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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
AMENDMENT NO. 1
FORM 10
GENERAL FORM FOR REGISTRATION OF SECURITIES
Pursuant to Section 12(b) or (g) of the Securities Exchange Act of 1934
THE CREDIT STORE, INC.
(Exact name of registrant as specified in its charter)
Delaware 87-029-6990
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
3401 North Louise Avenue
Sioux Falls, South Dakota 57107
(Address of principal executive offices) (zip code)
(800) 240-1855
(Issuer's telephone number, including area code)
Securities to be registered under Section 12(b) of the Act:
Title of each class Name of each exchange on which
to be so registered each class is to be registered
None None
Securities to be registered under Section 12(g) of the Act:
Common Stock, par value $0.001
(Title of Class)
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ITEM 1 - BUSINESS
The Credit Store, Inc. is a technology based, financial services
company that provides credit card products to consumers who may otherwise fail
to qualify for a traditional unsecured bank credit card. The Company reaches
these consumers by acquiring portfolios of non-performing consumer receivables
and offering a new credit card to those consumers who agree to pay all or a
portion of the outstanding amount due on their debt and who meet the Company's
underwriting guidelines. The new card is issued with an initial balance and
credit line equal to the agreed repayment amount. After the consumers have made
a certain number of on-time payments on their outstanding credit card balance,
the Company seeks to sell or securitize the credit card receivables generated by
this business strategy. The Company offers other forms of settlement to those
consumers who do not accept the credit card offer.
GENERAL DEVELOPMENT OF BUSINESS
The Company was incorporated in 1972 in Utah as Valley West Development
Corporation, changed its corporate domicile to Delaware in 1995, and changed its
name to Credit Store, Inc. on October 8, 1996. Prior to October 8, 1996, the
Company discontinued operations of its prior line of business, which was
unrelated to its current operations. On December 4, 1996, the Company acquired
from Taxter One LLC ("Taxter") all the capital stock of Service One Holdings
Inc. ("Holdings"). At the time of the acquisition, Holdings' sole asset was the
capital stock of Service One International Corporation ("SOIC"), which had been
engaged since January 1996 in the business of acquiring non-performing consumer
debt portfolios, and the marketing and servicing of credit cards, generated from
these portfolios. From 1982 through December 1995, SOIC had been a marketer and
servicer of secured credit cards for a South Dakota bank under a contractual
arrangement which expired in December 1995. Following the acquisition of
Holdings, the Company engaged directly, and through SOIC and its affiliates, in
the acquisition of non-performing consumer debt and the marketing and servicing
of credit cards generated from these portfolios. In February 1998, Holdings and
Credit Store Mortgage, Inc., a wholly-owned subsidiary of the Company, were each
merged into the Company. In March 1998, SOIC was merged into the Company and the
Company's name was changed to The Credit Store, Inc.
The Company recorded significant losses during fiscal years 1997 and
1998 and had an accumulated deficit of $39.6 million at November 30, 1999. The
Company uses cost recovery accounting for the acquisition of portfolios of
non-performing consumer receivables. Such accounting method can have a material
impact on revenue and net income during periods of increasing or decreasing
portfolio acquisitions. The Company made significant investments in portfolio
acquisitions during fiscal years 1997 and 1998. The application of cost recovery
accounting resulted in decreased revenue during the period and contributed to
the Company's net losses experienced in fiscal years 1997 and 1998 of $14.4
million and $29.8 million, respectively. During fiscal year 1999, a period of
decreased portfolio acquisitions, cost recovery helped contribute to a
significant increase in revenue. In addition, as part of its business plan, the
Company was able to sell and securitize certain portfolios for cash proceeds
well in excess of the cost bases of those receivables, generating gains on the
sale of those portfolios. The above factors combined to generate net income of
$3.9 million and $526,541 for fiscal 1999 and for the six months ended November
30, 1999, respectively. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Accounting - Investments in Non-Performing
Consumer Debt and the Impact of Cost Recovery Accounting" below.
NARRATIVE DESCRIPTION OF BUSINESS
The Company is primarily in the business of providing credit card
products to consumers who may otherwise fail to qualify for a traditional
unsecured bank credit card. The Company primarily focuses on consumers who have
previously defaulted on a debt and reaches these consumers by acquiring their
defaulted debt. The Company acquires these defaulted accounts in large
portfolios typically from the original lender for a nominal percentage of the
face amount of the debt, ranging from 0.50% to 3.00% of the receivable balance.
Through its direct mail and telemarketing operations, the Company locates and
offers a new credit card to those consumers who agree to pay all or a portion of
the outstanding amount due on their debt and who meet the Company's underwriting
guidelines. The new card is issued with an initial balance and credit line equal
to the agreed repayment amount. The Company's objective is to ultimately sell
and/or securitize these receivables at a price in excess of the Company's
investment in the receivables. To date, the Company has considered an account
available to sell or securitize ("seasoned") when the consumer has made eight or
more on-time payments on the consumer's outstanding credit card balance.
Under the Company's marketing approach, consumers are offered an
opportunity to settle their debt, typically at a discount, to transfer the
settled amount to a newly issued unsecured MasterCard(R) or Visa(R) credit card,
and to begin establishing a positive credit history by making timely and
consistent payments on the newly issued credit card. After making principal
payments on the transferred balance, the consumer can begin using the credit
card for new purchases or cash advances and may be granted increased credit
limits over time based on their
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payment performance. The Company's credit card offer is attractive to those
consumers contacted by the Company, who given the nonperforming status of their
debt, are typically receiving few or no solicitations from traditional credit
card companies. Many of these consumers cannot easily obtain an unsecured credit
card, want to improve their credit standing or have experienced the negative
aspects of not having access to the credit card payment system for travel and
the daily purchase of goods and services. The Company's approach differs from
traditional credit card companies that compete for new customers through mass
marketing and direct mail campaigns on the basis of interest rates, fees, and
services offered.
INDUSTRY OVERVIEW
The Company operates in the consumer finance industry, competing with
issuers of revolving credit products and other buyers of non-performing consumer
debt.
The United States Federal Reserve reported that American consumers owed
an aggregate of $1.36 trillion of debt at the end of August 1999, exclusive of
home mortgages, and that the size of the revolving credit market in the United
States was in excess of $581 billion as of the end of August 1999, up from $383
billion at the end of 1994. The United States Federal Reserve also reported that
pools of securitized revolving credit assets totaled $309 billion at the end of
August 1999, up from $96 billion at the end of 1994. The Company believes that
the purchasing convenience associated with unsecured credit cards has driven the
growth of credit cards and has made them the preferred consumer credit vehicle.
In addition, the Company believes that the purchase of consumer goods and
services over the Internet will continue to fuel the demand for credit cards.
The Company also believes that the relative liquidity and predictability of
these assets has fostered the widespread acceptance of revolving credit
securitizations by investors.
While traditional banking organizations have enjoyed significant
advantages in consumer lending compared to non-bank providers of consumer loans,
greater access to capital and the emergence of securitization markets, coupled
with technological advances, has allowed non-banks to compete effectively with
banks in this arena. The Company believes that future success in the credit card
industry will continue to be experienced primarily by highly focused
organizations that are adept at using information and technology to market their
products and manage risk within their portfolios, as such organizations will be
able to quickly access a large number of potential accounts while screening out
potentially bad accounts.
Credit card issuers make credit cards available to their clients in a
variety of ways. Many issuers offer cards as a convenience to existing clients,
a strategy to create greater affinity and client loyalty. This is generally the
case with credit cards offered by department stores, who offer private label
credit cards, as well as smaller banks and credit unions. In contrast, the
larger credit card issuers who control the vast majority of the market use mass
mailing of credit card offers to consumers as the most cost-effective means of
achieving the growth rates they seek. Often this process is accomplished by
obtaining a list of names of individuals who meet the issuer's credit guidelines
from one of the national credit bureaus. The Company sources its customers by
purchasing charged-off consumer debt from banks and finance companies and
believes that the purchase of charged-off debt is an efficient means to source
new credit card customers in its target market.
The Company sources its new customers from the portfolios of
non-performing consumer debt that it acquires. The Company believes that the
market for buying and selling non-performing consumer debt portfolios has
expanded due to a steadily increasing volume of charged-off consumer debt
coupled with a shift by originating institutions toward selling their portfolios
of non-performing consumer loans. Historically, originating institutions had
relied upon large internal collection staffs for their initial collection
efforts and outside collection agencies for accounts delinquent more than 180
days. As buyers emerged to purchase non-performing debt, originating
institutions have increasingly sold these portfolios for cash. Institutions will
usually sell accounts when the market prices exceed the net present value of
retaining and working the accounts. In deciding whether to sell accounts,
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sellers also evaluate the potential return on investment of reinvesting the cash
proceeds from portfolio sales in the core operations of originating and
servicing new loans.
According to the Debt Sales Directory, published by Faulkner & Gray, a
leading receivables management publisher, the sales volume of charged-off debt
by initial credit grantors has grown from $2.5 billion in 1990, to $18.5 billion
in 1998, to an estimated $22.5 billion in 1999. These numbers exclude resale
volume, which is also significant in size. Sellers have developed a variety of
ways to sell non-performing receivables. Some originating institutions pursue
auction type sales by constructing a portfolio of receivables and seeking bids
from specially invited competing parties. This approach has resulted in an
increase in the number of receivables portfolios offered for sale by account
brokers. Other means of selling receivables include privately negotiated direct
sales when the originating institution contacts known, reputable purchasers and
the terms of sale are negotiated. Originating institutions have also entered
into "forward flow" sales contracts. The contracts require an originating
institution to sell some or all of its receivables that meet specified criteria,
such as balance size and elapsed time since delinquency, to a single purchaser
during a specified period of time for an agreed upon price.
BUSINESS OPERATIONS
The Company's operations integrate the following disciplines: (1)
portfolio acquisitions; (2) marketing and card origination; (3) customer service
and collections; and (4) receivables sales and securitizations.
PORTFOLIO ACQUISITIONS:
The Company acquires non-performing credit card receivables, consumer
installment loans, and automobile deficiencies on a nationwide basis, from a
wide range of originating institutions, including banks and finance companies.
Through November 30, 1999, the Company has acquired in excess of $3.6 billion in
receivables. These portfolios have been purchased by the Company for prices
typically ranging from 0.50% to 3.00% of the receivable balance. A typical
portfolio contains between 5,000 and 150,000 consumer accounts that have been
typically charged-off by the original lending institution and have passed
through various stages of collection efforts. The size of each account has
typically ranged between $1,000 and $6,000, with an average balance since the
Company began purchasing non-performing portfolios of approximately $2,100.
The consumer debt and credit card industries generally categorize
delinquent and charged-off accounts into three groups: primary, secondary and
tertiary. Primary accounts are typically 120 to 270 days past due and are in the
process of being placed with collection agencies or collection attorneys for the
first time. Secondary accounts are 270 to 360 days past due and may have already
been placed with one collection agency. Tertiary accounts have already been
placed unsuccessfully with more than two collection agencies. The Company
acquires primarily tertiary accounts.
The Company has also purchased "bankruptcy" and "out of statute"
accounts. A "bankruptcy account" is one with respect to which the debtor has
filed a bankruptcy petition and may have had their debt discharged. The Company
is not presently offering credit cards to bankruptcy accounts. An "out of
statute" account is one with respect to which the statute of limitations for
collection of the debt has expired. Debt that is "out of statute" will not be
enforced by a court of law. Accordingly, the likelihood of recoveries from such
accounts is lower than on accounts that are currently enforceable by a court of
law.
The Company continually seeks new and continuing sources of
non-performing portfolios for purchase. Once such portfolios are located, an
acquisition team is responsible for coordinating due diligence, stratifying and
analyzing the portfolio characteristics, projecting conversions to new credit
cards and the total cash collections on the accounts. The acquisition team is
also responsible for preparing bid proposals for review and approval by
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senior management, processing and tracking the bids, documenting and closing the
purchase, and coordinating the receipt of account documentation and media for
acquired portfolios.
The Company uses its proprietary analytical methodology and database to
evaluate a potential portfolio purchase. The Company has developed a large and
valuable database of performance characteristics from the over $3 billion of
receivables it has purchased since inception that enables it to predict future
portfolio performance. This methodology and database comprise the model which
the Company uses to analyze and price the potential portfolio purchase. The
Company believes that its methodology permits it to accurately price portfolio
purchases so it may realize an appropriate return on capital from its new credit
card originations and the subsequent cash flows generated from these new credit
cards.
MARKETING AND CARD ORIGINATION:
MARKETING STRATEGY. Once a portfolio acquisition is completed, the
receivables and accounts in an acquired portfolio are processed by the Company's
marketing and card origination departments. The Company believes that its
consumer friendly and hands-on approach to the consumer is a key component of
its business strategy. Many of the receivables acquired by the Company represent
obligations of individuals who have, in the past several years, experienced some
life-altering event, such as divorce, career displacement or major medical
illness, and have recovered or currently are recovering financially from their
setback. Potential customers are contacted through direct mail and by telephone
and offered the opportunity to settle their debt and obtain an unsecured credit
card which can be used to make new purchases. A customer who accepts the
Company's offer, and meets the Company's underwriting guidelines, is issued a
new unsecured credit card by one of the Company's unaffiliated issuing banks.
The card has an outstanding balance and credit limit equal to the amount agreed
upon by the customer to settle his outstanding debt. As the customer makes
principal payments on the outstanding balance, the customer frees up his credit
limit for new purchases. In addition, the Company may increase the credit limit
for customers who make a certain number of payments on the settled amount. The
Company reports the payment history on the credit card to the major credit
bureaus. The Company believes that its credit card product provides its
customers with an opportunity to establish a positive payment history on their
credit record by making timely and consistent payments on their new credit card.
The Company believes its credit card product affords it more
flexibility in working with the consumer than the originating institution or
third-party collection agency who are simply attempting to recover all or a
portion of the amount owed on an account. Factors that contribute to this
increased flexibility include: (i) the Company is able to settle the account
with the consumer at an amount that fits within the consumer's budget because
the Company acquired the account at a typical range of 0.50% to 3.00% of the
actual outstanding balance; (ii) the Company offers a new unsecured credit card
which has utility to the consumer due to its revolving nature; (iii) the Company
is not limited by many of the cultural and regulatory constraints that influence
account resolution decisions of banks, savings and loan and other financial
institutions; and (iv) the Company is not bound by the limited time periods to
resolve receivables faced by third-party collection agencies.
CARD ORIGINATION. In the Company's experience, much of the account
information contained in the portfolios it acquires is stale. Accordingly, once
a particular portfolio has been purchased, a "scrubbing" process begins.
Scrubbing describes the process of electronically updating phone numbers and
addresses on each account purchased and searching for bankrupt and deceased
accounts. Scrubbing is done pursuant to an agreement with a third party that
specializes in locating consumers with little or no credit history. The Company
has also developed proprietary models which allow it to focus on accounts with
the best marketing potential. The Company believes that using third-party
scrubbing services produces quality results and allows it to efficiently focus
its resources on marketing and servicing its customers. Contemporaneously with
the initial scrubbing, the Company conducts an
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analysis to determine which accounts in the acquired portfolio should be
returned to the seller because they do not meet the criteria established for
each account under the terms of the portfolio acquisition agreement. Although
the terms of each portfolio acquisition agreement differ, examples of accounts
that may be returned under the typical portfolio acquisition agreement include
debts paid off prior to the Company's acquisition, debts in which the consumer
filed bankruptcy prior to the Company's acquisition and debts in which the
consumer was deceased prior to the Company's acquisition. Typically, the
agreement with the seller of the portfolio allows the Company to return such
non-qualifying accounts in the portfolio for a specified period of time, which
is generally between 120 and 180 days from the date of purchase. Under the
typical portfolio acquisition agreement, the seller either replaces a returned
account or refunds the portion of the purchase price attributable to the
account.
Once the portfolio has been scrubbed, the Company uses both direct mail
and phone contact to market the credit card product. The Company operates a
25,000 square foot direct mail and account file storage center (the "Mail
Center") in Sioux Falls, South Dakota. The Mail Center is equipped with
high-speed printing, folding, inserting, zip sorting and mailing equipment
capable of sending 100,000 pieces per day. Having its direct mail operations
in-house allows the Company to manage high quality direct mail campaigns in a
cost-effective manner. The Mail Center is linked electronically with the
Company's operation center, allowing the Mail Center to receive database
information to print and mail specific mail campaigns. The Company also
maintains a trained telemarketing sales force that operates from the Company's
Sioux Falls, South Dakota headquarters. The group is supported by a
state-of-the-art auto-dialer, which enables telemarketers to effectively manage
their large inventory of accounts. The Company employs approximately 70
telemarketers (35 per shift) which results in 100,000 to 150,000 production
hours annually. This enables the Company to maximize calling efficiency and
customer contact capabilities. The Company currently has space and system
capacity to significantly expand its telemarketing staff. The auto-dialer
enhances productivity via high-speed dialing coupled with a screening process to
detect no-answers, nonexistent numbers and answering machines. This technology
allows sales agents to concentrate their efforts on actual customers. Phone
numbers are loaded into the auto-dialer and cleared during each shift of sales
agents to ensure all numbers have been called. In addition to outbound
telemarketing calls, the Company receives incoming calls that are prompted by
mailings. Incoming calls are routed directly to the telemarketing department
where sales agents service the inquiry.
The telemarketing agents are trained to understand the customer base,
keeping in mind that the individual has experienced collection efforts employed
by several agencies. The Company believes the utility of an unsecured credit
card often is a major benefit to this segment of consumers because they may not
qualify for a traditional unsecured account. The Company also believes that an
important feature of its program is the opportunity to settle an old account and
to gain the opportunity to establish a positive payment history on one's credit
record by making timely and consistent payments on a new credit card.
The table below summarizes the Company's standard credit card program as
currently offered:
Initial Credit Line: Settlement Amount
Annual Fee: $0 the 1st year; $35 annual thereafter
Interest Rate: 18.9% or 19.9%
Grace Period: 25 Days
Late Fee: $10.00
Over Limit Fee: $10.00
Cash Advance Fee: Greater of 2% or $2.00
Minimum Payment: Greater of 3% or $10.00
For any customer who does not wish to maintain a new credit card
account but who agrees to settle his previously charged-off debt account, the
Company has established a non-card resolutions department whereby the customer
can make an installment or lump sum payment to settle his obligation.
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The Company also offers the convenience of an Automatic Payment Program
("APP") to its customers, whereby the customer authorizes the Company to
withdraw from the customer's bank account the monthly minimum credit card
payment. Approximately 18% of the Company's customers are currently using APP.
Accounts on APP have a lower incidence of delinquency than those accounts that
are not on APP.
Applicants who meet defined underwriting or exception criteria and
satisfy all verification standards are notified of acceptance into the program
and issued a card. Although the initial credit limit of the credit card is fully
utilized when issued, an applicant regains availability of credit on the card as
and to the extent the applicant makes principal payments. The applicant may also
earn additional credit by establishing a positive payment history with the
Company. Applicants failing to meet the defined underwriting or exception
criteria or to satisfy all verification standards are notified of denial in
accordance with the Equal Credit Opportunity Act. Such applicants are offered
installment and lump sum payment options to settle their debt. Historically,
over 95% of the applicants have qualified for the credit card.
Once a customer has accepted the offer and has cleared the underwriting
process, the relevant data is transmitted to First Data Resources, Inc. ("FDR")
to establish the new account on FDR's credit card processing system. The Company
has arranged, through two unaffiliated banks, to issue the credit cards and for
FDR to provide certain cardholder services including data processing, card
issuance, monthly customer statement processing, and customer correspondence.
FDR is a subsidiary of First Data Corporation, a provider of information
processing and related services, including cardholder processing and merchant
processing, for major financial institutions throughout the United States. The
Company believes that outsourcing these services to FDR gives the Company
certain operational efficiencies and the flexibility to handle additional
growth.
CUSTOMER SERVICE AND COLLECTIONS:
The Company believes that in order to maximize the customer's payment
performance, it is imperative to have a sophisticated, highly structured
hands-on approach to educating and servicing the customers and addressing
situations that would result in default without attention and assistance from
the Company. The front-end servicing group, the customer service group, and the
back-end servicing group are key components of the Company's credit card
servicing and collections functions.
The front-end servicing group conducts, among other services, the
Company's "Welcome Aboard" program by verifying that the customer has received
the credit card and that the customer thoroughly understands the program and how
to use the credit card. In addition, the front-end servicing group places calls
to customers at other critical junctures, including approximately ten days prior
to the first payment due date and at various other specified times if a customer
becomes delinquent in his payments. The front-end servicing group also pursues
all first payment defaults and handles the majority of inbound collection calls.
These calls are a part of the Company's educational approach with customers that
stresses the importance and benefits of making timely and consistent payments.
The customer service group handles calls from customers regarding their
accounts, including balance inquiries, billing inquires and disputes, requests
for replacement cards, requests for temporary credit line increases and requests
for evidence of account activity. Customer service representatives counsel the
customer on use of the card and continue the process of instilling the
importance and benefits of making timely and consistent payments.
The back-end servicing group is responsible for collection of
delinquent credit card accounts in a prompt, professional and thorough manner in
order to reduce net credit losses. The Company uses state of the art predictive
and power dialing technology to maximize collector productivity, and heavily
emphasizes the "instant payment" products such as Western Union Quick Collect.
Collection calls are prioritized based on models developed by the Company for
their specific customer base. The Company maintains a strict reage policy which
allows accounts to
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be reaged if the cardholder displays a desire to correct the status of the
account as well as an ability to continue making monthly payments on the
account. The Company has systemic restrictions in place which prevent customer
service representatives from performing unauthorized reaging of accounts. In an
effort to maximize cash flow, the settlement of an account may be negotiated in
cases where the Company has determined that the account is destined to become a
charge-off and there is no potential to retain the customer. Accounts are
charged off and taken as a loss either after formal notification of bankruptcy
or when they become contractually 120 days past due. Accounts identified as
fraud losses are immediately reserved for and charged off no later than 90 days
after the last activity. Charged-off accounts are referred to the Company's
Resolutions Department for further recovery efforts.
FINANCINGS, RECEIVABLE SALES, AND SECURITIZATIONS:
An important piece of the Company's business strategy is to securitize
seasoned receivables and/or sell receivables to third parties for cash, thereby
realizing an economic gain in an amount equal to the excess of the cash proceeds
from the sale or securitization over the Company's cost basis in the
receivables. To date, the Company has considered an account available to sell or
securitize when the consumer has made eight or more on-time payments on the
consumer's outstanding credit card balance.
The Company has significant ongoing cash needs to fund its operations
and to fund the purchase of non-performing consumer debt portfolios. The
Company's ability to sell or securitize the receivables and/or finance these
receivables on-balance sheet is critical to the future and growth of the
business. In order to sell or securitize its receivables, the Company maintains
a detailed database concerning the status and performance of each of the
receivables in its portfolio. Maintaining this database is necessary for the
Company to provide historical performance information to potential lenders and
purchasers of its receivables. Potential lenders and purchasers assess the
Company's portfolio of receivables according to a variety of factors including
monthly repayment rates by the cardholders and annualized default rates.
During the fiscal year ended May 31, 1999, the Company sold
approximately $7.0 million in credit card receivables to an unaffiliated bank
for $5 million. In addition, the Company completed three securitizations of
seasoned credit card receivables ("Receivables") with a principal balance of
approximately $20.4 million with three unconsolidated wholly-owned qualified
special purpose entities ("SPE's"). All credit cards sold in these transactions
were current with a minimum of eight consecutive payments made on each account.
The SPE's financed the purchase of the Receivables by issuing a series of senior
beneficial interests to an investment bank totaling approximately $13 million.
The Company sold the Receivables to the SPE's for approximately $17.3 million.
The difference between the sales price and debt proceeds was accounted for as a
retained interest on the Company's balance sheet. In November 1999, the Company
sold its retained interest in the three SPE's to the senior beneficial interest
holder for approximately $8.6 million in cash. Subsequent to the stock sale, the
Receivables owned by the SPE's were sold to an unaffiliated credit card bank by
the investment bank that now held 100% of the beneficial interests. The Company
intends to securitize receivables in the capital markets and sell receivables to
unaffiliated credit card banks in the ordinary course of business.
The Company also maintains a senior secured revolving credit line with
Coast Business Credit, a division of Southern Pacific Bank. The credit line was
established in May 1998 for $5 million and was subsequently increased to $10
million in June 1999 and to $15 million in December 1999. The line of credit
expires in June 2001 and is secured by substantially all of the Company's
assets. Borrowings under the credit line are based on a formula which is
dependent primarily upon the performance and seasoning of the Company's credit
card receivables.
The Company has also received secured financing from a related party,
JLB of Nevada, Inc., which is subordinated to the Company's senior secured
revolving credit line. See "Item 7 - Certain Relationships and Related
Transactions." The principal amount outstanding of these subordinated notes,
excluding accrued interest, totaled $10,009,042 at May 31, 1997, $27,674,940 at
May 31, 1998 and $17,674,940 at May 31, 1999.
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In October 1999, the Company established a $17.5 million secured
revolving credit line with General Electric Capital Corporation to finance the
acquisition of non-performing consumer debt portfolios. The borrower is a
bankruptcy remote special purpose entity, Credit Store Capital, Corp. ("CSCC"),
established by the Company for this transaction. Borrowings are non-recourse to
the Company and based on the age of the non-performing consumer debt portfolios
acquired by the Company coupled with contracts that CSCC enters into to resell
portfolios to other debt buyers. The transfer of receivables to CSCC by the
Company does not qualify for sale treatment under SFAS 125. CSCC will be fully
consolidated with the Company's financial results.
COMPETITIVE CONDITIONS
The Company experiences competition in all segments of its business
operations. The Company competes with a wide range of third-party collection
companies and other financial services companies seeking to purchase portfolios
of non-performing consumer debt and with traditional collection companies
seeking consignments of such debt for collection. The Company also competes with
companies that provide financing to consumers that have previously defaulted on
a debt obligation. As more buyers enter the market to purchase portfolios of
non-performing consumer debt, the price for the purchase of such portfolios may
increase and the Company's business strategy may become less profitable or
viable. Some of these competitors may have substantially greater personnel and
financial resources than the Company. The Company believes it competes
effectively based on what it believes are superior information technology
capabilities, which enable it to evaluate and purchase receivables more
effectively than some of its competitors. Further, the Company believes it
differentiates itself from most of its competitors through its innovative credit
card program, which allows the consumer to resolve a prior obligation in a
positive manner.
The Company anticipates that additional competitors will seek to enter
its niche within the financial services market. Because of the high costs in
developing and servicing a credit card program and the high costs of acquiring
non-performing consumer debt, the Company believes that new competitors will
likely be large, established finance companies.
GOVERNMENT REGULATION
The Company's collection practices, business operations and credit card
receivables are subject to numerous federal and state consumer protection laws
and regulations imposing licensing and other requirements with respect to
purchasing, collecting, making and enforcing consumer loans. The Company
conducts periodic compliance reviews and, if necessary, implements procedures to
bring the Company into compliance with all applicable state and federal
regulatory requirements. The failure to comply with such statutes or regulations
could have a material adverse effect on the Company's results of operations or
financial condition.
The Fair Debt Collection Practices Act (FDCPA) and comparable state
statutes establish specific guidelines and procedures that debt collectors must
follow to communicate with consumer debtors, including the time, place and
manner of such communications. It is the Company's policy to comply with the
provisions of the FDCPA and comparable state statutes in all of its collection
activities, although it may not be specifically subject thereto. If these laws
apply to some or all of the Company's collection activities, the Company's
failure to comply with such laws could have a material adverse effect on the
Company.
As a purchaser of consumer receivables, the Company may acquire certain
receivables subject to legitimate claims, defenses or rights of offset on the
part of the consumer. As a result, the Company may not be able to collect
certain receivables it has purchased. For example, the Company, as previously
described, acquires "out of statute" accounts which are subject to a statute of
limitations defense, and may also acquire some credit card accounts
9
<PAGE> 10
where customers cannot be held liable for, or their liability may be limited
with respect to, charges to a credit card account that were a result of an
unauthorized use of a credit card.
The relationship of a customer and a credit card issuer is extensively
regulated by federal and state consumer protection and related laws and
regulations. While the Company itself is not a credit card issuer, because many
of its receivables are originated through credit card transactions, certain of
the Company's operations are affected by such laws and regulations. Significant
laws include the Federal Truth-In-Lending Act, the Fair Credit Billing Act, the
Equal Credit Opportunity Act, the Fair Credit Reporting Act and the Electronic
Funds Transfer Act (and the Federal Reserve Board's regulations which relate to
these Acts), as well as comparable statutes in those states in which customers
reside or in which the originating institutions are located. State laws may also
limit the interest rate and the fees that a credit card issuer or other consumer
lender may impose on its customers. Among other things, the laws and regulations
applicable to credit card issuers impose disclosure requirements when a credit
card account is advertised, when it is applied for and when it is opened, at the
end of monthly billing cycles and at year end. Federal law requires credit card
issuers to disclose to consumers the interest rates, fees, grace periods and
balance calculation methods associated with their credit card accounts, among
other things. In addition, customers are entitled under current laws to have
payments and credits applied to their credit card accounts promptly, to receive
prescribed notices and to require billing errors to be resolved promptly. In
addition, some laws prohibit certain discriminatory practices in connection with
the extension of credit. Failure by the originating institutions or the Company
to comply with applicable statutes, rules and regulations could create claims
and/or rights of offset by the customers which could have a material adverse
effect on the Company.
Changes in any such laws or regulations, or in the interpretation or
application thereof, could have a material adverse effect on the Company.
Various proposals which could affect the Company's business have been introduced
in Congress in recent years, including, among others, proposals relating to
imposing a statutory cap on credit card interest rates, substantially revising
the laws governing consumer bankruptcy, limiting the use of social security
numbers, permitting affiliations between banks and commercial, insurance or
securities firms, and other regulatory restructuring proposals. There have also
been proposals in state legislatures in recent years to restrict telemarketing
activities, impose statutory caps on consumer interest rates, limit the use of
social security numbers and expand consumer protection laws. It is impossible to
determine whether any of these proposals will become law and, if so, what impact
they will have on the Company.
Due to the consumer-oriented nature of the collections and credit card
industry, there is a risk that the Company or other industry participants may be
named as defendants in litigation involving alleged violations of federal and
state laws and regulations, including consumer protection laws and consumer law
torts, including fraud. A significant judgment against the Company or within the
industry in connection with any such litigation could have a material adverse
effect on the Company's results of operations or financial condition. See "Item
8 - Legal Proceedings."
EMPLOYEES
As of November 30, 1999, the Company had 314 employees. No employee
group is covered under a collective bargaining agreement. The Company conducts
on-site training in all facets of its business and does not anticipate
difficulties in hiring from the local market. The Company believes its
relationship with its employees is good.
TECHNOLOGY AND SYSTEMS
10
<PAGE> 11
The Company utilizes a variety of management information and
telecommunications systems to enhance productivity in all areas of its business.
The Company utilizes the latest technology in its operations and employs
multiple levels of backup to minimize the risk of systemic breakdown.
The Company implemented a new proprietary credit card origination and
servicing system ("NOCS") in fiscal year 1999 which, among other advances, made
the Company Year 2000 compliant. NOCS puts all aspects of the Company's
operation on a seamless platform from the time a new portfolio is purchased
until an account is converted to a new credit card and set up on the First Data
Resources ("FDR") credit card servicing platform. NOCS includes specialized
applications for telesales, underwriting, non-card collections, payment
processing, account scrubbing, portfolio stratification, and customer service.
The overall computing platform is client-server, Windows NT/SQL based,
and is scaleable to accommodate the Company's growth plans. The Company employs
the latest technology in telephony, including a predictive auto-dialer and voice
recognition technology. The telephony platform is capable of supporting in
excess of 2000 workstations and the Company believes it is easily expandable to
accommodate the Company's growth plans.
The Company uses FDR as its third party processor of credit card data
and merchant interchange. FDR also processes and mails the monthly cardholder
statements. FDR, the largest card processor in the world, provides these
services to major financial institutions throughout the United States.
The Company uses image-based technology and processing to minimize
paper flow wherever possible. The Company has also invested in the latest
electronic data warehousing technologies to support its data mining strategies.
The Company believes data warehousing gives it a distinct competitive advantage
in the portfolio analysis and acquisitions aspect of its business. In addition,
the Company believes data warehousing will give it an advantage in the
securitization markets through its ability to provide a sophisticated level of
performance detail to investors.
IMPACT OF THE YEAR 2000 COMPUTER PROBLEM
OVERVIEW. The Year 2000 issue arises out of potential problems with
computer systems or any equipment with computer chips that use dates where the
date has been stored as just two digits (e.g., 98 for 1998). On January 1, 2000,
any clock or date recording mechanism, including date sensitive software, which
uses only two digits to represent the year, might have recognized a date using
00 as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations and cause a disruption of operations, including,
among other things, a temporary inability to process transactions, send letters
and statements or engage in similar activities.
STATE OF READINESS. The Company believes it has replaced or modified
all of its material computer systems and business applications software so that
its computer systems will properly utilize dates beyond December 31, 1999 and
does not believe that any further material expenditures will be necessary to
make these systems Year 2000 compliant. The Company created a Year 2000 Project
Team which identified all internal systems and third party vendors and evaluated
them as critical or non-critical. The team then evaluated and addressed all
systems and any Year 2000 issues applicable to each system. Throughout this
process, comprehensive Year 2000 information was documented and saved.
Most of the Company's major vendors are large institutions, which the
Company believes either are or will become Year 2000 compliant due to the
regulated nature of their businesses and the size and financial strength of
11
<PAGE> 12
these businesses. To date, the Company has been able to convert data received
from lenders and other third parties rendering it Year 2000 compliant and
expects that it will continue to be able to do so in the future.
The Company believes that its most critical outside vendor is FDR,
which provides services to the Company, including data processing, card
issuance, monthly customer statement processing and customer correspondence. The
Company believes that FDR applied substantial time and resources into its Year
2000 compliance efforts. FDR has certified to the Company that all FDR systems
are Year 2000 compliant. As of February 22, 2000 the Company has experienced no
vendor related Year 2000 issues.
COSTS. To date, the Company has incurred less than $100,000 in
third-party expenses as a result of the Company's Year 2000 compliance efforts.
The Company believes it has replaced or modified all of its critical computer
systems and business applications software in the normal course of its business
expansion and that its computer systems are currently Year 2000 compliant. The
Company used in-house programmers for most of the modifications and did not
separately account for the costs of making these systems Year 2000 compliant.
Year 2000 issues with third-party processing vendors were addressed internally
between the Company and each specific vendor. The Company currently does not
expect to incur additional expenses for Year 2000 efforts. The Company has not
experienced any adverse systems or vendor effects of the Year 2000 issue and,
therefore, the Company's business, operating results, and financial position
were not impacted negatively as of April 1, 2000.
WORST-CASE SCENARIO. The Company believes that its worst-case scenario
is that its outside vendors (such as FDR) are not Year 2000 compliant due to
unforeseen or unexpected problems with their systems that their Year 2000
testing did not discover and that there are errors and/or delays in processing
or billing the credit card accounts. Since FDR services all of the Companies
credit card receivables, any Year 2000 problem at FDR could cause a material
disruption in the Company's business. Management believes that the cost of any
such disruption would have a material adverse effect on the Company's results
and financial condition.
RISKS. The Company has not experienced and is not currently aware of
any internal Year 2000 compliance problem that could reasonably be expected to
have a material adverse effect on the Company's business, operating results or
financial condition. However, the Company may discover unanticipated Year 2000
compliance problems in the Company's computer infrastructure that will require
substantial revisions or replacements. In addition, third-party software,
hardware, or services incorporated into our material systems or other systems
upon which we rely may need to be revised or replaced. Such revisions and
replacements could be time consuming and expensive.
The computer systems of governmental agencies, utility companies,
third-party service providers and others outside of our control may not be Year
2000 compliant. The failure by such entities to achieve timely Year 2000
compliance could result in a systemic failure beyond our control, such as
prolonged telecommunications or electrical failures. If a protracted disruption
in electrical power or telecommunications services were to occur, the Company's
collection and marketing efforts, and therefore its operations, could be
materially adversely affected.
CONTINGENCY PLAN. The Company has contingency plans that include, in
the event of computer hardware or software non-compliance, identification and
replacement of critical products as appropriate. In the event of vendor-related
Year 2000 problems, alternate vendors who have the ability to provide similar
products or services have been identified. The Year 2000 project team will
continue to test, monitor, evaluate, and address any Year 2000 issues that may
arise in the future.
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<PAGE> 13
THIRD-PARTY SERVICING
At November 30, 1999, the Company serviced approximately 20,000
accounts subject to third party servicing agreements. The Company intends to
concentrate on servicing its own accounts and accounts that it has either
securitized or sold to third party investors.
ITEM 2 - FINANCIAL INFORMATION
SELECTED FINANCIAL DATA
The following selected financial data presented below should be read in
conjunction with the Company's consolidated financial statements and the notes
thereto. The selected statement of operations data with respect to the years
ended December 31, 1994 and 1995 and the period from January 1, 1996 to October
8, 1996 and the selected balance sheet data at December 31, 1994 and 1995 and at
October 8, 1996 are derived from the audited financial statements of the
Company's predecessor, SOIC. The statement of operations data with respect to
the years ended May 31, 1997, 1998 and 1999 and the balance sheet data at May
31, 1997, 1998 and 1999 are derived from, and are qualified by reference to, the
Company's audited financial statements included elsewhere herein. The
consolidated financial statements for the years ended May 31, 1998 and 1999 were
audited by Grant Thornton, LLP, independent auditors, and the consolidated
financial statements for the year ended May 31, 1997 were audited by Tanner &
Co., independent auditors. The selected financial data as of November 30, 1998
and 1999 for the six months then ended were derived from the Company's unaudited
consolidated financial statements included elsewhere herein and, in the opinion
of management, includes all material adjustments (consisting only of normal
recurring adjustments) necessary for a fair presentation of the financial
condition and results of operations for such periods. Operating results for the
six months ended November 30, 1999 are not necessarily indicative of results
that may be expected for the remainder of the fiscal year ending May 31, 2000.
The following financial information should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" below.
<TABLE>
<CAPTION>
PREDECESSOR(1) COMPANY
------------------------------------------------------------------------------------------------------
JANUARY 1,
FOR THE YEAR ENDED 1996 TO FOR THE YEAR ENDED FOR THE SIX MONTHS
DECEMBER 31 OCTOBER 8, MAY 31 ENDED NOVEMBER 30
----------------------- ---------------------------------------- -------------------------
1994 1995 1996 1997 1998 1999 1998 1999
----------- ----------- ----------- ------------- ------------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED OPERATIONS
DATA:
Income from credit
card receivables* $ 971,174 $ 3,951,602 $ 6,438,460 $ 3,029,342 $ 4,961,764
Revenue in excess of
cost recovered* 3,934 8,138,122 22,308,908 10,492,017 10,209,919
Gain on sale of - - 11,851,080 5,649,418 6,336,221
portfolios*
Servicing fees and
other income $ 9,052,306 $ 6,528,503 $ 2,078,506 1,601,228 1,292,596 1,564,356 1,013,632 1,346,061
----------- ----------- ------------ ------------ ----------- ------------ ------------ ------------
</TABLE>
13
<PAGE> 14
<TABLE>
<CAPTION>
PREDECESSOR(1) COMPANY
------------------------------------------------------------------------------------------------------
JANUARY 1,
FOR THE YEAR ENDED 1996 TO FOR THE YEAR ENDED FOR THE SIX MONTHS
DECEMBER 31 OCTOBER 8, MAY 31 ENDED NOVEMBER 30
----------------------- ---------------------------------------- -------------------------
1994 1995 1996 1997 1998 1999 1998 1999
----------- ----------- ----------- ------------- ------------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Total revenue 9,052,306 6,258,503 2,078,506 2,576,336 13,382,320 42,162,804 20,184,409 22,853,965
Provision for losses - - - 1,494,001 6,483,736 4,607,081 2,559,044 3,737,867
----------- ----------- ------------ ------------ ------------- ------------ ------------ ------------
Net revenue 9,052,306 6,258,503 2,078,506 1,082,335 6,898,584 37,555,723 17,625,365 19,116,098
Net income (loss) 2,242,672 2,727,711 (1,512,488) (14,405,555) (29,445,031) 3,875,680 673,241 526,541
Dividends on
preferred stock* (7,397) (399,996) (1,799,999) (799,999) (1,000,000)
----------- ----------- ----------- ------------- ------------- ------------ ------------ ------------
Net income (loss)
applicable to common
shareholders $2,242,672 $2,727,711 $(1,512,488)$(14,412,952) $(29,845,027) $ 2,075,681 $ (126,758) $ (473,459)
=========== =========== =========== ============= ============= ============ ============ ============
Net income (loss) per
common share, basic $ 0.45 $ 0.55 $ (0.30)$ (0.56) $ (0.90) $ 0.06 $ (0.00) $ (0.01)
---------- ----------- ----------- ------------ ------------- ------------ ------------ ------------
Net income (loss) per
common share, diluted $ 0.45 $ 0.55 $ (0.30)$ (0.56) $ (0.90) $ 0.05 $ (0.00) $ (0.01)
=========== =========== =========== ============= ============= ============ ============ ============
CONSOLIDATED BALANCE
SHEET DATA:
Cash and restricted cash $ 515,600 $ 279,357 $ 58,162 $ 2,685,581 $ 8,205,071 $4,283,930 $ 3,444,862 $ 5,273,121
Investment in
on-performing
consumer debt, net* 8,193,453 5,672,514 3,016,697 5,823,528 4,237,335
Credit card receivables, 2,566,909 12,919,970 18,631,403 17,164,632 26,020,644
net*
Notes payable - - 1,158,336 428,973 5,902,041 6,086,766 5,775,711 13,649,987
Subordinated notes and
accrued interest-related
party - - 880,000 10,446,043 31,807,322 19,246,595 23,183,213 19,591,152
------------- ------------ ------------ ------------ ------------
Total assets 1,547,899 524,579 2,884,860 24,743,871 39,723,418 45,780,956 41,260,596 50,609,385
</TABLE>
14
<PAGE> 15
<TABLE>
<CAPTION>
PREDECESSOR(1) COMPANY
------------------------------------------------------------------------------------------------------
JANUARY 1,
FOR THE YEAR ENDED 1996 TO FOR THE YEAR ENDED FOR THE SIX MONTHS
DECEMBER 31 OCTOBER 8, MAY 31 ENDED NOVEMBER 30
----------------------- ----------------------------------------- -------------------------
1994 1995 1996 1997 1998 1999 1998 1999
----------- ----------- ----------- ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Total liabilities 784,695 279,960 4,007,145 18,118,396 47,366,530 33,692,311 37,546,119 39,597,298
Total stockholders'
equity (deficit) 763,204 244,619 (1,122,285) 6,625,475 (7,643,112) 12,088,645 4,008,178 11,012,087
SELECTED OPERATING DATA:
Outstanding balance of
non-performing debt
acquired during the $1,067,579,343 $890,634,206 $891,904,454 $627,945,069 $780,374,021
period*
Credit card receivables
owned and managed* 35,709,395 84,830,552 89,149,715 91,477,519 87,734,443
Number of accounts
owned and managed* 26,803 84,351 94,278 88,564 94,733
Total employees, end
of period* 233 292 305 294 314
- - - ---------------------
</TABLE>
* Information not applicable for predecessor company.
(1) The information for the fiscal years ended December 31, 1994 and 1995 and
for the period from January 1, 1996 to October 8, 1996 relates to SOIC, the
Company's predecessor. See "Item 1 -- Business -- General Development of
Business" and Note A of Notes to Consolidated Financial Statements.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following management's discussion and analysis focuses on those
factors that had a material effect on the Company's financial results of
operations and financial condition for fiscal years ended May 31, 1997, 1998 and
1999 and the six months ended November 30, 1998 and 1999. The following
discussion of the Company's financial condition and results of operations should
be read in connection with the Company's consolidated financial statements and
notes thereto appearing elsewhere herein. The following discussion contains
certain forward-looking statements that involve risk and uncertainties. The
Company's actual results could differ materially from those discussed herein.
Factors that could cause or contribute to such differences include, but are not
limited to, risks and uncertainties related to the need for additional funds,
the rapid growth of the operations and the ability of the Company to operate
profitably after the initial growth period is completed. For a more extensive
discussion of such risks and uncertainties, see "Cautionary Statements and
Factors that may Affect Future Results" below.
15
<PAGE> 16
OVERVIEW
The Credit Store, Inc. is a technology based, financial services
company that provides credit card products to consumers who may otherwise fail
to qualify for a traditional unsecured bank credit card. The Company reaches
these consumers by acquiring portfolios of non-performing consumer receivables
and offering a new credit card to those consumers who agree to pay all or a
portion of the outstanding amount due on their debt and who meet the Company's
underwriting guidelines. The new card is issued with an initial balance and
credit line equal to the agreed repayment amount. After the consumers have made
a certain number of on-time payments on their outstanding credit card balance,
the Company seeks to finance, sell, or securitize the credit card receivables
generated by this business strategy. The Company offers other forms of
settlement to those consumers who do not accept the credit card offer.
The Company was incorporated in 1972 in Utah as Valley West Development
Corporation, changed its corporate domicile to Delaware in 1995, and changed its
name to Credit Store, Inc. on October 8, 1996. Prior to October 8, 1996, the
Company discontinued operations of its prior line of business, which was
unrelated to its current operations. On December 4, 1996, the Company acquired
from Taxter, all the capital stock of Holdings. At the time of the acquisition,
Holdings' sole asset was the capital stock of SOIC, which had been engaged since
January 1996 in the business of acquiring non-performing consumer debt
portfolios, and the marketing and servicing of credit cards generated from these
portfolios. From 1982 through December 1995, SOIC had been a marketer and
servicer of secured credit cards for a South Dakota bank under a contractual
arrangement which expired in December 1995. Following the acquisition of
Holdings, the Company engaged directly, and through SOIC and its affiliates, in
the acquisition of non-performing consumer debt and the marketing and servicing
of credit cards generated from these portfolios. In February 1998, Holdings and
Credit Store Mortgage, Inc., a wholly owned subsidiary of the Company, were each
merged into the Company and the Company's name was changed to The Credit Store,
Inc. As a result of the above, and because the Company had no operations during
the period from May 31, 1996 to October 8,1996, the operations for the period
ended May 31, 1997 are not comparable to any prior period, including the period
immediately prior to the acquisition when the predecessor was owned and managed
by different groups. Further, the operations of the Company's predecessor, SOIC,
did not include many of the activities currently engaged in by the Company.
ACCOUNTING.
INVESTMENTS IN NON-PERFORMING CONSUMER DEBT AND THE IMPACT OF COST
RECOVERY ACCOUNTING. The Company accounts for its investments in non-performing
consumer debt in accordance with the provisions of the American Institute of
Certified Public Accountants' Practice Bulletin 6, "Amortization of Discounts on
Certain Acquired Loans," which prescribes two methods (yield method and cost
recovery method) for amortizing the excess of face value over the purchase price
of acquired portfolios. Under Practice Bulletin 6, a company may use the yield
method of accounting if the company has the experience and data to predict the
amount and timing of collections that will be received from the acquired
portfolio. Under the yield method, the acquirer makes an estimate of the amount
and timing of collections on an acquired portfolio and accretes the discount
into income over the economic life of the acquired portfolio according to an
internal rate of return established for the acquired portfolio. Given the
Company's short history, the Company believes it is required to use the cost
recovery method to account for the acquired portfolios. The Company adopted cost
recovery in fiscal year 1998 and restated fiscal year 1997 to conform to the
cost recovery presentation. Under the cost recovery method, the Company records
the purchase price of a portfolio and any costs directly related to the purchase
as an investment in non-performing consumer debt on the balance sheet. Cash
flows related to the acquired portfolio are applied to reduce the investment on
the balance sheet to zero prior to recognizing revenue from that portfolio. Once
the cost of a portfolio has been recovered, the ensuing cash flow is recorded as
the excess of revenue over cost recovered. The application of cost recovery can
have a material impact on revenue and net income during periods of
16
<PAGE> 17
increasing or decreasing portfolio acquisitions. The Company made significant
investments in portfolio acquisitions during fiscal years 1997 and 1998 totaling
$14.3 million and $15.6 million, respectively. The application of cost of
recovery resulted in decreased revenue during the period, since cash flows from
an acquired portfolio are applied first to reduce the investment in that
portfolio to zero, which takes between 9 and 13 months on the average, depending
upon the performance of the acquired portfolio. During the same period, the
Company expensed, as incurred, all costs associated to market and service the
portfolios which, when, combined with the effects of cost recovery on revenue,
contributed to the large losses experienced in fiscal years 1997 and 1998.
During fiscal year 1999, the majority of the portfolios acquired during the two
preceding years experienced full cost recovery, leading to a significant
increase in revenue in excess of cost recovered. In addition, portions of the
Company's performing credit card receivables had matured to the point where the
Company was able to sell and securitize certain portfolios at prices well in
excess of the cost bases of those receivables, generating gains on the sale of
those portfolios. The above factors combined to generate net income of $3.9
million in fiscal 1999 compared to a net loss of $29.8 million in fiscal year
1998.
CREDIT CARD RECEIVABLES. The Company records the amounts funded for
new purchases and cash advances, accrued interest on new purchases and cash
advances, and accrued fees, less a provision for losses as net credit card
receivables, on the balance sheet. However, this amount is substantially below
the amount owed to the Company by the cardholder, which amount includes new
purchases and cash advances, accrued interest and fees, along with the remaining
balance of the original settlement amount. For example, at May 31, 1999, the
Company owned $55,184,540 in credit card receivables, while the amount of funded
purchases and cash advances, accrued interest on the purchases and advances, and
accrued fees, were recorded on the Company's balance sheet as $21,879,209. The
difference represents the remaining balance of the original settlement amount on
the Company's portfolio of performing credit card receivables.
SECURITIZATIONS. The Company completed three securitizations of credit
card receivables ("Receivables") with a principal balance of approximately $20.4
million with three unconsolidated wholly-owned qualified special purpose
entities ("SPE's). All credit cards sold in these transactions were current with
a minimum of eight consecutive payments made on each account. The SPE's financed
the purchase of the Receivables by issuing a series of senior beneficial
interests to an investment bank totaling approximately $13 million. The Company
sold the Receivables to the SPE's for approximately $17.3 million. The
difference between the sales price and debt proceeds was accounted for as a
retained interest on the Company's balance sheet.
Under the provisions of SFAS 125, the securitizations are accounted for
as sales. As a result, the Company recognized a pre-tax gain of approximately $8
million and recorded a retained interest in securitized credit card receivables
at an allocated basis in the amount of approximately $1.3 million based on its
relative fair value. At May 31, 1999, the allocated basis amount was adjusted to
a fair value of approximately $5.1 million, resulting in approximately $3.8
million of unrealized gain on the retained interest in securitized credit card
receivables. The unrealized gain was recorded net of tax of approximately $1.3
million, resulting in approximately $2.5 million as a separate component of
stockholders' equity and a component of Consolidated Statement of Operations and
Comprehensive Income (Loss). In estimating the fair value of the retained
interest, the Company has estimated net cash flows based on the Company's
historical collection results for similar receivables and discounted it using an
appropriate rate.
The retained interest in securitized credit card receivables is treated
as a debt security classified as available-for-sale in accordance with SFAS No.
115, "Accounting for Certain Investments in Debt and Equity Securities," and is
carried at fair value. At the time of securitization, the retained interest is
initially recorded at the basis allocated in accordance with SFAS No. 125. This
original cost basis is adjusted to fair value, which is based on the discounted
anticipated future cash flows on a "cash out" basis, with such adjustment (net
of related deferred
17
<PAGE> 18
income taxes) recorded as a component of other comprehensive income. The cash
out method projects cash collections to be received only after all amounts owed
to investors and lenders have been remitted.
Income on the retained interest is accrued based on the effective
interest rate applied to its original cost basis, adjusted for accrued interest
and principal paydowns. The effective interest rate is the internal rate of
return determined based on the timing and amounts of anticipated future cash
flow projections for the underlying pool of securitized credit card receivables.
The Company monitors impairment of the retained interest based on discounted
anticipated future cash flows of the underlying receivables on a cash out basis
compared to the original cost basis of the retained interest, adjusted for
accrued interest and principal repayments.
In November 1999, the Company sold its retained interest in the SPE's
to the investment bank, who held the senior beneficial interests issued by the
SPE's. Given the limitations placed on the activities of the SPE's and the
general lack of liquidity inherent in the retained interest, the Company
accepted an offer from the investment bank to purchase the retained interest for
approximately $8.6 million in cash resulting in a pretax gain of approximately
$6.5 million.
COMPREHENSIVE INCOME. The Financial Accounting Standards Board issued
SFAS No. 130, "Reporting Comprehensive Income," which is effective for fiscal
years beginning after December 15, 1997. SFAS No. 130 establishes standards for
reporting and display of comprehensive income and its components (revenue,
expenses, gains and losses) in a full set of general-purpose financial
statements. All items required to be recognized under accounting standards as
components of comprehensive income are required by SFAS No. 130 to be reported
in a financial statement that is displayed with the same prominence as other
financial statements. SFAS No. 130 does not require a specific format for that
financial statement but requires that an enterprise display an amount
representing total comprehensive income for the period in that financial
statement. Pursuant to SFAS No. 130, an enterprise must classify items of other
comprehensive income by their nature in a financial statement and display the
accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in capital in the equity section of a statement of
financial position. Reclassification of financial statements for earlier periods
provided for comparative purposes is required. For the year ended May 31, 1998,
the Company had no sources of other comprehensive income. For the year ended May
31, 1999, the Company's investment in securitizations is classified as available
for sale; and, therefore, in accordance with SFAS No. 115, the Company
recognizes as other comprehensive income the unrealized gains or losses for the
difference between the amortized cost and estimated fair value, net of tax.
RESULTS OF OPERATIONS
FISCAL YEAR ENDED MAY 31, 1999 COMPARED TO FISCAL YEAR ENDED MAY 31,
1998:
REVENUES. Total revenue for the fiscal year ended May 31, 1999 was
$42,162,804, a 215% increase from $13,382,320 during the same period ended May
31, 1998. The increase was primarily due to a combination of increased revenues
from a maturing credit card portfolio, portfolio securitizations and portfolio
sales. Income from credit card receivables increased 63% from $3,951,602 to
$6,438,460 due to an increase in the weighted average credit card receivables
funded. Income from credit card receivables represents interest and fees on new
advances or purchases made by holders of the Company's credit cards on an
accrual basis. Revenue in excess of costs recovered increased 174% from
$8,138,122 to $22,308,908 due to increased cash flow related to acquired
portfolios and the effect of fully recovering the acquisition costs on the
majority of the
18
<PAGE> 19
portfolios acquired during the two previous fiscal years. The Company's
performing credit card receivables had matured to the stage where the Company
achieved the sale or securitization of approximately $27.4 million in
receivables. The Company's portfolio sales and securitizations resulted in an
$11,851,080 gain on sales of portfolios representing the excess of cash proceeds
over the cost basis in those assets. There were no such sales in the previous
fiscal year. Servicing fees and other income increased 21% from $1,292,596 to
$1,564,356 due to a higher average number of accounts under management subject
to a servicing fee. The provision for losses decreased 29% from $6,483,736 to
$4,607,081 based on the experience of a more matured portfolio. The above
combined to produce net revenue of $37,555,723 for the fiscal year ended May 31,
1999, a 452% increase over $6,802,717 recorded for the fiscal year ended May 31,
1998.
EXPENSES. Salaries and employee benefits decreased 6% from $13,268,863
to $12,484,582 based on an average lower number of full-time personnel. Interest
expense decreased 15% from $4,760,905 in fiscal year 1998 to $4,029,491 in
fiscal year 1999 based on a lower average amount of debt outstanding due to the
conversion of $10 million of subordinated debt to preferred stock in May 1998
and the conversion of $10 million of subordinated debt in August 1998 and a
reduction in the interest rate on senior debt. Professional fees decreased 36%
from $4,215,891 in fiscal year 1998 to $2,701,016 in fiscal year 1999 as the
Company moved beyond its startup period requiring fewer outside professional
services. Depreciation and amortization decreased 19% from $3,223,620 in fiscal
year 1998 to $2,614,216 in fiscal year 1999. Fiscal year 1998 included an
$816,667 writedown of existing software systems. Third party card service fees
increased 36% from $3,486,915 in fiscal year 1998 to $4,733,528 in fiscal year
1999, in line with the increase in the average number of accounts under
management. Mail processing fees increased 28% from $1,121,623 in fiscal year
1998 to $1,434,506 in fiscal year 1999 largely in line with increased marketing
campaigns on existing portfolios of non-performing debt. Rental expenses
decreased 7% from $825,517 in fiscal year 1998 to $766,832 in fiscal year 1999.
Royalty expense, pursuant to a mutual business development agreement, increased
644% from $207,238 in fiscal year 1998 to $1,541,944 in fiscal year 1999. The
royalty expense is accrued when new credit card accounts make their third
payment according to the terms of the cardholder agreement. Increased royalty
expense is due to a higher percentage of cards reaching a third payment due to a
more thorough sales process and better account retention in the early months of
a new account. Other operating expenses as a group were stable, increasing 2%
from $5,233,043 in fiscal year 1998 to $5,360,337 in fiscal year 1999.
The above combined for income before taxes of $1,889,271 in fiscal year
1999 compared to a loss before taxes of $29,445,031 in fiscal year 1998. The
historical losses of the Company have resulted in net operating loss
carryforwards of approximately $49 million at May 31, 1999. These deferred tax
assets may be applied against positive earnings in subsequent years to reduce
taxable income of the Company on such earnings. However, these tax assets may
not be utilized, if ever, until the Company achieves, or can demonstrate that it
will achieve, ongoing profitability. Accordingly, the Company has established a
valuation allowance for those deferred tax assets. As established, the
valuation allowance was based on a number of factors, including the Company's
historically large losses and the Company's achieving profitable operations only
recently. In addition, federal tax regulations also may reduce the amount of
tax assets that the Company may use in subsequent periods. Considering these
factors, the Company only recognized a limited amount of its deferred tax assets
in fiscal year 1999 and did not record any tax benefit in fiscal year 1998.
Therefore, the loss before and after taxes was $29,445,031 for fiscal year 1998.
In valuing the net operating losses as of May 31, 1999, the Company recognized a
tax benefit of $1,986,409 resulting in net income of $3,875,680 for fiscal year
1999. The Company will continue to value the net operating losses and will
recognize tax benefits as the analyzed factors indicate that it is more likely
than not that the future benefits will be realized.
NET INCOME (LOSS). Dividends on preferred stock have accumulated but
have not been declared and are not yet payable. The Company, however, treats the
dividends as declared and payable for the purpose of calculating net income
applicable to common shareholders and earnings per share. Preferred dividends
for fiscal year 1999 increased 350% from $399,996 in fiscal year 1998 to
$1,799,999 due to the previously discussed conversion of debt to Series D and E
Preferred Stock. After the effect of preferred dividends, net income applicable
to common shareholders in fiscal year 1999 was
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$2,075,681 in fiscal year 1999 compared to a net loss applicable to common
shareholders of $29,845,027 for fiscal year 1998.
FISCAL YEAR ENDED MAY 31, 1998 COMPARED TO FISCAL YEAR ENDED MAY 31,
1997:
REVENUES. Total revenue for fiscal year 1998 was $13,382,320, a 419%
increase from $2,576,336 during the same period ended May 31, 1997. The increase
was primarily due to a combination of increased revenues from a growing
portfolios of performing credit card receivables and a full 12 months of
operations compared to just under eight months of operations in fiscal year
1997. Income from credit card receivables increased 307% from $971,174 to
$3,951,602. Revenue in excess of cost recovered was $8,138,122 in fiscal year
1998 compared to $3,934 in fiscal year 1997 due to the startup nature of the
operation in fiscal year 1997. Servicing fees and other income decreased
24% from $1,601,228 to $1,292,596 as the Company de-emphasized servicing for
third parties in order to concentrate on servicing and developing its own
portfolios.
The provision for losses increased 333% from $1,494,001 in fiscal year
1997 to $6,483,736 in fiscal year 1998 as the portfolio of performing credit
card receivables grew and as the volume of funded cardholder charges and cash
advances grew proportionately. This combined to produce net revenue of
$6,898,584 for the fiscal year ended May 31, 1998, a 537% increase over net
revenue of $1,082,335 produced for the fiscal year ended May 31, 1997.
EXPENSES. Salaries and employee benefits increased 120% from $6,154,929
to $13,268,863 due to increased full time personnel and a full 12 months of
operations. Interest expense increased 533% from $751,729 to $4,760,905 based on
a higher level of debt outstanding during fiscal year 1998 versus fiscal year
1997. Professional fees increased 77% from $2,388,274 in fiscal year 1997 to
$4,215,891 in fiscal year 1998 as the Company continued to incur expenses
related to startup. Depreciation and amortization increased 239% from $952,362
in fiscal year 1997 to $3,223,620 in fiscal year 1998 as the Company invested in
equipment and incurred a full year of depreciation related to it. Third party
credit card service fees increased 229% from $1,059,282 in fiscal year 1997 to
$3,486,915 in fiscal year 1998 due to the increased number of accounts serviced
and a full 12 months of fees experienced in fiscal year 1998. All other expenses
as a group increased 53% from $4,823,026 in fiscal year 1997 to $7,387,421 in
fiscal year 1998 primarily due to the inclusion of a full 12 months of costs in
the period.
NET LOSS. The above factors combined to produce net loss before
preferred dividends of $29,445,031 in fiscal year 1998 compared to a net loss
before preferred dividends of $14,405,555 in fiscal year 1997. After accounting
for preferred dividends of $399,996 in fiscal year 1998 and $7,397 in fiscal
year 1997, the net loss applicable to common shareholders was $29,845,027 in
fiscal year 1998 compared to $14,412,952 in fiscal year 1997.
SIX MONTHS ENDED NOVEMBER 30, 1999 COMPARED TO SIX MONTHS ENDED NOVEMBER
30, 1998:
REVENUES. Total revenue for the six months ended November 30, 1999 was
$22,853,965, a 13.2% increase from $20,184,409 recorded during the six months
ended November 30, 1998. Gains from portfolio sales and retained interests
increased 12.2% from $5,649,418 in the six months ended November 30, 1998 to
$6,336,221 in the six months ended November 30, 1999. The Company sold its
retained interests in securitizations during the second quarter of fiscal year
2000, but conducted no sales in the first quarter of fiscal
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year 2000. The Company recorded gains from portfolio sales and securitizations
in both the first and second quarters of fiscal year 1999. All other revenue
components ("core revenues") increased 13.6% as a group during the first half of
fiscal year 2000. Income from credit card receivables (including interest, fees
and interchange processing fees) increased 63.8% from $3,029,342 in the six
months ended November 30, 1998 to $4,961,764 due to a higher amount of funded
credit card receivables during the period. Revenue in excess of costs recovered
decreased 2.7% from $10,492,017 to $10,209,919, while servicing and all other
income increased from $1,013,632 in the six months ended November 30, 1998 to
$1,346,061 in the six months ended November 30, 1999, primarily due to income
related to previously securitized portfolios. The provision for losses increased
46.1% from $2,559,044 in the six months ended November 30, 1998 to $3,737,867 in
the six months ended November 30, 1999 and increased as a percentage of core
revenue from 17.6% in the six months ended November 30, 1998 to 22.6% in the six
months ended November 30, 1999 due to a higher level of principal funded on the
credit cards, due to the maturing of the portfolio. The above factors combined
for a 8.5% increase in net revenue from $17,625,365 in the six months ended
November 30, 1998 to $19,116,098 in the six months ended November 30, 1999.
EXPENSES. Total operating expenses for the first half of fiscal year
2000 increased 1.5% from $17,052,124 in the six months ended November 30, 1998
to $17,303,148 in the six months ended November 30, 1999. Salaries and employee
benefits increased 12.6% from $5,878,047 in the six months ended November 30,
1998 to $6,615,777 in the six months ended November 30, 1999, but decreased as a
percentage of core revenue from 40.44% in the six months ended November 30, 1998
to 40.05% in the six months ended November 30, 1999. Interest expense decreased
3.6% from $2,219,073 to $2,139,454, based on a lower average amount of debt
outstanding. As a percentage of core revenue, interest expense decreased from
15.3% in the six months ended November 30, 1998 to 13.0% in the six months ended
November 30, 1999. Professional fees declined 9.8% from $1,229,946 in the six
months ended November 30, 1998 to $1,109,517 in the six months ended November
30, 1999 and as a percentage of core revenue declined from 8.5% in the six
months ended November 30, 1998 to 6.7% in the six months ended November 30,
1999. Depreciation and amortization increased 5.8% from $1,260,364 in the six
months ended November 30, 1998 to $1,333,893 in the six months ended November
30, 1999, but as a percentage of core revenue declined from 9.2% in the six
months ended November 30, 1998 to 8.1% in the six months ended November 30,
1999. Third party card service fees increased 3.6% from $2,204,057 in the six
months ended November 30, 1998 to $2,282,397 in the six months ended November
30, 1999 and as a percent of core revenue declined from 15.2% in the six months
ended November 30, 1998 to 13.8% in the six months ended November 30, 1999 as
the Company's cost per account declined. All other
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expenses as a group declined 10.3% from $4,260,637 in the six months ended
November 30, 1998 to $3,822,110 in the six months ended November 30, 1999 due to
more efficient operating systems and declines in per unit costs. The Company
recorded a $1,286,409 tax expense during the first half of fiscal year 2000 as a
result of the gain from sale of the retained interests in its securitizations
versus a $100,000 tax benefit during the first half of fiscal year 1999 related
to the securitization completed during the first half of fiscal year 1999.
NET INCOME (LOSS). Net income before dividends was $526,541 for the
first half of fiscal year 2000 versus net income of $673,241 in the first half
of fiscal year 1999. After providing for preferred dividends of $1,000,000 in
the first half of fiscal year 2000, the net loss applicable to common
shareholders was $473,459, or $(0.01) per common share, versus preferred
dividends of $799,999 and a net loss of $126,758, or $0.00 per common share,
in the first half of fiscal year 1999.
LIQUIDITY AND CAPITAL RESOURCES
The Company seeks to maintain an adequate level of liquidity through
active management of assets and liabilities. Because the characteristics of its
assets and liabilities change, liquidity management is a dynamic process
affected significantly by the maturity of the Company's assets and the
seasonality of the credit card business, which places significant demands on
funding new charges and cash advances during certain times of the year,
including the year-end holiday season.
At May 31, 1997, the Company had $2,685,581 of cash and cash
equivalents, compared to $8,205,071 at May 31, 1998 and $4,283,930 at May 31,
1999. The Company maintains restricted cash reserves at its banks to facilitate
the funding of new charges and advances on its customer's credit cards. These
restricted balances were $1,000,000 at May 31, 1997, $1,000,000 at May 31, 1998,
and 750,000 at May 31, 1999. At August 31, 1998, the Company had $5,524,377 in
cash and cash equivalents, of which $1,000,000 was restricted. At August 31,
1999, the Company had $5,273,121 in cash and cash equivalents of which $750,000
was restricted. The Company believes it has sufficient cash and cash equivalents
from its receivables portfolio and credit lines to operate its business over the
next twelve months.
A significant source of liquidity for the Company has been the sale and
securitization of credit card receivables. During the fiscal year ended May 31,
1999, the Company sold approximately $7.0 million in face amount of receivables
to an unaffiliated bank for $5.0 million and raised approximately $13.0 million
from three securitizations of credit card receivables totaling $20.4 million.
During the second quarter of fiscal year 2000, the Company sold its ownership
interests in its three securitization subsidiaries for approximately $8.6
million in cash, realizing a pretax gain of approximately $6.5 million.
The Company also maintains a senior secured revolving credit line with
Coast Business Credit, a division of Southern Pacific Bank. The credit line was
established in April 1998 for $5 million and was subsequently increased to $10
million in June 1999, and to $15 million in December 1999. The line of credit
expires in July 2001 and is secured by substantially all of the Company's
assets. Borrowings under the credit line are based on a formula, which is
dependent primarily upon the performance and maturing of the Company's credit
card receivables. There was $4,957,452 outstanding under the credit line at
November 30, 1999.
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The Company has also received secured financing from a related party,
J.L.B. of Nevada, Inc.,which is subordinated to the senior secured revolving
credit line. The principal amount outstanding on these notes totaled $10,009,042
at May 31, 1997, $27,674,940 at May 31, 1998 and $17,674,940 at May 31, 1999 and
at November 30, 1999. As noted in Item 7, $10 million of the initial debt amount
was converted to Series D preferred stock in May 1998. In August 1998, an
additional $10 million of the initial debt amount was converted to Series E
preferred stock. See "Item 7 - Certain Relationships and Related Transactions."
In October 1999, the Company established a $17.5 million secured
revolving credit line with General Electric Capital Corporation to finance the
acquisition of non-performing consumer debt portfolios. There was $2,547,596
outstanding under the credit line at November 30, 1999. The borrower is a wholly
owned, bankruptcy remote special purpose entity established by the Company for
this transaction. The transfer of receivables to this SPE by the Company does
not qualify for sale treatment under SFAS 125. The SPE will be fully
consolidated with the Company's financial results.
CAPITAL EXPENDITURES AND PORTFOLIO ACQUISITIONS
During fiscal year 1999, the Company invested $8,622,478 to acquire
portfolios of non-performing consumer debt, a decrease of 45% from the
$15,641,657 invested in fiscal year 1998, which was a 9% increase over the
$14,310,037 invested in fiscal year 1997. The decrease in fiscal year 1999 was
due in part to a shortage of available financing for the industry in general and
a shortage of available portfolios for purchase by the Company that met the
Company's requirements and were available for acceptable prices. The Company
invested $4,188,003 to acquire portfolios of non-performing consumer debt during
the six months ended November 30, 1999, a decrease of 42% from $7,195,786
invested during the six months ended November 30, 1998. The Company also
invested $4,085,604 to acquire a portfolio of fully performing credit card
receivables, at a discount.
The Company invested $682,539 in property and equipment during fiscal
year 1999 compared to $4,170,472 in fiscal year 1998 and $10,164,477 in fiscal
year 1997. A majority of the hardware commitments to build the Company's
business platform were made in fiscal years 1997 and 1998. During the first six
months of fiscal year 2000, the Company invested $75,972 in new capital
equipment compared to $394,627 during the first six months of fiscal year 1999.
The Company plans to make continued investments in technology and
non-performing portfolios for the remainder of the fiscal year, the amount of
which will depend on the amount of financing and new capital available for such
investments. The Company believes that its asset securitization programs,
together with the revolving credit facility, long term debt issuance, equity
issuance, and cash flow from operations, will provide adequate liquidity to the
Company for meeting anticipated cash needs, although no assurance can be given
to that effect.
INFLATION
The Company believes that inflation has not had a material impact on
its results of operations for the fiscal years ended May 31, 1997, 1998 and
1999.
MARKET RISK
Market risk is the risk of loss from adverse changes in market prices
and rates. The Company's principal market risk is due to changes in interest
rates. These changes affect the Company directly in its lending and borrowing
activities, as well as indirectly as interest rates may impact the payment
performance of the Company's credit card holders.
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To manage the Company's direct risk to market interest rates,
management actively monitors the interest rates and the interest sensitive
components of the Company's balance sheet to minimize the impact changes in
interest rates have on the fair value of assets, net income and cash flow.
Management seeks to minimize the impact of changes in interest rates on the
Company primarily by matching asset and liability repricings.
The Company's credit card receivables earn interest at a fixed annual
percentage rate. The Company's fixed annual percentage rate credit card
receivables have no stated maturity or repricing period. However, the Company
may reprice its credit card receivables upon providing the required prior notice
to the customer, which is generally no more than 60 days. The interest rates on
the Company's liabilities are generally indexed to the prime rate. These
characteristics of the Company's receivables and liabilities expose the Company
to repricing risk, which results from differences between the timing of rate
changes and the timing of cash flows, which could impact net interest income if
liabilities reprice more often than assets. The principal objective of the
Company's asset/liability risk management activities is to monitor and control
the Company's exposure to adverse effects resulting from movements of interest
rates over time. The Company has not entered into derivative transactions to
hedge repricing risk.
CAUTIONARY STATEMENTS AND FACTORS THAT MAY AFFECT FUTURE RESULTS
The business of the Company involves many risks. The following summarizes some
of these risks and uncertainties. If any of the following risks actually occur,
our business, financial condition, operating results or cash flows could be
materially adversely affected. This could cause the market price of the
Company's Common Stock to decline and/or cause the Company to seek additional
financing.
This Registration Statement on Form 10 also contains certain
forward-looking statements that involve risks and uncertainties. These
statements relate to the Company's future plans. objectives, expectations and
intentions. These statements may be identified by the use of words such as
"believes," "expects," "may," "will," "could," "should," "seeks," "pro forma,"
"as adjusted" or "anticipates," and similar expressions. Our actual results
could differ materially from those discussed in these statements. Factors that
could contribute to these differences include those discussed below and
elsewhere in this prospectus.
THE COMPANY MAY NOT GENERATE SUFFICIENT CASH FLOWS FROM ITS RECEIVABLES
TO FUND ITS OPERATIONS. The Company is primarily in the business of providing
credit card products to consumers who have previously defaulted on a debt. Prior
to the Company's acquisition of the receivables, the originating institutions
and intermediary owners, if any, have generally made numerous attempts, using
both in-house and third-party collection agencies,to collect on the
non-performing accounts. The Company acquires the receivables at a discounted
price and believes it can successfully generate cash flows on the new credit
card accounts in excess of its acquisition cost for the receivables. While the
Company believes its knowledge of the market and its ability to collect and
convert non-performing accounts into new credit card accounts enables the
Company to minimize the higher risks inherent in the purchase of non-performing
debt, no assurance can be given that the Company has adequate protection against
these risks. In the event that the conversion of charged-off accounts to credit
card accounts and/or the collection on receivables is less than
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anticipated, or if the new credit card accounts experience higher delinquency
rates or losses than anticipated, the Company may not be able to generate
sufficient cash from its receivables to cover the costs associated with
purchasing the receivables and running its business.
THE COMPANY MAY NOT BE ABLE TO MANAGE ITS GROWTH OR OBTAIN THE
RESOURCES NECESSARY TO ACHIEVE ITS GROWTH PLANS. If the Company cannot manage
its growth, it may experience fluctuations in net income or sustain net losses.
Since inception, the Company has grown rapidly, placing significant demands on
its management, administrative, operational and financial resources. The Company
seeks to continue its growth trends, which could place additional demands on its
resources. Future growth will depend on numerous factors, including the
development of additional relationships with banks willing to issue credit cards
for the Company, the availability of additional non-performing portfolios for
purchase and the availability of financing to purchase these portfolios and
finance its ongoing operations, the ability to sell and securitize the Company's
seasoned credit card receivables, the ability to maintain a high quality of
customer service, and the recruitment, motivation and retention of qualified
personnel.
Sustained growth also may require the implementation of enhancements to
the Company's operational and financial systems and may require additional
management, operational and financial resources. There can be no assurance that
the Company will be able to manage its expanding operations effectively or to
maintain its historical level of cash flows from the portfolios it has
purchased, or that it will be able to maintain or accelerate its growth. The
failure of the Company to manage growth could harm the Company's results of
operations or financial condition.
THE COMPANY'S QUARTERLY OPERATING RESULTS MAY FLUCTUATE AND CAUSE ITS
STOCK PRICE TO DECREASE. The timing of portfolio acquisitions along with the
timing of its credit card receivables sales and securitizations can affect the
timing of recorded income and result in periodic fluctuations in the Company's
quarterly operating results, which may adversely affect the market price of its
common stock. The timing of any sale or securitization transaction is affected
by a number of factors beyond the Company's control including market conditions
and the presence of investors and lenders interested in the Company's seasoned
credit card accounts. An account is seasoned when a consumer has made a certain
number of on-time payments on the consumer's outstanding credit card balance.
THE COMPANY'S CASH REQUIREMENTS MAY FLUCTUATE FROM PERIOD TO PERIOD.
The Company may experience seasonal fluctuations in cash requirements due to a
variety of factors beyond the Company's control including the rate at which
customers pay down their credit card balance and the rate at which the customers
make new purchases and cash advances on their accounts. The Company may
experience higher cash requirements during the year-end holiday season and at
other times during the year when customers make new purchases on their credit
cards at a faster rate than they pay their debts.
THE COMPANY HAS INCURRED NET LOSSES AND HAS AN ACCUMULATED DEFICIT. The
Company has incurred substantial net losses and had an accumulated deficit of
approximately $39.6 million at May 31, 1999. There can be no assurance that the
Company will be able to maintain profitability long enough to recover the
accumulated deficit. Significant expenditures have been made to build the
infrastructure necessary to acquire charged-off portfolios, market and create
new credit card accounts from these portfolios, and service the resulting base
of credit card accounts. Results of operations will depend upon numerous factors
including without limitation, costs associated with the purchase of charged-off
consumer debt portfolios and the marketing, origination and servicing of the
Company's credit card receivables, the revenue generated from the Company's
credit card portfolio, the availability of additional financing to purchase
non-performing consumer debt portfolios and finance working capital, the
performance of the Company's receivables,
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the ability to sell and securitize the Company's credit card receivables, and
the market acceptance of the Company's products and services.
THE COMPANY MAY BE UNABLE TO MEET ITS ADDITIONAL FINANCING
REQUIREMENTS. There is no assurance that the Company will be able to meet its
future liquidity requirements. The Company has a substantial ongoing need for
liquidity to finance its operations, and this need is expected to increase along
with the growth in the Company's business. The Company's primary operating cash
requirements include the purchase of non-performing portfolios, the marketing,
servicing and collection of credit cards, and ongoing administrative expenses.
The Company funds its cash requirements through a combination of cash
flow from operations, asset sales and securitizations, loans and other financing
transactions.
In the event additional financing is unavailable to the Company and
additional receivable sales and securitizations are not completed, the Company's
ability to operate its business would be limited and its financial condition,
operating results or cash flows could be materially adversely affected.
THE COMPANY USES ESTIMATES IN ITS ACCOUNTING AND WOULD HAVE TO CHARGE
ITS INCOME IF ACTUAL RESULTS WERE LESS THAN ESTIMATED. The Company uses gain on
sale accounting, pursuant to which the Company records the unrealized gain from
the sale of receivables in securitization transactions as a component of
comprehensive income and as retained interest in securitized receivables on the
balance sheet. The unrealized gain is an estimate based upon management's
assessment of future payment and default rates and other considerations in light
of conditions existing at the time of the estimate. If actual default rates,
with respect to those receivables included in securitizations, are higher than
the Company projected at the time of sale of the receivables, the Company would
be required to record a charge to comprehensive income in future periods which
would also reduce the Company's retained interest on the balance sheet.
LACK OF MATURITY OF THE COMPANY'S CREDIT CARD PORTFOLIO MAY RESULT IN
INCREASED DELINQUENCIES AND DEFAULTS. The average age of a credit card issuer's
portfolio of accounts is an indicator of the stability of delinquency and
default levels of that portfolio; a portfolio of older accounts generally
behaves more predictably than a newly originated portfolio. The majority of the
credit card receivables owned by the Company are less than three years old as of
December 1999. As a result there can be no assurance as to the levels of
delinquencies and defaults, which may affect the Company's earnings through net
charge-offs over time. Any material increases in delinquencies and defaults
above management's expectations would have a material adverse effect on the
Company's results of operations and financial condition.
THE MARKET FOR THE COMPANY'S CREDIT CARD RECEIVABLES IS LIMITED. The
Company's future is highly dependent upon the Company's ability to sell or
securitize its portfolios of credit cards that have been generated from
non-performing debt. Although to date the Company has sold two portfolios and
completed three securitizations, no assurance can be given that any more will be
sold or securitized. While there have been securitizations completed by
companies that purchase non-performing consumer debt portfolios and subsequently
attempt to collect on these accounts, the Company is unaware of any significant
securitization of credit card receivables generated from portfolios of
non-performing debt. The Company believes that the market for receivables of
this nature is limited and that there can be no assurance that any such market
will develop to the stage where the Company can be assured of buyers for it's
securitizations and portfolio sales.
In addition, financial institutions that buy credit card receivables
or invest in securitizations may become subject to increasing regulatory burdens
or requirements that could affect the pricing or the size of the market for
such sales or securitizations. This could negatively affect the Company's
profitability and its ability to securitize or sell its credit card receivable
portfolios.
SECURITIZATIONS EXPOSE THE COMPANY TO VARIOUS RISKS. The Company
completed its first securitzations in fiscal 1999. The transactions resulted in
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recognition of a gain on sale and the recording of the retained interests in the
securitizations for financial reporting purposes. These and future
securitizations reduce income from credit card receivables and revenue in excess
of cost recovered, which reduction is partially offset by the receipt of
servicing income, and the accretion income on the residual investment in the
securitizations. In addition, in accordance with SFAS 115 unrealized holding
gains and losses, net of the related tax effect, are not reflected in earnings
but are recorded as a separate component of comprehensive income until realized.
A decline in the value of an available-for-sale security below cost that is
deemed other than temporary is charged to earnings and results in the
establishment of a new cost basis for the security and, therefore, could have an
adverse effect on the Company's financial position and/or results of operations.
Any downward adjustment in the carrying amount of this or future residual
interests could also have an adverse effect on the market price of the Company's
Common Stock. The Company intends to pursue additional securitizations and
portfolio sales, which will result in fluctuations in the Company's quarterly
income and will affect period-to-period comparisons. There also can be no
assurance that the Company will be able to complete future securitizations or
portfolio sales at all or on terms favorable to it.
ADVERSE PUBLICITY MAY IMPAIR ACCEPTANCE OF THE COMPANY'S PRODUCTS.
Critics of the credit card industry have in the past focused on marketing
practices that they claim encourage consumers to borrow more money than they
should, as well as on pricing practices that they claim are either confusing or
result in prices that are too high. Increased criticism of the industry or
criticism of the Company in the future could hurt client acceptance of the
Company's products or lead to changes in the law or regulatory environment,
either of which would significantly harm the Company's business.
THE COMPANY HAS PLEDGED ALL OF ITS ASSETS WHICH MAY MAKE FUTURE
FINANCING MORE DIFFICULT. On April 30, 1998, to secure its payment and
performance under its senior secured debt financing, the Company granted the
lender a security interest in all of the Company's assets including, among other
things, all receivables, inventory and equipment. The Company had previously
pledged its assets to its major shareholder as collateral for the loans
evidenced by certain shareholder notes. All shareholder notes have been
subordinated to the Company's senior debt lender. By pledging all of its assets
to secure financings, the Company may find it more difficult to secure
additional financing in the future.
THE COMPANY DOES NOT HAVE BACKUP ARRANGEMENTS FOR ALL SERVICES AND
EXISTING ARRANGEMENTS MAY BE INSUFFICIENT. The Company, through the issuing
bank's arrangement with FDR, uses FDR for third-party processing of credit card
data and services. The Company provides credit card data to FDR on a daily basis
and such data is backed up and stored by FDR. In addition, the Company's
marketing data on its purchased portfolios is backed up on a daily basis and is
stored off-site.
While it is currently evaluating a second service center, the Company
does not have a back-up servicer for its portfolio of credit cards, nor does it
have a back-up telemarketer for its marketing programs. In the event of a
disaster or other occurrence that closes the Company's main facility or shuts
down its primary and redundant data connections to FDR, the Company's business
would be interrupted during the period required to repair its data lines and/or
facilities or to relocate to temporary facilities. Such interruption in the
Company's operations could have a material adverse impact on its business and
revenues. The Company is evaluating back-up servicing and marketing solutions
that can seamlessly move servicing and marketing operations to alternative
locations or to third-party service providers in a manner that would minimize
losses in the event of a disaster or other occurrence that affects the Company's
primary facility or data transmission to third parties.
THE COMPANY CANNOT ISSUE ITS OWN CREDIT CARDS AND IT IS RELIANT UPON
CREDIT CARD ISSUERS. The Company is not licensed to nor does it currently have
the ability to independently issue credit cards. Accordingly, the Company is
dependent upon third-party financial institutions to issue credit cards to the
Company's customers. The Company currently has two banks through which cards are
issued. If the
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<PAGE> 28
Company's existing credit card issuers discontinue their agreements with the
Company and the Company were unable to find a new credit card issuer willing to
issue cards to consumers with impaired credit history, the Company would not be
able to operate its business as it is currently conducted. In addition, the
Company may not be able to enter into an agreement with an alternate provider on
terms that the Company considers favorable or in a timely manner without
disruption of the Company's business.
In addition, the third-party financial institutions upon which the
Company relies are subject to extensive governmental regulation. If such
regulators were to impose additional regulations or restrictions on third-party
financial institutions in connection with issuing credit cards, such regulations
or restrictions could impose additional costs or limitations upon the Company's
operations. These costs and/or limitations could reduce the Company's
profitability and adversely affect financial results.
LABOR AVAILABILITY. The credit card industry is labor intensive and
generally experiences a high rate of turnover in personnel. A high turnover rate
among the Company's employees would increase the Company's recruiting and
training costs and could adversely impact the overall recovery of its
receivables. In addition, Sioux Falls, South Dakota experiences a low incidence
of unemployment. If the Company were unable to recruit and retain a sufficient
number of employees, it would be forced to limit its growth or possibly curtail
its operations. Growth in the Company's business will require it to continue to
recruit and train significant numbers of qualified personnel. There can be no
assurance that the Company will be able to hire, train and retain a sufficient
number of qualified employees.
THE COMPANY MAY NOT BE ABLE TO ACQUIRE ENOUGH RECEIVABLES ON FAVORABLE
TERMS TO OPERATE PROFITABLY. To obtain additional credit card customers, the
Company depends on the continued availability of non-performing portfolios that
meet its requirements. Any decrease in availability of receivables or any
increase in the cost of receivables could reduce the Company's profitability and
liquidity and have a material adverse affect on the Company's results of
operations or financial condition.The availability of portfolios of receivables
for future purchase at prices favorable to the Company depends on a number of
factors outside of the control of the Company, including the continuation of the
current growth trend in credit card and consumer installment debt. Curtailment
of that trend could result in less credit being extended by lending institutions
and consequently fewer receivables available for purchase at prices that conform
to the Company's strategy for profitable collection. In addition, to the extent
consumers with negative credit history have less difficulty in obtaining credit,
especially obtaining unsecured credit cards, there may be less consumer demand
for the Company's product. The possible entry of new competitors (including
competitors that historically have focused on the acquisition of different asset
types) may adversely affect the Company's access to portfolios. The Company's
access to receivables portfolios may also be adversely affected if traditional
credit card lenders rehabilitate their own non-performing credit card
receivables. In addition, overly aggressive pricing by competitors could have
the effect of raising the cost of portfolios of receivables above those that
conform to the Company's pricing models.
FLUCTUATIONS IN ECONOMIC CONDITIONS COULD ADVERSELY AFFECT THE
COMPANY'S BUSINESS. During strong economic cycles, available credit, including
consumer credit, generally increases and payment delinquencies and defaults
generally decrease. During periods of economic slowdown and recession, such
delinquencies and defaults generally increase. No assurances can be given that
the Company's credit card losses and delinquencies would not worsen in a weak
economic cycle. Significant increases in credit card losses would weaken the
financial condition of the Company.
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<PAGE> 29
THE COMPANY MAY NOT BE ABLE TO SUCCESSFULLY ANTICIPATE, INVEST IN OR
ADOPT TECHNOLOGICAL ADVANCES WITHIN ITS INDUSTRY. The Company's success is
dependent in large part on its continued investment in sophisticated
telecommunications and computer systems, including predictive dialers, automated
call distribution systems and digital switching equipment. The Company has
invested significantly in technology in an effort to remain competitive and
anticipates that it will be necessary to continue to do so. Moreover, computer
and telecommunications technologies are evolving rapidly and are characterized
by short product life cycles, which require the Company to anticipate and stay
current with technological developments. There can be no assurance that the
Company will be successful in anticipating, managing or adopting such
technological changes on a timely basis or that the Company will have the
capital resources available to invest in new technologies.
THE COMPANY IS DEVELOPING NEW PRODUCTS AND SERVICES WHICH MAY NOT BE
SUCCESSFUL. While the Company may, from time to time, develop additional
products and services, there can be no assurance that such products and services
will be completed or successfully marketed and implemented. Consumer preferences
for credit card and credit related products are difficult to predict,
specifically where consumers have experienced past credit difficulties. There
can be no assurance that the products and services introduced by the Company
will be accepted by credit card holders, or that the Company's methodology for
restructuring past consumer debt delinquency will be accepted by the consumer.
Failure to obtain significant customer satisfaction or market share for the
Company's products and services would have a material adverse effect on the
Company's operations and financial condition.
LACK OF LIQUIDITY OF COMMON STOCK. The Company's Common Stock currently
trades on the National Quotation Bureau's "Pink Sheets" under the symbol
"PLCR", although the Company anticipates that its Stock will again trade on the
NASDAQ OTC Bulletin Board under the symbol "PLCR" as it has done in the past.
While a number of registered broker-dealers are currently making a market in the
Company's Common Stock, there can be no assurance that an active public market
for the Company's Common Stock will be sustained. Accordingly, investors may not
be able to sell their Common Stock should they desire to do so, or may be able
to do so only at lower than desired prices. While no prediction can be made as
to the effect, if any, that future sales of shares of the Company's Common
Stock, or the availability of additional shares for future sales, will have on
the market price of the Common Stock prevailing from time to time, sales of
substantial amounts of Common Stock or the perception that such sales could
occur, would likely adversely affect the market price for the Common Stock.
THE COMPANY IS DEPENDENT ON ITS KEY PERSONNEL. The Company is dependent
upon the continued contributions of its officers and other key employees. The
loss of the services of one or more of our executive officers or key employees
could disrupt the Company's operations. The Company has entered into employment
agreements with Martin J. Burke, its Chief Executive Officer and Chairman of the
Board of Directors, Kevin T. Riordan, its President and Chief Operating Officer,
Michael J. Philippe, its Executive Vice President and Chief Financial Officer,
and Richard S. Angel, its Executive Vice President and General Counsel. The loss
of the services of any such individual or the services of certain other officers
or key employees would cause the Company to incur costs for recruiting
replacements, could result in the loss of the valuable expertise and business
relationships, and could have a material adverse effect on the Company's
business and prospects. See "Item 5 - Directors and Executive Officers."
THE COMPANY'S MAJOR SHAREHOLDERS ARE RELATED AND HAVE THE ABILITY TO
CONTROL SHAREHOLDER ACTIONS ON FUNDAMENTAL CORPORATE MATTERS. Jay L. Botchman, a
director of the Company, has control over the Company's affairs through his
ability to elect the Company's directors and determine the outcome of votes by
the Company's stockholders on fundamental corporate matters, including mergers,
sales of all or substantially all of the Company's assets, charter amendments
and other matters subject to stockholder approval. Generally, such actions
require approval by a majority of the outstanding shares of common stock.
However, because of the control by Mr. Botchman, the common stockholders of the
Company are not able to elect a majority of the Company's directors and would
not be able to control a fundamental corporate action, such as a merger, sale of
the Company's assets, or a charter amendment.
Mr. Botchman, individually and through his control of certain entities,
beneficially owns all of the preferred stock of the Company. The terms of the
preferred stock contain certain preferential voting rights, particularly the
Company's Series A Preferred Stock. The outstanding shares of Series A Preferred
Stock represents 80% of all votes
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<PAGE> 30
entitled to be voted at any meeting of the Shareholders of the Company, subject
to dilution to the extent capital stock of the Company is subsequently issued.
Currently, the shares of the Series A Preferred Stock represent approximately
77.88% of all votes entitled to be voted at any meeting of the stockholders of
the Company. Finally, if Mr. Botchman were to cease to be the managing member of
Taxter, Martin J. Burke, the Company's Chief Executive Officer, would become the
managing member of Taxter. For additional information regarding Mr. Botchman's
ownership interests in the Company, see "Item 4 - Security Ownership of Certain
Beneficial Owners and Management." See "Item 11 - Description of Securities to
be Registered; Preferred Stock" for more information on the rights and
preferences of the preferred stock of the Company.
THE COMPANY'S OPERATIONS DEPEND, IN PART, UPON THE PROTECTION OF CERTAIN
PROPRIETARY INFORMATION. The Company's operations are dependent, in part, upon
certain proprietary data and analytical computer programs, methods and related
know-how for stratifying and analyzing characteristics of non-performing
receivable portfolios, projecting conversions to new credit cards and the total
cash collections, and predicting cardholder payment performance. The Company
currently relies upon a combination of confidentiality agreements,contract
provisions and trade secret laws to protect its proprietary rights. Although the
Company intends to protect its rights vigorously, there can be no assurance that
the Company will be successful in protecting its proprietary rights. If it is
not able to protect such rights, or if such information and data become widely
available, the Company may lose a competitive advantage within its market niche.
Such loss of competitive advantage could result in decreased revenues and
profitability for the Company.
FAILURE TO COMPLY WITH CONSUMER AND DEBTOR PROTECTION LAWS AND
REGULATIONS COULD ADVERSELY AFFECT THE COMPANY'S BUSINESS. The Company's
collection practices, business operations and credit card receivables are
subject to numerous federal and state consumer protection laws and regulations
imposing licensing and other requirements with respect to purchasing,
collecting, making and enforcing consumer loans. The Company conducts periodic
compliance reviews and, if necessary, implements procedures to bring the Company
into compliance with all applicable state and federal regulatory requirements.
Failure by the Company to comply with such statutes or regulations could have a
material adverse effect on the Company's results of operations or financial
condition. In addition, due to the consumer-oriented nature of the collections
and credit card industry, there is a risk that the Company or other industry
participants may be named as defendants in litigation involving alleged
violations of federal and state laws and regulations, including consumer
protection laws, and consumer law torts, including fraud. A significant judgment
against the Company or within the industry in connection with any such
litigation could have a material adverse effect on the Company's results of
operations or financial condition. See "Item 1 - Business; Government
Regulation."
RISKS ASSOCIATED WITH PENDING LITIGATION. The Company is currently
named as a defendant in seven class action lawsuits. These lawsuits generally
allege that persons in the class were purportedly solicited to voluntarily repay
debt that had been discharged in bankruptcy, and that the Company has violated
other provisions of federal or state law, including violations of the Bankruptcy
Code, the Fair Debt Collection Practices Act, the Truth in Lending Act, various
state consumer protection laws and, in one case, RICO. A significant judgment
against the Company in one or more of the lawsuits could subject the Company to
a monetary judgment that could substantially affect the Company's liquidity and
profitability. In addition, a loss may also require the Company to modify its
methods of operation to the extent its operations are deemed to not comply with
applicable legal standards, which could have a material adverse effect on the
Company's profitability and ability to conduct its operations. See "Item 8 -
Legal Proceedings."
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THE COMPANY HAS ACCUMULATED CASH DIVIDENDS. The Company has accumulated
approximately $3.2 million in undeclared and unpaid dividends on its preferred
stock. Although the Board of Directors has not declared, and therefore not paid,
such dividends to date, the Company may be called on to pay such dividends in
the future, assuming it has the legal capacity to do so under Delaware law. To
the extent such preferred stock remains outstanding, additional cash dividends
will accumulate. If the Company is required to pay out such cash dividends, such
payments would limit the amount of cash available to use in other operations and
may, therefore, decrease the cash liquidity of the Company. Such a decrease in
liquidity may require the Company to seek additional financing if the Company's
operations are not sufficient to fund its cash needs. See "Description of
Capital Stock--Preferred Stock."
THE COMPANY CAN ISSUE PREFERRED STOCK WITHOUT SHAREHOLDER APPROVAL
WHICH COULD DILUTE AND REDUCE THE VALUE OF THE COMPANY'S STOCK . The Company's
Certificate of Incorporation authorizes the issuance of "blank check" preferred
stock with such designations, rights and preferences as may be determined from
time to time by the Company's Board of Directors. Accordingly, the Board of
Directors is empowered, without stockholder approval, to issue preferred stock
with dividend, liquidation, conversion, voting or other rights which could
adversely affect the relative voting power or other rights of the holders of the
Company's Common Stock or reduce the market value of the Common Stock. In the
event of additional issuances, the preferred stock may be used, under certain
circumstances, as a method of discouraging, delaying or preventing a change in
control of the Company and could prevent stockholders from receiving a premium
for their shares in the event of a third party tender offer or change of control
transaction. There can be no assurance that the Company will not issue
additional shares of preferred stock in the future. When the Company issues
additional preferred stock, the issuance may have a dilutive effect upon the
holders of the Company's Common Stock.
ANTI-TAKEOVER PROVISIONS IN THE COMPANY'S CHARTER DOCUMENTS AND STATE
LAW MAY INHIBIT BENEFICIAL CHANGES OF CONTROL. The Company's charter documents
and Delaware law contain provisions that could make it more difficult for a
third party to acquire the Company, even if such a change of control would be
beneficial to the Company's stockholders. For example:
- - - -- the Company's board of directors has the power to issue shares of preferred
stock and set the related terms without stockholder approval;
- - - -- the Company is restricted in its ability to enter into business combinations
with interested stockholders; and
- - - -- the ability of stockholders to call a special meeting is limited.
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<PAGE> 32
LIMITATIONS ON LIABILITY OF DIRECTORS AND OFFICERS. The Company's
Certificate of Incorporation contains provisions limiting the liability of
directors of the Company for monetary damages to the fullest extent permissible
under Delaware law. This is intended to eliminate the personal liability of a
director for monetary damages in an action brought by or in the right of the
Company for breach of a director's duties to the Company or its stockholders
except in certain limited circumstances. In addition, the By-laws of the Company
contain provisions requiring the Company to indemnify directors, officers,
employees and agents of the Company serving at the request of the Company
against expenses, judgments (including derivative actions), fines and amounts
paid in settlement. This indemnification is limited to actions taken in good
faith in the reasonable belief that the conduct was lawful and in or not opposed
to the best interests of the Company. The By-laws of the Company provide for the
indemnification of directors and officers in connection with civil, criminal,
administrative or investigative proceedings when acting in their capacities as
agents for the Company. The foregoing provisions may reduce the likelihood of
derivative litigation against directors and officers and may discourage or deter
stockholders or management from suing directors or officers for breaches of
their duties to the Company, even though such an action, if successful, might
otherwise benefit the Company and its stockholders.
EXERCISE OF OUTSTANDING OPTIONS COULD CAUSE EXPENSE TO THE COMPANY AND
DILUTE STOCKHOLDERS. As of February 1, 2000 Company had granted options to
purchase 10,910,747 shares of Common Stock pursuant to stock option and
warrant agreements entered into by the Company with certain individuals
associated with the Company. While 5,417,000 of such options are not
immediately exercisable, any exercise could cause immediate and substantial
dilution. Certain of the shares subject to these options give the holder the
right to demand that the Company to file a registration statement at the
Company's expense under the Securities Act of 1933, as amended, covering the
shares. Exercise of such rights could involve substantial expense to the
Company.
SHARES OF THE COMPANY'S COMMON STOCK ELIGIBLE FOR FUTURE SALE IN THE
PUBLIC MARKET COULD CAUSE THE COMPANY'S STOCK PRICE TO DECREASE OR LIMIT ITS
ABILITY TO RAISE CAPITAL. If one or more of the Company's stockholders sell
substantial amounts of the Company's Common Stock, the market price of the
Common Stock could drop. These sales could make it difficult for the Company to
raise funds through offerings of Common Stock or depress the stock price at a
time when the Company needs to raise capital. As of February 1, 2000, the
Company had 34,761,965 shares of Common Stock issued and outstanding, all of
which are available for sale in the public market subject to the volume and
other selling limitations of Rule 144 ("Rule 144") of the Securities Act of
1933, as amended (the "Securities Act").In addition, certain holders of options
or warrants to purchase Common Stock and certain holders of preferred stock of
the Company that is convertible into Common Stock have the right to demand that
the Company register such shares of Common Stock (8,157,500 shares of Common
Stock in the aggregate) under the Securities Act.
RISK OF LOW-PRICED SECURITIES. The Securities Enforcement and Penny
Stock Reform Act of 1990 requires additional disclosure relating to the market
for penny stocks in connection with trades in any stock defined as a penny
stock. Securities Exchange Commission regulations generally define a penny stock
to be an equity
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<PAGE> 33
security that has a market price of less than $5.00 per share, subject to
certain exceptions. As the Company does not currently satisfy the requirements
to comply with any exception, the regulations require the delivery, prior to
certain transactions involving the Company's Common Stock, of a disclosure
schedule explaining the penny stock market and the risks associated therewith.
Transactions that meet the requirements of Regulation D under the Securities Act
or transactions with an issuer not involving a public offering pursuant to
Section 4(2) of the Securities Act are exempt from the disclosure schedule
delivery requirements.
Since the Company is subject to the penny stock regulations cited
above, trading in the Company's securities is covered by Rule 15g-9 promulgated
under the Securities Exchange Act of 1934, as amended (the "Exchange Act") for
non-NASDAQ and non-national securities exchange listed securities. Under such
rule, broker/dealers who recommend such securities to persons other than
established customers and accredited investors must make a special written
suitability determination for the purchaser and receive the purchaser's written
agreement to a transaction prior to sale.
The effect of theses regulations may decrease the liquidity in the
market for the Company's Common Stock because of the additional costs and
burdens imposed.
ITEM 3 - PROPERTIES
The Company's headquarters consist of a 30,000 square foot leased
facility in Sioux Falls, South Dakota. The lease expires on September 30, 2011.
The Company owns an additional 5 acres of undeveloped property adjacent to this
site that can be utilized for expansion purposes.
The Company's Mail Center consists of a 25,000 square foot leased
facility in Sioux Falls, South Dakota. The lease was amended on November 18,
1997 to extend the terms of the lease for two years commencing on March 1, 1998
and ending on February 28, 2000.
ITEM 4 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding the
beneficial ownership of the Company's Common Stock and Preferred Stock as of
December 15, 1999, based upon the most recent information available to the
Company for (i) each person known by the Company who owns beneficially more than
five percent of any class of capital stock of the Company, (ii) each of the
Company's directors, (iii) the Company's Chief Executive Officer and each of the
four other most highly compensated executive officers (the "Named Executive
Officers") and (iv) all officers and directors of the Company as a group. Except
as set forth below, each stockholder's address is c/o the Company, 3401 North
Louise Avenue, Sioux Falls, South Dakota 57107.
<TABLE>
<CAPTION>
COMMON STOCK PREFERRED STOCK (1)
------------ -------------------
NUMBER PERCENTAGE NUMBER PERCENTAGE
OF SHARES OF SHARES OF SHARES OF SHARES
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Principal Shareholders:
Taxter One LLC 15,678,000 45.1% 2,000,000(2) 100%(2)
565 Taxter Road
Elmsford, NY 10523
</TABLE>
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<TABLE>
<S> <C> <C> <C> <C>
J.L.B. of Nevada, Inc. 6,650,000(3) 16.1% 20,000(4) 100%(4)
1500 E. Tropicana Ave.
Suite 100
Las Vegas, NV 89119
Michael Lauer 8,252,500(5) 23.7% -- --
Directors and Named Executive
Officers:
Martin J. Burke 1,000,000(6) 2.8% -- --
Kevin T. Riordan 815,000(7) 2.3% -- --
Michael J. Philippe 355,334(8) 1.0% -- --
Richard S. Angel 250,000(9) * -- --
Cynthia D. Hassoun 50,000(10) * -- --
Jay L. Botchman(11) 22,328,000(3) 53.9% 2,025,000(11) 100%(11)
Barry E. Breeman 75,000(12) * -- --
J. Richard Budd, III 91,300(13) * -- --
Geoffrey A. Thompson 95,000(14) * -- --
All directors and executive officers as 25,125,234(15) 57.2% 2,025,000(11) 100%(11)
a group
</TABLE>
- - - ----------------
* Less than 1%
(1) The Company currently has outstanding 1,200,000 shares of Series A
Preferred Stock, 80,000 shares of Series B Preferred Stock, 5,000
shares of Series C Preferred Stock, 10,000 shares of Series D Preferred
Stock, and 10,000 shares of Series E Preferred Stock, all of which are
owned by one of Jay L. Botchman, a director of the Company, Taxter and
JLB all of which and are under the control of Mr. Botchman. See "Item
11--Description of Securities to be Registered; Preferred Stock."
(2) Consists of 1,200,000 shares of Series A Preferred Stock and 800,000
shares of Series B Preferred Stock held by Taxter.
(3) Includes 3,800,000 shares of Common Stock issuable upon conversion of
10,000 shares of Series D Preferred Stock held by JLB and 2,850,000
shares of Common Stock issuable upon conversion of 10,000 shares of
Series E Preferred Stock held by JLB.
(4) Consists of 10,000 Series D Preferred Stock and 10,000 Series E
Preferred Stock held by JLB.
(5) Consists of 2,987,500 shares of Common Stock owned by Lancer Partners,
L.P., 4,730,000 shares of Common Stock owned by Lancer Offshore, Inc.,
and 535,000 shares of Common Stock owned by Michael Lauer. Mr. Lauer
is the investment manager for Lancer Partners, L.P. and Lancer
Offshore, Inc. and has the authority to vote and dispose of all shares
of Common Stock owned by these entities.
(6) Consists of 1,000,000 shares issuable upon the exercise of options
exercisable at a price of $2.00 per share.
(7) Includes shares issuable upon the exercise of options exercisable in
the following amounts and prices: 300,000 shares at $2.00 per share,
100,000 shares at $2.70 per share, and 200,000 shares at $2.40 per
share. Includes 215,000 shares owned by Mr. Riordan's wife, of which
shares Mr. Riordan disclaims beneficial ownership.
(8) Includes shares issuable upon the exercise of options exercisable in
the following amounts and prices: 50,000 shares at $2.00 per share,
100,000 shares at $2.70 per share, and 200,000 shares at $2.40 per
share.
(9) Includes shares issuable upon the exercise of options exercisable in
the following amounts and prices: 50,000 shares at $2.00 per share,
100,000 shares at $2.70 per share, and 100,000 shares at $2.40 per
share.
(10) Consists of 50,000 shares issuable upon the exercise of options
exercisable at a price of $2.00 per share.
(11) Includes 5,000 shares of Series C Preferred Stock held of record by
Jay L. Botchman, 1,200,000 shares of Series A Preferred Stock and
800,000 shares of Series B Preferred Stock held of record by Taxter and
the 10,000 shares of Series D Preferred Stock and 10,000 shares of
Series E Preferred Stock held of record by JLB. Mr. Botchman owns
approximately 99.95% of the membership interests in Taxter and owns
100% of the outstanding capital stock of JLB.
(12) Consists of 75,000 shares issuable upon the exercise of options
exercisable at a price of $2.00 per share.
(13) Includes 75,000 shares issuable upon the exercise of options
exercisable at a price of $2.00 per share.
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<PAGE> 35
(14) Includes 75,000 shares issuable upon the exercise of options
exercisable at a price of $2.19 per share.
(15) Includes 65,000 shares issuable upon the exercise of options in
addition to those shares set forth in footnote 3 and footnotes 6
through 14. Also includes 500 shares owned by William Buriak's wife.
ITEM 5 - DIRECTORS AND EXECUTIVE OFFICERS
The Company's directors, executive officers and key employees are as
follows:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Martin J. Burke, III 41 Chairman of the Board of Directors and Chief Executive
Officer
Kevin T. Riordan 47 President and Chief Operating Officer
Michael J. Philippe 41 Executive Vice President, Chief Financial Officer and
Treasurer
Richard S. Angel 41 Executive Vice President and General Counsel
William Buriak 45 Senior Vice President and Chief Information Officer
Cynthia D. Hassoun 49 Senior Vice President and Corporate Secretary
Michael L. Neher 35 Senior Vice President
Jonathan Pike 38 Senior Vice President
Patrick Steffl 33 Senior Vice President
Jay L. Botchman 67 Director
Barry Breeman 50 Director
J. Richard Budd, III 47 Director
Geoffrey Thompson 59 Director
</TABLE>
Each director of the Company holds office until the next annual meeting
of the stockholders, or until his successor is elected and qualified. The
Company's By-laws provide for not less than one director. The By-laws permit the
Board of Directors to fill any vacancy on the Board. Officers serve at the
discretion of the Board of Directors.
The principal occupation and business experience of each officer,
director and key employee of the Company is as follows:
MARTIN J. BURKE, III. Mr. Burke has been the Chief Executive Officer of
the Company since October 1996. Mr. Burke has served as the Chairman of the
Board of Directors of the Company since May 1998, prior to which he had been
Vice-Chairman of the Board of Directors. From March 1995 through September 1996,
Mr. Burke was the Chairman of American Home Credit, a company engaged in the
financing of sub-prime debt. During 1994, Mr. Burke sat on the Board of the
corporate finance subsidiary of G & L Realty, a R.E.I.T. specializing in medical
offices and nursing homes. From November 1983 through May 1998, Mr. Burke was
Chief Executive Officer and principal owner of The Martin Burke Company, a
company engaged in structuring and arranging financing for sophisticated real
estate transactions and start-up corporations.
KEVIN T. RIORDAN. Mr. Riordan has been the President and Chief
Operating Officer of the Company since April 1997. From February 1995 to March
1997, Mr. Riordan served as President and Chief Executive Officer of Long Beach
Acceptance Corp., a subsidiary of Long Beach Mortgage Corp. From February 1985
to February 1995, Mr. Riordan was President and Chief Executive Officer of
Alliance Funding Company and its successor in interest Alliance Funding Company,
a division of Superior Bank FSB. Prior to 1985, Mr. Riordan acted as Senior Vice
President of American Funding, a national consumer mortgage company.
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<PAGE> 36
MICHAEL J. PHILIPPE. In June 1999, Mr. Philippe was elected Executive
Vice President, Chief Financial Officer and Treasurer of the Company. Mr.
Philippe joined the Company in June 1997 as Vice President of Finance and became
Chief Financial Officer in September 1997. The prior 13 years, Mr. Philippe
served as a Vice President and Manager for The Sumitomo Bank, Ltd. and its
predecessors.
RICHARD S. ANGEL. Mr. Angel joined the Company in August 1997 as Vice
President, Secretary and Corporate Counsel. In June 1999, Mr. Angel was elected
Executive Vice President and General Counsel of the Company. From January 1992
to August 1997, Mr. Angel was a shareholder in the law firm of Buchalter, Nemer,
Fields & Younger in Los Angeles, California. From May 1985 to December 1991 he
was an associate with such firm.
WILLIAM G. BURIAK. Mr. Buriak joined the Company as Chief Information
Officer July 1999. From November 1996 to July 1999, Mr. Buriak was Director of
Management Information Services and Director of Business Office Operations for
CCDM, a non-profit healthcare system in Perth Amboy, New Jersey. From June 1986
to November 1996, Mr. Buriak was Assistant Vice President at Beneficial Finance
Corporation in Peapack, New Jersey.
CYNTHIA D. HASSOUN. Ms. Hassoun joined the Company in October 1997 as
Chief Coordinating Officer. In April 1999, Ms. Hassoun was elected Corporate
Secretary of the Company and she was elected Senior Vice President of the
Company in June 1999. From April 1997 to September 1997, Ms. Hassoun served as a
consultant to the Company. From January 1992 to November 1996, Ms. Hassoun was
Vice President of Customer Service for Superior Bank FSB, a savings bank.
MICHAEL L. NEHER. Mr. Neher joined the Company as Senior Vice President
responsible for Non-Card Resolutions and Portfolio Divestitures in November
1999. From September 1998 to October 1999, Mr. Neher was the Assistant Vice
President for Outsourcing-Card Services/Consumer Products of the Atlanta Georgia
operation of the Bank of Hawaii. From December 1995 to September 1998, he was
the Regional Sales Manager for Primus Automotive Financial Services, Atlanta,
Georgia. From June 1993 to November 1995, Mr. Neher served as the Business Line
Supervisor, Collections and Recovery-Consumer Loans for Ocwen Federal Bank &
Trust FSB, West Palm Beach, Florida.
JONATHAN L. PIKE. Mr. Pike has been the Sr. Vice President of
Operations for the Company since August 1999. From November 1997 to July 1999,
Mr. Pike served as Vice President of Credit Risk for Stage Stores in Houston,
Texas. From August 1992 until November 1997, Mr. Pike served as Director of
Strategic Marketing and Director of Risk Management for First Data Corporation
in Omaha, Nebraska.
PATRICK STEFFL. Mr. Steffl was elected Senior Vice President of the
Company in June 1999. Prior to joining the Company in August 1997 as Vice
President of Marketing, Mr. Steffl had been with Fingerhut Companies, Inc. in
Minnetonka, Minnesota since 1989, managing mail and telemarketing media of six
phone centers throughout the country.
JAY L. BOTCHMAN. Mr. Botchman has been a director of the Company since
October 1996. From October 1996 through May 1998, Mr. Botchman served as the
Chairman of the Board of Directors of the Company. Mr. Botchman also serves as
the Chairman and majority owner of Taxter. For more than the past five years,
Mr. Botchman has been the owner of J.L.B. Equities, Inc. and JLB, both of which
are investment and commercial finance companies. In addition, Mr. Botchman acts
as a consultant to various entities in the consumer finance business.
BARRY E. BREEMAN. Mr. Breeman joined the Board of Directors in
September 1998. Since April 1998, Mr. Breeman has been Vice Chairman and Chief
Investment Officer of Manley-Berenson Realty & Development, LLC. From January
1991 to the present, Mr. Breeman has been the managing member of Cambridge Real
Estate
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<PAGE> 37
Services, LLC, a real estate investment banking services business. From January
1980 to December 1991, he was President, Chief Executive Officer and a director
of Carnegie Realty Holdings Corp. and its subsidiaries.
J. RICHARD BUDD, III. Mr. Budd joined the Board of Directors in
September 1998. Mr. Budd served as Senior Vice President of Metallurg, Inc., an
international specialty metals producer, from January 1996 to October 1998. From
July 1994 to January 1996, Mr. Budd served as Vice President and Director of
Cityscape Corp and from 1992 to 1994, Mr. Budd worked as a consultant with the
consulting firm of Zolfo Cooper LLC. Prior to 1992, Mr. Budd was Executive Vice
President of European American Bank and President and Chief Executive of Euram
Management, Inc., a subsidiary of ABN AMRO Bank NV, a foreign bank holding
company.
GEOFFREY A. THOMPSON. Mr. Thompson joined the Board of Directors in
April 1999. Mr. Thompson retired from Marine Midland Bank, Inc., Buffalo, New
York in October 1992, where he had served as President and Chief Executive
Officer. Mr. Thompson currently serves on the board of directors of Magnavision
Corp., a provider of private cable (wireless compatible communication) to
colleges, hospitals and nursing homes. In addition, he serves on the boards of
three privately-held corporations and four not-for-profit corporations.
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<PAGE> 38
ITEM 6 - EXECUTIVE COMPENSATION
The following summary compensation table sets forth information
concerning the annual compensation paid by the Company to the Named Executive
Officers for services rendered during the fiscal years ended May 31, 1999, May
31, 1998 and May 31, 1997.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
------------
AWARDS
------
ANNUAL COMPENSATION NUMBER OF
------------------- SECURITIES
FISCAL UNDERLYING
NAME AND PRINCIPAL POSITION YEAR(1) SALARY BONUS OPTION (#)
- - - --------------------------- ------- ------ ----- ----------
<S> <C> <C> <C> <C>
Martin J. Burke, III 1999 $60,000.00 -- --
Chairman of the Board 1998 62,518.48 -- 1,000,000
and Chief Executive Officer 1997 29,999.97 -- --
Kevin Riordan 1999 $305,769.20 -- 100,000
President and Chief 1998 305,968.06 -- 300,000
Operating Officer 1997 39,230.78 $2,000,000 --
Michael J. Philippe
Executive Vice President, 1999 $184,951.60 $5,000 100,000
Chief Financial Officer and 1998 161,233.76 -- 100,000
Treasurer 1997 -- -- --
Richard S. Angel 1999 $220,154.00 -- 100,000
Executive Vice President 1998 153,989.12 -- 100,000
and General Counsel 1997 -- -- --
Cynthia D. Hassoun 1999 $152,884.90 -- --
Senior Vice President and 1998 92,223.15 $50,000 75,000
Corporate Secretary 1997 -- -- --
</TABLE>
- - - ---------------------
(1) The Named Executive Officers commenced their employment with the Company as
follows: Mr. Burke, October 1996; Mr. Riordan, April 1997; Mr. Philippe,
June 1997; Mr. Angel, August 1997; Ms. Hassoun, October 1997.
CREDIT CARD FOR OFFICERS
Mr. Burke has a personal credit card from the Company that he uses for
personal purposes. The terms of the credit card impose interest at the rate of
18.9% APR, with a minimum monthly payment equal to 3.0% of the outstanding
balance. The credit limit on the card is $450,000. As of May 31, 1999, the
balance due on the credit card was $442,094.14.
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<PAGE> 39
OPTION/SAR GRANTS IN LAST FISCAL YEAR
The following table contains information concerning the grant of stock
options to the Named Executive Officers for the Company's fiscal year ended May
31, 1999. These grants are also reflected in the Summary Compensation Table,
above.
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
% OF TOTAL VALUE AT ASSUMED
NUMBER OF OPTIONS ANNUAL RATES OF STOCK
SECURITIES GRANTED PRICE APPRECIATION FOR
UNDERLYING TO OPTION TERM(2)
OPTIONS EMPLOYEES EXERCISE EXPIRATION --------------
NAME GRANTED(1) IN YEAR PRICE DATE 5% 10%
- - - ---- ---------- ------- ----- ---- -- ---
<S> <C> <C> <C> <C> <C> <C>
Kevin Riordan 100,000 13% $2.70 August 9, 2003 $36,000 $117,000
Michael J. Philippe 100,000 13% $2.70 August 9, 2003 $36,000 $117,000
Richard S. Angel 100,000 13% $2.70 August 9, 2003 $36,000 $117,000
</TABLE>
- - - ------------------
(1) Option granted to the Company's 1997 Stock Option Plan, as amended. See
"Stock Option Plan."
(2) Potential realized values shown above represent the potential gains based
upon compound price appreciation of 5% and 10% from the date of grant
through the full option term. The actual value realized, if any, on stock
option exercises will be dependent upon overall market conditions and the
future performance of the Company and its Common Stock. There is no
assurance that the actual value will approximate the amounts reflected in
this table.
The following table summarizes option exercises by the Named Executive
Officers of the Company during fiscal 1999 and the value of unexercised stock
options as of May 31, 1999.
AGGREGATED OPTION EXERCISES IN FISCAL 1999 AND FISCAL YEAR-END
OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SHARES VALUE OF UNEXERCISED
SHARES UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
ACQUIRED OPTIONS AT FISCAL YEAR-END AT FISCAL YEAR-END(1)
ON VALUE -------------------------------- ------------------------------
NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- - - --------------------------- -------- -------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Martin J. Burke 0 0 1,000,000 0 $562,000 0
Kevin Riordan 0 0 400,000 0 $168,600 0
Michael J. Philippe 0 0 125,000 75,000 $14,050 $42,150
Richard S. Angel 0 0 125,000 75,000 $14,050 $42,150
Cynthia D. Hassoun 0 0 25,000 50,000 $14,050 $28,100
</TABLE>
- - - ---------------------
(1) Value is based on the per share closing price of the Company's Common Stock
on May 28, 1999, the last trading day of fiscal 1999, which was $2.562.
39
<PAGE> 40
STOCK OPTION PLAN
In March 1997, the Board of Directors adopted and the stockholders
approved the Company's 1997 Stock Option Plan. The Board of Directors and the
stockholders approved an amendment to the 1997 Stock Option Plan in December
1997 (as amended, the "Amended 1997 Stock Option Plan"). The Amended 1997 Stock
Option Plan provides for the grant of (i) options that are intended to qualify
as incentive stock options ("Incentive Stock Options") within the meaning of
Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"), to
employees and (ii) options not intended to so qualify ("Nonqualified Stock
Options") to employees (including directors and officers who are employees of
the Company), directors and consultants. The total number of shares of Common
Stock for which options may be granted under the Amended 1997 Stock Option Plan
is 4,000,000 shares. As of May 31, 1999, the Company had granted options to
purchase 2,871,500 shares of Common Stock under the Amended 1997 Stock Option
Plan. The term of each option granted pursuant to the Amended 1997 Stock Option
Plan shall be established by the Board of Directors, or a committee of the Board
of Directors, in its sole discretion; provided, however, that the maximum term
of each Incentive Stock Option granted pursuant to the Amended 1997 Stock Option
Plan is ten years. Options shall become exercisable at such times and in such
installments as the Board of Directors, or a committee of the Board of
Directors, shall provide in the terms of each individual option. The exercise
price per share of these options shall be determined by the Board of Directors,
in their sole discretion, as set forth in the applicable option contract;
provided, however, that the exercise price of an Incentive Stock Option shall
not be less than the fair market value of the Common Stock subject to such
option on the date of grant; and further provided, that if, at the time an
Incentive Stock Option is granted, the optionee owns (or is deemed to own under
Section 424(d) of the Code) stock possessing more than 10% of the total combined
voting power of all classes of stock of the Company, of any of its subsidiaries
or of a parent entity, the exercise price of such Incentive Stock Option shall
not be less than 110% of the fair market value of the Common Stock subject to
such Incentive Stock Option on the date of grant.
The Amended 1997 Stock Option Plan is administered by the Board of
Directors or a committee of the Board of Directors, which determines the terms
of options granted, including the exercise price, the number of shares subject
to the option and the terms and conditions of exercise. No option granted under
the Amended 1997 Stock Option Plan is transferable by the optionee other than by
will or the laws of descent and distribution, and each option is exercisable
during the lifetime of the optionee only by such optionee.
OTHER OPTIONS
On December 4, 1996, Taxter entered into a First Amended Stock Option
Agreement with one of the sellers of the Holdings stock (the "Selling Entities")
and the assignee of the other Selling Entity (the "Amended Option Holders")
canceling an original Stock Option Agreement between the Company and the Selling
Entities. Each of the Amended Option Holders, their assignees or designees have
the option (the "Option") to purchase from Taxter 4,000,000 shares of Common
Stock of the Company and 400,000 shares of Series B Preferred Stock of the
Company, exercisable in full by the Amended Option Holders, their assignees or
designees, at any one time commencing October 8, 1999 and terminating on October
9, 2000, for an aggregate purchase price of $500,000. The Option immediately
terminates if, at any time prior to the Amended Option Holders exercising their
Options, Taxter tenders to each of the Amended Option Holders $50,000,000. In
the agreement, Taxter agreed to various transfer restrictions, and the Amended
Option Holders received certain registration rights.
COMPENSATION OF DIRECTORS
Directors J. Richard Budd, III, Barry E. Breeman and Geoffrey A.
Thompson each receive $50,000 as annual compensation for their services as
directors of the Company. In addition, Mr. Budd and Mr. Breeman were each
granted options to purchase 75,000 shares with an exercise price of $2.00 per
share. Mr. Thompson received
40
<PAGE> 41
options to purchase 75,000 shares an exercise price of $2.19 per share. Martin
Burke, who is Chairman of the Board of Directors and the Chief Executive Officer
of the Company, does not receive compensation for his services as a director,
but does receive compensation for his services as Chief Executive Officer. Jay
Botchman does not receive compensation for his services as a director. The Board
of Directors may authorize the payment of compensation to directors for their
attendance at regular and special meetings of the Board of Directors and for
attendance at meetings of committees of the Board of Directors as is customary
for similar companies. Directors are reimbursed for their reasonable
out-of-pocket expenses incurred in connection with their duties as directors or
officers of the Company.
EMPLOYMENT AGREEMENTS
On March 27, 1997 the Company entered into a five year employment
agreement with Martin Burke, the Company's Chief Executive Officer. Under the
terms of the employment agreement, Mr. Burke will receive an annual base salary
of $60,000 for each year of his employment subject to annual review by the Board
of Directors. In addition, Mr. Burke has the right to receive under the terms of
the employment agreement (i) 1.5% of the annual net earnings of the Company
before taxes as reflected on the Company's certified financial statements, and
(ii) options to purchase 1,000,000 shares of the Company's Common Stock at a
purchase price of $2.00 per share for a period of five years commencing March
27, 1997. The employment agreement also entitles Mr. Burke to all employee
benefit plans such as medical and dental coverage, life insurance, pension and
profit-sharing plans, that may be maintained by the Company. Under the terms of
the employment agreement, employment terminates upon death or total disability
of Mr. Burke and may be terminated by the Company for cause (such as misconduct,
disregard of instructions from the Board, commission of certain crimes or acts
or a material breach of the terms of the employment agreement.) The employment
agreement contains a change in control provision that provides Mr. Burke with
the right to terminate his employment within 60 days of the date of a change in
control and have such termination treated as a termination without cause meaning
that Mr. Burke shall have the right to continue to be compensated through the
term of the employment agreement. For purposes of the employment agreement, a
change of control is deemed to have occurred at such time as either (a) Taxter
owns directly or indirectly less than 10% of the Common Stock of the Company and
less than 50% of each other outstanding class of securities the majority vote of
which is required for shareholder action, or (b) Jay Botchman owns less than 50%
of the membership interest in Taxter. The employment agreement also contains
certain customary terms regarding proprietary information, confidentiality, and
the surrender of records upon termination. A copy of the employment agreement
has been filed as an exhibit hereto.
On April 1, 1997, the Company entered into a five year employment
agreement with Kevin Riordan, the Company's President and Chief Operating
Officer. Under the terms of the employment agreement, Mr. Riordan receives an
annual base salary of $300,000 for each year of his employment subject to annual
review by the Board of Directors of the Company. In addition to the base salary,
the Company agreed to pay Mr. Riordan a signing bonus of $2,000,000.
Additionally, he was granted options to purchase 300,000 shares of the Company's
Common Stock at an exercise price of $2.00 per share. Such options are
exercisable commencing April 1, 1999, and shall expire on the earlier of March
31, 2002, or the termination of Mr. Riordan's employment with the Company. The
employment agreement also entitles Mr. Riordan to all employee benefit plans
such as medical and dental coverage, life insurance, pension and profit-sharing
plans, that may be maintained by the Company. Under the employment agreement,
employment terminates upon death or total disability of Mr. Riordan and may be
terminated by the Company for cause (such as misconduct, disregard of
instructions from the Board of Directors, commission of certain crimes or acts
or a material breach of the terms of the employment agreement.) The employment
agreement also contains certain customary terms regarding proprietary
information, confidentiality, and the surrender of records upon termination.
A copy of the employment agreement has been filed as an exhibit hereto.
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<PAGE> 42
On June 17, 1997, the Company entered into an employment agreement with
Michael J. Philippe, the Company's Chief Financial Officer and an Executive Vice
President, which was amended effective June 1, 1999 to extend the term of the
agreement to June 20, 2002. Under the terms of the employment agreement, as
amended, Mr. Philippe receives an annual base salary of $210,000 subject to
annual review by the Board of Directors. In addition, Mr. Philippe received
under the terms of the employment agreement options to purchase 100,000 shares
of the Company's Common Stock at a purchase price of $2.00 per share. The
options to purchase the shares vest as follows: (i) 25,000 option shares on
December 15, 1997, which have vested, (ii) 25,000 option shares on June 17,
1999, which have vested, and (iii) 50,000 option shares on June 17, 2000. The
options are exercisable, according to their vesting schedules, for a period of
five years from the date they were granted. The employment agreement also
entitles Mr. Philippe to all employee benefit plans such as medical and dental
coverage, life insurance, pension and profit-sharing plans, that may be
maintained by the Company. Under the terms of the employment agreement,
employment terminates upon death or total disability of Mr. Philippe and may be
terminated by the Company for cause (such as misconduct, disregard of
instructions from the Board of Directors, commission of certain crimes or acts
or a material breach of the terms of the employment agreement.) The employment
agreement contains a change in control provision that provides Mr. Philippe with
the right to terminate his employment within 60 days of the date of a change in
control and have such termination treated as a termination without cause,
meaning that Mr. Philippe shall have the right to continue to be compensated
through the term of the employment agreement. For purposes of the employment
agreement, a change of control is deemed to have occurred at such time as either
(a) Taxter owns directly or indirectly less than 10% of the Common Stock of the
Company and less than 50% of each other outstanding class of securities the
majority vote of which is required for shareholder action, or (b) Jay Botchman
owns less than 50% of the membership interests in Taxter. The employment
agreement also contains certain customary terms regarding proprietary
information, confidentiality, and the surrender of records upon termination. A
copy of the employment agreement has been filed as an exhibit.
On August 1, 1997, the Company entered into an employment agreement
with Richard S. Angel, the Company's General Counsel and an Executive Vice
President, which was amended effective June 1, 1999 to extend the term of the
agreement to September 30, 2000. Under the terms of the employment agreement, as
amended, Mr. Angel receives an annual base salary of $240,000 per year subject
to annual review by the Board of Directors. In addition, Mr. Angel received
under the terms of the employment agreement options to purchase 100,000 shares
of the Company's Common Stock at a purchase price of $2.00 per share. The
options to purchase the option shares vest as follows: (i) 25,000 option shares
on December 15, 1997, which have (ii) 25,000 option shares on July 31, 1999,
which have vested, and (iii) 50,000 option shares on July 31, 2000. The options
are exercisable, according to their vesting schedules, for a period of five
years from the date they were granted. The employment agreement also entitles
Mr. Angel to all employee benefit plans such as medical and dental coverage,
life insurance, pension and profit-sharing plans, that may be maintained by the
Company. Under the terms of the employment agreement, employment terminates upon
death or total disability of Mr. Angel and may be terminated by the Company for
cause (such as misconduct, disregard of instructions from the Board of
Directors, commission of certain crimes or acts or a material breach of the
terms of the employment agreement.) The employment agreement contains a change
in control provision that provides Mr. Angel with the right to terminate his
employment within 60 days of the date of a change in control and have such
termination treated as a termination without cause, meaning that Mr. Angel shall
have the right to continue to be compensated through the term of the employment
agreement. For purposes of the employment agreement, a change of control is
deemed to have occurred at such time as either (a) Taxter owns directly or
indirectly less than 10% of the Common Stock of the Company and less than 50% of
each other outstanding class of securities the majority vote of which is
required for shareholder action, or (b) Jay Botchman owns less than 50% of the
membership interests in Taxter. The employment agreement also contains certain
customary terms regarding proprietary information, confidentiality, and the
surrender of records upon termination. A copy of the employment agreement has
been filed as an exhibit hereto.
On October 15, 1997, the Company entered into a three-year agreement
with Cynthia Hassoun, the Corporate Secretary and a Senior Vice President. Under
the terms of the agreement, Ms. Hassoun receives an annual base salary of
$150,000. In addition, Ms. Hassoun received a $50,000 signing bonus,
compensation for all
42
<PAGE> 43
relocation expenses and 75,000 stock options. Under the terms of the agreement,
25,000 of Ms. Hassoun's stock options vest on October 15 of the years 1998, 1999
and 2000. The exercise price of all of the options is $2.00 per share. The
letter agreement also entitles Ms. Hassoun to all employee benefit plans, such
as medical and dental coverage, life insurance, and pension and profit-sharing
plans, that may be maintained by the Company.
ITEM 7 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
During fiscal year 1998, the Company issued subordinated promissory
notes to JLB, a corporation wholly-owned by Jay L. Botchman, a director of the
Company, totaling $40,000,000 which are payable on demand and bear interest at
the rate of 12% per annum. $30,000,000 of the new notes were issued in exchange
for outstanding notes totaling $11,518,042 which carried an interest rate of 12%
per annum and $18,481,958 in new debt. Interest expense on these notes was
$2,307,467 and $3,635,891 for the years ended May 31, 1999 and 1998,
respectively. On May 29, 1999, JLB forgave $5,000,000 of accrued interest on
these subordinated notes in return for warrants to purchase 4,000,000 shares of
the Company's Common Stock and for the Company's assumption of the payment
obligations under personal property lease agreements of certain entities
affiliated with JLB. JLB had previously guaranteed the payment of these
obligations on behalf of the entities. On the date of the assumption of the
obligations, the fair value of the obligations was $1.7 million and the warrants
had a fair market value of $3.3 million. The warrant is exercisable one year
after the grant date at an exercise price of $3.25 per share and expires May 29,
2004. Accrued interest related to subordinated notes payable to JLB that was not
forgiven was approximately $1.3 million and $4.0 million, respectively, at May
31, 1999 and 1998.
On February 27, 1998, the Company issued a subordinated promissory note
payable to Mr. Botchman in the amount of $350,000 payable on demand with
interest of 12% per annum. Interest expense for the year ended May 31, 1999 and
May 31, 1998 was $42,583 and $10,733. This note was issued per an agreement
dated February 27, 1998 between Mr. Botchman and the Company. As part of the
terms of the agreement, the Company agreed to purchase an interest in certain
investment securities, owned by Mr. Botchman, of a subprime mortgage banking
company. The mortgage company had subsequent financial difficulties and ceased
operations. The Company wrote off this investment and a receivable due from this
company of approximately $189,000 during the fiscal year ended May 31, 1998.
As of May 31, 1999, the Company, through its wholly-owned subsidiary,
American Credit Alliance, Inc., has an $880,000 note payable to JLB with an
interest rate of 10% per annum. Interest expense for the year ended May 31, 1999
and May 31, 1998 was $89,222, and $85,195, respectively. American Credit
Alliance, Inc. is the managing member and owns 50% of the membership interests
in Dakota Card Fund II, LLC, an entity that owns performing credit card
receivables.
The Company made a series of investments, during the period May 1997
through December 1997, amounting to $508,600, in a subprime mortgage banking
company affiliated with JLB. Due in large part to the severe downturn in the
subprime mortgage banking industry, the Company wrote off its investment in this
company in the amount of $508,600 at May 31, 1998 in addition to a receivable of
$183,000 from the same company, as there was substantial doubt regarding this
company's ability to continue as a going concern.
The Series A Preferred Stock and Series B Preferred Stock were each
issued at $1.00 per share (for a total of $2,000.00) for all of Taxter's shares
of Holdings. See "Item 1 - Business; General Development of Business." The
Series A Preferred Stock, as a class, has 80% of the voting rights in the
Company. The Series B Preferred Stock has one vote per share. The Series A
Preferred Stock and the Series B Preferred Stock each has a liquidation
preference of $1.00 per share and each earns cumulative dividends at a rate of
5% per annum. After five years, (i) the Series A Preferred Stock and the Series
B Preferred Stock will be redeemable at the option of the Company, and (ii) the
Series B Preferred Stock will be convertible at the option of the holder into
Series A Preferred Stock on a share-for-share basis.
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<PAGE> 44
On December 31, 1996, the Company issued 5,000 shares of Series C
Preferred Stock to Mr. Botchman for $5,000,000 consideration. The Series C
Preferred Stock earns cumulative dividends at 6% per annum. The shares also have
liquidation preference of $1,000 per share. The Series A and B Preferred Stock
rank senior to the Series C Preferred Stock with respect to dividend and
liquidation rights.
On May 29, 1998, the Company issued 10,000 shares of Series D Preferred
Stock to JLB in exchange for the cancellation of the outstanding principal
amount of the $10,000,000 promissory note dated August 1, 1997 payable by the
Company to JLB. The Series D Preferred Stock is non-voting and earns a dividend
of 8% per annum payable annually on December 31. The shares have a par value of
$0.001 per share and a stated value of $1,000 per share. The shares have a
liquidation preference of $1,000 per share. The Series D Preferred Stock ranks
senior to the Series A, B and C with respect to dividend and liquidation rights.
Each share of Series D Preferred Stock is convertible into 380 shares of Common
Stock. The agreement between the Company and JLB with respect to the issuance of
the Series D Preferred Stock grants JLB piggyback registration rights for any
Common Stock issuable upon conversion of the shares of Series D Preferred Stock.
On August 31, 1998, the Company issued 10,000 shares of Series E
Preferred Stock at a price of $1,000 per share to JLB in exchange for JLB
agreeing to cancel the $10,000,000 principal outstanding under a subordinated
promissory note dated August 1, 1997. The holder of Series E Preferred Stock is
entitled to dividends at a rate of 8% of stated value per annum payable in cash
commencing on December 31, 1998. Each share of Series E Preferred Stock is
convertible into 285 shares of Common Stock. The agreement between the Company
and JLB with respect to the issuance of the Series E Preferred Stock grants JLB
piggyback registration rights for any Common Stock issuable upon conversion of
the shares of Series E Preferred Stock.
As of May 31, 1999 and May 31, 1998, accumulated but undeclared and
unpaid preferred dividends on preferred stock amounted to approximately $2.2 and
$0.4 million respectively. Such dividends have not been declared or paid by the
Board of Directors and, accordingly, remain outstanding obligations of the
Company. Such dividends have not been paid because the Company believes it to be
in the best interests of the Company to retain its earnings to reinvest in the
Company's operations. In addition, the Company is a party to certain loan
agreements that contain customary restrictions on the ability of the Company to
pay dividends. The Company does not anticipate that it will be required by the
holders of the preferred stock to pay such dividends in the short term. Once
the Company does pay such accumulated dividends, the Company's cash for
operating activities will be accordingly reduced.
Taxter, an entity in which Mr. Botchman is a managing member, as part of
the purchase price of acquiring Holdings, granted the former owners of Holdings
a future interest in Holdings in the form of an identical option to each former
owner of Holdings to purchase 2,000 shares of Holdings from Taxter for $500,000.
Following the acquisition of Holdings by the Company, these options were amended
to enable each of the former owners of Holdings to purchase 4,000,000 shares of
the Company's Common Stock and 400,000 shares of the Company's Series B
Preferred Stock for $500,000.
ITEM 8 - LEGAL PROCEEDINGS
The Company, in the ordinary course of business, receives notices of
consumer complaints from regulatory agencies and reviews these complaints in
accordance with internal policy.
On October 24, 1996, the Company, SOIC and certain former officers and
directors of SOIC were sued in the United States District Court for the Northern
District of Illinois in an action entitled Louis G. Apostol, as Administrator
for the Estate of Curtis Kim v. M. Reza Fayazi, et al. This action was brought
as a class action on behalf of persons purportedly solicited to voluntarily
repay debt that had been discharged in bankruptcy to open credit card accounts.
The complaint alleged that these practices violated the bankruptcy code, various
consumer protection statutes, including the Fair Debt Collection Practices Act,
the Truth in Lending Act, the Colorado
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Uniform Consumer Credit Code, the Illinois Consumer Fraud Act and RICO.
Plaintiffs also asserted common law theories of recovery. The district court
dismissed all bankruptcy-related claims on the grounds that they should be
asserted in the bankruptcy court. On November 9, 1998, a complaint was filed in
the United States Bankruptcy Court for the Northern District of Illinois. The
complaints seek (i) monetary damages, (ii) declaratory judgments that the
agreements reached with plaintiffs have no legal effect, (iii) criminal
contempt, (iv) injunctive relief to prohibit defendants from purchasing or
selling debts that have been discharged in bankruptcy and to rescind any such
agreements, and to require cessation of collection efforts and the removal of
debts from credit reports.
On May 14, 1998, the Company and an unaffiliated third party bank were
sued in the United States District Court for the District of Rhode Island in an
action entitled McGlynn v. The Credit Store, Inc., et al. The action is brought
as a class action on behalf of persons who allegedly were solicited to
voluntarily repay debt that had been discharged in bankruptcy. The complaint
alleges that inducing repayment of discharged debt violates the Bankruptcy Code,
and the Fair Debt Collection Practices Act. The complaint also contains a common
law theory of recovery. The complaints seek (i) monetary damages, (ii) a
declaratory judgment that the agreements reached with plaintiffs have no legal
effect, (iii) criminal contempt, and (iv) injunctive relief to preclude
defendants from purchasing or selling debts that have been discharged in
bankruptcy.
On June 1, 1998, the Company was sued in the United States District
Court for the Northern District of Illinois in an action entitled Le v. The
Credit Store, Inc., et al. The action is brought as a class action on behalf of
certain persons who were allegedly part of a portfolio of consumer debt
purchased by the Company. The complaint alleges that these people were sent
letters by the Company attempting to collect debts previously discharged in
bankruptcy and that these actions violate the Fair Debt Collection Practices
Act. The complaint seeks monetary damages.
On May 27, 1999, the Company was sued in the United States District
Court for the District of Florida in an action entitled McIntyre v. Credit Store
Inc. The action is brought as a class action on behalf of certain persons to
whom the Company sent written communications and alleges that such
communications violate the Fair Debt Collection Practices Act and statutory
provisions of Florida and South Dakota law. On May 21, 1999, the Company was
sued in the United States District Court for the District of Arizona in an
action entitled Bingham v. The Credit Store, Inc. The action is brought as a
class action on behalf of certain persons to whom the Company sent written
communications and alleges that such communications violate the Fair Debt
Collection Practices Act. Both complaints seek monetary damages and declaratory
judgments that the Company's mailers violate statutory provisions.
On February 3, 2000, the Company was sued in the United States
District Court for the District of New York in an action entitled Strum v. Bank
of New York. The action is brought as a class action on behalf of certain
persons to whom the Company sent written communications and alleges that such
communications violate the Fair Debt Collection Practices Act. The Complaint
seeks monetary damages for alleged violations of the Fair Debt Collection
Practices Act and for Restitution and Unjust Enrichment.
On February 22, 2000, the Company and an unaffiliated third party bank
were sued in the United States District Court for the Northern District of
Illinois in an action entitled Greene v. Martin J. Burke, III, et al. The action
is brought as a class action on behalf of certain persons, residing in the
state of Illinois, to whom the Company sent written communications and alleges
that such communications violate the Fair Debt Collection Practices Act, the
Credit Repair Organizations act and statutory provisions of Illinois law. The
complaint seeks monetary damages.
The Company does not believe that these suits will have a material
adverse effect on the consolidated financial position of the Company, nor on the
results of operations.
ITEM 9 - MARKET PRICE OF AND DIVIDENDS ON THE COMPANY'S COMMON STOCK AND RELATED
STOCKHOLDER MATTERS
The Company's Common Stock is presently traded on the National
Quotation Bureaus' "Pink Sheets" under the symbol "PLCR". However, the Company's
Common Stock has historically traded on the Over the Counter Bulletin Board
under trading symbol "PLCR" and the Company anticipates that its Common Stock
will resume trading on the OTC Bulletin Board in the near future. The
quotations are inter-dealer prices without retail mark-ups, mark-downs or
commissions and may not represent actual transactions.
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<PAGE> 46
The high and low bid prices for the Company's Common Stock for each
quarter for the past three years were as follows:
<TABLE>
<CAPTION>
Period High Low
------ ---- ---
<S> <C> <C>
1997 First Quarter $ N/A $ N/A
Second Quarter 13 3/4 4 1/2
Third Quarter 12 5 3/4
Fourth Quarter 9 1/4 5 1/4
1998 First Quarter $ 9 3/8 $ 5 3/4
Second Quarter 7 5/8 2 7/8
Third Quarter 3 3/4 1 1/2
Fourth Quarter 2 15/16 1 9/32
1999 First Quarter $ 3 7/8 $ 1 7/8
Second Quarter 2 3/4 1 3/4
Third Quarter 2 15/16 1 7/8
Fourth Quarter 2 5/8 1 15/16
2000 First Quarter $ 3 17/32 $ 2 13/32
Second Quarter $ 5 7/15 $ 2 9/16
Third Quarter (as of 2/18/00) $ 5 1/4 $ 3 15/16
</TABLE>
As of December 15, 1999, there were 949 holders of record of the
Company's Common Stock.
The Company has not paid any cash dividends on its Common Stock and
does not anticipate paying cash dividends in the foreseeable future. The Company
anticipates that it will follow a policy of retaining earnings, if any, to
finance the expansion and development of the Company. The Board of Directors of
the Company will review its dividend policy from time to time to determine the
feasibility and desirability of paying dividends, after giving consideration to
the Company's results of operations, financial condition, capital requirements
and such other factors as the Board of Directors deems relevant.
Each issued and outstanding share of Series A Preferred Stock and
Series B Preferred Stock will be entitled, as and when declared by the Board of
Directors, to receive, out of any assets at the time legally available therefor,
dividends at the rate of $.05 per share, per annum. Such dividends on the Series
A and Series B Preferred Stock are prior in preference to any outstanding shares
of Common Stock or of Preferred Stock, other than Series D and Series E
Preferred Stock.
Subject to the right of the holders of the Series B Preferred Stock to
receive a preferential dividend, the holders of shares of Series C Preferred
Stock will be entitled, as and when declared by the Board of Directors, to
receive, out of any assets at the time legally available therefor, dividends at
the rate of 6% per share per annum, payable in cash commencing on December 31,
1997. Such dividends on the Series C Preferred Stock are prior in preference to
any declaration or payment of any distribution on any outstanding shares of
Common Stock or any Preferred Stock which by its terms is junior to Series C
Preferred Stock, but are junior in preference to Series A, Series B, Series D
and Series E Preferred Stock.
The holder of shares of Series D Preferred Stock will be entitled, as
and when declared by the Board of Directors, to receive, out of any assets at
the time legally available therefor, dividends at the rate of 8% per share
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<PAGE> 47
per annum, payable in cash commencing on December 31, 1998 and thereafter on the
last day of December of each year that any such shares are outstanding. Such
dividends on the Series D Preferred Stock are prior in preference to any
declaration or payment of any distribution on any other outstanding shares of
Common Stock or of Preferred Stock, other than Series E Preferred Stock.
The holders of shares of Series E Preferred Stock shall be entitled to
receive, out of any assets at the time legally available therefor and when and
as declared by the Board of Directors of the Company, dividends calculated on
the stated value per share at the rate of 8% per share per annum, payable in
cash commencing on December 31, 1998, and thereafter on the last day of December
of each year that any such shares shall be outstanding. Such dividends on the
Series E Preferred Stock are prior in preference to any declaration or payment
of any distribution on any other outstanding shares of Common Stock or Preferred
Stock.
Other than the foregoing, the Company does not anticipate the
declaration or payment of any dividends in the foreseeable future. There can be
no assurance that cash dividends of any kind will ever be paid.
ITEM 10 - RECENT SALES OF UNREGISTERED SECURITIES
The Company issued the following securities during the prior three
fiscal years without registering the securities under the Securities Act:
Issuance of Capital Stock:
1. On September 12, 1996, the Company issued 20,000,000 shares of Common
Stock to Jay Botchman for aggregate consideration of $20,000. Mr.
Botchman subsequently transferred these shares to Taxter.
2. On December 4, 1996, Taxter exchanged all of its shares of Common Stock
in Service One Holdings for the issuance by the Company of 1,200,000
shares of Series A Preferred Stock and 800,000 shares of Series B
Preferred Stock of the Company to Taxter.
3. On December 31, 1996, the Company issued 5,000 shares of Series C
Preferred Stock to Jay Botchman in exchange for aggregate consideration
of $5,000,000.
4. On February 19, 1997, the Company sold 830,000 shares of Common Stock
to Lancer Partners, L.P., Lancer Offshore Inc., Lancer Voyager Fund,
and Michael Lauer (collectively, the "Lancer Group") for aggregate
consideration of $6,017,500.
5. On March 12, 1997 the Company privately sold 827,500 shares of Common
Stock to the Lancer Group for aggregate consideration of $5,999,375.
6. On January 2, 1998, the Company privately sold 1,250,000 shares of
Common Stock to the Lancer Group for aggregate consideration of
$2,500,000.
7. On February 2, 1998, the Company privately sold 1,250,000 shares of
Common Stock to the Lancer Group for aggregate consideration of
$2,500,000.
8. On May 29, 1998, the Company issued 10,000 shares of Series D Preferred
Stock to JLB in exchange for JLB agreeing to cancel $10,000,000 of the
principal outstanding under the $10,000,000 Subordinated Promissory
Note dated August 1, 1997.
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<PAGE> 48
9. On August 31, 1998, the Company issued 10,000 shares of Series E
Preferred Stock to JLB in exchange for JLB agreeing to cancel
$10,000,000 of the principal outstanding under the $20,000,000
Subordinated Promissory Note dated August 1, 1997.
Grant of Stock Options and Warrants:
1. On March 27, 1997, the Company granted options to purchase 950,000
shares of Common Stock at an exercise price of $5.50 per share to
employees.
2. On December 15, 1997, the Company granted options to purchase 935,500
shares of Common Stock under the Amended 1997 Stock Option Plan at an
exercise price of $2.00 per share to employees, granted options to
purchase 1,000,000 shares of Common Stock under the Amended 1997 Stock
Option Plan at an exercise price of $2.00 per share to a director of
the Company and granted options to purchase 600,000 shares of Common
Stock at an exercise price of $2.00 per share to employees.
3. On January 16, 1998, the Company granted options to purchase 170,500
shares of Common Stock under the Amended 1997 Stock Option Plan at an
exercise price of $2.50 per share to employees.
4. On April 30, 1998, the Company issued to Coast Business Credit, a
division of Southern Pacific Bank, a warrant to purchase 650,247 shares
of the Common Stock at an exercise price of $2.50. The warrant was
issued in connection with a loan from Coast Business Credit to the
Company.
5. On August 3, 1998, the Company granted options to purchase 10,000
shares of Common Stock under the Amended 1997 Stock Option Plan at an
exercise price of $3.00 per share to employees.
6. On August 10, 1998, the Company granted options to purchase 300,000
shares of Common Stock under the Amended 1997 Stock Option Plan at an
exercise price of $2.70 per share to employees.
7. On September 15, 1998, the Company granted options to purchase 10,000
shares of Common Stock under the Amended 1997 Stock Option Plan at an
exercise price of $2.00 per share to employees.
8. On November 23, 1998, the Company granted options to purchase a total
of 150,000 shares of Common Stock under the Amended 1997 Stock Option
Plan at an exercise price of $2.00 per share to two directors of the
Company.
9. On February 15, 1999, the Company granted options to purchase 13,000
shares of Common Stock under the Amended 1997 Stock Option Plan at an
exercise price of $2.38 per share to employees.
10. On March 17, 1999, the Company granted options to purchase 200,500
shares of Common Stock under the Amended 1997 Stock Option Plan at an
exercise price of $2.00 per share to employees.
11. On March 18, 1999, the Company issued a warrant to purchase 1,000,000
shares of Common Stock to Business Transactions Express, Inc. at an
exercise price of $2.00 per share. The warrant was issued in connection
with the execution of a strategic modeling services agreement between
the Company and Business Transactions Express, Inc.
12. On March 22, 1999, the Company granted options to purchase 3,500 shares
of Common Stock under the Amended 1997 Stock Option Plan at an exercise
price of $2.30 per share to employees.
13. On March 29, 1999, the Company granted options to purchase 3,500 shares
of Common Stock under the Amended 1997 Stock Option Plan at an exercise
price of $2.30 per share to employees.
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<PAGE> 49
14. On April 15, 1999, the Company granted options to purchase 75,000
shares of Common Stock under the Amended 1997 Stock Option Plan at an
exercise price of $2.19 per share to a director of the Company.
15. On June 1, 1999, the Company granted options to purchase 503,000 shares
of Common Stock under the Amended 1997 Stock Option Plan at an exercise
price of $2.40 per share to employees.
16. On June 22, 1999, the Company issued a warrant to purchase 4,000,000
shares of Common Stock to JLB at an exercise price of $3.25 per share
issued as partial consideration for JLB's forgiveness of certain
interest owed to JLB by the Company.
17. On July 26, 1999, the Company granted options to purchase 10,000 shares
of Common Stock under the Amended 1997 Stock Option Plan at an exercise
price of $2.88 per share to employees.
18. On August 1, 1999, the Company granted options to purchase 22,000
shares of Common Stock under the Amended 1997 Stock Option Plan at an
exercise price of $3.00 per share to employees.
19. On August 3, 1999, the Company granted options to purchase 10,000
shares of Common Stock under the Amended 1997 Stock Option Plan at an
exercise price of $2.97 per share to employees.
20. On August 27, 1999, the Company granted options to purchase 10,000
shares of Common Stock under the Amended 1997 Stock Option Plan at an
exercise price of $2.69 per share to employees.
21. On September 1, 1999, the Company granted options to purchase 1,500
shares of Common Stock under the Amended 1997 Stock Option Plan at an
exercise price of $2.75 per share to employees.
22. On September 10, 1999, the Company issued a warrant for 25,000 shares
of Common Stock to Cappello Capital Corp. at an exercise price of $2.56
per share. The warrant was issued in connection with Cappello Capital
Corp. providing financial advisory services to the Company.
23. On September 16, 1999, the Company granted options to purchase 8,000
shares of Common Stock under the Amended 1997 Stock Option Plan at an
exercise price of $2.75 per share to employees.
24. On October 18, 1999, the Company granted options to purchase 2,000
shares of Common Stock under the Amended 1997 Stock Option Plan at an
exercise price of $2.75 per share to employees.
25. On October 25, 1999, the Company granted options to purchase 5,000
shares of Common Stock under the Amended 1997 Stock Option Plan at an
exercise price of $3.13 per share to employees.
26. On November 8, 1999, the Company granted options to purchase 10,000
shares of Common Stock under the Amended 1997 Stock Option Plan at an
exercise price of $3.88 per share to employees.
27. On November 19, 1999, the Company granted options to purchase 310,000
shares of Common Stock under the Amended 1997 Stock Option Plan at an
exercise price of $3.44 per share to employees.
28. On November 29, 1999, the Company granted options to purchase 15,000
shares of Common Stock under the Amended 1997 Stock Option Plan at an
exercise price of $5.00 per share to employees.
The sales and issuance described in paragraphs 1-9 under "Issuance of
Capital Stock" and in paragraphs 4, 16 and 22 under "Granted Stock
Options and Warrants"
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<PAGE> 50
above were deemed to be exempt from registration under the Securities Act by
virtue of Rule 4(2), Regulation D promulgated thereunder or Rule 701 of the
Securities Act. The sales and issuances under Rule 4(2) and Regulation D were
conducted in a manner to avoid a public offering, were made to a limited number
of financially sophisticated persons or entities with a high net worth and were
not made pursuant to any general advertising or general solicitation. The sales
and issuances under Rule 701 were offered and sold either pursuant to a written
compensatory benefit plan or pursuant to a written contract relating to
compensation.
Appropriate legends are affixed to the stock certificates issued in the
aforementioned transactions. Similar legends were imposed in connection with any
subsequent sales of any of these securities. All recipients either received
adequate information about the Company or had access, through employment or
other relationships, to such information.
ITEM 11 - DESCRIPTION OF SECURITIES TO BE REGISTERED
COMMON STOCK
- - - ------------
The Company is authorized to issue up to 65,000,000 shares of Common
Stock, par value $.001 per share. As of the date of this registration statement
there are 34,761,965 issued and outstanding shares of Common Stock.
Voting, Shareholders' Meetings and Resolutions. Holders of Common Stock
have one vote for each share held on all matters submitted to a vote of
stockholders, but such votes are subject to the voting preference of the holders
of the Series A Preferred Stock. Holders of the Series A Preferred Stock,
regardless of the number of such shares outstanding and as long as at least one
of such shares is outstanding, shall represent 80% of all votes entitled to be
voted at any annual or special meeting of the shareholders of the Company,
subject to dilution by capital stock of the Company issued after the date of
issuance of the Series A Preferred Stock. Holders of Series B Preferred Stock
have one vote on all matters as to which holders of common stock shall be
entitled to vote.
Dividend and Liquidation Rights. Subject to the prior rights of any
series of preferred stock, as described below, which may from time to time be
outstanding, holders of Common Stock are entitled to receive dividends when, as
and if declared by the Board of Directors out of funds legally available
therefor and, upon the liquidation, dissolution or winding up of the Company,
are entitled to share ratably in all assets remaining after payment of
liabilities and payment of accrued dividends and liquidation preferences on the
preferred stock. Holders of Common Stock have no preemptive rights and have no
rights to convert their Common Stock into any other securities.
PREFERRED STOCK
- - - ---------------
The following series of preferred stock are currently issued by the
Company.
SERIES A PREFERRED STOCK
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<PAGE> 51
There are 2,000,000 shares of Series A Preferred Stock, $.001 par value
(the "Series A Preferred Stock") authorized, of which 1,200,000 shares are
issued and outstanding.
DIVIDENDS. Each issued and outstanding share of Series A Preferred
Stock shall be entitled to receive, pari passu with the Series B Preferred
Stock, out of any assets at the time legally available therefor and when and as
declared by the Board of Directors of the Company, dividends at the rate of $.05
per share, per annum. Such dividends accrue on each share of Series A Preferred
Stock from the initial date of issuance thereof whether or not earned or
declared.
VOTING RIGHTS. The outstanding shares of Series A Preferred Stock,
regardless of the number of such shares outstanding and as long as at least one
of such shares is outstanding, shall represent 80% of all votes entitled to be
voted at any annual or special meeting of the shareholders of the Company
subject to dilution by subsequently issued capital stock of the Company.
Accordingly, the holders of the Company's Series A Preferred Stock effectively
control all matters that may be put to a stockholder vote, including the
election of directors and fundamental corporate changes and, therefore,
effectively control the Company. Currently, the shares of the Series A Preferred
Stock represent approximately 77.88% of all votes entitled to be voted at any
annual or special meeting of the shareholders of the Company. Each share of
Series A Preferred Stock shall represent its proportionate share of the 80%
which is allocated to the outstanding shares of Series A Preferred Stock.
REDEMPTION. At any time after December 31, 2001, the Company may redeem
all or part of the outstanding shares of Series A and Series B Preferred Stock,
treated as one class, at a cash price equal one dollar ($1.00) per share,
together will all unpaid dividends to and including the date of redemption,
provided that the Company provides written notice to the holders of such stock
to be redeemed at least 20 days prior to the date specified for redemption.
LIQUIDATION. In the event of any voluntary or involuntary liquidation,
dissolution or winding up of the Company, the holders of shares of Series A and
Series B Preferred Stock then outstanding, treated as one class, shall be
entitled to be paid, out of the assets of the Company available for distribution
to its stockholders, whether from capital, surplus or earnings, before any
payment shall be made in respect of the Company's Common Stock or Series C
Preferred Stock, an amount equal to $1.00 per share, plus all unpaid dividends
thereon to the date fixed for distribution.
RANK. The Series A Preferred Stock shall, with respect to dividend
rights and rights on liquidation, winding up and dissolution, (i) rank pari
passu with the Series B Preferred Stock, (ii) rank senior to any of the
Company's Common Stock, the Company's Series C Preferred Stock and any other
class or series of stock of the Company which by its terms shall rank junior to
the Series A Preferred Stock, and (iii) rank junior to the Series D and Series E
Preferred Stock and any other class or series of stock of the Company which by
its terms shall rank senior to the Series A Preferred Stock.
SERIES B PREFERRED STOCK
There are 800,000 shares of Series B Preferred Stock, $.001 par value
(the "Series B Preferred Stock"), of which 800,000 shares are issued and
outstanding.
DIVIDENDS. Each issued and outstanding share of Series B Preferred
Stock shall be entitled to receive, pari passu with the Series A Preferred
Stock, out of any assets at the time legally available therefor and when and as
declared by the Board of Directors of the Company, dividends at the rate of $.05
per share per annum. Such
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<PAGE> 52
dividends accrue on each share of Series B Preferred Stock from the initial date
of issuance thereof whether or not earned or declared.
VOTING RIGHTS. Each outstanding share of Series B Preferred Stock shall
entitle the holder thereof to one vote on all matters as to which holders of
common stock shall be entitled to vote.
REDEMPTION. At any time after December 31, 2001, the Company may redeem
all or part of the outstanding shares of Series A and Series B Preferred Stock,
treated as one class, at a cash price equal one dollar ($1.00) per share,
together will all unpaid dividends to and including the date of redemption,
provided that the Company provides written notice to the holders of such stock
to be redeemed at least 20 days prior to the date specified for redemption.
LIQUIDATION. In the event of any voluntary or involuntary liquidation,
dissolution or winding up of the Company, the holders of shares of Series A and
Series B Preferred Stock then outstanding, treated as one class, shall be
entitled to be paid, out of the assets of the Company available for distribution
to its stockholders, whether from capital, surplus or earnings, before any
payment shall be made in respect of the Company's Common Stock or Series C
Preferred Stock, an amount equal to $1.00 per share, plus all unpaid dividends
thereon to the date fixed for distribution.
CONVERSION. At any time after December 31, 2001, the holders of
outstanding shares of Series B Preferred Stock, at their option, may convert
said shares, in whole or in part, on a share for share basis, to shares of
Series A Preferred Stock.
RANK. The Series B Preferred Stock shall, with respect to dividend
rights and rights on liquidation, winding up and dissolution, (i) rank pari
passu with the Series A Preferred Stock, (ii) rank senior to any of the
Company's Common Stock, the Company's Series C Preferred Stock and any other
class or series of stock of the Company which by its terms shall rank junior to
the Series A Preferred Stock, and (ii) rank junior to the Series D and Series E
Preferred Stock and any other class or series of stock of the Company which by
its terms shall rank senior to the Series B Preferred Stock.
SERIES C PREFERRED STOCK
There are 5,000 shares of Series C Preferred Stock, $.001 par value
(the "Series C Preferred Stock") of which 5,000 shares are issued and
outstanding.
DIVIDENDS. The holders of shares of Series C Preferred Stock shall be
entitled to receive, out of any assets at the time legally available therefor
and when and as declared by the Board of Directors of the Company, dividends at
the rate of 6% per share per annum, payable in cash commencing on December 31,
1997. Such dividends accrue on each share of Series C Preferred Stock from the
initial date of issuance thereof whether or not earned or declared.
VOTING RIGHTS. The holders of the Series C Preferred Stock shall not
have the right to vote on matters presented to the stockholders of the Company,
except as provided by the General Corporation Law of the State of Delaware.
REDEMPTION. At any time after December 31, 1998, the Company may redeem
all or part of the outstanding shares of the Series C Preferred Stock, at a cash
price equal to $1,000 per share, together with all unpaid dividends to and
including the date of redemption, provided that the Company provides written
notice to the holders of such stock to be redeemed at least 20 days prior to the
date specified for redemption.
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<PAGE> 53
LIQUIDATION. In the event of any voluntary or involuntary liquidation,
dissolution, or winding up of the Company, the holders of shares of Series C
Preferred Stock then outstanding, shall be entitled to be paid, out of the
assets of the Company available for distribution, whether from capital, surplus
or earnings, before any payment shall be made in respect of the Company's Common
Stock, an amount equal to $1,000 per share, plus all unpaid dividends thereon to
the date fixed for distribution.
RANK. The Series C Preferred Stock, with respect to dividend rights and
rights on liquidation, winding up and dissolution, (i) ranks senior to any class
of the Company's Common Stock, and any other series of capital stock of the
Company which by its terms ranks junior to the Series C Preferred Stock, and
(ii) ranks junior to the Series A, Series B, Series D and Series E Preferred
Stock, and any other class or series of stock of the Company which by its terms
ranks senior to the Series C Preferred Stock.
SERIES D PREFERRED STOCK
There are 10,000 shares of Series D Preferred Stock, $.001 par value
(the "Series D Preferred Stock") of which 10,000 shares are issued and
outstanding.
DIVIDENDS. The holders of shares of Series D Preferred Stock shall be
entitled to receive, out of any assets at the time legally available therefor
and when and as declared by the Board of Directors of the Company, dividends
calculated on the stated value per share at the rate of 8% per share per annum,
and no more, payable in cash commencing on December 31, 1998, and thereafter on
the last day of December of each year that any such shares shall be outstanding.
Such dividends accrue on each share of Series D Preferred Stock from the initial
date of issuance thereof whether or not earned or declared.
VOTING RIGHTS. Except as otherwise required by law, the holders of
Series D Preferred Stock shall not be entitled to vote upon any matter relating
to the business or affairs of the Company or for any other purpose.
REDEMPTION. The Company may, at the option of the Board of Directors,
redeem all or part of the outstanding shares of the Series D Preferred Stock at
a cash price equal to $1,000 per share, together with all unpaid dividends to
and including the redemption date (the "Series D Redemption Price"); provided,
however, that payment of the Series D Redemption Price shall be made from any
funds of the Company legally available therefor; provided that the Company shall
give written notice by mail, postage prepaid, to the holders of such stock to be
redeemed at least 20 days prior to the date specified for redemption (the
"Series D Redemption Date"); and provided further that such holders may, at any
time prior to the Series D Redemption Date, convert their shares of Series D
Preferred Stock. The holder of any shares of Series D Preferred Stock shall have
the right, at such holder's option, at any time (and from time to time) prior to
May 31, 2001, to convert any of such shares into that number of fully paid and
nonassessable shares of common stock (calculated as to each conversion to the
nearest 1/100th of a share) equal to the Conversion Rate (as defined below)
multiplied by the number of shares of Series D Preferred Stock to be converted.
The "Conversion Rate" per share of Series D Preferred Stock is 380 shares of
Common Stock.
LIQUIDATION. In the event of any voluntary or involuntary liquidation,
dissolution, or winding up of the Company, the holders of shares of the Series D
Preferred Stock then outstanding shall be entitled to be paid, out of the assets
of the Company available for distribution to its stockholders, whether from
capital, surplus or earnings, before any payment shall be made in respect of the
Company's Common Stock, an amount equal to $1,000 per share, plus all unpaid
dividends thereon to the date fixed for distribution.
RANK. The Series D Preferred Stock shall, with respect to dividend
rights and rights on liquidation, winding up and dissolution, (i) rank senior to
any of the Company's Common Stock, the Company's Series A, Series B and Series C
Preferred Stock and any other class or series of stock of the Company which by
its terms
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<PAGE> 54
shall rank junior to the Series D Preferred Stock, and (ii) rank junior to the
Series E Preferred Stock and any other class or series of stock of the Company
which by its terms shall rank senior to the Series D Preferred Stock.
SERIES E PREFERRED STOCK
There are 20,000 shares of Series E Preferred Stock, $.001 par value
(the "Series E Preferred Stock") of which 10,000 shares are issued and
outstanding.
DIVIDENDS. The holders of shares of Series E Preferred Stock shall be
entitled to receive, out of any assets at the time legally available therefor
and when and as declared by the Board of Directors of the Company, dividends
calculated on the stated value per share at the rate of 8% per share per annum,
and no more, payable in cash commencing on December 31, 1998, and thereafter on
the last day of December of each year that any such shares shall be outstanding.
Such dividends accrue on each share of Series E Preferred Stock from the initial
date of issuance thereof whether or not earned or declared.
VOTING RIGHTS. Except as otherwise required by law, the holders of
Series E Preferred Stock are not entitled to vote upon any matter relating to
the business or affairs of the Company or for any other purpose.
REDEMPTION. The Company may, at the option of the Board of Directors,
redeem all or part of the outstanding shares of the Series E Preferred Stock at
a cash price equal to $1,000 per share, together with all unpaid dividends to
and including the redemption date (the "Series E Redemption Price"); provided,
however, that payment of the Redemption Price shall be made from any funds of
the Company legally available therefor; provided that the Company shall give
written notice by mail, postage prepaid, to the holders of such stock to be
redeemed at least 20 days prior to the date specified for redemption (the
"Series E Redemption Date"); and provided further that such holders may, at any
time prior to the Series E Redemption Date, convert their shares of Series E
Preferred Stock. The holder of any shares of Series E Preferred Stock shall have
the right, at such holder's option, at any time (and from time to time) prior to
August 31, 2001, to convert any of such shares into that number of fully paid
and nonassessable shares of common stock (calculated as to each conversion to
the nearest 1/100th of a share) equal to the Conversion Rate (as defined below)
multiplied by the number of shares of Series E Preferred Stock to be converted.
The "Conversion Rate" per share of Series E Preferred Stock is 285 shares of
Common Stock.
LIQUIDATION. In the event of any voluntary or involuntary liquidation,
dissolution, or winding up of the Company, the holders of shares of the Series E
Preferred Stock then outstanding shall be entitled to be paid, out of the assets
of the Company available for distribution to its stockholders, whether from
capital, surplus or earnings, before any payment shall be made in respect of the
Company's Common Stock, an amount equal to $1,000 per share, plus all unpaid
dividends thereon to the date fixed for distribution.
RANK. The Series E Preferred Stock shall, with respect to dividend
rights and rights on liquidation, winding up and dissolution, (i) rank senior to
any of the Company's Common Stock, the Company's Series A, Series B, Series C
and Series D Preferred Stock and any other class or series of stock of the
Company which by its terms shall rank junior to the Series E Preferred Stock,
and (ii) rank junior to any class or series of stock of the Company which by its
terms shall rank senior to the Series E Preferred Stock.
UNDESIGNATED PREFERRED STOCK
The number of shares constituting the undesignated Preferred Stock (the
"Preferred Stock") is 965,000, $.001 par value. The Preferred Stock may be
issued in one or more series, the terms of which may be determined at
54
<PAGE> 55
the time of issuance by the Board of Directors, without further action by
stockholders, and may include voting rights, preferences as to dividends and
liquidation, conversion and redemption rights and sinking fund provisions.
ANTI-TAKEOVER PROVISIONS OF THE DELAWARE GENERAL CORPORATION LAW
The Company is subject to the provisions of Section 203 of the Delaware
General Corporation Law ("DGCL"). In general, this statute prohibits a publicly
held Delaware corporation from engaging, under certain circumstances, in a
"business combination" with an "interested stockholder" for a period of three
years after the date of the transaction in which the person became an interested
stockholder unless (i) prior to the date at which the stockholder became an
interested stockholder, the Board of Directors approved either the business
combination or the transaction in which the person became an interested
stockholder; (ii) the stockholder acquires more than 85% of the outstanding
voting stock of the corporation (excluding shares held by directors who are
officers or held in certain employee stock plans) upon consummation of the
transaction in which the stockholder became an interested stockholder; or (iii)
the business combination is approved by the Board of Directors and by at least
66-2/3% of the outstanding voting stock of the corporation (excluding shares
held by the interested stockholder) at a meeting of stockholders (and not by
written consent) held on or subsequent to the date such stockholder became an
interested stockholder. An "interested stockholder" is a person who, together
with affiliates and associates, owns (or at any time within the prior three
years did own) 15% or more of the corporation's voting stock. Section 203
defines a "business combination" to include, without limitation, mergers,
consolidations, stock sales and asset-based transactions and other transactions
resulting in a financial benefit to the interested stockholder.
ITEM 12 - INDEMNIFICATION OF DIRECTORS AND OFFICERS
LIMITATION ON DIRECTOR's LIABILITY
In accordance with the DGCL, the Company's Certificate of Incorporation
provides that the directors shall not be personally liable to the Company or its
stockholders for monetary damages for breach of duty as a director except (i)
for any breach of the director's duty of loyalty to the Company and its
stockholders; (ii) for acts or omissions not in good faith or which involve
intentional misconduct, or knowing violation of law; (iii) under Section 174 of
the DGCL, which relates to unlawful payments of dividends and unlawful stock
repurchases and redemptions; or (iv) for any transaction from which the director
derived an improper personal benefit. This provision does not eliminate a
director's fiduciary duties; it merely eliminates the possibility of damage
awards against a director personally which may be occasioned by certain
unintentional breaches (including situations that may involve grossly negligent
business decisions) by the director of those duties. The provision has no effect
on the availability of equitable remedies, such as injunctive relief or
rescission, which might be necessitated by a director's breach of his or her
fiduciary duties. However, equitable remedies may not be available as a
practical matter where transactions (such as merger transactions) have already
been consummated. The inclusion of this provision in the Certificate of
Incorporation may have the effect of reducing the likelihood of derivative
litigation against directors and may discourage or deter stockholders or
management from bringing a lawsuit against directors for breach of their duty of
care, even though such an action, if successful, might otherwise have benefited
the Company and its stockholders.
INDEMNIFICATION
The Certificate of Incorporation provides that the Company shall
indemnify its officers, directors, employees and agents to the fullest extent
permitted by the DGCL. Section 145 of the DGCL provides that the Company may
indemnify any person who was or is a party, or is threatened to be made a party,
to any threatened, pending or completed action, suit or proceeding, whether
civil, criminal, administrative or investigative (other than
55
<PAGE> 56
a "derivative" action by or in the right of the Company) by reason of the fact
that such person is or was a director, officer, employee or agent of the
Company, against expenses (including attorneys' fees), judgments, fines and
amounts paid in settlement in connection with such action, suit or proceeding if
such person acted in good faith and in a manner such person reasonably believed
to be in or not opposed to the best interests of the Company, and, with respect
to any criminal action or proceeding, had no reasonable cause to believe was
unlawful. A similar standard of care is applicable in the case of derivative
actions, except that no indemnification shall be made where the person is
adjudged to be liable to the Company, unless and only to the extent that the
Court of Chancery of the State of Delaware or the court in which such action was
brought determines that such person is fairly and reasonably entitled to such
indemnity and such expenses.
ITEM 13 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements and the report thereon of Grant
Thornton LLP, independent certified public accountants, dated August 16, 1999
are filed as part of this Registration Statement. See Item 15.
ITEM 14 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On July 8, 1999 the Board of Directors recommended the appointment of
Grant Thornton LLP as the Company's auditors for the year ended May 31, 1998 and
determined not to engage Tanner & Co. ("Tanner") as the Company's auditors for
the year ended May 31, 1998. The Board had previously appointed Tanner as
auditors for the May 31, 1997 financial statements. The reports of Tanner on the
financial statements of the Company for the period ended May 31, 1997 did not
contain any adverse opinion or disclaimer of an opinion and were not qualified
or modified as to uncertainty audit scope or accounting principles. During the
fiscal year in the period ended May 31, 1997, and the subsequent interim periods
preceding the Company's decision, there were no disagreements with Tanner on any
matter of accounting principles or practices, financial statement disclosure, or
auditing scope or procedure or any reportable events as defined in Item 304 of
Regulation S-K under the Securities Act of 1934.
ITEM 15 - FINANCIAL STATEMENTS AND EXHIBITS
(a) Index to Financial Statements
The Financial Statements required by this item are submitted in a
separate section beginning on page F-1 of this registration statement
<TABLE>
<CAPTION>
PAGE
<S> <C>
Report of Certified Public Accountants (Grant Thornton LLP) F-2
Report of Independent Certified Public Accountants (Tanner & Company LLP) F-3
Consolidated Balance Sheets F-4 - F-5
Consolidated Statements of Operations F-6 - F-7
Consolidated Statements of Comprehensive Income (Loss) F-8
Consolidated Statement of Stockholders' Equity (Deficit) F-9 - F-10
Consolidated Statements of Cash Flows F-11 - F-13
</TABLE>
56
<PAGE> 57
Notes to Consolidated Financial Statements F-14 - F-44
(b) Index to Exhibits
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
<S> <C>
3.1* Amended and Restated Certificate of Incorporation
3.2* Amended and Restated By-Laws
4* Specimen certificate representing shares of Common
Stock
10.1* Amended and Restated Lease Agreement dated December
12, 1996 between Service One International Corporation
and Donald A. Dunham, Jr.
10.2* Amendment No. One to the Amended and Restated Lease
Agreement dated June 11, 1997 between Service One
International Corporation and Donald A. Dunham, Jr.
10.3* Amendment No. Two to the Amended and Restated Lease
Agreement dated July 31, 1997 between Service One
International Corporation and Donald A. Dunham, Jr.
10.4* Lease Agreement dated February 28, 1997 between
Service One International Corporation and Eagle
Properties, L.L.C.
10.5* Addendum to Lease Agreement dated November 18, 1997
between Service One International Corporation and
Eagle Properties, L.L.C.
10.6* Mutual Business Development Agreement dated as of
October 8, 1996, between Service One International
Corporation and the O. Pappalimberis Trust
10.7* Amendment dated as of December 16, 1997 to the Mutual
Business Development Agreement dated as of October 8,
1996, such amendment among O. Pappalimberis Trust,
Taxter One LLC, Service One International Corporation,
Eikos Management, LLC and Thesseus International Asset
Fund
10.8* Amendment dated September 1, 1998 to the Mutual
Business Development Agreement dated as of October 8,
1996, as amended, between the Company and Eikos
Management LLC
10.9* Mutual Business Development Agreement dated as of
October 8, 1996, between Service One International
Corporation and Renaissance Trust I
10.10* Strategic Modeling Agreement dated March 18, 1999,
between the Company and Business Transactions Express,
Inc.
</TABLE>
57
<PAGE> 58
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
<S> <C>
10.11* Warrant to purchase Common Stock of the Company issued
to JLB on June 22, 1999
10.12* Loan and Security Agreement, dated as of April 30,
1998, between the Company and Coast Business Credit, a
division of Southern Pacific Bank
10.13* First Amendment to Loan and Security Agreement, dated
as of September 30, 1998, between the Company and
Coast Business Credit, a division of Southern Pacific
Bank
10.14* Second Amendment to Loan and Security Agreement, dated
as of December 1, 1998, between the Company and Coast
Business Credit, a division of Southern Pacific Bank
10.15* Amendment Number Two to Loan and Security Agreement,
dated as of April 27, 1999, between the Company and
Coast Business Credit, a division of Southern Pacific
Bank
10.16* Fourth Amendment to Loan and Security Agreement, dated
as of May 27, 1999, between the Company and Coast
Business Credit, a division of Southern Pacific Bank
10.17* Amendment Number Five to Loan and Security Agreement,
dated as of June 25, 1999, between the Company and
Coast Business Credit, a division of Southern Pacific
Bank
10.18* Amendment Number Six to Loan and Security Agreement
Dated as of December 6, 1999 between the Company and
Coast Business Credit, a division of Southern Pacific
Bank
10.19* Security Agreement dated as of August 1, 1997, between
J.L.B. of Nevada, Inc., Credit Store Mortgage, Inc.,
New Beginnings Corp., Consumer Debt Acquisitions,
Inc., Sleepy Hollow Associates, Inc., Service One
Holdings Inc., Service One International Corporation,
American Credit Alliance, Inc., Service One
Receivables Acquisition Corporation, the Company,
Service One Commercial Corporation and Soiland Company
10.20* First Amendment to Security Agreement, dated as of
October 23, 1997 between J.L.B. of Nevada, Inc., the
Company and Credit Store Mortgage, Inc., New
Beginnings Corp., Consumer Debt Acquisitions, Inc.,
Sleepy Hollow Associates, Inc., Service One Holdings,
Inc., Service One International Corporation, Service
One Receivables Acquisition Corporation, the Company,
Service One Commercial Corporation and Soiland Company
</TABLE>
58
<PAGE> 59
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
<S> <C>
10.21* Second Amendment to Security Agreement, dated as of
November 21, 1997 between J.L.B. of Nevada, Inc., the
Company, Sleepy Hollow Associates, Inc., Service One
International Corporation, American Credit Alliance,
Inc. and Service One Receivables Acquisition
Corporation
10.22* Credit Agreement Dated as of October 15, 1999 among
Credit Store Capital Corp., the Company, The Lenders
Signatory thereto from time to time, and General
Electric Capital Corporation
10.23* Amended 1997 Stock Option Plan of the Company
10.24* Employment Agreement dated March 27, 1997, between the
Company and Martin Burke
10.25* Letter from Martin Burke dated March 27, 1997,
regarding credit card repayment terms
10.26* Employment Agreement dated April 1, 1997, between the
Company and Kevin Riordan
10.27* Employment Agreement dated June 17, 1997, between the
Company and Michael Philippe
10.28* Amendment to Employment Agreement between Company and
Michael Philippe dated December 15, 1999
10.29* Employment Agreement dated August 1, 1997, between the
Company and Richard Angel
10.30* Amendment to Employment Agreement between Company and
Richard Angel dated December 15, 1999
10.31* Employment Agreement dated October 15, 1997, between
the Company and Cynthia Hassoun
10.32* Bankcard Marketing Agreement between the Company and
Bank of Hoven dated February 9, 1999
</TABLE>
59
<PAGE> 60
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
<S> <C>
10.33* Purchase Agreement between Bank of Hoven and the
Company dated February 9, 1999
10.34* Bankcard Marketing Agreement between Service One
International Corporation and First National Bank in
Brookings dated October 2, 1997
10.35* Purchase Agreement between First National Bank in
Brookings and Service One International Corporation
doing business as TCS Services, Inc. dated October 2,
1997
10.36* Amendment to Purchase Agreement by First National Bank
in Brookings and the Company dated August 31, 1998
10.37* Letter Agreement Regarding Bankcard Marketing
Agreement and Purchasing Agreement between the Company
and First National Bank in Brookings dated August 17,
1999
10.38* Agreement Regarding Transfer of Accounts between the
Company and First National Bank in Brookings dated
December 14, 1998
10.39* Subordinated Grid Promissory Note of the Company in
favor of JLB dated August 1, 1997 in the amount of
$20,000,000
10.40* Subordinated Grid Promissory Note of the Company in
favor of JLB dated October 23, 1997 in the amount of
$5,000,000
10.41* Subordinated Grid Promissory Note of the Company in
favor of JLB dated November 21, 1997 in the amount of
$5,000,000
16* Letter re Change in Certifying Accountant from Tanner
& Company
21* List of Subsidiaries
27.1* Financial Data Schedule
27.2* Financial Data Schedule
27.3* Financial Data Schedule
27.4* Financial Data Schedule
27.5* Financial Data Schedule
27.6* Financial Data Schedule
</TABLE>
- - - ------------------------
*Previously filed
60
<PAGE> 61
SIGNATURES
In accordance with Section 12 of the Securities Exchange Act of 1934,
the Company has duly caused this Amendment No. 1 to Registration Statement on
Form 10 to be signed on its behalf by the undersigned, thereunto duly
authorized.
THE CREDIT STORE, INC.
Dated: April 3, 2000
By /s/ Martin J. Burke, III
-----------------------------------
Martin J. Burke, III
Chief Executive Officer
By /s/ Michael J. Philippe
-----------------------------------
Michael J. Philippe
Chief Financial Officer
61
<PAGE> 62
<TABLE>
<CAPTION>
DESCRIPTION OF DOCUMENT
<S> <C>
3.1* Amended and Restated Certificate of Incorporation
3.2* Amended and Restated By-Laws
4* Specimen certificate representing shares of Common Stock
10.1* Amended and Restated Lease Agreement dated December
12, 1996 between Service One International Corporation
and Donald A. Dunham, Jr.
10.2* Amendment No. One to the Amended and Restated Lease
Agreement dated June 11, 1997 between Service One
International Corporation and Donald A. Dunham, Jr.
10.3* Amendment No. Two to the Amended and Restated Lease
Agreement dated July 31, 1997 between Service One
International Corporation and Donald A. Dunham, Jr.
10.4* Lease Agreement dated February 28, 1997 between
Service One International Corporation and Eagle
Properties, L.L.C.
10.5* Addendum to Lease Agreement dated November 18, 1997
between Service One International Corporation and
Eagle Properties, L.L.C.
10.6* Mutual Business Development Agreement dated as of
October 8, 1996, between Service One International
Corporation and the O. Pappalimberis Trust
10.7* Amendment dated as of December 16, 1997 to the Mutual
Business Development Agreement dated as of October 8,
1996, such amendment among O. Pappalimberis Trust,
Taxter One LLC, Service One International Corporation,
Eikos Management, LLC and Thesseus International Asset
Fund
10.8* Amendment dated September 1, 1998 to the Mutual
Business Development Agreement dated as of October 8,
1996, as amended, between the Company and Eikos
Management LLC
10.9* Mutual Business Development Agreement dated as of
October 8, 1996, between Service One International
Corporation and Renaissance Trust I
10.10* Strategic Modeling Agreement dated March 18, 1999,
between the Company and Business Transactions Express,
Inc.
10.11* Warrant to purchase Common Stock of the Company issued
to JLB on June 22, 1999
</TABLE>
62
<PAGE> 63
<TABLE>
<CAPTION>
DESCRIPTION OF DOCUMENT
<S> <C>
10.12 * Loan and Security Agreement, dated as of April 30,
1998, between the Company and Coast Business Credit, a
division of Southern Pacific Bank
10.13 * First Amendment to Loan and Security Agreement, dated
as of September 30, 1998, between the Company and
Coast Business Credit, a division of Southern Pacific
Bank
10.14 * Second Amendment to Loan and Security Agreement, dated
as of December 1, 1998, between the Company and Coast
Business Credit, a division of Southern Pacific Bank
10.15 * Amendment Number Two to Loan and Security Agreement,
dated as of April 27, 1999, between the Company and
Coast Business Credit, a division of Southern Pacific
Bank
10.16 * Fourth Amendment to Loan and Security Agreement, dated
as of May 27, 1999, between the Company and Coast
Business Credit, a division of Southern Pacific Bank
10.17 * Amendment Number Five to Loan and Security Agreement,
dated as of June 25, 1999, between the Company and
Coast Business Credit, a division of Southern Pacific
Bank
10.18 * Amendment Number Six to Loan and Security Agreement
Dated as of December 6, 1999 between the Company and
Coast Business Credit, a division of Southern Pacific
Bank
10.19 * Security Agreement dated as of August 1, 1997, between
J.L.B. of Nevada, Inc., Credit Store Mortgage, Inc.,
New Beginnings Corp., Consumer Debt Acquisitions,
Inc., Sleepy Hollow Associates, Inc., Service One
Holdings Inc., Service One International Corporation,
American Credit Alliance, Inc., Service One
Receivables Acquisition Corporation, the Company,
Service One Commercial Corporation and Soiland Company
10.20 * First Amendment to Security Agreement, dated as of
October 23, 1997 between J.L.B. of Nevada, Inc., the
Company and Credit Store Mortgage, Inc., New
Beginnings Corp., Consumer Debt Acquisitions, Inc.,
Sleepy Hollow Associates, Inc., Service One Holdings,
Inc., Service One International Corporation, Service
One Receivables Acquisition Corporation, the Company,
Service One Commercial Corporation and Soiland Company
10.21 * Second Amendment to Security Agreement, dated as of
November 21, 1997 between J.L.B. of Nevada, Inc., the
Company, Sleepy Hollow Associates, Inc., Service One
International Corporation, American Credit Alliance,
Inc. and Service One Receivables Acquisition
Corporation
</TABLE>
63
<PAGE> 64
<TABLE>
<CAPTION>
DESCRIPTION OF DOCUMENT
<S> <C>
10.22* Credit Agreement Dated as of October 15, 1999 among
Credit Store Capital Corp., the Company, The Lenders
Signatory thereto from time to time, and General
Electric Capital Corporation
10.23* Amended 1997 Stock Option Plan of the Company
10.24* Employment Agreement dated March 27, 1997, between the
Company and Martin Burke
10.25* Letter from Martin Burke dated March 27, 1997,
regarding credit card repayment terms
10.26* Employment Agreement dated April 1, 1997, between the
Company and Kevin Riordan
10.27* Employment Agreement dated June 17, 1997, between the
Company and Michael Philippe
10.28* Amendment to Employment Agreement between Company and
Michael Philippe dated December 15, 1999
10.29* Employment Agreement dated August 1, 1997, between the
Company and Richard Angel
10.30* Amendment to Employment Agreement between Company and
Richard Angel dated December 15, 1999
10.31* Employment Agreement dated October 15, 1997, between
the Company and Cynthia Hassoun
10.32* Bankcard Marketing Agreement between the Company and
Bank of Hoven dated February 9, 1999
10.33* Purchase Agreement between Bank of Hoven and the
Company dated February 9, 1999
10.34* Bankcard Marketing Agreement between Service One
International Corporation and First National Bank in
Brookings dated October 2, 1997
10.35* Purchase Agreement between First National Bank in
Brookings and Service One International Corporation
doing business as TCS Services, Inc. dated October 2,
1997
10.36* Amendment to Purchase Agreement by First National Bank
in Brookings and the Company dated August 31, 1998
</TABLE>
64
<PAGE> 65
<TABLE>
<CAPTION>
DESCRIPTION OF DOCUMENT
<S> <C>
10.37 * Letter Agreement Regarding Bankcard Marketing
Agreement and Purchasing Agreement between the Company
and First National Bank in Brookings dated August 17,
1999
10.38 * Agreement Regarding Transfer of Accounts between the
Company and First National Bank in Brookings dated
December 14, 1998
10.39 * Subordinated Grid Promissory Note of the Company in
favor of JLB dated August 1, 1997 in the amount of
$20,000,000
10.40 * Subordinated Grid Promissory Note of the Company in
favor of JLB dated October 23, 1997 in the amount of
$5,000,000
10.41 * Subordinated Grid Promissory Note of the Company in
favor of JLB dated November 21, 1997 in the amount of
$5,000,000
16 * Letter re Change in Certifying Accountant from Tanner
& Company
21 * List of Subsidiaries
27.1 * Financial Data Schedule
27.2 * Financial Data Schedule
27.3 * Financial Data Schedule
27.4 * Financial Data Schedule
27.5 * Financial Data Schedule
27.6 * Financial Data Schedule
</TABLE>
* Previously filed.
65
<PAGE> 66
I N D E X
Page
----
Report of Independent Certified Public Accountants (GT) F-2
Report of Independent Certified Public Accountants (Tanner) F-3
Consolidated Financial Statements
Consolidated Balance Sheets F-4 - F-5
Consolidated Statements of Operations F-6 - F-7
Consolidated Statements of Comprehensive Income (Loss) F-8
Consolidated Statement of Stockholders' Equity (Deficit) F-9 - F-10
Consolidated Statements of Cash Flows F-11 - F-13
Notes to Consolidated Financial Statements F-14 - F-44
F-1
<PAGE> 67
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
THE CREDIT STORE, INC.
We have audited the accompanying consolidated balance sheets of The Credit
Store, Inc. (a Delaware corporation) (the "Company") and subsidiaries as of May
31, 1999 and 1998, and the related consolidated statements of operations and
comprehensive income (loss), stockholders' equity (deficit) and cash flows for
the years then ended. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of The Credit Store,
Inc. and subsidiaries as of May 31, 1999 and 1998, and the consolidated results
of their operations and their consolidated cash flows for the year then ended in
conformity with generally accepted accounting principles.
GRANT THORNTON LLP
New York, New York
August 16, 1999
F-2
<PAGE> 68
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To Board of Directors
THE CREDIT STORE, INC. AND
SERVICE ONE INTERNATIONAL CORPORATION
We have audited the accompanying consolidated statements of operations and
comprehensive income (loss), stockholders' equity (deficit) and cash flows of
The Credit Store, Inc. (a Delaware corporation) (the "Company") and its
subsidiaries and Service One International Corporation ("The Predecessor") for
the year ended May 31, 1997 and the period January 1, 1996 to October 8, 1996,
respectively. These financial statements are the responsibility of the Company's
and the Predecessor's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated statements of operations,
stockholders' equity (deficit) and cash flows are free of material misstatement.
An audit includes examining, on a test basis, evidence supporting the amounts
and disclosures in the consolidated statements of operations, stockholders'
equity (deficits) and cash flows. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall presentation of the consolidated statements of
operations, stockholders' equity (deficit) and cash flows. We believe that our
audits of the consolidated statements of operations and comprehensive income
(loss), stockholders' equity (deficit) and cash flows provide a reasonable basis
for our opinion.
In our opinion, the consolidated statements of operations and comprehensive
income (loss), stockholders' equity (deficit) and cash flows referred to above
present fairly, in all material respects, the consolidated results of their
operations and the consolidated cash flows of The Credit Store, Inc. and
subsidiaries and the Predecessor for the year ended May 31, 1997 and the period
January 1, 1996 to October 8, 1996, respectively in conformity with generally
accepted accounting principles.
TANNER + CO.
Salt Lake City, Utah
August 1, 1997
F-3
<PAGE> 69
The Credit Store, Inc.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
NOVEMBER 30, May 31,
ASSETS 1999 1999 1998
---------------- ------------ ------------
(unaudited)
<S> <C> <C> <C>
Cash $ 4,523,121 $ 3,533,930 $ 7,205,071
Restricted cash 750,000 750,000 1,000,000
Accounts and notes receivable, net of allowance
for doubtful accounts of $715,912 at November 30,
1999 and $746,463 and $780,027 at May 31,
1999 and 1998, respectively 3,166,873 1,150,207 492,666
Prepaid expenses 888,105 618,198 444,836
Amounts due from special purpose entities 1,230,700
Investments in consumer debt and credit cards
Investments in nonperforming consumer debt, net
of cost recovery of $38,524,840, $35,557,477
and $24,279,180 at November 30, 1999 and at
May 31, 1999 and 1998, respectively 4,237,335 3,016,697 5,672,514
Credit card receivables, net of provision for
Losses and unearned fees of $ 4,560,236,
$3,247,806 and $3,904,812 at November 30, 1999
and at May 31, 1999 and 1998, respectively 26,020,644 18,631,403 12,919,970
Investment in unconsolidated affiliate 1,646,154 1,612,648 1,287,465
Retained interest in securitized credit card receivables 5,130,372
Property and equipment, net of accumulated depreciation
of $6,432,571, $5,202,266 and $2,795,673 at November 30,
1999, and at May 31, 1999 and 1998, respectively 4,978,278 6,132,612 7,396,616
Goodwill, net of accumulated amortization of $656,058,
$552,470 and $345,294 at November 30, 1999,
and at May 31, 1999 and 1998, respectively 2,451,587 2,555,175 2,762,351
Deferred tax asset 700,000 700,000
Other assets 1,247,288 719,014 541,929
----------- ------------ ------------
Total assets $50,609,385 $45,780,956 $39,723,418
========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these statements.
F-4
<PAGE> 70
The Credit Store, Inc.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
LIABILITIES AND STOCKHOLDERS' November 30, May 31,
EQUITY (DEFICIT) 1999 1999 1998
--------------- -------------- --------------
(unaudited)
<S> <C> <C> <C>
Liabilities
Accounts payable and accrued expenses $ 2,887,049 $ 3,611,334 $ 4,245,019
Accrued royalties 28,568 702,075 261,667
Notes payable 13,649,987 6,086,766 5,902,041
Capitalized lease obligations 3,440,542 4,045,541 5,150,481
Subordinated notes and accrued interest payable -
related party 19,591,152 19,246,595 31,807,322
----------- ----------- -----------
Total liabilities 39,597,298 33,692,311 47,366,530
----------- ----------- -----------
Stockholders' equity (deficit)
Series A Preferred Stock, $.001 par value; 2,000,000 shares
authorized; 1,200,000 shares issued and outstanding;
stated at liquidation value of $1 per share 1,200,000 1,200,000 1,200,000
Series B Preferred Stock, $.001 par value; 800,000 shares
authorized; 800,000 shares issued and outstanding;
Stated at liquidation value of $1 per share 800,000 800,000 800,000
Series C Preferred Stock; 5,000 shares
authorized; 5,000 shares issued and outstanding;
Stated at liquidation value of $1,000 per share 5,000,000 5,000,000 5,000,000
Series D Preferred Stock, $.001 par value; 10,000 shares,
convertible into 3,800,000 of common stock
Authorized; 10,000 shares issued and outstanding;
Stated at liquidation value of $1,000 per share, 10,000,000 10,000,000 10,000,000
Series E Preferred Stock, $.001 par value; 20,000 shares,
convertible into 5,700,000 shares of common stock
Authorized; 10,000 shares issued and outstanding;
stated at liquidation value of $1,000 per share 10,000,000 10,000,000
Common Stock, $.001 par value; 65,000,000 shares
authorized at November 30, 1999 and 50,000,000 shares
authorized at May 31, 1999 and 1998; 34,761,965 shares
issued and outstanding at November 30, 1999 and at
May 31, 1999 and 1998 34,762 34,762 34,762
Additional paid-in capital 23,564,760 22,670,711 19,311,782
Unrealized gain from retained interest in securitized
receivables, net of tax 2,497,148
Accumulated deficit (39,587,435) (40,113,976) (43,989,656)
----------- ----------- -----------
Total stockholders' equity (deficit) 11,012,087 12,088,645 (7,643,112)
----------- ----------- -----------
Total liabilities and stockholders' equity (deficit) $ 50,609,385 $ 45,780,956 $ 39,723,418
=========== ========== ===========
</TABLE>
F-5
The accompanying notes are an integral part of these statements.
<PAGE> 71
The Credit Store, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the six For the years ended
months ended November 30, May 31,
1999 1998 1999 1998
------------- ------------ ------------ -------------------
(unaudited)
<S> <C> <C> <C> <C>
Revenue
Income from credit card receivables $ 4,961,764 $ 3,029,342 $ 6,438,460 $ 3,951,602
Revenue in excess of cost recovered 10,209,919 10,492,017 22,308,908 8,138,122
Gain on sales of portfolios 6,336,221 5,649,418 11,851,080
Servicing fees and other income 1,346,061 1,013,632 1,564,356 1,292,596
------------ ------------ ------------ -------------
Total revenue 22,853,965 20,184,409 42,162,804 13,382,320
Provision for losses 3,737,867 2,559,044 4,607,081 6,483,736
------------ ------------ ------------ -------------
Net revenue 19,116,098 17,625,365 37,555,721 6,898,584
Expenses
Salaries and employee benefits 6,615,777 5,878,047 12,484,582 13,268,863
Interest expense 2,139,454 2,219,073 4,029,491 4,760,905
Professional fees 1,109,517 1,229,946 2,701,016 4,215,891
Depreciation and amortization 1,333,893 1,260,364 2,614,216 3,223,620
Third-party credit card services 2,282,397 2,204,057 4,733,528 3,486,915
Mail processing 475,898 758,960 1,434,506 1,121,623
Telephone 430,298 460,900 838,007 913,757
Occupancy and equipment rental 392,123 399,654 766,832 825,517
Royalty expense 181,493 1,045,895 1,541,944 207,238
Termination/settlements on
servicing agreements 5,890 5,008 1,163,068 511,094
Financing fees 757,942 126,897 211,864 90,182
Loss on investments 1,028,600
Other 1,578,466 1,463,323 3,147,398 2,689,410
------------ ------------ ------------ -------------
Total expenses 17,303,148 17,052,124 35,666,452 36,343,615
------------ ------------ ------------ -------------
Income (loss) before income taxes 1,812,950 573,241 1,889,271 (29,445,031)
Income tax benefit (expense) (1,286,409) 100,000 1,986,409 -
------------ ------------ ------------ -------------
Net income (loss) 526,541 673,241 3,875,680 (29,445,031)
Dividends on preferred stock (1,000,000) (799,999) (1,799,999) (399,996)
Net income (loss), applicable to ----------- ------------ ----------- -------------
common shareholders $ (473,459) $ (126,758) $ 2,075,681 $ (29,845,027)
=========== ============ =========== =============
Income (loss) per share
Basic $(.01) $.00 $.06 $(0.90)
===== ==== ==== ======
Diluted $(.01) $.00 $.05 $(0.90)
===== ==== ==== ======
Weighted-average common shares
outstanding
Basic 34,761,965 34,761,965 34,761,965 33,109,781
========== ========== ========== ==========
Diluted 34,761,965 34,761,965 38,436,119 33,109,781
========== ========== ========== ==========
<CAPTION>
The Credit Store, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
January 1,
1996 to
October 8,
1996
1997 ("Predecessor")
------------- ---------------
<S> <C> <C>
Revenue
Income from credit card receivables $ 971,174
Revenue in excess of cost recovered 3,934
Gain on sales of portfolios
Servicing fees and other income 1,601,228 $ 2,078,506
------------- --------------
Total revenue 2,576,336 2,078,506
Provision for losses 1,494,001 -
------------- -------------
Net revenue 1,082,335 2,078,506
Expenses
Salaries and employee benefits 6,154,929 1,757,101
Interest expense 751,729 151,906
Professional fees 2,388,274 76,753
Depreciation and amortization 952,362 138,338
Third-party credit card services 1,059,282 -
Mail processing 527,372 666,889
Telephone 511,131 138,770
Occupancy and equipment rental 349,383 76,283
Royalty expense 1,229,180 -
Termination/settlements on
servicing agreements 59,284 3,168
Financing fees
Loss on investments
Other 1,504,964 1,002,066
------------- -------------
Total expenses 15,487,890 4,011,274
------------- -------------
Income (loss) before income taxes (14,405,555) (1,932,768)
Income tax benefit (expense) - 420,280
------------- -------------
Net income (loss) (14,405,555) (1,512,488)
Dividends on preferred stock (7,397) -
------------- -------------
Net income (loss), applicable to
common shareholders $(14,412,952) $ (1,512,488)
============ ============
Income (loss) per share
Basic and diluted $(.56) $(.30)
===== =====
Diluted $(.56) $(.30)
===== =====
Weighted-average common shares
outstanding
Basic 25,912,465 5,000,000
============= ============
Diluted 25,912,465 5,000,000
============= ============
</TABLE>
F-6
<PAGE> 72
The Credit Store, Inc.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(CONTINUED)
<TABLE>
<CAPTION>
For the six For the years ended
months ended November 30, May 31,
----------------------------------
1999 1998 1999 1998
-------------- ----------- ------------ -------------
<S> <C> <C> <C> <C>
Net income (loss) $ 526,541 $ 673,241 $ 3,875,680 $(29,445,031)
Unrealized gain on retained interest
in securitized credit card
receivables, net of tax 1,424,065 784,348 2,497,148 -
Less: reclassification adjustment for gains
included in net income (3,921,213) - - -
--------- --------- --------- ----------
Comprehensive income (loss) $(1,970,607) $ 1,457,589 $ 6,372,828 $(29,445,031)
========= ========= ========= ==========
The Credit Store, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
(CONTINUED)
<CAPTION>
January 1,
1996 to
October 8,
----------- 1996
1997 ("Predecessor")
----------- ---------------
<S> <C> <C>
Net income (loss) $(14,405,555) $(1,512,488)
Unrealized gain on retained interest
in securitized credit card
receivables, net of tax - -
Less: reclassification adjustment for gains
included in net income - -
----------- ------------
Comprehensive income (loss) $(14,405,555) $(1,512,488)
============= ============
</TABLE>
The accompanying notes are an integral part of these statements.
F-7
<PAGE> 73
The Credit Store, Inc.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(DEFICIT)
Periods ended November 30, 1999 (unaudited), and May 31, 1999,
1998 and 1997
<TABLE>
<CAPTION>
Common
Stock -
Common Shares
stock - ($.001 par Series A Series B Series C Series D
shares Value) Preferred Preferred Preferred Preferred
---------- ---------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Formation of Predecessor 5,000,000 $ 5,000
========== =======
Net loss
Balance at October 8, 1996 5,000,000 $ 5,000
========== =======
Formation of Company,
October 8, 1996 12,049,965 $12,050 $1,200,000 $800,000 $5,000,000
Net loss
Issuance of common stock 20,157,500 20,158
---------- ------ --------- ------- ---------
Balance at May 31, 1997 32,207,465 32,208 1,200,000 800,000 5,000,000
Net loss
Issuance of Series D Preferred
Stock in exchange for $10 million
subordinated note $10,000,000
Issuance of common stock 2,554,500 2,554
----------- ------- ---------- ---------- ---------- ----------
Balance at May 31, 1998 34,761,965 34,762 1,200,000 800,000 5,000,000 10,000,000
Net income
Unrealized gain on retained interest in
securitization, net of tax
Issuance of Series E Preferred
Stock in exchange for $10 million
subordinated note
Issuance of 4 million warrants in lieu
of payment of accrued interest on
subordinated debt
---------- ------ --------- ------- --------- ----------
Balance at May 31, 1999 34,761,965 34,762 1,200,000 800,000 5,000,000 10,000,000
---------- ------ --------- ------- --------- ----------
Net loss
Unrealized gain on retained interest in
securitized receivables, net of tax
Sale of retained interest in
securitized receivables, net of tax
Issuance of warrants in lieu of
payment for assets acquired
---------- ------ --------- ------- --------- ----------
Balance at November 30, 1999 34,761,965 $34,762 $1,200,000 $800,000 $5,000,000 $10,000,000
========== ====== ========= ======= ========= ==========
</TABLE>
The accompanying notes are an integral part of this statement.
F-8
<PAGE> 74
The Credit Store, Inc.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT) (continued)
Periods ended November 30, 1999 (unaudited), and May 31, 1999, 1998 and 1997
<TABLE>
<CAPTION>
Additional Other Total
Series E paid-in Accumulated comprehensive stockholders'
Preferred capital deficit income equity (deficit)
----------- ------------ ------------ ------------- ----------------
<S> <C> <C> <C> <C> <C>
Formation of Predecessor $ 385,203 $ 390,203
Net loss $ (1,512,488) (1,512,488)
------------ ------------ ------------
Balance at October 8, 1996 $ 385,203 $ (1,512,488) $ (1,122,285)
============ ============ ============
Formation of Company,
October 8, 1996 $ 121,175 $ (131,673) $ 7,001,552
Net loss (14,405,555) (14,405,555)
Dividends (7,397) (7,397)
Issuance of common stock 14,016,717 14,036,875
------------ ------------ ------------
Balance at May 31, 1997 14,137,892 (14,544,625) 6,625,475
Net loss (29,445,031) (29,445,031)
Issuance of Series D Preferred
Stock in exchange for $10 million
subordinated note 10,000,000
Issuance of common stock 5,173,890 5,176,444
------------ ------------ ------------
Balance at May 31, 1998 19,311,782 (43,989,656) (7,643,112)
Net income 3,875,680 3,875,680
Accretion on retained interest in
securitization, net of tax $ 2,497,148 2,497,148
Issuance of Series E Preferred
Stock in exchange for $10 million
subordinated note $10,000,000 10,000,000
Issuance of 4 million warrants in lieu
of payment of accrued interest on
subordinated debt 3,358,929 3,358,929
----------- ------------ ------------ ----------- ------------
Balance at May 31, 1999 10,000,000 22,670,711 (40,113,976) 2,497,148 12,088,645
----------- ------------ ------------ ----------- ------------
Net income 526,541 526,541
Accretion on retained interest in
securitized receivables, net of tax 1,424,065 1,424,065
Sale of retained interest in
securitized receivables, net of tax (3,921,213) (3,921,213)
Issuance of warrants in lieu of
payment for services 894,049 894,049
----------- ----------- ------------ ----------- ------------
Balance at November 30, 1999 $10,000,000 $23,564,760 $(39,587,435) $ - $ 11,012,082
=========== =========== ============ =========== ============
</TABLE>
The accompanying notes are an integral part of this statement.
F-9
<PAGE> 75
The Credit Store, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the six For the years ended
months ended November 30, May 31,
--------------------------- --------------------------------------------
1999 1998 1999 1998 1997
----------- ----------- ------------ ------------ ------------
(unaudited)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities
Net income (loss) 536,541 673,241 $ 3,875,680 $(29,445,031) $(14,405,555)
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating
activities
Provision for credit card losses 3,737,867 2,559,044 4,607,081 6,483,736 1,494,001
Amortization of discount on performing
credit card portfolio (626,110) -- -- -- --
Provision for losses on accounts receivable -- -- 768,860 780,027 199,797
Depreciation and amortization 1,333,893 1,260,364 2,614,216 3,223,620 952,362
Deferred tax (benefit)/expense 5,260,358 (100,000) (1,986,409) -- --
Gain on sale of interest in affiliates (5,260,358) -- -- -- --
Gain from unconsolidated affiliates (33,506) (210,331) (325,183) (277,159) (1,010,306)
Gain on sale of credit card receivable
portfolios -- (5,649,418) (11,851,080) -- --
Services received for stock issued -- -- -- 176,444 --
(Increase) decrease in
Restricted cash -- 250,000 250,000 -- (1,000,000)
Accounts and notes receivable (2,016,666) (262,356) (1,426,401) (473,436) (999,054)
Receivable from unconsolidated affiliate 1,230,701 (463,601) (1,230,700) -- --
Prepaid expenses (269,907) (11,568) (173,362) (327,177) (117,659)
Accrued interest on funds advanced
on credit cards -- -- 82,488 (263,255) (62,722)
Accrued fees -- -- 291,161 (48,382) (575,225)
Other assets 365,775 (218,027) (177,085) (383,338) (158,591)
Increase (decrease) in
Unearned fees 132,041 219,453 184,551 216,721 --
Accounts payable and accrued expenses (724,285) (425,334) (633,685) 2,495,854 1,683,604
Deferred revenue
Accrued interest payable on subordinated
notes 694,557 1,375,891 2,439,273 3,675,381 457,001
Accrued royalties (673,507) 119,358 440,408 (1,265,013) 1,526,680
----------- ----------- ------------ ------------ ------------
Net cash used in
operating activities (296,555) (883,284) (2,250,187) (15,431,008) (12,015,667)
----------- ----------- ------------ ------------ ------------
<CAPTION>
January 1,
1996 to
October 8,
1996
("Predecessor")
---------------
<S> <C>
Cash flows from operating activities
Net income (loss) $ (1,512,488)
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating activities
Provision for credit card losses --
Amortization of discount on performing
credit card portfolio --
Provision for losses on accounts receivable
Depreciation and amortization 138,338
Deferred tax benefit (420,280)
Gain on sale of interest in affiliates --
Loss from unconsolidated affiliates
Gain on sale of credit card receivable --
portfolios --
Services received for stock issued
(Increase) decrease in --
Restricted cash
Accounts and notes receivable (72,069)
Receivable from unconsolidated affiliate --
Prepaid expenses (13,308)
Accrued interest on funds advanced
on credit cards --
Accrued fees --
Other assets
Increase (decrease) in --
Unearned fees
Accounts payable and accrued expenses 670,993
Deferred revenue 166,800
Accrued interest payable on subordinated --
notes --
Accrued royalties ---------------
Net cash used in (1,042,014)
operating activities ---------------
</TABLE>
F-10
<PAGE> 76
The Credit Store, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
<TABLE>
<CAPTION>
For the six For the years ended
months ended November 30, May 31,
---------------------------- --------------------------------------------
1999 1998 1999 1998 1997
------------ ------------ ------------ ------------- ------------
(unaudited)
<S> <C> <C> <C> <C> <C>
Cash flows from investing activities
Collection of funds advanced on credit cards 11,970,423 8,670,071 $ 13,305,543 $ 1,887,306 $ 1,063,729
Cash received on collection of nonperforming
consumer debt 2,967,365 7,044,772 11,278,295 18,162,596 6,116,584
Funds advanced on securitized credit card (2,036,060) (3,758,290) (1,346,815) -- --
receivables
Proceeds from sale of credit card receivable
portfolios -- 8,507,558 17,129,109 -- --
Funds advanced on credit cards (18,517,858) (15,149,800) (29,460,286) (18,629,185) (4,486,692)
Purchase of nonperforming consumer debt
portfolios (4,188,003) (7,195,786) (8,622,478) (15,641,657) (14,310,037)
Proceeds from sale of beneficial interest in 8,613,233 -- -- -- --
affiliates
Purchase of performing consumer debt portfolios (4,085,604)
Development of proprietary software (460,497) (460,497)
Purchase of property and equipment (75,972) (394,627) (682,539) (4,170,472) (10,164,477)
Cash received in purchase of subsidiary -- -- -- -- 58,162
------------ ------------ ------------ ------------ ------------
Net cash provided by (used in) investing
Activities (5,322,476) (2,736,599) 1,140,332 (18,391,412) (21,722,731)
------------ ------------ ------------ ------------ ------------
Cash flows from financing activities
Proceeds from debt 8,367,263 1,378,565 576,643 33,240,887 10,794,741
Payments on debt (1,154,042) (1,504,895) (2,032,989) (101,921) (356,726)
Borrowings from sale/leaseback transactions 424,000 25,138 559,713 3,146,275 4,442,520
Payments on capital lease obligations (1,028,999) (789,134) (1,664,653) (1,943,331) (494,983)
Proceeds from issuance of stock -- -- -- 5,000,000 21,036,875
------------ ------------ ------------ ------------ ------------
Net cash provided by (used in) financing
Activities 6,608,222 (890,326) (2,561,286) 39,341,910 35,422,427
------------ ------------ ------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH 989,191 (4,510,209) (3,671,141) 5,519,490 1,684,029
Cash at beginning of period 3,533,930 7,205,071 7,205,071 1,685,581 1,552
------------ ------------ ------------ ------------ ------------
Cash at end of period 4,523,121 2,694,862 $ 3,533,930 $ 7,205,071 $ 1,685,581
============ ============ ============ ============ ============
<CAPTION>
January 1,
1996 to
October 8,
1996
("Predecessor")
---------------
<S> <C>
Cash flows from investing activities
Collection of funds advanced on credit cards --
Cash received on collection of nonperforming
consumer debt --
Funds advanced on securitized credit card
receivables --
Proceeds from sale of credit card receivable
portfolios $ 1,300,000
Funds advanced on credit cards --
Purchase of nonperforming consumer debt
portfolios --
Proceeds from sale of beneficial interest in
affiliates --
Purchase of performing consumer debt portfolios --
Development of proprietary software --
Purchase of property and equipment (957,720)
Cash received in purchase of subsidiary --
---------------
Net cash provided by (used in) investing
Activities 342,280
---------------
Cash flows from financing activities
Proceeds from debt 1,546,842
Payments on debt (1,068,303)
Borrowings from sale/leaseback transactions --
Payments on capital lease obligations --
Proceeds from issuance of stock --
---------------
Net cash provided by (used in) financing
Activities 478,539
---------------
NET INCREASE (DECREASE) IN CASH (221,195)
Cash at beginning of period 279,357
---------------
Cash at end of period $ 58,162
===============
</TABLE>
F-11
<PAGE> 77
The Credit Store, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
<TABLE>
<CAPTION>
January 1,
For the six For the years ended 1996 to
Months ended November 30, May 31, October 8,
------------------------- -------------------------------------- 1996
1999 1998 1999 1998 1997 ("Predecessor")
---------- ---------- ---------- ---------- ---------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Supplemental disclosures of cash flow information:
Cash paid during the year for
Interest 1,115,205 843,183 $ 1,592,864 $ 1,006,663 $ 306,691 $ 144,573
Noncash financing activities:
Series E and D preferred stock issued in
exchange for subordinated note 10,000,000 $ 10,000,000 $ 10,000,000
Obligations assumed in lieu of payment of
accrued interest on subordinated debt $ 1,641,071
Issuance of warrants in lieu of payment of
accrued interest on subordinated debt $ 3,358,929
Issuance of warrants in lieu of payment for
assets acquired 894,049
Property and equipment provided with debt $3,754,408
</TABLE>
The accompanying notes are an integral part of these statements.
F-12
<PAGE> 78
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
May 31, 1999, 1998, 1997 and January 1, 1996 to
October 8, 1996 ("Predecessor"), and for the six months ended
November 30, 1999 and 1998 (unaudited)
NOTE A - ORGANIZATION
The Credit Store, Inc. is a technology based financial services company
that provides credit card products to consumers who may otherwise fail to
qualify for a traditional unsecured bank credit card. The Company reaches
these consumers by acquiring portfolios of non-performing consumer
receivables and offering a new credit card to those consumers who agree to
pay all or a portion of the outstanding amount due on their debt and who
meet the Company's underwriting guidelines. The new card is issued with an
initial balance and credit line equal to the agreed repayment amount. After
the consumers have made a certain number of on-time payments on their
outstanding credit card balance, the Company seeks to sell or securitize
the credit card receivables generated by this business strategy. The
Company offers other forms of settlement to those consumers who do not
accept the credit card offer.
The Company was incorporated in 1972 in Utah as Valley West Development
Corporation, changed its corporate domicile to Delaware in 1995, and had
discontinued all operations. On September 12, 1996, the 98%-owner of Taxter
One LLC ("Taxter") invested $20,000 in cash and obtained voting control of
the Company. Subsequently the name of the Company was changed to Credit
Store, Inc. and the owner contributed his ownership in the Company to
Taxter. The other shareholders of the Company did not receive shares of
Taxter.
On October 8, 1996, Taxter acquired Service One Holdings, Inc. ("Holdings")
from two selling entities ("Selling Entities") for $2,000,000 in cash.
Holdings, through its wholly-owned subsidiary, Service One International
Corporation, Inc. ("SOIC"), engaged in the business of acquiring
non-performing consumer debt portfolios, and the marketing and servicing of
credit cards. SOIC (the "Predecessor") is the predecessor of the Company. At
the time of the acquisition, Holdings owned all of the capital stock of
Service One International Corporation ("SOIC"), its sole asset, which was
engaged in the business of acquiring nonperforming consumer debt portfolios,
and the marketing and servicing of credit cards. Following the acquisition
of Holdings, the Company engaged directly, and through SOIC and its
affiliates, in the acquisition of nonperforming consumer debt portfolios and
the marketing and servicing of credit cards. Holdings and SOIC were merged
into the Company in February and March, 1998, respectively, and the
Company's name was changed to The Credit Store, Inc. in March, 1998. In
connection with the acquisition by Taxter of Holdings (and its subsidiary,
SOIC), the agreements also provided for:
- An option for each of the Selling Entities to acquire 4,000,000
shares of common stock owned by Taxter and 400,000 shares of
Series B Preferred Stock by Taxter.
- Royalty fees of up to $25,000,000 payable to each Selling Entity
by SOIC.
F-13
<PAGE> 79
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996 to
October 8, 1996 ("Predecessor"), and for the six months ended
November 30, 1999 and 1998 (unaudited)
NOTE A (CONTINUED)
The excess of the (cash) purchase price over the fair value of the net
assets acquired was allocated to goodwill and amounted to $3.1 million.
The assets acquired and liabilities assumed (in millions) were:
<TABLE>
<S> <C>
Assets acquired $ 2.9
Liabilities assumed $(4.0)
Cash paid $(2.0)
</TABLE>
On December 4, 1996, the Company acquired all of the capital stock of
Holdings from Taxter for 2,000,000 shares of Series A and B Preferred
Stock. The acquisition was accounted for as a purchase of entities under
common control as the minority shareholders of the Company did not exchange
their shares. Holdings operations were recorded as of October 8, 1996.
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
1. Principles of Consolidation
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All significant intercompany
transactions have been eliminated.
2. Cash and Cash Equivalents
For purposes of the statement of cash flows, cash includes all cash and
investments with original maturities to the Company of three months or
less when purchased except restricted cash. The Company maintains its
cash in bank deposit accounts, which at times may exceed federally
insured limits. The Company classifies as restricted cash $750,000 at
November 30, 1999 and at May 31, 1999 and $1,000,000 at May 31, 1998,
on deposit with a bank in order to facilitate funding of credit card
loans.
3. Investments and Credit Card Receivables
Investments in nonperforming consumer debt consist of portfolios of
consumer debt purchased by the Company, which is recorded at cost, less
cost recovered. Cost is substantially less than the remaining
outstanding balance of these portfolios. To the extent that the cost of
a particular
F-14
<PAGE> 80
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996 to
October 8, 1996 ("Predecessor"), and for the six months ended
November 30, 1999 and 1998 (unaudited)
NOTE B (CONTINUED)
portfolio of debt purchased exceeds the estimated amount of cash
expected to be collected, a valuation allowance would be recognized in
the amount of such impairment.
Credit card receivables consist of amounts funded by the Company for
new purchases or advances, accrued interest on new purchases and
advances, and accrued fees, less a provision for losses.
Investment in unconsolidated affiliate represents the Company's 50%
ownership interest in an entity involved in substantially the same
business as the Company and is recorded on the equity method of
accounting.
4. Securitization Accounting
Statement of Financial Accounting Standards No. 125 ("SFAS No. 125"),
"Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities," requires an entity to recognize the
financial and servicing assets it controls and the liabilities it has
incurred and to derecognize financial assets when control has been
surrendered. The basis of securitized financial assets is allocated to
the assets sold, the servicing asset or liability and retained interest
based on their relative fair values at the transfer date in determining
the gain on the securitization transaction.
SFAS No. 125 requires an entity to recognize a servicing asset or
servicing liability each time it undertakes an obligation to service
financial assets that have been securitized and amortize it over the
period of estimated net servicing income. Servicing assets or
liabilities are amortized in proportion to and over the period of
estimated net servicing income or loss. The Company received adequate
compensation for the servicing of securitized credit card receivables
and therefore no servicing asset or liability, was recorded.
5. Retained Interest in Securitized Credit Card Receivables
The retained interest in securitized credit card receivables is treated
as a debt security classified as available-for-sale in accordance with
Statement of Financial Accounting Standards No. 115 ("SFAS No. 115"),
"Accounting for Certain Investments in Debt and Equity Securities," and
is carried at fair value. At the time of securitization, the retained
interest is initially recorded at the basis allocated in accordance
with SFAS No. 125. This original cost basis is adjusted to fair value,
which is based on the discounted anticipated future cash flows on a
"cash out" basis, with such adjustment (net of related deferred income
taxes) recorded as a component of other comprehensive income. The cash
out method projects cash collections to be received only after all
amounts owed to investors have been remitted.
F-15
<PAGE> 81
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996 to
October 8, 1996 ("Predecessor"), and for the six months ended
November 30, 1999 and 1998 (unaudited)
NOTE B (CONTINUED)
Income on the retained interest is accrued based on the effective
interest rate applied to its original cost basis, adjusted for accrued
interest and principal paydowns. The effective interest rate is the
internal rate of return determined based on the timing and amounts of
anticipated future cash flow projections for the underlying pool of
securitized credit card receivables.
The Company monitors impairment of the retained interest based on
discounted anticipated future cash flows of the underlying receivables
on a cash out basis compared to the original cost basis of the retained
interest, adjusted for accrued interest and principal paydowns. The
discount rate is based on an acceptable rate of return adjusted for
specific risk factors. The retained interest is evaluated for
impairment by management monthly based on current market and cash flow
assumptions applied to the underlying receivables. Provisions for
losses are charged to earnings when it is determined that the retained
interest's original cost basis, adjusted for accrued interest and
principal paydowns, is greater than the present value of expected
future cash flows. No provision for losses was recorded during the six
months ended November 30, 1999 and for the fiscal year ended May 31,
1999.
6. Property and Equipment
Property and equipment are recorded at cost, less accumulated
depreciation and amortization. Depreciation and amortization on capital
leases and property and equipment are determined using the
straight-line method over the estimated useful lives of the assets or
terms of the lease. Expenditures for maintenance and repairs are
expensed when incurred and betterments are capitalized.
7. Goodwill
Goodwill originating from the acquisition of companies acquired in
purchase transactions is being amortized using the straight-line method
over fifteen years.
The Company evaluates the realizability of goodwill based on
expectations of future non-discounted cash flows and operating income
related to purchased businesses.
8. Revenue Recognition
Income from credit cards receivable represents interest and fees on new
advances or purchases made by holders of the Company's credit cards on
an accrual basis.
F-16
<PAGE> 82
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996 to
October 8, 1996 ("Predecessor"), and for the six months ended
November 30, 1999 and 1998 (unaudited)
NOTE B (CONTINUED)
For the portfolios of nonperforming consumer debt revenue in excess of
cost recovery is accounted for on a pool basis using the cost recovery
method of accounting in accordance with Practice Bulletin No. 6,
"Amortization of Discounts on Certain Acquired Loans." Under the cost
recovery method of accounting, all cash receipts relating to individual
portfolios of nonperforming consumer debt are applied first to recover
the cost of the portfolios, prior to recognizing any revenue. Cash
receipts in excess of cost of acquired portfolios are then recognized
as revenue. The cost of the portfolio includes the purchase price
paid to the seller plus costs directly related to the acquisition of
the portfolio. All direct mail, telemarketing and scrubbing costs are
expensed as incurred.
Servicing revenues are fees related to processing and managing credit
cards for third parties. These revenues are recognized when the related
services are provided.
The Company's policy is to accrue interest and fee income on all credit
card accounts including delinquent accounts, until the account is
charged off. A credit card is contractually delinquent if the minimum
payment is not received on the specified payment due date on the
customers statement.
For performing credit card portfolios purchased, the Company uses
models to estimate the amount and timing of future cash flows. These
models are based on historical cash collection data from performing
receivable portfolios and are used to compute an effective interest
rate for income recognition. For these portfolios the fair value of
credit card receivables is based upon discounted expected cash flows.
The discount rate is based upon an acceptable rate of return adjusted
for specific risk factors inherent in each individual portfolio. The
Company accrues interest on new advances of performing credit card
receivables.
9. Allowance for Loan Losses
The provision for possible credit losses includes current period losses
and an amount which, in the judgment of management, is necessary to
maintain the allowance for possible credit losses at a level that
reflects known and inherent risks in the credit card loan portfolio. In
evaluating the adequacy of the allowance for loan losses, management
considers several factors, including: historical trends of charge-off
activity for each loan portfolio as well as current economic conditions
and the impact that such conditions might have on a borrowers' ability
to repay. Significant changes in these factors could affect the
adequacy of the allowance for loan losses in the near term. Credit card
accounts are generally charged off at the end of the month during which
the loan becomes contractually 120 days past due, with the exception of
bankrupt accounts, which are charged off immediately upon formal
notification of bankruptcy, and accounts of deceased cardholders
without a surviving, contractually liable individual, which are also
charged off immediately upon notification.
F-17
<PAGE> 83
The following table summarizes information about the Company's
allowance for loan losses.
<TABLE>
<CAPTION>
For the six For the years ended
months ended November 30, May 31,
-------------------------- -----------------------------------------
1999 1998 1999 1998 1997
-------- -------- -------- -------- --------
(Unaudited)
<S> <C> <C> <C> <C> <C>
Balance at beginning of period $2,846,533 $ 3,688,091 $ 3,688,091 $ 1,337,081 $ ---
Provision for loan losses 3,737,867 2,559,044 4,607,081 6,483,736 1,494,000
Additional reserve for acquired
portfolios of performing credit
cards 1,027,654
Loans charged-off (3,585,131) (3,295,620) (5,448,639) (4,132,726) (156,919)
---------- ----------- ------------ ----------- ----------
Balance at end of period 4,026,923 2,951,515 2,846,533 3,688,091 1,337,081
</TABLE>
10. Use of 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,
the disclosure of contingent assets and liabilities at the date of the
financial statements, and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
Significant estimates have been made by management with respect to the
timing and amount of collection of future cash flows from nonperforming
consumer debt and credit card receivables ("Portfolios"). Among other
things, the estimated future cash flows of the Portfolios are used to
F-18
<PAGE> 84
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996 to
October 8, 1996 ("Predecessor"), and for the six months ended
November 30, 1999 and 1998 (unaudited)
NOTE B (CONTINUED)
recognize impairment in investment in nonperforming consumer debt,
provision for losses on credit card receivables and fair value of
retained interest in securitized credit card receivables. Actual
results could differ from these estimates, making it reasonably
possible that a change in these estimates could occur within one year.
On a periodic basis, management reviews the estimate of future
collections, and it is reasonably possible that its assessment may
change based on actual results and other factors. The change could be
material.
11. Income Taxes
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax
purposes.
12. Earnings Per Share
Earnings per share are calculated under the provisions of Statement of
Financial Accounting Standards No. 128 ("SFAS No. 128"), "Earnings Per
Share." SFAS No. 128 requires the presentation and disclosure of basic
earnings per share, and, if applicable, diluted earnings per share.
Basic earnings per share is computed by dividing income applicable to
common stockholders by the weighted-average number of common shares
outstanding during the period. Income (loss) applicable to common
stockholders is computed by deducting dividends on preferred stock from
net income or loss. Diluted earnings per share are based on the
weighted-average number of common and common equivalent shares
outstanding. The calculation takes into account the shares that may be
issued upon exercise of stock options, reduced by the shares that may
be repurchased with the funds received from the exercise, based on the
average price during the year. In computing diluted earnings per share,
only potential common shares that are dilutive (those that reduce
earnings per share) are included. Exercise of stock options is not
assumed if the result would be antidilutive, such as when a loss from
continuing operations is reported.
13. Reporting Comprehensive Income
The Financial Accounting Standards Board ("FASB") issued Statement of
Financial Accounting Standards No. 130 ("SFAS No. 130"), "Reporting
Comprehensive Income," which is effective for fiscal years beginning
after December 15, 1997. The Statement establishes standards for
reporting
F-19
<PAGE> 85
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996 to
October 8, 1996 ("Predecessor"), and for the six months ended
November 30, 1999 and 1998 (unaudited)
NOTE B (CONTINUED)
and display of comprehensive income and its components (revenue,
expenses, gains and losses) in a full set of general-purpose financial
statements. The Statement requires all items required to be recognized
under accounting standards as components of comprehensive income, to be
reported in a financial statement that is displayed with the same
prominence as other financial statements. SFAS No. 130 does not require
a specific format for that financial statement but requires that an
enterprise display an amount representing total comprehensive income
for the period in that financial statement. The Statement requires that
an enterprise classify items of other comprehensive income by their
nature in a financial statement and display the accumulated balance of
other comprehensive income separately from retained earnings and
additional paid-in capital in the equity section of a statement of
financial position. Reclassification of financial statements for
earlier periods provided for comparative purposes is required. For
the years ended May 31, 1998 and 1997 and for the period January 1,
1996 to October 8, 1996, the Company had no sources of other
comprehensive income. For the year ended May 31, 1999, the Company's
investment in securitizations is classified as available for sale; as
such, in accordance with SFAS No. 115, the Company recognizes as other
comprehensive income the unrealized gains or losses for the difference
between the amortized cost and estimated fair value.
14. Reclassification
Certain reclassifications have been made to prior period amounts to
conform to the current period presentation.
15. Interim Period Information
The unaudited consolidated financial statements as of November 30, 1999
and for the six-month periods ended November 30, 1999 and 1998, have
been prepared in accordance with generally accepted accounting
principles for interim financial information and the instruction to
Form 10-Q and do not include all of the information and notes required
by generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments consisting of
normal recurring accruals considered necessary for a fair presentation
of the results for the interim period have been included.
16. Sale/Leaseback Transactions
The Company pools certain non-specialized fixed asset acquisitions and
periodically, sells and leases back the pooled assets at their
acquisition costs. There is no gain or loss recognized on these
transactions.
F-20
<PAGE> 86
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996 to
October 8, 1996 ("Predecessor"), and for the six months ended
November 30, 1999 and 1998 (unaudited)
NOTE C - INVESTMENTS IN NONPERFORMING CONSUMER DEBT AND CREDIT CARD RECEIVABLES
Investments in Nonperforming Consumer Debt
The Company acquires portfolios of nonperforming consumer installment debt,
credit card receivables, and automobile deficiency debt from originating
financial institutions. These debts are acquired at a substantial discount
from the actual consumer outstanding balance The remaining outstanding
balance of the debt acquired by the Company at November 30, 1999, May 31,
1999 and 1998 was approximately $2.6 billion, $2.0 billion and $1.8
billion, respectively. The Company's objective is to offer the consumer an
opportunity to settle these debts, typically at a discount, and transfer
the settled amount to a newly issued credit card. (See Credit Card
Receivables below.)
Investments in nonperforming consumer debt consist of:
<TABLE>
<CAPTION>
May 31,
NOVEMBER 30, ----------------------------
1999 1999 1998
------------- -------- --------
(unaudited)
<S> <C> <C> <C>
Cost of portfolios purchased including capitalized
acquisition costs of $2,144,041, $1,868,883
and $1,051,552 $ 42,762,175 $ 38,574,174 $ 29,951,694
Cost recovered (38,524,840) (35,557,477) (24,279,180)
------------ ------------ ------------
Investment in nonperforming consumer debt $ 4,237,335 $ 3,016,697 $ 5,672,514
============ ============ ============
</TABLE>
Credit Card Receivables
Upon settlement of the debt, a credit card is issued to the consumer with
the opening balance and credit line equal to the settlement amount. The
Company expenses origination costs including direct mail and telemarketing
costs as incurred. The cardholder upon settlement of the debt is issued a
credit card with an opening balance and credit line equal to the settlement
amount. The settlement amount represents the amount actually owed under the
new credit card with the cardholder. The Company does not record a credit
card asset until the cardholder begins to make new charges on the account.
For financial statement purposes the Company records as credit card
receivables, the amount funded on new advances and purchases, accrued
interest on new advances and accrued fees, less provision for losses on
credit card receivables and unearned fees. After making principal payments
on the transferred balance, the customer may use the credit card for new
purchases and cash advances up to their available credit limit, which may
be increased from time to time based on their consecutive payment history.
Total credit card balances in the chart below represent the total amount
owed to the Company by the cardholders. Available credit represents the
amount that the Company would be obligated to fund if the credit cards were
fully utilized by the cardholders.
F-21
<PAGE> 87
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996 to
October 8, 1996 ("Predecessor"), and for the six months ended
November 30, 1999 and 1998 (unaudited)
NOTE C (CONTINUED)
<TABLE>
<CAPTION>
May 31,
NOVEMBER 30, ----------------------------
1999 1999 1998
------------- -------- --------
(unaudited)
<S> <C> <C> <C>
Total credit card balances $65,828,285 $55,184,540 $74,096,668
=========== =========== ===========
Available credit $ 6,166,332 $ 4,296,364 $ 6,093,820
=========== =========== ===========
Principal funded on new advances and purchases $29,770,385 $21,303,274 $15,875,198
Accrued interest on principal funded 427,448 243,489 325,977
Accrued fees 383,047 332,446 623,607
----------- ----------- -----------
30,580,880 21,879,209 16,824,782
----------- ----------- -----------
Less
Provision for losses on credit card receivables 4,026,923 2,846,533 3,688,091
Unearned fees 533,313 401,273 216,721
------------ ----------- -----------
4,560,236 3,247,806 3,904,812
----------- ----------- -----------
Credit card receivables $26,020,644 $18,631,403 $12,919,970
=========== =========== ===========
</TABLE>
NOTE D - SECURITIZATION AND OTHER GAIN ON CREDIT CARD RECEIVABLE PORTFOLIOS
During the fiscal year ended May 31, 1999, the Company completed three
securitizations of seasoned credit card receivables ("Receivables") of
approximately $20.4 million with three unconsolidated wholly-owned
qualified special purpose entities ("SPE's"). All credit card receivables
sold in these transactions were current with a minimum of eight payments
made on each account. The SPE's each issued a senior debt interest owed to
third parties and retained a residual interest. The SPE's purchased the
Receivables from the Company for $17.3 million, which was funded with the
sale of senior debt interest. The remaining $4.3 million represented
residual interest retained by the SPE.
F-22
<PAGE> 88
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996 to
October 8, 1996 ("Predecessor"), and for the six months ended
November 30, 1999 and 1998 (unaudited)
NOTE D (CONTINUED)
The senior debt beneficial interest for the first two SPEs have revolving
periods of 18 months during which, after fees and interest are paid, excess
cash collections can be used by the SPE's to purchase new receivables
arising under existing accounts or, in certain cases, receivables arising
in new credit card accounts from the Company. The revolving period is
followed by a maximum 21 month amortization period. The interest rate is
11.5% fixed for the first 12 months and Prime plus 2.5% thereafter. During
the amortization period, all cash collections relating to the senior debt
interest in the Receivables are used to repay principal, after the payment-
related servicing fees and interest payments are made. The senior debt
beneficial interest for the third SPE has a "revolving period" of 12 months
followed by a maximum 24-month amortization period. The interest rate is
10.5% fixed for the first 12 months and Prime plus 2.5% thereafter.
All new charges on the sold accounts are either sold to the SPEs at fair
value or contributed to the SPE as an additional capital contribution.
While the senior debt beneficial interest is in place, there are
restrictions on payments that can be made by the Company, as the Servicer
of the accounts, to certain related parties. The sole obligor for the
senior debt beneficial interests are the SPEs and the senior debt
beneficial interest holders have no direct recourse to the Company for
repayment of the debt.
Under the provisions of SFAS No. 125, the securitizations are accounted for
as sales. As a result, the Company recognized a pre-tax gain of
approximately $8 million and recorded a retained interest in securitized
credit card receivables on an allocated basis in the amount of
approximately $1.3 million based on its relative fair value as discussed in
Note B.
- At May 31, 1999, the allocated basis amount was adjusted to a fair
value of approximately $5.1 million, resulting in approximately $3.8
million of unrealized gain on the retained interest in securitized
credit card receivables. The unrealized gain was recorded net of tax of
approximately $1.3 million, resulting in approximately $2.5 million, as
a separate component of stockholders' equity and approximately $2.5
million as a component of the consolidated statement of operations and
comprehensive income (loss), respectively. In estimating the fair value
of the retained interest, the company calculates the present value of
all projected net cash flows from the credit cards reduced by servicing
costs and an annualized default rate of 12%. Further, the net cash flows
after defaults and servicing costs were discounted by an annualized
interest rate of 23%. The discount rate was arrived at by comparison to
the market rate on investments of similar risk and term that are
available for the company to invest in. During November 1999, the
Company sold its residual interest in the three SPE's to the Lender for
approximately $8.6 million, resulting in a pre-tax gain of approximately
$6.5 million.
In accordance with the terms of the securitization, the Company deposited
$962,000 in a spread account with a third-party bank to be used as the
reserve for the benefit of the senior debt interest in the SPE's. This
amount was released to the Company when it sold its residual interest in
the SPE's in November 1999.
As of May 31, 1999, the Company included $1,230,700 in amounts due from
SPE's representing funds advanced with respect to revolving period
requirements and servicing fee income which are paid to the Company on a
monthly basis.
During the year ended May 31, 1999, The Company also sold a portfolio of
receivables with a total credit card balance of $7 million and a carrying
value of $2.25 million for $5 million to an unrelated party without
recourse.
F-23
<PAGE> 89
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996 to
October 8, 1996 ("Predecessor"), and for the six months ended
November 30, 1999 and 1998 (unaudited)
NOTE E - PROPERTY AND EQUIPMENT
Property and equipment consist of the following at:
<TABLE>
<CAPTION>
Useful May 31,
life NOVEMBER 30, ----------------------------
(in years) 1999 1999 1998
---------- ------------- -------- --------
(unaudited)
<S> <C> <C> <C> <C>
Computer equipment and
Software 3 - 5 $ 6,687,832 $ 6,631,043 $ 6,063,242
Office equipment 5 - 7 2,280,037 2,275,037 2,271,184
Furniture and fixtures 5 - 7 1,197,582 1,183,400 1,105,230
Proprietary software 5 460,497 460,497
Leasehold improvements Life of leases 654,475 654,475 622,207
----------- ----------- -----------
11,280,423 11,204,452 10,061,863
Less accumulated depreciation
and amortization (6,432,571) (5,202,266) (2,795,673)
----------- ------------ -----------
4,847,852 6,002,186 7,266,190
----------- ----------- -----------
Land 130,426 130,426 130,426
----------- ----------- -----------
$ 4,978,278 $ 6,132,612 $ 7,396,616
=========== =========== ===========
</TABLE>
NOTE F - NOTES PAYABLE
Notes payable consist of the following:
<TABLE>
<CAPTION>
May 31,
NOVEMBER 30, ----------------------------
1999 1999 1998
------------- -------- --------
<S> <C> <C> <C>
Note payable - bank $ 4,958,516 $3,644,776 $4,630,890
Note payable - other lenders 8,527,337 2,217,714 944,099
Note payable - previous owner 164,134 224,276 327,052
----------- ---------- ----------
$13,649,987 $6,086,766 $5,902,041
=========== ========== ==========
</TABLE>
F-24
<PAGE> 90
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996 to
October 8, 1996 ("Predecessor"), and for the six months ended
November 30, 1999 and 1998 (unaudited)
NOTE F (CONTINUED)
Note Payable - Bank
On April 30, 1998, the Company entered into a financing agreement with a
bank. The revolving line of credit, which may not exceed $5,000,000 or 35%
of the Company's eligible receivables as defined by the agreement, is used
for general working capital purposes. This line is collateralized by
substantially all of the Company's assets. Interest is charged at the prime
rate plus 2.75% per annum. On June 25, 1999, the rate was reduced to prime
rate plus 2.5% per annum and the line of credit increased to $10,000,000.
The agreement is in effect until July 29, 2001. Interest expense for the
six months ended November 30, 1999 and 1998 and for the years ended May 31,
1999 and 1998 was $477,799, $320,986, $617,249 and $27,936, respectively.
Note Payable - Other Lenders
The Company has uncollateralized installment notes with respect to
purchases of nonperforming consumer debt in addition to assuming
installment obligations from the closing of certain affiliated mortgage
companies (see Note L). The notes have various maturity dates through May
2002, with interest rates ranging up to 23.7%. The amount outstanding as of
November 30, 1999, May 31, 1999 and 1998 was $2,979,741, $2,217,714 and
$944,099, respectively. Interest expense for the six months ended November
30, 1999 and 1998, and the years ended May 31, 1999, 1998 and 1997 was
$23,705, $30,178, $65,353, $51,925 and $0, respectively. On October 15,
1999, the Company, through a bankruptcy remote special purpose entity
(SPE), entered into a revolving line of credit ("revolving line") with a
financial institution. The revolving line, which may not exceed
$17,500,000, is non-recourse to the Company and is secured by all assets of
the SPE. The revolving line is used to acquire non-performing consumer debt
portfolios. The Company services the accounts subject to a agreement with
the SPE and purchases all newly originated credit card accounts for a
pre-determined price. The SPE is not a Qualified SPE for accounting
purposes and is fully consolidated with the Company in the accompanying
financial statements. Interest is charged at a floating daily rate and is
equal to the reference rate plus 2.5% per annum. The agreement is in effect
until August 31, 2002. The amount outstanding as of November 30, 1999 was
$2,547,596. Interest expense from October 15, 1999 to November 30, 1999 was
$29,691.
On September 20, 1999, the Company entered into a repurchase agreement with
a bank. Under the agreement the bank purchased credit card receivables from
the Company for a purchase price of $3 million. . The agreement had an
initial repurchase date of December 20, 1999 and was extended by the
Company for an additional 90 days upon payment to the bank of $15,000. For
accounting purposes the repurchase agreement was treated as a $3 million
financing transaction. Interest is charged at a rate of 15% per annum.
Interest expense for the six months ended November 30, 1999 was $88,750.
F-25
<PAGE> 91
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996 to
October 8, 1996 ("Predecessor"), and for the six months ended
November 30, 1999 and 1998 (unaudited)
NOTE F (CONTINUED)
Note Payable - Previous Owner
The Company assumed debt of the Selling Entities representing part of their
purchase price of SOIC on January 2, 1996 (see Note K). Under the
agreement, the previous owner is being paid on a 10%, $550,000 note
collateralized by the stock of the Company payable in monthly installments
maturing February 2001. Interest expense for the six months ended November
30, 1999 and 1998, and for the years ended May 31, 1999, 1998 and 1997 and
for the period January 1, 1996 to October 8, 1996 of the "Predecessor" was
$9,973, $15,220, $25,769, $38,310 and $53,299 and $34,982, respectively.
At May 31, 1999, future minimum principal payments for all notes payable
were as follows:
<TABLE>
<CAPTION>
Year Amount
<S> <C>
2000 $1,575,964
2001 612,624
2002 3,898,178
----------
$6,086,766
==========
</TABLE>
NOTE G - CAPITAL LEASES
The Company leases computer equipment, furniture and fixtures under
long-term leases and has the option to purchase the equipment for a nominal
cost at the termination of the lease. Assets under capital leases have been
capitalized at a cost of $6,526,915, $6,526,915 and $6,501,777,
respectively, and have accumulated amortization of $4,432,456, $3,646,314
and $2,000,609, respectively, at November 30, 1999, May 31, 1999 and 1998.
F-26
<PAGE> 92
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996 to
October 8, 1996 ("Predecessor"), and for the six months ended
November 30, 1999 and 1998 (unaudited)
NOTE G (CONTINUED)
Future minimum lease payments for capitalized leases are as follows at May
31, 1999:
<TABLE>
<CAPTION>
Year Amount
<S> <C>
2000 $2,521,835
2001 1,429,304
2002 959,866
2003 85,570
----------
4,996,575
Less amount representing interest (951,034)
----------
$4,045,541
==========
</TABLE>
Amortization expense for assets under capital leases for the six months
ended November 30, 1999 and 1998, was $786,142 and $706,221, respectively,
and during fiscal 1999, 1998, 1997 and for the period January 1, 1996 to
October 8, 1996 was $1,645,705, $1,535,029, $126,606 and $69,000,
respectively.
NOTE H - STOCK OPTIONS AND STOCK-BASED COMPENSATION
1. Stock Options
The Board of Directors of the Company approved the Company's 1997 Stock
Option Plan (the "Plan"). The Plan authorizes the grant of stock
options covering 4,000,000 shares of the Company's common stock. In
addition, the Board of Directors has granted stock options outside the
Plan covering a total of 1,550,000 shares of Common Stock. The Board of
Directors has the authority to determine the key employees,
consultants, and directors who shall be granted options as well as the
number of options granted and the nature of each grant. The options
granted under the Plan may be either incentive stock options or
nonqualified stock options.
F-27
<PAGE> 93
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996
to October 8, 1996 ("Predecessor"), and for the six
months ended
November 30, 1999 and 1998 (unaudited)
NOTE H (CONTINUED)
Information regarding the stock options is summarized below:
<TABLE>
<CAPTION>
Year ended May 31,
-----------------------------------------------------
1999 1998
----------------------- ---------------------------
June 1, June 1, Weighted- Weighted-
1999 to 1998 to average average
November 30, November 30, Number exercise Number exercise
1999 1998 of options price of options price
------------ ----------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of
period 4,346,500 3,656,000 3,656,000 $ 2.93 2,550,000 $5.76
====== =====
Options granted 906,500 460,000 690,500 $ 2.35 3,021,000 (1) 2.45
Options modified/cancelled (1,915,000)(1) 5.93
--------- ---------- --------- ------ ---------- -----
Outstanding at end of period 5,253,000 4,116,000 4,346,500 $ 2.84 3,656,000 $2.93
========= ========== ========= ====== ========== =====
Exercisable at end of period 4,414,060 2,705,000 3,305,500 $ 3.08 2,395,000 $3.39
========= ========== ========= ====== ========== =====
<CAPTION>
Year ended May 31,
1997
------------------------
Weighted-
average
Number exercise
of options price
---------- ----------
<S> <C> <C>
Outstanding at beginning of
period
Options granted 2,550,000 $5.76
Options modified/cancelled
--------- -----
Outstanding at end of period 2,550,000 $5.76
========= =====
Exercisable at end of period
2,550,000 $5.76
========= =====
</TABLE>
(1) On December 15, 1997, the Board of Directors authorized the
modification of stock options c overing an aggregate of 1,915,000
shares of common stock adjusting the exercise price from $6.00 per
share to $2.00 per share. The affected stock option agreements
were cancelled and new options were issued containing identical
provisions other than the exercise price.
F-28
<PAGE> 94
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996
to October 8, 1996 ("Predecessor"), and for the six
months ended
November 30, 1999 and 1998 (unaudited)
NOTE H (CONTINUED)
2. Stock-Based Compensation
In October 1995, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 123 ("SFAS No. 123"),
"Accounting for Stock-Based Compensation," which established financial
accounting and reporting standards for stock-based compensation. The
new standard defines a fair value method of accounting for an employee
stock option or similar equity instrument. This statement gives
entities the choice between adopting the fair value method or
continuing to use the intrinsic value method under Accounting
Principles Board ("APB") Opinion No. 25 with footnote disclosures of
the pro forma effects as if the fair value method had been adopted. The
Company has opted for the latter approach. Accordingly, no compensation
expense has been recognized for stock options. Had compensation expense
for the Company's stock options been determined based on the fair value
at the grant date for awards for the six months ended November 30, 1999
and 1998 and for the years ended May 31, 1999, 1998 and 1997 consistent
with the provisions of SFAS No. 123, the Company's results of
operations would be the pro forma amounts indicated below.
<TABLE>
<CAPTION>
For the six For the years ended
months ended November 30, May 31,
--------------------------- ---------------------------------------
1999 1998 1999 1998 1997
--------- --------- --------- --------- -------
(unaudited)
<S> <C> <C> <C> <C> <C>
Net income (loss) applicable to common
shareholders:
- as reported $(473,459) $ (126,758) $2,075,681 $(29,845,027) $(14,412,952)
- pro forma (1,224,310) (1,144,531) 292,092 (30,508,257) (25,905,952)
Income per share - as reported
Basic $(.01) $(.00) $.06 $(.90) $ (.56)
Diluted $(.01) $(.00) $.05 $(.90) $ (.56)
===== ===== ==== ===== ======
Income per share - pro forma
Basic and diluted $(.04) $(.03) $.01 $(.92) $(1.00)
</TABLE>
F-29
<PAGE> 95
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996
to October 8, 1996 ("Predecessor"), and for the six
months ended
November 30, 1999 and 1998 (unaudited)
NOTE H (CONTINUED)
The fair value of each option grant is established on the date of grant
using the Black-Scholes option pricing model with the following
assumptions:
<TABLE>
<CAPTION>
For the six For the years ended
months ended November 30, May 31,
-------------------------- ------------------------------------------
1999 1998 1999 1998 1997
--------- --------- --------- --------- ----------
(unaudited)
<S> <C> <C> <C> <C> <C>
Expected dividend yield $ - $ - $ - $ - $ -
Expected stock price volatility 90% 90% 90% 120% 50%
Expected life of options 5 OR 10 YEARS 5 or 10 years 5 or 10 years 5 or 10 years 5 years
</TABLE>
F-30
<PAGE> 96
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996 to
October 8, 1996 ("Predecessor"), and for the six months ended
November 30, 1999 and 1998 (unaudited)
NOTE H (CONTINUED)
The risk-free interest rate used in the valuation of the option grants
ranged from 5.92% to 6.42% and 4.68% to 5.33% for the six months ended
November 30, 1999 and 1998, respectively, 4.80% to 5.47% for the year
ended May 31, 1999, 5.75% to 5.81% for the year ended May 31, 1998, and
was 4.50% for the year ended May 31, 1997, depending on the expiration
date of the options.
The weighted-average fair value of options granted during the six
months ended November 30, 1999 and 1998, was $2.08 and $2.00,
respectively, and during the years ended May 31, 1999, 1998, 1997 was
$1.70, $1.95 and $4.51, respectively. The Company granted stock options
whose weighted-average exercise price and weighted-average fair value
was $2.85 and $2.08, and $2.47 and $2.00, respectively, for the six
months ended November 30, 1999 and 1998 and $2.35 and $1.70,
respectively, for the years ended May 31, 1999 and 1998.
On April 30, 1998, the Company granted warrants to purchase 650,247
shares of the Company's common stock for $2.50 per share to the bank
with which it has a financing agreement. 278,677 of the shares were
exercisable immediately, while the remaining 371,570 were exercisable
on June 25, 1999, when the Company's line of credit increased to $10
million (see Note F). The fair value of the warrants was $1.01 at the
date of grant. For the six months ended November 30, 1999, amortization
expense was $359,648.
On March 18, 1999, the Company granted a five-year warrant to purchase
250,000 shares of the Company's common stock at $2.00 per share to a
vendor that the Company uses. The fair value of the warrant was $.85
per share. For the six months ended November 30, 1999, amortization
expense was $32,212.
F-31
<PAGE> 97
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996 to
October 8, 1996 ("Predecessor"), and for the six months ended
November 30, 1999 and 1998 (unaudited)
NOTE H (CONTINUED)
The following table summarizes information about stock options
outstanding at November 30, 1999, and May 31, 1999:
<TABLE>
<CAPTION>
Options outstanding Options exercisable Options outstanding Options exercisable
----------------------------------- ----------------------- ----------------------------------- ---------------------
Weighted- Weighted-
Number average Number Number average Number
outstanding remaining Weighted- Exercisable Weighted- outstanding remaining Weighted- exercisable Weighted-
Range of at contractual average At average at contractual average at average
exercise November 30, life exercise November 30, exercise May 31, life exercise May 31, exercise
prices 1999 (years) price 1999 price 1999 (years) price 1999 price
---------- --------- ---------- --------- --------- --------- ----------- ---------- --------- --------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
$2.00-$2.50 3,589,500 4.23 $2.09 3,130,060 $2.07 3,086,500 4.68 $2.03 2,050,500 $2.01
2.51- 3.00 373,500 3.86 2.74 331,500 2.71 310,000 4.19 2.71 305,000 2.70
3.01- 5.50 1,290,000 3.37 4.98 952,500 5.50 950,000 3.29 5.50 950,000 5.50
--------- ---------- ---------- ---------
5,253,000 3.99 $2.84 4,414,060 $2.86 4,346,500 4.34 $2.84 3,305,500 $3.08
========= ========= ========= =========
</TABLE>
F-32
<PAGE> 98
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996 to
October 8, 1996 ("Predecessor"), and for the six months ended
November 30, 1999 and 1998 (unaudited)
NOTE I - INCOME TAXES
Deferred income tax assets (liabilities) consist of the following:
<TABLE>
<CAPTION>
For the six
months ended November 30,
--------------------------
1999 1998
--------- ---------
(unaudited)
<S> <C> <C>
Deferred tax assets
Net operating loss carryforward $ 16,463,065 $ 596,332
Allowance for doubtful accounts 1,622,951 14,236,334
------------ ------------
Total deferred tax assets 18,086,016 14,832,666
Less valuation allowance (13,356,648) (14,832,666)
------------ ------------
Net deferred tax asset 4,729,368 100,000
Deferred tax liabilities
Gain on sales of portfolios (4,029,368)
Unrealized gain on retained
interest in securitization
------------ ------------
Net deferred tax liabilities (4,029,368)
------------ ------------
Net deferred tax asset $ 700,000 $ 100,000
============ ============
<CAPTION>
January 1,
For the years ended 1996 to
May 31, October 8,
---------------------------------------- 1996
1999 1998 1997 ("Predecessor")
----------- ---------- ---------- ---------------
<S> <C> <C> <C> <C>
Deferred tax assets
Net operating loss carryforward $ 17,065,146 $ 13,676,297 $ 4,637,024 $ 657,000
Allowance for doubtful accounts 1,221,619 1,519,160 366,000
------------ ------------ -----------
Total deferred tax assets 18,286,765 15,195,457 5,003,024 657,000
Less valuation allowance (12,270,988) (15,195,457) (5,003,024) (237,000)
------------ ------------ ----------- ---------
Net deferred tax asset 6,015,777 - -
Deferred tax liabilities
Gain on sales of portfolios (4,029,368) (420,000)
Unrealized gain on retained
interest in securitization (1,286,409)
------------
Net deferred tax liabilities (5,315,777) - - -
------------ ------------ ----------- ---------
Net deferred tax asset $ 700,000 $ - $ - $ -
============ ============ =========== =========
</TABLE>
F-33
<PAGE> 99
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996 to
October 8, 1996 ("Predecessor"), and for the six months ended
November 30, 1999 and 1998 (unaudited)
NOTE I (CONTINUED)
The difference between the total income tax benefit and the income tax
expense computed using the applicable Federal income tax rate was as
follows:
<TABLE>
<CAPTION>
January 1,
For the six For the years ended 1996 to
months ended November 30, May 31, October 8,
-------------------------- ---------------------------------------- 1996
1999 1998 1999 1998 1997 ("Predecessor")
---------- ---------- ----------- ---------- ---------- ---------------
(unaudited)
<S> <C> <C> <C> <C> <C> <C>
Computed Federal income
taxes at 34% 616,403 194,902 $ 642,352 $(10,011,311) $(4,897,888) $(657,000)
Increase (release) of
deferred tax asset
valuation allowance 670,006 (294,902) (2,628,761) 10,011,311 4,897,888 236,720
----------- ---------- ----------- ------------ ----------- ---------
Income tax (benefit)/expense $ 1,286,409 $ (100,000) $(1,986,409) $ - $ - $(420,280)
=========== ========== =========== ============ =========== =========
</TABLE>
F-34
<PAGE> 100
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996
to October 8, 1996 ("Predecessor"), and for the six
months ended
November 30, 1999 and 1998 (unaudited)
NOTE I (CONTINUED)
At November 30, 1999 and May 31, 1999 the Company has a net operating loss
carryforward available to offset future taxable income of approximately
$49,000,000, $49,500,000 and $43,000,000, respectively, which will begin to
expire in 2012. The benefit of the net operating loss carryforwards is
dependent upon the tax laws in effect at the time the net operating loss
carryforwards are to be utilized and the change of control rules.
The Company has provided a valuation allowance against the net operating
losses and the provision for bad debts. The Company continually reviews
the adequacy of the valuation allowance and recognizes those benefits only
as the Company's assessment indicates that it is more likely than not that
future tax benefits will be realized. Since inception the Company has
experienced losses except for in the current year and as a result the
Company has recorded a $700,000 benefit which it believes is more likely
than not to be realized.
NOTE J - EMPLOYEE BENEFIT PLANS
In January 1998, the Company adopted a defined contribution 401(k)
profit-sharing plan for its employees. All employees working at least 1,000
hours per year are eligible to participate in the plan. Employees could
contribute up to 15% of their salary up to $10,000 and $9,500 for the
calendar years 1999 and 1998, respectively. The plan requires the employer
to match 100% of the first 3% of compensation contributed to the plan by
the employees. Employer contributions vest at a rate of 20% per year.
Additional employer contributions are allowable at the discretion of the
Board of Directors. The contributions to this plan by the Company at
November 30, 1999 and 1998, and at May 31, 1999 and 1998 was $169,768,
$153,753, $79,958 and $84,573, respectively.
Prior to January 1998, employees of the Company participated in the defined
contribution profit sharing plan of Service One International Corporation
Employee Savings Plan, a wholly-owned subsidiary of the Company. This plan
contained the same terms and provisions as the Company's current plan
except that the employer contribution was 100% of the first 1% of employee
contributions. Contributions by the Company to this plan were $12,342 and
$7,912 for the years ended May 31, 1998 and 1997, respectively. The assets
of this plan were transferred into the new plan as of January 1, 1998.
NOTE K - MUTUAL BUSINESS DEVELOPMENT AGREEMENTS
The Selling Entities entered into Mutual Business Development Agreements
("Development Agreements") in connection with the sale of Holdings to
Taxter. Pursuant to the terms of the
F-35
<PAGE> 101
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996
to October 8, 1996 ("Predecessor"), and for the six
months ended
November 30, 1999 and 1998 (unaudited)
NOTE K (CONTINUED)
Development Agreements, SOIC agreed to pay a base fee of $510,000 to each
Selling Entity (which was paid in its entirety by May 31, 1998) and a
royalty equal to five percent of the balance transfer amount, as defined,
on all converted credit card accounts which: (i) are delivered to a
pre-securitization credit facility, (ii) become a qualifying receivable, or
(iii) meet other specified account age and payment parameters. A qualifying
receivable is defined as any converted account on which the cardholder has
made three consecutive payments within certain time restrictions. In
addition, the Company is required to pay royalties equal to five percent of
all principal cash collections on certain accounts that are not converted
to credit cards. The term of each of the Development Agreements is six
years and the total royalty, if earned, payable to each of the Selling
Entities, after certain deductions and exclusions, shall not exceed
$25,000,000. For the six months ended November 30, 1999 and for the years
ended May 31, 1999, 1998 and 1997, $181,493, $1,541,944, $207,238 and
$1,229,180, respectively, of royalty expenses were incurred with $28,568,
$702,075, and $261,667, payable at November 30, 1999, May 31, 1999 and
1998, respectively, under the Development Agreements. One of the
Development Agreements was amended on September 1, 1998. The amendment
clarifies the amount and timing of payments, gives the Company a buyout
option and alternate royalty payment options, and extends the term of the
agreement to May 31, 2005. The Company, which assumed the obligations of
its predecessor SOIC, assumed SOIC's liabilities under the Development
Agreements.
Taxter, as part of the purchase price of acquiring Holdings, granted the
Selling Entities a future interest in Holdings in the form of an identical
option to each selling entity to purchase 2,000 shares each of Holdings
from Taxter for $500,000. Following the acquisition of Holdings by the
Company, these options were amended to enable the Selling Entities to
purchase 4,000,000 shares each of the Company's common stock and 400,000
shares each of the Company's Series B Preferred Stock for $500,000.
NOTE L - RELATED PARTY TRANSACTIONS
During fiscal year 1998, the Company issued subordinated promissory notes
to JLB of Nevada, Inc. ("JLB"), an entity wholly owned by Jay L. Botchman
("Botchman"), totalling $40,000,000 payable on demand with interest of 12%
per annum. Of the new notes, $30,000,000 was issued in exchange for
outstanding notes totaling $11,518,042 which carried an interest rate of
12% per annum and
F-36
<PAGE> 102
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996
to October 8, 1996 ("Predecessor"), and for the six
months ended
November 30, 1999 and 1998 (unaudited)
NOTE L (CONTINUED)
$18,481,958 in new debt. Interest expense on these notes was $2,307,467,
$3,635,891 and $419,942 for the years ended May 31, 1999, 1998 and 1997,
respectively. On May 29, 1999, JLB, in lieu of payment of $5,000,000 of
interest on these subordinated notes, received a warrant to purchase
4,000,000 shares of the Company's common stock with an exercise price of
$3.25 per share, expiring on May 29, 2004 and the Company's assumption of
equipment and related lease obligations from a company affiliated with JLB
in the amount of approximately $1.7 million. The fair value of the warrant
was approximately $3.3 million. Accrued interest related to subordinated
notes payable to JLB was approximately $2.0, $1.3 and $4.0 million,
respectively, at November 30, 1999, May 31, 1999 and 1998. The notes are
secured by substantially all the Company's assets, but subordinated to the
Company's revolving credit line.
On February 27, 1998, the Company issued a subordinated promissory note
payable to Botchman in the amount of $350,000 payable on demand with
interest at 12% per annum. Interest expense for the six months ended
November 30, 1999 and 1998 and for the years ended May 31, 1999 and May 31,
1998 was $18,200, $21,350, $42,583 and $10,733, respectively. This note was
issued per an agreement dated February 27, 1998 between Botchman and the
Company. As part of the terms of the agreement, the Company agreed to
purchase an interest in certain investment securities, owned by Botchman,
of a subprime mortgage banking company. The Company has fully written off
this investment in the amount of $350,000 as of May 31, 1998. In addition,
the Company had a receivable due from this company of approximately
$189,000, which has also been written off as of May 31, 1998.
The Company, through its wholly-owned subsidiary, American Credit Alliance,
Inc., has an $880,000 note payable to JLB with an interest rate of 10% per
annum. American Credit Alliance Inc. is the managing member of Dakota Card
Fund II, LLC ("DCF") and owns 50% of the membership interests in DCF , an
entity that owns performing credit card receivables. Interest expense for
the six months ended November 30, 1999 and 1998 and for the years ended May
31, 1999 and May 31, 1998 was $44,733, $44,733, $89,222 and $85,195,
respectively.
The Company made a series of investments, during the period May 1997
through December 1997, amounting to $508,600 in a subprime mortgage banking
company affiliated with JLB. At May 31, 1998, there was substantial doubt
regarding this company's ability to continue as a going concern. The
Company had fully written off its investment in this company. In addition,
the Company had a receivable due from this company of approximately
$183,000, which has also been written off as of May 31, 1998.
F-37
<PAGE> 103
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996
to October 8, 1996 ("Predecessor"), and for the six
months ended
November 30, 1999 and 1998 (unaudited)
NOTE L (CONTINUED)
The Series A and B Preferred Shares were issued at $1.00 per share (total
of $2,000.00) for all of Taxter's shares of Holdings described in Note A.
The Series A Preferred Stock, as a class, has 80% of the voting rights in
the Company. The Series B Preferred Stock has one vote per share. The
shares of Series A and B Preferred Stock have a liquidation preference of
$1.00 per share and will earn cumulative dividends at a rate of 5% per
annum. After five years, (i) the Series A and B Preferred Stock will be
redeemable at the option of the Company, and (ii) while the Series B
Preferred Stock is outstanding will be convertible at the option of the
holder into Series A Preferred Stock on a share-for-share basis.
On December 31, 1996, the Company issued 5,000 shares of Series C Preferred
Stock to Taxter for $5,000,000. The Series C Preferred Stock is non-voting
and will earn cumulative dividends at 6% per annum. The shares have a
liquidation preference of $1,000 per share. The Series A and B Preferred
Stock ranks senior to the Series C with respect to dividend and liquidation
rights.
On May 29, 1998, the Company issued 10,000 shares of Series D Preferred
Stock to JLB in exchange for cancellation of the $10,000,000 Promissory
Note dated August 1, 1997 payable by the Company to JLB. The Series D
Preferred Stock is non-voting and will earn a dividend of 8% per annum
payable annually on December 31. The series has a par value of $.001 per
share and a stated value of $1,000 per share. The shares have a liquidation
preference of $1,000 per share. The Series D Preferred Stock ranks senior
to the Series A, B and C with respect to dividend and liquidation rights.
Each share of Series D Preferred Stock is convertible into 380 shares of
common stock. The agreement grants JLB piggyback registration rights with
respect to the Common Stock issuable upon conversion of the shares of
Series D Preferred Stock.
On August 31, 1998, the Company issued 10,000 shares of Series E Preferred
Stock to JLB in exchange for JLB agreeing to cancel $10,000,000
subordinated promissory note. The Series E Preferred Stock is non-voting
and will earn a dividend of 8% per annum payable annually on December 31.
Each share of Series E Preferred Stock is convertible into 285 shares of
common stock at any time prior to August 31, 2001. The Series E Preferred
Stock ranks senior to the Series A, B, C and D with respect to dividend and
liquidation rights.
As of November 30, 1999, May 31, 1999, 1998 and 1997, accumulated preferred
dividends undeclared and unpaid on preferred stock amounted to
approximately $3.2 million, $2.2 million, $.4 million, and $7,000,
respectively.
F-38
<PAGE> 104
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996
to October 8, 1996 ("Predecessor"), and for the six
months ended
November 30, 1999 and 1998 (unaudited)
NOTE M - COMMITMENTS AND CONTINGENCIES
1. Operating Leases
The Company leases certain properties, vehicles and equipment under
noncancelable operating leases. Total lease rentals charged to
operations were approximately $392,123 and $361,936 for the six months
ended November 30, 1999 and 1998, respectively, and $766,832, $776,615,
and $349,383, for the years ended May 31, 1999, 1998 and 1997,
respectively. Future minimum lease payments under the noncancelable
operating leases are as follows at May 31:
Year ending May 31, Amount
- - - ------------------- ------
2000 $ 587,641
2001 361,697
2002 348,533
2003 295,103
2004 285,000
Thereafter 2,272,875
---------
$4,150,849
==========
2. Contingencies and Litigation
The Company, in the ordinary course of business, receives notices of
consumer complaints from regulatory agencies and is named as a
defendant in legal actions filed by those who have been solicited to
participate in its credit card programs. Currently pending against the
Company are: (i) three class actions on behalf of persons solicited by
the Company to open credit card accounts and voluntarily to repay debt
that had been discharged in bankruptcy, and (ii) four class actions
alleging violation of the Fair Debt Collection Practices Act and state
law in connection with mailers sent to prospective customers whose debt
was out-of-statute. The Company is defending itself vigorously in these
lawsuits. The Company does not believe that pending litigation and
regulatory complaints involving the Company will have a material
adverse effect on the consolidated financial position and results of
operations. However, a significant judgment against the Company in one
or more of the lawsuits could subject the Company to a monetary
judgement and/or require the Company to modify its methods of
operation, either of which could have a material adverse effect on the
Company's results of operations or financial condition.
F-39
<PAGE> 105
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996
to October 8, 1996 ("Predecessor"), and for the six
months ended
November 30, 1999 and 1998 (unaudited)
NOTE N - FAIR VALUE OF FINANCIAL INSTRUMENTS
The accompanying financial statements include various estimated fair value
information as of May 31, 1999, 1998 and 1997. As required by SFAS No. 107,
"Disclosures About Fair Value of Financial Instruments," such information,
which pertains to the Company's financial instruments, is based on the
requirements set forth in the statement and does not purport to represent
the aggregate net fair value of the Company. None of the Company's
financial instruments are held for trading purposes.
The following methods and assumptions were used to estimate the fair value
of each class of financial instrument for which it is practicable to
estimate fair value.
Cash
The carrying amount approximates fair value.
Trade Receivables
The carrying amount approximates fair value.
Investment in Nonperforming Consumer Debt
The Company records investments in nonperforming consumer debt at the cost
of the purchased portfolios, net of costs recovered. As the debt was
purchased at a significant discount, the value of these portfolios may be
significantly higher than presented in these financial statements. It was
not possible to estimate a fair value of these portfolios at May 31, 1998.
However, given the expanded market to trade these portfolios and the
Company's recent experience, the fair value at May 31, 1999 was estimated
using a net present value calculation of the cash flows the Company expects
to generate from these portfolios. The fair value at November 30, 1999 and
May 31, 1999 was approximately $12 million and $14.4 million in comparison
to its carrying value of approximately $2.4 million and $3.2 million,
respectively.
Credit Card Receivables
Credit card loans are originated with an initial interest rate of 18.9%. As
discussed in Note C, the settlement amount of the receivables exceeds the
credit card receivables reflected on the consolidated
F-40
<PAGE> 106
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996
to October 8, 1996 ("Predecessor"), and for the six
months ended
November 30, 1999 and 1998 (unaudited)
NOTE N (CONTINUED)
balance sheet. The Company did not feel it was possible to estimate the
fair value of the credit card receivables at May 31, 1998. Fair values at
November 30, 1999 and May 31, 1999 have been established based on a net
present value of the cash flows expected to be generated by the credit
cards for the Company. The Company applied its actual static pool
experience of repayment rates and defaults to estimate fair value. The fair
value at November 30, 1999 and May 31, 1999 was approximately $36.9 million
and $27.5 million in comparison to its carrying value of approximately
$24.5 million and $18.6 million, respectively.
Retained Interest in Securitized Credit Card Receivables
The carrying amount approximates fair value. Fair value is estimated by
discounting anticipated future cash flows using a discount rate based on
specific factors. The anticipated future cash flows are projected on a
"cash out" basis to reflect the restriction of cash flows until the
investors have been fully paid. At May 31, 1999, the carrying value of $5.1
million approximated fair value.
Notes Payable
The carrying amount approximates fair value. Rates currently available to
the Company for debt with similar terms and remaining maturities are used
to estimate the fair value of existing debt.
Subordinated Notes Payable
Due to the related party relationship of these notes, it is not practical
to estimate fair value.
Accounts Payable and Accrued Expenses
The carrying amount approximates fair value.
F-41
<PAGE> 107
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996
to October 8, 1996 ("Predecessor"), and for the six
months ended
November 30, 1999 and 1998 (unaudited)
NOTE O - EARNINGS PER SHARE
The weighted-average shares used in computing earnings per share were
34,761,965, 34,761,965, 34,761,965, 33,109,781, 25,912,465 and 5,000,000,
for the six months ended November 30, 1999 and 1998, and for the years
ended May 31, 1999, 1998, and 1997 and for the period January 1, 1996 to
October 8, 1996, respectively.
<TABLE>
<CAPTION>
November 30, May 31,
-------------------------- ----------------------------------------
1999 1998 1999 1998 1997
--------- --------- ----------- ---------- ----------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Basic earnings per share
Income (loss)
Income (loss) available to common
Stockholders $ (473,459) $ (126,758) $ 2,075,681 $(29,845,027) $(14,412,952)
============ ========== =========== =========== ===========
Weighted-average shares
outstanding 34,761,965 34,761,965 34,761,965 33,109,781 25,912,465
============ ========== ========== =========== ==========
Basic earnings (loss) per share $(.01) $(.00) $.06 $(.90) $(.56)
============ ========== ========== =========== ==========
Diluted earnings per share
Income (loss)
Income (loss) available to common
Stockholders $ (473,459) $ (126,758) $2,075,681 $(29,845,027) $(14,412,952)
============ ========== ========== =========== ===========
Weighted-average shares 34,761,965 34,761,965 34,761,965 33,109,781 25,912,465
outstanding
Effective of diluted securities * * 3,674,154 * *
options ------------ ---------- ---------- ----------- -----------
Weighted-average of diluted
shares outstanding 34,761,965 34,761,965 38,436,119 33,109,781 25,912,465
============ ========== ========== ========== ==========
Diluted earnings (loss) per share $(.01) $(.00) $.05 $(.90) $(.56)
============ ========== ========== ========== ===========
<CAPTION>
January 1,
1996 to
October 8,
1996
("Predecessor")
---------------
<S> <C>
Basic earnings per share
Income (loss)
Income (loss) available to common
Stockholders $(1,512,488)
==========
Weighted-average shares
outstanding 5,000,000
==========
Basic earnings (loss) per share $(.30)
==========
Diluted earnings per share
Income (loss)
Income (loss) available to common
Stockholders $(1,512,488)
==========
Weighted-average shares 5,000,000
outstanding
Effective of diluted securities
options *
----------
Weighted-average of diluted
shares outstanding 5,000,000
==========
Diluted earnings (loss) per share $(.30)
==========
</TABLE>
*Antidilutive.
F-42
<PAGE> 108
The Credit Store, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
May 31, 1999, 1998, 1997 and January 1, 1996
to October 8, 1996 ("Predecessor"), and for
the six months ended November 30, 1999 and
1998 (unaudited)
NOTE P - OTHER EXPENSES
The Company includes the following in other expenses:
<TABLE>
<CAPTION>
For the six For the years ended
months ended November 30, May 31,
1999 1998 1999 1998
-------------- ----------- ------------ -------------
(unaudited)
<S> <C> <C> <C> <C>
Travel, meals, and entertainment 343,738 288,196 591,054 756,157
Insurance 235,967 127,862 379,589 226,268
Technology expense 163,208 73,269 370,185 119,568
Printing 161,226 198,905 403,679 336,980
Repairs, maintenance, and equipment expense 155,578 152,277 350,629 448,831
License, fees, and subscriptions 92,142 53,980 153,840 147,015
Office supplies and utilities 84,206 99,389 176,452 284,693
Training and temporary labor 69,724 101,519 247,508 214,302
Miscellaneous expenses 272,677 367,926 474,462 155,596
------- ------- ------- --------
Total Other Expense $1,578,466 $1,463,323 $3,147,398 $2,689,410
========== ========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
For the years ended
May 31,
-------------
January 1,
1996 to
October 8,
1996
1997 ("Predecessor")
-------------- ---------------
<S> <C> <C>
Travel, meals, and entertainment 298,397 27,379
Insurance 60,916 754
Technology expense 257,790 5,342
Printing 285,511 270,742
Repairs, maintenance, and equipment expense 253,286 76,449
License, fees, and subscriptions 103,705 49,753
Office supplies and utilities 153,819 64,985
Training and temporary labor 41,388 114,148
Miscellaneous expenses 50,152 392,514
------- -------
Total Other Expense $1,504,964 $1,002,066
========== ==========
</TABLE>
F-43
