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As filed with the Securities and Exchange Commission on February 26, 1999
Registration No. 333-70887
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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POST-EFFECTIVE AMENDMENT NO. 1 TO FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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Creditrust Corporation
(Exact name of registrant as specified in its charter)
Maryland 7389 52-1754916
(Primary Standard (I.R.S.
(State of Industrial EmployerIdentification
incorporation) Classification Code No.)
Number)
7000 Security Boulevard
Baltimore, Maryland 21244-2543
(410) 594-7000
(Address, including zip code, and telephone number,
including area code, of registrant's principal executive offices)
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Joseph K. Rensin
Chairman and Chief Executive Officer
Creditrust Corporation
7000 Security Boulevard
Baltimore, Maryland 21244
(410) 594-7000
(Name, address, including zip code, and telephone number,
including area code, of agent for service)
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Copies of all communications, including all communications sent to the agent
for service, should be sent to:
Henry D. Kahn, Esquire
Piper & Marbury L.L.P.
36 South Charles Street
Baltimore, Maryland 21201
410-539-2530
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Approximate date of commencement of proposed sale to the public: As soon as
practicable after the effective date of this Registration Statement. If any of
the securities being registered on this Form are to be offered on a delayed or
continuous basis pursuant to Rule 415 under the Securities Act of 1933, other
than securities offered in connection with dividend or interest reinvestment
plans, check the following box:[X]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering: [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering: [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering: [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box: [_]
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CALCULATION OF REGISTRATION FEE
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<TABLE>
<CAPTION>
Title of Each Class of
Securities Amount to be Proposed Maximum Proposed Maximum Amount of
to be Registered Registered Offering Price Per Share(1) Aggregate Offering Price(1) Registration Fee(2)
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<S> <C> <C> <C> <C>
Common Stock, $.01 par
value per share....... 450,000 $ 23.19 $10,434,375 $2,901
</TABLE>
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(1) Calculated pursuant to Rule 457(c) under the Securities Act of 1933, as
amended.
(2) The registration fee was previously paid on January 21, 1999.
The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant
shall file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until the Registration Statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
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<PAGE>
450,000 Shares
Creditrust Corporation
Common Stock
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The selling stockholders identified in this prospectus are offering all the
common stock sold in the offering. Their common stock is issuable upon
conversion of warrants issued in a private placement before our initial public
offering in August 1998. On April 9, 1998, Creditrust issued units consisting
of $100,000 principal amount of senior subordinated notes and warrants to
purchase common stock. We retired our senior subordinated notes with a portion
of the proceeds of the initial public offering in August 1998. We will not
receive any proceeds from the sale of shares by the selling stockholders, but
will receive proceeds equal to the exercise price of the warrants when they are
exercised. None of our officers or directors are selling stockholders.
The common stock is listed on the Nasdaq National Market under the symbol
"CRDT." On February 23, 1999 the closing price of one share of our common stock
was $ 25.25.
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Investing in our common stock involves a high degree of risk. See "Risk
Factors" beginning on page 4 .
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Neither the Securities and Exchange Commission nor any state securities
commission approved or disapproved of these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
The date of this Prospectus is , 1999.
<PAGE>
TABLE OF CONTENTS
<TABLE>
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Page
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<S> <C>
Prospectus Summary....................................................... 1
Risk Factors............................................................. 4
Use of Proceeds.......................................................... 9
Price Range of Common Stock.............................................. 9
Dividend Policy.......................................................... 9
Capitalization........................................................... 10
Selected Financial Data.................................................. 11
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 12
Business................................................................. 25
Management............................................................... 38
Certain Transactions..................................................... 44
Selling Stockholders..................................................... 45
Description of Capital Stock............................................. 46
Shares Eligible for Future Sale.......................................... 49
Plan of Distribution..................................................... 50
Legal Matters............................................................ 51
Experts.................................................................. 51
Index to Consolidated Financial Statements............................... F-1
</TABLE>
<PAGE>
PROSPECTUS SUMMARY
You should read the following summary together with the more detailed
information and consolidated financial statements and the related notes
appearing elsewhere in this prospectus.
This summary highlights information contained elsewhere in this prospectus.
It is not complete and may not contain all of the information that you should
consider before investing in the common stock. You should read the entire
prospectus carefully, including the "Risk Factors" section and the consolidated
financial statements and the related notes.
The Company
Overview. Creditrust Corporation is a leading information-based purchaser,
collector and manager of defaulted consumer receivables. Defaulted consumer
receivables are the unpaid debts of individuals to credit grantors, including
banks, finance companies, retail merchants and other service providers. We seek
to use our proprietary pricing models and software systems as well as extensive
information databases to generate high rates of return on purchased
receivables. Most of our receivables are VISA(R) and MasterCard(R) credit card
accounts that the issuing banks have charged off their books for non-payment.
By purchasing receivables, we allow credit grantors to enhance their yields by
making a recovery on these charged-off accounts. Since Creditrust's founding in
1991 through December 31, 1998, we have invested $69.0 million to purchase
receivables at a significant discount. At December 31, 1998, we managed 1.3
million accounts with a charged-off amount of over $2.5 billion. We currently
have over 640 employees and operate two facilities which can accommodate over
900 employees.
We believe that the amount of consumer credit card charge-offs has grown and
will continue to grow at a very rapid rate. According to the Nilson Report,
gross credit card charge-offs were $9.1 billion in 1990 and increased to $36.3
billion in 1997. We also believe that the number of credit grantors selling
their charged-off receivables has grown and will continue to grow.
We believe we resolve receivables more efficiently than our competitors,
credit grantors and third-party collection agencies. We can tailor repayment
plans to help obligors, whom we refer to as customers, repay their obligations
as part of a monthly budget. We use a customer-focused approach which
emphasizes treating customers with dignity and respect. Many of our customers
have recently experienced some life-altering event, such as divorce, job loss
or major illness and are currently trying to recover financially from their
setback. By using a friendly approach and providing, when necessary, flexible
repayment plans, we help customers resolve their credit problems. Our customer-
focused approach not only aids our customers but also enables us to realize a
greater return on our receivables. Our experience is that customers are
generally more willing to repay their debts when treated respectfully.
Technology. We use technology to enhance the return on our receivables. When
we purchase receivables, we use our Portfolio Analysis Tool (PAT), a
proprietary portfolio analysis software system. PAT uses historical information
we maintain about all receivables we have managed in the past to help to
forecast future recoveries on receivables and to enable us to determine the
appropriate price to pay for a portfolio of receivables. When we collect on and
manage purchased receivables, we use Mozart, our proprietary revenue and
workflow management software. Mozart assists us in locating customers,
determining the appropriate repayment plans for our customers and monitoring
repayment by our customers. These systems allow us to:
. buy portfolios on more favorable terms;
. collect the portfolios efficiently; and
. identify trends in defaulted consumer portfolios earlier than our
competitors who lack our information advantage.
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Business Strategy. Our business goal is to be the most efficient purchaser,
collector and manager of defaulted consumer receivables within our targeted
markets. We seek to attain this goal by emphasizing customer-focused services,
investing in information technology and maintaining an information advantage
over our competitors. The key elements of our business strategy are:
. enhance our knowledge about our customer base by continuously expanding
our information databases;
. emphasize our flexible, customer-focused collection process;
. maintain strong relationships with credit grantors so that we can
continue to purchase defaulted receivables on advantageous terms;
. continue to train our employees to act as financial counselors in the
collections process;
. service substantially larger volumes of receivables without
proportionally increasing our servicing costs; and
. selectively develop new products and services for our expanding customer
base.
Funding Sources. We have funded our receivables purchases and the expansion
of our business through a combination of bank and other warehouse funding,
public and private equity funding and asset-backed securitizations. We raised
net proceeds of $27.3 million in our initial public offering in July 1998. We
currently have a total of $50.0 million in revolving warehouse facilities from
two lenders, and we completed $42.0 million in two asset-backed securitizations
in June and December 1998.
We were incorporated in Maryland in 1991 and our main offices are located at
7000 Security Boulevard, Baltimore, Maryland 21244. Our telephone number is
(410) 594-7000.
The Offering
<TABLE>
<CAPTION>
<C> <S>
Common stock offered by the selling stockholders.. 450,000 shares. See "Plan
of Distribution."
Use of proceeds................................... We will not receive any
proceeds from the sale of
the Shares but will receive
a total of $5.6 million if
all of the warrants are
exercised, if ever.
Nasdaq National Market Symbol..................... CRDT
</TABLE>
2
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Summary Financial Data
(dollars in thousands, except share data)
<TABLE>
<CAPTION>
As of and for
the Year Ended December 31,
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1994 1995 1996 1997 1998
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<S> <C> <C> <C> <C> <C>
Statement of Earnings
Data:
Revenue................. $ 3,639 $ 4,560 $ 5,521 $ 9,826 $ 34,874
Total Expenses from
Operations............. 2,984 3,114 4,518 8,782 16,805
Earnings Before
Extraordinary Loss..... 265 734 474 456 10,761
Extraordinary Loss...... -- -- -- -- (566)
Net Earnings............ 265 734 474 456 10,195
Basic Earnings per
Common Share .......... .04 .12 .08 .08 1.49
Diluted Earnings per
Common Share........... $ .04 $ .12 $ .08 $ .08 $ 1.48
Weighted Average Number
of Basic Shares
Outstanding............ 6,000,000 6,000,000 6,000,000 6,000,000 6,827,506
Weighted Average Number
of Diluted Shares
Outstanding............ 6,000,000 6,000,000 6,000,000 6,000,000 6,898,870
Other Data:
Weighted Average
Investment in Finance
Receivables(1)......... $ 1,470 $ 1,731 $ 3,198 $ 5,842 $ 13,574
Collections on Managed
Receivables(2)......... 3,971 4,914 6,252 12,420 20,585
EBITDA(3)............... 726 1,538 1,162 1,268 18,751
Collections Applied to
Principal (Accretion)
on Finance
Receivables............ 328 670 832 2,111 (3,413)
Cash Flows provided by
(used in):
Operating Activities... 191 982 1,207 1,237 258
Investing Activities... (738) (585) (4,188) 1,431 (24,951)
Financing Activities... 1,015 (138) 2,909 (2,374) 31,830
Charged-off Balance of
Managed Receivables (at
end of year)(2)........ $ 119,256 $ 175,512 $ 434,563 $1,104,647 $2,535,256
Number of Managed
Accounts............... 55,524 84,528 213,899 580,353 1,267,369
Number of Employees..... 44 61 125 245 639
</TABLE>
<TABLE>
<CAPTION>
As of December 31, 1998
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Actual As adjusted(4)
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<S> <C> <C>
Balance Sheet Data:
Cash and Cash
Equivalents............ $ 7,906 $13,420
Total Debt.............. 6,789 6,789
Total Stockholders'
Equity................. 46,425 51,939
</TABLE>
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(1) This represents only receivables owned by us. This does not include
receivables owned by other parties but serviced by us, including
receivables that are included in our securitizations.
(2) Managed receivables includes receivables that we own and receivables that
we service but do not own, including receivables included in our
securitizations.
(3) EBITDA is defined as earnings before interest, taxes, depreciation and
amortization. EBITDA is presented because we rely on this indicator in the
management of our business as a key measure of our ability to derive cash
from our investing and financing activities and because it provides useful
information regarding our ability to service existing debt, incur
additional debt and fund the purchase of additional receivables or meet
other capital requirements. For instance, an increase in EBITDA would
generally indicate to us that increases in income on finance receivables
and servicing fees represent increased capacity to fund purchases of
additional portfolios without reliance on external funding sources.
Conversely, a reduction in the indicator would mean that there was less
internally generated cash available for new portfolio investments.
Additionally, the manner in which we compute EBITDA may not be the same way
in which other companies compute similarly described data. Therefore, this
data may not be comparable to similarly titled measures of other companies.
(4) Gives effect to the issuance of 450,000 shares of common stock and the
application of the net proceeds from the exercise of the warrants. As of
December 31, 1998, there are outstanding exercisable employee stock
options, most of which are not currently exercisable, to purchase an
aggregate of 312,500 shares of common stock at a weighted average exercise
price of $15.65 per share.
3
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RISK FACTORS
Before you invest in the common stock, you should be aware of various risks
associated with an investment in our common stock, including those described
below. You should consider carefully these risk factors together with all of
the other information included in this prospectus before you decide to purchase
the common stock.
This prospectus contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. The outcome of the events
described in these forward-looking statements is subject to risks and the
actual outcome could differ materially. The sections entitled "Risk Factors,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business" as well as those discussed elsewhere in this
prospectus contain a discussion of some of the factors that could contribute to
these differences.
Receivables May Not Be Collectible
We purchase, collect and manage previously defaulted consumer receivables
generated by consumer credit card and other consumer credit transactions. These
are obligations that the individual consumer has failed to pay when due. We
purchase the receivables from credit grantors, including banks, finance
companies, retail merchants and other service providers. Substantially all of
the receivables consist of account balances that the credit grantor has deemed
uncollectible and has charged off from its books. Before we purchase the
receivables, the credit grantors generally make numerous attempts to collect on
the defaulted accounts. Credit grantors typically use their in-house collection
departments, as well as third-party collection agencies to attempt to collect
on the overdue payments. We purchase the receivables at a significant discount
to the amount the customer owes. We believe we can successfully obtain
recoveries on the receivables in amounts in excess of the amount we pay for the
receivables. Despite this belief, actual recoveries on the receivables may vary
as the result of a variety of factors within and beyond our control and may be
less than the amount we expect to recover. We cannot assure the timing or
amounts to be collected on our receivables.
We May Not Be Able to Maintain Our Growth Rate
We expanded rapidly during the last two years, placing great demands on our
management, administrative, operational and financial resources. As of December
31, 1998, we managed 1.3 million customer accounts, up from 580,000 customer
accounts at December 31, 1997. We are trying to continue our rapid growth,
which will place additional demands on our resources. Future growth will depend
on numerous factors including our ability to:
. develop and expand relationships with credit grantors;
. recruit, train and retain a sufficient number of qualified employees;
. obtain additional financing to purchase additional receivables;
. maintain quality service to our customers and credit grantors; and
. enhance and maintain our information technology, operational and
financial systems.
We may not be able to manage our expanding operations effectively or
maintain our historical collection rates, growth or profitability. Our failure
to do any of these things would have a material adverse effect on our business,
profitability and financial condition.
Labor Shortages Could Diminish Our Growth and Profitability
Our industry is very labor intensive and generally experiences high rates of
personnel turnover. We experienced an approximate personnel turnover rate of
15% for 1995, 12% for 1996, 15% for 1997, and 15% for 1998. We calculate this
annual personnel turnover rate by dividing the number of employees who left the
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company during a particular month by the number of employees who were employed
at the beginning of the month, averaged over 12 months.
Because of our growth plans and our personnel turnover, our business
requires recruiting and training significant numbers of qualified personnel. A
higher turnover rate among our employees would increase our recruiting and
training costs and could adversely impact our business. If we are unable to
recruit and retain enough employees, we will be forced to limit our growth or
possibly curtail operations. If companies in our business and similar
industries, such as the collection agency business and the teleservices and
telemarketing industries, increase their efforts to recruit available qualified
employees, or if new companies recruit in our labor market, our business and
profitability could be adversely affected. These adverse effects could include
reducing our ability to hire, train and retain qualified employees or
increasing our employee costs.
We Depend on Financing to Purchase Receivables
Our continued success depends on our ability to raise new capital to help us
purchase new receivables. On September 29, 1998, we entered into a warehouse
facility which provided $30 million to finance the purchase of additional
receivables. In addition, on October 28, 1998, we entered into a $20 million
line of credit facility which we use to finance additional purchases of
receivables. We have also funded our operations through equity offerings and
securitizations. If we cannot complete other financing transactions in the
future, our future growth and profitability will be materially adversely
affected. Our ability to finance further purchases of receivables depends on
our continued success in predicting collectibility and cash flows on the pools
of receivables we manage. We cannot guarantee that our operating performance
will attract further financing. Prevailing interest rates may also affect the
cost of future financings, the value of future receivables and our profit
margins on receivables. In recent months, the market for securitizations of
many asset classes, including defaulted consumer receivables, has been very
volatile. We cannot be certain that we will be able to complete future
securitization transactions or that the terms of any future securitization will
be beneficial to us.
Securitizations Expose Us to Various Risks
In June 1998, we completed a securitization of $412 million of charged-off
amount of receivables we owned and $692 million of charged-off amount of
receivables owned by a third party and serviced by us. We completed a second
securitization of $956 million of charged-off amount of receivables we owned in
December 1998. The securitizations resulted in recognition of $17.0 million of
gain on sale included in our statement of earnings, which represented a
significant portion of our total revenues for 1998. We also recorded as assets
residual investments in the securitizations. We receive servicing income with
respect to the securitizations, but in an amount considerably less than the
income on finance receivables we would have received had we not securitized
these receivables. We record changes in the unrealized gain or loss on our
residual investment in securitizations as a separate component of stockholders'
equity. However, we would make a charge to our earnings if there was a decline
in the fair value of the investment in securitizations which was larger than
any unrealized gain and deemed other than temporary. As a result, our quarterly
financial statements will be materially affected by the timing of
securitization transactions and could be materially adversely affected by any
possible future write-down associated with securitizations or changes in the
fair value of the residual investment in securitizations. This also may make
quarter-to-quarter comparisons difficult to interpret.
We could lose the right to service the receivables included in
securitizations for a variety of reasons. These reasons include defaults in
servicing obligations, breaches of representations and warranties related to a
securitization, bankruptcy or other insolvency of Creditrust, and other
matters. The loss of the right to service the receivables included in the
securitizations would have a material adverse effect on us.
5
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Our Stock Price May be Adversely Affected by Fluctuations in Our Quarterly
Operating Results
Because of the nature of our business, our quarterly operating results may
fluctuate in the future which may adversely affect the market price of the
common stock. The reasons our results may fluctuate include:
. The timing and size of any future securitization transactions. When we
securitize, we recognize gain on sale revenues in the period of the sale
and reduce our income on finance receivables related to the securitized
receivables in the succeeding periods.
. The timing and amount of collections on our receivables.
. Any charge to earnings resulting from a decline in value of our
investment in securitizations.
. Increases in operating expenses associated with the growth of our
operations.
For example, our earnings from operations (pre-tax) in the second quarter of
1998 were $5.1 million as compared to a net loss from operations (pre-tax) of
$371,000 in the third quarter of 1998. This loss occurred primarily because we
sold most of our owned receivables in a securitization in June 1998. This
transaction eliminated the income on finance receivables that would have been
generated by those receivables in the third quarter. In addition, our operating
expenses increased during the third quarter as we added staff to service the
larger volume of owned and securitized receivables managed by us.
We Use Estimates in Our Accounting
If the value of the portfolios of receivables we purchase turns out to be
less than we estimated, our operating results may be adversely affected. We
recognize revenue based on estimates of future collections on the pools of
receivables we manage. Although our estimates are based on statistical
analysis, the actual amount collected by us on these pools may not correlate to
our historical statistical experience. If collections on these pools are less
than estimated, we may be required to take a charge to earnings in an amount
that could materially adversely affect our earnings.
Unanticipated future events, including further refinements to our cash flow
models, may result in changes in estimates in future periods. We adjust our
models with a view toward refining the predictability of both the amount and
timing of collections. For the years ended December 31, 1995 and 1996, we
relied largely on the average past performance of our entire portfolio. After
extensive statistical analysis of static pool performance data during the year
ended December 31, 1997, we implemented a further refinement in our cash flow
models. The refinement included static pool-specific estimates and had the
effect of reducing total future projected cash flows on a portfolio-wide basis.
The total effect on the individual static pools of this change in estimates was
to decrease net earnings for the year ended December 31, 1997 by approximately
$700,000 after taxes from the amount which would have been computed prior to
this change. While we believe that our cash flow models will continue to
provide accurate forecasts of future collections, changes in collection
patterns within our portfolios, which may result from a variety of factors
beyond our control, including changes in general economic conditions and
changes in consumer attitudes toward repayment of defaulted obligations, may
make our previous estimates inaccurate or alter the way we make future
estimates.
Possible Shortage of Receivables for Purchase
Our success depends on the continued availability of receivables that meet
our requirements. The availability of portfolios of receivables for purchase at
favorable prices depends on a number of factors outside of our control,
including the continuation of the current growth trend in consumer debt and
competitive factors affecting potential purchasers and sellers of portfolios of
receivables. Any slowing of the consumer debt growth trend could result in less
credit being extended by credit grantors. Consequently, fewer receivables could
be available at prices that we find attractive. If new competitors enter our
business, our access to additional receivables may become limited. In addition,
if our competitors raise the prices they are willing to pay for
6
<PAGE>
portfolios of receivables above those we wish to pay, we may be unable to buy
receivables at prices consistent with our historic return targets.
We Depend on Management and Key Personnel
We believe that our success depends on the performance and continued
services of senior management. We do not have an employment agreement with
Joseph K. Rensin, Chairman and Chief Executive Officer, but do maintain "key
man" life insurance coverage in the amount of $4.0 million on Mr. Rensin. We
have employment agreements with each of our other executive officers. The loss
of the services of Mr. Rensin or other members of the senior management team
could have an adverse effect on our operations and financial results.
Control by Principal Stockholder
Joseph K. Rensin owns 65.0% of the common stock. If all the shares of common
stock offered by this prospectus are sold, Mr. Rensin will beneficially own
approximately 61.5% of the outstanding common stock. Mr. Rensin will be able to
control effectively most matters requiring approval by our stockholders,
including the election of directors, the approval of charter amendments, and
the approval of major transactions for which stockholders have approval rights.
Directors and Executive Officers Have Been Involved in Litigation and Other
Matters
In 1986, Mr. Rensin and a partner formed a company which engaged in the
business of purchasing and operating pay telephones. During 1987, while Mr.
Rensin was in his senior year in college, a dispute arose between this company
and an individual who had purchased telephones that were to be placed in
service by the company. Ultimately, the commercial dispute was settled for a
nominal amount and the return to the individual of the telephone equipment and
a full release was executed. Subsequently, in September 1987, the individual
swore out a criminal complaint with the local authorities in a Maryland county
against the company and Mr. Rensin. The local prosecutor did not act on the
complaint and it was dismissed in October of 1987 and subsequently expunged
from the court records. A related civil suit was filed in January 1989 by the
same individual against Mr. Rensin, his partner and the company but was later
dismissed for failure to proceed. Mr. Rensin was 21 years of age at the time
this matter arose.
In 1990, Mr. Rensin and Mr. Witlin formed PrimEquity, Inc., which engaged in
the business of purchasing properties at foreclosure sales and renovating the
properties for future sale. In 1990, PrimEquity purchased a house prior to
foreclosure in a transaction structured as a sale and lease back with an option
to repurchase. The seller was represented by counsel in the transaction, which
closed through an independent title company. After the sale, the seller/lessee
failed to make the required rental payments and vacated the house. The house
was subsequently renovated by PrimEquity and sold to a third party in 1991. In
mid-1992, the seller filed a civil lawsuit alleging that PrimEquity and Mr.
Rensin had led the plaintiff to believe that the transaction was a loan and not
a sale, that she did not need to make the rent payments called for in the
rental agreement, and that the house was being renovated to give the plaintiff
a better place to live. Defendants denied the allegations, and asserted that
they had acted in accordance with their rights under the parties' written
agreements. Five of the six claims in the plaintiff's complaint were dismissed,
leaving only a claim for fraud. After a jury trial, the defendants were found
liable and the plaintiff was awarded damages. Both parties appealed, and the
case subsequently settled for $85,000 while on appeal.
In early 1997, in connection with a proposed private securitization
transaction for Creditrust, it came to the attention of a potential investor
that information about Mr. Rensin submitted on Mr. Rensin's behalf in
connection with the transaction inaccurately stated that he was a graduate of
the University of Maryland. In fact, Mr. Rensin lacked nine course credits
necessary to graduate and did not receive a degree. Mr. Rensin promptly
corrected this information. However, the securitization ultimately did not
close because the potential lead investor withdrew from the transaction. Mr.
Rensin has voluntarily brought these circumstances to the attention of
investors and underwriters in all subsequent securitizations and related
financing transactions by Creditrust.
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Competition
Our business is highly competitive, and we expect that competition from new
and existing companies will intensify. We compete with other purchasers of
defaulted consumer receivables and with third-party collection agencies. Our
ability to obtain new customers is also affected by the financial services
companies that choose to manage their own defaulted consumer receivables. Some
of these companies may have substantially greater personnel and financial
resources. We seek to compete with these companies on the basis of our superior
information technology capabilities, which we believe enable us to purchase,
collect and manage receivables more effectively than our competitors. Following
allegations of fraud, our competitor Commercial Financial Services, Inc.
recently filed for protection from its creditors under the federal bankruptcy
laws. We are unable to assess the potential long-term effect of this
development on our industry or the markets for purchasing and financing
defaulted consumer receivables.
Government Regulation May Limit Our Collection Activities
Some aspects of our operations are governed by consumer protection laws and
regulations. Federal and state consumer protection and related laws and
regulations govern the relationship of a customer and a creditor. Significant
laws include the Fair Debt Collection Practices Act, the Federal Truth-In-
Lending Act, the Fair Credit Billing Act, the Equal Credit Opportunity Act, the
Fair Credit Reporting Act and the Electronic Funds Transfer Act (and various
federal regulations which relate to these acts), as well as comparable statutes
in the states where customers reside or where credit grantors are located. Some
of these laws may apply to our collection activities. If credit grantors who
sell receivables to us fail to comply with these laws, our ability to collect
on those receivables could be limited regardless of any act or omission on our
part. Although we frequently receive indemnities from credit grantors against
violations of law, these indemnities may not be adequate to protect us from
losses on the receivables or liabilities to customers. Our failure to comply
with these laws may also limit our ability to collect on the receivables.
Additional consumer protection laws may be enacted that could impose
requirements on the enforcement of and collection on receivables. Any new laws
or rulings that may be adopted may adversely affect our ability to collect on
the receivables. In addition, our failure to comply with those laws applicable
to us could adversely affect our ability to enforce the receivables.
Anti-takeover Provisions May Inhibit Changes of Control
Our charter and bylaws and Maryland law contain provisions which could make
it more difficult for a third party to acquire us, even if such a change in
control would be beneficial to our stockholders.
Shares Eligible for Future Sale
If one or more of our stockholders sell substantial amounts of our common
stock (including shares issued upon the exercise of warrants or options) in the
public market, the market price of our common stock could drop. Such sales
could make it difficult for us to raise funds through future offerings of
common stock.
As of December 31, 1998, there were 7,984,480 shares of common stock
outstanding. If all of the warrants are exercised, there will be 8,434,480
shares of common stock outstanding. Of these shares, 2,808,711 shares sold in
the initial public offering are freely tradeable without restriction, except
for any shares purchased by an "affiliate." In addition, the 450,000 shares of
common stock offered by this prospectus will be freely tradeable without
restriction when the registration statement registering these shares becomes
effective. Mr. Rensin has owned 5,191,289 shares of common stock for more than
two years and these shares have not been registered under the Securities Act of
1933, as amended. These shares may be sold under Rule 144 of the Securities
Act, including the volume limitations.
A warrant holder that purchased 54,000 warrants has agreed, subject to
certain exceptions, not to sell or otherwise dispose, directly or indirectly,
of any shares of common stock until April 1999.
8
<PAGE>
USE OF PROCEEDS
We will not receive any proceeds from the sale of shares of common stock by
the selling stockholders.
PRICE RANGE OF COMMON STOCK
We initially offered our common stock to the public on July 29, 1998 at a
price of $15.50 per share. Our common stock is quoted on the Nasdaq National
Market under the symbol "CRDT." The following table sets forth the high and
low closing sales prices as reported by the Nasdaq National Market.
<TABLE>
<CAPTION>
High Low
------ ------
<S> <C> <C>
1998
Third Quarter (from July 29, 1998).......................... $17.13 $14.50
Fourth Quarter.............................................. 25.00 12.63
1999
First Quarter (through February 23, 1999)................... 27.25 23.19
</TABLE>
On February 23, 1999, the last sale price for the common stock as reported
by the Nasdaq National Market was $25.25 per share. On December 31, 1998,
approximately 900 holders of record held our common stock.
DIVIDEND POLICY
We have never declared or paid dividends on our common stock. We expect
that we will retain future earnings, if any, to finance the growth and
development of our business. Thus, we do not intend to declare or pay
dividends on the common stock in the foreseeable future. Our board of
directors will determine when to declare and pay dividends and the amount of
any such dividends. Our board would be required to consider our future
earnings, results of operations, financial condition and capital requirements
before deciding to declare a dividend. Also, under Maryland law, we are
prohibited from paying any dividend unless after giving effect to the payment
of the dividend (i) we may continue to pay our debts in the ordinary course of
business, and (ii) our assets equal or exceed our liabilities plus the
preferences of any outstanding preferred equity securities upon dissolution.
Our line of credit facility restricts payments of dividends that would reduce
our net worth below a certain amount. Future credit facilities may have
similar or more stringent restrictions.
9
<PAGE>
CAPITALIZATION
The following table sets forth our actual capitalization as of December 31,
1998 and as adjusted to give effect to the assumed exercise of all outstanding
warrants. To better understand this table you should review Management's
Discussion and Analysis of Financial Condition and Results of Operations, our
consolidated financial statements, including the related notes, and the other
financial information included elsewhere in this prospectus.
<TABLE>
<CAPTION>
December 31, 1998
-----------------------
Actual As Adjusted(1)
------- --------------
(dollars in thousands)
<S> <C> <C>
Debt:
Notes Payable.................................... $ 6,789 $ 6,789
Stockholders' Equity:
Preferred Stock, par value $0.01 per share,
5,000,000 shares authorized; none issued and
outstanding..................................... -- --
Common Stock, par value $0.01 per share,
20,000,000 shares authorized; 8,000,000 shares
issued and 7,984,480 shares outstanding; and
8,450,000 shares issued and 8,434,480 shares
outstanding, as adjusted........................ 80 85
Paid-in Capital.................................. 27,754 33,263
Retained Earnings................................ 12,146 12,146
Net unrealized gains on available for sale
securities...................................... 6,714 6,714
Stock held for benefit plans..................... (269) (269)
------- -------
Total Stockholders' Equity..................... 46,425 51,939
------- -------
Total Capitalization......................... $53,214 $58,728
======= =======
</TABLE>
- --------
(1) In addition, Creditrust had outstanding as of December 31, 1998, options to
purchase 312,500 shares of Common Stock at a weighted average exercise
price of $15.65 per share.
10
<PAGE>
SELECTED FINANCIAL DATA
(dollars in thousands, except share data)
The following table sets forth our selected balance sheet, statement of
earnings and cash flow data as of the end of and for each of the years in the
five-year period ended December 31, 1998. The selected financial data for the
years ended December 31, 1995, 1996, 1997 and 1998 have been derived from our
audited financial statements. The selected financial data for the year ended
December 31, 1994 has been derived from unaudited financial statements not
included in this prospectus. Our consolidated balance sheets as of December 31,
1997 and 1998 and our consolidated statements of earnings, stockholders' equity
and comprehensive income and cash flows for the years ended December 31, 1996,
1997 and 1998 are included elsewhere in this prospectus. The selected financial
data presented below should be read in conjunction with our consolidated
financial statements and the related notes and "Management's Discussion and
Analysis of Financial Conditions and Results of Operations" included in this
prospectus.
<TABLE>
<CAPTION>
As of and for the Year Ended December 31,
----------------------------------------------------------
1994 1995 1996 1997 1998
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Statement of Earnings
Data:
Revenue:
Income on Finance
Receivables........... $ 3,639 $ 4,560 $ 5,521 $ 7,246 $ 12,817
Servicing Fees......... -- -- -- 2,580 3,110
Interest on Investment
in Securitizations.... -- -- -- -- 534
Gain on Sale........... -- -- -- -- 18,414
---------- ---------- ---------- ---------- ----------
Total Revenue........... 3,639 4,560 5,521 9,826 34,875
Expenses from
Operations:
Personnel.............. 1,390 1,847 2,618 5,922 11,918
Communications......... 361 404 573 912 1,645
Rent................... 216 240 382 853 1,195
Other Expenses......... 1,016 624 945 1,095 2,047
---------- ---------- ---------- ---------- ----------
Total Expenses from
Operations............. 2,983 3,115 4,518 8,782 16,805
---------- ---------- ---------- ---------- ----------
Earnings from
Operations............. 656 1,445 1,003 1,044 18,070
Other Income (Expense).. (252) (249) (213) (362) (304)
---------- ---------- ---------- ---------- ----------
Earnings Before Income
Taxes and Extraordinary
Loss................... 404 1,196 790 682 17,766
Provision For Income
Taxes.................. 139 462 316 226 7,005
---------- ---------- ---------- ---------- ----------
Earnings Before
Extraordinary Loss..... 265 734 474 456 10,761
Extraordinary Loss (net
of taxes).............. -- -- -- -- (566)
---------- ---------- ---------- ---------- ----------
Net Earnings............ 265 734 474 456 10,195
========== ========== ========== ========== ==========
Basic Earnings per
Common Share........... .04 .12 .08 .08 1.49
Diluted Earnings per
Common Share........... $ .04 $ .12 $ .08 $ .08 $ 1.48
Weighted Average Number
of Basic Shares
Outstanding............ 6,000,000 6,000,000 6,000,000 6,000,000 6,827,506
Weighted Average Number
of Diluted Shares
Outstanding ........... 6,000,000 6,000,000 6,000,000 6,000,000 6,898,870
Other Data:
Weighted Average
Investment in Finance
Receivables(1)......... $ 1,470 $ 1,731 $ 3,198 $ 5,842 $ 13,574
Collections on Managed
Receivables(2)......... 3,971 4,914 6,252 12,420 20,585
EBITDA(3)............... 726 1,538 1,162 1,268 18,751
Collections Applied to
Principal (Accretion)
on Finance
Receivables............ 328 670 832 2,111 (3,413)
Cash Flows Provided by
(Used in)
Operating Activities... 191 982 1,207 1,237 258
Investing Activities... (738) (585) (4,188) 1,431 (24,951)
Financing Activities... 1,015 (138) 2,909 (2,374) 31,830
Charged-off Balance of
Managed
Receivables(2)......... $ 119,256 $ 175,512 $ 434,563 $1,104,647 $2,535,256
Number of Managed
Accounts............... 55,524 84,528 213,899 580,353 1,267,369
Number of Employees..... 44 61 125 245 639
Balance Sheet Data:
Cash and Cash
Equivalents............ $ 289 $ 548 $ 476 $ 770 $ 7,906
Total Debt.............. -- -- 3,793 2,106 6,789
Stockholders' Equity.... $ 400 $ 1,134 $ 1,608 $ 2,064 $ 46,425
</TABLE>
- -------
(l) This represents only receivables owned by us. This does not include
receivables owned by other parties but serviced by us, including
receivables that are included in our securitizations.
(2) Managed receivables includes receivables that we own and receivables that
we service but do not own, including receivables included in our
securitizations.
(3) EBITDA is defined as earnings before interest, taxes, depreciation and
amortization. EBITDA is presented because we rely on this indicator in the
management of our business as a key measure of our ability to derive cash
from our investing and financing activities and because it provides useful
information regarding our ability to service existing debt, incur
additional debt and fund the purchase of additional receivables or meet
other capital requirements. For instance, an increase in EBITDA would
generally indicate to us that increases in income on finance receivables
and servicing fees represent increased capacity to fund purchases of
additional portfolios without reliance on external funding sources.
Conversely, a reduction in the indicator would mean that there was less
internally generated cash available for new portfolio investments.
Additionally, the manner in which we compute EBITDA may not be the same way
in which other companies compute similarly described data. Therefore, this
data may not be comparable to similarly titled measures of other companies.
11
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
Creditrust Corporation (the "Company" or "Creditrust") is a leading
information-based purchaser, collector and manager of defaulted consumer
receivables. Receivables are the unpaid debts of individuals to credit
grantors, including banks, finance companies, retail merchants and other
service providers. Creditrust seeks to use its proprietary pricing models and
software systems as well as extensive information databases to generate high
rates of return on purchased receivables. Most of its receivables are VISA(R)
and MasterCard(R) credit card accounts that the issuing banks have charged off
their books for non-payment. By purchasing receivables, Creditrust allows
credit grantors to make a recovery on these charged-off accounts.
From the Company's founding in 1991, the Company has purchased charged-off
receivables (measured at the amount charged off by the credit grantors that
originated the charged-off VISA(R), MasterCard(R) and private label credit card
accounts and consumer loan accounts at the date of charge-off) aggregating $1.4
million in 1991, $22.6 million in 1992, $47.3 million in 1993, $48.0 million in
1994, $56.3 million in 1995, $259.1 million in 1996, $670.0 million in 1997,
and $1.4 billion in 1998. Creditrust has invested since its founding in 1991
through December 31, 1998 $69.0 million to purchase receivables at a
significant discount. At December 31, 1998, the Company managed 1.3 million
accounts with a charged-off amount of over $2.5 billion. The following chart
illustrates this growth:
Managed Portfolio--Charged-Off Amounts
[GRAPH APPEARS HERE]
Millions
1991 1992 1993 1994 1995 1996 1997 1998
---- ---- ---- ----- ----- ----- ------ ------
Purchase Amount ($MM) 1.4 22.6 47.3 48.0 56.3 259.1 670.0 1400.0
Total Portfolio ($MM) 1.4 24.0 71.3 119.3 175.6 434.7 1104.7 2504.7
12
<PAGE>
The following table illustrates Creditrust's collection experience for the
periods indicated:
<TABLE>
<CAPTION>
As of and for the Year Ended
December 31,
------------------------------
1996 1997 1998
-------- ---------- ----------
(dollars in thousands)
<S> <C> <C> <C>
Revenues:
Income on Finance Receivables........ $ 5,521 $ 7,246 $ 12,817
Servicing Fees....................... -- 2,580 3,110
Interest on Investment in
Securitizations..................... -- -- 534
Gain on Sale......................... -- -- 18,414
-------- ---------- ----------
Total Revenues......................... 5,521 9,826 34,875
Collections on Managed Receivables(1).. 6,252 12,420 20,585
Weighted Average Investment in Finance
Receivables(2)........................ 3,198 5,842 13,574
Weighted Average Charged-off Balance on
Managed Receivables(1)(3)............. 248,990 689,924 1,474,085
Charged-off Balance of Managed
Receivables (at end of period)(1)(4).. $434,563 $1,104,647 $2,535,256
</TABLE>
- --------
(1) Managed receivables includes receivables that Creditrust owns and
receivables that Creditrust services but does not own, including
receivables included in Creditrust's securitizations.
(2) Does not include any receivables for which the Company acts as servicer and
represents the average investment balance during the period measured by the
financial statement carrying value of portfolios of receivables owned by
the Company determined by dividing the total value for the portfolio of
receivables at the end of each month in the period by the number of months
in the period.
(3) Represents the average of the charged-off balances purchased by the Company
determined by dividing the total charged-off balance at the end of each
month in the period by the number of months in the period, without regard
to collections or receivables settled.
(4) Represents the balance of receivables purchased by the Company as of the
end of the period measured by balances charged off by the credit grantors,
without regard to collections or receivables settled.
The Company accounts for its investment in finance receivables on an accrual
basis using static pools. Static pools are established using similar accounts
with similar attributes, usually based on acquisition timing and/or by seller.
Once a static pool is established the receivables in the pool are not changed.
The difference between the contractual receivable balance of the accounts in
the static pools and the cost of each static pool (the discount) is not
recorded since the Company expects to collect a relatively small percentage of
each static pool's contractual receivable balance. Each static pool is
initially recorded at cost. See Note D of Notes to Consolidated Financial
Statements.
For accounting purposes, each static pool is measured as a unit for the
estimated economic life of the static pool (similar to a loan). Income on
finance receivables, collections applied to principal on finance receivables
and provisions for loss or impairment are established on a pool by pool basis.
The effective interest rate for each static pool is estimated based on the
estimated monthly collections over the estimated economic life of each pool.
The estimated economic life of each static pool is currently five years based
on the Company's collection experience. Income on finance receivables is
accrued monthly based on each static pool's effective interest rate applied to
each static pool's monthly opening carrying value. While these monthly accruals
increase the carrying value of each pool, monthly collections received for each
static pool reduce each static pool's carrying value. To the extent collections
in any period exceed the income accruals for the pool for such period, the
carrying value of the pool is reduced and the reduction is recorded as
collections applied to principal. After the carrying value of any static pool
is fully amortized, any further collections on that pool would be recorded
entirely as income on finance receivables. If the income accrual in any period
is greater than collections for such period, then the carrying value of the
pool accretes. Creditrust typically records accretion in the early months of
ownership of the static pool as a result of collection rates being lower than
the estimated effective yield, which reflects estimated collections for the
entire economic life of the static pool.
Fair value for each static pool is determined by discounting the projected
recovery value (estimated future cash flows) for the pool at the current
effective interest rate being used by the Company. Any measurement of
impairment and any provision for loss is determined separately for each static
pool. To the extent the
13
<PAGE>
Company's estimate of future cash flow for a static pool, discounted at the
then current estimated effective interest rate, increases or decreases the
Company adjusts the estimated effective interest rate prospectively. To the
extent that the carrying value of a particular static pool exceeds its fair
value, a valuation allowance will be recognized and charged to expense in the
amount of such an impairment. The Company has not recorded an impairment for
any period to date. The estimated effective interest rate for each static pool
is based on estimates of future cash flows from collections, and actual cash
flows may vary from current estimates.
The Company monitors its models with a view toward refining the
predictability of both the amount and timing of collections. For the years
ended December 31, 1995 and 1996, the Company relied largely on the average
past performance of the Company's entire portfolio. After extensive statistical
analysis of static pool performance data during the year ended December 31,
1997, the Company implemented a further refinement in its cash flow models. The
refinement included static pool-specific estimates and had the effect of
reducing total future projected cash flows on a portfolio-wide basis. The total
effect on the individual static pools of this change in estimates was to
decrease net income for the year ended December 31, 1997 by approximately
$700,000 after taxes from the amount which would have been computed prior to
this change. Total cash flow for 1997 was unaffected by the change in future
estimates, with the result that the reduction in income on finance receivables
was applied to increase the amount of collections applied to finance
receivables. See Note D of Notes to Consolidated Financial Statements. While
the Company believes that its cash flow models will continue to provide
accurate forecasts of future collections, changes in collection patterns within
the Company's portfolios, which may result from a variety of factors beyond the
Company's control, including changes in general economic conditions and changes
in consumer attitudes toward repayment of defaulted obligations, may have an
impact on the Company's future estimates.
The Company also receives servicing fees with respect to the receivables it
services but does not own. In the quarter ended September 30, 1997, the Company
began recognizing servicing income in connection with its agreement to manage
the liquidation of receivables owned by a third party. Under the terms of the
servicing agreement, the financial institution had agreed to accept any third-
party offer to purchase or allow the Company to securitize these receivables
provided the proceeds to the financial institution exceeded a minimum amount.
These receivables were included in the Initial Securitization described below.
See "--Liquidity and Capital Resources."
In June 1998, the Company completed its first securitization of finance
receivables (the "Initial Securitization"). The Initial Securitization included
receivables owned by the Company with a charged-off amount of $412 million and
a carrying value of $4.8 million as well as $6.5 million of receivables
Creditrust was servicing for a third party with a charged-off amount of $692
million. These receivables were transferred to Creditrust SPV2, LLC ("SPV2"), a
special purpose finance subsidiary. SPV2 issued an aggregate principal amount
of $14.5 million of 6.43% Creditrust receivables-Backed Notes, Series 1998-1,
which notes are secured by the receivables transferred to SPV2 and a financial
guaranty insurance policy. The Company completed its second securitization in
December 1998 (the "Second Securitization"). The Second Securitization included
receivables with a charged-off amount of $956 million and a carrying value of
$28.6 million. The Company transferred the receivables to Creditrust SPV98-2,
LLC ("SPV98-2"), a special purpose finance subsidiary. SPV98-2 issued an
aggregate principal amount of $27.5 million of 8.61% Creditrust Receivables-
Backed Notes, Series 1998-2, which notes are secured by the receivables
transferred to SPV98-2 and a financial guaranty insurance policy. As of
December 31, 1998, the Company owned receivables not contributed to any
securitization with a charged-off amount of $475 million and a carrying value
of $26.9 million.
In both securitizations, the projected recovery value of the transferred
receivables significantly exceeded the principal balance of the securitization
notes, causing the securitization notes to be over-collateralized. The Company
retains an investment in securitizations representing this residual interest in
the securitized receivables. The Company acts as servicer with respect to the
receivables included in both securitizations, and receives a servicing fee
equal to 20% of collections. As servicer, the Company continues its collection
activities with its customers as it otherwise would with owned receivables.
Accordingly, customer relationships are not affected by securitizations.
14
<PAGE>
After payment of all principal and interest on the securitization notes, the
Company will receive all collections, subject to an obligation in the Initial
Securitization to pay the seller of a portfolio of receivables, which the
Company began servicing in 1997, 10% of collections with respect to this
portfolio after aggregate collections on this portfolio exceed a specified
amount.
Both securitizations qualified as sales under generally accepted accounting
principles. Upon the closing of the Initial Securitization, the Company: (1)
recognized gain on the sale of the owned receivables of $6.0 million, and (2)
received total cash of $6.3 million, after payment of the purchase price of the
serviced receivables included in the Initial Securitization and repayment of
associated debt of $7.5 million in the aggregate and payment of related
transaction costs. Of the $6.3 million in total cash, $435,000 was used to fund
a reserve account in trust, leaving net cash of $5.8 million for use in the
Company's business. Upon the closing of the Second Securitization, the Company:
(1) recognized gain on sale of $11.0 million, and (2) received total cash of
$7.4 million, after repayment of associated debt and the Company's cash used to
finance the receivables of $19.5 million in the aggregate and payment of
related transaction costs. Of the $7.4 million in total cash, $1.6 million was
used to fund a reserve account in trust, leaving net cash of $5.8 million for
use in the Company's business. The investment in securitizations is accounted
for under the provisions of SFAS 115 as debt securities available-for-sale and
is estimated to accrue income at the rate of 12% per annum. This accrual is a
non-cash item included in the statement of earnings as interest on investment
in securitizations and in the balance sheet as a component of the fair value of
the investment in securitizations. Once the securitization notes are retired,
recoveries will be applied to reduce the carrying amount of the investment in
securitizations. The Company records its investment in securitizations at fair
value, and any unrealized gains and losses, net of the related tax effect,
generally are not reflected in earnings but are recorded as a separate
component of stockholders' equity until realized. The fair value of the
Company's investment in securitizations was $30.3 million at December 31, 1998,
which included an unrealized gain of $11.0 million (pre-tax) or $6.7 million
(net of taxes). A decline in the value of the investment in securitizations
which is larger than any unrealized gain and which is deemed other than
temporary would be charged to earnings and result in the establishment of a new
cost basis. The Company may pursue similar securitization transactions in the
future. The timing of any future securitizations will affect quarter-to-quarter
comparisons. See Notes to Consolidated Financial Statements for additional
discussion concerning the financial statement effects of the securitizations.
Income taxes have been provided in the results of operations based on the
statutory federal and state rates on accounting income. Temporary differences
arise because income on finance receivables is recognized on the cost recovery
method for federal income tax purposes. Under the cost recovery method, gross
collections on finance receivables are not taxable until the cost of the
finance receivables has been collected. In addition, temporary differences
arise from gain on sale because of securitizations which are treated as
financings for tax purposes. Permanent differences between the statutory rates
and actual rates are minimal. In the past the Company has financed certain
portfolio purchases through participations with certain investors, but does not
anticipate that this will be used as a funding source in the future. Imputed
loan repayments and interest expense on payments to participants are recorded
as costs for tax purposes when due based on collection participation levels.
Temporary differences in recognition of income on finance receivables and gain
on sale have resulted in deferred tax liabilities. Temporary differences in
recognition of payments to participants and deferred gain generally have
accumulated deferred tax assets. The Company's deferred tax liabilities have
grown as a result of the rapid increase in purchases of receivables and gains
from securitizations by the Company, providing the Company with additional
liquidity offered by the deferred tax liabilities. Management expects deferred
tax liabilities to increase as long as the operating expenses on existing and
additional finance receivables exceed collections on fully cost recovered
portfolios.
15
<PAGE>
Results of Operations
The following table sets forth certain statement of earnings and
supplemental cash flow data on an historical basis, each as a percentage of
revenues:
<TABLE>
<CAPTION>
Year Ended
December 31,
-------------------
1996 1997 1998
----- ----- -----
<S> <C> <C> <C>
Revenue:
Income on finance receivables......................... 100.0% 73.7% 36.8%
Servicing fees........................................ -- 26.3 8.9
Interest on investment in securitizations............. -- -- 1.5
Gain on sale.......................................... -- -- 52.8
----- ----- -----
Total Revenue....................................... 100.0 100.0 100.0
Expenses From Operations:
Personnel............................................. 47.4 60.3 34.2
Communications........................................ 10.4 9.3 4.7
Rent and other occupancy.............................. 6.9 8.7 3.4
Other expenses........................................ 17.1 11.1 5.9
----- ----- -----
Total Expenses From Operations...................... 81.8 89.4 48.2
----- ----- -----
Earnings from Operations................................ 18.2 10.6 51.8
Other Income (Expense)
Interest and other.................................... 1.3 0.1 0.9
Interest expense...................................... (5.2) (3.8) (1.8)
----- ----- -----
Earnings before income taxes and extraordinary loss..... 14.3 6.9 50.9
Provision for income taxes.............................. 5.7 2.3 20.1
----- ----- -----
Earnings before extraordinary loss...................... 8.6 4.6 30.8
Extraordinary loss (net of taxes)....................... -- -- (1.6)
----- ----- -----
Net Earnings............................................ 8.6 4.6 29.2
===== ===== =====
EBITDA.................................................. 21.0 12.9 53.8
Collections applied to principal (accretion) on
receivables............................................ 15.1% 21.5% (9.8)%
</TABLE>
Year ended December 31, 1998 Compared to Year Ended December 31, 1997
Revenues. Total revenues increased by $25.1 million, or 254.9%, from $9.8
million for the year ended December 31, 1997 to $34.9 million for the year
ended December 31, 1998. This increase was largely due to $18.4 million in gain
on sale and increased income on finance receivables resulting from receivables
purchases during the year.
Income on finance receivables increased by $5.6 million, or 76.9%, from $7.2
million for the year ended December 31, 1997 to $12.8 million for the year
ended December 31, 1998. This increase was attributable to the purchase of
receivables in the last three quarters of 1998 with proceeds from the sale of
the Company's Subordinated Notes, Series 1998 (the "Subordinated Notes"), the
initial public offering and the Company's credit facilities. The Company's
weighted average investment in receivables increased by $7.8 million, or
132.4%, from $5.8 million during the year ended December 31, 1997 to $13.6
million during the year ended December 31, 1998. The weighted average charged-
off balance of the receivables managed by the Company correspondingly increased
by $784 million, or 113.7% from $690 million at December 31, 1997 to $1.5
billion at December 31, 1998. Collections on managed receivables increased by
$8.2 million, or 65.7%, from $12.4 million for the year ended December 31, 1997
to $20.6 million for the year ended December 31, 1998. The growth in
collections was lower than the growth in the managed receivables because lower
recovery rates are typically experienced in the early months of ownership of
receivables.
Servicing fees increased by $530,000, or 20.5%, from $2.6 million for the
year ended December 31, 1997 to $3.1 million for the year ended December 31,
1998. The increase was due to the receipt of servicing fees
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under the Initial Securitization. During the last six months of 1997 and the
first six months of 1998, the Company received servicing fees associated with
certain receivables which ceased when they were included in the Initial
Securitization.
Interest on investment in securitizations was $534,000 for the year ended
December 31, 1998. This revenue was associated with the interest accrual on the
Company's investment in securitizations, resulting primarily from the Initial
Securitization.
Gain on sale for 1998 included $17.0 million gain on sale resulting from the
Company's second and fourth quarter 1998 securitizations, an $800,000 gain on
sale in the third quarter of 1998 resulting from the sale of a portfolio of
receivables and a $658,000 gain on sale in the first quarter of 1998 resulting
from the resale of a portfolio of receivables repurchased under a settlement
agreement. In this latter transaction, previously deferred income of $895,000
was recognized against a $235,000 cost of resale.
Expenses from Operations. Total expenses from operations increased by $8.0
million, or 91.4%, from $8.8 million for the year ended December 31, 1997 to
$16.8 million for the year ended December 31, 1998. Operating expenses
increased in 1998 primarily as a result of increased personnel expenses
associated with the rapid growth of the Company's managed receivables base and
associated recovery efforts. The Company's communications and rent expenses
also increased as the Company's managed receivables base grew. Operating
expenses as a percent of revenues decreased to 48.2% of revenues for the year
ended December 31, 1998, as compared to 89.4% of revenues for the year ended
December 31, 1997, as the revenues resulting from gain on sale recognized in
1998 substantially offset operating expense growth.
Personnel expenses increased by $6.0 million, or 101.2%, from $5.9 million
for the year ended December 31, 1997 to $11.9 million for the year ended
December 31, 1998. Major categories of personnel expense increases included:
(a) recruiting, training and compensation costs associated with the increase in
the number of employees from 245 to 639 needed to service the larger volume of
managed receivables, and (b) additional costs for development, installation and
training associated with the Company's expanded information technology systems.
Communications costs increased by $733,000, or 80.5%, from $912,000 for the
year ended December 31, 1997 to $1.6 million for the year ended December 31,
1998. This increase was due to greater use of credit reporting and long
distance telephone services to service the higher volume of managed
receivables.
Rent and other occupancy costs increased from $853,000 for the year ended
December 31, 1997 to $1.2 million for the year ended December 31, 1998 as the
Company completed its first full year in a second operations center which
opened in June 1997. The Company will incur additional rent and occupancy
expenses in 1999 associated with its third facility.
Other expenses increased from $1.1 million for the year ended December 31,
1997 to $2.0 million for the year ended December 31, 1998, primarily as a
result of increased professional fees, including accounting and legal fees
associated with the Company's capital raising and securitization activities
during 1998, and increases in overall staffing levels. Other expenses for the
years ended December 31, 1997 and 1998 included (a) contingency legal and court
costs of $320,000 and $349,000, respectively, (b) professional fees of $504,000
and $1.0 million, respectively, and (c) general and administrative expenses of
$271,000 and $686,000, respectively.
Earnings from Operations. Earnings from operations increased by $17.1
million from $1.0 million for the year ended December 31, 1997 to $18.1 million
for the year ended December 31, 1998. This increase resulted from numerous
factors, particularly the increase in gain on sale and income on finance
receivables, which more than offset the substantial growth in operating costs
associated with the additions to corporate infrastructure to support a
substantially larger base of operations.
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Other Income (Expense). Other income (expense) decreased from an expense of
$362,000 for the year ended December 31, 1997 to an expense of $304,000 for the
year ended December 31, 1998. This decrease resulted from a $298,000 increase
in interest and other income primarily due to interest earned on short term
cash equivalent investments which were acquired with proceeds from the initial
public offering offset by an increase in interest expense of $238,000 as a
result of higher borrowing incurred in connection with the Subordinated Notes
and the credit facilities.
Earnings Before Income Taxes and Extraordinary Loss. As the result of the
foregoing, earnings before income taxes increased from $682,000 for the year
ended December 31, 1997 to $17.8 million for the year ended December 31, 1998.
Provision for Income Taxes. Income tax rates were 33% for the year ended
December 31, 1997 and 39% for the year ended December 31, 1998. The Company's
effective tax rate may fluctuate as a result of changes in pre-tax income and
nondeductible expenses. Deferred tax liabilities increased from $1.1 million at
December 31, 1997 to $11.9 million at December 31, 1998, principally due to the
deferred taxes of $10.8 million provided for on the gain on sale related to
both securitizations, which were treated as financing transactions for tax
purposes, and the reversal of a deferred tax benefit of $345,000 on the first
quarter portfolio resale and recognition of deferred income which was
previously taxed, offset by $6.1 million in net operating loss carryforward.
Extraordinary Loss (Net of Taxes). The extraordinary loss of $566,000 (net
of taxes) recognized for the year ended December 31, 1998 resulted from the
early retirement of $5 million of Subordinated Notes required to be repaid upon
the closing of the Company's initial public offering. The carrying value of the
debt was $4.6 million due to the value attributed to the warrants issued in
connection with the debt and credited to paid in capital. The difference in the
carrying value of the debt and the amount owed is original issue discount and
was written off upon the early retirement. In addition, $515,000 of offering
costs were incurred in connection with the Subordinated Notes net of
amortization and charged to extraordinary loss.
Net Earnings. Net earnings increased by $9.7 million from $456,000 for the
year ended December 31, 1997 to $10.2 million for the year ended December 31,
1998. This increase resulted from the same factors which affected earnings from
operations, along with a $6.8 million increase in tax expenses and the
extraordinary loss of $556,000 upon repayment of the Subordinated Notes.
EBITDA. EBITDA increased by $17.5 million from $1.3 million for the year
ended December 31, 1997 to $18.8 million for the year ended December 31, 1998.
EBITDA increased slightly more than earnings from operations primarily because
of growth in interest income in 1998.
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
Revenues. Total revenues for the year ended December 31, 1997 were $9.8
million compared to total revenues of $5.5 million for the year ended December
31, 1996, an increase of 78.0%. This increase in revenues was the result of an
increase in the weighted average investment in finance receivables from $3.2
million in 1996 to $5.9 million in 1997, as well as the receipt of $2.6 million
in servicing income in 1997; there was no servicing income prior to 1997. The
31.2% increase in income on finance receivables resulted from the increase in
the amount of collections on higher levels of receivables owned or serviced by
the Company in 1997. Offsetting the increase was a decrease of approximately
$1.1 million ($700,000 net of deferred tax benefit) in income on finance
receivables as a result of the change in estimate of future collections.
Collections increased $6.2 million or 98.7%. The weighted average charged-off
balances owned or serviced by the Company increased from $249.0 million at the
end of 1996 to $689.9 million at the end of 1997, an increase of 177.1%.
Total Expenses from Operations. Total expenses from operations increased by
$4.3 million to $8.8 million in the year ended December 31, 1997 from $4.5
million in the year ended December 31, 1996.
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<PAGE>
Operating expenses increased over 1996 by 94.4% due to (a) a 126.2% increase in
personnel costs as a result of growing total staff from 125 to 245 as of
December 31, 1996 and 1997, respectively; (b) a 123.4% increase in rent and
occupancy due to the relocation of the headquarters and operations groups into
larger space and the start up of the approximately 36,000 square foot
operations center in March 1997; (c) increases in communications, other
expenses and professional fees as a result of usage increases in long distance,
credit reporting, facility, legal and accounting services; and (d) offset by
the absence of portfolio repurchase costs in 1997.
Expenses increased in 1997 primarily as a result of costs associated with
recovery on increased purchases of receivables, including the receivables
serviced by the Company for a third-party owner, and in anticipation of
additional purchases in 1998. Management believes that many of the expense
categories discussed above can support the servicing and management of
substantially larger volumes of receivables without proportional expense
increases.
Personnel expenses were $2.6 million in 1996 and $5.9 million for the year
ended December 31, 1997. Major categories of personnel expense increases
included: (a) additional compensation costs for development, installation and
training associated with the expanded information technology systems; and (b) a
significant investment in senior management infrastructure, including senior
management staff in financing, acquisitions, information technology, legal,
recovery and skiptrace; and (c) an increase in the number of account officers
to service larger volumes of receivables.
Rent and other occupancy costs were $382,000 and $853,000 in 1996 and 1997,
respectively. This increase is attributable to the leasing of additional office
space for the headquarters for a full year in 1997 as compared to eight months
in 1996, the addition of 36,000 square feet of space for the new operations
center started up in the first half of 1997 and depreciation expense increases
due to equipment and furniture additions of approximately $1 million for
headquarters and the new operations center.
Other expenses increased from $945,000 for the year ended December 31, 1996
to $1.1 million for the year ended December 31, 1997, primarily as a result of
increased professional fees, offset by the elimination of expenses related to
portfolio repurchases. Other expenses for the years ended December 31, 1996 and
1997 included (a) contingency legal and court costs of $213,000 and $320,000,
respectively, (b) professional fees of $156,000 and $504,000, respectively, and
(c) general and administrative expenses of $192,000 and $271,000, respectively.
Other expenses for the year ended December 31, 1996 also included portfolio
repurchase costs of $384,000.
Earnings from Operations. As the result of these factors, and particularly
the substantial growth in corporate infrastructure to support a substantially
larger base of operations, earnings from operations were $1.0 million in 1996
and $1.0 million in 1997.
Other Income (Expense). Interest expense increased from $288,000 in 1996 to
$377,000 in 1997. Interest attributable to amounts due to participants
decreased from $204,000 in 1996 to $21,000 in 1997, as a result of a decrease
in the average annual amount outstanding due to participants from $516,000 in
1996 to $68,000 in 1997. The interest expense on the Company's bank credit
facility increased from $60,000 in 1996 to $296,000 in 1997 as a result of the
establishment of a bank credit facility on September 23, 1996, to provide
advances of up to $4.0 million for the purchase of receivables and the
increased volume of receivables balances financed with this facility. The
facility was retired in June 1998. Interest expense further increased due to
two additional equipment leases completed in 1997.
Earnings Before Income Taxes and Extraordinary Loss. As the result of the
foregoing, earnings before income taxes were $790,000 in the year ended
December 31, 1996 and $682,000 in the year ended December 31, 1997.
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<PAGE>
Provision for Income Taxes. Income taxes for the calendar years ended
December 31, 1996 and 1997 were at effective tax rates of 39.9% and 33.0%,
respectively. The effective tax rate fluctuates as a result of changes in pre-
tax income and nondeductible expenses. Deferred tax liabilities increased from
$623,000 at December 31, 1996 to $1,094,000 at December 31, 1997, principally
due to growth in timing differences on finance receivables as significantly
most of the carrying value in finance receivables has been written off for tax
purposes. The increase was partially offset by a deferred tax benefit incurred
on an increase of $195,000 in lease incentives attributable to the free rent
period on the operations center.
Net Earnings. Net earnings for the year ended December 31, 1996 were
$474,000 versus $456,000 for the year ended December 31, 1997. The 3.7%
decrease was attributable principally to higher revenues in 1997 over 1996 of
$4.25 million offset by higher costs of $4.35 million and further increased by
a $90,000 decrease in tax expenses.
EBITDA. EBITDA increased $106,000 or 9.1% from $1.2 million to $1.3 million
from December 31, 1996 to 1997, respectively. EBITDA increased more than net
income due to a decline in the growth rate of interest expense, taxes and
depreciation relative to total revenues.
Financial Condition
Cash and Cash Equivalents. Cash and cash equivalents increased from $770,000
as of December 31, 1997 to $7.9 million as of December 31, 1998, primarily as a
result of an increase in net cash from financing activities including the
initial public offering offset by investing activities, principally purchases
of receivables, and by net cash used in operating activities.
Finance Receivables. Investment in finance receivables increased 433.0% to
$26.9 million, as of December 31, 1998 from $5.0 million as of December 31,
1997. All of the receivables owned as of December 31, 1997 were securitized in
the second quarter of 1998 and therefore removed from the balance sheet. The
carrying value of the receivables, along with the $6.5 million purchase price
of the serviced receivables included in the Initial Securitization, was
allocated to cost of sales and the investment in securitizations. Investment in
finance receivables was further reduced by an additional $28.6 million of
carrying value of receivables included in the Second Securitization. Receivable
purchases of $58.3 million during the year ended December 31, 1998 included
$6.5 million for the serviced receivables and $51.8 million for additional
receivables. The Company purchased the $51.8 million of finance receivables
during the year ended December 31, 1998 with a portion of the net proceeds from
the initial public offering, the securitizations and other cash on hand.
Investment in Securitizations. Investment in securitizations increased from
none at December 31, 1997 to $30.3 million as of December 31, 1998 as the
result of the completion of the securitizations. After payment of interest and
principal on the securitization notes, servicing costs, trustee fees, insurance
premiums and certain other costs, all remaining cash flows with respect to the
securitized receivables are for the account of the Company. The retained
investment in securitizations is accounted for at fair value. The fair value of
the investment in securitizations was estimated by management based on future
projected recoveries employing the Company's Portfolio Analysis Tool (PAT). PAT
projected recoveries were reduced by 20% to take into account unforeseen
reduced collection trends and further reduced for the estimated costs to
service in the future at the 20% servicing rates established in the servicing
documents and then discounted at 12% per annum, reflecting the Company's
estimate of a reasonable rate of return on a subordinated retained interest.
This methodology results in an effective total discount of over 30% applied to
the Company's projected recoveries. Interest income is accrued on the carrying
value of the investment in securitizations at 12% per annum for the estimated
remaining life of the receivables of approximately five years. Once the
securitization notes are retired, any collections will be applied to amortize
the investment in securitizations including accrued interest income. The
investment in securitizations will be accounted for under the provisions of
SFAS 115 as a security available for sale and marked to market in the
stockholders' equity accounts of the Company. As of December 31, 1998 the
amount of fair value over amortized cost is recorded as unrealized gain in the
Company's
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stockholders' equity accounts. As of December 31, 1998, the fair value of
investment in securitizations was $30.3 million and the unrealized gain was
$11.0 million (pre-tax) or $6.7 million (net of taxes). Unrealized gains may
fluctuate based upon changes in the discount rate utilized by the Company and
changes in collection rates.
Property and Equipment. Property and equipment, net, increased 70.7% to $2.4
million as of December 31, 1998 from $1.4 million as of December 31, 1997 due
to $1.4 million in purchases (principally through capital leases) of computer
equipment net of $369,000 of depreciation.
Deferred Costs. Deferred costs decreased to $475,000 as of December 31, 1998
from $535,000 as of December 31, 1997. The deferred costs as of December 31,
1997 which represented costs incurred related to the initial public offering
and the Initial Securitization, were eliminated upon completion of these
transactions in 1998. The deferred costs as of December 31, 1998 represents
costs incurred related to the establishment of the revolving line of credit and
warehouse facilities.
Accounts Payable and Accrued Expenses. Accounts payable and accrued expenses
increased 148.3% from $653,000 at December 31, 1997 to $1.6 million at December
31, 1998. The increase was principally due to increased accrued legal and
accounting costs incurred in connection with the Second Securitization and
higher accounts payable associated with increased payroll levels.
Notes Payable and Capitalized Lease Obligations. Notes payable increased
from $2.1 million as of December 31, 1997 to $6.8 million as of December 31,
1998. Capitalized lease obligations increased from $972,000 to $1.7 million for
the same period. The increase in notes payable was attributable to receivables
purchased under a line of credit facility offset by repayments on the Company's
former bank line of credit facility from proceeds from the Initial
Securitization in June 1998. The increase in capitalized lease obligations is
due to equipment purchases net of lease payments.
Deferred Income. As of December 31, 1997 the Company had deferred income of
$895,000. During the first quarter of 1998, the deferred income was recognized.
Historically, the Company purchased receivables from time to time with
commitments from a third party to purchase a portion of the newly purchased
receivables. The Company entered into three such transactions during 1996
resulting in gains totaling $996,000. In 1997, a complaint was filed against
the Company by one such purchaser. In June 1997, the Company settled, resulting
in a dismissal of the complaint. Under the terms of the settlement, the Company
agreed to repurchase the receivables for approximately $1.3 million, as
adjusted for collections until consummation of the repurchase, resulting in
deferred income of $895,000. The repurchase occurred in February 1998 for
approximately $1.0 million. The portfolio was resold in February 1998 to a
financial institution for $800,000. The Company recognized a gain on sale of
approximately $658,000 in the first quarter of 1998, approximately $404,000
after tax.
Deferred Tax Liability. The Company's deferred tax liability at December 31,
1998 was $11.9 million compared to $1.1 million as of December 31, 1997. This
increase of $10.8 million was primarily attributable to an increase in deferred
income for tax purposes since the gain on sale and the unrealized gain are not
taxable income and the securitization notes are treated as a financing
transaction and was further attributable to a decrease in deferred tax benefit
on previously deferred gain on sale reported in the first quarter of 1998 for
book purposes.
Total Stockholders' Equity. Total stockholders' equity increased $44.3
million to $46.4 million at December 31, 1998 from $2.1 million at December 31,
1997 as a result of net income of $10.2 million during year ended December 31,
1998, $27.3 million of additional paid in capital resulting from the Company's
initial public offering, $410,000 of additional paid in capital resulting from
the Subordinated Notes, reduced by $270,000 by the Company's common stock
purchase for the Company's benefit plans, and increased by $6.7 million (net of
taxes) from unrealized gains related to the fair value of the Company's
investment in securitizations.
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Liquidity And Capital Resources
Historically, the Company has derived substantially all of its cash flow
from collections on finance receivables and servicing income. In the past, the
primary sources of funds to purchase receivables were cash flow, the sale of
participations to third parties, and borrowings under a former bank line of
credit facility.
As an additional means of increasing the amount of receivables under
management, in August 1997, the Company entered into an exclusive servicing
agreement with a financial institution pursuant to which the Company serviced
approximately 400,000 additional accounts representing approximately $737
million of charged-off amount of receivables. The Company exercised a right to
purchase these receivables and included this portfolio in the Initial
Securitization.
In April 1998, the Company issued $5.0 million of Subordinated Notes in a
private placement transaction. These notes were repaid upon consummation of the
initial public offering. In connection with the private placement, the Company
issued warrants to purchase 396,000 shares of common stock exercisable at
$12.00 per share and warrants to purchase 54,000 shares of common stock
exercisable at $15.50 per share.
On June 19, 1998, the Company completed the Initial Securitization. Gross
proceeds of the Initial Securitization were $14.5 million. After securitization
expenses, the purchase of the receivables for which the Company acted as
servicer, and the funding of a reserve amount required in the securitization,
the Company retired its notes payable to its existing senior lender of $1
million resulting in net cash proceeds available for working capital (including
receivables purchases) of $5.8 million.
On August 3, 1998, the Company completed an initial public offering of its
common stock and, after payment of underwriting discounts and commissions and
other offering expenses, received net proceeds of $27.3 million. A portion of
these proceeds was used to repay principal and interest on the Subordinated
Notes; of the remaining proceeds, a portion has been used to make additional
portfolio purchases and the balance was added to working capital.
In September 1998, the Company, through a special-purpose financing
subsidiary, entered into a securitized receivables acquisition facility (the
"Warehouse Facility") with Banco Santander, New York. Utilizing an indenture
and servicing agreement and an independent trustee, the Company secured a $30
million two-year commitment. The Warehouse Facility carries a floating interest
rate of 65 basis points over LIBOR and is "AA" rated by Standard & Poor's
Corporation. The Warehouse Facility is secured by a trust estate, primarily
consisting of certain receivables to be purchased by the Company. The Company
placed some of the receivables assembled in the facility into the
securitization completed in December 1998 and may securitize additional
receivables that are part of this trust estate, subject to market conditions,
although the Warehouse Facility does not require such a take out. Generally,
the Warehouse Facility provides 95% of the acquisition cost of receivables
purchased and the Company funds the remaining 5%. The Company also made a one
time $900,000 liquidity reserve payment. Borrowings under the Warehouse
Facility are interest-only for six months, after which time all collections of
receivables, after payment of servicing costs including the servicing fee for
the Company, are used to reduced the borrowings.
In October 1998, the Company entered into a $20 million revolving line of
credit with a commercial lender to provide receivables acquisition financing
(the "Line of Credit Facility") with Sunrock Capital Corp., a commercial
lender. The facility has a term of three years during which time the Company
may borrow and repay funds to purchase receivables at 80% of cost. Interest is
based on prime plus 0.5% or LIBOR plus 2.5% at the option of the Company on
each advance. The facility is secured by substantially all of the Company's
assets, other than receivables in the Warehouse Facility. Together, with the
Warehouse Facility discussed above, the Company's receivables acquisition
facilities equal $50 million in revolving acquisition lines.
As of December 31, 1998, the Company had cash and cash equivalents of $7.9
million. Capital expenditures from operations were $347,000 for the year ended
December 31, 1998. Capital additions made pursuant to capital leases were $1.0
million in 1998. Receivables purchases were $58.3 million for the year ended
December 31, 1998.
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On December 29, 1998, the Company completed the Second Securitization. Gross
proceeds of the Second Securitization were $27.5 million. The Company received
total cash of $7.4 million, after repayment of associated debt and the
Company's cash used to finance the receivables of $19.5 million in the
aggregate and payment of related transaction costs. Of the $7.4 million in
total cash, $1.6 million was used to fund a reserve account in trust, leaving
net cash of $5.8 million for use in the Company's business.
The debt service requirements associated with borrowings under the new
credit facilities will significantly increase liquidity requirements although
both the Line of Credit Facility and the Warehouse Facility have interest only
periods for up to six months. The Company anticipates that its operating cash
flow and proceeds from this offering and its existing credit facilities will be
sufficient to meet its anticipated future operating expenses, and receivables
purchases and to service its debt requirements as they become due. To the
extent the Company is successful in closing additional term securitizations,
amounts repaid under both facilities may be reborrowed.
Year 2000
The Year 2000 issue arises out of potential problems with computer systems
or any equipment with computer chips that use dates where the date has been
stored as just two digits (e.g. 98 for 1998). On January 1, 2000, any clock or
date recording mechanism, including date sensitive software, which uses only
two digits to represent the year, may recognize a date using 00 as the year
1900 rather than the year 2000. This could result in a system failure or
miscalculations and cause a disruption of operations, including, among other
things, a temporary inability to process transactions, send letters and
statements or engage in similar activities.
The Company believes it has replaced or modified all of its critical
computer systems and business applications software in the normal course of its
business expansion and that its computer systems will be able to utilize
properly dates beyond December 31, 1999. The Company used its in-house
programmers in the modification. Accordingly, the Company is unable to identify
separately the costs of making these systems Year 2000 compliant.
Most of the Company's major vendors are the largest credit grantors in the
country, which the Company expects will become Year 2000 compliant due to the
nature and financial strength of these businesses. Additionally, the Company
does not generally communicate on-line with credit grantors on a continuing
basis, but rather receives discrete data files for analysis and to support
recovery activities. The Company has to date been able to convert data received
from credit grantors and other third parties to be Year 2000 compliant and
expects that it will continue to be able to do so in the future. The Company is
in the process of seeking Year 2000 certifications from key vendors.
The Company also relies on internal and third-party information databases in
its portfolio analysis and collection efforts. A significant amount is
maintained in internal databases. However, the Company must timely receive new
data from third party sources and an interruption in this data supply could
adversely affect the Company's ability to purchase additional portfolios and to
collect on existing receivables. The Company has successfully checked and
converted third-party data that is not Year 2000 compliant, and based on its
efforts to date, believes that it can continually effect any necessary
conversions.
The Company's collection efforts rely heavily on telephone systems. The
Company has contracts with multiple telephone carriers. Based on communications
with vendors to date, the Company believes that major telephone systems will
not be interrupted by Year 2000 failures. However, if a protracted and major
disruption in the availability of local or long-distance telephone service were
to occur as the result of the Year 2000 problem or otherwise, the Company's
collection efforts, and therefore its operations, could be materially adversely
affected. Disruption of power supply by the Company's electric utilities could
also have a serious effect on the Company's ability to conduct business.
Inflation
The Company believes that inflation has not had a material impact on its
results of operations for the three years ended December 31, 1996, 1997 and
1998.
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Quantitative and Qualitative Disclosures About Market Risk
The Company retains an investment in securitizations with respect to its
securitized receivables which are market risk sensitive financial instruments
held for purposes other than trading; it does not invest in derivative
financial or commodity instruments. This investment exposes the Company to
market risk which may arise in the credit standing of the investment in
securitizations and in interest and discount rates applicable to this
investment.
The impact of a 1% increase in the discount rate used by the Company in the
fair value calculations would decrease the fair value reflected on the
Company's balance sheet by $783,000 as of December 31, 1998. There would be no
impact on the Company's future cash flows or net earnings.
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BUSINESS
General
Creditrust is a leading information-based purchaser, collector and manager
of defaulted consumer receivables. Defaulted consumer receivables are the
unpaid debts of individuals to credit grantors, including banks, finance
companies, retail merchants and other service providers. Creditrust seeks to
use its proprietary pricing models and software systems as well as extensive
information databases to generate high rates of return on purchased
receivables. Most of the Company's receivables are VISA(R) and MasterCard(R)
credit card accounts that the issuing banks have charged off their books for
non-payment. By purchasing receivables, the Company allows credit grantors to
enhance their yields by making a recovery on these charged-off accounts. Since
its founding in 1991 through December 31, 1998, Creditrust has invested $69.0
million to purchase receivables at a significant discount. At December 31,
1998, the Company managed 1.3 million accounts with a charged-off amount of
over $2.5 billion. The Company currently has over 640 employees and operates
two facilities which can accommodate over 900 employees.
Industry Overview
According to a January 1999 statistical release by the Federal Reserve,
consumer credit at the end of November 1998 exceeded $1.3 trillion. Duff &
Phelps projects that consumer credit will grow to over $1.48 trillion by the
year 2000.
Outstanding credit card receivables have grown as the share of credit card
debt within consumer credit has increased. According to the Nilson Report
credit card receivables represented 41% of consumer credit or $459 billion in
1995 and 44% or $557 billion in 1997. This share of credit card debt is
expected to rise to 46% or $636 billion in 2000 and 51% or $828 billion in
2005.
Credit Card Receivables
[GRAPH APPEARS HERE]
$ billions
1995A 1997A 2000E 2005E
----- ----- ----- -----
VISA(R), MasterCard(R) 321 397 464 621
Other credit card issuers 138 160 172 207
Credit card receivables: VISA(R), MasterCard(R) and other credit card issuers
Data Source: Nilson Report
25
<PAGE>
As the amount of credit card debt has risen, total delinquencies have grown
as well. According to the August 1998 Nilson Report the dollar amount of
VISA(R) and MasterCard(R) delinquencies increased from $12.6 billion in 1995
(3.93% of debt outstanding) to $18.8 billion in 1997 (4.72% of debt
outstanding) and is expected to increase further as set forth in the chart
below:
Total Credit Card Delinquencies
VISA(R) and MasterCard(R) Accounts
[GRAPH APPEARS HERE]
$ billions
1995A 1996A 1997A 1998E 1999E 2000E 2001E 2002E 2003E 2004E 2005E
----- ----- ----- ----- ----- ----- ----- ----- ----- ----- -----
12.6 17.7 18.8 20.4 21.4 22.4 23.4 23.8 24.0 27.5 32.0
Data Source: Nilson Report
According to the Nilson Report gross credit card charge-offs (including all
credit card issuers) as of 1990 was $9.1 billion or 3.83% of total outstanding
credit card receivables and increased in 1997 to $36.3 billion or 6.48% of
outstandings. Concurrently with the increase in the level of charged-off
consumer debt, credit grantors have sought a variety of ways to increase their
collections. Generally, there are three alternatives credit grantors have to
collect outstanding indebtedness: (1) maintain an internal collection staff,
(2) outsource collection efforts to traditional third-party collection
agencies, or (3) sell portfolios of charged-off debt to third parties such as
Creditrust who are willing to pay cash for those accounts. Historically, credit
grantors have relied upon large internal collection staffs for their initial
collection efforts, which efforts tended to be transferred to third-party
collection agencies for accounts delinquent for more than 180 days. More
recently, in an effort to focus on core business activities and to take
advantage of economies of scale, better performance and the lower cost
structure offered by third parties, many credit grantors have chosen to
outsource some or all of their collection efforts. Further, credit grantors
have realized that by removing non-performing consumer loans from their systems
and balance sheets through bulk sales of portfolios of non-performing consumer
loans, they can redirect their personnel and assets to service their performing
loan customer base and can receive immediate cash flow in the amount of the
discounted sale price.
The secondary market for charged-off credit card portfolios has expanded as
a result of the significant growth in delinquent credit card portfolios at
major credit card issuing banks and the increasing tendency for banks to sell
their portfolios of non-performing consumer loans to asset recovery
specialists. The Nilson Report states that the total value of credit card
portfolios brokered or sold directly, which was $3.0 billion in 1993, reached
$19.5 billion in 1997, and is projected to grow to $25.0 billion by 2000.
Strategy
Creditrust's business goal is to be the most efficient purchaser, collector
and manager of receivables within its targeted markets. Creditrust seeks to
attain this goal by emphasizing customer-focused services, investing in
information technology and maintaining an information advantage over its
competitors. The key elements of Creditrust's business strategy are:
26
<PAGE>
. Enhance Our Knowledge of Our Customer Base by Expansion of Our Extensive
Information Databases. Creditrust maintains extensive information
databases compiled from seven years of analyzing and managing over 1.3
million consumer accounts. Creditrust has also developed and is upgrading
on an ongoing basis its proprietary software tools which it uses to
analyze and score portfolios offered to it for sale and to manage the
collections and information flow process. These systems and data provide
the Company with an information advantage over its competitors and allow
it to (1) buy portfolios on more favorable terms than competing buyers
who lack its information technology advantage, (2) collect the portfolios
efficiently and (3) identify trends in defaulted consumer portfolios
earlier than its competitors who lack this knowledge advantage.
Creditrust's information technology tools enable it to buy portfolios
which management believes can yield the most attractive returns on its
investments. Through its sophisticated revenue management systems,
Creditrust can apply the most appropriate collection process to an
individual account.
. Emphasize a Flexible, Customer-Focused Collection Process. The Company
believes that it resolves defaulted consumer receivables more efficiently
than its competitors, credit grantors and third-party collection
agencies. The Company is not faced with the various regulatory and
financial reporting constraints that many credit grantors face. Because
Creditrust's only business is the collection of defaulted consumer
receivables, it is not subject to some of the business and customer
relations constraints faced by credit grantors which must consider the
effect of their collection decisions on their lending business. In the
case of third-party collection agencies, the Company is able to offer
credit terms which most other collectors cannot. Third-party collection
agencies normally work on a cycle which requires them to complete working
a portfolio in a specified period of time. These considerations work
together to enable the Company to structure repayment plans that are
flexible and present, in the Company's belief, more attractive and
realistic repayment prospects.
. Maintain Strong Relationships with Leading Credit Grantors. The Company
pioneered the purchase of defaulted consumer receivables and has
developed strong relationships with many of the largest credit grantors
from which it is a frequent buyer. These relationships offer the Company
the regular opportunity to be invited to bid on a range of portfolios. In
addition, the Company has secured "forward flow" contracts with a number
of leading credit grantors. Forward flow contracts provide for a credit
grantor to sell some or all of its receivables over a period of time to
Creditrust on the terms agreed to in the contracts. The diversity of the
credit grantors and their respective customer bases also allows the
Company to maintain geographically diversified portfolios.
. Continue Employee Training. The Company has developed highly effective
training programs and methods. In contrast to many third-party collection
agencies, the Company trains its employees to function in a manner
similar to financial counselors. Our employees routinely help customers
with issues related to their financial health and credit history. The
Company seeks to instill in its employees a culture of professionalism
and reinforces this message through incentive arrangements intended to
moderate the rate of employee turnover in an industry that typically has
high turnover rates.
. Use of Current Platform to Sustain Growth. In 1996 and 1997, the Company
made extensive commitments to expand its operations by moving into new
corporate headquarters and opening its operations center. It has invested
in information technology and telephony systems capable of supporting as
many as 900 account officers. Key members have been added to the
management team. As a result of these investments, Creditrust believes it
is capable of servicing substantially larger volumes of receivables
without incurring proportional infrastructure and additional fixed costs.
. Develop New Products and Services. The Company believes that it may be in
a position to offer additional products and services to its customers
that aid customers in managing their debts and, where possible, improving
their credit standing. In September 1998, the Company announced the
introduction of its Creditrust Plus MasterCard(R) program. This card is
issued by a third-party bank under Creditrust's name and is intended to
afford certain customers the opportunity to reestablish credit and create
a new positive credit history, while satisfying their existing Creditrust
receivable balance. The Company may introduce other programs from time to
time in the future.
27
<PAGE>
Receivables Analysis and Acquisition
Creditrust purchases defaulted consumer receivables that have been incurred
through VISA(R), MasterCard(R), private label credit cards and consumer loans
issued by credit grantors, including banks, finance companies, retail merchants
and other service providers. The receivables typically are charged-off by the
credit grantors after a default-period of 180 days. The Company focuses on
purchasing such charged-off receivables. From the time of purchase, Creditrust
has found that the average portfolio of receivables has an estimated economic
life of 60 months.
Portfolios of receivables typically are purchased by Creditrust at a
discount from their charged-off amount, typically the aggregate unpaid balance
at the time of charge-off. There is an inverse correlation between purchase
price and the perceived effort necessary to recover the receivables. Some
credit grantors pursue an auction type sales approach by constructing a
portfolio of receivables and seeking bids from specially invited competing
parties. Other means of purchasing receivables include privately negotiated
direct sales when the credit grantors contacts known, reputable purchasers and
the terms are negotiated. Credit grantors have also entered into "forward flow"
contracts that provide for a credit grantor to sell some or all of its
receivables over a period of time to a single third party on the terms agreed
to in a contract.
Creditrust has entered into forward flow contracts with a number of credit
grantors. These contracts obligate Creditrust to make monthly purchases of
receivables portfolios providing they meet certain agreed-upon criteria. The
Company projects its obligations under these contracts based upon the Company's
experience to date, its estimates of future receivable offerings meeting these
criteria, and its expectations for general market conditions for receivables.
Based upon these factors, the Company estimates that its monthly obligations
under existing forward flow contracts will range from $12.0 million in January
1999 to $1.0 million in December 2000. The Company believes that it will have
sufficient liquidity to meet any future monthly obligations under these
contracts. See Note N of Notes to Consolidated Financial Statements.
The Company has historically funded its receivables purchases and the
expansion of its business through a combination of bank and other credit
facilities, public and private equity funding and asset-backed securitizations.
The Company believes that its growth is partially attributable to its diverse
funding arrangements.
The Company's Acquisitions Department locates and develops new and
continuing sources of portfolios of defaulted consumer receivables for
purchase. Once such portfolios are located, the Acquisitions Department is
responsible for coordinating due diligence, including site visits as needed,
coordinating ordering, receipt, tracking and distribution of account
documentation and related media, and ensuring that Creditrust's purchase costs
stay within clearly defined parameters. The Acquisitions Department also
supervises the Post-Purchase Liaison Group, a group that verifies buy-backs and
returns with sellers after the purchase of receivables. The Post-Purchase
Liaison Group also coordinates the import of purchased portfolios into Mozart,
the Company's proprietary revenue and workflow management software system, and
routinely supports the efforts of both the Legal and Recovery Departments by
facilitating the receipt of additional information from the seller which is
pertinent to an account or group of accounts such as account statements or loan
files.
In order for Creditrust to consider a potential seller as a portfolio
source, a variety of factors must be considered. A seller should be able to
demonstrate a significant volume of receivables available for sale and the
reasonable expectation of significant capacity for subsequent sales. To attempt
to avoid an unacceptable level of returned accounts resulting from verified
fraud, prior satisfaction or erroneous sale, all qualified sellers must be able
to demonstrate that they have satisfactory procedures in place for internal
audits, underwriting criteria, post-sales support and return/buy-back
warranties.
Before purchasing any receivables, Creditrust receives a due diligence disk
or tape containing information about each of the accounts being proposed for
sale. Creditrust uses its PAT software to analyze electronic information
provided on each receivable account being proposed for sale. PAT reviews and
analyzes each account and compares its asset type, last known geographic
location of the customer, age since last collection, charged-off amount and
other characteristics with Creditrust's recovery results from similar
receivables
28
<PAGE>
purchased in the past. This computer model is updated automatically every time
a customer payment is received. PAT produces a comprehensive analysis of the
proposed portfolio, which compares receivables in the proposed portfolio with
Creditrust's recovery history on similar receivables in other portfolios. PAT
then summarizes all anticipated recoveries and projects a recovery value
expressed in both dollars and liquidation percentages for the first year, as
well as the total recovery for the portfolio's estimated five-year economic
life. In order to determine a bid price for a portfolio, the Company uses the
PAT-projected recovery value. This projection is taken in concert with the
Company's knowledge of the current consumer credit marketplace and any
subjective factors that may be available regarding the portfolio or seller. The
Company has a credit committee (the "Credit Committee") which is composed of
the Company's Chief Executive Officer, Chief Financial Officer and Vice
President of Acquisitions. The Credit Committee, by unanimous decision,
determines whether to purchase the portfolio of receivables and establishes a
minimum and maximum bid range based on the PAT-projected recovery for the
portfolio.
It is not uncommon for a seller to require an almost immediate analysis and
funding. The Company's ability to accomplish next-day turnaround on pricing and
funding provides it with a significant competitive advantage.
PAT was developed based on the theory that each portfolio, no matter how
similar it may appear to other similar size portfolios, has its own unique
"fingerprint," because of the individual receivables of which it is comprised.
No two portfolios will score the same on PAT because of the different
characteristics of the receivables in each portfolio. For example, two
similarly aged portfolios would score differently because the underlying
receivables are located in different geographic areas.
PAT utilizes a sophisticated CHAID (Chi-squared Automatic Interaction
Detector) algorithm to sort each account in the proposed portfolio (the
population) and constructs classification trees evaluating distinct segments of
the population based upon one or more predictor variables. CHAID is an
algorithm that calculates the probability that the observed relationship
between the predictor and the dependent variable would occur if the predictor
and the dependent variable were statistically independent of each other. Using
statistical significance, CHAID automatically subgroups the data into
exhaustive and exclusive segments which differ significantly in terms of a
target variable (exhaustive means that every data point belongs to at least one
segment, while exclusive means that every data point belongs to only one
segment). This method of analysis is very flexible. Classification trees can
examine the effects of predictor variables one at a time, unlike regression,
which examines them all at once.
The CHAID analysis begins by dividing the population into two or more
distinct segments based upon predictor variables. It continues by segmenting
each of the newly created sub-segments, or nodes, based upon a secondary
predictor variable. This process is repeated until no more distinct subgroups
can be created.
In Creditrust's situation, the liquidity of accounts would be Y, while those
factors which are related to liquidity would be X. Here, liquidity pertains to
the expected recovery on a receivable divided by its charged-off amount. The
target variable is predicted liquidity, and the predictor variables are factors
which are related to the ability to collect payments, including numerous
cohorts such as age of the account, size of the account balance and
geographical location. The average historical liquidity for each segment is
then used to forecast future liquidity for any accounts which fall into the
specific segment. A relationship between Y and X does not fit any mathematical
functional form. The majority of accounts will have zero liquidity as most of
Creditrust's collections come from a small number of customers. This skewed
distribution does not lend itself to traditional regression analysis. Moreover,
it is accurate to separate accounts into groups and identify those customers
who have a high likelihood of collection. For this reason, the CHAID algorithm
is utilized to forecast liquidity as it appears to exhibit a relatively high
confidence level for predictive analysis of recovery on these accounts.
In analyzing a portfolio of receivables for purchase, the Company reviews
various characteristics of the individual receivables within the portfolio. The
following tables illustrate certain of the characteristics of receivables owned
by the Company at specified dates. Because a significant portion of the
Company's customers recently have experienced some life-altering event, the
Company has found that a period of time must pass before those customers are
able to commence recovering financially. Newer receivables (i.e., receivables
that are between three and eighteen months past due) generally
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<PAGE>
are more expensive to purchase than older receivables. The range of age since
default on receivables managed by the Company in respect of both number of
accounts and charged-off amount as of December 31, 1996, 1997 and 1998 is as
follows:
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1997 December 31, 1998
--------------------------------------------------- ------------------------
Charged- Charged- Charged-
off off off
No. of Amount No. of Amount No. of Amount
Year Accounts (millions) Year Accounts (millions) Year Accounts (millions)
---- -------- ---------- ---- -------- ---------- ---- -------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
0-2 89,548 $167.6 0-2 73,685 $146.9 0-2 488,276 $1,052.7
2-4 57,809 $130.7 2-4 428,646 $796.1 2-4 228,792 $ 401.7
4-6 30,999 $ 66.5 4-6 52,454 $117.5 4-6 473,105 $ 919.7
6+ 15,210 $ 21.4 6+ 25,553 $ 44.0 6+ 75,356 $ 155.3
</TABLE>
Creditrust specializes in purchasing larger balance receivables. The Company
has found the best cost-to-collect ratio generally occurs when the charged-off
amount is at least $1,000, and typically less than $8,000. Select ranges of
charged-off amounts of receivables managed by the Company as of December 31,
1996, 1997 and 1998 are as follows:
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1997 December 31, 1998
-------------------------------------------------------------------- ---------------------------------
Charged- Charged- Charged-
No. of off Amount No. of off Amount No. of off Amount
Range Accounts (millions) Range Accounts (millions) Range Accounts (millions)
------------- -------- ---------- ------------- -------- ---------- ------------- -------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
$0-$1,000 70,680 $ 40.2 $0-$1,000 184,176 $113.4 $0-$1,000 537,928 $ 270.3
$1,001-$5,000 109,703 $251.2 $1,001-$5,000 362,891 $764.5 $1,001-$5,000 618,732 $1,367.3
>$5,001 13,183 $ 94.7 >$5,001 33,271 $226.7 >$5,001 108,869 $ 891.7
</TABLE>
The Company's receivables grouped by asset type as of December 31, 1996,
1997 and 1998 were as follows:
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1997 December 31, 1998
---------------------------------------------------------------------- -----------------------------------
Charged- Charged- Charged-
No. of off Amount No. of off Amount No. of off Amount
Asset Type Accounts (millions) Asset Type Accounts (millions) Asset Type Accounts (millions)
-------------- -------- ---------- -------------- -------- ---------- -------------- --------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
VISA(R)/ VISA(R)/ VISA(R)/
MasterCard(R) 102,969 $229.0 MasterCard(R) 487,249 $942.4 MasterCard(R) 1,108,085 $2,243.5
Private Label/ Private Label/ Private Label/
Discover(R) 38,032 $ 39.0 Discover(R) 38,077 $ 39.1 Discover(R) 43,498 $ 45.8
Installment Installment Installment
Obligations 52,565 $118.1 Obligations 55,012 $123.1 Obligations 113,946 $ 240.1
</TABLE>
The seller must be able to demonstrate that the receivables originated from
a satisfactory geographic distribution, because the Company has found that
heavy concentration in a single state or area creates a substantially greater
risk of non-recovery. The size of receivables balances falls within the range
that the Company has found to provide the best cost-to-collect ratio.
Creditrust also reviews the geographic distribution of the proposed receivables
for reasons other than to avoid portfolios concentrated in one or a few areas.
For example, certain states have more debtor-friendly laws than others and,
therefore, would be less desirable from an account officer's perspective.
Additionally, different regions may place differing degrees of importance on
fiscal responsibility and creditworthiness. Based on experience and historical
data, the Company attempts to determine the future recovery potential of the
receivables in a given portfolio.
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<PAGE>
State credit laws, population demographics and population size affect the
number of accounts originating from a particular state, as well as the
collectibility of these accounts. The Company's portfolios are broadly
dispersed across the United States, as shown in the following chart:
Portfolio Composition by State
[CREDITRUST CORP. PIE CHART APPEARS HERE]
North Carolina 2.40%
Illinois 2.86%
New Jersey 3.25%
Maryland 2.69%
Massachusetts 3.87%
Pennsylvania 3.68%
New York 8.90%
Florida 10.59%
Texas 11.92%
California 16.96%
Other States 32.88%
This quantitative and qualitative data is evaluated together with
Creditrust's knowledge of the current debt marketplace and any subjective
factors that may be available regarding the portfolio or the seller. The Credit
Committee must decide unanimously whether to purchase the portfolio and, based
on the Company's internal guidelines and limited by the specific portfolio's
PAT score, the committee determines the maximum price that Creditrust would be
willing to pay for the given portfolio and the bid price which will maximize
yield on the receivables. Once a particular purchase has been agreed upon, the
acquisition is documented in an agreement that contains customary terms and
conditions.
In December 1998, Creditrust purchased approximately 200,000 defaulted
customer accounts from a large provider of wireless telephone services. The
wireless telephone industry is growing rapidly and the Company purchased these
receivables primarily to gain experience with this type of account as a
possible source of future receivables purchases.
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<PAGE>
Servicing Organization
Creditrust utilizes two servicing facilities. The headquarters facility,
approximately 19,000 square feet, houses the executive offices and servicing
facilities for approximately 225 employees. The second facility, approximately
36,000 square feet, serves as Creditrust's primary operations center and is
designed to house approximately 700 additional employees, along with
information systems and recruiting departments. Currently, the Company has over
640 employees and is organized into five functional departments: Acquisitions;
Information Technology; Skiptrace; Recovery and Legal.
Information Technology Department
The Information Technology ("IT") Department is the backbone of the
Company's operations, handling all computer and telephone systems and providing
for the ongoing development necessitated by both technological advances and
business needs. The IT Department is responsible for the ongoing enhancement of
Mozart and PAT, servicing reports and database developments. The IT Department
regularly reports to all credit bureaus on the Company's entire portfolio. The
IT Department works in concert with the Acquisitions Department to import,
analyze and evaluate all prospective purchases using PAT. The technologies
serviced by this Department include:
Software. PAT and Mozart were developed in-house by Creditrust's
programmers. The software is written in a high-speed, relational database
language and is designed to reside on powerful, but readily available, servers.
Both programs have been in use for more than six years and are considered to be
bug-free. Back-up tapes of account information are recorded each day and are
stored at an off-site location for safety and security.
Computer Hardware and Networks. The software programs reside on three
Novell-based servers and are connected via fiber-optic wide area networks and
local area networks to Intel Pentium(R)-based PCs. The call centers have been
fully wired so that additional employee terminals simply may be placed onto
open desks and plugged into the network. The architecture of the system is
technologically sophisticated, while remaining easily scaleable and updateable,
two features critical to the rapid growth anticipated by the Company. The
current architecture is capable of supporting 1,500 account officers with the
simple addition of PCs. This should allow the Company to experience significant
growth without a need for further upgrade in the near-term. The systems are
fully redundant so as to ensure uninterrupted operations. The Company has
extensive emergency plans in place for access to an off-site call center
location, should the need arise.
Telephony. The Company employs advanced technology in telephony, including
predictive dialers, automatic routers, two Lucent Technologies Definity(R) G-3
telephone systems (scaleable to over 1,500 account officers) and many other
components. The call centers have been fully wired so that additional account
officer telephones may simply be placed onto an open desk and plugged into the
network. The architecture is technologically sophisticated, while remaining
scaleable and updateable.
Verification and Research of Account Information. When a portfolio of
receivables is purchased, each account automatically is run through an
extensive series of proprietary and commercially available databases to compile
as much information about each receivable as possible. The information is
combined with the information already provided by the credit grantor and
automatically entered into Mozart.
Within 24 hours of importing the Receivable into Mozart account officers
begin calling every telephone number available, and within days a letter is
sent out to the customer advising that Creditrust has purchased the Receivable.
This initial letter is designed to invite discussion or the resolution of the
Receivable and generally contains an offer of settlement at a modest discount.
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<PAGE>
Skiptrace Department-Locating Customers
In the event that contact is not made with a customer based on the compiled
information for that Receivable, the account is automatically transferred to
the Skiptrace Department. Skiptracers are technology-driven telephone
detectives. The Skiptrace Department is divided into multiple teams, each of
which is headed by a supervisor. As an initial step to locate customers, each
skiptracer endeavors to compile a complete "electronic profile" for each
customer and to find every possible telephone number for the customer.
Skiptracers utilize internally developed databases consisting of more than
65,000 creditors, plus a variety of public databases and third-party database
providers. The Skiptrace Department has the capability of accessing real-time
customer credit reports, electronic nationwide directory assistance, an
internally maintained "neighbors file" of over 100 million nationwide residents
and numerous other resources. The Company maintains over 800 million individual
database records on its current and potential customers. Employing any or all
of these tools frequently enables the Skiptracers to locate otherwise
unreachable customers. A working phone number is frequently found for those
customers transferred to the Skiptrace Department. Once a customer is found,
Mozart automatically assigns the customer to one of the teams in the Recovery
Department.
Recovery Department-Servicing Customers and Collection of Receivables
The Recovery Department, unlike a traditional "collections shop," uses a
friendly, customer-focused approach to collect on receivables. Instead of
simply calling about an old bill, Creditrust's employees work to maximize yield
while minimizing customer negativity and maintaining a positive working
environment.
The Recovery Department is responsible for recovering account balances and
selling customer service to our customers. The Company employs advanced
Pentium(R) PC Workstations and sophisticated telephone call management systems
to maximize its employee productivity and thereby increase recovery from its
receivables. The telephone call management systems include predictive dialers,
automated call and account distribution systems, digital switching and
customized computer software. Mozart provides the Recovery Department with: (1)
real-time customer reporting; (2) full customer account data information; (3)
collection discussion notes on each account; (4) telephone numbers and
addresses; (5) payment history; (6) automatic notice of acquisition, settlement
letters, reminders and late payment notices; (7) automatic legal pleadings
production; (8) automatic account distribution to employees; (9) surveillance
of on-screen activity and telephone conversations for quality control,
productivity and regulatory compliance; and (10) exception reports on payment
plans. Creditrust's employees work to maximize yield while minimizing customer
apprehension and maintaining a positive working environment. The Recovery
Department currently is organized into teams of 16 with one supervisor per
team. The supervisors work with the team members and assist employees with
quality control and productivity. Through the Company's extensive network of
computer and telephone systems, each team member in the Recovery Department is
responsible for contacting customers, explaining the benefits of paying
Creditrust, working with customers to develop acceptable means to satisfy their
obligations to Creditrust and recovering the Receivables.
Making Customer Contact. When an account officer is able to establish
contact with a given customer, the customer's account automatically is placed
inside that account officer's work queue. Each account officer is assigned a
number of dedicated customer accounts depending on the account officer's skill
level. This work queue automatically is replenished on a daily basis, by
Mozart, as the receivables are resolved, whether favorably or unfavorably. In
addition to their group of dedicated accounts, account officers receive
Receivables from a general pool daily.
On the initial customer contact call, the customer is given a standardized
and strictly controlled presentation regarding the benefits of resolving its
account with Creditrust. Emphasis is placed on determining the reason for the
customer's default in order to better assess the customer's situation and to
assist in creating a plan for repayment. Creditrust account officers are
trained to follow rigid receivables resolution priorities.
33
<PAGE>
Mozart presents the account officer with all available information and a
variety of resolution options. A large emphasis is placed by the account
officer on making the customer aware of all possible alternative methods
available. The computer system will not allow an account officer to exceed his
or her specified settlement authority without electronic authorization of a
supervisor approval code. Once a customer and the account officer agree to a
repayment schedule, the account officer records the terms of the arrangement in
Mozart. The computer system then automatically will generate a series of
letters reminding the customer of important dates.
Cash Management. Creditrust, through its strong emphasis on technology and
innovation, has built a customer base that is not exclusively dependent on the
postal service to deliver payments. As a result, more than 70% of all payments
are completed by either the Western Union Quick Collect(TM) program, which is
an electronic money order system, or by Creditrust's QuickChek pre-authorized
checks drawn on the customer's checking account. Creditrust participates as an
authorized agent for the Quick Collect(TM) program and is therefore able to
receive payments directly in its offices within minutes. Creditrust's QuickChek
system allows the account officer to obtain the customer's authorization to
reproduce an actual check, drawn on the customer's checking account on an
agreed upon date over a series of months and for the exact amount of the agreed
payment.
Delinquency Follow-Up. The problem of delinquent or late payments on
established repayment plans is greatly mitigated through the use of the Quick
Collect(TM) and QuickChek programs. However, some customers cannot or will not
participate in one of these plans. The Company has developed a system to deal
with late payments to minimize the drain on the productivity of the account
officers. In the event that payment is not received within one day of the
scheduled due date, Mozart automatically issues a late payment letter to the
customer. This is followed by a second letter ten days after the due date.
Unless a scheduled payment is received on or before the day it is due, Mozart
automatically moves the Receivable to the account officer's late queue for
immediate customer contact.
Late Payment Account Officer. When a customer falls more than 30 days late
in a payment plan, the Receivable automatically is transferred to a specially
trained, dedicated late payment account officer. These individuals are tasked
with getting the customer back on track according to the terms of his or her
payment plan or, in certain circumstances, negotiating revised terms for
payment. In some instances, a customer's financial circumstances may have
worsened and a plan that accurately fits the new situation is necessary. In
other cases, the customer is able to dispense with the perceived burden of
monthly installments by making a lump sum payment. The Company induces
resolution through a variety of methods. Late payment account officers act as
financial counselors to the customer and may assist the customer in securing
new resources for the resolution of its account.
Legal Department
An important component of the Company's collections effort involves the
Legal Department and the pursuit of those customers who have the ability, but
not the willingness, to resolve their obligations. Creditrust employs three in-
house attorneys, several paralegals and a dedicated support staff to process
thousands of court cases each year. The Legal Department has the capacity to
internally prepare and file collection proceedings in multiple jurisdictions.
The Legal Department is responsible for coordinating a network of in excess of
55 attorneys nationwide, determining the suit criteria for each individual
jurisdiction, placing cases for immediate suit, obtaining judgment, seizing
bank accounts, repossessing automobiles that have equity, coordinating sales of
property and instituting wage garnishments to satisfy judgments. In addition,
the Legal Department is responsible for overseeing the Company's compliance
with applicable laws, rules and regulations associated with the conduct of its
business.
Foreclosure and Asset Disposition. Creditrust, through its Legal Department,
occasionally engages in the execution and foreclosure of real property. In the
event that a judgment has been secured, and real estate has been verified as
belonging solely to the customer, foreclosure in support of execution of
judgment is
34
<PAGE>
considered. Unlike foreclosure pursuant to the power of sale contained in a
mortgage or deed of trust, a judicial sale of real property follows the state
court rules for sheriff's levy and seizure of property. Those rules vary widely
by state.
Consumer Resolution Center. Creditrust maintains an independent consumer
resolution center to assist its customers in any dispute they may have with
either the original credit grantor or the efforts made by the Company to
resolve the dispute. The Company has found that a function separate from and
that does not operate in the manner of a recovery department can be useful in
resolving certain matters. In turn, Creditrust's employees are freed up to
address accounts that are capable of immediate resolution. The consumer
resolution center benefits the Company by permitting its employees to use their
time more productively.
Compliance Procedures. The Company's policy is to comply with all provisions
of the Fair Debt Collection Practices Act (the "FDCPA") and applicable state
laws, regardless of whether such laws apply to it. The Company monitors
employee activity on an ongoing basis through its Quality Improvement Group.
Employees are trained and tested on their knowledge of the FDCPA, and they are
telephonically monitored for compliance with the FDCPA and the Company's
stringent standards of customer satisfaction and complaint-free receivables
resolution. In conjunction with telephonic monitoring, an employee's
receivables activities are monitored through the Company's DoubleVision system,
which allows a supervisor or manager to observe exactly what the employee sees
on the computer monitor, including every keystroke and every system activity
generated.
On a daily basis, a series of audit reports is generated automatically by
Mozart, including daily management reports, liquidity reports, telephone
reports, skiptrace reports and account officer cash transaction reports. The
flexibility of Mozart allows management to make real-time queries of any
necessary information.
Competition
The Company's business is highly competitive, and it expects that
competition from new and existing companies will intensify. The Company
competes with other purchasers of defaulted consumer receivables and with
third-party collection agencies. The Company's ability to obtain new customers
is also materially affected by the financial services companies that choose to
manage their own defaulted consumer receivables. Some of these companies may
have substantially greater personnel and financial resources. The Company seeks
to compete with these companies on the basis of its superior information
technology capabilities, which the Company believes enable it to purchase,
collect and manage receivables more effectively than its competitors. Following
allegations of fraud, the Company's competitor Commercial Financial Services,
Inc. filed for protection from its creditors under the federal bankruptcy laws
in October 1998. The Company is unable to assess the potential long-term effect
of this development on the industry or the markets for purchasing and financing
defaulted consumer receivables.
Trademarks and Proprietary Information
The Company has obtained federal trademark registrations with the United
States Patent and Trademark Office with respect to the name "Creditrust" and
the Creditrust logo.
The Company relies on trade secrets to protect its proprietary rights in its
systems and information databases. The Company attempts to protect its trade
secrets and other proprietary information through agreements with employees and
other security measures. Although the Company intends to protect its rights
vigorously, there can be no assurance that these measures will be successful.
Government Regulation
The FDCPA and comparable state statutes establish specific guidelines and
procedures which debt collectors must follow to communicate with consumer
debtors, including the time, place and manner of such communications. It is the
Company's policy to comply with the provisions of the FDCPA and comparable
state
35
<PAGE>
statutes in all of its collection activities, although it may not be
specifically subject thereto. If these laws apply to some or all of the
Company's collection activities, the Company's failure to comply with such laws
could have a materially adverse effect on the Company. The relationship of a
customer and a credit card issuer is extensively regulated by federal and state
consumer protection and related laws and regulations. Because many of its
receivables were originated through credit card transactions, certain of the
Company's operations are affected by such laws and regulations. Significant
laws include the Federal Truth-In-Lending Act, the Fair Credit Billing Act, the
Equal Credit Opportunity Act, the Fair Credit Reporting Act and the Electronic
Funds Transfer Act (and the Federal Reserve Board's regulations which relate to
these Acts), as well as comparable statutes in those states in which customers
reside or in which the credit grantors are located. State laws may also limit
the interest rate and the fees that a credit card issuer may impose on its
customers. Among other things, the laws and regulations applicable to credit
card issuers impose disclosure requirements when a credit card account is
advertised, when it is applied for and when it is opened, at the end of monthly
billing cycles and at year end. Federal law requires credit card issuers to
disclose to consumers the interest rates, fees, grace periods and balance
calculation methods associated with their credit card accounts, among other
things. In addition, customers are entitled under current laws to have payments
and credits applied to their credit card accounts promptly, to receive
prescribed notices and to require billing errors to be resolved promptly. In
addition, some laws prohibit certain discriminatory practices in connection
with the extension of credit. Failure by the credit grantors to have complied
with applicable statutes, rules and regulations could create claims and rights
offset by the customers that would reduce or eliminate their obligations under
their receivables, and this could have a materially adverse effect on the
Company. Pursuant to agreements under which the Company purchases receivables,
the Company is normally indemnified against losses caused by the failure of the
credit grantor to have complied with applicable statutes, rules and regulations
relating to the receivables before they are sold to Creditrust.
Certain laws, including the laws described above, may limit the Company's
ability to collect amounts owing with respect to the receivables regardless of
any act or omission on the part of the Company. For example, under the federal
Fair Credit Billing Act, a credit card issuer is subject to all claims (other
than tort claims) and defenses arising out of certain transactions in which a
credit card is used if the obligor has made a good faith attempt to obtain
satisfactory resolution of a disagreement or problem relative to the
transaction and, except in cases where there is a specified relationship
between the person honoring the card and the credit card issuer, the amount of
the initial transaction exceeds $50.00 and the place where the initial
transaction occurred was in the same state as the customer's billing address or
within 100 miles of that address. As a purchaser of defaulted consumer
receivables, the Company may purchase receivables subject to legitimate
defenses on the part of the customer. The statutes further provide that, in
certain cases, customers cannot be held liable for, or their liability is
limited with respect to, charges to the credit card account that were a result
of an unauthorized use of the credit card. No assurances can be given that
certain of the receivables were not established as a result of unauthorized use
of a credit card, and, accordingly, the amount of such receivables could not be
collected by the Company. Pursuant to some agreements under which the Company
purchased receivables, the Company is indemnified against certain losses with
respect to such Receivables regardless of any act or omission on the part of
the Company or the credit grantor.
Additional consumer protection laws may be enacted that would impose
requirements on the enforcement of and collection on consumer credit card or
installment accounts. Any new laws, rules or regulations that may be adopted as
well as existing consumer protection laws, may adversely affect the ability of
the Company to collect the receivables. In addition, the failure of Creditrust
to comply with such requirements could adversely affect the Company's ability
to enforce the receivables.
Properties
Creditrust is headquartered in a leased facility, consisting of
approximately 19,000 square feet, at 7000 Security Boulevard, Baltimore,
Maryland 21244. The headquarters facility has capacity for approximately 225
employees and houses all of the training facilities and administrative offices.
The Company has also leased an
36
<PAGE>
additional facility located approximately two miles from its headquarters at
1705 Whitehead Road, Baltimore, Maryland 21244. This operations center
comprises approximately 36,000 square feet and has the capacity to accommodate
approximately 700 additional employees and expanded training and recruiting
departments. The operations center houses the Company's updated communications
and software systems center, which is fully redundant to the computer center,
located at the corporate headquarters.
In February 1999, Creditrust entered into a lease for additional space in
Maryland to be used for the Company's third call center. The facility consists
of approximately 27,080 square feet and has capacity for approximately 500
employees.
Employees
The Company currently has over 640 full-time employees. None of the
Company's employees are represented by a labor union. The Company believes that
its relations with its employees are good.
Legal Proceedings
The Company is subject to routine litigation in the ordinary course of
business, including contract, collections and employment-related litigation.
None of these routine matters, individually or in the aggregate, is believed by
the Company to be material to its business or financial condition.
Additional Information
The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance
therewith files reports, proxy statements and other information with the
Securities and Exchange Commission (the "Commission"). Reports, proxy
statements and other information filed by the Company with the Commission can
be inspected and copied at the Public Reference Room maintained by the
Commission at 450 Fifth Street, N.W., Washington, D.C. 20549. Information about
the operation of the Public Reference Room may be obtained by calling the
Commission at 1-800-SEC-0330. Copies of such material can also be obtained from
the Commission's Internet web site at http://www.sec.gov. The common stock of
the Company is quoted on the Nasdaq National Market. Reports, proxy statements
and other information concerning the Company can be inspected at the offices of
The Nasdaq Stock Market, 1735 K Street, Washington, D.C. 20006.
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<PAGE>
MANAGEMENT
Directors and Executive Officers
The table below sets forth certain information concerning each of the
executive officers and directors of the Company.
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Joseph K. Rensin............... 33 Chairman of the Board, President and Chief
Executive Officer
Frederick W. Glassberg(1)(2)... 65 Director
John G. Moran(1)(2)............ 53 Director
Michael S. Witlin.............. 30 Director
John L. Davis.................. 36 Vice President, Business Development and
Corporate Secretary
J. Barry Dumser................ 50 Vice President, General Counsel
John D. Frey................... 53 Vice President, Recovery
James L. Isett................. 42 Vice President, Chief Information Officer
Jefferson B. Moore............. 36 Vice President, Acquisitions
Richard J. Palmer.............. 47 Vice President, Chief Financial Officer and
Treasurer
W. Lawrence Petcovic........... 53 Vice President, Human Resources
</TABLE>
- --------
(1) Member of the Audit Committee.
(2) Member of the Compensation Committee.
Joseph K. Rensin, Chairman of the Board, President and Chief Executive
Officer--Mr. Rensin co-founded Creditrust in 1991 and has served as Chairman of
the Board, President and Chief Executive Officer since that time. Mr. Rensin
was the initial developer of the Company's PAT and Mozart systems and its
extensive database, as well as the customer relations approach to collections
and recovery. He attended the University of Maryland College Park from 1983 to
1987. While in college, he wrote three books on computers published by
Prentice-Hall.
Frederick William Glassberg, Director--Mr. Glassberg has been a director of
Creditrust since 1997. Mr. Glassberg has been since 1991 president of Dornbush
Enterprises, Inc., d/b/a Crystal Hill Advisors or its predecessors, Columbia,
Maryland, which provides commercial real estate management advice and financial
advisory services to corporate and municipal clients. Mr. Glassberg serves on
the Board of Directors of three subsidiaries of The Enterprise Foundation that
own low- and moderate-income housing. Earlier in his career, Mr. Glassberg
served as Chief Financial Officer of a subsidiary of The Rouse Company from
1973 to 1983.
John G. Moran, Director--Mr. Moran has been a director of Creditrust since
1997. He has been Associate Dean and Executive-in-Residence of the Sellinger
School of Business and Management at Loyola College in Baltimore, Maryland
since 1995 and was President of The Moran Group, LTD, which offers management
consulting services to for-profit and not-for-profit organizations, from 1995
to 1998. From 1986 until 1995, Mr. Moran was President of Household Bank, FSB
(Eastern Division).
Michael S. Witlin, Director--Mr. Witlin co-founded Creditrust in 1991 and he
served as Vice President of the Company until 1995. From 1995 to 1997, Mr.
Witlin served as a consultant with the Company Entier, providing business
process re-engineering services to privately held and public companies as well
as federal agencies. Since 1998, Mr. Witlin has been a consultant with RWD
Technologies, Inc., providing management and technology consulting services to
Fortune 100 companies.
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<PAGE>
John L. Davis, Vice President, Business Development and Corporate
Secretary--Mr. Davis has been an employee of Creditrust since 1993. Mr. Davis'
duties have included service in the Recovery Department, various functions in
the Legal Department, including Manager of the Legal Department, and more
recently Vice-President of Business Development. Mr. Davis has been
instrumental in the development of Creditrust's nationwide network of
collection attorneys. Prior to joining Creditrust, Mr. Davis worked in two law
firms, while also earning his BS degree in Paralegal Studies at the University
of Maryland.
J. Barry Dumser, Vice President, General Counsel--Mr. Dumser joined
Creditrust in 1997 as its General Counsel. From 1995 to 1997, Mr. Dumser served
as Vice President, Chevy Chase Bank where he managed the bank's bankruptcy and
deceased processing units and supervised the litigation unit, which supported
the collection efforts with respect to the Chevy Chase Bank's approximately $5
billion credit card portfolio. From 1994 to 1995, Mr. Dumser served as Vice
President and Counsel to Matterhorn Bank Programs, and from 1990 to 1993, Mr.
Dumser served as Vice President, Commercial Loan Collateral Control, of First
American Bank of Virginia. Mr. Dumser received his BS in Economics from Wharton
School of Finance and Commerce and his MBA from Boston University School of
Management. Mr. Dumser received his JD from the University of Baltimore School
of Law in 1983 and was admitted to the Maryland Bar that same year.
John D. Frey, Vice President, Recovery--Mr. Frey, joined Creditrust in 1998.
From 1995 through 1998, Mr. Frey managed recovery operations of Chevy Chase
Bank, F.S.B., with a credit card portfolio of approximately $5 billion and
served as Vice President Recovery. From 1992 to 1995, Mr. Frey served as Vice
President, Collections for First Card Services, and from 1990 to 1992, Mr. Frey
was employed by HHL Financial Services, an accounts receivable management
company primarily serving the healthcare industry. In addition, Mr. Frey served
in a variety of managerial roles in the collection operations of American
Express Company from 1968 to 1990.
James L. Isett, Vice President and Chief Information Officer--Mr. Isett
joined Creditrust in 1998. Prior to joining Creditrust, Mr. Isett was with
National Data Corporation from April 1998 to October 1998. He was Chief
Information Officer for Universal Savings Bank, a credit card processor, from
1997 to 1998, an independent information technology consultant from 1996 to
1997, a member of the information technology departments supporting credit card
operations at American Express Company from 1995 to 1996, and Vice President,
Technology at Bank of America NT & SA from 1993 to 1995. He received his BS
degree from Texas Tech University.
Jefferson Barnes Moore, Vice President, Acquisitions--Mr. Moore joined
Creditrust in 1997. From 1994 to 1997, Mr. Moore was Vice President of Koll-
Dove Global Disposition Services, LLC, where he helped the company develop its
industry-leading defaulted consumer receivables brokerage operations. Prior to
Koll-Dove, Mr. Moore was involved in commercial real estate sales for 12 years.
Mr. Moore received his BS degree in Business Administration from the University
of Missouri, Columbia.
Richard J. Palmer, Vice President, Chief Financial Officer and Treasurer--
Mr. Palmer has been Chief Financial Officer of Creditrust since 1996. From 1983
to 1996, Mr. Palmer served as Chief Financial Officer of, and in various other
financial functions for, CRI, Inc., a national real estate investment company
with headquarters in Rockville, Maryland. Prior to CRI, Inc., Mr. Palmer was
with Grant Thornton LLP from 1976 until 1983 and KPMG Peat, Marwick from 1973
to 1976. Mr. Palmer has a BS degree in accounting from Florida Atlantic
University in Boca Raton, Florida. He received his Florida certified public
accounting certificate in 1974, and received reciprocity in the District of
Columbia in 1976.
W. Lawrence Petcovic, Vice President, Human Resources--Mr. Petcovic joined
Creditrust in November 1998. He was Vice President of Training at Chevy Chase
Credit Card Operations Center from 1996 to 1998 and Director of Training and
Total Quality Management for The Ryland Group, Inc, a large homebuilder and
financial services company, from 1989 to 1993. Mr. Petcovic has over 22 years
experience in training, human resources, business process improvement, and
operations.
The Company's officers are elected annually by and serve at the discretion
of the Board of Directors. Creditrust's Board of Directors is not divided into
classes. At each annual meeting of stockholders, directors
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<PAGE>
are elected to serve until the next annual meeting of stockholders and until
their successors have been elected and qualified.
Board Committees
The Board of Directors has standing Audit and Compensation Committees. The
Audit Committee annually recommends to the Board the appointment of independent
certified public accountants for the Company, reviews the scope and fees of the
annual audit and any special audit, and reviews the results with the auditors.
Further, it reviews accounting practices and policies of the Company with the
auditors and the adequacy of the accounting and financial controls of the
Company and submits recommendations to the Board regarding oversight and
compliance with accounting principles and legal requirements. The Compensation
Committee reviews and makes recommendations to the Board regarding salaries and
benefits of officers of the Company and administers the Company's incentive
stock option and employee stock purchase plans.
Compensation of Directors
Directors of the Company who are also employees of the Company do not
receive additional compensation for their services as directors. Non-employee
directors of the Company receive annual director compensation consisting of
shares of common stock with a value of $10,000 pursuant to the Company's 1998
Stock Incentive Plan and $5,000 in cash. Each non-employee director receives
$1,500 for each Board meeting attended in person and $500 for each Board
meeting attended telephonically. In addition, each non-employee director
receives $500 for each committee meeting attended in person and $300 for each
committee meeting attended telephonically. Non-employee directors also are
reimbursed for expenses incurred to attend meetings of the Board of Directors
and its committees. Further, Mr. Witlin was granted an option to purchase
32,258 shares of common stock on the same terms as the grants to executive
officers described below under "Compensation Pursuant to Plans."
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<PAGE>
Executive Compensation
The following table sets forth the compensation paid by Creditrust during
the fiscal years ended December 31, 1997 and December 31, 1998 to Creditrust's
Chief Executive Officer and all other executive officers receiving compensation
in excess of $100,000 in 1997 and 1998 (the "Named Executive Officers").
Summary Compensation Table
<TABLE>
<CAPTION>
Annual
Compensation
---------------- All Other
Name and Principal Position Year Salary Bonus Compensation(1)
- --------------------------- ---- -------- ------- ---------------
<S> <C> <C> <C> <C>
Joseph K. Rensin........................ 1998 $218,846 $ -- $ 1,295
Chairman and Chief Executive Officer 1997 150,010 -- --
Rick W. Chandler(2)..................... 1998 95,022 21,664 91,934(3)
Vice President, Recovery 1997 101,637 22,667 --
John L. Davis........................... 1998 150,010 5,000 1,195
Vice President, Business Development 1997 150,010 16,777 1,772
Jefferson B. Moore...................... 1998 150,010 128,728 1,615
Vice President, Acquisitions 1997 138,470 2,000 --
Richard J. Palmer....................... 1998 150,010 42,584 1,444
Vice President and Chief Financial
Officer 1997 150,010 118,589 188
</TABLE>
- --------
(1) Represents amounts contributed by the Company to the individuals' accounts
in the Company's 401(k) plan.
(2) Mr. Chandler was employed by the Company through September 1998. John D.
Frey became the Company's Vice President, Recovery in September 1998.
(3) Includes the amount paid to Mr. Chandler upon cancellation of his options
in connection with the termination of his employment with the Company.
Employment Agreements
The Company has entered into employment agreements with Messrs. Palmer,
Moore, Frey and Davis. The employment agreements entitle Messrs. Palmer and
Moore to annual incentive compensation in an amount up to $100,000 in the
discretion of the Compensation Committee, in addition to an annual base
compensation of $150,000. Mr. Davis receives annual compensation of $150,000.
Mr. Frey receives annual compensation of $150,000 and incentive compensation
based upon the performance of the Recovery Department. Effective April 14,
1998, the Compensation Committee increased Mr. Rensin's annual salary to
$250,000. Mr. Rensin is also entitled to incentive compensation in an amount up
to $100,000 annually in the discretion of the Compensation Committee.
Messrs. Palmer, Moore, Frey and Davis are entitled to all Company benefits
to which employees generally are eligible, and each is subject to a
confidentiality agreement that prohibits him from disclosing the Company's
proprietary information, removing Company documents or soliciting other
employees for outside employment for two years after he leaves the Company. In
the event of a breach of the confidentiality agreement, the Company is entitled
to liquidated damages of $100 per day for each day the agreement is violated,
among other remedies.
Messrs. Palmer, Moore, Frey and Davis each have agreed not to compete with
the Company for three years from the date he leaves the Company, subject to
certain geographic limitations. Pursuant to his employment agreement, the
Company reimbursed Mr. Moore for $15,000 in moving expenses in connection with
his relocation to Maryland and $10,000 for his temporary residence costs during
the first several months of his employment, as well as certain temporary
financial assistance in connection with his relocation. See "Certain
Transactions."
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<PAGE>
Compensation Pursuant to Plans
1998 Stock Incentive Plan. The Company has reserved a total of 800,000
shares of common stock for issuance pursuant to the Creditrust Corporation 1998
Stock Incentive Plan (the "Stock Plan"). The Stock Plan was established to
provide incentives to motivate and retain key employees of the Company. The
Stock Plan is administered by the Compensation Committee of the Board of
Directors and provides for the grant of incentive stock options and non-
qualified stock options, as well as stock appreciation rights, restricted or
unrestricted stock awards, phantom stock, performance awards, or any
combination of the foregoing. The Compensation Committee is authorized to grant
options under the Stock Plan to all eligible employees of the Company,
including executive officers. Directors who are not also employees of the
Company are eligible for grants under the Stock Plan. Options granted under the
Stock Plan are granted on such terms and at such prices as are determined by
the Compensation Committee, except that the per share exercise price of
incentive stock options granted under the Stock Plan cannot be less than the
fair market value of the common stock on the date of grant. Each option is
exercisable after the period or periods specified in the option agreement, but
no incentive stock option may be exercised after the expiration of 10 years
from the date of grant. No option may be granted under the Stock Plan after
July 29, 2008. Incentive stock options granted to an individual who owns (or is
deemed to own) 10% or more of the total combined voting power of all classes of
stock of the Company must have an exercise price of at least 110% of the fair
market value of the common stock on the date of grant, and a term of no more
than five years. The Board of Directors has the authority to amend or terminate
the Stock Plan, however certain amendments are subject to stockholder approval.
Currently, there are 800,000 shares of common stock available for issuance
under the Stock Plan, of which 312,500 shares are subject to outstanding
options.
Option Grants In Last Fiscal Year
The following table sets forth information regarding non-qualified stock
options granted under the Stock Plan by Creditrust during the fiscal year ended
December 31, 1998 to each of the Named Executive Officers.
<TABLE>
<CAPTION>
Potential
Realizable Value at
Assumed Annual
Rates of Stock
Price Appreciation
Individual Grants for Option Term(4)
---------------------------------------------- -------------------
Number of
Securities Percentage of
Underlying Total Options
Options Granted in Exercise Expiration
Name Granted(1) Fiscal Year(2) Price (3) Date 5% 10%
- ---- ---------- -------------- --------- ---------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
Joseph K. Rensin........ -- -- -- -- -- --
John L. Davis........... 64,516 20.65% $15.50 7/29/08 $628,893 $1,593,739
Jefferson B. Moore...... 64,516 20.65 15.50 7/29/08 628,893 1,593,739
Richard J. Palmer....... 64,516 20.65 15.50 7/29/08 628,893 1,593,739
</TABLE>
- --------
(1) Twenty percent of the options vested on the date of grant and the remaining
options vest at a rate of 20% on each anniversary of the date of grant.
(2) Based on an aggregate of 312,500 shares subject to options grant to
employees, officers and directors of Creditrust in the fiscal year ended
December 31, 1998, including the Named Executive Officers.
(3) The options were granted at an exercise price equal to the fair market
value of the common stock on the date of grant.
(4) As mandated by regulations promulgated by the Commission, the table
describes the hypothetical gains that would exist for the respective
options granted based on assumed rates of annual stock price appreciation
of 5% and 10% from date of grant to the end of the option term. These
hypothetical gains are based on assumed rates of appreciation and,
therefore, the actual gains, if any, on stock option exercises are
dependent on the future performance of the common stock, overall stock
market conditions and the continued employment of the named individuals
with the Company. As a result, the amounts reflected in this table may not
necessarily be achieved.
Messrs. Frey, Isett and Petcovic have been granted options to purchase a
total of 38,306 shares of common stock at a weighted average exercise price of
$16.97.
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<PAGE>
Stock Purchase Plan. The Company has reserved a total of 100,000 shares of
common stock for issuance pursuant to the Creditrust Corporation 1998 Employee
Stock Purchase Plan (the "Stock Purchase Plan"). The Stock Purchase Plan was
established to promote the long-term success of the Company by providing
employees of the Company with a convenient opportunity to become stockholders.
Options granted and shares of common stock purchased under the Stock Purchase
Plan are intended to qualify for the favorable tax treatment for employees
available under Section 423 of the Internal Revenue Code of 1986, as amended.
The Compensation Committee administers the Stock Purchase Plan. Under the
terms of the Stock Purchase Plan, all eligible employees of the Company have
the opportunity to purchase common stock through payroll deductions. The
purchase price is determined by the Compensation Committee but in no event will
it be lower than 85% of the lesser of (1) the fair market value of a share of
common stock on the offering date, or (2) the fair market value of a share of
common stock on the purchase date, provided that the price per share is not
less than par value. The fair market value on any offering date shall be the
average on that date of the high and low prices of a share of common stock on
the principal national securities exchange on which the common stock is
trading. The maximum number of shares for which each employee may purchase
options in each annual period is determined by the Compensation Committee prior
to the commencement of each offering period. The Stock Purchase Plan limits
purchases to $25,000 per participant for each calendar year. The aggregate
amount of shares of common stock that have been reserved under the Stock
Purchase Plan is subject to adjustment for recapitalization, stock dividend,
reorganization, merger, consolidation or other changes in capital affecting the
common stock.
Indemnification of Directors and Officers
Pursuant to the Company's Charter and Bylaws, the Company is obligated to
indemnify each of its directors and officers to the fullest extent permitted by
Maryland law with respect to all liability and losses suffered and reasonable
expenses incurred in any action, suit or proceeding in which such person was or
is made or threatened to be made a party or is otherwise involved by reason of
the fact that such person is or was a director or officer of the Company. The
Company is obligated to pay the reasonable expenses of the directors or
officers incurred in defending such proceedings if the indemnified party agrees
to repay all amounts advanced by the Company if it is ultimately determined
that such indemnified party is not entitled to indemnification. See
"Description of Capital Stock--Limitations on Liability of Officers and
Directors."
43
<PAGE>
CERTAIN TRANSACTIONS
Mr. Rensin had unconditionally and personally guaranteed (the "Guaranty")
the Company's former bank credit facility, including attorneys fees and
expenses, incurred by the bank in enforcing its rights under the Guaranty. A
portion of the proceeds of the Initial Securitization was used to pay off and
terminate this facility, and, consequently the Guaranty has terminated.
Mr. Rensin had unconditionally and personally guaranteed the Subordinated
Notes. A portion of the proceeds of the initial public offering was used to
repay the Subordinated Notes and consequently terminated this subordinated
guaranty.
Jefferson B. Moore, who has served as the Company's Vice President,
Acquisitions since January 22, 1997, received a loan of $78,000 on February 28,
1997 pursuant to his employment agreement. The Company issued the loan to Mr.
Moore and his wife to assist with their purchase of a residence in Maryland.
Mr. and Mrs. Moore paid a $38,000 installment on May 30, 1997, leaving a
balance of $40,000 which was repaid in June 1998.
The Company remitted payments on loans due participants (including interest)
of approximately $743,000 and $58,000 to Mr. Rensin and various investment
vehicles owned or controlled by Mr. Rensin during the years ended December 31,
1996 and 1997, respectively. The remaining amounts due to participants will be
repaid as the related receivables are liquidated.
The Company also remitted a payment of approximately $66,000 to a
corporation prior to the initial public offering, of which Mr. Glassberg is an
executive officer, as a finder's fee in connection with the contract for the
receivables that were serviced by the Company and included in the Initial
Securitization.
Any future related-party transactions will be on terms at least as favorable
to the Company as available from third parties and will be approved by a
majority of the disinterested directors.
44
<PAGE>
SELLING STOCKHOLDERS
The common stock offered hereby (the "Shares") is issuable upon exercise of
the warrants. The Selling Stockholders may from time to time offer and sell
pursuant to this prospectus any or all of the Shares. The term "Selling
Stockholder" includes the holders listed below and the beneficial owners of the
warrants or Shares and their transferees, pledges, donees or other successors.
The following table sets forth information with respect to the Selling
Stockholders and the respective number of warrants beneficially owned by each
Selling Stockholder and the number of shares of stock into which such warrants
will be convertible into upon exercise thereof that may be offered pursuant to
this prospectus.
<TABLE>
<CAPTION>
Number of
Shares to Percentage
be of Total
Number of Issued Upon Percentage of Voting
Warrants Percentage Exercise of Common Stock Power After
Held of Total Warrants(1) Outstanding(2) Exercise(3)
--------- ---------- ----------- -------------- -----------
<S> <C> <C> <C> <C> <C>
Odyssey Capital Group,
L.P., a Pennsylvania
limited partnership.... 67,500 15.0% 67,500 *% *%
Porter Partners......... 58,500 13.0 58,500 * *
Lancaster Investment
Partners, L.P.(4)...... 54,000 12.0 54,000 1.3 1.3
American High Growth
Equities Retirement
Trust(5)............... 45,000 10.0 45,000 * *
Losty Capital
Management(6).......... 45,000 10.0 45,000 1.1 1.1
Sonz Partners L.P....... 45,000 10.0 45,000 * *
Lagunitas Partners
LP(7).................. 36,000 8.0 36,000 * *
Gruber & McBaine
Int'l(8)............... 21,600 4.8 21,600 * *
Jeff Porter............. 18,000 4.0 18,000 * *
Allan Bortel or Sydne
Bortel, trustees, or
their successors in
trust, under the Sydne
and Allan Bortel living
trust, dated September
14, 1998, and any
amendments thereto..... 13,500 3.0 13,500 * *
EDJ Limited............. 13,500 3.0 13,500 * *
Mindful Partners, L.P... 13,500 3.0 13,500 * *
Jon and Linda
Gruber(9).............. 9,000 2.0 9,000 * *
Mayer Kanter............ 9,000 2.0 9,000 * *
Dawn Dobras(10)......... 450 1.0 450 * *
Eric B. Swergold(11).... 450 1.0 450 * *
</TABLE>
- --------
* Less than 1%.
(1) Assumes exercise of the full number of warrants held by such holder.
Fractional shares will be redeemed in cash.
(2) Computed in accordance with Rule 13d-3(d)(1) promulgated under the
Exchange Act and based upon 7,984,480 shares of common stock outstanding
as of December 31, 1998, treating as outstanding the number of Shares
shown as being issuable upon the assumed exercise of the named holder of
the full amount of such holder's warrants but not assuming the conversion
of the warrants of any other holder. Includes common stock, if any,
beneficially owned by the holder other than the Shares.
(3) The percentage of total voting power after exercise represents the
percentage of the voting power each stockholder will have after the
exercise based upon 7,984,480 shares of common stock outstanding as of
December 31, 1998 treating as outstanding the number of Shares as being
issuable upon the assumed exercise by the named holder of the full amount
of such holder's warrants but not assuming the exercise of the warrants of
any other holder. Includes common stock, if any, beneficially owned by the
holder other than the Shares.
(4) Lancaster Investment Partners, L.P. ("Lancaster") owns 48,500 shares of
common stock. Lancaster is an affiliate of Boenning & Scattergood, Inc.
which participated in the initial public offering of the Company's common
stock in July 1998 and the placement of the Warrants described herein.
Lancaster agreed, subject to certain exceptions, not to sell or otherwise
dispose, directly or indirectly, of any shares of common stock until April
2, 1999.
(5) American High Growth Equities Retirement Trust owns 27,500 shares of
common stock.
(6) Losty Capital Management owns 42,000 shares of common stock.
(7) Lagunitas Partners LP owns 4,500 shares of common stock.
(8) Gruber & McBaine Int'l owns 2,500 shares of common stock.
(9) Jon and Linda Gruber own 3,000 shares of common stock.
(10) Ms. Dobras owns 100 shares of common stock.
(11) Mr. Swergold owns 100 shares of common stock.
None of the Selling Stockholders has, or within the past three years has
had, any position, office or other material relationship with the Company or
any of its predecessors or affiliates. Because a Selling Stockholder may,
pursuant to this prospectus, offer all or some portion of the Shares, no
estimate can be given as to the amount of Shares that will be held by the
Selling Stockholders upon termination of any such sales. In addition, the
Selling Stockholders identified above may have sold, transferred or otherwise
disposed of all or a portion of their warrants, in transactions exempt from the
registration requirements of the Securities Act of 1933, as amended (the
"Securities Act"), since the date on which they provided the information
regarding their warrants. Information regarding changes with respect to the
Selling Stockholders will be set forth in supplements to this prospectus if and
when necessary. See "Plan of Distribution."
45
<PAGE>
DESCRIPTION OF CAPITAL STOCK
General
The Company is authorized to issue 20,000,000 shares of common stock, $0.01
par value per share, and 5,000,000 shares of preferred stock, $0.01 par value
per share (the "Preferred Stock"). As of December 31, 1998, the Company had
8,000,000 shares of common stock issued, 7,984,480 shares of common stock
outstanding and no shares of Preferred Stock outstanding. The following
description of capital stock of the Company is qualified in its entirety by
reference to the Company's Charter.
Common Stock
Holders of common stock are entitled to one vote per share on all matters
submitted to a vote of stockholders generally. Stockholders have no right to
cumulate their votes in the election of directors. Accordingly, holders of a
majority of the outstanding shares of common stock entitled to vote in any
election of directors may elect all of the directors standing for election. If
all the shares of common stock offered by this prospectus are sold, Mr. Rensin
will own 61.5% of the outstanding common stock. Mr. Rensin will be able to
control effectively most matters requiring approval by the Company's
stockholders, including the election of directors, the approval of charter
amendments, and the approval of major transactions for which stockholders have
approval rights. Holders of common stock are entitled to receive dividends and
other distributions pro rata when, as and if declared from time to time by the
Board of Directors out of funds legally available therefor. The Company does
not intend to declare or pay any dividends on the shares of its common stock in
the near future. See "Dividend Policy." In the event of a voluntary or
involuntary liquidation, dissolution or winding up of the Company, the holders
of common stock are entitled to share ratably in all assets remaining after
payment of liabilities, including all distributions to holders of Preferred
Stock having a liquidation preference over the common stock. The Company's
Charter gives the holders of common stock no preemptive or other subscription
or conversion rights, and there are no redemption provisions with respect to
such shares. All outstanding shares of common stock are, and the shares offered
hereby will be, when issued and paid for, fully paid and non-assessable. The
rights, preferences and privileges of holders of common stock are subject to,
and may be adversely affected by, the rights of holders of shares of any series
of Preferred Stock, which the Company may designate and issue in the future
from time to time.
Preferred Stock
Under the Charter, the Board of Directors is authorized to issue Preferred
Stock, in one or more series, and to fix the number of shares constituting such
series and the designation of such series, the voting powers (if any) of the
shares of such series, and the preferences and relative, participating,
optional or other special rights, if any, and any qualifications, limitations
or restrictions thereof, of the shares of such series. The Company has not
issued any series of Preferred Stock.
Warrants
The Company has issued and outstanding warrants to purchase 396,000 shares
of common stock at an exercise price of $12.00 per share and warrants to
purchase 54,000 shares of common stock at an exercise price of $15.50 per
share. The warrants expire on April 1, 2003 and are subject to customary anti-
dilution adjustments upon dividends and distributions on the common stock,
subdivisions or reclassifications of common stock, combinations and
reclassifications of the common stock, and certain transactions occurring prior
to an initial public offering of common stock.
Limitations on Liability of Officers and Directors
The Company's Charter and Bylaws provide for mandatory indemnification of
the officers and directors of the Company to the fullest extent permitted by
the Maryland General Corporation Law ("MGCL"), including
46
<PAGE>
some instances in which indemnification is otherwise discretionary under the
MGCL. The Charter contains provisions that eliminate the personal liability of
the Company's directors and officers for monetary damages resulting from
breaches of their fiduciary duties as directors or officers other than for a
judgment or other final adjudication adverse to the officer or director that is
entered based on a finding of active or deliberate dishonesty, payment of
unlawful distributions, or for any transaction from which the director or
officer derived an improper personal benefit. The Company believes that these
provisions are essential to attracting and retaining qualified persons as
directors and officers.
There is no pending litigation or proceeding involving a director or officer
of the Company as to which indemnification is being sought, and the Company is
not aware of any threatened litigation that may result in claims for
indemnification by any officer or director.
Anti-Takeover Provisions
Business Combinations
Under the MGCL, certain "business combinations" (including a merger,
consolidation, share exchange, or, in certain circumstances, an asset transfer
or issuance or reclassification of equity securities) between a Maryland
corporation and (i) any person who beneficially owns 10% or more of the voting
power of the corporation's shares, (ii) an affiliate or associate of such
corporation who, at any time within the two-year period prior to the date in
question, was the beneficial owner of 10% or more of the voting power of the
then-outstanding voting stock of the corporation (in either case, an
"interested stockholder"), or (iii) any affiliate of an interested stockholder,
are prohibited for five years after the most recent date on which the
interested stockholder became an interested stockholder, and thereafter must be
recommended by the board of directors of the Maryland corporation and approved
by the affirmative vote of at least (a) 80% of the votes entitled to be cast by
holders of its outstanding voting shares, and (b) two-thirds of the votes
entitled to be cast by holders of such outstanding voting shares, other than
shares held by the interested stockholder with whom the business combination is
to be effected; unless, among other things, the corporation's stockholders
receive a minimum price (as defined in the MGCL) for their shares and the
consideration is received in cash or in the same form as previously paid by the
interested stockholder for its shares. These provisions of the MGCL do not
apply to business combinations that are approved or exempted by the board of
directors of the corporation prior to the time that the interested stockholder
becomes an interested stockholder.
The Company is generally governed by the MGCL's business combinations
statute. However, the Company's Charter exempts any business combination with
Mr. Rensin or his present or future affiliates from the application of such
statute.
Control Share Acquisitions
The MGCL provides that "control shares" of a Maryland corporation acquired
in a "control share acquisition" have no voting rights except to the extent
approved by a vote of two-thirds of the votes entitled to be cast by
stockholders, excluding shares of stock as to which the acquiring person,
officers of the corporation and directors of the corporation who are employees
of the corporation are entitled to exercise or direct the exercise of the
voting power of the shares in the election of directors. "Control shares" are
voting shares of stock which, if aggregated with all other shares of stock
previously acquired by such person, would entitle the acquirer to exercise
voting power in electing directors within one of the following ranges of voting
power: (i) one-fifth or more but less than one-third, (ii) one-third or more
but less than a majority or (iii) a majority of all voting power. Control
shares do not include shares that the acquiring person is entitled to vote as a
result of having previously obtained stockholder approval. A "control share
acquisition" means the acquisition, directly or indirectly, of control shares,
subject to certain exceptions.
47
<PAGE>
A person who has made or proposes to make a control share acquisition, upon
satisfaction of certain conditions (including an undertaking to pay expenses),
may compel the board of directors to call a special meeting of stockholders to
be held within 50 days of demand to consider the voting rights of the shares.
If voting rights are not approved at the meeting or if the acquirer does not
deliver an acquiring person statement as required by the statute, then subject
to certain conditions and limitations, the corporation may redeem any or all of
the control shares, except those for which voting rights have previously been
approved, for fair value determined, without regard to voting rights, as of the
date of the last control share acquisition or of any meeting of stockholders at
which the voting rights of such shares are considered and not approved. If
voting rights for control shares are approved at a stockholders' meeting and
the acquirer becomes entitled to vote a majority of the shares entitled to
vote, all other stockholders may exercise appraisal rights. The fair value of
the shares as determined for purposes of such appraisal rights may not be less
than the highest price per share paid in the control share acquisition, and
certain limitations and restrictions generally applicable to the exercise of
appraisal rights do not apply in the context of a control share acquisition.
The control share acquisition statute does not apply to shares acquired in a
merger, consolidation or share exchange if the corporation is a party to the
transaction or to acquisitions approved or excepted by the charter or the
bylaws of the corporation.
The business combination statute and the control share acquisition statute
could have the effect of discouraging unsolicited offers to acquire the Company
and of increasing the difficulty of consummating any such offer.
Transfer Agent and Registrar
The transfer agent and registrar for the common stock is American Stock
Transfer & Trust Company.
48
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
As of December 31, 1998, the Company had 7,984,480 shares of common stock
outstanding. If all the warrants are exercised, there will be 8,434,480 shares
of common stock outstanding. Of those shares, the 2,808,711 shares of common
stock sold in the initial public offering of the Company's common stock are
freely transferable without restriction or registration under the Securities
Act, unless purchased by persons deemed to be "affiliates" of the Company (as
that term is defined in the Act) ("Affiliates"). In addition, the 450,000
shares of common stock offered by this prospectus will be freely tradeable
without restriction or registration under the Act when the registration
statement, of which this prospectus is a part, becomes effective. The remaining
5,191,289 shares of common stock outstanding ("Restricted Shares") may only be
sold in the public market if such shares are registered under the Act or sold
in accordance with Rule 144 promulgated under the Act. In general, under Rule
144 a person (or persons whose shares are aggregated) including an affiliate,
who has beneficially owned the shares for one year, may sell in the open market
within any three-month period a number of shares that does not exceed the
greater of (i) 1% of the then outstanding shares of the Company's common stock,
or (ii) the average weekly trading volume in the common stock on the Nasdaq
National Market during the four calendar weeks preceding such sale. Sales under
Rule 144 are also subject to certain limitations on the manner of sale, notice
requirements and availability of current public information about the Company.
A person (or persons whose shares are aggregated) who is deemed not to have
been an Affiliate of the Company at any time during the 90 days preceding a
sale by such person and who has beneficially owned his shares for at least two
years, may sell such shares in the public market under Rule 144(k) without
regard to the volume limitations, manner of sale provisions, notice
requirements or availability of current information referred to above.
Restricted shares properly sold in reliance upon Rule 144 are thereafter freely
tradeable without restrictions or registration under the Act, unless thereafter
held by an Affiliate of the Company.
The Company has reserved an aggregate of 800,000 shares of common stock for
issuance pursuant to the Stock Plan and 100,000 shares for issuance under the
Stock Purchase Plan and the Company registered such shares on Form S-8. Subject
to restrictions imposed pursuant to the Stock Plan and the Stock Purchase Plan,
shares of common stock issued pursuant to the Stock Plan or Stock Purchase Plan
after the effective date of any Registration Statement on Form S-8 will be
available for sale in the public market without restriction to the extent they
are held by persons who are not Affiliates of the Company, and by Affiliates
pursuant to Rule 144.
49
<PAGE>
PLAN OF DISTRIBUTION
Pursuant to a Registration Rights Agreement dated as of April 9, 1998 (the
"Registration Rights Agreement") between the Company and Ferris, Baker Watts,
Incorporated, as placement agent, entered into in connection with the offering
of the warrants and the Shares to be issued upon exercise thereof, the
Registration Statement of which this prospectus forms a part was filed with the
Commission covering the resale of the Shares. The Company has agreed to use all
reasonable efforts to keep the Registration Statement effective until July 28,
2001, two years from the effective date of the initial public offering (or such
earlier date when the holders of the Shares are able to sell all such Shares
immediately without restriction as described in the Registration Rights
Agreement). The Company will be permitted to suspend the use of this prospectus
(which is a part of the Registration Statement) in connection with the sale of
the Shares by holders during certain time periods under certain circumstances
relating to pending corporate developments and public filings with the
Commission and similar events. The specific provisions relating to the
registration rights described above are contained in the Registration Rights
Agreement, and the foregoing summary is qualified in its entirety by reference
to the provisions of such agreement.
The Company will not receive any of the proceeds of the offering of the
Shares by the Selling Stockholders. Sales of the Shares may be effected by or
for the account of the Selling Stockholders from time to time in transactions
(which may include block transactions) on any exchange or market on which such
securities are listed or quoted, as applicable, in negotiated transactions,
through a combination of such methods of sale, or otherwise, at fixed prices
that may be changed, at market prices prevailing at the time of sale, at prices
related to prevailing market prices, or at negotiated prices. The Selling
Stockholders may effect such transactions by selling the Shares directly to
purchasers, through broker-dealers acting as agents for the Selling
Stockholders, or to broker-dealers who may purchase Shares as principals and
thereafter sell the Shares from time to time in transactions (which may include
block transactions) on any exchange or market on which such securities are
listed or quoted, as applicable, in negotiated transactions, through a
combination of such methods of sale, or otherwise. In effecting sales, broker-
dealers engaged by Selling Stockholders may arrange for other broker-dealers to
participate. Such broker-dealers, if any, may receive compensation in the form
of discounts, concessions or commissions from the Selling Stockholders and/or
the purchasers of the Shares for whom such broker-dealers may act as agents or
to whom they may sell as principals, or both (which compensation as to a
particular broker-dealer might be in excess of customary commissions). The
Selling Stockholders and any broker-dealers, agents or underwriters that
participate with the Selling Stockholders in the distribution of the Shares may
be deemed "underwriters" within the meaning of the Securities Act. Any
commissions paid or any discounts or concessions allowed to any such persons,
and any profits received on the resale of the Shares offered hereby and
purchased by them may be deemed to be underwriting commissions or discounts
under the Securities Act.
Pursuant to the Registration Rights Agreement, the Company has agreed to pay
all expenses incident to the offer and sale of the Shares offered by the
Selling Stockholders hereby, except that the Selling Stockholders will pay all
underwriting discounts and selling commissions, if any. The Company and the
Selling Stockholders are obligated to indemnify each other against certain
liabilities arising under the Securities Act.
The outstanding common stock is quoted on the Nasdaq National Market and the
Shares have been approved for listing on the Nasdaq National Market subject to
official notice of issuance.
To comply with the securities laws of certain states, if applicable, the
Shares offered hereby will be offered or sold in such jurisdictions only
through registered or licensed brokers or dealers. In addition, in certain
states the Shares may not be sold unless they have been registered or qualified
for sale in the applicable state or an exemption from the registration or
qualification requirement is available and is complied with.
Under applicable rules and regulations under the Exchange Act, any person
engaged in a distribution of the Shares may be limited in its ability to engage
in market activities with respect to such Shares. In addition and without
limiting the foregoing, each Selling Stockholder will be subject to applicable
provisions of the Exchange Act and the rules and regulations thereunder, which
provisions may limit the timing of purchase and sales of any of the Shares by
the Selling Stockholders. The foregoing may affect the marketability of the
Shares.
50
<PAGE>
LEGAL MATTERS
The validity of the shares of common stock offered hereby and general
corporate legal matters will be passed upon for the Company by Piper & Marbury
L.L.P., Baltimore, Maryland.
EXPERTS
The consolidated financial statements as of December 31, 1997 and 1998 and
for each of the years ended December 31, 1996, 1997 and 1998 included in this
prospectus have been audited by Grant Thornton LLP, independent certified
public accountants, as stated in their reports thereon appearing elsewhere
herein, and are included in reliance on their authority as experts in
accounting and auditing.
51
<PAGE>
CREDITRUST CORPORATION
Index to Consolidated Financial Statements
<TABLE>
<S> <C>
Report of Independent Certified Public Accountants.................... F-2
Consolidated Financial Statements
Consolidated Balance Sheets as of December 31, 1997 and 1998........ F-3
Consolidated Statements of Earnings for the years ended
December 31, 1996, 1997 and 1998................................... F-4
Consolidated Statements of Stockholders' Equity and Comprehensive
Income for the years ended December 31, 1996, 1997 and 1998........ F-5
Consolidated Statements of Cash Flows for the years ended December
31, 1996, 1997 and 1998............................................ F-6
Notes to Consolidated Financial Statements.......................... F-7-F-20
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
Creditrust Corporation
We have audited the accompanying consolidated balance sheets of Creditrust
Corporation (the "Company") as of December 31, 1997 and 1998, and the related
consolidated statements of earnings, stockholders' equity and comprehensive
income and cash flows for the years ended December 31, 1996, 1997 and 1998.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with 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 Creditrust
Corporation as of December 31, 1997 and 1998, and the results of its operations
and its cash flows for the years ended 1996, 1997 and 1998 in conformity with
generally accepted accounting principles.
Grant Thornton LLP
Vienna, Virginia
February 15, 1999
F-2
<PAGE>
CREDITRUST CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
------------------------
1997 1998
----------- ------------
<S> <C> <C>
Assets
Cash and Cash Equivalents............................ $ 769,576 $ 7,906,151
Income Taxes Receivable.............................. 200,163 --
Finance Receivables.................................. 5,049,839 26,915,035
Investment in Securitizations........................ -- 30,269,001
Property and Equipment............................... 1,434,218 2,448,912
Deferred Costs....................................... 534,700 475,402
Other Assets......................................... 215,740 733,195
----------- ------------
Total Assets..................................... $ 8,204,236 $ 68,747,696
=========== ============
Liabilities and Stockholders' Equity
Accounts Payable and Accrued Expenses................ $ 653,065 $ 1,621,486
Notes Payable........................................ 2,105,972 6,788,933
Capitalized Lease Obligations........................ 972,342 1,651,637
Deferred Income...................................... 895,449 --
Lease Incentives..................................... 266,630 301,639
Deferred Tax Liability............................... 1,093,846 11,914,753
Other Liabilities.................................... 152,539 43,877
----------- ------------
Total Liabilities................................ 6,139,843 22,322,325
Stockholders' Equity
Preferred stock, $.01 par value; 5,000,000 shares
authorized, none issued and outstanding........... -- --
Common stock, $.01 par value; 20,000,000 shares
authorized, 6,000,000 shares issued and
outstanding at December 31, 1997 and 8,000,000
shares issued and 7,984,480 outstanding at
December 31, 1998................................. 60,000 80,000
Paid-in capital.................................... 52,824 27,753,619
Stock held for benefit plans....................... -- (268,690)
Net unrealized gains on available for sale
securities........................................ -- 6,713,978
Retained earnings.................................. 1,951,569 12,146,464
----------- ------------
Total Stockholders' Equity....................... 2,064,393 46,425,371
----------- ------------
Total Liabilities and Stockholders' Equity....... $ 8,204,236 $ 68,747,696
=========== ============
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-3
<PAGE>
CREDITRUST CORPORATION
CONSOLIDATED STATEMENTS OF EARNINGS
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------------------
1996 1997 1998
---------- ---------- -----------
<S> <C> <C> <C>
Revenue
Income on finance receivables.......... $5,521,063 $7,245,744 $12,816,698
Servicing fees......................... -- 2,580,200 3,109,940
Interest on investment in
securitizations....................... -- -- 533,588
Gain on sale........................... -- -- 18,414,182
---------- ---------- -----------
5,521,063 9,825,944 34,874,408
Expenses
Personnel.............................. 2,617,862 5,922,172 11,917,689
Communications......................... 573,118 911,508 1,644,928
Rent and other occupancy............... 382,020 853,344 1,195,025
Professional fees...................... 155,754 504,003 1,011,781
General and administrative............. 193,221 270,509 686,326
Contingency legal and court costs...... 212,530 320,104 349,040
Portfolio repurchase costs............. 383,736 -- --
---------- ---------- -----------
4,518,241 8,781,640 16,804,789
---------- ---------- -----------
Earnings from Operations................. 1,002,822 1,044,304 18,069,619
Other Income (Expense)
Interest and other..................... 74,307 14,755 312,264
Interest expense....................... (287,530) (377,410) (615,750)
---------- ---------- -----------
Earnings Before Income Taxes............. 789,599 681,649 17,766,133
Provision for Income Taxes............... 315,699 225,275 7,004,815
---------- ---------- -----------
Earnings Before Extraordinary Item....... 473,900 456,374 10,761,318
Extraordinary Item--loss on
extinguishment of debt (net of taxes)... -- -- (566,423)
---------- ---------- -----------
Net Earnings............................. $ 473,900 $ 456,374 $10,194,895
========== ========== ===========
Basic Earnings Per Common Share Before
Extraordinary Item...................... $ .08 $ .08 $ 1.57
Extraordinary Item--loss on
extinguishment of debt (net of taxes)... -- -- (.08)
---------- ---------- -----------
Basic Earnings Per Common Share.......... $ .08 $ .08 $ 1.49
---------- ---------- -----------
Weighted-Average Number of Basic Common
Shares Outstanding During the Year...... 6,000,000 6,000,000 6,827,506
========== ========== ===========
Diluted Earnings Per Common Share Before
Extraordinary Item...................... $ .08 $ .08 $ 1.56
Extraordinary Item--loss on
extinguishment of debt (net of taxes)... -- -- (.08)
---------- ---------- -----------
Diluted Earnings Per Common Share........ $ .08 $ .08 $ 1.48
========== ========== ===========
Weighted-Average Number of Diluted Common
Shares Outstanding During the Year...... 6,000,000 6,000,000 6,898,870
========== ========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-4
<PAGE>
CREDITRUST CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
<TABLE>
<CAPTION>
Stock
Common Stock Additional Preferred Stock Held for Net
------------------ Paid-in ------------------ Benefit Unrealized Retained
Shares Amount Capital Shares Amount Plans Gains Earnings Total
--------- ------- ----------- ------- -------- --------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1,
1996................... 6,000,000 $60,000 $ 52,824 -- $ -- $ -- $ -- $ 1,021,295 $ 1,134,119
Net Earnings............ -- -- -- -- -- -- -- 473,900 473,900
--------- ------- ----------- ------- -------- --------- ----------- ----------- -----------
Balance at December 31,
1996................... 6,000,000 60,000 52,824 -- -- -- -- 1,495,195 1,608,019
Net Earnings............ -- -- -- -- -- -- -- 456,374 456,374
--------- ------- ----------- ------- -------- --------- ----------- ----------- -----------
Balance at December 31,
1997................... 6,000,000 60,000 52,824 -- -- -- -- 1,951,569 2,064,393
Initial public
offering............... 2,000,000 20,000 27,291,289 -- -- -- -- -- 27,311,289
Value of common stock
purchase warrants
issued in connection
with subordinated debt
financing.............. -- -- 409,506 -- -- -- -- 409,506
Stock purchased for
benefit plans ......... (15,520) -- -- -- -- (268,690) -- -- (268,690)
Net earnings............ -- -- -- -- -- -- -- 10,194,895 10,194,895
Other Comprehensive
Income, unrealized
gains on available for
sale securities, net of
taxes of $4,213,980.... -- -- -- -- -- -- 6,713,978 -- 6,713,978
-----------
Total Comprehensive
Income................. -- -- -- -- -- -- -- -- 16,908,873
--------- ------- ----------- ------- -------- --------- ----------- ----------- -----------
Balance at December 31,
1998................... 7,984,480 $80,000 $27,753,619 -- $ -- $(268,690) $ 6,713,978 $12,146,464 $46,425,371
========= ======= =========== ======= ======== ========= =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-5
<PAGE>
CREDITRUST CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------------------
1996 1997 1998
---------- ---------- -----------
<S> <C> <C> <C>
Increase (Decrease) in Cash and Cash
Equivalents
Cash Flows from Operating Activities
Net earnings............................ $ 473,900 $ 456,374 $10,194,895
Adjustments to reconcile net earnings to
net cash provided by operating
activities:
Depreciation and amortization.......... 84,463 208,643 369,288
Deferred tax expense................... 249,462 470,670 6,956,757
Gain on sale........................... -- -- (18,414,182)
Extraordinary item--loss on
extinguishment of debt (net of
taxes)................................ 566,423
Changes in assets and liabilities:
Decrease (increase) in other assets.... 97,832 (196,977) (517,455)
Increase in accounts payable and
accrued expenses...................... 345,010 195,879 968,420
Increase (decrease) in other
liabilities........................... -- 101,358 (101,358)
Increase in lease incentives........... 72,000 194,630 35,009
Increase (decrease) in current income
taxes payable/receivable.............. (115,452) (193,749) 200,163
---------- ---------- -----------
Net Cash and Cash Equivalents Provided by
Operating Activities..................... 1,207,215 1,236,828 257,960
---------- ---------- -----------
Cash Flows from Investing Activities
Collections applied to principal
(accretion) on finance receivables..... 831,505 2,111,394 (3,412,997)
Investment in securitizations........... -- -- (1,933,855)
Purchases of property and equipment..... (332,152) (122,668) (347,246)
Acquisitions of finance receivables..... (5,583,130) (557,498) (58,335,683)
Proceeds from securitizations........... -- -- 38,516,596
Deferred gain on sale of finance
receivables............................ 895,449 -- --
Proceeds from portfolios sold, net...... -- -- 562,181
---------- ---------- -----------
Net Cash and Cash Equivalents (Used in)
Provided by Investing Activities......... (4,188,328) 1,431,228 (24,951,004)
---------- ---------- -----------
Cash Flows from Financing Activities
(Payments on) proceeds from notes
payable and other debt, net............ 2,932,262 (1,659,918) 4,675,658
Proceeds from subordinated debt......... -- -- 4,529,614
(Payments on) subordinated debt......... -- -- (4,529,614)
Payments on capital lease obligations... (23,748) (179,497) (357,441)
Proceeds from issuance of common stock.. -- -- 27,311,289
Common stock purchased for benefit
plans.................................. -- -- (268,690)
Proceeds from issuance of warrants...... -- -- 409,505
Deferred costs.......................... -- (534,700) 59,298
---------- ---------- -----------
Net Cash and Cash Equivalents Provided by
(Used in) Financing Activities........... 2,908,514 (2,374,115) 31,829,619
---------- ---------- -----------
Net (Decrease) Increase in Cash and Cash
Equivalents.............................. (72,599) 293,941 7,136,575
Cash and Cash Equivalents at Beginning of
Year..................................... 548,234 475,635 769,576
---------- ---------- -----------
Cash and Cash Equivalents at End of Year.. $ 475,635 $ 769,576 $ 7,906,151
========== ========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated
statements.
F-6
<PAGE>
CREDITRUST CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A--ORGANIZATION AND BUSINESS
Creditrust Corporation (the "Company") was incorporated in Maryland on
October 17, 1991. The Company purchases, collects and manages defaulted
consumer receivables from credit grantors, including banks, finance companies,
retail merchants and other service providers. The Company's customers are
located throughout the United States. The Company has funded its receivables
purchases and the expansion of its business through a combination of bank and
other warehouse funding, public and private equity funding and asset-backed
securitizations.
NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Accounting
The Company's accounts are presented on the accrual basis of accounting in
accordance with generally accepted accounting principles.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiary, Creditrust Funding I LLC. All material inter-
company accounts and transactions have been eliminated.
Significant Estimates
In preparing financial statements in conformity with generally accepted
accounting principles, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities and the disclosure
of contingent assets and liabilities at the date of the financial statements
and revenue and expenses during the reporting period. Actual results could
differ from those estimates.
Significant estimates have been made by management with respect to the
amount of future cash flows of portfolios. The estimated future cash flows of
the portfolios are used to recognize income on finance receivables and to
estimate the fair value of investment in securitizations. Actual results could
differ from these estimates, making it reasonably possible that a change in
these estimates could occur within one year. On a quarterly basis, management
reviews the estimate of future collections, and it is reasonably possible that
its assessment may change based on actual results and other factors. The change
could be material.
Cash and Cash Equivalents
The Company considers all highly liquid securities purchased with a maturity
of three months or less to be cash equivalents.
Finance Receivables/Interest Income
The Company accounts for its investment in finance receivables on an accrual
basis under the guidance of Practice Bulletin 6, "Amortization of Discounts on
Certain Acquired Loans," using unique and exclusive static pools. Static pools
are established with accounts having similar attributes, usually based on
acquisition timing and/or by seller. Once a static pool is established, the
receivables in the pool are not changed. The discount between the cost of each
static pool and the contractual receivable of the accounts in the static pools
is not recorded since the Company expects to collect a relatively small
percentage of each static pool's contractual receivable balance. Each static
pool is initially recorded at cost.
F-7
<PAGE>
CREDITRUST CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Accrual accounting for each static pool is measured as a unit for the
economic life of the static pool (similar to one loan) for recognition of
income on finance receivables, or collections applied to principal on
finance receivables, and for provision of loss or impairment. The effective
interest rate for each static pool is estimated based on the estimated monthly
collections over the estimated economic life of each pool (currently five
years, based on the Company's collection experience). Income on finance
receivables is accrued monthly based on each static pool's effective interest
rate applied to each static pool's monthly opening carrying value. Monthly
collections received for each static pool reduce each static pool's carrying
value. To the extent collections exceed the interest accrual, the carrying
value is reduced and the reduction is recorded as collections applied to
principal. If the accrual is greater than collections, the carrying value
accretes. Accretion arises as a result of collection rates lower in the early
months of ownership than the estimated effective yield which reflects
collections for the entire economic life of the static pool. Measurement of
impairment and any provision for loss is based on each static pool. To the
extent the estimated future cash flow, discounted at the estimated yield,
increases or decreases, the Company adjusts the yield accordingly. To the
extent that the carrying amount of a particular static pool exceeds its fair
value, a valuation allowance would be recognized in the amount of such an
impairment. The estimated yield for each static pool is based on estimates of
future cash flows from collections, and actual cash flows may vary from current
estimates.
Servicing Fees
Servicing fees are recognized on securitized receivables under the terms of
two indenture and servicing agreements. The Company recognizes as a servicing
fee 20% of collections in the securitizations. In accordance with terms of a
servicing agreement on a non-securitized portfolio from August 1997 through
June 1998, the Company recognized as a servicing fee a predetermined percentage
of collections on the related receivables.
Investments in Debt and Equity Securities
The Company accounts for investments in accordance with Statement of
Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." As such, investments are recorded
as either trading, available for sale, or held to maturity. The Company records
its investment in securitizations (see Note E) as available for sale debt
securities. Such securities are recorded at fair value, and unrealized gains
and losses, net of the related tax effect, are not reflected in earnings but
are recorded as a separate component of stockholders' equity. The investment in
securitizations is estimated to accrue income over the estimated life of the
underlying portfolio of receivables. A decline in the value of an available for
sale security below cost that is deemed other than temporary is charged to
earnings and results in the establishment of a new cost basis for the security.
Deferred Costs
The Company accounted for expenditures, principally legal and accounting
fees in connection with its preparation to sell stock in its initial public
offering, as capitalized and deferred until the offering occurred. The costs
were netted against the capital raised in the offering.
The Company accounted for legal and professional fees in connection with its
securitization efforts as capitalized and deferred until the securitizations
are closed. All transaction costs, including legal and accounting fees, are
expensed when the gain on sale is recognized.
The Company capitalized legal and accounting costs incurred in connection
with its placement of senior subordinated notes in 1998. The costs were
allocated between the financing costs of the notes and the paid-in
capital of the warrants. The debt financing costs were amortized until the
notes were paid off with the proceeds
F-8
<PAGE>
CREDITRUST CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
of the initial public offering, at which time the balance of deferred costs
were expensed and included in the extraordinary loss.
The Company capitalized legal and accounting costs incurred in connection
with its establishment of the warehouse and revolving line-of-credit facilities
in 1998. The costs will be amortized over the terms of the facilities.
Depreciation/Amortization
Property and equipment, consisting of computer equipment, furniture and
fixtures and leasehold improvements, are stated at cost and
depreciated/amortized using a straight-line method of depreciation over the
lives of the assets, which range from five to seven years. Leasehold
improvements are amortized over the shorter of the lease term or estimated
useful life. Accelerated methods are used for tax purposes.
Accounting for Transfers of Financial Assets
In 1996, the Financial Accounting Standards Board issued SFAS No. 125,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities." The Statement provides accounting and reporting standards for
transfers and servicing of financial assets and extinguishments of liabilities.
The standards are based on consistent application of a financial-components
approach that focuses on control; under this approach, after a transfer of
financial assets, an entity recognizes the financial and servicing assets it
controls and liabilities it has incurred, derecognizes financial assets when
control has been surrendered, and derecognizes liabilities when extinguished.
The Statement provides consistent standards for distinguising transfers of
financial assets that are sales from transfers that are secured borrowings. The
Company adopted SFAS No. 125 for the year ended December 31, 1997.
Reporting Comprehensive Income
The Financial Accounting Standards Board issued SFAS No. 130, "Reporting
Comprehensive Income," effective for fiscal years beginning after December 15,
1997. The Statement establishes standards for reporting and display of
comprehensive income and its components (revenue, expenses, gains and losses)
in a full set of general-purpose financial statements. The Statement requires
all items required to be recognized under accounting standards as components of
comprehensive income, to be reported in a financial statement that is displayed
with the same prominence as other financial statements. SFAS No. 130 does not
require a specific format for that financial statement but requires that an
enterprise display an amount representing total comprehensive income for the
period in that financial statement. The Statement requires that an enterprise
classify items of other comprehensive income by their nature in a financial
statement and display the accumulated balance of other comprehensive income
separately from retained earnings and additional paid-in capital in the equity
section of a statement of financial position. Reclassification of financial
statements for earlier periods provided for comparative purposes is required.
For the years ended December 31, 1996, and 1997, the Company had no material
sources of other comprehensive income. The Company's investment in
securitizations is classified as available for sale, as such, in accordance
with SFAS No. 115, the Company recognizes as other comprehensive income the
unrealized gains or losses for the difference between the amortized cost and
estimated fair value net of income taxes. (see Note E).
Stock Split/Authorization
On February 19, 1998, the Company effected a 60,000-for-1 stock split of its
common stock in the form of a stock dividend. Pursuant to the split, the
Company increased the number of shares of common stock
F-9
<PAGE>
CREDITRUST CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
authorized for issuance from 1,000 to 20,000,000. The stated par value of each
common share was changed from no par to $0.01. In addition, the Company
authorized 5,000,000 shares of preferred stock, with a par value of $0.01.
The accompanying financial statements, including stockholders' equity and
per share amounts, give retroactive effect to the stock split.
Initial Public Offering
On July 29, 1998, the Company commenced an initial public offering of 2.0
million shares of common stock at an initial public offering price of $15.50
per share. The Company's sole stockholder also sold 500,000 shares of common
stock in the offering, which closed on August 3, 1998, and an additional
308,711 shares pursuant to an underwriters' overallotment option which was
subsequently exercised and closed on September 2, 1998. After payment of
underwriting discounts and commissions and estimated other offering expenses,
the Company received net proceeds of $27.3 million. The proceeds were used to
repay the subordinated notes, purchase additional portfolios and contribute to
working capital.
Earnings per Common Share
In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share" (EPS). This
Statement replaces the presentation of primary EPS with a presentation of basic
EPS. It also requires dual presentation of basic and diluted EPS on the face of
the statement of earnings for all entities with complex capital structures and
requires a reconciliation of the numerator and denominator of the basic EPS
computation to the numerator and denominator of the diluted EPS computation.
Basic EPS excludes dilution and is computed by dividing earnings available 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 common stock were exercised or converted
into common stock or resulted in the issuance of common stock that then shared
in the earnings of the entity.
The Company did not have any potentially dilutive items for the years ended
December 31, 1997 and 1996. The following table reconciles basic and diluted
EPS for the year ended December 31, 1998:
<TABLE>
<CAPTION>
Per
Earnings Shares Share
(Numerator) (Denominator) Amount
----------- ------------- ------
<S> <C> <C> <C>
Basic EPS
Earnings before extraordinary item.......... $10,761,318 $1.57
Extraordinary item--loss on extinguishment
of debt (net of taxes)..................... (566,423) (.08)
----------- -----
Net earnings................................ 10,194,895 6,827,506 1.49
Effect of Dilutive Securities
Warrants.................................... -- 54,276
Stock options............................... -- 17,088
----------- ---------
Diluted EPS
Earnings before extraordinary item plus
assumed conversions........................ 10,761,318 1.56
Extraordinary item--loss on extinguishment
of debt (net of taxes)
plus assumed conversions................... (566,423) (.08)
----------- -----
Net earnings plus assumed conversions....... $10,194,895 6,898,870 $1.48
=========== ========= =====
</TABLE>
F-10
<PAGE>
CREDITRUST CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Employee Stock Options
The Company accounts for its employee stock options in accordance with the
intrinsic value-based method of Accounting Principles Board Opinion No. 25
(APB 25). Under this method, if options are priced at or above the quoted
market price on the date of grant, there is no compensation expense recognized
by the Company as a result of the options.
NOTE C--FAIR VALUE OF FINANCIAL INSTRUMENTS
The accompanying financial statements include various estimated fair value
information as of December 31, 1997 and 1998, as required by SFAS No. 107,
"Disclosures About Fair Value of Financial Instruments." Such information,
which pertains to the Company's financial instruments, is based on the
requirements set forth in the Statement and does not purport to represent the
aggregate net fair value of the Company.
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practicable to estimate
fair value.
Cash and Cash Equivalents
The carrying amount approximates fair value.
Finance Receivables
The Company records finance receivables at cost, which is discounted from
the actual principal balance. The fair value of finance receivables was
estimated based upon discounted expected cash flows. The carrying value of
finance receivables approximates fair value at December 31, 1997 and 1998.
Investment in Securitizations
Investment in securitizations is recorded at estimated fair value based on
discounted future cash flows.
Notes Payable
Quoted market prices for the same or similar issues or the current rate
offered to the Company for debt of the same remaining maturities are used to
estimate the fair value of the Company's notes payable. At December 31, 1997
and 1998, the carrying amount of the notes payable approximates fair value.
F-11
<PAGE>
CREDITRUST CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE D--FINANCE RECEIVABLES
The Company purchases defaulted consumer receivables at a discount from the
actual principal balance. The following summarizes the change in finance
receivables for the year ended December 31:
<TABLE>
<CAPTION>
1997 1998
------------- -------------
<S> <C> <C>
Balance, at beginning of year.................... $ 6,603,735 $ 5,049,839
Purchases of finance receivables............... 557,498 58,335,683
Net (collections applied) accretion to
principal on finance receivables.............. (2,111,394) 3,412,997
Securitization of finance receivables.......... -- (39,883,484)
------------- -------------
Balance, at end of year.......................... $ 5,049,839 $ 26,915,035
------------- -------------
Unrecorded discount (unaudited).................. $ 403,307,742 $ 448,473,014
============= =============
</TABLE>
To the extent that the carrying amount of a static pool exceeds its fair
value, a valuation allowance would be recognized in the amount of such
impairment. As of December 31, 1997 and 1998, no provision for loss has been
recorded.
Change in Estimate
The Company monitors its projection models with a view towards enhancing
predictability of both the amount and timing of collections. In 1996 and prior
years, the principal model relied on the best available information at the
time, largely based on the past performance characteristics of the aggregate
static pools. After extensive statistical analysis of individual static pool
performances in 1997, the Company implemented a refinement in its analysis of
projected collections used to compute the effective interest rate for income
recognition. The refinement included individual static pool estimates and had
the effect of reducing total static pools' future projected cash flows.
Management believes the change reflects a more predictable and conservative
estimate. The total aggregate effect on the specific static pools of the change
in estimate was to decrease net earnings for 1997 by approximately $700,000.
NOTE E--INVESTMENT IN SECURITIZATIONS
Investment in securitizations for the year ended December 31, 1998 is
comprised of the following:
<TABLE>
<CAPTION>
Estimated
Cash Amortized Unrealized Fair
Reserves Cost Gains Value
---------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Balance at beginning of
year................... $ -- $ --
Retained interests
recorded............... 2,085,000 16,873,600
Interest accrued........ -- 533,588
Allowed reduction in
reserves............... (151,145) --
---------- ----------- ----------- -----------
Balance at end of year.. $1,933,855 $17,407,188 $10,927,958 $30,269,001
========== =========== =========== ===========
</TABLE>
The investment in securitizations accrues interest at 12% per annum. The net
after tax effect of unrealized gains is reflected as a separate component of
stockholders' equity and is included in other comprehensive income. Fair value,
absent actual market quotations for similar securities, was calculated by a
discounted cash flow valuation.
F-12
<PAGE>
CREDITRUST CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE F--PROPERTY AND EQUIPMENT
Property and equipment consist of the following at:
<TABLE>
<CAPTION>
December 31,
-----------------------
1997 1998
---------- -----------
<S> <C> <C>
Computer equipment................................. $ 845,215 $ 2,104,566
Furniture and fixtures............................. 855,631 955,498
Leasehold improvements............................. 95,109 119,872
---------- -----------
1,795,955 3,179,936
Less accumulated depreciation and amortization..... (361,737) (731,024)
---------- -----------
$1,434,218 $ 2,448,912
========== ===========
</TABLE>
As of December 31, 1997 and 1998, property and equipment purchased pursuant
to capital leases was $1,117,287 and $2,154,022, less accumulated depreciation
of $128,943 and $372,741, respectively.
NOTE G--DEFERRED COSTS
Deferred costs consist of the following at:
<TABLE>
<CAPTION>
December 31,
-----------------
1997 1998
-------- --------
<S> <C> <C>
Credit facilities............................................ $ -- $475,402
Securitizations.............................................. 203,105 --
Initial public offering...................................... 331,595 --
-------- --------
$534,700 $475,402
======== ========
</TABLE>
NOTE H--ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses consist of the following at:
<TABLE>
<CAPTION>
December 31,
-------------------
1997 1998
-------- ----------
<S> <C> <C>
Accounts payable........................................ $238,684 $ 512,406
Accrued other liabilities............................... 105,350 413,802
Accrued salaries, taxes and fringe benefits............. 309,031 695,278
-------- ----------
$653,065 $1,621,486
======== ==========
</TABLE>
NOTE I--NOTES PAYABLE
Warehouse Facility
In September 1998, the Company established through a wholly owned
consolidated special purpose finance subsidiary a $30 million revolving
warehouse facility for use in acquiring finance receivables. The warehouse
facility carries a floating interest rate of LIBOR plus .65%, with the
revolving period expiring in October 2000. The final due date of all payments
due under the facility is October 2005. The warehouse facility is secured by a
trust estate, primarily consisting of specific consumer receivables that the
Company has absolutely assigned to the newly formed special purpose finance
subsidiary. Generally, the warehouse facility provides 95% of the acquisition
costs of receivables purchased, with the Company funding the remaining 5% and a
one-time $900,000 liquidity reserve requirement. The $900,000 reserve account
is included in cash on the balance sheet and restricted as to use until the
warehouse facility is retired. The facility contains financial covenants the
most restrictive of which requires that the Company maintains a net worth of
$1.8 million plus 75% of net earnings.
F-13
<PAGE>
CREDITRUST CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
During November and December 1998, the Company borrowed approximately $15.5
million under the facility, which was repaid in December 1998. Interest
expense, trustee fees and guarantee fees aggregated $109,691 in 1998.
Revolving Line of Credit
In October 1998, the Company entered into a $20 million revolving line of
credit with a commercial lender to provide receivables financing. The facility
has a term of three years, during which time the Company may borrow and repay
funds to purchase receivables at 80% of acquisition cost. Interest is based on
prime plus 0.5%, or LIBOR plus 2.5% at the option of the Company on each
advance. The facility is secured by any receivables purchased under the
facility and substantially all the Company's other assets. Interest expense
totaled $96,537 in 1998. The facility contains financial covenants the most
restrictive of which requires that the Company maintains a net worth of $30.0
million plus 50% of net earnings.
As of December 31, 1998, required minimum principal payments payable by the
Company were as follows:
<TABLE>
<CAPTION>
Year ending December 31,
------------------------
<S> <C>
1999........................................................ $2,262,979
2000........................................................ 3,394,467
2001........................................................ 1,131,487
----------
Total minimum principal payments.......................... $6,788,933
==========
</TABLE>
NOTE J--SUBORDINATED NOTES AND EXTRAORDINARY LOSS
In April 1998, the Company sold $5.0 million aggregate principal amount of
subordinated notes, together with common stock purchase warrants exercisable
for an aggregate of 450,000 shares of the Company's common stock. Each of the
50 units sold consisted of $100,000 principal amount for the note and a warrant
exercisable for 9,000 shares. The exercise price is $12.00 per share for
396,000 of the warrants and $15.50 for 54,000 of the warrants. Upon the closing
of the initial public offering in August 1998, the notes plus accrued interest
at 10% per annum were repaid.
The Company recorded the fair value of the subordinated notes at $4.5
million and recorded as paid-in capital the remaining consideration of $410,000
net of offering expenses attributable to the fair value of the warrants. The
effective interest rate on the subordinated notes based on the allocation is
12.8%. The Company repaid the subordinated notes at $5.0 million plus accrued
interest. The repayment resulted in the Company's recording an extraordinary
charge for the early repayment of indebtedness which, including debt issuance
costs, resulted in an extraordinary charge in August 1998 of $566,000 after-
tax, net of amortization of financing costs and original issue discount.
NOTE K--CAPITALIZED LEASE OBLIGATIONS
The Company has entered into capital lease obligations to finance the
purchase of computer equipment and furniture. The terms of these leases range
from 36 to 48 months. The balance due on the leases was $972,342 and $1,651,637
as of December 31, 1997 and 1998, respectively. Interest rates range from 7.0%
to 12.7%; and interest expense was $3,629, $60,647 and $133,174 in 1996, 1997
and 1998, respectively.
F-14
<PAGE>
CREDITRUST CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the year ended December 31, 1998, future minimum annual lease payments
under capital leases together with their present value were as follows:
<TABLE>
<CAPTION>
As of December 31,
------------------
<S> <C>
1999......................................................... $ 709,762
2000......................................................... 709,762
2001......................................................... 484,014
2002......................................................... 526
-----------
Total minimum lease payments................................. 1,904,064
Amount representing interest................................. (252,427)
-----------
Present value of minimum lease payments...................... $ 1,651,637
===========
</TABLE>
NOTE L--INCOME TAXES
Deferred income taxes are recognized for the tax consequences of temporary
differences by applying enacted statutory tax rates applicable to future years
to differences between the financial statement carrying amounts and the tax
bases of existing assets and liabilities, following the guidance of SFAS No.
109, "Accounting for Income Taxes." These differences primarily result from the
use of the cost recovery method of accounting for finance receivables for
income tax purposes versus the effective interest rate method for financial
reporting purposes and the recognition of securitizations as sales under SFAS
No. 125 versus financing transactions for tax reporting.
The provision for income taxes consists of the following for the years
ended:
<TABLE>
<CAPTION>
December 31,
--------------------------------
1996 1997 1998
--------- --------- -----------
<S> <C> <C> <C>
Current expense (refund)
Federal...................................... $ 52,794 $(161,050) $ --
State........................................ 13,443 (39,113) --
--------- --------- -----------
66,237 (200,163) --
Deferred
Federal...................................... 204,246 346,519 5,810,735
State........................................ 45,216 78,919 1,194,080
--------- --------- -----------
249,462 425,438 7,004,815
--------- --------- -----------
Total.......................................... $ 315,699 $ 225,275 $ 7,004,815
========= ========= ===========
</TABLE>
F-15
<PAGE>
CREDITRUST CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The net deferred tax liability consists of the following as of:
<TABLE>
<CAPTION>
December 31,
------------------------
1997 1998
----------- ------------
<S> <C> <C>
Deferred tax assets
Due to/from participants............................. $ 7,378 $ --
Deferred income...................................... 345,822 116,493
Net operating loss carryforward...................... 230,674 5,846,392
Other................................................ 147,308 43,534
----------- ------------
Gross deferred tax assets............................. 731,182 6,006,419
Deferred tax liabilities
Finance receivables.................................. 1,733,864 399,716
Investment in securitizations........................ -- 17,223,962
Other................................................ 91,164 297,494
----------- ------------
Gross deferred tax liabilities........................ 1,825,028 17,921,172
----------- ------------
Net deferred tax liability............................ $ 1,093,846 $ 11,914,753
=========== ============
</TABLE>
The differences between the total income tax expense and the income tax
expense computed using the federal income tax rate were as follows for the
years ended December 31:
<TABLE>
<CAPTION>
1996 1997 1998
--------- --------- -----------
<S> <C> <C> <C>
Pretax income................................ $ 789,599 $ 681,649 $17,766,133
--------- --------- -----------
Computed federal income taxes at 34%......... 268,464 231,761 6,040,485
Computed state income taxes, net of federal
benefits.................................... 36,479 31,492 820,795
Other taxes not based on income.............. -- -- 44,818
Permanent differences........................ 10,756 7,366 18,675
Other adjustments............................ -- (45,344) 80,042
--------- --------- -----------
Income tax expense........................... $ 315,699 $ 225,275 $ 7,004,815
========= ========= ===========
</TABLE>
The 1997 adjustment to the deferred tax liability is attributable to the
Company's 1997 analysis of its 1996 and prior tax returns compared to the
respective deferred tax liabilities. The Company's analysis resulted in 1996
and prior differences which were adjusted through the 1997 deferred tax
liability. In 1997, the Company generated a net operating loss of $1.1 million
for tax purposes, of which approximately $517,000 was carried back to prior
years resulting in a refund of approximately $200,000. The remaining tax loss
of $582,000 is available to offset future taxable earnings of the Company and
expires on December 31, 2012. Additional net operating tax loss carryforward
was generated in 1998 of $14.6 million and expires in December 31, 2018.
Utilization of net operating losses is subject to annual limitations due to the
ownership change limitations provided by the Internal Revenue Code and similar
state provisions. Management does not expect such limitations, if any, to
impact the ultimate utilization of the carryforwards.
NOTE M--DEFERRED INCOME
Occasionally, the Company purchases portfolios with commitments from a third
party to purchase a portion of the newly acquired portfolio. During 1996, a
complaint was filed against the Company by a buyer. On June 16, 1997,
management settled the litigation which resulted in the complaint being
dismissed, and the Company repurchased the portfolio for $1,037,819, as
adjusted for collections until execution of the repurchase. As a result, in
1996, management deferred the gain on the transaction totaling $895,449.
F-16
<PAGE>
CREDITRUST CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
On February 9, 1998, the Company purchased the portfolio that was the
subject of the deferral of income in 1996 for $1,037,819, and immediately
resold the portfolio for $800,000 to an unrelated major credit card issuer.
Consequently, in the first quarter of 1998, the Company recorded a gain on sale
net of taxes on the resale and recognition of previously deferred income as
follows:
<TABLE>
<S> <C>
Proceeds from resale.......................................... $ 800,000
Deferred income recognized.................................... 895,449
Cost of portfolio............................................. (1,037,819)
-----------
Gain on resale................................................ 657,630
Deferred taxes................................................ (253,976)
-----------
Gain after taxes.............................................. $ 403,654
===========
</TABLE>
NOTE N--COMMITMENTS AND CONTINGENCIES
Leases
The Company's former headquarters was leased until December 31, 1996. Rent
expense under this lease for the year ended December 31, 1996, was $120,983.
In January 1996, the Company entered into an agreement to lease a new
headquarters and collection facility to accommodate future expansion. The lease
commenced on May 1, 1996. The lease also provided reimbursement to the Company
of $10,000 per month to cover rent expense at the former headquarters from the
date of occupancy through December 31, 1996, which totaled $80,000 for the
year. The Company recorded this amount as a lease incentive and is amortizing
it straight-line over the term of the new lease. Rent expense for this lease
for the years ended December 31, 1996, 1997 and 1998 net of the offset
amortized, was $140,027, $210,040 and $249,883 respectively. In October 1998,
the Company amended the lease to expand the leased space in return for
additional monthly rent.
In September 1997, the Company entered into an agreement to lease additional
office space for its operations center to accommodate expansion. The lease
required no payments for the first six months. The Company recorded the free
rent period as a lease incentive and is amortizing it straight-line over the
term of the lease. Rent expense for this lease for 1997 and 1998 was $531,932
and $405,203, respectively including $211,363 and $218,698 of accrued lease
incentive, respectively.
Future minimum operating lease commitments, net of reimbursements, are as
follows:
<TABLE>
<CAPTION>
Year ending December 31,
------------------------
<S> <C>
1999.......................................................... $ 830,678
2000.......................................................... 838,032
2001.......................................................... 871,507
2002.......................................................... 906,691
2003.......................................................... 12,946
----------
$3,459,854
==========
</TABLE>
In January 1999, the Company entered into a facility lease agreement for a
satellite operations center. The lease begins in February 1999 and expires in
January 2003. The yearly commitment pursuant to this lease is $142,000. The
Company has an option to terminate the lease after 24 months, or anytime
thereafter, with three months prior notice.
F-17
<PAGE>
CREDITRUST CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Forward Flow Agreements
Beginning in September 1998, the Company entered into multiple forward flow
agreements with certain financial institutions which obligate the Company to
purchase, on a monthly basis, portfolios of charged-off receivables meeting
certain criteria. The Company estimates its future minimum commitments pursuant
to these agreements for 1999 and 2000 to be $130.7 million and $56.3 million,
respectively, aggregating $187.0 million for the term of the agreements.
Litigation
The Company is involved in various litigation arising in the ordinary course
of business. Management believes these items, individually or in aggregate,
will not have a material adverse impact on the Company's financial position,
results of operations or liquidity.
NOTE O--SERVICING FEES
In June 1997, the Company arranged for a commercial bank to acquire, under
an exclusive purchasing agent agreement, a portfolio of approximately $737
million of charged-off balances of credit card accounts originated by a major
money center bank. In August 1997, the Company closed the acquisition for the
bank and acquired the exclusive rights to the servicing, re-marketing and
securitization of, and a majority interest in the underlying recoverable value
of, the portfolio. Under the contract, the Company received servicing income of
85% of net collections through February 1998, and thereafter received 60% of
net collections until the bank received a required amount under the contract.
The Company securitized the portfolio in June 1998.
In 1998 the Company completed two securitizations (see Note P). Pursuant to
the securitizations the Company receives a fee of 20% of the collections of the
receivables in the securitizations.
NOTE P--GAIN ON SALE--SECURITIZATIONS
On June 19, 1998, a special purpose finance subsidiary formed by the Company
issued $14.5 million aggregate principal amount of 6.43% Creditrust
Receivables--Backed Notes, Series 1998-1. The notes are secured by a trust
estate consisting substantially of consumer receivables previously owned by the
Company with a carrying value as of June 1998 of approximately $4.8 million and
all of the serviced receivables. The Company purchased the serviced receivables
included in the securitization for $6.5 million. After payment of the purchase
price of the serviced receivables, retirement of a credit facility and payment
of transaction costs, the Company received cash of $5.8 million, recognized a
gain on sale of $6.0 million and recorded an investment in securitizations of
$4.6 million.
On December 29, 1998, a special purpose finance subsidiary formed by the
Company issued $27.5 million aggregate principal amount of 8.61% Creditrust
Receivables--Backed Notes, Series 1998-2. The notes are secured by a trust
estate consisting substantially of consumer receivables previously owned by the
Company with a carrying value as of December 1998 of approximately $28.6
million. After retirement of a credit facility and payment of transaction
costs, the Company received cash of $7.3 million, recognized a gain on sale of
$11.0 million and recorded an investment in securitizations of $14.4 million.
NOTE Q--GAIN ON SALE--FINANCE RECEIVABLES
The Company sold miscellaneous finance receivables in July 1998 for $800,000
to a major credit card issuer. The finance receivables sold were fully
amortized, resulting in a gain on sale of $800,000.
F-18
<PAGE>
CREDITRUST CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE R--STOCK OPTIONS
Employee Stock Purchase Plan
In conjunction with the initial public offering, the Company reserved a
total of 100,000 shares of common stock for issuance pursuant to the 1998
Creditrust Employee Stock Purchase Plan. The plan is administered by the Board
of Directors and is open to all eligible employees, who can purchase shares at
a 15 percent discount to the fair market value, subject to certain annual
limitations. As permitted by SFAS No. 123, "Accounting for Stock-Based
Compensation," the Company will account for stock-based compensation on the
intrinsic value-based method of Accounting Principles Board Opinion No. 25. As
the plan is non-compensatory in nature, no compensation expense will be
recorded for stock purchased pursuant to the plan.
Stock Incentive Plan
In conjunction with the initial public offering, the Company reserved a
total of 800,000 shares of common stock for issuance pursuant to the 1998
Creditrust Stock Incentive Plan. The plan is administered by the Board of
Directors and provides for the grant of stock options and other stock grants to
directors and to all eligible employees of the Company, including executive
officers and directors. Options granted under the plan are granted on such
terms and at such prices as determined by the Board of Directors, except the
per share exercise price may not be less than the fair market value of the
common stock on the date of the grant. The Board of Directors has the authority
to amend or terminate the plan, provided no such amendment or termination
adversely affects the rights of any holder of any outstanding option without
the written consent of such holder.
Stock Options Issued
The Company issues options to employees and members of its Board of
Directors based on merit. The Company has accounted for its options under APB
Opinion No. 25 and related interpretations. The options, which have a term of
10 years when issued, are granted at various times during the year and vest
based upon individual grant specifications. The exercise price of each option
equals or exceeds the market price of the Company's stock on the date of grant.
No compensation cost has been recognized for employee options. Had compensation
cost for the plan been determined based on the fair value of the options at the
grant dates, consistent with the method in Statement of Financial Accounting
Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation," the
Company's net earnings would have been decreased to the pro forma amounts
indicated below:
<TABLE>
<CAPTION>
1998
-----------
<S> <C>
Net earnings--as reported....................................... $10,194,895
Net earnings--pro forma......................................... $10,042,687
Net earnings per diluted common share--as reported.............. $1.48
Net earnings per diluted common share--pro forma................ $1.45
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes options-pricing method with the following weighted-average
assumptions used for grants in 1998: expected volatility of 16%; risk-free
interest rate of 5.15% and expected lives of 5 years.
F-19
<PAGE>
CREDITRUST CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following tables depict activity in the plan for the year ended
December 31, 1998:
<TABLE>
<CAPTION>
Shares
-------
<S> <C>
Options outstanding at beginning of year.......................... --
Granted......................................................... 377,016
Exercised....................................................... --
Forfeited....................................................... (64,516)
Expired......................................................... --
-------
Outstanding at end of year........................................ 312,500
Options exercisable at year-end................................... 62,500
Weighted-average fair value per share of options granted during
the year......................................................... $4.57
Weighted-average exercise price .................................. $15.68
</TABLE>
NOTE S--SUPPLEMENTAL CASH FLOWS INFORMATION
Supplemental Disclosures of Cash Flows Information
The Company paid the following amounts for interest and income taxes during
the years ended:
<TABLE>
<CAPTION>
December 31,
--------------------------
1996 1997 1998
-------- -------- --------
<S> <C> <C> <C>
Interest.......................................... $287,530 $377,410 $615,750
-------- -------- --------
Income taxes...................................... $181,681 $ 8,000 $ 2,940
-------- -------- --------
</TABLE>
Supplemental Disclosures of Non-cash Investing and Financing Activities
The Company financed the following purchases of property and equipment with
capitalized lease obligations during the years ended:
<TABLE>
<CAPTION>
December 31,
----------------------------
1996 1997 1998
----- ---------- -----------
<S> <C> <C> <C>
Equipment and furniture purchases............. $ -- $1,051,193 $ 1,036,735
----- ---------- -----------
The Company recorded an unrealized gain on investment in securitizations as
follows for the years ended:
<CAPTION>
December 31,
----------------------------
1996 1997 1998
----- ---------- -----------
<S> <C> <C> <C>
Unrealized gain on investment in
securitizations.............................. $ -- $ -- $11,461,546
----- ---------- -----------
</TABLE>
NOTE T--SUBSEQUENT EVENT
Subsequent to December 31, 1998, the Company filed a registration statement
relating to a public offering of 2,400,000 shares of common stock by the
Company.
F-20
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
450,000 Shares
Common Stock
----------------
PROSPECTUS
, 1999
----------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution.
The following table sets forth estimated expenses in connection with the
offering described in this Registration Statement, all of which are to be borne
by the Registrant. All amounts are estimates, except for the Securities and
Exchange Commission registration fee and the Nasdaq National Market listing
fee.
<TABLE>
<S> <C>
Securities and Exchange Commission registration fee................. $ 2,901
Nasdaq National Market listing fee.................................. 9,000
Printing and engraving expenses..................................... 25,000
Legal fees and expenses............................................. 10,000
Accounting fees and expenses........................................ 25,000
Transfer agent and registrar's fees................................. 1,000
Miscellaneous expenses.............................................. 2,099
-------
Total............................................................. $75,000
=======
</TABLE>
Item 14. Indemnification of Directors and Officers.
The Charter of the Company provides that, to the fullest extent permitted by
the Maryland General Corporation Law (the "MGCL"), the Company shall indemnify
current and former directors and officers of the Company against any and all
liabilities and expenses in connection with their services to the Company in
such capacities. The Charter further mandates that the Company shall advance
expenses to its directors and officers to the full extent permitted by the
MGCL. The Charter also permits the Company, by action of its Board of
Directors, to indemnify its employees and agents with the same scope and effect
as the foregoing indemnification of directors and officers.
The Company's Charter provides that, to the fullest extent that limitations
on the liability of directors. And officers are permitted by the MGCL, no
director or officer of the Company shall have any liability to the Company or
its stockholders for monetary damages. The MGCL provides that a corporation's
charter may include a provision which restricts or limits the liability of its
directors or officers to the corporation or its stockholders for money damages
except: (i) to the extent that it is proved that the person actually received
an improper benefit or profit in money, property or services, for the amount of
the benefit or profit in money, property or services actually received, or (ii)
to the extent that a judgment or other final adjudication adverse to the person
is entered in a proceeding based on a finding in the proceeding that the
person's action, or failure to act, was the result of active and deliberate
dishonesty and was material to the cause of action adjudicated in the
proceeding. This provision does not limit the ability of the Company or its
stockholders to obtain other relief, such as an injunction or recission.
The Charter of the Company authorizes the Company to purchase liability
insurance for its officers and directors, and the Company currently maintains
such insurance coverage on behalf of its officers and directors.
Item 15. Recent Sales of Unregistered Securities.
The following information relates to unregistered securities issued or sold
by the Company within the last three years:
On April 2, 1998, the Registrant issued $5,000,000 principal amount of
Senior Subordinated Notes, Series 1998 and Warrants to purchase 450,000 shares
of common stock in a transaction exempt from the registration requirements of
the Securities Act of 1933, as amended (the "Act"), pursuant to Rule 506 under
the Act. The
II-1
<PAGE>
Placement Agents were Ferris, Baker Watts, Incorporated and Boenning &
Scattergood, Inc. The net proceeds were used to purchase defaulted consumer
receivables and for general corporate purposes. Neither the Registrant nor any
person acting on its behalf offered or sold the Senior Subordinated Notes or
Warrants by any form of general solicitation or general advertising. The
Registrant reasonably believes that the Senior Subordinated Notes and Warrants
were sold only to accredited investors, and the Registrant provided all
material information available to the investors. Further, the Registrant
exercised reasonable care to assure that the investors were not underwriters,
as such term is defined in Section 2 (11) of the Act.
Item 16. Exhibits and Financial Statement Schedules.
(a) Exhibits:
<TABLE>
<CAPTION>
Exhibit
No Description
------- -----------
<C> <S>
3.1 Charter of the Company.*
3.2 By-Laws of the Company.*
4.1 Form of stock certificate.*
4.2 Form of Senior Subordinated Note, Series 1998.*
4.3 Form of Common Stock Purchase Warrant.*
Senior Subordinated Note Series and Common Stock Warrant Purchase
4.4 Agreement.*
4.5 Registration Rights Agreement.*
5 Opinion of Piper & Marbury L.L.P.+
10.1 Creditrust 1998 Stock Incentive Plan.*
10.2 Creditrust 1998 Employee Stock Purchase Plan.*
10.3 Employment Agreement between the Company and Jefferson B. Moore.*
10.4 Employment Agreement between the Company and Richard J. Palmer.*
10.5 Employment Agreement between the Company and John D. Frey.***
10.6 Employment Agreement between the Company and John L. Davis.*
Agreement dated March 13, 1997 by and between Crystal Hill Advisors
10.7 and the Company.*
10.8 Servicing Agreement, dated August 6, 1997, by and between Creditrust
Corporation and Heartland Bank.*
10.9 Loan and Security Agreement, dated September 23, 1996, by and between
Oxford Capital Corporation and Signet Bank.*
10.10 Lease Agreement, dated January 24, 1996, by and between BRIT Limited
Partnership and Oxford Capital Corporation.*
10.11 Lease Agreement, dated January 22, 1997, by and between A&E Partners
and Creditrust Corporation.*
10.12 First Amendment to Lease, dated February 27, 1997, by and between A&E
Partners and Creditrust Corporation.*
10.13 Indenture and Servicing Agreement, dated as of June 1, 1998, by and
among Creditrust SPV2, LLC, Norwest Bank Minnesota, National
Association, Creditrust Corporation and Asset Guaranty Insurance
Company.*
Limited Liability Company Agreement of Creditrust SPV2, LLC, dated
10.14 June 19, 1998.*
10.15 Indenture and Servicing Agreement, dated as of September 1, 1998, by
and among Creditrust Funding I LLC, Norwest Bank Minnesota, National
Association, Creditrust Corporation and Asset Guaranty Insurance
Company.**
10.16 Credit Agreement, dated as of October 28, 1998, between Creditrust
Corporation, the Lenders party thereto and Sunrock Capital Corp.***
10.17 Indenture and Servicing Agreement, dated as of December 29, 1998, by
and among Creditrust SPV98-2, LLC, Norwest Bank Minnesota, National
Association, Creditrust Corporation and Asset Guaranty Insurance
Company.***
10.18 Limited Liability Company Agreement of Creditrust SPV98-2, LLC, dated
as of December 29, 1998.***
</TABLE>
II-2
<PAGE>
<TABLE>
<CAPTION>
Exhibit
No Description
------- -----------
<C> <S>
10.19 Lease, dated January 11, 1999, by and between Butera Properties, LLC,
as Landlord, and Creditrust Card Services Corporation, as Tenant. ***
21.1 List of Subsidiaries.***
23.1 Consent of Grant Thornton LLP.++
Consent of Piper & Marbury L.L.P. (included in the opinion filed as
23.2 Exhibit 5).+
24 Powers of Attorney.+
</TABLE>
- --------
* Previously filed as an exhibit to the Company's Registration Statement on
Form S-1 (Reg. No. 333-50103) and incorporated herein by reference.
** Previously filed as an exhibit to the Company's Quarterly Report on Form 10-
Q for the quarterly period ended September 30, 1998 and incorporated herein
by reference.
*** Previously filed as an exhibit to the Company's Registration Statement on
Form S-1, including Amendment No. 1 thereto (Reg. No. 333-70845), and
incorporated herein by reference.
+ Previously filed.
++ Filed herewith.
(b) Financial Statement Schedules:
None.
Item 17. Undertakings.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 (the "Securities Act") may be permitted to directors, officers and
controlling persons of the Registrant pursuant to the provisions of its Charter
or Bylaws or laws of the State of Maryland or otherwise, the Registrant has
been advised that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Securities Act and
is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the Registrant of expenses
incurred or paid by a director, officer or controlling person of the Registrant
in the successful defense of any action, suit or proceeding) is asserted by
such director, officer or controlling person in connection with the securities
being registered, the Registrant will, unless in the opinion of its counsel the
matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Securities Act and will be governed
by the final adjudication of such issue.
The undersigned registrant hereby undertakes that:
(1) To file, during any period in which offers or sales are being made,
a post-effective amendment to this registration statement:
(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act;
(ii) To reflect in the prospectus any facts or events arising after the
effective date of the registration statement (or the most recent post-
effective amendment thereof) which, individually or in the aggregate,
represent a fundamental change in the information set forth in the
registration statement. Notwithstanding the foregoing, any increase or
decrease in volume of securities offered (if the total dollar value of
securities offered would not exceed that which was registered) and any
deviation from the low or high end of the estimated maximum offering range
may be reflected in the form of prospectus filed with the Commission
pursuant to Rule 424(b) if, in the aggregate, the changes in volume and
price represent no more than 20 percent change in the maximum aggregate
offering price set forth in the "Calculation of Registration Fee" table in
the effective registration statement.
(iii) To include any material information with respect to the plan of
distribution not previously disclosed in the registration statement or any
material change to such information in the registration statement.
(2) That, for the purpose of determining any liability under the
Securities Act, each post-effective amendment shall be deemed to be a new
registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial
bona fide offering thereof.
(3) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering.
II-3
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
has duly caused this post-effective amendment no. 1 to the registration
statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Baltimore, State of Maryland, on February 26, 1999.
Creditrust Corporation
By: /s/ Joseph K. Rensin
-------------------------------
Joseph K. Rensin Chairman of the
Board and Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, this post-
effective amendment no. 1 to the registration statement has been signed by the
following persons in the capacities indicated on this 26th day of February,
1999.
<TABLE>
<CAPTION>
Signature Title Date
<S> <C> <C>
/s/ Joseph K. Rensin Chairman of the February 26, 1999
- ------------------------------------- Board and Chief
Joseph K. Rensin Executive Officer
(Principal
Executive Officer)
/s/ Richard J. Palmer Vice President, February 26, 1999
- ------------------------------------- Chief Financial
Richard J. Palmer Officer and
Treasurer
(Principal
Financial and
Accounting Officer)
* Director February 26, 1999
- -------------------------------------
Frederick W. Glassberg
* Director February 26, 1999
- -------------------------------------
John G. Moran
* Director February 26, 1999
- -------------------------------------
Michael S. Witlin
* By: /s/ Joseph K. Rensin
---------------------------------
Joseph K. Rensin
Attorney in fact
</TABLE>
II-4
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
No Description Page
------- ----------- ----
<C> <S> <C>
3.1 Charter of the Company.*
3.2 By-Laws of the Company.*
4.1 Form of stock certificate.*
4.2 Form of Senior Subordinated Note, Series 1998.*
4.3 Form of Common Stock Purchase Warrant.*
4.4 Senior Subordinated Note Series and Common Stock Warrant
Purchase Agreement.*
4.5 Registration Rights Agreement.*
5 Opinion of Piper & Marbury L.L.P.+
10.1 Creditrust 1998 Stock Incentive Plan.*
10.2 Creditrust 1998 Employee Stock Purchase Plan.*
10.3 Employment Agreement between the Company and Jefferson B.
Moore.*
10.4 Employment Agreement between the Company and Richard J.
Palmer.*
10.5 Employment Agreement between the Company and John D. Frey.***
10.6 Employment Agreement between the Company and John L. Davis.*
10.7 Agreement dated March 13, 1997 by and between Crystal Hill
Advisors and the Company.*
10.8 Servicing Agreement, dated August 6, 1997, by and between
Creditrust Corporation and Heartland Bank.*
10.9 Loan and Security Agreement, dated September 23, 1996, by and
between Oxford Capital Corporation and Signet Bank.*
10.10 Lease Agreement, dated January 24, 1996, by and between BRIT
Limited Partnership and Oxford Capital Corporation.*
10.11 Lease Agreement, dated January 22, 1997, by and between A&E
Partners and Creditrust Corporation.*
10.12 First Amendment to Lease, dated February 27, 1997, by and
between A&E Partners and Creditrust Corporation.*
10.13 Indenture and Servicing Agreement, dated as of June 1, 1998, by
and among Creditrust SPV2, LLC, Norwest Bank Minnesota,
National Association, Creditrust Corporation and Asset
Guaranty Insurance Company.*
10.14 Limited Liability Company Agreement of Creditrust SPV2, LLC,
dated June 19, 1998.*
10.15 Indenture and Servicing Agreement, dated as of September 1,
1998, by and among Creditrust Funding I LLC, Norwest Bank
Minnesota, National Association, Creditrust Corporation and
Asset Guaranty Insurance Company.**
10.16 Credit Agreement, dated as of October 28, 1998, between
Creditrust Corporation, the Lenders party thereto and Sunrock
Capital Corp.***
10.17 Indenture and Servicing Agreement, dated as of December 29,
1998, by and among Creditrust SPV98-2, LLC, Norwest Bank
Minnesota, National Association, Creditrust Corporation and
Asset Guaranty Insurance Company.***
</TABLE>
<PAGE>
Exhibit 23.1
Accountants and [LOGO OF GRANT THORNTON
Management Consultants APPEARS HERE]
The US Member Firm of
Grant Thornton International
Consent of Independent Certified Public Accountants
We have issued our report dated February 15, 1999, accompanying the consolidated
financial statements of Creditrust Corporation contained in the Registration
Statement and Prospectus. We consent to the use of the aforementioned report in
the Registration Statement and Prospectus, and to the use of our name as it
appears under the caption "Experts."
/s/ Grant Thornton LLP
Vienna, Virginia
February 23, 1999
Suite 375
2070 Chain Bridge Road
Vienna, VA 22182-2536
Tel: 703 847-7500
Fax: 703 848-9580
