the year ended December 31,
1999, was a loss of $61.6 million, or $1.60 per share, down from net income
applicable to common stockholders of $56.2 million, or $1.41 per share for 1998.
Net loss applicable to common stockholders for the year ended December 31, 1999,
included a $152.4 million one-time, non-cash, accounting impact from the
issuance of the Series C Perpetual Convertible Preferred Stock, extinguishing
the Series B Preferred, the 12% Senior Notes, and the ten-year warrants reported
in the second quarter 1999. Without this adjustment, income before extraordinary
items for the year ended December 31, 1999, would have been $115.4 million, or
$2.12 per share, an increase of 101% over net income of $57.3 million or $1.41
per share for 1998. The increase in income before extraordinary items results
from an increase in net interest income and other operating income partially
offset by increases in the provision for loan losses and other operating
expenses. These increases are largely attributable to the growth in average
managed loans and active fee-based members. Average managed loans increased to
$6.0 billion for the year ended December 31, 1999, from $4.0 billion for the
same period in 1998, an increase of 50% and active fee-based members grew to 4.9
million from 3.6 million in 1998. In addition, credit card charge volume was
approximately $5.7 billion for the full year 1999, a 48% increase over the same
period in 1998.
The provision for loan losses on a managed basis was $742.5 million in
1999, compared to $534.1 million in 1998. The increase primarily reflects higher
credit card loan balances and the addition of new credit card portfolios as well
as an increase in net charge-offs. The managed net charge-off rate was 9.0% in
1999 compared to 10.1% in 1998. The charge-off ratio for the year ended December
31, 1999, was 10.4% compared to 10.8% for the year ended December 31, 1998,
before the impact of purchase accounting related to portfolio acquisitions.
Other operating income on a managed basis increased $194.9 million to
$543.6 million, primarily due to credit card fees, interchange and other credit
card income, which increased to $382.2 million for 1999, up 52% over $251.2
million for 1998. In addition, fee-based services revenues increased 60% to
$175.1 million for 1999, up from $109.1 million for 1998. These increases were
primarily due to the growth in total credit card and fee-based accounts and
outstanding receivables in the managed credit card loan portfolio, as well as
the repricing of credit card fees in late 1998.
Other operating expenses increased to $438.0 million in 1999, compared to
$227.2 million in 1998. The increase in operating costs was due to continued
investments in our infrastructure needed to service the growth in total accounts
and outstanding receivables in the managed credit card loan portfolio, to secure
the growth in fee-based members and the overall increase in marketing
expenditures. Our operating effectiveness as measured by the our managed
operating efficiency ratio increased to 31.9% in 1999 from 26.6% in 1998, due to
the investment in infrastructure and marketing programs.
Year Ended December 31, 1998, Compared to Year Ended December 31, 1997
Net income for the year ended December 31, 1998, was $57.3 million, or
$1.41 per share, an increase of $19.2 million over net income of $38.1 million,
or $0.94 per share, for 1997. The 51% increase in net income is the result of an
increase in net interest income and other operating income partially offset by
increases in the provision for loan losses and other operating expenses. These
increases are largely attributable to the growth in average managed loans to
$4.0 billion for 1998 from $2.3 billion for 1997, an increase of 74%, and growth
in total credit card accounts to 3.0 million at December 31, 1998, from 2.3
million at December 31, 1997.
The provision for loan losses on a managed basis was $534.1 million in
1998, compared to $319.3 million in 1997. The increase primarily reflects higher
credit card loan balances as well as an increase in net charge-offs. The managed
net charge-off rate was 10.1% for 1998, compared to 8.3% in 1997. The charge-off
ratio for the years ended December 31, 1998 and 1997, was 10.8% and 9.3%,
respectively, excluding the impact of purchase accounting related to portfolio
acquisitions.
Other operating income on a managed basis increased $134.7 million to
$348.7 million, primarily due to credit card fees, interchange and other credit
card income, which increased to $251.2 million for 1998, up 64% over $153.6
million for 1997. In addition, fee-based services revenues increased 69% to
$109.1 million for 1998, up from $64.5 million for 1997. These increases were
primarily due to the growth in total accounts and outstanding receivables in the
managed credit card loan portfolio, the continued strong performance of debt
waiver and additional club membership sales.
Other operating expenses increased to $227.2 million in 1998, compared to
$139.2 million in 1997. The increase in operating costs was due to continued
investments in the infrastructure of the Company. Even while making these
investments, the operating efficiency ratio improved to 26.6% in 1998 from 26.7%
in 1997.
Managed Loan Portfolio and the Impact of Credit Card Securitizations
Securitization
A major source of our funding is the securitization of credit card loans.
Securitization requires us to remove credit card loans sold with limited
recourse from the consolidated balance sheet. The securitization and sale of
credit card loans changes our interest in the loans from lender to servicer,
with a corresponding change in how we report revenues and expenses in our
statements of income. For securitized credit card loans, amounts that we
otherwise would have recorded as net interest income, fee income and provision
for loan losses are instead reported in other operating income as net
securitization and credit card servicing income.
Managed Loan Portfolio
We analyze our financial performance on a managed loan portfolio basis. To
do so, we adjust the income statement and balance sheet to reverse the effects
of securitization. Our discussion of revenues, where applicable, and provision
for loan losses include comparisons to amounts reported in our consolidated
statements of income ("owned basis"), as well as on a managed basis.
Our managed loan portfolio is comprised of credit card loans, loans held
for securitization, retained interests in loans securitized and the investors'
share of securitized credit card loans. The investors' share of securitized
credit card loans is not an asset of the Company. Therefore, we do not show it
on our consolidated balance sheets. The following tables summarize our managed
loan portfolio:
<TABLE>
December 31,
------------
1999 1998 1997
---- ---- ----
(Dollars in thousands)
Year-end balances:
Credit card loans:
<S> <C> <C> <C>
Credit card loans ....................... $ 143,213 $ -- $ --
Loans held for securitization ........... 2,570 3,430 8,795
Retained interests in loans securitized . 1,617,226 753,469 471,831
Investors' interests in securitized loans 5,518,313 4,558,143 3,066,310
---------- ---------- ----------
Total managed loan portfolio .............. $7,281,322 $5,315,042 $3,546,936
========== ========== ==========
</TABLE>
<PAGE>
<TABLE>
Year Ended December 31,
-----------------------
1999 1998 1997
---- ---- ----
(Dollars in thousands)
Average balances:
Credit card loans:
<S> <C> <C> <C>
Credit card loans ....................... $ 11,486 $ -- $ --
Loans held for securitization ........... 9,019 52,016 78,264
Retained interests in loans securitized . 1,146,567 544,364 278,554
Investors' interests in securitized loans 4,836,719 3,404,087 1,938,075
---------- ---------- ----------
Total managed loan portfolio .............. $6,003,791 $4,000,467 $2,294,893
========== ========== ==========
</TABLE>
Impact of Credit Card Securitizations
The following table provides a summary of the effects of credit card
securitizations on selected line items of our statements of income for each of
the periods presented, as well as selected financial information on both an
owned and managed loan portfolio basis:
<TABLE>
Year Ended December 31,
-----------------------
(Dollars in thousands) 1999 1998 1997
---- ---- ----
Statements of Income (owned basis):
<S> <C> <C> <C>
Net interest income ........................ $ 180,328 $ 82,698 $ 57,243
Provision for loan losses .................. 174,800 77,770 43,989
Other operating income ..................... 623,772 315,480 187,796
Other operating expense .................... 437,984 227,160 139,167
----------- ----------- -----------
Income before income taxes and extraordinary
loss .................................... $ 191,316 $ 93,248 $ 61,883
=========== =========== ===========
Adjustments for Securitizations:
Net interest income ........................ $ 647,918 $ 423,114 $ 249,118
Provision for loan losses .................. 567,737 456,354 275,310
Other operating income ..................... (80,181) 33,240 26,192
Other operating expense .................... -- -- --
----------- ----------- -----------
Income before income taxes and extraordinary
loss .................................... $ -- $ -- $ --
=========== =========== ===========
Statements of Income (managed basis):
Net interest income ........................ $ 828,246 $ 505,812 $ 306,361
Provision for loan losses .................. 742,537 534,124 319,299
Other operating income ..................... 543,591 348,720 213,988
Other operating expense .................... 437,984 227,160 139,167
----------- ----------- -----------
Income before income taxes and extraordinary
loss .................................... $ 191,316 $ 93,248 $ 61,883
=========== =========== ===========
Other Data:
Owned Basis:
Average interest-earning assets ............ $ 1,303,528 $ 636,133 $ 403,375
Return on average assets (1) ............... 8.0% 7.4% 9.1%
Return on average total equity (1) ......... 21.3% 26.1% 24.1%
Net interest margin (2) .................... 13.8% 13.0% 14.2%
Managed Basis:
Average interest-earning assets ............ $ 6,140,247 $ 4,040,220 $ 2,341,451
Return on average assets (1) ............... 1.8% 1.4% 1.6%
Return on average total equity (1) ......... 21.3% 26.1% 24.1%
Net interest margin (2) .................... 13.5% 12.5% 13.1%
</TABLE>
(1) Excluding the one-time, non-cash, accounting impact from conversion of
the Series B Preferred Stock, 12% Senior Notes and cancellation of warrants
in June 1999.
(2) Net interest margin is equal to net interest income divided by average
interest-earning assets.
Risk Based Pricing
We price credit card offers based on a prospect's risk profile prior to
solicitation or upon receipt of a completed application. We evaluate a prospect
to determine credit needs, credit risk, and existing credit availability and
then develop a customized offer that includes the most appropriate product,
brand, pricing and credit line. After customers open credit card accounts, we
periodically monitor customers' internal and external credit performance and
periodically recalculate behavior, revenue, attrition and bankruptcy predictors.
The customers are rescored on a regular basis and the lending relationship can
evolve to include more competitive (or more restrictive) pricing and product
configurations. These analyses consider the overall profitability of accounts
using both credit information and the profitability from selling fee-based
services to the customers.
Net Interest Income
Net interest income consists primarily of interest earned on our credit
card loans, less interest expense on borrowings to fund the loans. Managed net
interest income for the year ended December 31, 1999, was $828.2 million
compared to $505.8 million for the same period in 1998, an increase of $322.4
million. This increase was primarily due to a $2.0 billion increase in average
managed loans over the comparable period in 1998. The average net yield on
managed interest-earning assets increased to 13.5% for the year ended December
31, 1999, from 12.5% for the year ended December 31, 1998. The net interest
margin increased compared to 1998, primarily due to a repricing of accounts that
occurred late in 1998 that had a positive impact on 1999. The average yield on
interest-earning assets on an owned basis increased to 13.8% for the year ended
December 31, 1999, from 13.0% for the same period in 1998.
Managed net interest income for the year ended December 31, 1998, was
$505.8 million compared to $306.4 million for the same period in 1997, an
increase of $199.4 million. This increase was primarily due to a $1.7 billion
increase in average managed loans over the comparable period in 1997. The
managed net interest margin decreased to 12.5% for the year ended December 31,
1998, from 13.1% for the year ended December 31, 1997. The reduction in the
managed net interest margin was primarily due to increased charge-offs of
finance charges in 1998. The net interest margin on an owned basis decreased to
13.0% for the year ended December 31, 1998, from 14.2% for the same period in
1997 primarily due to higher financing costs as a percent of average
interest-earning assets.
Analysis of Average Balances, Interest and Average Yields and Rates
The following table provides an analysis of interest income and
expense, net interest spread, net interest margin and average balance sheet data
for the years ended December 31, 1999, 1998 and 1997:
<TABLE>
Year Ended December 31,
-----------------------
1999 1998
---- ----
(Dollars in thousands) Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
Owned Basis
- -----------
Assets:
Interest-earning assets:
<S> <C> <C> <C> <C> <C> <C>
Federal funds sold ................................. $ 90,748 $ 4,477 4.9% $ 20,190 $ 1,065 5.3%
Short-term investments ............................. 45,708 2,298 5.0% 19,563 1,028 5.3%
Credit card loans and retained interests in loans
securitized ..................................... 1,167,072 229,394 19.7% 596,380 111,118 18.6%
----------- ----------- ----------- -----------
Total interest-earning assets ...................... $ 1,303,528 $ 236,169 18.1% $ 636,133 $ 113,211 17.8%
Other assets ....................................... 651,227 -- -- 423,278 -- --
Allowance for loan losses .......................... (505,458) -- -- (285,244) -- --
----------- ----------- ----------- -----------
Total assets ....................................... $ 1,449,297 -- -- $ 774,167 -- --
=========== ===========
Liabilities and Equity:
Interest-bearing liabilities:
Deposits ........................................... $ 328,035 $ 19,329 5.9% $ -- $ -- --
Debt ............................................... 323,260 36,512 11.3% 284,038 30,513 10.7%
----------- ----------- ----------- -----------
Total interest-bearing liabilities ................. $ 651,295 $ 55,841 8.6% $ 284,038 $ 30,513 10.7%
Other liabilities .................................. 255,952 -- -- 270,294 -- --
----------- ----------- ----------- -----------
Total liabilities .................................. 907,247 -- -- 554,332 -- --
Stockholders' equity ............................... 542,050 -- -- 219,835 -- --
----------- ----------- ----------- -----------
Total liabilities and equity ....................... $ 1,449,297 -- -- $ 774,167 -- --
=========== ===========
Net interest income and interest margin (1) ........ -- $ 180,328 13.8% -- $ 82,698 13.0%
Net interest rate spread (2) ....................... -- -- 9.5% -- -- 7.1%
Managed Basis
- -------------
Credit card loans .................................. $ 6,003,791 $ 1,156,888 19.3% $ 4,000,467 $ 738,675 18.5%
Total interest-earning assets ...................... 6,140,247 1,163,663 19.0% 4,040,220 740,768 18.3%
Total interest-bearing liabilities ................. 5,488,015 335,417 6.1% 3,719,960 234,956 6.3%
Net interest income and interest margin (1) ........ -- 828,246 13.5% -- 505,812 12.5%
Net interest rate spread (2) ....................... -- -- 12.9% -- -- 12.0%
</TABLE>
(1) Net interest margin is computed by dividing net interest income by average
total interest-earning assets.
(2) The interest rate spread is the yield on average interest-earning assets
minus the funding rate on average interest-bearing liabilities.
<PAGE>
Analysis of Average Balances, Interest and Average Yields and Rates (continued)
Year Ended December 31, 1997
----------------------------
(Dollars in thousands) Average Yield/
Balance Interest Rate
------- -------- ----
Owned Basis
- -----------
Assets:
Interest-earning assets:
Federal funds sold ............... $ 30,049 $ 1,636 5.4%
Short-term investments ........... 16,509 863 5.2%
Credit card loans and retained
interests in loans securitized 356,817 66,695 18.7%
----------- ----------- ----
Total interest-earning assets .... $ 403,375 $ 69,194 17.2%
Other assets ..................... 172,739 -- --
Allowance for loan losses ........ (158,211) -- --
----------- -----------
Total assets ..................... $ 417,903 -- --
===========
Liabilities and Equity:
Interest-bearing liabilities:
Deposits ......................... $ -- $ -- --
Debt ............................. 149,726 11,951 8.0%
----------- ----------- ----
Total interest-bearing liabilities $ 149,726 $ 11,951 8.0%
Other liabilities ................ 109,997 -- --
-----------
Total liabilities ................ 259,723 -- --
Stockholders' equity ............. 158,180 -- --
-----------
Total liabilities and equity ..... $ 417,903 -- --
===========
Net interest income and interest
margin (1) ................... -- $ 57,243 14.2%
Net interest rate spread (2) ..... -- -- 9.2%
Managed Basis
- -------------
Credit card loans ................ $ 2,294,893 $ 433,334 18.9%
Total interest-earnings assets ... 2,341,451 435,833 18.6%
Total interest-bearing liabilities 2,087,801 129,472 6.2%
Net interest income and interest
margin (1) .................... -- 306,361 13.1%
Net interest rate spread (2) ..... -- -- 12.4%
(1) Net interest margin is computed by dividing net interest income by
average total interest-earning assets.
(2) The interest rate spread is the yield on average interest-earning assets
minus the funding rate on average interest-bearing liabilities.
<PAGE>
Interest Variance Analysis
Net interest income is affected by changes in the average interest rate
earned on interest-earning assets and the average interest rate paid on
interest-bearing liabilities, in addition to changes in the volume of
interest-earning assets and interest-bearing liabilities. The following table
presents the effects of changes in average volume and interest rates on
individual financial statement line items on an owned basis:
<TABLE>
Year Ended December 31, Year Ended December 31,
1999 vs. 1998 1998 vs. 1997
----------------------- -----------------------
Change due to* Change due to*
(Dollars in thousands) Increase/
Increase Volume Rate (Decrease) Volume Rate
Interest Income:
<S> <C> <C> <C> <C> <C> <C>
Federal funds sold .............. $ 3,412 $ 3,476 $ (64) $ (571) $ (521) $ (50)
Short-term investments .......... 1,270 1,313 (43) 165 160 5
Credit card loans and retained
interests in loans securitized 118,276 111,855 6,421 44,423 44,635 (212)
-------- -------- -------- -------- -------- --------
Total interest income ........... 122,958 120,288 2,670 44,017 43,061 956
Interest expense ................ 25,328 30,015 (4,687) 18,562 13,397 5,165
-------- -------- -------- -------- -------- --------
Net interest income ............. $ 97,630 $ 90,273 $ 7,357 $ 25,455 $ 29,664 $ (4,209)
======== ======== ======== ======== ======== ========
</TABLE>
* The change in interest due to both volume and rates has been allocated in
proportion to the relationship of the absolute dollar amounts of the change in
each. We calculate changes in income and expense independently for each caption
in the analysis. The totals for the volume and rate columns are not the sum of
the individual lines.
Other Operating Income
Other operating income contributes substantially to our results of
operations, representing 73%, 74% and 73% of owned revenues for the years ended
December 31, 1999, 1998 and 1997, respectively. Fee-based services revenues,
particularly from debt waiver products, provide a significant percentage of
other operating income. Debt waiver products and other fee-based services
revenues are expected to increase with growth in credit card accounts and as we
continue to offer other fee-based services to our customer base and to customers
of third parties. The following table presents other operating income on an
owned basis:
<TABLE>
Year Ended December 31,
-----------------------
(Dollars in thousands) 1999 1998 1997
---- ---- ----
Other Operating Income:
<S> <C> <C> <C>
Net securitization and credit card servicing income ...... $318,873 $138,221 $ 79,533
Credit card fees, interchange and other credit
card income ........................................... 129,808 68,136 43,731
Fee-based services revenues .............................. 175,091 109,123 64,532
-------- -------- --------
Total .................................................... $623,772 $315,480 $187,796
======== ======== ========
</TABLE>
Other operating income increased $308.3 million for the year ended December
31, 1999, over 1998, primarily due to income generated from the growth in
average securitized credit card loans. Additionally, fee-based services revenues
increased 60% to $175.1 million because of our marketing efforts to sell other
products and services to our customers and customers of third parties.
Specifically, debt waiver product revenue increased by $32.2 million to $106.0
million for the year ended December 31, 1999, as we continued to add new credit
card customers with debt waiver protection. In addition, interchange revenue
increased over the prior year due to credit card charge volume increasing to
approximately $5.7 billion in 1999 from approximately $3.9 billion in 1998.
Other operating income increased $127.7 million for the year ended December
31, 1998, over 1997, primarily due to income generated from the growth in
average credit card loans. Additionally, fee-based services revenues increased
69% to $109.1 million because of our marketing efforts to sell other products
and services to our customers and customers of third parties. Specifically, debt
waiver product revenue increased by $26.2 million to $73.8 million for the year
ended December 31, 1998, as the Company continued to add new credit card
customers with debt waiver protection. In addition, interchange revenue
increased over the prior year due to credit card charge volume increasing to
approximately $3.9 billion in 1998 from $2.7 billion in 1997.
Other Operating Expense
<TABLE>
Year Ended December 31,
-----------------------
(Dollars in thousands) 1999 1998 1997
---- ---- ----
Other Operating Expense:
<S> <C> <C> <C>
Credit card account and other product solicitation and
marketing expenses .................................... $107,726 $ 43,471 $ 31,622
Employee compensation .................................... 122,417 62,627 35,200
Data processing services and communications .............. 52,355 35,445 20,087
Third-party servicing expense ............................ 13,615 11,074 12,711
Warranty and debt waiver underwriting and claims servicing
expense ............................................... 21,091 12,279 6,053
Credit card fraud losses ................................. 7,384 4,436 3,240
Customer base intangible amortization .................... 31,752 10,051 2,467
Other .................................................... 81,644 47,777 27,787
-------- -------- --------
Total .................................................... $437,984 $227,160 $139,167
======== ======== ========
</TABLE>
Total other operating expenses for the year ended December 31, 1999,
increased $210.8 million over 1998, largely due to costs associated with the
continued growth of our business activities. Credit card account and other
product solicitation and marketing expenses increased $64.3 million over 1998,
largely due to the increases in credit card marketing expenses to generate new
accounts and retain existing profitable accounts and due to fee-based marketing
activity for new and existing programs during 1999. Employee compensation
increased $59.8 million for the year ended December 31, 1999, due to increased
staffing needs to support the increase in credit card accounts and fee-based
services active member growth. Other expenses increased $33.9 million for the
full year 1999 due to increases in general expenses to support the growth in
credit card accounts and fee-based services members.
Total other operating expenses for the year ended December 31, 1998,
increased $88.0 million over 1997, largely due to costs associated with the
growth of our business activities. Employee compensation and other expenses
increased $27.4 million and $20.0 million, respectively, for the year ended
December 31, 1998, due to increased staffing needs and use of outside services
to support the increase in credit card accounts, fee-based services active
member growth and other functions. Also, data processing services and
communications expenses increased $15.4 million, largely due to the growth in
credit card accounts, transaction volumes and loan balances.
Income Taxes
Our provision for income taxes includes both federal and state income
taxes. Applicable income tax expense was $76.0 million, $35.9 million and $23.8
million for the years ended December 31, 1999, 1998 and 1997, respectively. This
tax expense represents an effective tax rate of 39.7% for the year ended
December 31, 1999, and 38.5% for the years ended December 31, 1998 and 1997,
respectively. The increase in 1999 was due to the conversion of the Series B
Perpetual Convertible Preferred Stock and 12% Senior Notes to the Series C
Perpetual Convertible Preferred Stock and the cancellation of warrants.
Asset Quality
Our delinquency and net loan charge-off rates at any point in time reflect,
among other factors, the credit risk of loans, the average age of our various
credit card account portfolios, the success of our collection and recovery
efforts, and general economic conditions. The average age of our credit card
portfolio affects the stability of delinquency and loss rates. In order to
minimize losses, we continue to focus our resources on refining our credit
underwriting standards for new accounts, and on collections and post charge-off
<PAGE>
recovery efforts. At December 31, 1999, 58% of our managed accounts and 50%
of our loans were less than 36 months old.
For the year ended December 31, 1999, our net charge-off ratio was 9.0%,
compared to 10.1% and 8.3% for the years ended December 31, 1998 and 1997,
respectively. Without the impact of purchase accounting related to acquired
portfolios, the charge-off rate was 10.4%, 10.8% and 9.3% for the years ended
December 31, 1999, 1998 and 1997, respectively. Our charge-offs have been
stable, with losses between 10% and 11% for the last eight quarters. We believe,
consistent with our statistical models and other credit analyses that this rate
will continue to fluctuate within this range over the next few quarters.
We use credit line analyses, account management and customer transaction
authorization procedures to minimize loan losses. Our risk models determine
initial credit lines at the time of solicitation and generally result in lower
credit lines than the industry average. Credit lines are managed on an ongoing
basis and are adjusted based on customer usage and payment patterns. Customer
accounts are continually monitored to maximize profitability. Appropriate
collection activities are initiated when an account is delinquent or over limit.
Delinquencies
Delinquencies not only have the potential to affect earnings in the form of
net loan losses, but are also costly in terms of the personnel and other
resources dedicated to their resolution. We monitor delinquency levels on a
managed basis, since delinquency on either an owned or managed basis subjects us
to credit loss exposure. A credit card account is contractually delinquent if we
do not receive the minimum payment by the specified date on the cardholder's
statement. It is our policy to continue to accrue interest and fee income on all
credit card accounts, except in limited circumstances, until we charge off the
account and all related loans, interest and other fees. The following table
presents the delinquency trends of our credit card loan portfolio on a managed
portfolio basis:
Managed Loan Delinquency
<TABLE>
December 31, % of December 31, % of December 31, % of
1999 Total 1998 Total 1997 Total
------------ ---- ------------ ---- ------------ ----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Managed loan portfolio ........ $7,281,322 100% $5,315,042 100% $3,546,936 100%
Loans contractually delinquent:
30 to 59 days .............. 168,882 2.3% 113,449 2.1% 72,114 2.0%
60 to 89 days .............. 117,740 1.6% 75,049 1.4% 49,300 1.4%
90 or more days ............ 270,092 3.7% 173,812 3.3% 111,166 3.2%
---------- --- ---------- --- ---------- ---
Total ................... $ 556,714 7.6% $ 362,310 6.8% $ 232,580 6.6%
========== === ========== === ========== ===
</TABLE>
The above numbers reflect the continued seasoning of our managed loan
portfolio. Without the impact of purchase accounting related to acquired
portfolios, delinquency rates would have been 7.8%, 7.4% and 7.1%, respectively.
We intend to continue to focus our resources on our collection efforts to
minimize the negative impact to net loan losses that results from increased
delinquency levels.
<PAGE>
Net charge-offs
Net charge-offs include the principal amount of losses from cardholders
unwilling or unable to pay their loan balances, as well as bankrupt and deceased
cardholders, less current period recoveries. Net charge-offs exclude accrued
finance charges and fees, which are charged against the related income at the
time of charge-off. The following table presents our net charge-offs for the
periods indicated as reported in the consolidated financial statements and on a
managed portfolio basis:
<TABLE>
Year Ended December 31,
-----------------------
1999 1998 1997
---- ---- ----
(Dollars in thousands)
Owned Basis:
<S> <C> <C> <C>
Average loans and retained interests
in loans securitized outstanding ..... $1,167,072 $ 596,380 $ 356,817
Net charge-offs .................... 96,102 58,793 29,398
Net charge-offs as a percentage
of average loans outstanding ... 8.2% 9.9% 8.2%
========== ========== ==========
Managed Basis:
Average loans outstanding .......... $6,003,791 $4,000,467 $2,294,893
Net charge-offs .................... 543,085 405,077 191,130
Net charge-offs as a percentage of
average loans outstanding ...... 9.0% 10.1% 8.3%
========== ========== ==========
</TABLE>
Provision and allowance for loan losses
We maintain an allowance for loan losses for both owned loans and the
retained interests in loans securitized. The portion allocated to the retained
interest in loans securitized represents our estimate of a valuation adjustment
to report this asset in accordance with SFAS 125. For securitized loans,
anticipated losses and related provisions for loan losses are reflected in the
calculations of net securitization and credit card servicing income. We make
provisions for loan losses in amounts necessary to maintain the allowance at a
level estimated to be sufficient to absorb probable future losses of principal
and earned interest, net of recoveries, inherent in the existing loan portfolio.
The provision for loan losses on a managed basis for the year ended
December 31, 1999, totaled $742.5 million compared to a provision of $534.1
million in 1998. The increase in the provision for loan losses in 1999 compared
to 1998 is primarily reflective of the large increase in loans and the overall
seasoning of the portfolio.
Analysis of Allowance for Loan Losses
The following table presents the change in our allowance for loan losses
and other ratios on a managed portfolio basis for the periods presented:
<PAGE>
<TABLE>
Year Ended December 31,
-----------------------
(Dollars in thousands) 1999 1998 1997
---- ---- ----
Managed Basis:
<S> <C> <C> <C>
Balance at beginning of year ....................................... $ 393,283 $ 244,084 $ 95,669
Allowance related to assets acquired, net .......................... 26,293 20,152 20,246
Provision for loan losses .......................................... 742,537 534,124 319,299
Loans charged off .................................................. (582,637) (420,875) (195,535)
Recoveries ......................................................... 39,552 15,798 4,405
--------- --------- ---------
Net loan charge-offs ............................................... (543,085) (405,077) (191,130)
--------- --------- ---------
Balance at end of year ............................................. $ 619,028 $ 393,283 $ 244,084
========= ========= =========
Ending allowance as a percent of loans ............................. 8.5% 7.4% 6.9%
========= ========= =========
</TABLE>
We believe the allowance for loan losses is adequate to cover probable
losses in the loan portfolio under current conditions. However, there can be no
assurance as to the future credit losses that may be incurred in connection with
our loan portfolio, nor can there be any assurance that the loan loss allowance
that has been established will be sufficient to absorb such expected loan
losses. We continually monitor the allowance for loan losses and make additional
provisions to the allowance as we deem appropriate.
Derivatives Activities
We use derivative financial instruments for the purpose of managing our
exposure to interest rate risks. We have a number of procedures in place to
monitor and control both market and credit risk from these derivatives
activities. Our senior management approves all derivatives strategies and
transactions.
Market Risk
Market risk is the risk of loss from adverse changes in market prices and
rates. Our principal market risk is the possibility of changes in interest
rates. This affects us directly in our lending and borrowing activities, as well
as indirectly, as interest rates may impact the payment performance of our
cardholders.
To manage our direct risk to market interest rates and minimize the impact
that changes in interest rates have on the fair market value of assets, net
income and cash flow, we actively monitor the interest rates and the
interest-sensitive components of our owned and managed balance sheet. We manage
the impact of changes in interest rates on the Company primarily by matching
asset and liability repricings.
Our primary managed assets are credit card loans, which are virtually all
priced at rates indexed to the variable Prime Rate. We fund credit card loans
through a combination of securitizations, subsidiary bank deposits, our $300
million bank credit facilities, $250 million in senior notes, cash flow from
operations, and equity issuance. Our securitized loans are owned by a trust and
bank-sponsored multi-seller receivables conduits, which have committed funding
indexed to variable commercial paper rates and the London Interbank Offered Rate
("LIBOR"). The $300 million bank credit facilities have pricing that is also
indexed to LIBOR or Prime Rate. The subsidiary bank deposits and long-term debt
are at fixed interest rates. At December 31, 1999, approximately 15.2% of the
trust and conduit funding of securitized receivables was funded with fixed rate
certificates.
Including the impact of interest rate derivative transactions with the
trust and conduit funding, in an interest rate environment with rates
significantly below current rates, 87% of the funding for the managed loan
portfolio is indexed to floating commercial paper and LIBOR rates. In an
interest rate environment with rates significantly above current rates, we
mitigate the potentially negative impact on earnings of higher interest expense
through the fixed rate funding and interest rate cap contracts.
The approach we use to quantify interest rate risk is a sensitivity
analysis, which we believe best reflects the risk inherent in our business. This
approach calculates the impact on net income from an instantaneous and sustained
change in interest rates by 200 basis points. Assuming no counteractive measures
by management, a 200 basis point increase in interest rates affecting our
floating rate financial instruments, including both debt obligations and loans,
will result in an increase in net income of approximately $25.4 million relative
to a base case over the next 12 months; while a decrease of 200 basis points
will result in a reduction in net income of approximately $25.1 million. Our use
of this methodology to quantify the market risk of financial instruments should
not be construed as an endorsement of its accuracy or the accuracy of the
related assumptions. In addition, this methodology does not take into account
the indirect impact interest rates may have on the payment performance of our
cardholders. The quantitative information about market risk is necessarily
limited because it does not take into account operating transactions or other
costs associated with managing immediate changes in interest rates.
Liquidity, Funding and Capital Resources
One of our primary financial goals is to maintain an adequate level of
liquidity through active management of assets and liabilities. Because the
pricing and maturity characteristics of our assets and liabilities change,
liquidity management is a dynamic process, affected by changes in short- and
long-term interest rates. We use a variety of financing sources to manage
liquidity, refunding, and interest rate risks.
Metris Companies Inc. Year-End Funding Mix*
-------------------------------------------
(At December 31)
----------------
1999 1998
---- ----
Total Year-End Funding ....... $7.3 billion $5.3 billion
Bank Loans ................... 1.4% 2.1%
Long-term Debt ............... 3.4% 3.8%
Equity ....................... 8.6% 8.1%
Bank Conduit Securitizations . 10.3% 17.6%
Deposits ..................... 10.7% --
Metris Master Trust .......... 65.6% 68.4%
----- -----
100.0% 100.0%
===== =====
(*Chart replaces graph in 1999 Annual Report.)
We finance the growth of our credit card loan portfolio through asset
securitization, subsidiary bank deposits, bank loans, long-term debt issuance,
cash flow from operations, and equity issuance.
At December 31, 1999 and 1998, we had received cumulative net proceeds of
approximately $5.5 billion and $4.6 billion, respectively, from sales of credit
card loans to the trust and conduits. We used cash generated from these
transactions to reduce borrowings and to fund credit card loan portfolio growth.
We rely upon the securitization of our credit card loans to fund portfolio
growth. To date, we have completed securitization transactions on terms that we
believe are satisfactory. Our ability to securitize our assets depends on the
favorable investor demand and legal, regulatory and tax conditions for
securitization transactions, as well as continued favorable performance of our
securitized portfolio of receivables. Any adverse change could force us to rely
on other potentially more expensive funding sources and, in the worst case
scenario, could create liquidity risks if other funding is unavailable or
significantly limit our ability to grow.
The following table presents the amounts, at December 31, 1999, of investor
principal in securitized receivables scheduled to amortize in future years. We
base the amortization amounts on estimated amortization periods, which are
subject to change based on the trust and conduit performance.
(Dollars in thousands)
2000 .......................................... $2,116,040
2001 .......................................... 2,102,273
2002 .......................................... 0
2003 .......................................... 500,000
2004 .......................................... 300,000
Thereafter .................................... 500,000
----------
Total Securitized Loans at December 31, 1999 $5,518,313
==========
Beginning in the first quarter of 1999, Direct Merchants Bank began issuing
certificates of deposit. These CDs are issued in increments of $100,000. As of
December 31, 1999, $758.5 million of CDs were outstanding with maturities
ranging from three months to two years with fixed interest rates ranging from
5.2% to 6.6%.
We have a $200 million, three-year revolving credit facility and a $100
million five-year term loan, collectively (the "Credit Facilities") with a
syndicate of banks and money market mutual funds. These credit facilities became
effective upon the spin off from Fingerhut on September 25, 1998. At December
31, 1999 and 1998, we were in compliance with all financial covenants under
credit facilities. At December 31, 1999 and 1998, we had outstanding borrowings
of $100 million and $110 million, respectively, under these credit facilities.
On July 15, 1999, we privately issued and sold $150 million of 10.125%
Senior Notes due 2006 pursuant to an exemption from registration under Rule 144A
of the Securities Act of 1933. In October of 1999, we commenced an exchange
offer for the Senior Notes pursuant to a registration statement. The terms of
the new Senior Notes were identical in all material respects to the original
private issue. The exchange offer was completed in November of 1999. In November
1997, we privately issued and sold $100 million of 10% Senior Notes due 2004.
The Senior Notes are guaranteed on the same basis as the Senior Notes due 2006.
On November 13, 1998, we sold $200 million in Series B Perpetual Preferred
Stock and $100 million in 12% Senior Notes due 2006 to affiliates of the Thomas
H. Lee Company. We also issued 7.5 million ten-year warrants to purchase shares
of our common stock for $15, subject to adjustment in certain circumstances. The
Series B Preferred had a 12.5% dividend payable in additional shares of Series B
Preferred for ten years, then converting to payable in cash.
On March 12, 1999, shareholders approved conversion of the Series B
Preferred and 12% Senior Notes into Series C Perpetual Convertible Preferred
Stock. On May 28, 1999, notice was received that there was no regulatory
objection to the conversion to the Series C Preferred, and the Series B
Preferred and the 12% Senior Notes were converted into 0.8 million shares of
Series C Preferred at a conversion price of $18.63 and the warrants were
canceled. The Series C Preferred has a 9% dividend payable in additional shares
of Series C Preferred and will also receive any dividends paid on the Company's
common stock on an as converted basis. The cumulative payment-in-kind dividends
are effectively guaranteed for a seven-year period. Assuming conversion of the
Series C Preferred into common stock had occurred at December 31, 1999, the Lee
Company would have owned over 30% of the Company on a diluted basis.
Converting to the Series C Preferred caused a one-time, non-cash,
accounting adjustment for extinguishing the Series B Preferred and 12% Senior
Notes. We allocated the excess of the fair value of the Series C Preferred over
the carrying value of the Series B Preferred and the 12% Senior Notes at the
time of the conversion to the 12% Senior Notes and the Series B Preferred Stock
based upon their initial fair values. We recognized the $50.8 million allocated
to the 12% Senior Notes as an extraordinary loss from the early extinguishment
of debt and the $101.6 million allocated to the Series B Preferred as a
reduction of net income applicable to common stockholders. We did not record the
extraordinary loss attributable to the 12% Senior Notes net of taxes. These
adjustments had no impact on total stockholders' equity.
The Federal Reserve Act imposes various legal limitations on the extent to
which banks that are members of the Federal Reserve System can finance or
otherwise supply funds to certain of their affiliates. In particular, Direct
Merchants Bank is subject to certain restrictions on any extensions of credit to
us or our subsidiaries. Additionally, Direct Merchants Bank is limited in its
ability to declare dividends to us. Therefore, Direct Merchants Bank's
investments in federal funds sold are generally not available for the general
liquidity needs of the Company or its subsidiaries. These restrictions were not
material to our operations at December 31, 1999 and 1998.
As the portfolio of credit card loans grows, or as the trust and conduit
securitization fundings amortize, our funding needs will increase accordingly.
We believe that our asset securitization, subsidiary bank deposits, bank loans,
long-term debt, cash flow from operations and equity will provide us with
adequate liquidity for meeting anticipated cash needs, although no assurance can
be given to that effect.
Capital Adequacy
During 1999, we improved our financial position, as reflected by an
increase in stockholders' equity, through the conversion of the 12% Senior Notes
into Series C Preferred as described above, which increased stockholders' equity
by approximately $104 million.
Direct Merchants Bank is subject to certain capital adequacy guidelines
adopted by the Office of the Comptroller of the Currency (the "OCC"), its
primary regulator. At December 31, 1999 and 1998, Direct Merchants Bank exceeded
the minimum required capital levels and was considered a "well-capitalized"
depository institution under regulations of the OCC.
Newly Issued Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities," which establishes accounting and
reporting standards for derivative instruments. It requires enterprises to
recognize all derivatives as either assets or liabilities in the statement of
financial position and to measure those instruments at fair value. This
statement is effective for all fiscal quarters of fiscal years beginning after
June 15, 2000. We are evaluating the financial impact the adoption of this
statement will have on in our financial statements.
In December 1999, the Securities and Exchange Commission released Staff
Accounting Bulletin No. 101 - Revenue Recognition in Financial Statements. This
SAB formalized the accounting for services sold with a full refund, requiring
all companies to defer recognition of service revenues until the cancellation
period is complete. We adopted this practice for membership programs in 1998,
before the official guidance was released. Due to the adoption of this SAB, we
expect to record a cumulative effect of exchange in accounting principle in the
first quarter of 2000, with a net after-tax impact of $3-4 million. This
one-time, non-cash, adjustment is to defer recognition of debt waiver revenue
until the cancellation period is complete, which is one month. Prior to this
change, we recognized one-half of the current period revenues in the month
billed.
Year 2000
The "Year 2000 Problem" is a result of software systems or hardware systems
utilizing two digits instead of four digits to define the year. Software or
hardware with only two-digit capacity may interpret the year 00 as 1900 when
calculating age, length of a phone call, financing period for a loan, or
expiration for a credit card.
The Company established a project team to manage its Year 2000 efforts. The
Year 2000 Project consisted of the following phases: Awareness Phase, Assessment
Phase, Renovation Phase, and Validation and Implementation Phase. The project is
complete.
The Company did not experience any problems related to the Year 2000 date
change. In addition, the costs of Year 2000 compliance were not material to the
Company's consolidated financial position, results of operations, or cash flows.
Forward-Looking Statements
This annual report contains some forward-looking statements. Forward-
looking statements give our current expectations of future events. You will
recognize these statements because they do not strictly relate to historical or
current facts. Such statements may use words such as "anticipate," "estimate,"
"expect," "project," "intend," "think," "believe," and other words or terms of
similar meaning in connection with any discussion of future performance of the
Company. For example, these include statements relating to future actions,
future performance of current or anticipated products, solicitation efforts,
expenses, the outcome of contingencies such as litigation, and the impact of the
capital markets on liquidity. From time to time, we also may provide oral or
written forward-looking statements in other material released to the public.
Any or all of our forward-looking statements in this report and in any
other public statements we make may turn out to be wrong. They can be affected
by inaccurate assumptions or by known or unknown risks and uncertainties. Many
factors, which can not be predicted with certainty, will be important in
determining future results. Among such factors are the Company's limited
operating history as a stand alone entity, its limited experience in originating
and servicing credit card accounts, the lack of seasoning of its credit card
accounts which renders predictability of delinquencies more difficult, higher
default and bankruptcy rates of the Company's target market of moderate-income
consumers, interest rate risks, risks associated with acquired portfolios,
dependence on the securitization markets, state and federal laws and
regulations, and general economic conditions that can have a major impact on the
performance of loans. Each of these factors and others are more fully discussed
under the caption "Business--Risk Factors" contained in the Company's Annual
Report on Form 10-K for the year ended December 31, 1999. As a result of these
factors, we cannot guarantee any forward-looking statements. Actual future
results may vary materially. Also, please note that the factors we provide are
those we think could cause our actual results to differ materially from expected
and historical results. Other factors besides those listed here or in the
Company's 10-K for the year ended December 31, 1999, could also adversely affect
the Company.
We undertake no obligations to publicly update any forward-looking
statements, whether as a result of new information, future events or otherwise.
You are advised, however, to consult any further disclosure we make on related
subjects in our periodic filings with the Securities and Exchange Commission.
This discussion is provided to you as permitted by the Private Securities
Litigation Reform Act of 1995.
<PAGE>
MANAGEMENT'S REPORT ON CONSOLIDATED FINANCIAL STATEMENTS
AND INTERNAL CONTROL
The accompanying consolidated financial statements, related financial data,
and other information in this annual report were prepared by the management of
Metris Companies Inc. Management is responsible for the integrity and
objectivity of the data presented, including amounts that must necessarily be
based on judgments and estimates. The consolidated financial statements were
prepared in conformity with generally accepted accounting principles.
Management of Metris Companies Inc. depends on its accounting systems and
internal control structures in meeting its responsibilities for reliable
consolidated financial statements. In management's opinion, these systems and
structures provide reasonable assurance that assets are safeguarded and that
transactions are properly recorded and executed in accordance with management's
authorizations. As an integral part of these systems and structures, the Company
utilizes a professional staff of internal auditors who conduct operational and
special audits and coordinate audit coverage with Company management and the
independent auditors.
The consolidated financial statements have been audited by the Company's
independent auditors, KPMG LLP, whose independent professional opinion appears
separately. Their opinion on the consolidated financial statements is based on
auditing procedures that include performing selected tests of transactions and
records as they deem appropriate. These auditing procedures are designed to
provide reasonable assurance that the consolidated financial statements are free
of material misstatement.
The Audit Committee of the Board of Directors, composed solely of outside
directors, meets periodically with the internal auditors, the independent
auditors and management to review the work of each and ensure that each is
properly discharging its responsibilities. The internal and independent auditors
have free access to the Committee to discuss the results of their audit work and
their findings.
Ronald N. Zebeck David D. Wesselink
President and Executive Vice President,
Chief Executive Officer Chief Financial Officer
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Metris Companies Inc.:
We have audited the accompanying consolidated balance sheets of Metris
Companies Inc. and subsidiaries as of December 31, 1999 and 1998, and the
related consolidated statements of income, changes in stockholders' equity and
cash flows for each of the years in the three-year period ended December 31,
1999. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Metris
Companies Inc. and subsidiaries as of December 31, 1999 and 1998, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1999, in conformity with generally accepted
accounting principles.
KPMG LLP
Minneapolis, Minnesota
January 19, 2000
Item 8. Financial Statements and Supplementary Data
<TABLE>
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(Dollars in thousands, except per-share data)
December 31,
------------
1999 1998
---- ----
Assets:
<S> <C> <C>
Cash and due from banks ........................................................ $ 28,505 $ 22,114
Federal funds sold ............................................................. 118,962 15,060
Short-term investments ......................................................... 46,966 173
---------- --------
Cash and cash equivalents ................................................... 194,433 37,347
---------- --------
Retained interests in loans securitized ........................................ 1,617,226 753,469
Less: Allowance for loan losses ............................................. 606,853 393,283
---------- --------
Net retained interests in loans securitized .................................... 1,010,373 360,186
---------- --------
Credit card loans (net of allowance for loan losses of $12,175) 131,038 --
Loans held for securitization .................................................. 2,570 3,430
Property and equipment, net .................................................... 56,914 21,982
Accrued interest and fees receivable ........................................... 17,704 6,009
Prepaid expenses and deferred charges .......................................... 57,371 59,104
Deferred income taxes .......................................................... 185,613 153,021
Customer base intangible ....................................................... 83,809 81,892
Other receivables due from credit card securitizations, net ................... 243,978 185,935
Other assets ................................................................... 61,279 36,813
---------- --------
Total assets ............................................................. $2,045,082 $945,719
========== ========
Liabilities:
Deposits ....................................................................... $ 775,381 $ --
Debt ........................................................................... 345,012 310,896
Accounts payable ............................................................... 45,850 19,091
Current income taxes payable ................................................... 22,969 31,783
Deferred income ................................................................ 171,666 124,892
Accrued expenses and other liabilities ......................................... 60,403 26,075
---------- --------
Total liabilities ........................................................... $1,421,281 $512,737
---------- --------
Stockholders' Equity:
Preferred stock - Series B, par value $.01 per share; 10,000,000 shares
authorized, 539,866 shares issued and outstanding $ -- $201,100
Convertible preferred stock - Series C, par value $.01 per share; 10,000,000
shares authorized, 885,178 shares issued and outstanding 329,729 --
Common stock, par value $.01 per share; 100,000,000 shares authorized,
38,612,955 and 38,519,500 shares issued and outstanding, respectively 386 193
Paid-in capital ................................................................ 130,772 107,615
Retained earnings .............................................................. 162,914 124,074
---------- --------
Total stockholders' equity .................................................. $ 623,801 $432,982
---------- --------
Total liabilities and stockholders' equity .................................. $2,045,082 $945,719
========== ========
See accompanying Notes to Consolidated Financial Statements.
</TABLE>
<PAGE>
<TABLE>
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Statements of Income
(Dollars in thousands, except per-share data)
Year Ended December 31,
-----------------------
1999 1998 1997
---- ---- ----
Interest Income:
<S> <C> <C> <C>
Credit card loans and retained
interests in loans securitized ....... $ 229,394 $ 111,118 $ 66,695
Federal funds sold ........................ 4,477 1,065 1,636
Other ..................................... 2,298 1,028 863
--------- --------- ---------
Total interest income ..................... 236,169 113,211 69,194
Interest expense .......................... 55,841 30,513 11,951
--------- --------- ---------
Net Interest Income ....................... 180,328 82,698 57,243
Provision for loan losses ................. 174,800 77,770 43,989
--------- --------- ---------
Net Interest Income
After Provision for Loan Losses ...... 5,528 4,928 13,254
--------- --------- ---------
Other Operating Income:
Net securitization and credit card
servicing income ..................... 318,873 138,221 79,533
Credit card fees, interchange
and other credit card income ......... 129,808 68,136 43,731
Fee-based services revenues ............... 175,091 109,123 64,532
--------- --------- ---------
623,772 315,480 187,796
--------- --------- ---------
Other Operating Expense:
Credit card account and other product
solicitation and marketing expenses .. 107,726 43,471 31,622
Employee compensation ..................... 122,417 62,627 35,200
Data processing services and
communications ....................... 52,355 35,445 20,087
Third-party servicing expense ............. 13,615 11,074 12,711
Warranty and debt waiver underwriting
and claims servicing expense ......... 21,091 12,279 6,053
Credit card fraud losses .................. 7,384 4,436 3,240
Customer base intangible amortization ..... 31,752 10,051 2,467
Other ..................................... 81,644 47,777 27,787
--------- --------- ---------
437,984 227,160 139,167
--------- --------- ---------
Income Before Income Taxes and
Extraordinary Loss ................... 191,316 93,248 61,883
Income taxes .............................. 75,953 35,900 23,825
--------- --------- ---------
Income Before Extraordinary Loss .......... 115,363 57,348 38,058
Extraordinary loss from early
extinguishment of debt ............... 50,808 -- --
--------- --------- ---------
Net Income ................................ 64,555 57,348 38,058
Preferred stock dividends-Series B ........ 7,506 1,100 --
Convertible preferred stock
dividends-Series C.................... 17,080 -- --
Adjustment for the retirement of
Series B preferred stock.............. 101,615 -- --
--------- --------- ---------
Net (Loss) Income Applicable to
Common Stockholders .................... $ (61,646) $ 56,248 $ 38,058
========= ========= =========
</TABLE>
<PAGE>
Earnings per share:
Basic-(loss) income before
extraordinary loss .......... $ (0.28) $ 1.46 $ 0.99
Basic-extraordinary loss ........ (1.32) -- --
Basic-net (loss) income ......... (1.60) 1.46 0.99
Diluted-(loss) income before
extraordinary loss .......... (0.28) 1.41 0.94
Diluted-extraordinary loss ...... (1.32) -- --
Diluted-net (loss) income ....... (1.60) 1.41 0.94
Shares used to compute earnings
per share:
Basic ................................ 38,570 38,464 38,450
Diluted .............................. 38,570 39,937 40,476
See accompanying Notes to Consolidated Financial Statements.
<PAGE>
<TABLE>
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity
(Dollars in thousands)
Total
Preferred Common Paid-In Retained Stockholders'
Stock Stock Capital Earnings Equity
----- ----- ------- -------- ------
<S> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1996 ............... $ -- $ 192 $ 107,220 $ 31,306 $ 138,718
Net income ............................ -- -- -- 38,058 38,058
Common stock dividends and other - cash -- -- (161) (577) (738)
--------- --------- --------- --------- ---------
BALANCE, DECEMBER 31, 1997 ............... $ -- $ 192 $ 107,059 $ 68,787 $ 176,038
========= ========= ========= ========= =========
Net income ............................ -- -- -- 57,348 57,348
Issuance of preferred stock ........... 200,000 -- -- -- 200,000
Common stock dividends and other - cash -- -- -- (961) (961)
Preferred dividends in kind - Series B 1,100 -- -- (1,100) --
Issuance of common stock under employee
benefit plans ...................... -- 1 556 -- 557
--------- --------- --------- --------- ---------
BALANCE, DECEMBER 31, 1998 ............... $ 201,100 $ 193 $ 107,615 $ 124,074 $ 432,982
========= ========= ========= ========= =========
Net income .......................... -- -- -- 64,555 64,555
Retirement of preferred stock -
Series B ........................ (208,606) -- (101,615) -- (310,221)
Issuance of preferred stock -
Series C ........................ 312,910 -- 122,369 -- 435,279
Cash dividends ...................... -- -- -- (1,390) (1,390)
June 1999 two-for-one stock split ... -- 193 (193) -- --
Preferred dividends in kind -
Series B ........................ 7,506 -- -- (7,506) --
Preferred dividends in kind -
Series C ........................ 16,819 -- -- (16,819) --
Issuance of common stock under
employee benefit plans .......... -- -- 2,596 -- 2,596
--------- --------- --------- --------- ---------
BALANCE, DECEMBER 31, 1999 ............... $ 329,729 $ 386 $ 130,772 $ 162,914 $ 623,801
========= ========= ========= ========= =========
See accompanying Notes to Consolidated Financial Statements.
</TABLE>
<PAGE>
<TABLE>
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Dollars in thousands)
Year Ended December 31,
-----------------------
1999 1998 1997
---- ---- ----
Operating Activities:
<S> <C> <C> <C>
Net income ...................................................... $ 64,555 $ 57,348 $ 38,058
Adjustments to reconcile net income to net cash provided by
operating activities:
Extraordinary loss from early extinguishment of debt.......... 50,808 -- --
Depreciation and amortization ................................ 75,341 48,678 15,942
Change in allowance for loan losses .......................... 225,745 149,199 148,415
Changes in operating assets and liabilities:
Accrued interest and fees receivable ...................... (11,695) (1,699) (1,368)
Prepaid expenses and deferred charges ..................... (46,448) (61,163) (23,150)
Deferred income taxes ..................................... (32,592) (72,234) (49,259)
Other receivables due from credit card securitizations, net (61,144) (112,170) (31,911)
Accounts payable and accrued expenses ..................... 65,337 (14,553) 28,246
Current income taxes payable .............................. (8,814) 22,082 8,241
Deferred income ........................................... 46,774 75,688 26,021
Other ..................................................... (39,983) (26,264) (16,022)
----------- ----------- -----------
Net cash provided by operating activities ....................... 327,884 64,912 143,213
----------- ----------- -----------
Investing Activities:
Proceeds from repayments of securitized loans................... 960,170 1,491,832 1,665,700
Net loans originated or collected ............................... (843,274) (901,740) (1,231,223)
Credit card portfolio acquisitions .............................. (1,156,673) (921,558) (738,104)
Additions to premises and equipment ............................. (41,724) (10,814) (11,705)
----------- ----------- -----------
Net cash used in investing activities ........................... (1,081,501) (342,280) (315,332)
----------- ----------- -----------
Financing Activities:
Net (decrease)/increase in short-term borrowings................. (10,000) (34,000) 88,837
Proceeds from the issuance of long-term debt..................... 144,116 100,896 100,000
Net increase in deposits ........................................ 775,381 -- --
Cash dividends paid ............................................. (1,390) (961) (577)
(Decrease)/Increase in preferred equity ......................... (124) 200,000 --
Increase in common equity ....................................... 2,720 557 --
----------- ----------- -----------
Net cash provided by financing activities ....................... 910,703 266,492 188,260
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents............. 157,086 (10,876) 16,141
Cash and cash equivalents at beginning of year................... 37,347 48,223 32,082
----------- ----------- -----------
Cash and cash equivalents at end of year ........................ $ 194,433 $ 37,347 $ 48,223
=========== =========== ===========
See accompanying Notes to Consolidated Financial Statements.
</TABLE>
<PAGE>
METRIS COMPANIES INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except as noted)
NOTE 1 - ORGANIZATION AND BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Metris
Companies Inc. ("MCI") and its subsidiaries (collectively, the "Company")
including Direct Merchants Credit Card Bank, N.A. ("Direct Merchants Bank")
which may be referred to as "we," "us" and "our." The Company is an
information-based direct marketer of consumer credit products and fee-based
services primarily to moderate-income consumers.
Prior to September 25, 1998, Fingerhut Companies, Inc. owned 83% of the
Company. On September 25, 1998, Fingerhut distributed its remaining shares of
the Company to Fingerhut shareholders in a tax-free distribution (the "spin
off").
All significant intercompany balances and transactions have been eliminated
in consolidation. Certain prior year amounts have been reclassified to conform
with the current year's presentation.
Pervasiveness of Estimates
We have prepared the consolidated financial statements in accordance with
generally accepted accounting principles, which require us to make estimates and
assumptions that affect the reported amount of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the consolidated
financial statements as well as the reported amount of revenues and expenses
during the reporting periods. Actual results could differ from these estimates.
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of the significant accounting and reporting
policies used in preparing the consolidated financial statements.
Federal Funds Sold and Short-term Investments
Federal funds sold are short-term loans made to banks through the Federal
Reserve System. It is the Company's policy to make such loans only to banks that
are considered to be in compliance with their regulatory capital requirements.
Short-term investments are investments in commercial paper, money market mutual
funds and certificates of deposits with maturities less than three months.
Loans Held for Securitization and Credit Card Loans
Loans held for securitization are credit card loans we intend to
securitize, generally no later than three months from origination and are
recorded at the lower of aggregate cost or market value. Credit card loans are
receivables from consumers that we do not intend to securitize.
<PAGE>
Securitization, Retained Interests in Loans Securitized and
Securitization Income
We securitize and sell a significant portion of our credit card loans to
both public and private investors through the Metris Master Trust and
third-party bank-sponsored, multi-seller receivables conduits. We retain
participating interests in the credit card loans under "Retained interests in
loans securitized" on the consolidated balance sheets. Our retained interests in
loans securitized are subordinate to the interests of investors in the trust and
conduit portfolios. Although we continue to service the securitized credit card
accounts and maintain the customer relationships, these transactions are treated
as sales for financial reporting purposes and the associated loans are not
reflected on the consolidated balance sheets.
The sales of these loans have been recorded in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities." Upon sale,
the sold credit card loans are removed from the balance sheet and the related
financial and servicing assets controlled and liabilities incurred are initially
measured at fair value, if practicable. SFAS 125 also requires that servicing
assets and other retained interests in the transferred assets be measured by
allocating the previous carrying amount between the assets sold, if any, and
retained interests, if any, based on their relative fair values at the date of
the transfer.
The securitization and sale of credit card loans changes our interest in
such loans from lender to servicer, with a corresponding change in how revenue
is reported in the statements of income. For securitized and sold credit card
loans, amounts that otherwise would have been recorded as interest income,
interest expense, fee income and provision for loan losses are instead reported
in other operating income as "Net securitization and credit card servicing
income." We have various receivables from the trust or conduits and other assets
as a result of securitizations, including: amounts deposited in accounts held by
the trust for the benefit of the trust's security holders; amounts due from
interest rate caps, swaps and floors; accrued interest and fees on the
securitized receivables; servicing fee receivables and various other
receivables. These amounts are reported as "Other receivables due from credit
card securitizations, net" on the consolidated balance sheets. The provision for
loan losses reflected on the statements of income in "Net securitization and
credit card servicing income" was $567.7 million, $456.4 million and $275.3
million for the years ended December 31, 1999, 1998 and 1997, respectively.
Allowance for Loan Losses
Provisions for loan losses are made in amounts necessary to maintain the
allowance at a level estimated to be sufficient to absorb probable future losses
of principal and earned interest, net of recoveries, inherent in the existing
managed loan portfolio, effectively reducing our retained interests in loans
securitized to fair value. In evaluating the adequacy of the allowance for loan
losses, we consider several factors, including: historical charge-off and
recovery activity by age (vintage) of each loan portfolio (noting any particular
trends over recent periods); recent delinquency and collection trends by
vintage; current economic conditions and the impact such conditions might have
on borrowers' ability to repay; the risk characteristics of the portfolios; and
other factors. Significant changes in these factors could affect the adequacy of
the allowance for loan losses in the near term. Credit card accounts are
generally charged off at the end of the month during which the loan becomes
contractually 180 days past due, with the exception of bankrupt accounts, which
are charged off immediately upon formal notification of bankruptcy, and accounts
of deceased cardholders without a surviving, contractually liable individual, or
an estate large enough to pay the debt in full, which are also charged off
immediately upon notification.
Property and Equipment
Property and equipment, and computer hardware and software are stated at
cost and depreciated on a straight-line basis over their estimated economic
useful lives. We capitalize software developed for internal use that represents
major enhancements or replacements of operating and management information
systems. Amortization of such capitalized software begins when the systems are
fully developed and ready for implementation. Repairs and maintenance are
charged to expense as incurred.
Customer Base Intangible
The customer base intangible represents the excess of amounts paid for
portfolio acquisitions over the related credit card loan balances net of
reserves and discounts. The intangible assets are amortized over the estimated
periods of benefit, generally five to seven years, in proportion to the expected
benefits to be recognized. The amounts amortized for 1999, 1998 and 1997 were
$31.8 million, $10.1 million and $2.5 million, respectively.
Interest Income on Credit Card Loans
Interest income on credit card loans is accrued and earned based on the
principal amount of the loans outstanding using the effective-yield method.
Accrued interest which has been billed to the customer but not yet received is
classified on the balance sheet with the related credit card loans. Accrued
interest which has not yet been billed to the customer is estimated and
classified on the balance sheet separate from the loan balance. Interest income
is generally recognized until a loan is charged off. At that time, the accrued
interest portion of the charged-off balance is deducted from current period
interest income.
Fee-Based Services
Debt Waiver Products
Direct Merchants Bank offers various debt waiver products to its credit
card customers for which it retains the claims risk. Revenue for such products
is recognized ratably over the coverage period, generally one month, and
reserves are provided for pending claims based on Direct Merchants Bank's
historical experience with settlement of such claims. Revenues recorded for debt
waiver products are included in the consolidated statements of income under
"Fee-based services revenues" and were $106.0 million, $73.8 million and $47.6
million for the years ended December 31, 1999, 1998 and 1997, respectively.
Unearned revenues and reserves for pending claims are recorded in the
consolidated balance sheets in "Deferred income" and "Accrued expenses and other
liabilities" and combined amounted to $7.1 million and $4.8 million as of
December 31, 1999 and 1998, respectively.
Membership Programs
Membership fees for fee-based product sales are generally billed through
financial institutions, including Direct Merchants Bank, and other
cardholder-based institutions and are recorded as deferred membership income
upon acceptance of membership and pro-rated over the membership period beginning
after the contractual cancellation period is complete. Deferred fee-based
revenues totaled $127.5 million and $72.9 million at December 31, 1999 and 1998,
respectively.
In accordance with the provisions of Statement of Position 93-7, "Reporting
on Advertising Costs," qualifying membership acquisition costs are deferred and
charged to expense as membership fees are recognized. These costs, which relate
directly to membership solicitations (direct response advertising costs),
principally include: postage, printing, mailings and telemarketing costs. Such
costs are amortized on a straight-line basis as revenues are realized over the
membership period. Amortization of membership acquisition costs amounted to $9.9
million, $8.9 million and $2.3 million for the years ended December 31, 1999,
1998 and 1997, respectively. If deferred membership acquisition costs were to
exceed the membership fee, an appropriate adjustment would be made for
impairment. Deferred fee-based membership acquisition costs amounted to $30.6
million and $22.4 million as of December 31, 1999 and 1998, respectively.
During the quarter ended September 30, 1998, we changed our method of
recognizing revenue for certain fee-based services for which a cancellation
period with a full refund exists. This change was made to be consistent with
revenue recognition policy changes made by others in our industry. Previously,
we had recognized a portion of the revenue, net of estimated cancellations,
associated with such services during the refund period. We now defer the
recognition of revenue until the expiration of the cancellation period, at which
time revenue relating to the full refund period is recognized. The remaining
revenue is recognized over the remaining term of the membership. We continue to
defer qualifying direct-response advertising costs and amortize these expenses
in proportion to revenue recognized. This change resulted in a cumulative
one-time reduction in revenues of approximately $3.0 million and a corresponding
reduction in expenses of approximately $3.1 million, or a $68,000 increase in
net income. This cumulative impact is reflected in the consolidated statement of
income for the year ended December 31, 1998.
Extended Service Plans
We coordinate the marketing activities for Fingerhut's sales of extended
service plans. We perform administrative services and retain the claims risk for
all extended service plans sold. As a result, extended service plan revenues and
the incremental direct acquisition costs are deferred and recognized on a
straight-line basis over the life of the related extended service plan contracts
beginning after the expiration of any manufacturers' warranty coverage. The
provision for service contract returns charged against deferred income for the
years ended December 31, 1999, 1998 and 1997, amounted to $5.0 million, $4.8
million and $4.6 million, respectively. Additionally, prior to 1999, we
reimbursed Fingerhut for the cost of its marketing media and other services
utilized in the sales of extended service plans, based on contracts sold and on
media utilization costs as agreed to by us and Fingerhut. Beginning in 1999,
Fingerhut was responsible for paying a majority of the marketing expense and
therefore retained a larger portion of the related revenue.
Credit Card Fees and Origination Costs
Credit card fees include annual membership, late payment, overlimit,
returned check, cash advance transaction fees and other miscellaneous fees.
These fees are assessed according to the terms of the related cardholder
agreements.
We defer direct credit card origination costs associated with successful
credit card solicitations that we incur in transactions with independent third
parties, and certain other costs that we incur in connection with loan
underwriting and the preparation and processing of loan documents. These
deferred credit card origination costs are netted against the related credit
card annual fee, if any, and amortized on a straight-line basis over the
cardholder's privilege period, generally 12 months. Net deferred fees were $11.8
million and $9.6 million as of December 31, 1999 and 1998, respectively.
Solicitation Expenses
Credit card account costs, including printing, credit bureaus, list
processing costs, telemarketing and postage, are generally expensed as incurred
over the two to three month period during which the related responses to such
solicitation are received.
Credit Card Fraud Losses
We experience credit card fraud losses from the unauthorized use of credit
cards. These fraudulent transactions are expensed when identified, through the
establishment of a reserve for the transactions. These amounts are charged off
after 90 days, after all attempts to recover the amounts from such transactions,
including chargebacks to merchants and claims against cardholders, are
exhausted.
Interest Rate Risk Management Contracts
The nature and composition of our assets and liabilities and securitized
loans expose us to interest rate risk. We enter into a variety of interest rate
risk management contracts such as interest rate swap, floor and cap agreements
with highly rated counterparties in order to hedge our interest rate exposure.
The monthly interest rate differential to be paid or received on these contracts
is accrued and included in "Net securitization and credit card servicing income"
on the consolidated statements of income. Premiums paid for such contracts and
the related interest payable or receivable under such contracts are classified
under "Other receivables due from credit card securitization, net," on the
consolidated balance sheets. Premiums paid for interest rate contracts are
recorded at cost and amortized on a straight-line basis over the life of the
contract.
Debt Issuance Costs
Debt issuance costs are the costs related to issuing new debt securities
and establishing new securitizations under the trust or conduits. The costs are
capitalized as incurred and amortized to expense over the term of the new debt
security.
Income Taxes
We determine deferred taxes based on the temporary differences between the
financial statement and the tax bases of assets and liabilities that will result
in future taxable or deductible amounts. The deferred taxes are based on the
enacted rate that is expected to apply when the temporary differences reverse.
For periods prior to the spin off, we were included in the consolidated federal
and certain state income tax returns of Fingerhut Companies, Inc. Based on a tax
sharing agreement between us and Fingerhut Companies, Inc., the provision and
deferred income taxes are computed based only on our financial results as if we
filed our own federal and state tax returns.
Statements of Cash Flows
We prepare our consolidated statements of cash flows using the indirect
method, which requires a reconciliation of net income to net cash from operating
activities. In addition, we net certain cash receipts and cash payments from
credit card loans made to customers, including principal collections on those
loans. For purposes of the consolidated statements of cash flows, cash and cash
equivalents include cash and due from banks, federal funds sold, short-term
investments (mainly commercial paper and money market funds), and all other
highly liquid investments with original maturities of three months or less.
Cash paid for interest during the years ended December 31, 1999, 1998 and
1997, was $29.5 million, $28.4 million and $9.4 million, respectively. Cash paid
for income taxes for the same periods was $117.0 million, $86.1 million and
$64.8 million, respectively.
The statement of cash flows for the year ended December 31, 1999, reflects
the non-cash adjustments related to the conversion of the Series B Perpetual
Preferred Stock and 12% Senior Notes and the cancellation of warrants (see Note
6). The conversion to Series C Perpetual Convertible Preferred Stock resulted in
non-cash reductions in debt and accrued interest of $100 million and $4.3
million, respectively, offset by an increase of $104.3 million in equity.
Earnings Per Share
Basic earnings per share ("EPS") excludes dilution and is computed by
dividing net income applicable to common stockholders by the weighted average
number of common shares outstanding for the period. Diluted EPS reflects the
potential dilution that could occur if securities or other contracts to issue
<PAGE>
common stock were exercised or converted into common stock. The following table
presents the computation of basic and diluted weighted average shares used in
the per-share calculations:
Year Ended December 31,
-----------------------
1999 1998 1997
---- ---- ----
(In thousands, except per-share amounts)
Income before extraordinary loss ........ $ 115,363 $ 57,348 $ 38,058
Preferred dividends - Series B .......... 7,506 1,100 --
Preferred dividends - Series C .......... 17,080 -- --
Adjustment for the retirement of Series B
preferred stock .................... 101,615 -- --
--------- --------- ---------
Net (loss) income applicable to common
stockholders before extraordinary
items .............................. (10,838) 56,248 38,058
Extraordinary loss from the early
extinguishment of debt ............. 50,808 -- --
--------- --------- ---------
Net (loss) income applicable to common
stockholders ....................... $ (61,646) $ 56,248 $ 38,058
========= ========= =========
Weighted average common shares
outstanding ........................ 38,570 38,464 38,450
Adjustments for dilutive securities:
Assumed exercise of outstanding stock
options(1) ........................... -- 1,473 2,026
--------- --------- ---------
Diluted common shares ................... 38,570 39,937 40,476
========= ========= =========
Earnings per share:
Basic-(loss) income before
extraordinary loss ............. $ (0.28) $ 1.46 $ 0.99
Basic-extraordinary loss ........... (1.32) -- --
Basic-net (loss) income ............ (1.60) 1.46 0.99
Diluted-(loss) income before
extraordinary loss ............. (0.28) 1.41 0.94
Diluted-extraordinary loss ......... (1.32) -- --
Diluted-net (loss) income .......... (1.60) 1.41 0.94
(1) For the year ended December 31, 1999, there were options and convertible
preferred stock outstanding to purchase 2.1 million and 10.2 million common
shares. These potential common shares have been excluded from the computation of
diluted earnings per share because their inclusion would have been
anti-dilutive.
Comprehensive Income
During 1998, we adopted SFAS 130, "Reporting Comprehensive Income." This
statement does not apply to our current financial results and therefore, net
income equals comprehensive income.
NOTE 3 - ALLOWANCE FOR LOAN LOSSES
We maintain an allowance for loan losses for both owned loans and the
retained interests in loans securitized. The portion allocated to the retained
interest in loans securitized represents our estimated valuation adjustment to
report this asset in accordance with SFAS 125. For securitized loans,
anticipated losses and related provisions for loan losses are reflected in the
calculations of net securitization and credit card servicing income. We make
provisions for loan losses in amounts necessary to maintain the allowance at a
level estimated to be sufficient to absorb probable future losses of principal
and earned interest, net of recoveries, inherent in the existing loan portfolio.
The activity in the allowance for loan losses is as follows:
Year Ended December 31,
-----------------------
1999 1998 1997
---- ---- ----
Balance at beginning of year ............ $ 393,283 $ 244,084 $ 95,669
Allowance related to assets acquired, net 26,293 20,152 20,246
Provision for loan losses ............... 174,800 77,770 43,989
Provision for loan losses (1) ........... 567,737 456,354 275,310
Loans charged off ....................... (582,637) (420,875) (195,535)
Recoveries .............................. 39,552 15,798 4,405
--------- --------- ---------
Net loans charged off ................... (543,085) (405,077) (191,130)
--------- --------- ---------
Balance at end of year .................. $ 619,028 $ 393,283 $ 244,084
========= ========= =========
(1) Amounts are included in "Net securitizations and credit card servicing
income."
NOTE 4 - PROPERTY AND EQUIPMENT
The carrying value of property and equipment is as follows:
December 31,
------------
1999 1998
---- ----
Furniture and equipment ....................... $12,186 $10,974
Computer software and equipment ............... 24,675 9,077
Construction in progress ...................... 24,500 2,013
Leasehold improvements ........................ 8,631 6,204
------- -------
Total ......................................... $69,992 $28,268
Less: Accumulated depreciation and amortization 13,078 6,286
------- -------
Balance at end of year ........................ $56,914 $21,982
======= =======
Depreciation and amortization expense for the years ended December 31,
1999, 1998 and 1997, was $6.8 million, $4.4 million and $1.4 million,
respectively.
NOTE 5 - PORTFOLIO ACQUISITIONS
On June 30, 1999, Direct Merchants Bank purchased a portion of the consumer
bank card portfolio of GE Capital Consumer Card Co., a unit of General Electric
Company. The acquired credit card portfolio had approximately 485,000 active
accounts, which were converted to the Direct Merchants Bank platform in October
1999, and approximately $1.2 billion in receivables. In December 1998, the
Company acquired an $800 million credit card portfolio from PNC Bank Corp.
representing loans from customers outside of PNC's normal banking relationship.
In October 1997, the Company acquired a $405 million credit card portfolio from
Mercantile Bank National Association. In September 1997, the Company acquired a
$317 million credit card portfolio from Key Bank USA, National Association.
NOTE 6 - PRIVATE EQUITY PLACEMENT
On November 13, 1998, we entered into agreements with affiliates of the
Thomas H. Lee Company, a private equity firm, to make a total private equity
investment of $300 million in the Company. The Lee Company agreed to purchase
0.8 million shares of Series C Perpetual Convertible Preferred Stock, which are
convertible into common shares at a conversion price of $18.63 per common share
subject to adjustment in certain circumstances. The Series C Preferred has a 9%
dividend payable in additional shares of Series C Preferred and will also
receive any dividends paid on our common stock on an as converted basis. The
cumulative payment-in-kind dividends are effectively guaranteed for a seven-year
period. Assuming conversion of the Series C Preferred into common stock, the Lee
Company would own over 30% of the Company on a diluted basis at December 31,
1999. The Series C Preferred entitles the holders to elect four members to our
Board of Directors. The Series C Preferred may be redeemed by us in certain
circumstances after December 31, 2001 by paying 103% of the redemption price of
$372.50 and any accrued dividends at the time of redemption. We also have the
option to redeem the Series C Preferred after December 9, 2008, without
restriction by paying the redemption price of $372.50 and any accrued dividends
at the time of redemption. The conversion to the Series C Preferred would have
resulted in a "change in control" in certain of our agreements with Fingerhut
and our credit facilities. Therefore, prior to closing the transaction, we
increased the change in control ownership percentage from 30 to 35 or otherwise
exempted the Lee Company from the change in control provision in its agreements.
Prior to shareholder approval and the receipt of notice that there was no
regulatory objection to the Series C Preferred investment, the Lee Company
agreed to purchase $200 million in Series B Perpetual Preferred Stock and $100
million in 12% Senior Notes due 2006. We also issued the Lee Company 7.5 million
ten-year warrants to purchase shares of our common stock.
On March 12, 1999, shareholders approved the conversion of the Series B
Preferred and 12% Senior Notes into Series C Preferred. Notice was received on
May 28, 1999, that there was no regulatory objection to the conversion to the
Series C Preferred. On June 1, 1999, the Series B Preferred and the 12% Senior
Notes were extinguished, and the warrants were canceled causing a one-time,
non-cash, accounting adjustment. The excess of the fair value of the Series C
Preferred over the carrying value of the Series B Preferred and the 12% Senior
Notes at the time of the conversion was allocated to the 12% Senior Notes and
the Series B Preferred based upon their initial fair values. To arrive at net
income applicable to common stockholders in the calculation of earnings per
share, the amount allocated to the 12% Senior Notes was recognized as an
extraordinary loss from the early extinguishment of debt in the amount of $50.8
million and the amount allocated to the Series B Preferred was recognized as a
reduction of net income applicable to common stockholders in the amount of
$101.6 million. The extraordinary loss attributable to the 12% Senior Notes is
not recorded net of taxes. These adjustments did not have an impact on total
stockholders' equity.
NOTE 7 - STOCK OPTIONS
We offer the Metris Companies Inc. Long-Term Incentive and Stock Option
Plan, which permits a variety of stock-based grants and awards and gives us
flexibility in tailoring our long-term compensation programs. Originally, this
stock option plan permitted up to 3.7 million shares of common stock for awards
of options, subject to certain adjustments in certain circumstances. In 1998,
the Board of Directors amended the plan to provide 8.0 million shares of common
stock for awards of stock options or other stock-based awards, subject to
adjustment in certain circumstances. As of December 31, 1999 and 1998, 1.5
million and 3.0 million shares, respectively, were available for grant. There
were 0.6 million shares available for grant at December 31, 1997, prior to the
amendment which increased the total number of shares available for awards under
the plan to 8.0 million.
The Compensation Committee has the authority to determine the exercise
prices, vesting dates or conditions, expiration dates and other material
conditions upon which options or awards may be exercised, except that the option
price for Incentive Stock Options ("ISOs") may not be less than 100% of the fair
market value of the common stock on the date of grant (and not less than 110% of
the fair market value in the case of an ISO granted to any employee owning more
than 10% of the common stock) and the terms of nonqualified stock options may
not exceed 15 years from the date of grant (not more than 10 years for ISOs and
five years for ISOs granted to any employee owning more than 10% of the common
stock). Full- or part-time employees, consultants or independent contractors are
eligible to receive nonqualified options and awards. Only full- or part-time
employees are eligible to receive ISOs.
During 1999, 1998 and 1997, we granted 1.8 million, 2.1 million and 0.6
million options, respectively, to officers and employees. Restricted stock
grants are also issued under the stock option plan to our executive officers. A
total of 0.2 million common shares were granted in 1999, with an approximate
aggregate market value of $4.0 million at the time of the grant. The market
value of these restricted shares at the date of grant is amortized into expense
over a period not less than the restriction period. We recognized $0.6 million
in 1999 for these restricted shares. If the restrictions have been removed,
generally upon death, disability or retirement, the remaining unamortized market
value of the restricted shares is expensed.
We also offer the Metris Companies Inc. Non-Employee Director Stock Option
Plan. Originally, such plan permitted up to 40,000 shares of common stock for
awards of options, subject to certain adjustments in certain circumstances. In
1997, the Board of Directors amended the plan to provide up to 200,000 shares of
common stock for awards of options, subject to adjustments in certain
circumstances. This Director Plan was approved by our stockholders at the 1998
annual meeting. In 1999, the Board of Directors amended the plan to provide up
to 500,000 shares of common stock for awards of options, subject to adjustments
in certain circumstances. During 1999, 1998 and 1997, we granted 85,000, 50,000
and 40,000 options, respectively. At December 31, 1999, 1998 and 1997, 305,000,
90,000 and 140,000 shares, respectively, were available for grant.
We have adopted the disclosure-only provisions of SFAS No. 123 "Accounting
for Stock-Based Compensation." Accordingly, we continue to account for
stock-based compensation under the provisions of Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees." Under the guidelines
of Opinion 25, compensation cost for stock-based employee compensation plans is
recognized based on the difference, if any, between the quoted market price of
the stock on the date of grant and the amount an employee must pay to acquire
the stock. Had compensation cost for these plans been determined based on the
fair value methodology prescribed by SFAS 123, our net earnings and earnings per
share would have been reduced to the pro forma amounts indicated below:
Year Ended December 31,
-----------------------
1999 1998 1997
---- ---- ----
Net income as reported ...................... $ 4,555 $ 57,348 $ 38,058
Net income pro forma ........................ 59,733 47,264 36,819
Diluted (loss)/earnings per share as reported (1.60) 1.41 0.94
Diluted (loss)/earnings per share pro forma . (1.72) 1.18 0.91
The above pro forma amounts may not be representative of the effects on
reported net earnings for future years. The fair value of each option grant is
estimated on the date of grant using the Black-Scholes option-pricing model. The
following weighted-average assumptions were used for grants in 1999, 1998 and
1997, respectively: dividend yield of 0.10%, 0.10% and 0.11%; expected
volatility of 55.4%, 71.3% and 68.2%; risk-free interest rate of 5.30%, 4.72%
and 6.34%; and expected lives of six years, seven years and seven years,
respectively.
<PAGE>
Information regarding our stock option plans for 1999, 1998 and 1997, is as
follows:
<TABLE>
Year Ended December 31,
-----------------------
1999 1998 1997
---- ---- ----
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Options outstanding, beginning of
year .......................... 5,241,400 $12.84 3,364,400 $ 7.52 2,817,400 $ 4.47
Options exercised ................ 74,500 9.60 69,500 8.00 -- --
Options granted .................. 1,907,276 20.20 2,161,000 21.78 677,000 20.29
Options canceled/forfeited....... 321,100 20.68 214,500 20.88 130,000 8.00
--------- ------ --------- ------ --------- ------
Options outstanding,
end of year ................... 6,753,076 $14.58 5,241,400 $12.84 3,364,400 $ 7.52
========= ========= =========
Weighted-average fair value of
options granted during the year $ 9.80 $16.16 $14.15
</TABLE>
The following table summarizes information about stock options outstanding
at December 31, 1999:
<TABLE>
Options Outstanding Options Exercisable
------------------- -------------------
Weighted-
Average Weighted- Weighted-
Number Remaining Average Number Average
Outstanding Contractual Exercise Exercisable Exercise
at 12/31/99 Life Price at 12/31/99 Price
----------- ---- ----- ----------- -----
Exercise Price
<S> <C> <C> <C> <C> <C>
$ 1.38 .............. 1,704,400 5.1 $ 1.22 1,504,400 $ 1.38
$ 8.00-$18.25 .............. 1,905,000 7.8 11.34 1,705,000 10.95
$18.26-$27.75 .............. 2,108,176 8.8 21.03 382,000 21.00
$27.76-$34.69 .............. 1,035,500 8.6 29.41 766,000 29.25
--------- --- ------ --------- ------
6,753,076 7.5 $14.58 4,357,400 $11.74
========= =========
</TABLE>
Employee Stock Purchase Plan
During the third quarter of 1999, we adopted an employee stock purchase
plan (ESPP), whereby eligible employees may authorize payroll deductions of up
to 15% of their salary to purchase shares of our common stock. Under the plan,
shares of our common stock may be purchased at the end of each monthly offering
period at 85% of the lower of the fair market value on the first or last day of
the monthly offering period. Employees contributed $0.7 million to purchase
26,681 shares of common stock under the ESPP for 1999. We are authorized to
issue up to 1.7 million shares of common stock to employees under the plan, and
as of December 31, 1999 there were approximately 1.7 million shares available
for future issuance.
Management Stock Purchase Plan
During the third quarter of 1999, effective January 1, 2000, we adopted a
management stock purchase plan (MSPP), whereby any employee who is a Senior Vice
President or higher and who participates in the Metris Management Incentive
Bonus Plan is eligible to participate in the MSPP. Participants may elect to
defer up to 50% of their bonus received under the Management Bonus Plan, which
is credited to a stock purchase account as restricted stock units. We will make
a match of $1 for every $3 contributed by the participant. The participant's
contributions are vested immediately and our matching contributions vest after
three years (two years for contributions made for the year of adoption). We are
authorized to issue up to 300,000 shares of common stock to employees under the
plan, and as of December 31, 1999, 100% of the authorized shares were available
for future issuance.
Supplemental Executive Retirement Plan
Our funded Supplemental Executive Retirement Plan ("SERP"), established
in 1999, provides officers and other members of senior management with
supplemental retirement benefits in excess of limits imposed on qualified plans
by federal tax law. The SERP is an account balance plan to which we will make
annual contributions targeted to provide 60% of the average of the participant's
final five years of salary and bonus with us. These benefits will be paid in 15
annual installments beginning the year after they become eligible to receive
benefits. Participants are eligible to receive benefits upon leaving our
employment if they are at least 65 years of age or at least age 55 with five
years of plan participation, if a change of control occurs or in the event of
death. We recognized $2.2 million dollars of expense in 1999 related to the SERP
plan. This expense was calculated based on actuarial assumptions regarding years
of participation, future investment returns and participants continuing in the
plan until age 65.
NOTE 8 - EMPLOYEE BENEFIT PLANS
We offer a defined contribution plan that is intended to qualify under
section 401(k) of the Internal Revenue Code. The 401(k) Plan provides retirement
benefits for eligible employees. Eligible employees may elect to contribute to
the 401(k) Plan, and we match a portion of employee contributions and make
discretionary contributions based upon our financial performance. For the years
ended December 31, 1999, 1998 and 1997, we contributed $1.8 million, $0.9
million and $0.9 million to the 401(k), respectively.
<PAGE>
NOTE 9 - INCOME TAXES
The components of the provision for income taxes consisted of the
following:
Year Ended December 31,
-----------------------
1999 1998 1997
---- ---- ----
Current:
Federal .......... $ 94,309 $ 98,428 $ 66,496
State ............ 14,236 8,355 4,663
Deferred ............ (32,592) (70,883) (47,334)
-------- -------- --------
$ 75,953 $ 35,900 $ 23,825
======== ======== ========
A reconciliation of our effective income tax rate compared to the statutory
federal income tax rate is as follows:
Year Ended December 31,
-----------------------
1999 1998 1997
---- ---- ----
Statutory federal income tax rate ............... 35.0% 35.0% 35.0%
State income taxes, net of federal benefit ...... 3.2% 3.2% 3.2%
Other, net ...................................... 1.5% 0.3% 0.3%
---- ---- ----
Effective income tax rate ....................... 39.7% 38.5% 38.5%
---- ---- ----
Our deferred tax assets and liabilities are as follows:
December 31,
------------
1999 1998
---- ----
Deferred income tax assets resulting from
future deductible temporary differences:
Allowance for loan losses ............................ $196,840 $119,518
Deferred revenues .................................... 48,200 32,334
Other ................................................ 19,378 18,199
-------- --------
Total deferred tax assets ............................... $264,418 $170,051
Deferred income tax liabilities resulting from
future taxable temporary differences:
Accrued interest on credit card loans ................ $ 65,260 $ 5,048
Deferred costs ....................................... 11,464 10,672
Other ................................................ 2,081 1,310
-------- --------
Total deferred tax liabilities .......................... $ 78,805 $ 17,030
-------- --------
Net deferred tax assets ................................. $185,613 $153,021
======== ========
We believe, based on our history of operating earnings, expectations for
operating earnings in the future, and the expected reversal of taxable temporary
differences, earnings will be sufficient to fully utilize the deferred tax
assets.
NOTE 10 - RELATED PARTY TRANSACTIONS
Prior to September 1998, Fingerhut owned approximately 83% of our
outstanding common shares. In September 1998, Fingerhut distributed the
remaining shares of the Company to shareholders of Fingerhut in a tax-free
distribution.
Information related to transactions with Fingerhut have not been presented
for the year ended December 31, 1999; as Fingerhut is no longer considered a
related party after distributing their remaining shares. Prior to the
distribution of the shares, Fingerhut and its various subsidiaries had
historically provided financial and operational support to us. We believe the
fees paid for the operational support reasonably approximate market rates for
the services performed. The direct and allocated expenses represent charges for
various administrative services. We have also entered into several other
agreements with Fingerhut that detail further business arrangements between the
companies. Each of these agreements was negotiated and we believe they
reasonably approximate contracts between unrelated third parties.
The following table summarizes the amounts of revenues, direct expense
charges, cost allocations (including net interest income or expense), and our
costs of the agreements mentioned above for each of the years reflected in our
financial statements.
Year Ended December 31,
-----------------------
1998 1997
---- ----
Revenues:
Fee-based services ................................... $15,439 $ 9,030
Expenses:
Credit card account and other product solicitation and
marketing expenses ................................ 10,796 9,551
Data processing services and communications .......... 2,344 1,837
Other ................................................ 659 1,336
The Lee Company investment (see Note 6) would have resulted in a "change of
control" as defined in certain agreements between us and Fingerhut, which would
have permitted Fingerhut to terminate any or all of the agreements. On December
8, 1998, we obtained a waiver agreement from Fingerhut to waive their rights to
terminate the agreements if a change of control occurred as a result of the
conversion.
Pursuant to the waiver agreement, the Company and Fingerhut amended certain
of their other agreements. The most significant change was made in the database
access agreement. Our exclusive license to use Fingerhut's customer database to
market financial service products will now become non-exclusive after October
31, 2001.
In the ordinary course of business, our executive officers may have credit
card loans issued by us. Pursuant to our policy, such loans are issued on the
same terms as those prevailing at the time for comparable loans with unrelated
persons and do not involve more than the normal risk of collectibility.
NOTE 11 - COMMITMENTS AND CONTINGENCIES
Commitments to extend credit to consumers represent the unused credit
limits on open credit card accounts. These commitments amounted to $9.7 billion,
$5.9 billion and $4.1 billion as of December 31, 1999, 1998 and 1997,
respectively. While these amounts represent the total lines of credit available
to our customers, we have not experienced and do not anticipate all of our
customers will exercise their entire available line at any given point in time.
We also have the right to increase, reduce, cancel, alter or amend the terms of
these available lines of credit at any time.
We lease certain office facilities and equipment under various cancelable
and non-cancelable operating lease agreements that provide for the payment of a
proportionate share of property taxes, insurance and other maintenance expenses.
These leases also may include scheduled rent increases and renewal options.
Rental expense for these operating leases for the years ended December 31, 1999,
1998 and 1997, was $11.1 million, $6.4 million and $3.9 million, respectively.
Future minimum lease commitments at December 31, 1999, under cancelable and
non-cancelable operating leases are as follows:
2000 .............................................. $14,322
2001 .............................................. 13,870
2002 .............................................. 12,400
2003 .............................................. 10,306
2004 .............................................. 9,865
Thereafter ........................................ 20,353
-------
Total minimum lease payments .................. $81,116
=======
NOTE 12 - CAPITAL REQUIREMENTS AND RESTRICTED PAYMENTS
In the normal course of business, we enter into agreements, or are subject
to regulatory requirements, that result in cash, debt and dividend or other
capital restrictions.
The Federal Reserve Act imposes various legal limitations on the extent to
which banks can finance or otherwise supply funds to their affiliates. In
particular, Direct Merchants Bank is subject to certain restrictions on any
extensions of credit to or other covered transactions, such as certain purchases
of assets, with us and our affiliates. Such restrictions limit Direct Merchants
Bank's ability to lend to us and our affiliates. Additionally, Direct Merchants
Bank is limited in its ability to declare dividends to us in accordance with the
national bank dividend provisions.
Direct Merchants Bank is subject to certain capital adequacy guidelines
adopted by the OCC. At December 31, 1999 and 1998, Direct Merchants Bank's Tier
1 risk-based capital ratio, risk-based total capital ratio and Tier 1 leverage
ratio exceeded the minimum required capital levels, and Direct Merchants Bank
was considered a "well- capitalized" depository institution under regulations of
the OCC.
We are also bound by restrictions set forth in the indentures related to
the Senior Notes dated November 7, 1997, and July 15, 1999. Pursuant to those
indentures, we may not make dividend payments in the event of a default or if
all such restricted payments would exceed 25% of our aggregate cumulative net
income.
NOTE 13 - CONCENTRATIONS OF CREDIT RISK
A concentration of credit risk is defined as significant credit exposure
with an individual or group engaged in similar activities or affected similarly
by economic conditions. We are active in originating credit card loans
throughout the United States, and no individual or group had a significant
concentration of credit risk at December 31, 1999 or 1998. The following table
details the geographic distribution of our retained, sold and managed credit
card loans:
Retained Sold Managed
-------- ---- -------
December 31, 1999
California ........................ $ 224,359 $ 702,254 $ 926,613
Texas ............................. 158,760 496,927 655,687
New York .......................... 134,087 419,700 553,787
Florida ........................... 131,960 413,043 545,003
Ohio .............................. 73,313 229,473 302,786
Illinois .......................... 66,947 209,546 276,493
Pennsylvania ...................... 56,025 175,363 231,388
All others ........................ 917,558 2,872,007 3,789,565
---------- ---------- ----------
Total .......................... $1,763,009 $5,518,313 $7,281,322
========== ========== ==========
Retained Sold Managed
-------- ---- -------
December 31, 1998
California ........................ $ 94,521 $ 569,205 $ 663,726
Texas ............................. 76,542 460,937 537,479
Florida ........................... 57,138 344,084 401,222
New York .......................... 55,231 332,598 387,829
Ohio .............................. 31,936 192,320 224,256
Illinois .......................... 26,994 162,558 189,552
Pennsylvania ...................... 22,795 137,274 160,069
All others ........................ 391,742 2,359,167 2,750,909
---------- ---------- ----------
Total ....................... $ 756,899 $4,558,143 $5,315,042
========== ========== ==========
We target our consumer credit products primarily to moderate-income
consumers. Primary risks associated with lending to this market are that they
may be more sensitive to future economic downturn, which may make them more
likely to default on their obligations.
<PAGE>
NOTE 14 - FAIR VALUE OF FINANCIAL INSTRUMENTS
We have estimated the fair value of our financial instruments in accordance
with SFAS No. 107, "Disclosures About Fair Value of Financial Instruments."
Financial instruments include both assets and liabilities, whether or not
recognized in our consolidated balance sheets, for which it is practicable to
estimate fair value. Additionally, certain intangible assets recorded on the
consolidated balance sheets, such as purchased credit card relationships, and
other intangible assets not recorded on the consolidated balance sheets (such as
the value of the credit card relationships for originated loans and the
franchise values of our various lines of business) are not considered financial
instruments and, accordingly, are not valued for purposes of this disclosure. We
believe that there is substantial value associated with these assets based on
current market conditions, including the purchase and sale of such assets.
Accordingly, the aggregate estimated fair value amounts presented do not
represent the entire underlying value of the Company.
Quoted market prices generally are not available for all of our financial
instruments. Accordingly, in cases where quoted market prices are not available,
fair values were estimated using present value and other valuation techniques
that are significantly affected by the assumptions used, including the discount
rate and estimated future cash flows. These assumptions are based on historical
experience and assessments regarding the ultimate collectibility of assets and
related interest, and estimates of product lives and repricing characteristics
used in our asset/liability management process. These assumptions involve
uncertainties and matters of judgment, and therefore, cannot be determined with
precision. Thus, changes in these assumptions could significantly affect the
fair-value estimates.
A description of the methods and assumptions used to estimate the fair
value of each class of our financial instruments is as follows:
Cash and cash equivalents and accrued interest and fees receivable
The carrying amounts approximate fair value due to the short-term nature of
these instruments.
Net retained interests in loans securitized, loans held for securitizations and
credit card loans
Currently, credit card loans are originated with variable rates of interest
that adjust with changing market interest rates. Thus, carrying value less the
allowance for loan losses, approximates fair value. However, this valuation does
not include the value that relates to estimated cash flows generated from new
loans from existing customers over the life of the cardholder relationship.
Accordingly, the aggregate fair value of the credit card loans does not
represent the underlying value of the established cardholder relationships.
<PAGE>
Other receivables due from credit card securitizations, net
The following components of this net asset are as follows:
Interest-only strip
The fair value of the interest-only strip is estimated by discounting the
expected future cash flows from the trust and each of the conduits at rates
which we believe to be consistent with those that would be used by an
independent third party. However, because there is no active market for this,
the fair values presented may not be indicative of the value negotiated in an
actual sale. The future cash flows used to estimate fair value are limited to
the securitized receivables that exist at year end and does not reflect the
value associated with future receivables generated by cardholder activity. The
significant assumptions used to estimate fair value include: (i) discount rates;
(ii) customer payment rates; and (iii) anticipated charge-offs over the life of
the loans:
December 31,
------------
1999 1998
---- ----
Discount rate ......... 12% 10%
Payment rate .......... 7% 6%
Default rate .......... 17% 16%
Interest rate cap and floor agreements
The fair values of interest rate cap and floor agreements were obtained
from dealer quoted prices. These values generally represent the estimated
amounts we would receive or pay to terminate the agreements at the reporting
dates, taking into consideration current interest rates and the current
creditworthiness of the counterparties.
Other amounts
For the other components of other receivables due from credit card
securitizations, net, the carrying amount is a reasonable estimate of the fair
value.
Debt
Short-term borrowings are made with variable rates of interest that adjust
with changing market interest rates. Thus, carrying value approximates fair
value.
The fair value of long-term debt was obtained from quoted market prices,
when available.
Deposits
The fair value for fixed rate certificates of deposit are estimated based
on quoted market prices of comparable instruments.
<PAGE>
The estimated fair values of our financial instruments are summarized as
follows:
<TABLE>
December 31,
------------
1999 1998
---- ----
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
------ ---------- ------ ----------
<S> <C> <C> <C> <C>
Cash and cash equivalents ............ $ 194,433 $ 194,433 $ 37,347 $ 37,347
Retained interest in loans
securitized, net .................. 1,010,373 1,010,373 360,186 360,186
Credit card loans .................... 131,038 131,038 -- --
Loans held for securitization ........ 2,570 2,570 3,430 3,430
Other receivables due from credit card
securitizations, net:
Interest rate cap agreements ...... 27,113 34,526 2,912 2,925
Interest rate floor agreements .... 23 6 187 3,233
Interest-only strip ............... -- -- -- --
Other amounts ..................... 216,842 216,842 182,836 182,836
Debt ................................. 345,012 346,218 310,896 317,666
Deposits ............................. 775,381 775,381 -- --
</TABLE>
NOTE 15 - DERIVATIVE FINANCIAL INSTRUMENTS
We enter into interest rate floor, cap and swap agreements to hedge the
cash flow and earnings impact of fluctuating market interest rates on the spread
between the floating rate loans and the floating and fixed rate securities
issued to fund the loans. In connection with the issuance of term asset-backed
securities by the trust, we enter into term interest rate cap agreements with
highly rated bank counterparties to effectively cap the potentially negative
impact to us of increases in the floating interest rate of the securities. These
interest rate cap agreements are for original terms ranging from three to ten
years and will terminate between February 2002 and January 2010.
<PAGE>
<TABLE>
Notional Amounts of Interest Rate Swap,
Cap and Floor Agreements Purchased and Sold
-------------------------------------------
Weighted Weighted
Year Ended December 31, Average Average
(Dollars in thousands) Interest Interest
1999 Rate 1998 Rate
---- ---------- ---- ----------
Interest rate swap
agreements:
<S> <C> <C> <C> <C>
Beginning Balance ..... $ -- -- $1,328,000 6.5%
Additions ............. -- -- -- --
Maturities/Terminations -- -- 1,328,000 6.5%
---------- ----------
Ending Balance ........ $ -- -- $ -- --
========== ==========
Interest rate caps:
Beginning Balance ..... $2,393,021 8.7% $ -- --
Additions ............. 2,460,000 9.5% 3,393,021 8.8%
Maturities/Terminations 640,000 7.4% 1,000,000 9.3%
---------- ----------
Ending Balance ........ $4,213,021 9.4% $2,393,021 8.7%
========== ==========
Interest rate floor:
Beginning Balance ..... $ 467,367 6.2% $ -- --
Additions ............. -- -- 1,293,467 6.4%
Maturities/Terminations 409,034 6.2% 826,100 6.5%
---------- ----------
Ending Balance ........ $ 58,333 6.2% $ 467,367 6.2%
========== ==========
</TABLE>
Interest rate risk management contracts are generally expressed in notional
principal or contract amounts that are much larger than the amounts potentially
at risk for nonpayment by counterparties. Therefore, in the event of
nonperformance by the counterparties, our credit exposure is limited to the
uncollected interest and contract market value related to the contracts that
have become favorable to us. We manage the credit risk of such contracts through
established risk limits and monitoring of the credit ratings of our
counterparties. We currently have no reason to anticipate nonperformance by any
counterparty.
NOTE 16 - SEGMENTS
We operate in two principal areas: consumer credit products and fee-based
services. Our primary consumer credit products are unsecured and secured credit
cards, including the Direct Merchants Bank MasterCard(R) and Visa(R). Our credit
card accounts include customers obtained from third-party lists and other
customers for whom general credit bureau information is available.
We market our fee-based services, including (i) debt waiver protection for
unemployment, disability and death, (ii) membership programs such as card
registration, purchase protection and other club memberships, and (iii)
third-party insurance, directly to our credit card customers and customers of
third parties. We currently administer our extended service plans sold through a
third-party retailer, and the customer pays the retailer directly. In addition,
we develop customized targeted mailing lists from information contained in our
databases for use by unaffiliated companies in their own product solicitation
efforts that do not directly compete with our efforts.
The segment information reported below is presented on a managed basis. We
use this basis to review segment performance and to make operating decisions. To
do so, the income statement and balance sheet are adjusted to reverse the
effects of securitizations. Presentation on a managed basis is not in conformity
with generally accepted accounting principles. The elimination column in the
segment table includes adjustments to present the information on an owned basis
as reported in the financial statements of this annual report.
The expenses, assets and liabilities attributable to corporate functions
are not allocated to the operating segments, such as employee compensation, data
processing services and communications, third-party servicing expenses, and
other expenses including occupancy, depreciation and amortization, professional
fees, and other general and administrative expenses. These expenses are included
in the reconciliation of the income before income taxes (and extraordinary loss)
for the reported segments to the consolidated total. We do not allocate capital
expenditures for leasehold improvements, capitalized software and furniture and
equipment to operating segments. There were no operating assets located outside
of the United States for the periods presented.
The fee-based services operating segment pays a commission to the consumer
credit products segment for successful marketing efforts to the consumer credit
products segment's cardholders at a rate similar to those paid to our other
third parties. The fee-based services segment reports interest income and the
consumer credit products segment reports interest expense at our weighted
average borrowing rate for the excess cash flow generated by the fee-based
services segment and used by the consumer credit products segment to fund the
growth of cardholder balances.
<TABLE>
1999
----
Consumer
Credit Fee-Based
Products Services Reconciliation (a) Consolidated
-------- -------- ------------------ ------------
<S> <C> <C> <C> <C>
Interest revenue .... $1,163,663 $ 4,649 $ (932,143) (b) $ 236,169
Interest expense .... 340,066 -- (284,225) (c) 55,841
---------- ---------- ------------- ----------
Net interest income . 823,597 4,649 (647,918) 180,328
Other revenue ....... 368,500 175,091 80,181 623,772
Total revenue ....... 1,532,163 179,740 (851,962) 859,941
Income before income .
taxes and extra- ..
ordinary loss ..... 392,453(d) 100,646 (d) (301,783) (e) 191,316
Income taxes ........ -- -- 75,953 75,953
Total assets ........ $7,190,903 $ 116,106 $ (5,261,927) (f) $2,045,082
</TABLE>
<TABLE>
1998
----
Consumer
Credit Fee Based
Products Services Reconciliation (a) Consolidated
-------- -------- ------------------ ------------
<S> <C> <C> <C> <C>
Interest revenue .... $ 740,768 $ 2,754 $ (630,311) (b) $ 113,211
Interest expense .... 237,710 -- (207,197) (c) 30,513
---------- ---------- ------------- -----------
Net interest income . 503,058 2,754 (423,114) 82,698
Other revenue ....... 239,597 109,123 (33,240) 315,480
Total revenue ....... 980,365 111,877 (663,551) 428,691
Income before
income taxes ...... 188,148(d) 73,279 (d) (168,179) (e) 93,248
Income taxes ........ -- -- 35,900 35,900
Total assets ........ $5,375,925 $ 58,052 $ (4,488,258) (f) $ 945,719
</TABLE>
<PAGE>
<TABLE>
1997
----
Consumer
Credit Fee Based
Products Services Reconciliation (a) Consolidated
-------- -------- ------------------ ------------
<S> <C> <C> <C> <C>
Interest revenue .... $ 435,833 $ 2,484 $ (369,123) (b) $ 69,194
Interest expense .... 131,956 -- (120,005) (c) 11,951
---------- ---------- ------------- --------
Net interest income . 303,877 2,484 (249,118) 57,243
Other revenue ....... 149,456 64,532 (26,192) 187,796
Total revenue ....... 585,289 67,016 (395,315) 256,990
Income before
income taxes ...... 110,973 (d) 49,162(d) (98,252) (e) 61,883
Income taxes ........ -- -- 23,825 23,825
Total assets ........ $3,505,165 $ 30,488 $ (2,996,991) (f) $538,662
</TABLE>
(a) The reconciliation column includes: intercompany eliminations; amounts
not allocated to segments; and adjustments to the amounts reported on a managed
basis to reflect the effects of securitization.
(b) The reconciliation to consolidated owned interest revenue includes the
elimination of $4.6 million, $2.8 million and $2.5 million of intercompany
interest received by the fee-based services segment from the consumer credit
products segment for 1999, 1998 and 1997, respectively.
(c) The reconciliation to consolidated owned interest expense includes the
elimination of $4.6 million, $2.8 million and $2.5 million of intercompany
interest paid by the consumer credit products segment to the fee-based services
segment for 1999, 1998 and 1997, respectively.
(d) Income before income taxes includes intercompany commissions paid by
the fee-based services segment to the consumer credit products segment for
successful marketing efforts to consumer credit products cardholders of $6.7
million, $3.3 million and $4.4 million for 1999, 1998 and 1997, respectively.
(e) The reconciliation to the owned income before income taxes includes:
unallocated costs related to employee compensation; data processing and
communications; third-party servicing expenses; and other expenses. The majority
of these expenses, although not allocated for the internal segment reporting
used by management, relate to the consumer credit products segment.
(f) Total assets include the assets attributable to corporate functions not
allocated to operating segments and the removal of investors interest in
securitized loans to present total assets on an owned basis.
NOTE 17 - DEBT AND DEPOSITS
We have a $200 million, term revolving credit facility and a $100 million
term loan, (collectively, the "credit facilities"), with a syndicate of banks
and money market mutual funds. At December 31, 1999, we were in compliance with
all financial covenants under these agreements. At December 31, 1999 and 1998,
we had outstanding borrowings of $100 million and $110 million, respectively,
under the credit facilities. The weighted average interest rates on the
borrowings at December 31, 1999 and 1998, were 8.7% and 7.9%, respectively.
On July 15, 1999, we privately issued and sold $150 million of 10.125%
Senior Notes due 2006 pursuant to an exemption from registration under rule
144(a) of the Securities Act of 1933. In October 1999, we commenced an exchange
offer for the Senior Notes pursuant to a registration statement. The exchange
offer was completed in November 1999. The terms of the new Senior Notes are
identical in all material respects to the original private issue. The Senior
Notes due 2006 are unconditionally guaranteed on a senior basis, jointly and
severally, by Metris Direct, Inc. (the "Guarantor"), and all of our future
subsidiaries that guarantee any of our indebtedness, including the credit
facilities. The guarantee is an unsecured obligation of the Guarantor and ranks
equally with all existing and future unsubordinated indebtedness. We also have
$100 million of 10% Senior Notes due 2004 outstanding with terms and conditions
substantially similar to the Senior Notes due 2006.
Beginning in the first quarter of 1999, Direct Merchants Bank began issuing
certificates of deposit in increments of $100,000. As of December 31, 1999,
$758.5 million of CDs were outstanding with maturities ranging from three months
to two years with fixed interest rates ranging from 5.2% to 6.6%.
<PAGE>
Our debt and CDs outstanding as of December 31, 1999, mature as follows:
Debt CDs Total
---- --- -----
2000 $ -- $ 543,200 $ 543,200
2001 -- 215,300 215,300
2002 800 -- 800
2003 100,000 -- 100,000
2004 100,000 -- 100,000
Thereafter 144,212 -- 144,212
--------------- --------------- ---------------
Total $ 345,012 $ 758,500 $ 1,103,512
=============== =============== ===============
As part of the initial Lee Company investment, we issued the 12% Senior
Notes (see Note 6) which were similar in all material respects to the Senior
Notes due 2004. These notes were converted into Series C Preferred Stock in the
second quarter of 1999 after shareholders approved the conversion and the
Company received notice that there was no regulatory objection to the
conversion. We also have approximately $0.9 million of debt with local
governments to support growth in those areas.
Metris Direct, Inc., our wholly-owned subsidiary and guarantor, has various
subsidiaries which have not guaranteed the Senior Notes. The following condensed
consolidating financial statements of (a) the Company; (b) the guarantor
subsidiaries; and (c) the non-guarantor subsidiaries are presented for purposes
of complying with SEC reporting requirements. Separate financial statements of
Metris Direct, Inc. and the non-guaranteeing subsidiaries are not presented
because management has determined that the subsidiaries financial statements
would not be material to investors.
<PAGE>
<TABLE>
Metris Companies Inc. and Subsidiaries
Summary of Consolidated Quarterly Financial Information and Stock Data
(Dollars in thousands, expect per-share data) (unaudited)
1999
----
Fourth Third Second First
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Summary of Operations:
<S> <C> <C> <C> <C>
Interest Income ........................ $ 82,835 $ 67,935 $ 43,536 $ 41,863
Interest Expense ....................... 20,680 15,725 10,061 9,375
--------- --------- --------- ---------
Net Interest Income .................... 62,155 52,210 33,475 32,488
Provision for Loan Losses .............. 52,675 67,052 15,764 39,309
Other Operating Income ................. 176,538 172,081 138,152 137,001
Other Operating Expense ................ 129,569 105,527 108,068 94,820
--------- --------- --------- ---------
Income Before Income Taxes and
Extraordinary Loss .................. 56,449 51,712 47,795 35,360
Income Taxes ........................... 22,411 20,529 19,293 13,720
--------- --------- --------- ---------
Net Income Before Extraordinary Loss ... 34,038 31,183 28,502 21,640
Extraordinary Loss from Early
Extinguishment of Debt .............. -- -- 50,808 --
--------- --------- --------- ---------
Net Income (Loss) ...................... 34,038 31,183 (22,306) 21,640
Preferred Stock Dividends .............. 7,431 7,182 5,448 4,525
Adjustment for the Retirement of
Series B Preferred Stock ........... -- -- 101,615 --
--------- --------- --------- ---------
Net Income (Loss) Applicable to
Common Stockholders ................ $ 26,607 $ 24,001 $(129,369) $ 17,115
========= ======== ========= ==========
Per Common Share:
Earnings (Loss) per Common Share -
Diluted (1) ......................... $ 0.58 $ 0.54 $ (3.35) $ 0.42
Shares used to Compute Diluted
EPS (000's) (2) ..................... 58,415 58,077 38,570 40,265
Cash Dividends ......................... $ 0.010 $ 0.005 $ 0.005 $ 0.005
Market Prices:
High .............................. $ 38.81 $ 46.13 $ 40.75 $ 26.92
Low ............................... 25.56 24.88 20.25 19.00
Close ............................. 35.69 29.50 40.75 20.19
</TABLE>
(1) Earnings Per Share for the second quarter reflect the $152.4 million
one-time, non-cash, accounting impact from the issuance of the Series C
Convertible Preferred Stock extinguishing the Series B Preferred, the 12%
Senior Notes, and the ten-year warrants which reduced EPS by $3.89.
(2) There were options and convertible preferred stock outstanding to
purchase 2.4 million and 6.2 million common shares, respectively. These
potential common shares have been excluded from the computation of diluted
earnings per share for the second quarter because their inclusion would
have been anti-dilutive.
<PAGE>
1998
----
Fourth Third Second First
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Summary of Operations:
Interest Income ....................... $30,838 $28,564 $27,022 $26,787
Interest Expense ...................... 8,780 8,902 6,188 6,643
------- ------- ------- -------
Net Interest Income ................... 22,058 19,662 20,834 20,144
Provision for Loan Losses ............. 19,184 17,154 21,390 20,042
Other Operating Income ................ 92,166 76,824 73,217 73,273
Other Operating Expense ............... 67,842 51,695 52,498 55,125
------- ------- ------- -------
Income Before Income Taxes ............ 27,198 27,637 20,163 18,250
Income Taxes .......................... 10,470 10,641 7,763 7,026
------- ------- ------- -------
Net Income ............................ 16,728 16,996 12,400 11,224
Preferred Stock Dividends ............. 1,100 -- -- --
------- ------- ------- -------
Net Income Applicable to
Common Stockholders .................. $15,628 $16,996 $12,400 $11,224
======= ======= ======= =======
Per Common Share:
Earnings per Common Share
- Diluted ........................ $ 0.39 $ 0.42 $ 0.31 $ 0.28
Shares used to Compute
Diluted EPS (000's) .............. 39,793 40,126 39,964 40,591
Cash Dividends ........................ $ 0.005 $ 0.005 $ 0.005 $ 0.005
Market Prices:
High ............................. $ 25.16 $ 40.06 $ 31.88 $ 23.25
Low .............................. 8.88 23.13 22.44 16.00
Close ............................ 25.16 23.31 31.88 21.75
Stock Data
The Company's common stock, which is traded under the symbol "MXT," has
been listed on the New York Stock Exchange since May 7, 1999. Prior to its
listing on the New York Stock Exchange, the Company's common stock traded under
the symbol "MTRS" on the Nasdaq Stock Market since the initial public offering
on October 25, 1996. As of February 25, 2000, there were 533 holders of record
and 12,700 beneficial holders of the Company's common stock.
<PAGE>
CORPORATE INFORMATION
Corporate Offices
Executive Offices
600 South Highway 169
Interchange Tower, Suite 1800
St. Louis Park, Minnesota 55426
(952) 525-5020
Direct Merchants Credit Card Bank, National Association
6909 East Greenway Parkway
Scottsdale, Arizona 85254
Annual Meeting
Tuesday, May 9, 2000
10 a.m., Hyatt Regency Minneapolis
1300 Nicollet Mall
Minneapolis, Minnesota 55403
Stock Listing
New York Stock Exchange
Stock Symbol: MXT
Independent Auditors
KPMG LLP
Minneapolis, Minnesota
Transfer Agent and Registrar
Harris Trust and Savings Bank
Chicago, Illinois
Form 10-K
A copy of the Company's Annual Report on Form 10-K may be obtained free of
charge from the Company's Investor Relations contact:
Mark Van Ert
Vice President Investor Relations
Phone: (952) 525-5092
Fax: (952) 593-4733
<PAGE>
BOARD OF DIRECTORS
Theodore Deikel
Chairman
Metris Companies Inc.
Ronald N. Zebeck
President and Chief Executive Officer
Lee R. Anderson, Sr.
Chairman and CEO
API Group, Inc.
C. Hunter Boll
Managing Director
Thomas H. Lee Company
John A. Cleary
President
John Cleary Enterprises
Thomas M. Hagerty
Managing Director
Thomas H. Lee Company
David V. Harkins
Senior Managing Director
Thomas H. Lee Company
Walter M. Hoff
Chief Executive Officer
NDC Health Information Services
Thomas H. Lee
President
Thomas H. Lee Company
Derek V. Smith
President & CEO
ChoicePoint, Inc.
Frank D. Trestman
President
Trestman Enterprises
Audit Committee
Frank D. Trestman, Chairman
Walter M. Hoff
Derek V. Smith
Compensation Committee
John A. Cleary, Chairman
Lee R. Anderson, Sr.
David V. Harkins
Frank D. Trestman
EXECUTIVE OFFICERS
Ronald N. Zebeck
President and Chief
Executive Officer
Z. Jill Barclift
Executive Vice President, General Counsel and Secretary
Joseph A. Hoffman
Executive Vice President, Consumer Credit Card Marketing
Douglas B. McCoy
Executive Vice President, Operations
David R. Reak
Executive Vice President, Risk Management/Recovery
Douglas L. Scaliti
Executive Vice President, Fee-Based Products
David D. Wesselink
Executive Vice President, Chief Financial Officer
Jean C. Benson
Senior Vice President, Finance, Corporate Controller
Patrick J. Fox
Senior Vice President, Business Development
Paul T. Runice
Senior Vice President, Treasurer
Benson Woo
Senior Vice President, Finance
OTHER OFFICERS
William R. Anderson
Senior Vice President, Electronic Commerce
Adolph T. Barclift
Senior Vice President, Information Services
Matthew S. Melius
Senior Vice President, Portfolio Marketing
Jon Mendel
Senior Vice President, Human Resources
Jean P. Vernor
Senior Vice President, Business Development
<PAGE>
EXHIBIT 21
SUBSIDIARIES OF REGISTRANT
COMPANY JURISDICTION OF REGISTRANT
- ------- --------------------------
Direct Merchants Credit National Banking Association
Card Bank, National Association
(d/b/a Direct Merchants Bank)
Metris Direct, Inc. Minnesota
(d/b/a Metris Direct)
Metris Receivables, Inc. Delaware
Metris Funding Co. Delaware
Metris Asset Funding Co. Delaware
Metris Direct Services, Inc. Delaware
Exhibit 23
INDEPENDENT AUDITORS' CONSENT
The Board of Directors
Metris Companies Inc.:
We consent to the incorporation by reference in Registration Statement Nos.:
333-42529, 333-42961, 333-52627, 333-52629, 333-78345 and 333-91917 on Form S-8,
333-60973 and 333-82007 on Form S-3, and 333-43771 and 333-86695 on Form S-4 of
Metris Companies Inc. of our report dated January 19, 2000 relating to the
consolidated balance sheets of Metris Companies Inc. and subsidiaries as of
December 31, 1999 and 1998, and the related consolidated statements of income,
changes in stockholders' equity and cash flows for each of the years in the
three-year period ended December 31, 1999, which report appears in the December
31, 1999 Annual Report on Form 10-K of Metris Companies Inc.
/s/ KPMG LLP
Minneapolis, Minnesota
March 27, 2000
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