<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _____ TO _____
COMMISSION FILE NUMBER 333-50103
CREDITRUST CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
MARYLAND 52-1754916
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
7000 SECURITY BLVD., BALTIMORE, MD 21244-2543
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: 410-594-7000
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED
TO BE FILED BY SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING
THE PRECEDING 12 MONTHS (OR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED
TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR
THE PAST 90 DAYS YES [X] NO [_]
THE NUMBER OF SHARES OUTSTANDING OF THE REGISTRANT'S COMMON STOCK AS OF
JANUARY 17, 2001 WAS 10,453,548.
<PAGE>
CREDITRUST CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2000
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Page
<S> <C>
Consolidated Statements of Earnings
For the Three and Nine Months Ended September 30, 1999 and 2000............................. 1
Consolidated Balance Sheets
As of December 31, 1999 and September 30, 2000.............................................. 2
Consolidated Statements of Stockholders' Equity and Comprehensive
Income as of December 31, 1999 and September 30, 2000....................................... 3
Consolidated Statements of Cash Flows
For the Three and Nine Months Ended September 30, 1999 and 2000............................. 4
Notes to Consolidated Financial Statements.................................................. 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations......................................................... 17
Item 3. Quantitative and Qualitative Disclosures about Market Risk................................. 24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings........................................................................... 25
Item 2. Changes in Securities and Use of Proceeds................................................... 25
Item 3. Defaults Upon Senior Securities............................................................. 25
Item 5. Other Information........................................................................... 25
Item 6. Exhibits and Reports on Form 8-K............................................................ 26
SIGNATURE................................................................................................ 27
</TABLE>
<PAGE>
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CREDITRUST CORPORATION
CONSOLIDATED STATEMENTS OF EARNINGS
<TABLE>
<CAPTION>
(Dollars in thousands, except share data) THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
1999 2000 1999 2000
----------- ----------- ----------- -----------
Revenue
Income on finance receivables................. $ 21,646 $ 5,872 $ 46,549 $ 31,016
Servicing fees................................ 1,318 285 4,187 1,725
Income on investment in securitizations....... 1,206 868 3,876 2,614
----------- ----------- ----------- -----------
24,170 7,025 54,612 35,355
----------- ----------- ----------- -----------
Expenses
Personnel..................................... 8,671 4,388 21,644 19,397
Communications................................ 1,347 423 2,817 2,281
Rent and other occupancy...................... 764 1,104 1,764 4,090
Professional fees............................. 858 917 2,306 4,891
Contingency legal and court costs............. 375 1,131 515 2,698
Restructuring costs........................... -- -- -- 8,664
Impairment of finance receivables............. -- -- -- 52,851
Impairment of investment in securitizations... -- -- -- 18,849
Other expenses................................ 560 977 1,312 2,469
----------- ----------- ----------- -----------
12,575 8,940 30,358 116,190
----------- ----------- ----------- -----------
Earnings (loss) from operations................... 11,595 (1,915) 24,254 (80,835)
Other income (expense)
Interest and other income..................... 518 141 1,221 601
Interest expense.............................. (1,820) (3,546) (3,185) (9,625)
Reorganization items
Professional Fees............................. -- (1,182) -- (1,182)
----------- ----------- ----------- -----------
Earnings (loss) before income taxes............... 10,293 (6,502) 22,290 (91,041)
Provision for income taxes (benefit).............. 3,998 (2,536) 8,677 (35,506)
----------- ----------- ----------- -----------
Net earnings (loss)............................... $ 6,295 $ (3,966) $ 13,613 $ (55,535)
=========== =========== =========== ===========
Basic earnings per common share................... $.60 $(.38) $1.40 $(5.31)
=========== =========== =========== ===========
Weighted-average number of basic common shares
outstanding................................... 10,430,475 10,453,548 9,725,690 10,453,548
=========== =========== =========== ===========
Diluted earnings per common share................. $.58 $(.38) $1.35 $(5.31)
=========== =========== =========== ===========
Weighted-average number of diluted common shares
outstanding................................... 10,796,369 10,453,548 10,053,059 10,453,548
=========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
1
<PAGE>
CREDITRUST CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
(Dollars in thousands, except share data) DECEMBER 31, SEPTEMBER 30,
------------ -------------
1999 2000
---- ----
(Audited) (Unaudited)
Assets
<S> <C> <C>
Cash and cash equivalents, including restricted cash of $3.3 million and $3.4 million as of
December 31, 1999 and September 30, 2000.................................................... $ 11,927 $ 8,077
Finance receivables held for sale............................................................ 3,126 --
Finance receivables.......................................................................... 184,858 111,642
Investment in securitizations................................................................ 31,169 9,311
Property and equipment, net.................................................................. 9,297 3,594
Deferred costs, net.......................................................................... 3,111 5,080
Deferred tax asset........................................................................... -- 16,818
Other assets................................................................................. 2,087 1,236
-------- --------
Total assets.................................................................. $245,575 $155,758
======== ========
Liabilities and Stockholders' Equity
Liabilities Not Subject to Compromise:
Notes payable................................................................................ $111,306 $ 90,850
Accounts payable and accrued expenses........................................................ 4,986 3,833
Capitalized lease obligations................................................................ 5,208 1,581
Deferred tax liability....................................................................... 20,132 --
Other liabilities............................................................................ 1,606 226
-------- --------
Total liabilities not subject to compromise................................................ 143,238 96,490
-------- --------
Liabilities subject to compromise:
Other undersecured and unsecured liabilities................................................. -- 13,694
Total liabilities............................................................. 143,238 110,184
-------- --------
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, 10,469,068 shares
issued and 10,453,548 outstanding at December 31, 1999 and
September 30, 2000................................................................. 105 105
Paid-in capital........................................................................ 71,078 72,109
Stock held for benefit plans........................................................... (269) (269)
Net unrealized gains on available for sale securities.................................. 2,259 --
Retained earnings (deficit)............................................................ 29,164 (26,371)
-------- --------
Total stockholders' equity.................................................... 102,337 45,574
-------- --------
Total liabilities and stockholders' equity.................................... $245,575 $155,758
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
2
<PAGE>
CREDITRUST CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
AND COMPREHENSIVE INCOME
(Dollars in thousands, except share data)
<TABLE>
<CAPTION>
STOCK ACCUMULATED
----- -----------
COMMON STOCK ADDITIONAL PREFERRED STOCK HELD FOR OTHER
------------ ---------- --------------- -------- -----
PAID-IN BENEFIT COMPREHENSIVE RETAINED
------- ------- ------------- --------
SHARES AMOUNT CAPITAL SHARES AMOUNT PLANS INCOME EARNINGS TOTAL
------ ------ --------- ------ ------ ----- ------ -------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31,
1998 (audited)............... 7,984,480 $ 80 $27,754 -- $ -- $(269) $ 6,714 $ 12,146 $ 46,425
Common stock offering......... 2,400,000 24 42,429 -- -- -- -- -- 42,453
Common stock issued on
options and warrants
exercised.................... 69,068 1 895 -- -- -- -- -- 896
Net earnings.................. -- -- -- -- -- -- -- 17,018 17,018
Other comprehensive income,
decrease in unrealized
gains on available for sale
securities, net of taxes
of $2,288.................... -- -- -- -- -- -- (4,455) -- (4,455)
--------
Total comprehensive income.... 12,563
--------
Balance at December 31,
1999 (audited)............... 10,453,548 105 71,078 -- -- (269) 2,259 29,164 102,337
Value of common stock
purchase warrants issued in
connection with debt
financing.................... -- -- 1,031 -- -- -- -- -- 1,031
Net earnings (loss)........... -- -- -- -- -- -- -- (55,535) (55,535)
Other comprehensive income,
decrease in unrealized
gains on available for sale
securities, net of taxes
of $1,926.................... -- -- -- -- -- -- (2,259) -- (2,259)
--------
Total comprehensive income
(loss)....................... (57,794)
--------
Balance at September 30,
2000 (unaudited) 10,453,548 $ 105 $72,109 -- $ -- $(269) $ -- $(26,371) $ 45,574
========== ===== ======= ====== ======= ===== ======= ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
3
<PAGE>
CREDITRUST CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
1999 2000
---- ----
(Unaudited) (Unaudited)
<S> <C> <C>
Increase (decrease) in cash and cash equivalents
Cash flows from operating activities
Net earnings (loss)....................................................... $ 13,613 $(55,535)
Adjustments to reconcile net earnings to net cash (used in) provided
by operating activities:
Depreciation and amortization......................................... 653 3,200
Deferred tax expense.................................................. 8,677 (35,506)
Income on investment in securitization................................ (3,876) (2,614)
Impairment of investment in securitizations........................... -- 18,849
Impairment of finance receivables..................................... -- 52,851
Restructuring costs................................................... -- 8,664
Changes in assets and liabilities:
(Increase) decrease in other assets................................... (2,142) 781
Icrease in accounts payable and accrued expenses...................... 3,143 6,447
(Decrease) in other liabilities....................................... (51) (152)
--------- --------
Net cash and cash equivalents provided by (used in) operating activities.......... 20,017 (3,015)
--------- --------
Cash flows from investing activities
Collections applied to principal (accretion) on finance receivables....... (11,149) 20,365
(Increase) decrease in cash reserves on securitizations................... (2,616) 1,300
Residual collections on securitizations................................... -- 337
Purchases of property and equipment....................................... (5,384) (3,012)
Proceeds from sale of finance receivables held for sale................... -- 3,126
Acquisitions of finance receivables....................................... (128,328) --
--------- --------
Net cash and cash equivalents (used in) provided by investing activities.......... (147,477) 22,116
--------- --------
Cash flows from financing activities
Proceeds from issuance of common stock.................................... 43,349 --
(Payments on) proceeds from notes payable, net............................ 95,105 (19,424)
Proceeds from (payments on) capital lease obligations..................... (415) 86
Deferred costs............................................................ (3,024) (3,613)
--------- --------
Net cash and cash equivalents provided by (used in) financing activities.......... 135,015 (22,951)
--------- --------
Net increase (decrease) in cash and cash equivalents.............................. 7,555 (3,850)
Cash and cash equivalents at beginning of period.................................. 7,906 11,927
--------- --------
Cash and cash equivalents at end of period........................................ $ 15,461 $ 8,077
========= ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
4
<PAGE>
CREDITRUST CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Note A--Petition for Relief under Chapter 11 and Plan of Reorganization
On June 21, 2000, Creditrust Corporation ("Creditrust") filed a petition for
relief under Chapter 11 of the United States Bankruptcy Code ("Chapter 11") in
the United States Bankruptcy Court for the District of Maryland (the "Bankruptcy
Court"). None of Creditrust's subsidiaries filed. "Debtor", when used herein,
refers to Creditrust's assets and liabilities only. Creditrust and its
consolidated subsidiaries are referred to herein as the "Company". Under Chapter
11, collection of certain claims against the Debtor in existence prior to the
filing of the petition for relief under Chapter 11 are stayed while the Debtor
continues business operations as debtor-in-possession. These claims are
reflected in the September 30, 2000 balance sheet as "liabilities subject to
compromise". Additional claims (liabilities subject to compromise) may arise
subsequent to the filing date resulting from rejection of executory contracts,
including leases, and from the determination by the Bankruptcy Court (or agreed
to by parties of interest) of allowed claims for contingencies and other
disputed amounts. Claims secured against the Debtor's assets ("secured claims")
also are stayed, although the holders of such claims have the right to move the
court for relief from the stay. The Debtor received approval from the Bankruptcy
Court to pay or otherwise honor certain of its prepetition obligations,
including employee wages and benefits. As of September 30, 2000, liabilities
subject to compromise totaled approximately $13.7 million.
In accordance with provisions of Chapter 11, Creditrust filed a Plan of
Reorganization, dated October 5, 2000, with the Bankruptcy Court. Subsequent
amendments were filed, including the Fifth Amended Plan of Reorganization. The
Bankruptcy Court approved the Fifth Amended Disclosure Statement with respect to
the Fifth Amended Plan of Reorganization (the "Plan") on December 21, 2000 for
distribution to all parties of interest and balloting of the vote for the Plan.
Ballots are due back by January 12, 2001. The Plan effects a reorganization of
Creditrust's business. The Plan is premised on a business plan developed by
Creditrust's management involving a merger (the "Merger") of Creditrust with and
into NCO Portfolio Funding, Inc., a Delaware corporation ("NCOP" or the
"Surviving Corporation"). On the date the Plan is consummated (the "Effective
Date"), NCOP's name will be changed to NCO Portfolio Management, Inc., and
Creditrust will be merged into NCOP, which will be the Surviving Corporation.
Most of the Company's employees will become employees of NCO Financial Systems,
Inc. ("NCOF"), a subsidiary of NCO Group, Inc., a Pennsylvania corporation
("NCOG"), which will be the majority owner of NCOP, the Surviving Corporation.
The Merger agreement provides that on the Effective Date, NCOP (immediately
prior to the Merger) shall have a net book value of $25 million, including at
least $10 million of liquidity, and the Surviving Corporation will have a total
cash infusion of $15.52 million including the cash contributions for stock by
Mr. Michael Barrist and Mr. Joseph Rensin (see below).
On the Effective Date, the total number of shares of common stock of NCOP, no
par value per share (the "NCOP Common Stock"), issued and outstanding
immediately before the Effective Date shall, by virtue of the Merger and without
any action on the part of the holder thereof, be automatically converted into
and become such number of shares as follows: immediately after the Merger, NCOG
shall own approximately 60%, and the Series 1999-2 noteholders (the "SPV99-2
Noteholders") shall own approximately 18.5%, of the issued and outstanding
shares of NCOP (after giving effect to the issuance of shares of NCOP to holders
of certain options and warrants of Creditrust as described below). There may be
further adjustments upward to the percentage of stock issued to NCOG and the
holders of the Company's SPV99-2 Notes if there are NCOP Unsecured Obligations
after Disputed Claims are resolved (both as defined in the Plan).
After all Disputed Claims are resolved and the cash has been distributed from
the Reserve created under Section 4.4(c) of the Plan, NCOP Common Stock held in
the Reserve shall be distributed in the following priority:
(1) For every $418,000 of any outstanding NCOP Unsecured Obligations, 1%
of NCOP Common Stock shall be distributed to the following persons in the stated
proportions:
NCOG 72.73%
SPV99-2 Noteholders 22.42%
Michael J. Barrist 3.23%
Joseph K. Rensin 1.62%
------
100%
------
5
<PAGE>
CREDITRUST CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Note A--Petition for Relief under Chapter 11 and Plan of Reorganization
(Continued)
The amounts of NCOP Common Stock so issued shall be proportionally adjusted
based upon the exact amount of outstanding NCOP Unsecured Obligations.
(2) To holders of all existing equity interests, other than the SPV99-
2 Note Holders, including Common Stock, warrants and options, the Allowed Class
11 Interests under the Plan, pro rata.
No fractional shares of NCOP Common Stock shall be issued as a result of the
Merger. In lieu of the issuance of fractional shares, the number of shares of
NCOP Common Stock to be issued to each shareholder of Creditrust and NCOP shall
be rounded off to the nearest whole number of shares of NCOP Common Stock.
Although Creditrust believes the NCOP Unsecured Obligations will not exceed the
allowable amount of $7.315 million, there can be no assurance of that. In the
event that the NCOP Unsecured Obligations equal $7.315 million, the interest of
Creditrust's existing equity interest holders' in NCOP as the surviving
corporation of the Merger would be reduced to zero.
All options and warrants to acquire shares of common stock of Creditrust, $.01
par value per share ("Creditrust Common Stock"), that are issued and outstanding
immediately before the Effective Date (collectively, the "Convertible
Securities") shall, by virtue of the Merger and without any action on the part
of the holder thereof, be automatically voided and cancelled, and converted into
shares of the NCOP Common Stock as follows: shortly after the Effective Date,
each such holder shall be issued the number of shares having an aggregate value
equal to the positive difference, if any, between the aggregate buy-in value of
the NCOP Common Stock into which such Convertible Securities would have been
exercisable based on the Exchange Ratio (as defined under the Plan), as of the
Effective Date, and the aggregate exercise price of such Convertible Securities
as of the Effective Date. For purposes of the foregoing, the "buy-in" value
shall mean the equivalent per share price at which NCOG is deemed to have made
its investment in NCOP as of the Effective Date (i.e., $25 million divided by
the number of shares of NCOP Common Stock to be issued to NCOG). The Exchange
Ratio is one share of NCOP Common Stock for one share of Creditrust Common
Stock.
Asset Guarantee Insurance Company ("AGI") filed a claim against Creditrust for
$32.7 million in connection with AGI's guarantee of the Company's Series 1998-2
and Series 1998-A bonds (the "Warehouse Facility"). AGI also filed a motion to
appoint a Chapter 11 trustee for the Company. Creditrust had previously filed a
lawsuit against AGI, its parent company Enhance Financial Services ("EFS") and a
former officer of EFS (the "EFS Litigation"). Subject to certain conditions and
as part of the Plan, Creditrust has entered into an agreement with AGI and EFS
to settle these disputes (the "AGI Settlement Agreement"). AGI shall be
entitled to have an allowed claim in the amount of $4.55 million (the "AGI
Claim"). The AGI Claim, if any, will be paid in accordance with the provisions
of the AGI Settlement Agreement. In accordance with the terms of the AGI
Settlement Agreement, the EFS Litigation will be dismissed on the Effective
Date. Payment on the AGI Claim can only be demanded if AGI is required to pay
under its credit insurance policy for the Series 1998-A bond (and then only in
the amount of the payment, not to exceed $4.55 million) and after first
exhausting any reserves which are expected to be $4.2 million. NCOF will become
the successor servicer under the agreement. Although difficult to predict with
any certainty, Creditrust believes that the existing reserves for and
collections from the Series 1998-2 and Series 1998-A receivables will be
sufficient to pay off the bonds, and therefore there will be no payment on the
AGI Claim. Any claim payments would not result in a charge to earnings and
would be used to retire the debt.
The consummation of the Merger agreement is contingent upon the satisfaction of
certain conditions prior to the Effective Date. These conditions include, but
are not limited, to the following: a) the Plan shall have been duly approved in
accordance with applicable law, b) the NCOP Unsecured Obligations shall not
exceed $7.315 million, c) a credit facility with aggregate availability of at
least $50 million shall have been established for the benefit of NCOP, d) the
shares of NCOP shall have been approved for listing on the NASDAQ National
Market System, subject to official notice of issuance, e) a servicing agreement
between NCOFS and NCOP shall have been completed assigning all servicing rights
to NCOF for a period of ten years, f) an agreement of the holders of the
Company's Series 1999-1 bonds to recognize NCOF as the successor servicer to
Creditrust and NCOP as the parent company of the special purpose limited
liability company which owns the residual interest in the receivables, and g)
the cancellation of Creditrust's guarantee of the Company's Series 1999-2 bonds.
6
<PAGE>
CREDITRUST CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Note A--Petition for Relief under Chapter 11 and Plan of Reorganization
(Continued)
In connection with the Plan, Creditrust has entered into an agreement with
NCOFS, NCOP and the Series 1999-1 bondholders to provide for NCOFS to become
successor servicer to Creditrust, which could happen prior to the Effective Date
under certain circumstances. Creditrust has also entered into an agreement with
the Series 1999-2 bondholders to, among other things, cancel Creditrust's
guarantee of the Series 1999-2 bonds, provide for the transition of servicing to
NCOFS upon the Effective Date, reduce the servicing fee from 40% of collections
to 20% of collections, and cancel the bondholders' warrants for 1.2 million
shares of Creditrust's Common Stock in exchange for, among other things, 18.5%
of the NCOP Common Stock and a bond paydown of $5 million dollars payable on the
Effective Date.
Creditrust must satisfy the unsecured creditors' claims, and currently
contemplates that with the $13.2 million of cash to be received from NCOP and $2
million in cash to be received from new equity to be issued to Mr. Michael
Barrist and $1 million (approximately $320,000 in cash and $680,000 in stock in
lieu of an unsecured claim) to be received from new equity to be issued to Mr.
Joseph Rensin, Creditrust will be able to satisfy its unsecured creditors in
full in cash and pay $5 million to holders of the Company's Series 1999-2 bonds
in cash. The Plan, however, provides that any shortfall in cash to pay
unsecured creditors' claims, up to the maximum amount of permitted NCOP
Unsecured Obligations (or $7.315 million), shall be paid in full on the
Effective Date or upon resolution of a Disputed Claim.
Assuming there are no NCOP Unsecured Obligations, upon the closing of the Merger
on the Effective Date, Creditrust's existing equity interest holders will own
approximately 17.5% of NCOP after taking into account the 60% interest of NCOG,
the 18.5% interest of the 1999-2 bondholders, a 2.67% interest to Mr. Barrist
and 1.33% to Mr. Rensin for their equity contribution. The 17.5% interest is
subject to modification depending upon the total amount of Claims, including
Administrative Claims (both as defined in the Plan).
It is a condition to the obligations under the Merger Agreement of both
Creditrust, on the one hand, and of NCOG and NCOP, on the other, that upon the
Closing Date the Surviving Corporation enter into an Independent Contractor
Agreement (the "Contractor Agreement") with Joseph K. Rensin. Mr. Rensin
currently is the Chairman of the Board and Chief Executive Officer of
Creditrust, and is the holder of a near majority of the issued and outstanding
Creditrust Common Stock.
Pursuant to the Contractor Agreement, Mr. Rensin is to provide up to 20 hours
per month of consulting services to the Surviving Corporation on an as-needed,
as-requested basis for a term of three years from the Effective Date, and is to
receive base compensation for his services at the annualized rate of $400,000.
In addition to the services which Mr. Rensin has agreed to provide to the
Surviving Company, he has also agreed that he will not engage in any business
operation (with certain limitations) competing with the business of the
Surviving Company and that he will not induce any employee, customer or supplier
of Creditrust to terminate employment or any other relationship with the
Company.
The Nasdaq Stock Market halted trading in the Creditrust Common Stock on June
22, 2000, the day after Creditrust filed its Chapter 11 petition, and de-listed
the Creditrust Common Stock on September 26, 2000. The Creditrust Common Stock
last traded on the Nasdaq Stock Market on June 21, 2000.
On November 8, 2000, the Official Unsecured Creditors Committee ("OUCC") filed a
plan of reorganization with the Bankruptcy Court. The basis of the OUCC Plan is
an acquisition of Creditrust Common Stock by a co-sponsor solely for the benefit
of the creditors and the co-sponsor. While there can be no assurance that the
Plan proposed by Creditrust and the Merger with NCOP will prevail, the plan
proposed by the OUCC is believed by management to be inferior to Creditrust's
Plan. The OUCC has indicated that it now supports the Creditrust Plan and will
not be prosecuting its plan.
Except for Creditrust's Plan as discussed above, the bankruptcy and the defaults
on its line of credit and other facilities raise substantial doubt about the
Company's ability to continue as a going concern. There can be no assurance
that the Company will be successful in achieving its above objectives. The
accompanying financial statements do not include adjustments that might be
necessary in the event the Company is unable to continue as a going concern, or
as a result of the facilities defaults, or additional loss of servicing.
7
<PAGE>
CREDITRUST CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Note B -- Organization and Business
Creditrust 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 historically 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.
Basis of Accounting
In the opinion of management, the accompanying unaudited consolidated financial
statements include all adjustments necessary for their fair presentation in
conformity with generally accepted accounting principles. Interim results are
not necessarily indicative of results for a full year. The information included
in these Statements should be read in conjunction with Management's Discussion
and Analysis of financial condition and results of operations, and consolidated
financial statements and notes thereto included in the Company's Form 10-K, as
amended, for the year ended December 31, 1999.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries, Creditrust Funding I LLC, Creditrust Card
Services Corp., Creditrust SPV99-1, LLC, Creditrust SPV99-2 Capital, Inc., and
Creditrust SPV99-2, 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 as of 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. Estimates have been revised downward
each of the past three quarters. 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. (See notes D
and E)
Note C --Earnings per Common Share
Creditrust's options and warrants were anti-dilutive for the three and nine
months ended September 30, 2000 and therefore there was no difference between
basic and diluted EPS. However, the following table reconciles basic and
diluted EPS for last year for the three and nine months ended September 30,
1999:
(Dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, 1999 NINE MONTHS ENDED SEPTEMBER 30, 1999
------------------------------------- ------------------------------------
PER PER
EARNINGS SHARES SHARE EARNINGS SHARES SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT (NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ------ ----------- ------------- ------
<S> <C> <C> <C> <C> <C> <C>
Basic EPS
Net earnings............................... $6,295 10,430,475 $ .60 $ 13,613 9,725,690 $ 1.40
Effect of dilutive securities
Warrants................................... -- 243,098 -- 220,064
Stock options.............................. -- 122,796 -- 107,305
------ ---------- ------ ---------- ---------- ------
Diluted EPS
Net earnings plus assumed conversions...... $6,295 10,796,369 $ .58 $ 13,613 10,053,059 $ 1.35
====== ========== ====== ========== ========== ======
</TABLE>
8
<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 nine months ended September 30, 2000:
(Dollars in thousands)
Balance, at beginning of period..................... $ 184,858
Purchases of finance receivables........... --
Impairment of finance receivables.......... (52,851)
Accretion to principal..................... 3,919
Amortization of principal.................. (24,284)
----------
Balance, at end of period (unaudited)............... $ 111,642
==========
Unrecorded discount................................. $2,529,752
==========
The Company aggregates individual static pools (i.e. purchases) into larger
homogenous pools for financing purposes. As of September 30, 2000, the carrying
value of each of the financing related pools of receivables was:
(Dollars in thousands)
Warehouse Facility.......... 9,525
Revolving Line of Credit.... 15,612
SPV99-2..................... 32,614
SPV99-1..................... 48,990
Other....................... 4,901
--------
$111,642
========
Changes in Estimates
The Company monitors its projection models with a view towards enhancing
predictability of both the amount and timing of collections. In the second
quarter of 2000, the Company reduced the remaining collection estimates to
reflect changes in circumstances that occurred during the quarter. The changes
in circumstances that effected the Company's ability to meet collection
estimates for last quarter and prompted the revision of all future collections
were: a) the loss of servicing of the Warehouse Facility; b) the backup
servicer's collections were significantly lower than when the finance
receivables were managed by the Company, c) the loss of servicing on
securitization Series 1998-2, when combined with the loss of servicing of the
Warehouse Facility significantly changed the financial prospects of the Company,
d) the Company's inability to secure additional financing to support its
infrastructure and grow the operations, e) a reduction in personnel pursuant to
the restructuring of the Company's operations prior to the filing of Chapter 11
reorganization, f) disruption of operations due to the Company's relocating all
of its recovery personnel pursuant to the Company's restructuring, and f) the
diminished prospects of the Company while in Chapter 11 to meet growth targets
due to restricted availability of funds and a static work force.
To the extent that the carrying amount of an individual static pool exceeds its
fair value (i.e. its remaining collection estimates), a charge to earnings is
recognized in the amount of such excess or impairment. For the quarter ended
September 30, 2000, no impairment of finance receivables was recorded.
After the impairment of a static pool, no income is recorded on that static pool
and collections are recorded as a return of capital. Approximately $54.8 million
in carrying value is in this status.
9
<PAGE>
CREDITRUST CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Note E -- Investment in Securitizations
Investment in securitizations for the nine months ended September 30, 2000 is
comprised of the following:
<TABLE>
<CAPTION>
(Dollars in thousands) Estimated
Cash Amortized Unrealized Fair
Reserves Cost Gains Value
--------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
Balance at beginning of period............... $ 4,550 $ 22,434 $ 4,185 $ 31,169
Release of reserve upon bond payoff.......... (1,300) -- -- (1,300)
Income on investment......................... -- 2,614 -- 2,614
Residual collections......................... -- (337) -- (337)
Impairment of investment in securitizations.. (1,472) (17,377) -- (18,849)
Other........................................ -- 199 -- 199
Decrease in unrealized gains................. -- -- (4,185) (4,185)
------- -------- ------- --------
Balance at end of period (unaudited)......... $ 1,778 $ 7,533 $ -- $ 9,311
======= ======== ======= ========
</TABLE>
These are the residual interests in the two securitizations, Series 1998-1 and
1998-2. Prior to the quarter ended June 30, 2000, absent readily available
market quotes for similar investments, the Company computed the fair value of
the residual interests in its securitizations using a discounted cash flow
valuation. Effective with the NCO purchase offer, the Company believed NCO's
value was the best available indication of market value and in the second
quarter reduced the carrying value to reflect NCO's effective offer. Hence, the
carrying value was impaired by $18.8 million in the second quarter.
In April 2000, the Company received notification from the note insurer, Asset
Guaranty Insurance Company ("AGI," as previously defined), of a non-payment
related default and that it was terminating the Company's servicing rights
effective May 1, 2000 on the Series 1998-2 securitization. The successor
servicer is paid a servicing fee of 30% on monthly collections. Once the bond
is retired in full, including all interest and other administrative expenses of
the trust, the servicing will revert back to the Company. The carrying value of
the Series 1998-2 securitization at September 30, 2000 was $2.0 million, which
is net of the outstanding bond balance of $10.8 million.
The carrying value of Series 1998-1 securitization at September 30, 2000 was
$7.3 million. In August 2000, the Company retired the Series 1998-1 bond in
full, including all outstanding interest and administrative fees. Pursuant to
the retirement of the Series 1998-1 bond, the cash reserve of $1.3 million was
returned to the Company.
See Note A.
10
<PAGE>
CREDITRUST CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Note F -- Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses not subject to compromise consist of the
following at:
<TABLE>
<CAPTION>
(Dollars in thousands)
December 31, September 30,
<S> <C> <C>
1999 2000
------ ------
(Audited) (Unaudited)
Trade accounts payable......................................................... $1,453 $ 186
Accrued salaries, taxes and fringe benefits.................................... 1,550 1,070
Accrued conversion fee SPV99-2 financing....................................... -- 362
Accrued other liabilities...................................................... 1,983 2,215
------ ------
$4,986 $3,833
====== ======
</TABLE>
Note G -- Notes Payable
Debtor-In-Possession Financing
Effective June 22, 2000, the Debtor obtained (subject to Bankruptcy Court
approval) a post-petition working capital facility (the "DIP Facility") from
Sunrock Capital Corporation ("Sunrock"), the Company's prepetition revolving
line of credit lender. The agreement provides for loans to the Debtor for
working capital purposes through the earlier of the Effective Date of the Plan
of Reorganization, or one year. The DIP Facility extends $5 million in credit,
secured by the first priority lien on substantially all of the Debtor's personal
property, including accounts receivable, equipment, and general intangibles. The
DIP Facility provides for cross collateralization of Sunrock's prepetition loan
amounts and interest at prime plus 5%. As of September 30, 2000, the outstanding
balance on the DIP Facility was $1.3 million. No debt service payments are
required under this facility. Accrued interest in the amount of $79,000 is
included in the outstanding balance. The DIP Facility contains covenants, the
most restrictive of which are targeted collections and expense limits. The
Company is in compliance with these requirements.
Warehouse Facility
In September 1998, Creditrust established, through a wholly owned consolidated
special purpose finance subsidiary, Creditrust Funding I LLC, an initial $30
million revolving Warehouse Facility for use in acquiring finance receivables.
The Warehouse Facility carried 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 solely by a trust estate, primarily consisting of specific consumer
receivables that the Company has absolutely assigned to the newly formed special
purpose finance subsidiary, and is non-recourse to the parent company and its
other assets. Generally, the Warehouse Facility provided 95% of the acquisition
costs of receivables purchased, with the Company funding the remaining 5%, and
imposed a one-time $900,000 liquidity reserve requirement. The $900,000 cash
reserve account is included in cash on the balance sheet and restricted as to
use until the Warehouse Facility is retired. It is a requirement of the
indenture agreement governing the Warehouse Facility that the cash reserve be
increased by $1.3 million and $3.25 million, each increase to be effective one
day after the pay-off of Series 1998-1 and 1998-2 securitizations, respectively.
The Company's right to service the receivables funded by the Warehouse Facility
automatically terminates on a monthly basis subject to reappointment by the note
insurer. AGI notified the Company that it was not re-appointing the Company as
servicer effective April 1, 2000. The Trustee, as back-up servicer, appointed
the Company to be servicer for the month of April 2000, and thereafter, selected
a third party until the facility is repaid in full. Once the Warehouse Facility
is repaid, the servicing will revert back to the Company. The indenture and
servicing agreement was amended in February 2000, requiring the Warehouse
Facility to be reduced to $19 million by July 10, 2000. Debt service on the
Warehouse Facility is interest only during a six-month revolving period and
thereafter comprised of all collections from receivables less a 20% servicing
fee. In February 2000, the servicing fee increased to 35% pursuant to the
amended indenture and servicing agreement. These servicing fees are eliminated
in consolidation. As described in above Note E, AGI notified the Company that
the Warehouse Facility was in default due to a cross default provision with
Series 1998-2. The Company was notified that the Warehouse Facility is in
default due to the Company's failure to increase the cash reserves by $1.3
million after the retirement of the Series 1998-1 securitization. The backup
servicer has increased the cash reserve by $100,000 to $1.0 million from
collections received.
11
<PAGE>
CREDITRUST CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Note G--Notes Payable (Continued)
Interest expense, trustee fees and guarantee fees aggregated $677,000 and
$374,000 for the three months ended September 30, 1999 and 2000, respectively.
As of September 30, 2000, the amount outstanding on the facility was $20.7
million and the carrying value of the assets included in the Warehouse Facility
was $9.5 million.
See Note A.
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 had a
term of three years, during which time the Company could borrow and repay funds
to purchase receivables at 80% of acquisition cost. Interest was based on prime
plus 0.5%, or LIBOR plus 2.5% at the option of the Company on each advance.
Pursuant to an amendment to the loan documents in March 2000, interest was prime
plus 2.5% effective April 1, 2000. The facility is secured by any receivables
purchased under the facility and substantially all the Company's other assets.
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. Debt service on the revolving facility was interest only for six
months following the purchase of receivables. After six months, principal was
payable over twenty-four months.
The Company did not make its principal or interest payments on the revolving
line of credit facility for April and May 2000. The lender declared default, but
did not accelerate the loan. Interest on the line increased to prime plus 5% per
annum effective April 1, 2000. Pursuant to a court order and effective for June
2000, the Company modified the terms of the agreement whereby 60% of certain
collections are applied to debt service, and the remaining collections go to the
Company. Debt service payments are paid weekly. Outstanding debt on the line as
of September 30, 2000 was $14.5 million, including $1.1 million of interest
capitalized as part of the line, and the carrying value of the finance
receivables under this facility was $15.6 million. Interest expense totaled
$360,000 and $564,000 for the three months ended September 30, 1999 and 2000,
respectively.
SPV99-2 Financing
In August 1999, the Company entered into a $40.0 million interim credit facility
to fund purchases of additional portfolios of defaulted receivables. Under this
arrangement, Creditrust SPV99-2, LLC (Series 1999-2), a newly formed special
purpose subsidiary, issued secured, interim short-term notes in a private
placement to institutional investors. The notes are backed by a parent guarantee
from Creditrust. The subsidiary used the proceeds of the interim credit facility
to purchase portfolios including purchases under forward flow contracts. The
Company was initially obligated to retire this facility with proceeds from any
capital markets transactions or certain asset sales prior to the May 2000
initial maturity date. Interest was initially payable at 12% per annum. Debt
service was initially all collections on the receivables. The notes converted to
long-term financing effective March 1, 2000, at which time the interest rate
changed to 15% per annum and the maturity extended to September 2002. Pursuant
to the conversion of the notes, effective March 1, 2000, the Company may utilize
up to $20.0 million from capital markets transactions or certain asset sales for
working capital purposes in lieu of retiring the loan balance. Warrants for the
purchase of 1,236,138 shares of common stock of the Company were issued to the
lenders based on the average stock price under a defined formula at market
value. An original issue discount of $1.0 million was recorded pursuant to the
issuance of the stock warrants. The lenders will receive a conversion fee of
8.25% of the outstanding debt on March 1, 2000, or $2.8 million, payable from
collections on the receivables. As of September 30, 2000, $362,000 remains
unpaid on the conversion fee.
Debt service, including payment of the conversion fee, is all collections less a
40% servicing fee paid to the Company. Servicing fees are eliminated in
consolidation. The facility includes a technical cross default on the revolving
line of credit and securitizations. As a consequence of the Company's filing for
relief under Chapter 11 of the federal bankruptcy laws, under the terms of the
agreement, the interest rate increased to 21% per annum. As of September 30,
2000, the Company had $33.8 million outstanding under this facility. Interest
expense totaled $1.9 million and $800,000 for the three months ended September
30, 2000 and 1999, respectively, and the carrying value of the finance
receivables under this facility was $32.6 million.
See Note A.
12
<PAGE>
CREDITRUST CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Note G--Notes Payable (Continued)
Non Recourse SPV99-1 Securitization Note
In August 1999, the Company issued a $40.0 million asset backed securitization
note through its newly formed special purpose subsidiary Creditrust SPV99-1, LLC
(Series 1999-1). This note is secured by the receivables pledged to the note
holders and is non-recourse to the parent Company and its other assets. Interest
is payable at 9.43% per annum and the final maturity date of the note is July
2004. Interest expense totaled $532,000 and $314,000 for the three months ended
September 30, 2000 and 1999, respectively. A one-time $2.4 million liquidity
reserve is included in cash on the balance sheet and restricted as to use until
the note is retired. The securitization did not qualify for gain on sale
accounting under generally accepted accounting principles, with the result that
the securitization notes are treated as a secured borrowing and appear as debt
on the consolidated financial statements of the Company. As of September 30,
2000, the Company had $21.4 million outstanding under the facility, and the
carrying value of the finance receivables under the facility was $49.0 million.
Debt service is paid from all collections on the receivables less a 20%
servicing fee. Servicing fees are eliminated in consolidation.
Due to a cross default provision with any other defaulted securitization, the
trustee notified the Company that a servicer default had occurred. On May 4,
2000, the Company was notified by the trustee for the bondholders that effective
immediately, Creditrust was terminated of all its duties and obligations under
the servicing agreement. In subsequent discussions, the bondholders have
requested the Company to continue servicing the receivables for an indeterminate
period. The servicing will be transferred to NCOF as part of a settlement
reached with the Series 1999-1 bondholders.
See Note A.
As of September 30, 2000, estimated required minimum principal payments payable
by the Company were as follows:
(Dollars in thousands)
Year ending December 31,
2000 $ 4,941
2001 26,535
2002 35,292
2003 3,493
2004 and thereafter 21,388
-------
Total minimum principal payments 91,649
Original issue discount on warrants issued from SPV99-2 financing (799)
---
Fair value of debt recorded $ 90,850
========
The above table does not reflect the impact of potential acceleration of any
loans caused by defaults.
Note H--Commitments and Contingencies
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. As of September 30, 2000, the Company had no commitments under
forward flow agreements.
13
<PAGE>
CREDITRUST CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Note H--Commitments and Contingencies (continued)
Litigation
Reference is hereby made to Note A above for a description of the Chapter 11
proceeding to which the Company is a party, which description is incorporated
herein by reference.
The Company filed a complaint on April 4, 2000 against Enhanced Financial
Services Group Inc. ("EFS"), AGI and Charles Henneman in the United States
District Court for the District of Maryland containing 18 counts alleging
securities fraud, common law fraud and other common law tort actions and which
seeks compensatory and punitive damages in excess of $200 million. All
defendants have filed motions to dismiss, which have been briefed and answered.
After Creditrust filed for relief under Chapter 11 of the federal bankruptcy
laws, AGI filed a motion for a temporary restraining order in connection with
$1.3 million reserves held by Series 98-1 securitization. The court denied AGI's
motion. AGI also filed a motion seeking the appointment of a Chapter 11 trustee.
AGI filed a claim in the Bankruptcy Court for up to $32.7 million. See Note A
for a description of the AGI Settlement Agreement reached with AGI, EFS and
Henneman.
Creditrust filed a complaint in the United States District Court for the
District of Delaware seeking a declaratory judgment with respect to a contract
between the Company and MBNA which had terminated as a result of certain actions
by MBNA. MBNA answered by denying any liability, and filed a counterclaim
seeking damages (not calculated or stated) from the Company for breach of
contract. The Company answered by denying all liability. The counterclaim has
been stayed by the Chapter 11 proceedings and all parties have agreed to hold
off on any discovery with respect to the original claim. MBNA has filed an
unliquidated claim and an amended claim in the amount of $4.5 million in the
Bankruptcy Court to which the Company has objected. All parties have entered
into a Memorandum of Understanding, the terms of which set forth an agreed
settlement of all outstanding issues and allows MBNA a cash claim of $65,000.
The Company intends to contest this litigation vigorously in the event the
settlement was not completed.
The Company filed a complaint in the United States District Court for the
District of Maryland seeking damages from a former employee et al. for theft and
conversion of funds belonging to the Company (currently estimated to be in
excess of $200,000). A temporary restraining order was issued and converted to a
preliminary injunction preventing the removal or expenditure of assets by the
defendants. Subpoenas have been issued to various financial institutions in
order to discover any misdirected funds. An insurance claim has been filed.
A complaint was filed in the Court of Common Pleas for Lucas County, Ohio
seeking damages of approximately $400,000 from the Company and a co-defendant,
Key Bank, resulting from a tradeline which the Company allegedly filed on
plaintiff's credit report. Plaintiff alleges that the Company knew, or had
reason to know, that the account purchased had been previously settled. A stay
has been issued pursuant to a notice of suggestion of bankruptcy being filed.
Plaintiff has also filed a claim in the United States Bankruptcy Court for the
District of Maryland, Northern Division. The Company intends to contest this
litigation vigorously.
A complaint was filed in the Circuit Court for Baltimore County seeking damages
of $1,333,000 from the Company for alleged breach of a contract for the
construction of tenant improvements in the Company's former call center in Hunt
Valley, Maryland. An answer has been filed and all proceedings stayed by the
Chapter 11 filing. A claim was filed in the Bankruptcy Court and the Company has
objected to the claim. The Company has provided for any likely loss in
connection with this litigation.
A class action complaint was filed against the Company in the United States
District Court for the Northern District of Illinois seeking class damages for
all customers of the Company residing in Illinois who received a collection
letter alleged to be in violation of the Fair Debt Collection Practices Act. The
Company filed an answer and discovery has commenced. Class certification has
been challenged and the original plaintiff has withdrawn and a substitute
plaintiff has been added. The Company has again challenged certification of the
class based upon the lack of sufficient commonality of facts to support
liability. The proceeding was dismissed by the plaintiff for no consideration on
July 28, 2000. The plaintiff has filed a claim in the Bankruptcy Court. The
Company has objected to this claim. The Company intends to contest this
litigation vigorously.
14
<PAGE>
CREDITRUST CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Note H--Commitments and Contingencies (continued)
A complaint was filed against the Company in the United States District Court
for the Northern District of Alabama seeking class damages for all customers of
the Company who had filed for protection under the U.S. Bankruptcy Code and, in
alleged violation of the automatic stay provisions of the Code, continued to
receive requests for payment from the Company. Several counts have been
dismissed by the court. Class certification is pending. All proceedings have
been stayed as a result of the Chapter 11 proceeding. The plaintiff has filed a
claim in the Bankruptcy Court. The Company has objected to this claim.
Six complaints filed in the United States District Court for the District of
Maryland seeking class damages against certain officers of the Company for
alleged violation of the Securities and Exchange Act and various rules
promulgated thereunder. The Company is not a named defendant because of the
Chapter 11 proceeding, but may have indemnification responsibilities to some or
all defendants. Motions to dismiss to be filed. The Company's plan of
reorganization specifically provides for pre Chapter 11 filing related
indemnification claims to be limited to a trust fund and certain insurance
policies. The surviving corporation will have no ongoing responsibility for
these claims under the plan. Any deductibles the Company may incur have been
expensed.
Seven individual complaints, filed in the Circuit Court for Baltimore City by
the same attorney seek individual yet identical compensatory and punitive
damages and state identical causes of action. Said causes of action include the
violation of the Maryland Consumer Protection Act, fraud, constructive fraud,
the violation of Federal Consumer Credit Protections Act, negligence, breach of
contract, interference with contractual relations, and intentional infliction of
emotional distress. Motions to dismiss certain counts and defendants and to
remove the remaining matters to the United States District Court for the
District of Maryland have been filed. The Company believes these claims are
without merit. The Bankruptcy stay has caused the case to be administratively
closed. The plaintiffs have filed claims in the Bankruptcy Court. The Company
has objected to these claims. The Company intends to contest this litigation
vigorously.
On August 18, 2000 the Official Unsecured Creditors Committee filed a motion
seeking the appointment of a Chapter 11 trustee alleging that the Company had
failed to provide timely information. The Company opposed the motion, having
provided extensive information to the Committee's professionals. The motion was
resolved through a consent order setting forth procedures to accommodate the
Committee's requests in a reasonable manner.
In addition to the Chapter 11 proceeding described under Note A above and the
litigations described above in this Note H, the Company is involved in various
litigations in the ordinary course of business. Management believes that these
other litigations, individually and in the aggregate, will not have a material
adverse impact on the Company's financial position, results of operations or
liquidity.
Note I - Restructuring of Operations
In May 2000, the Company effectuated a restructuring plan and closed one of its
operations centers. The exit plan included relocating all employees in the
closed operations center to its main operations center, disposing of certain
equipment leases, and a reduction in staff. The cost of restructuring of $8.7
million before tax was presented as a charge to income as a separate component
of earnings from operations in the second quarter. The restructuring costs
included writing off unutilized property and equipment leases and leaseholds,
and costs of abandonment of the real property lease.
15
<PAGE>
CREDITRUST CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Note J - Subsequent Events
See Note A regarding the Company's plan of reorganization and Merger agreement.
Note K - related Party Transactions
In March 2000, the Company's Chairman and Chief Executive Officer loaned the
Company $648,000 as a short-term note. The proceeds of the note were used to
pay an obligation of the Company under the line of credit facility.
See Note A
In 2000, the Company paid $400,000 and has agreed to honor a claim of $416,000
to a company related to a director. The payments are in connection with the
return of specific accounts pursuant to account sales warrantees for accounts
sold in late 1999.
16
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Quarter Ended September 30, 2000 Compared to Quarter Ended September 30, 1999
Revenues. Total revenues decreased by $17.2 million, or 70.9%, from $24.2
million for the three months ended September 30, 1999 to $7.0 million for the
three months ended September 30, 2000. Contributing to the decrease were lower
income on finance receivables, servicing income and income on investment in
securitizations. Of the $17.2 decrease, $15.9 million was attributable to
finance receivables and reflects the effect of lower investment in receivables
as a result of the impairment in the second quarter of 2000, generally lower
effective interest rate returns compared to prior year reports due to lowered
estimates and from the effect on income this quarter of approximately $54.8
million in finance receivables not earning any income. Additionally, there were
decreases in servicing income of $1.0 million and investment in securitizations
of $300,000. Servicing fees, while expected to decline since the Company is no
longer undertaking securitizations, were primarily lower due to the loss of
servicing for the Series 1998-2 securitization. Income on securitizations
declined principally due to the lower investment balance of the securities as
the result of the revaluation of the securities to market. Third quarter 2000
revenues are reflective of the trend for the future quarters until the Merger.
Income on finance receivables decreased by $15.7 million, or 72.9%, from $21.6
million for the three months ended September 30, 1999 to $5.9 million for the
three months ended September 30, 2000. The decrease of $15.7 million in finance
receivables reflects the effect of lower investment in receivables as a result
of the impairment in the second quarter of 2000, generally lower effective
interest rate returns compared to prior year reports due to lowered estimates
and from the effect on income this quarter of approximately $54.8 million in
finance receivables not earning any income. The changes in circumstances that
effected the Company's ability to meet collection estimates in the second
quarter that prompted the revision of all future collections were: a) the loss
of servicing of the Warehouse Facility; the backup servicer collections were
significantly lower than when the finance receivables were managed by the
Company, b) the loss of servicing on securitization Series 1998-2, when combined
with the loss of servicing of the Warehouse Facility significantly changed the
financial prospects of the Company, c) the Company's inability to secure
additional financing, d) a decrease in personnel pursuant to the restructuring
of its operations prior to the filing of Chapter 11 reorganization, e)
disruption of operations due to the Company's relocating all of its recovery
personnel pursuant to the restructuring of its operations, and f) the diminished
prospects of the Company while in Chapter 11 to meet growth targets due to
restricted availability of funds and a static work force. After the impairment
of a static pool, no income is recorded on that pool and collections are
recorded as return of capital. The revision of estimates caused collections to
be allocated more to amortization of finance receivables than to income on
finance receivables for the quarter ended September 30, 2000. Net collections
applied to amortization or (accretion) of finance receivables was ($5.8) million
and $8.8 million for the three months ended September 30, 1999 and September 30,
2000, respectively. Collections on managed receivables decreased by $8.0
million, or 35.2%, from $22.7 million for the three months ended September 30,
1999 to $14.7 million for the three months ended September 30, 2000.
Servicing fees decreased by $1.0 million from $1.3 million for the three months
ended September 30, 1999 to $300,000 for the three months ended September 30,
2000. Recorded servicing fees represent 20% of collections from the two
investments in securitization. Effective May 2000, the Company was removed as
servicer on its Series 1998-2 securitization, and servicing was transferred to a
new third party servicer. Servicing fees lost due to the change are estimated
at $400,000 for the quarter ended September 30, 2000. Additionally, servicing
fees were higher in the quarter ended September 30, 1999 compared to September
30, 2000 due to collections on the securitization portfolios reaching their peak
in mid 1999.
Income on investment in securitization decreased $300,000 from $1.2 million for
the three months ended September 30, 1999 to $900,000 for the three months ended
September 30, 2000. Prior to the quarter ended June 30, 2000, absent readily
available market quotes for similar investments, the Company computed the fair
value of the residual interests in its securitizations using a discounted cash
flow valuation. Effective with the NCO purchase offer, the Company believed
NCO's value was the best available indication of market value and has reduced
the carrying value to reflect NCO's effective offer. Hence, the carrying value
was impaired by $18.8 million in the second quarter.
Expenses from Operations. Total expenses from operations decreased $3.7
million, or 29.4% from $12.6 million for the three months ended September 30,
1999 to $8.9 million for the three months ended September 30, 2000. Operating
expenses decreased primarily as a result of decreases in personnel and
communications costs offset by an increase in contingency legal and court costs.
17
<PAGE>
Personnel expenses decreased by $4.3 million, or 49.4%, from $8.7 million for
the three months ended September 30, 1999 to $4.4 million for the three months
ended September 30, 2000. The decrease in personnel expenses was attributable
to a decrease in overall staffing related to the Company's downsizing as part of
its restructuring. Staffing requirements were lowered as receivables under
management decreased due to the loss of servicing of the Series 1998-2
securitization and the Warehouse Facility portfolio. By the beginning of the
third quarter, total employees were reduced to approximately 350, down from
approximately 1100 at December 31, 1999.
Communications costs decreased by $900,000, or 68.6%, from $1.3 million for the
three months ended September 30, 1999 to $400,000 for the three months ended
September 30, 2000. The utilization of long distance telephone services and
credit reporting services decreased as receivables under management and staffing
decreased from the third quarter ended 1999 compared to 2000.
Rent and occupancy expenses increased by $300,000, or 44.6%, from $800,000 for
the three months ended September 30, 1999 to $1.1 million for the three months
ended September 30, 2000. This increase was due to the further expansion in its
third operations center in September 1999 resulting in rent expense greater for
the full third quarter of 2000 compared to 1999.
Professional fees, contingecy legal and court costs and other expenses increased
$1.2 million, or 66.7%, from $1.8 million for the three months ended September
30, 1999 to $3.0 million for the three month ended September 30, 2000. This
increase was principally due to increased contingency legal and court costs,
deferred financing costs, accounting fees, investor relations expenses, other
consulting fees, and miscellaneous other administrative costs.
Earnings(loss) from Operations. Earnings from operations, decreased $13.5
million, from $11.6 million for the three months ended September 30, 1999 to a
loss from operations of $1.9 million for the three months ended September 30,
2000. This decrease resulted primarily from the reduced income on finance
receivables for the quarter ended September 2000 compared to 1999.
Other Income (Expense). Other income (expense) increased $2.1 million, from a
net expense of $1.3 million for the three months ended September 30, 1999 to a
net expense of $3.4 million for the three months ended September 30, 2000. This
increase resulted from a $400,000 decrease in interest and other income earned
on short term cash equivalent investments and an increase in interest expense of
$1.7 million as a result of higher borrowing incurred in connection with the
credit facilities, SPV99-2 finance facility and the August 1999 securitization.
Reorganization items. Reorganization items were $1.2 million for the three
months ended September 30, 2000 and none for the three months ended September
30, 1999. Reorganization items were principally professional fees paid or
incurred on legal and financial professionals approved by the Bankruptcy Court
to handle representation of the debtor and the unsecured creditors.
Earnings (loss) Before Income Taxes. Earnings before income taxes, decreased
from $10.3 million for the three months ended September 30, 1999 to a loss of
$6.5 million for the three months ended September 30, 2000 primarily due to the
decrease in earnings from operations and by the increase in interest expense.
Provision for Income Taxes. Income tax rates were 39% for the three months
ended September 30, 1999. For the three months ended September 30, 2000, a
deferred tax asset was recorded at a rate of 39%. The Company's effective tax
rate may fluctuate as a result of changes in pre-tax income and nondeductible
expenses. The realization of the deferred tax asset is predicated on the
Company's ability to utilize most of its tax net operating losses in future
years. Any additional deferred tax asset will be limited to similar analysis.
Net Earnings (loss). Net earnings, decreased $10.3 from $6.3 million for the
three months ended September 30, 1999 to a net loss of $4.0 million for the
three months ended September 30, 2000. This decrease resulted from the same
factors which affected earnings from operations and the increase in interest
expense.
EBITDA. EBITDA, decreased $14.4 million, from $12.4 million for the three
months ended September 30, 1999 to a loss of $2.0 million for the three months
ended September 30, 2000.
18
<PAGE>
Nine Months Ended September 30, 2000 Compared to Nine Months Ended September 30,
1999
Revenues. Total revenues decreased by $19.2 million, or 35.2%, from $54.6
million for the nine months ended September 30, 1999 to $35.4 million for the
nine months ended September 30, 2000. Contributing to the decrease were lower
income on finance receivables, servicing income and income on investment in
securitizations. The decrease was primarily due to the lower investment in
receivables as a result of the impairment of $52.9 million in the second
quarter, and the effect on income for the second and third quarters of 2000 of
approximately $60.4 million and $54.8, respectively, in finance receivables not
earning any income. Additionally, servicing income decreased by $2.5 million
and income on investment in securitizations by $1.3 million. Servicing fees,
while expected to decline since the Company is no longer undertaking
securitizations, were primarily lower due to the loss of servicing for the
Series 1998-2 securitization. Income on securitizations declined principally
due to the lower investment balance of the securities as the result of the
revaluation of the securities to market.
Income on finance receivables decreased by $15.5 million, or 33.3%, from $46.5
million for the nine months ended September 30, 1999 to $31.0 million for the
nine months ended September 30, 2000. The decrease was primarily due to the
lower investment in receivables as a result of the impairment of $52.9 million
in the second quarter, and the effect on income for the second and third
quarters of 2000 of approximately $60.4 million and $54.8, respectively, in
finance receivables not earning any income.In the second quarter of 2000, the
Company reduced the remaining estimates to reflect changes in circumstances that
occurred during the quarter. The changes in circumstances that effected the
Company's ability to meet collection estimates for the quarter and prompted the
revision of all future collections were: a) the loss of servicing of the
Warehouse facility; the backup servicer collections were significantly lower
than when the finance receivables were managed by the Company, b) the loss of
servicing on securitization Series 1998-2, when combined with the loss of
servicing of the Warehouse facility significantly changed the financial
prospects of the Company, c) the Company's inability to secure additional
financing, d) a decrease in personnel pursuant to the restructuring of its
operations prior to the filing of Chapter 11 reorganization, e) disruption of
operations due to the Company's relocating all of its recovery personnel
pursuant to the restructuring of its operations, and f) the diminished prospects
of the Company while in Chapter 11 to meet growth targets due to restricted
availability of funds and a static work force. After the impairment of a static
pool, no income is recorded on that pool and collections are recorded as return
of capital. The revision of estimates caused collections to be allocated more to
amortization of finance receivables than to income on finance receivables for
the two quarters ended September 30, 2000. Net collections applied to
amortization or (accretion) of finance receivables was ($11.1) million and $20.4
million for the nine months ended September 30, 1999 and September 30, 2000,
respectively. Collections on managed receivables increased by $2.0 million, or
3.5%, from $56.5 million for the nine months ended September 30, 1999 to $58.5
million for the nine months ended September 30, 2000.
Servicing fees decreased by $2.5 million from $4.2 million for the nine months
ended September 30, 1999 to $1.7 million for the nine months ended September 30,
2000. Recorded servicing fees represent 20% of collections from the two
investments in securitization. Effective May 2000, the Company was removed as
servicer by AGI on its Series 1998-2 securitization, and servicing was
transferred to a new third party servicer. Servicing fees lost due to the
change are estimated at $800,000 for the two quarters ended September 30, 2000.
Additionally, servicing fees were higher in the nine months ended September 30,
1999 compared to September 30, 2000 due to collections on the two securitization
portfolios reaching their peak in mid 1999.
Income on investment in securitization decreased $1.3 million from $3.9 million
for the nine months ended September 30, 1999 to $2.6 million for the nine months
ended September 30, 2000. Prior to the quarter ended June 30, 2000, absent
readily available market quotes for similar investments, the Company computed
the fair value of the residual interests in its securitizations using a
discounted cash flow valuation. Effective with the NCO purchase offer, the
Company believed NCO's value was the best available indication of market value
and has reduced the carrying value to reflect NCO's effective offer. Hence, the
carrying value was impaired by $18.8 million in the second quarter.
Expenses from Operations. Total expenses from operations, prior to the one-time
charges for restructuring and impairment of receivables and securitizations of
$8.7 million and $71.7 million, respectively, increased $5.5 million, or 18.2%,
from $30.3 million for the nine months ended September 30, 1999 to $35.8 million
for the nine months ended September 30, 2000. Operating expenses increased
primarily as a result of increased professional fees incurred in connection with
the Company's reorganization planning efforts before the filing of its Chapter
11 petition, increased occupancy expenses related to the expansion to its third
operations center that occurred in the last half of 1999, and increased
contingency legal and court costs.
19
<PAGE>
Personnel expenses decreased by $2.2 million, or 10.4%, from $21.6 million for
the nine months ended September 30, 1999 to $19.4 million for the nine months
ended September 30, 2000. Personnel expenses decreased due to the reduction in
staff in connection with the Company's restructuring of operations in the second
quarter of 2000. By the beginning of the third quarter, total employees were
reduced to approximately 350, down from approximately 1100 at December 31, 1999.
Communications costs decreased by $500,000, or 19.0%, from $2.8 million for the
nine months ended September 30, 1999 to $2.3 million for the nine months ended
September 30, 2000. This decrease was due to lower utilization of long distance
telephone services and credit reporting services in the second and third quarter
of 2000 as the Company lost servicing on the 1998-A Warehouse Facility and 1998-
2 securitization pools in May 2000.
Rent and occupancy expenses increased by $2.3 million, or 131.9%, from $1.8
million for the nine months ended September 30, 1999 to $4.1 million for the
nine months ended September 30, 2000. This increase was due to the opening of
the Company's third operations center in September 1999 and expansion of its
operations boosting costs for the nine months of 2000 as compared to 1999.
Professional fees, contingency legal and court costs and other expenses
increased $6.0 million, or 172.0%, from $4.1 million for the nine months ended
September 30, 1999 to $10.1 million for the nine months ended September 30,
2000, primarily as a result of expenses incurred in connection with the
Company's workout and reorganization planning efforts prior to the filing of
Chapter 11, and increased contingency legal and court costs from the growth in
files owned compared to a year ago. Other expenses include amortization of
deferred financing costs, accounting fees, investor relations expenses, other
consulting fees, and miscellaneous other administrative costs.
Earnings (loss) from Operations. Earnings from operations, prior to the one-
time charges for restructuring and impairment of receivables and securitizations
of $8.7 million and $71.7 million, respectively, decreased $24.8 million from
$24.3 million for the nine months ended September 30, 1999 to a loss of $500,000
for the nine months ended September 30, 2000. This decrease resulted primarily
from the reduced income on finance receivables, and increased professional fees
and contingency legal and court costs for the second and third quarters ended
September 2000 compared to 1999.
Other Income (Expense). Other income (expense) increased $7.0 million, from a
net expense of $2.0 million for the nine months ended September 30, 1999 to a
net expense of $9.0 million for the nine months ended September 30, 2000. This
increase resulted from a $600,000 decrease in interest and other income earned
on short term cash equivalent investments plus an increase in interest expense
of $6.4 million as a result of higher borrowing incurred in connection with the
credit facilities, SPV99-2 finance facility and the August 1999 securitization.
Reorganization items. Reorganization items were $1.2 million for the nine
months ended September 30, 2000 and none for the nine months ended September 30,
1999. Reorganization items were principally professional fees paid or incurred
on legal and financial professionals approved by the Bankruptcy Court to handle
representation of the debtor and the unsecured creditors.
Earnings (loss) Before Income Taxes. Earnings before income taxes, prior to the
one-time charges for restructuring and impairment of receivables and
securitizations of $8.7 million and $71.7 million, respectively, decreased $33.0
million, from $22.3 million for the nine months ended September 30, 1999 to a
net loss of $10.7 million for the nine months ended September 30, 2000 primarily
due to the decrease in earnings from operations plus the increase in interest
expense.
Provision for Income Taxes. Income tax rates were 39% for the nine months ended
September 30, 1999. For the nine months ended September 30, 2000, a deferred
tax asset was recorded at a rate of 39%. The Company's effective tax rate may
fluctuate as a result of changes in pre-tax income and nondeductible expenses.
The realization of the deferred tax asset is predicated on the Company's ability
to utilize most of its tax net operating losses in future years. Any additional
deferred tax asset will be limited to similar analysis.
Net Earnings (loss). Net earnings, prior to the one-time after tax charges for
restructuring and impairment of receivables and securitizations of $5.3 million
and $43.7 million, respectively, decreased $20.1 million, from $13.6 million for
the nine months ended September 30, 1999 to a net loss of $6.5 million for the
nine months ended September 30, 2000. This decrease resulted from the same
factors which affected earnings from operations and the increase in interest
expense.
EBITDA. EBITDA, prior to the one-time charges for restructuring and impairment
of receivables and securitizations of $8.7 million and $71.7 million,
respectively, decreased $24.0 million from $26.1 million for the nine months
ended September 30, 1999 to $2.1 million for the nine months ended September 30,
2000.
20
<PAGE>
Financial Condition
Cash and Cash Equivalents. Cash and cash equivalents decreased from $11.9
million as of December 31, 1999 to $8.1 million as of September 30, 2000 due to
net cash used in financing activities exceeding net cash provided by operating
activities and investing activities due to increased debt service requirements
from borrowings.
Finance Receivables. Investment in finance receivables decreased $73.3 million
to $111.6 million as of September 30, 2000 from $184.9 million as of December
31, 1999. The Company made no purchases of finance receivables during the nine
months ended September 30, 2000. Net amortization to principal on finance
receivables of $20.4 million was recorded for the nine months ended September
30, 2000 as collections exceeded recorded income on finance receivables.
Additionally, finance receivables were written down to net realizable value in
the second quarter through an impairment in the amount of $52.9 due to revisions
in the future estimated collections.
Investment in Securitizations. Investment in securitizations decreased $21.9
million from $31.2 million as of December 31, 1999 to $9.3 million as of
September 30, 2000. The decrease is comprised of an impairment of
securitizations of $18.8 million, a decrease in the unrealized gain of $4.2
million, a decrease in the cash reserves of $1.3 million, residual collections
on the 1998-1 securitization of $300,000, offset by income on investment in
securitizations of $2.6 million, and other adjustments of $100,000.
Accounts Payable and Accrued Expenses. Accounts payable and accrued expenses
decreased $1.2 million, or 23.1%, from $5.0 million at December 31, 1999 to $3.8
million as of September 30, 2000. As of September 30, 2000, $13.7 million of
accrued expenses and accounts payable have been reclassified as liabilities
subject to compromise in accordance with the Company's filing for Chapter 11
reorganization in June 2000. The remaining $3.8 million of liabilities
represent post-petition trade payables and accrued expenses incurred after the
filing of Chapter 11 reorganization, and liabilities related to the Company's
consolidated subsidiaries.
Notes Payable and Capitalized Lease Obligations. Notes payable decreased from
$111.3 million as of December 31, 1999 to $90.9 million as of September 30,
2000. The decrease in notes payable was attributable to the repayments on the
Company's credit facilities from cash flow. Notes payable of $90.9 million are
presented net of an original issue discount of $800,000 from the issuance of
warrants in connection with the conversion of the SPV99-2 financing to a term
note on March 1, 2000.
Liquidity and Capital Resources
Historically, the Company has derived substantially all of its cash flow from
collections on finance receivables and servicing income. The primary sources of
funds to purchase receivables are cash flow, asset backed securitizations, the
SPV99-2 credit facility, borrowings under two credit facilities and equity
capital.
As of September 30, 2000, the Company had cash and cash equivalents of $8.1
million. Cash used in operating activities was $3.0 million for the nine months
ended September 30, 2000. There were no purchases of finance receivables for
the nine months ended September 30, 2000. No credit was available under the
Company's pre-petition credit facilities at September 30, 2000.
The Company had entered into forward flow contracts with a number of credit
grantors. These contracts obligated the Company to make monthly purchases of
receivables portfolios provided they met certain agreed-upon criteria. These
commitments have expired or terminated. The Company does not currently intend
to enter into new forward flow contracts. Presently, the Company does not
intend to purchase receivables prior to the Merger.
Other Matters
The Staff of the Division of Corporation Finance of the SEC has made certain
comments to Creditrust regarding its historical financial statements. The Staff
has raised certain questions as to the manner in which Creditrust estimates and
accounts for the collectibility of its purchased receivables, as well as to its
use of the accrual basis of accounting. The Company has discussed these matters
with its independent accountants, and believes that these matters have been
accounted for properly and that its financial statements are fairly stated.
21
<PAGE>
Events Leading to the Commencement of the Chapter 11 Petition:
Inability to Secure Additional Financing
The debt service requirements associated with our securitizations significantly
increased liquidity requirements. The interest only periods under both the Line
of Credit Facility and the Warehouse Facility expired, and no further borrowings
were permitted under the Warehouse Facility. The Company was unsuccessful in
obtaining financing with principal payments and other terms appropriately
matched to the anticipated cash flows from receivables that would be purchased
with the financing, including replacement financing to payoff the interim credit
facility SPV 99-2, which required 100% cash flow to service debt until March
2000. Throughout the third and fourth quarters of 1999, the Company endeavored
to float five-year notes to augment the existing financing and pay off SPV 99-2.
The credit market for specialty finance companies in general and the Company's
sector in particular was unavailable. The Company was unable to secure a
refinancing and in December, the Board of Directors voted to engage an advisor
to help the company locate a strategic partner and or pursue a sale of the
company. Several other financing options were pursued in the first quarter of
2000 including a $55 million high yield bond and indications of interest by one
or two potential strategic partners. None of these transactions were
consummated.
AGI Lawsuit; AGI's Termination of Servicing
On April 4, 2000, the Company filed in the United States District Court for the
District of Maryland an 18-count suit seeking compensatory and punitive damages
in excess of $200 million against Enhance Financial Services Group, Inc.
(NYSE:EFS), AGI, and Charles Henneman, Senior Vice President of EFS. EFS is the
parent of AGI, which insures three of the Debtor's four asset backed bonds. The
suit alleges that EFS, through its Senior Vice President Charles Henneman,
secretly posted maliciously false and disparaging statements about the Debtor on
the Yahoo! message board, an Internet web site, at which the Debtor is the
dedicated topic of discussion. This suit includes counts alleging violations
under the securities laws.
After the Company filed suit against AGI and its parent EFS, Creditrust's
servicing on two of the three securitizations (Creditrust Receivables Backed
Notes, Series 1998-2, and Creditrust Receivables Backed Warehouse Notes, Series
1998-A consolidated) was terminated. Wells Fargo Bank, successor to Norwest
Bank Minnesota, National Association, as trustee and back up servicer,
immediately became successor servicer and thereafter selected a third party sub-
servicer, Coldata Incorporated, effective as of May 1, 2000.
Actions to Avoid the Filing
In an attempt to avoid a Chapter 11 filing, the company took certain actions to
restructure its obligations and negotiate with its creditors. In early April,
Creditrust retained Seneca Financial Group, Inc. to assist as financial advisors
during the negotiations with its creditors and establish a financial plan to
avoid a filing. The Company had previously retained the law firm of Swidler
Berlin Shereff Friedman, LLP as restructuring counsel. During April and May the
Company, with the assistance of its advisors, developed a plan to restructure
the Company's operations and financing arrangements.
As management executed on its plan, it became apparent that due to concerns of
the Company's creditors and the lack of progress in negotiations, a Chapter 11
filing was necessary. At that time, management and the Company's advisors
turned their attention to planning for the June 21, 2000 petition filing.
Downsizing of Debtor and Move from Hunt Valley
As of December 31, 1999, Creditrust had more than 1,000 employees and utilized
three servicing facilities. The third facility, "Hunt Valley", included a call
center and a new centralized information technology center and had the capacity
to house approximately 1,600 additional employees.
Following the loss of servicing on the 99-3A (Warehouse) and 98-2 pools of
receivables, the Company immediately sought to further reduce its cost base.
The Company downsized from more than 1,000 employees in January 2000 to 330
employees in May 2000. However, the Company determined that the expenses
related to the new call center lease in Hunt Valley and the equipment required
to operate it would make the Company's restructuring more difficult, if not
impossible. It concluded that a Chapter 11 proceeding was the best way to
permit the infrastructure to be downsized and enable the Company to generate
positive cash flow from operations. Therefore, the Company moved from its Hunt
Valley facility and consolidated its operations in its remaining two facilities.
22
<PAGE>
Commencement of the Case
On June 20, 2000, Creditrust's Board of Directors voted unanimously to authorize
the Debtor to file for protection under Chapter 11 of the Bankruptcy Code. On
June 21, 2000 (the "Petition Date"), Creditrust filed a petition for
reorganization under Chapter 11 of the Bankruptcy Code. While the Companies
residual assets are contained in its special purpose subsidiaries, none of these
filed for protection. Subsequent to the filling of its bankruptcy petition, the
Debtor has remained in possession of its property and has conducted its business
as a Debtor-in-Possession, pursuant to Sections 1107 and 1108 of the Bankruptcy
Code.
DIP Financing and Use of Cash Collateral
To meet the working capital requirements and to support employee and vendor
confidence, the Debtor sought a post-petition working capital facility (the "DIP
Facility"). On July 7, 2000 the Bankruptcy Court entered an Interim Order and
on July 17, 2000 a Final Order authorizing a post-petition working capital
facility (the "DIP" Facility") from Sunrock Capital Corporation ("Sunrock"), the
Debtor's prepetition working capital lender. Pursuant to the DIP Facility,
Sunrock agreed to make loans to Creditrust through the earlier of the Effective
Date of a plan of reorganization, or one year from June 22, 2000.
The DIP Facility extends $5,000,000 in credit, secured by a first priority lien
on substantially all of the Debtor's personal property, including accounts,
receivables, inventory, equipment and general intangibles. The DIP Facility
provides for the cross collateralization of Sunrock's prepetition loan amounts
as well as (i) an interest rate of prime plus 5%, (ii) a commitment fee of
$100,000, (iii) an unused line fee of .5%, (iv) a collateral management fee of
$15,000, (v) a fee on the Effective Date of $700,000 and (vi) the reimbursement
of certain loan administration costs. Cash borrowings under the DIP Facility
have been granted super priority administrative status by the Bankruptcy Court
over all obligations except certain limited administrative expenses, as defined
in the DIP Facility credit agreement.
The Bankruptcy Court also approved a cash collateral agreement, allowing the
Debtor to use cash for operations in accordance with the budget attached to the
Cash Collateral Order dated July 3, 2000.
With the DIP Facility and the Cash Collateral Order, the Debtor is able to meet
its operating and reorganization expenses for the expected duration of the
Chapter 11 proceeding until closing of the Merger.
NASDAQ Suspension of Trading
The Nasdaq Stock Market halted trading in the Creditrust Common Stock on June
22, 2000, the day after Creditrust filed its Chapter 11 petition, and de-listed
the Creditrust Common Stock on September 26, 2000. The Creditrust Common Stock
last traded on the Nasdaq Stock Market on June 21, 2000.
23
<PAGE>
Item 3. 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 $53,000 as of September 30, 2000. A change in the discount rate would
have no impact on the Company's future cash flows.
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. 99 for 1999). 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. As of the date of this filing, the Company had not
experienced any significant system failures, miscalculations, or any disruption
of operations including, among other things, a temporary inability to process
transactions, send letters and statements or engage in similar activities.
Inflation
The Company believes that inflation has not had a material impact on its results
of operations for the nine months ended September 30, 1999 and 2000.
24
<PAGE>
PART II
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Reference is hereby made to Note A to the consolidated financial statements of
the Company set forth in Part 1, Item 1, above for a description of the Chapter
11 proceeding to which the Company is a party, which description is incorporated
herein by reference.
Reference is hereby made to Note H to the consolidated financial statements of
the Company set forth in Part 1, Item 1, above for a description of certain
other legal proceeding to which the Company is a party, which description is
incorporated herein by reference.
Item 2. Changes in Securities and Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities
The Company was notified of a payment related default for April, May and June
2000 on its revolving line of credit. The Company has been notified of a non-
payment related default with regard to its Series 1998-2 securitization. These
defaults caused the Company to be in technical cross default with regard to its
Warehouse Facility and Series 1999-2 facility, and its Series 1998-1 and Series
1999-1 securitizations. None of the above loans have been accelerated.
A note default has been declared with respect to the Warehouse Facility. A $1.3
million cash reserve increase was not satisfied.
Item 4 is not applicable and has been omitted.
Item 5. Other Information
The Nasdaq Stock Market halted trading in the Creditrust Common Stock on June
22, 2000, the day after Creditrust filed its Chapter 11 petition, and de-listed
the Creditrust Common Stock on September 26, 2000. The Creditrust Common Stock
last traded on the Nasdaq Stock Market on June 21, 2000.
25
<PAGE>
Risk Factors and Forward-Looking Statements
The Company's business prospects are highly dependant on a variety of factors
within and beyond the Company's control which may affect the timing and amount
of collections on the Company's portfolios of previously defaulted consumer
receivables. Future growth of the Company will depend on numerous factors,
including the development and expansion of relationships with credit grantors,
the availability of adequate financing to purchase additional receivables, the
ability to securitize receivables, the ability to maintain the quality of
services the Company provides to its customers and to credit grantors, the
recruitment, training and retention of qualified personnel, the enhancement and
maintenance of the Company's information technology, operational, and financial
systems, any higher than anticipated rate of personnel turnover and the
continued availability of receivables that meet the Company's requirements. The
Company's future prospects may be significantly affected either positively or
negatively depending upon the circumstances of the marketplace and competitive
developments. There can be no assurance that the Company will be able to
maintain its historical collection rates, or that it will be able to maintain or
accelerate its growth, and any failure to do so could have a material adverse
effect on the Company's business, results of operations, and financial
condition.
The Company's quarterly operating results may fluctuate in the future because of
a variety of factors. These factors include (1) the timing and amount of
collections on the Company's receivables, (2) any charge to earnings resulting
from a decline in value of the Company's existing investment in securitizations,
(3) increases in operating expenses associated with the growth of the Company's
operations, (4) the accuracy of the Company's pricing models, (5) the resolution
of defaults on its credit facilities, and (6) the approval of the Company's Plan
of Reorganization in accordance with applicable law. No assurance can be given
that unanticipated future events, including further refinements to the Company's
collection models, will not result in changes in estimates in future periods
which could adversely affect quarter-to-quarter comparisons. The Company does
not intend to securitize assets in the future that result in gain on sale
transactions.
Statements made herein and in other written and oral statements of the Company
may include the plans and objectives of management for future operations,
including plans and objectives relating to future growth in the number of
receivables and availability of adequate third-party financing. Any forward-
looking statements are based on current expectations which involve numerous
risks and uncertainties. Assumptions relating to the foregoing involve
judgments with respect to, among other things, future economic, competitive, and
market conditions and future business decisions, all of which are difficult or
impossible to predict accurately and many of which are beyond the control of the
Company. Although the Company believes that the assumptions underlying the
forward-looking statements are reasonable, any of the assumptions could be
inaccurate and, therefore, there can be no assurance that any of the forward-
looking statements will prove to be accurate. In light of the significant
uncertainties inherent in the forward-looking statements included herein, the
inclusion of such information should not be regarded as a representation by the
Company or by any other person that the objectives and plans of the Company will
be achieved.
Item 6. Exhibits and Reports on Form 8-K
(A)Exhibits:
10.1 Debtor-In-Possession Loan and Security Agreement by and among Creditrust
Corporation as Borrower and Sunrock Capital Corp. as Lender dated June
22, 2000.
10.2 Independent Contractor Agreement between NCO Portfolio Funding, Inc., and
Joseph K. Rensin
27.1 Financial Data Schedule
(B)Reports on Form 8-K
Creditrust Corporation filed on Form 8-K item 3, "Bankruptcy or Receivership" on
June 21, 2000.
Creditrust Corporation filed on Form 8-K item 4, "Changes in Certifying
Accountants" on July 21, 2000.
26
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of
Baltimore, State of Maryland, on January 17, 2001.
CREDITRUST CORPORATION
By: /s/ Richard J. Palmer
----------------------
Vice President and Chief Financial Officer
27
