**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON,D.C. 20549**

 

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**FORM 10-Q**

 

**For the quarterly period ended March 31,2005**

 

**of**

 
| ** **                                           | **** |
|------------------------------------------------------|------|
| ** **                                           |
| **COMPUCREDIT CORPORATION**                          |
| ** **                                           |
| ** **                                           |
| a Georgia  Corporation                               |
| IRS Employer  Identification No.** 58-2336689** |
| SEC File  Number**0-25751**                          |
|                                                 |
| **245 Perimeter Center Parkway, Suite 600**          |
| **Atlanta, Georgia 30346**                           |
| **(770) 206-6200**                              |

 

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CompuCredit’s Common Stock, no par value pershare, is registered pursuant to Section 12(g) of the Securities ExchangeAct of 1934.

 

CompuCredit has (1) filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Actof 1934 during the preceding 12 months and (2) been subject to suchfiling requirements for the past 90 days.

 

CompuCredit is an accelerated filer (asdefined in Exchange Act Rule 12b-2).

 

As of April 30, 2005, 51,507,157 sharesof Common Stock, no par value, of the registrant were outstanding.

 

 

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COMPUCREDIT CORPORATIONFORM 10-QTABLE OF CONTENTSMarch 31, 2005

 
| PART I.  | FINANCIAL INFORMATION | **Page**                                                                                    |
|---------------|-----------------------|---------------------------------------------------------------------------------------------|
|          | Item 1.               | Financial Statements (Unaudited)                                                            |   |
|          |                  | Condensed Consolidated Balance Sheets                                                       | 1 |
|          |                  | Condensed Consolidated Statements of  Operations                                            | 2 |
|          |                  | Condensed Consolidated Statement of  Shareholders’ Equity                              | 3 |
|          |                  | Condensed Consolidated Statements of Cash  Flows                                            | 4 |
|          |                  | Notes to Condensed Consolidated Financial  Statements                                       | 5 |
|          | Item 2.               | Management’s Discussion and Analysis of  Financial Condition and Results of Operations | 18 |
|          | Item 3.               | Quantitative and Qualitative Disclosures  About Market Risk                                 | 34 |
|          | Item 4.               | Controls and Procedures                                                                     | 35 |
| PART II. | OTHER INFORMATION     |                                                                                        |
|          | Item 1.               | Legal Proceedings                                                                           | 36 |
|          | Item 2.               | Changes in Securities, Use of Proceeds and  Issuer Purchases of Equity Securities           | 36 |
|          | Item 3.               | Defaults Upon Senior Securities                                                             | 36 |
|          | Item 4.               | Submission of Matters to a Vote of Security  Holders                                        | 36 |
|          | Item 5.               | Other Information                                                                           | 36 |
|          | Item 6.               | Exhibits                                                                                    | 36 |
|          |                  | Signatures                                                                                  | 37 |

 

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**CompuCreditCorporation and Subsidiaries**

**Condensed Consolidated Balance Sheets**

 

 
| ** **                                                                                                                                                    | ** ** | **March 31,  2005**   | ** ** | **December 31,  2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                    | ** ** | **(Unaudited)**            | ** ** | ** **                  | ** ** |
| ** **                                                                                                                                                    | ** ** | **(Dollars in thousands)** | ** ** |
| **Assets**                                                                                                                                                    |       |                       |       |                        |       |
| Cash and  cash equivalents (including restricted cash of $11,776 at March 31, 2005  and $11,615 at December 31, 2004)                               |       | $                          | 90,400     |                        | $          | 68,240 |   |
| Securitized  earning assets                                                                                                                                   |       | 473,367                    |       | 536,718                     |       |
| Non-securitized  earning assets, net                                                                                                                          |       | 176,730                    |       | 158,430                     |       |
| Deferred  costs, net                                                                                                                                          |       | 31,081                     |       | 34,920                      |       |
| Software,  furniture, fixtures and equipment, net                                                                                                             |       | 34,298                     |       | 31,552                      |       |
| Investments  in equity-method investees                                                                                                                       |       | 60,744                     |       | 42,059                      |       |
| Intangibles,  net                                                                                                                                             |       | 10,699                     |       | 10,643                      |       |
| Goodwill                                                                                                                                                      |       | 108,465                    |       | 100,552                     |       |
| Prepaid  expenses and other assets                                                                                                                            |       | 22,789                     |       | 20,412                      |       |
| Total assets                                                                                                                                                  |       | $                          | 1,008,573  |                        | $          | 1,003,526 |   |
|                                                                                                                                                          |       |                       |       |                        |       |
| **Liabilities**                                                                                                                                               |       |                       |       |                        |       |
| Accounts  payable and accrued expenses                                                                                                                        |       | $                          | 38,724     |                        | $          | 36,088 |   |
| Notes  payable                                                                                                                                                |       | 79,547                     |       | 83,624                      |       |
| Deferred  revenue                                                                                                                                             |       | 5,735                      |       | 6,390                       |       |
| Deferred  gain on Fingerhut receivables                                                                                                                       |       | 17,635                     |       | 23,440                      |       |
| Current and  deferred income tax liabilities                                                                                                                  |       | 77,060                     |       | 115,786                     |       |
| Total  liabilities                                                                                                                                            |       | 218,701                    |       | 265,328                     |       |
|                                                                                                                                                          |       |                       |       |                        |       |
| Minority  interests                                                                                                                                           |       | 55,671                     |       | 54,308                      |       |
|                                                                                                                                                          |       |                       |       |                        |       |
| **Shareholders’  equity**                                                                                                                                |       |                       |       |                        |       |
| Common  stock, no par value, 150,000,000 shares authorized: 53,352,938 and 53,159,253  issued at March 31, 2005 and December 31, 2004, respectively |       | —                     |       | —                      |       |
| Additional  paid-in capital                                                                                                                                   |       | 309,379                    |       | 303,356                     |       |
| Treasury  stock, at cost, 1,845,781 and 1,914,646 shares at March 31, 2005 and December 31, 2004                                               |       | (26,358                    | )          | (26,721                     | )          |
| Deferred  compensation                                                                                                                                        |       | (6,177                     | )          | (922                        | )          |
| Warrant                                                                                                                                                       |       | 25,610                     |       | 25,610                      |       |
| Retained  earnings                                                                                                                                            |       | 431,747                    |       | 382,567                     |       |
| Total  shareholders’ equity                                                                                                                              |       | 734,201                    |       | 683,890                     |       |
| Total  liabilities and shareholders’ equity                                                                                                              |       | $                          | 1,008,573  |                        | $          | 1,003,526 |   |

 

See accompanying notes.

 

1

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**CompuCreditCorporation and Subsidiaries**

**Condensed Consolidated Statements ofOperations (Unaudited)**

 
| ** **                                                                                                         | ** ** | **For the three months ended March 31,**     | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                                         | ** ** | **2005**                                          | ** ** | **2004** | ** ** |
| ** **                                                                                                         | ** ** | **(In  thousands, except per  share data) ** | ** ** |
| Interest  Income:                                                                                                  |       |                                              |       |   |   |
| Consumer  loans, including past due fees                                                                           |       | $                                                 | 14,037     |   | $ | 6,032 |   |
| Other                                                                                                              |       | 2,912                                             |       | 1,673 |   |
| Total  interest income                                                                                             |       | 16,949                                            |       | 7,705 |   |
| Interest  expense                                                                                                  |       | (2,422                                            | )          | (91 | ) |
| Net interest  income before fees and other income on non-securitized earning assets and  provision for loan losses |       | 14,527                                            |       | 7,614 |   |
| Fees and  other income on non-securitized earning assets                                                           |       | 100,766                                           |       | 30,775 |   |
| Provision  for loan losses                                                                                         |       | (19,224                                           | )          | (9,115 | ) |
| Net interest  income, fees and other income on non-securitized earning assets                                      |       | 96,069                                            |       | 29,274 |   |
| Other  operating income:                                                                                           |       |                                              |       |   |   |
| Fees and  other income on securitized earning assets                                                               |       | 43,492                                            |       | 40,643 |   |
| Servicing  income                                                                                                  |       | 30,459                                            |       | 25,298 |   |
| Ancillary  and interchange revenues                                                                                |       | 5,533                                             |       | 4,238 |   |
| Equity in  income of equity-method investees                                                                       |       | 18,819                                            |       | (214 | ) |
| Total other  operating income                                                                                      |       | 98,303                                            |       | 69,965 |   |
| Other  operating expense:                                                                                          |       |                                              |       |   |   |
| Salaries and  benefits                                                                                             |       | 7,107                                             |       | 6,245 |   |
| Card and  loan servicing                                                                                           |       | 59,335                                            |       | 37,018 |   |
| Marketing  and solicitation                                                                                        |       | 18,050                                            |       | 5,699 |   |
| Depreciation                                                                                                       |       | 4,213                                             |       | 3,993 |   |
| Other                                                                                                              |       | 19,058                                            |       | 9,915 |   |
| Total other  operating expense                                                                                     |       | 107,763                                           |       | 62,870 |   |
| Income  before minority interests and income taxes                                                                 |       | 86,609                                            |       | 36,369 |   |
| Minority  interests                                                                                                |       | (9,161                                            | )          | (6,293 | ) |
| Income  before income taxes                                                                                        |       | 77,448                                            |       | 30,076 |   |
| Income taxes                                                                                                       |       | (28,268                                           | )          | (11,288 | ) |
| Net income                                                                                                         |       | $                                                 | 49,180     |   | $ | 18,788 |   |
| Net income  attributable to common shareholders                                                                    |       | $                                                 | 49,180     |   | $ | 17,718 |   |
| Net income  per common share-basic                                                                                 |       | $                                                 | 0.96       |   | $ | 0.36 |   |
| Net income  per common share-diluted                                                                               |       | $                                                 | 0.94       |   | $ | 0.36 |   |

 

See accompanying notes.

 

2

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**CompuCreditCorporation and Subsidiaries**

**Condensed Consolidated Statement ofShareholders’ Equity (Unaudited)**

**Forthe Three Months Ended March 31, 2005**

 
| ** **                                              | ** ** | ** **                 | ** ** | ** **  | ** ** | ** **           | ** ** | ** **   | ** ** | ** **       | ** ** | ** **   | ** ** | ** **             | ** ** | ** ** | ** ** |
|---------------------------------------------------------|------------|----------------------------|------------|-------------|------------|----------------------|------------|--------------|------------|------------------|------------|--------------|------------|------------------------|------------|------------|------------|
| ** **                                              | ** ** | ** **                 | ** ** | ** **  | ** ** | **Additional ** | ** ** | ** **   | ** ** | ** **       | ** ** | ** **   | ** ** | ** **             | ** ** | **Total**  | ** ** |
| ** **                                              | ** ** | **Common Stock**           | ** ** | **Paid-In** | ** ** | **Treasury**         | ** ** | **Deferred** | ** ** | ** **       | ** ** | **Retained** | ** ** | **Shareholders’** | ** ** |
| ** **                                              | ** ** | **Shares**                 | ** ** | **Amount**  | ** ** | **Capital**          | ** ** | **Stock**    | ** ** | **Compensation** | ** ** | **Warrant**  | ** ** | **Earnings**           | ** ** | **Equity** | ** ** |
| ** **                                              | ** ** | **(Dollars in thousands)** | ** ** |
| Balance at December 31,  2004                      |       | 53,159,253                 |       | $           | —     |                 | $          | 303,356      |       | $                | (26,721    | )            | $          | (922                   | )          | $          | 25,610     |   | $ | 382,567 |   | $ | 683,890 |   |
| Exercise of stock options,  including tax benefit       |       | 68,865                     |       | —      |       | 598                  |       | —       |       | —           |       | —       |       | —                 |       | 598        |       |
| Use of treasury stock to  satisfy stock option exercise |       | (68,865                    | )          | —      |       | (363                 | )          | 363          |       | —           |       | —       |       | —                 |       | —     |       |
| Issuance of restricted  stock                           |       | 193,685                    |       | —      |       | 5,788                |       | —       |       | (5,788           | )          | —       |       | —                 |       | —     |       |
| Amortization of deferred  compensation                  |       | —                     |       | —      |       | —               |       | —       |       | 533              |       | —       |       | —                 |       | 533        |       |
| Net income                                              |       | —                     |       | —      |       | —               |       | —       |       | —           |       | —       |       | 49,180                 |       | 49,180     |       |
| Balance at March 31,  2005                         |       | 53,352,938                 |       | $           | —     |                 | $          | 309,379      |       | $                | (26,358    | )            | $          | (6,177                 | )          | $          | 25,610     |   | $ | 431,747 |   | $ | 734,201 |   |

 

See accompanying notes.

 

3

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**CompuCreditCorporation and Subsidiaries**

**Condensed Consolidated Statements of CashFlows (Unaudited)**

 
| ** **                                                                         | ** ** | **For the three months  ended March 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2005**                                       | ** ** | **2004** | ** ** |
| ** **                                                                         | ** ** | **(Dollars in thousands)**                     | ** ** |
| ** **                                                                         | ** ** | ** **                                     | ** ** |
| **Operating  activities**                                                          |       |                                           |       |   |   |
| Net income                                                                         |       | $                                              | 49,180     |   | $ | 18,788 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                                           |       |   |   |
| Depreciation  expense                                                              |       | 4,213                                          |       | 3,993 |   |
| Provision  for loan losses                                                         |       | 19,224                                         |       | 9,115 |   |
| Amortization  expense                                                              |       | 999                                            |       | 778 |   |
| Amortization  of deferred gain                                                     |       | (5,804                                         | )          | (3,847 | ) |
| Amortization  of deferred compensation                                             |       | 533                                            |       | 105 |   |
| Minority  interest                                                                 |       | 9,161                                          |       | 6,293 |   |
| Retained  interests income adjustment, net                                         |       | 12,698                                         |       | (15,441 | ) |
| (Distributions  in excess of) income associated with equity-method investees       |       | (7,736                                         | )          | 215 |   |
| Changes in  assets and liabilities, exclusive of business acquisitions:            |       |                                           |       |   |   |
| Increase in  deferred costs                                                        |       | (2,424                                         | )          | (19,045 | ) |
| Decrease in  income tax liability                                                  |       | (38,726                                        | )          | (25,720 | ) |
| Increase in  uncollected fees on non-securitized earning assets                    |       | (19,678                                        | )          | (22,491 | ) |
| Other                                                                              |       | 769                                            |       | (1,797 | ) |
| Net cash  provided by (used in) operating activities                               |       | 22,409                                         |       | (49,054 | ) |
|                                                                               |       |                                           |       |   |   |
| **Investing  activities**                                                          |       |                                           |       |   |   |
| Investments  in equity-method investees                                            |       | (10,949                                        | )          | — |   |
| Investments  in securitized earning assets                                         |       | (24,927                                        | )          | (207,126 | ) |
| Proceeds  from securitized earning assets                                          |       | 80,904                                         |       | 220,083 |   |
| Investments  in non-securitized earning assets                                     |       | (178,752                                       | )          | (30,088 | ) |
| Proceeds  from non-securitized earning assets                                      |       | 162,511                                        |       | 23,476 |   |
| Acquisition  of sub-prime lender’s assets                                     |       | (12,138                                        | )          | — |   |
| Purchases of  and development of software, furniture, fixtures and equipment       |       | (4,228                                         | )          | (576 | ) |
| Net cash  provided by investing activities                                         |       | 12,421                                         |       | 5,769 |   |
|                                                                               |       |                                           |       |   |   |
| **Financing  activities**                                                          |       |                                           |       |   |   |
| Minority  interests (distribution) contribution, net                               |       | (7,799                                         | )          | 1,152 |   |
| Proceeds  from exercise of stock options                                           |       | 598                                            |       | 685 |   |
| Proceeds  from borrowings                                                          |       | 13,500                                         |       | 32,855 |   |
| Repayment of  borrowings                                                           |       | (18,969                                        | )          | (34,647 | ) |
| Net cash  (used in) provided by financing activities                               |       | (12,670                                        | )          | 45 |   |
|                                                                               |       |                                           |       |   |   |
| **Net  increase (decrease) in cash**                                               |       | 22,160                                         |       | (43,240 | ) |
| Cash and  cash equivalents at beginning of period                                  |       | 68,240                                         |       | 122,526 |   |
| Cash and  cash equivalents at end of period                                        |       | $                                              | 90,400     |   | $ | 79,286 |   |
|                                                                               |       |                                           |       |   |   |
| **Supplemental  cash flow information**                                            |       |                                           |       |   |   |
| Cash paid  for interest                                                            |       | $                                              | 2,204      |   | $ | 91 |   |
| Cash paid  for income taxes                                                        |       | $                                              | 66,975     |   | $ | 36,783 |   |
|                                                                               |       |                                           |       |   |   |
| **Supplemental  non-cash information**                                             |       |                                           |       |   |   |
| Issuance of  warrant                                                               |       | $                                              | —     |   | $ | 25,610 |   |
| Notes  payable associated with capital leases                                      |       | $                                              | 8,457      |   | $ | — |   |
| Notes  payable associated with bond investments                                    |       | $                                              | 6,737      |   | $ | 2,800 |   |
| Accretion of  preferred stock dividends                                            |       | $                                              | —     |   | $ | 1,066 |   |
| Issuance of  restricted stock                                                      |       | $                                              | 5,788      |   | $ | — |   |

See accompanying notes.

 

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**CompuCreditCorporation and Subsidiaries**

**Notes to Condensed Consolidated FinancialStatements (Unaudited)**

**March 31,2005**

 

**1.****                                      Descriptionof Business**

 

The accompanying unaudited condensedconsolidated financial statements include the accounts of CompuCreditCorporation and its consolidated subsidiaries (collectively, the “Company”).The Company is a provider of various credit and related financial services andproducts to, or associated with, the underserved (or sub-prime) and “un-banked”consumer markets. Historically, the Company has served these markets throughits marketing and solicitation of credit card accounts and its servicing ofvarious credit card receivables underlying both its originated accounts and itsacquired portfolios. Because only financial institutions can issuegeneral-purpose credit cards, the Company has contractual arrangements withthird-party financial institutions pursuant to which the financial institutionsissue general purpose Visa and MasterCard credit cards, and the Companypurchases the receivables relating to such accounts on a daily basis. TheCompany markets to cardholders other fee-based products, including cardregistration, memberships in preferred buying clubs, travel services, debtwaiver and credit life, disability and unemployment insurance. During 2003, theCompany expanded its product and service offerings to include the purchase andrecovery of previously charged off receivables. The Company further expandedits product and servicing offerings in 2004 to include its marketing, servicingand/or origination of small-balance, short-term loans (generally less than $500for less than 30 days, which the Company refers to as “micro-loans”) throughvarious channels, including retail branch locations, grocery and conveniencestores, direct marketing, telemarketing and the Internet. The Company alsoserves un-banked consumers through its offering of a stored-value (or debit)card through various retail branch locations. Finally, although not reflectedin these unaudited condensed financial statements, on April 1, 2005, theCompany completed its acquisition of a portfolio of consumer receivablessecured by automobiles and a platform for the origination and servicing ofthese loans.

 

TheCompany’s condensed consolidated financial statements have been prepared inaccordance with accounting principles generally accepted in the United Statesof America (“GAAP”) for interim financial information and with the instructionsto Form 10-Q and Article 10 of Securities and Exchange Commission (“SEC”)Regulation S-X. Accordingly, they do not include all of the informationand notes required by GAAP for complete consolidated financial statements. Inthe opinion of management, all normal recurring adjustments considerednecessary to fairly state the results for the interim periods presented havebeen included. The preparation of condensed consolidated financial statementsin conformity with accounting principles generally accepted in the UnitedStates of America requires management to make estimates and assumptions thataffect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements, aswell as the reported amounts of revenues and expenses during the reportingperiod. Actual results could differ from these estimates. Certain estimates,such as credit losses, payments, discount rates and the yield earned onsecuritized receivables, significantly affect the Company’s reported gains andlosses on securitizations and income from retained interests in credit cardreceivables securitized (both of which are components of fees and other incomeon securitized earning assets on the Company’s condensed consolidatedstatements of operations) and the Company’s reported value of securitizedearning assets on its condensed consolidated balance sheets. Additionally,estimates of future credit losses on the Company’s non-securitized loans andfees receivable have a significant impact on the provision for loan losseswithin the Company’s condensed consolidated statements of operations and loansand fees receivable, net, which is a component of non-securitized earningassets, net on the Company’s condensed consolidated balance sheets. Operatingresults for the three months ended March 31, 2005 are not necessarilyindicative of the results for the year ending December 31, 2005. Theseunaudited condensed consolidated financial statements should be read in 

 

5

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conjunctionwith the notes to the consolidated financial statements for the year ended December 31,2004 contained in the Company’s Annual Report on Form 10-K filed with theSEC.

 

Certain amounts in prior period financialstatements have been reclassified to conform to the current periodpresentation. The primary reclassification relates to combining securitized andnon-securitized earning assets and results and cash flows thereon on theCompany’s condensed consolidated balance sheets, statements of operations andstatements of cash flows. All significant intercompany balances andtransactions have been eliminated for financial reporting purposes.

 

**2.****                                      SignificantAccounting Policies**

 

The following is a summary of significantaccounting policies followed in preparation of the condensed consolidatedfinancial statements.

 

***Non-SecuritizedEarning Assets, Net***

 

Non-securitized earning assets, net on theCompany’s condensed consolidated balance sheets include loans and feesreceivable, net, investments in previously charged off receivables andinvestments in debt securities, each of which are discussed separately below.Details of non-securitized earning assets, net balances are as follows (inthousands of dollars):

 
| ** **                                         | ** ** | **Balance at  March, 31 2005** | ** ** | **Balance at  December 31, 2004** | ** ** |
|----------------------------------------------------|------------|--------------------------------|------------|----------------------------------------|------------|
| Loans and  fees receivable, net                    |       | $                              | 108,498    |                                   | $          | 94,055 |   |
| Investments  in previously charged off receivables |       | 18,134                         |       | 15,094                                 |       |
| Investments  in debt securities                    |       | 50,098                         |       | 49,281                                 |       |
| Non-securitized  earning assets, net               |       | $                              | 176,730    |                                   | $          | 158,430 |   |

 

***Loansand Fees Receivable, Net****.*  Loans and feesreceivable, net include receivables associated with the Company’s largelyfee-based credit card offering to consumers at the lower end of the FICOscoring range, which have not been securitized, as well as receivablesassociated with the Company’s micro-lending activities; these receivables areshown net of an allowance for uncollectible loans and fees. Loans and feesreceivable are also presented net of unearned fees (or “deferred revenue”) inaccordance with Statement of Financial Accounting Standards No. 91, “Accountingfor Nonrefundable Fees and Costs Associated with Originating or AcquiringReceivables and Initial Direct Costs of Leases.”

 

The loans and fees receivable associated withthe Company’s largely fee-based credit card offering to consumers at the lowerend of the FICO scoring range consist of finance charges and fees, as well asprincipal balances receivable from this class of customer. In addition tofinance charges on principal balances, the fees associated with this particularproduct offering consist principally of activation, annual, monthlymaintenance, over-limit, cash advance and returned check fees. The activationfees are recognized over the estimated life of a customer (approximately oneyear), and the annual fees are recognized over the year to which they apply.The loans and fees receivable associated with the Company’s micro-lending activitiesinclude principal balances and associated fees due from consumers, as well asmarketing and servicing fees receivable from a third-party financialinstitution; these fees are recognized as earned—generally over a two-weekperiod.

 

The allowance for uncollectible loans andfees is provided for that portion of the loans and fees receivable thatmanagement believes will not ultimately be collected based on historicalexperience. The components of loans and fees receivable, net are as follows (inmillions of dollars):

 
| ** **                                  | ** ** | **Balance at  December 31, 2004** | ** ** | **Additions** | ** ** | **Subtractions** | ** ** | **Sub-prime Lender  Acquisitions** | ** ** | **Balance at  March 31, 2005** | ** ** |
|---------------------------------------------|------------|----------------------------------------|------------|---------------|------------|------------------|------------|------------------------------------|------------|-------------------------------------|------------|
| Loans and  fees receivable, gross           |       | $                                      | 145.2      |          | $          | 221.0            |       | $                                  | (203.1)    |                                | $          | 2.3 |   | $ | 165.4 |   |
| Deferred  revenue                           |       | (22.0                                  | )          | (28.4         | )          | 17.1             |       | —                             |       | (33.3                               | )          |
| Allowance  for uncollectible loans and fees |       | (29.1                                  | )          | (19.2         | )          | 24.7             |       | —                             |       | (23.6                               | )          |
| Loans and  fees receivable, net             |       | $                                      | 94.1       |          | $          | 173.4            |       | $                                  | (161.3     | )                                   | $          | 2.3 |   | $ | 108.5 |   |

 

6

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Reflected in interest income on the condensedconsolidated statements of operations is $14.0 million and$6.0 million of finance charge income associated with these loans and feesreceivable for the three months ended March 31, 2005 and 2004,respectively. Reflected in fees and other income from non-securitized earningassets is $48.6 million and $16.7 million of fee income associatedwith these loans and fees receivable for the three months ended March 31,2005 and 2004, respectively. As of March 31, 2005, the weighted-averageremaining amortization period for the $33.3 million of deferred revenuereflected in the above table was 7.4 months.

 

***Investmentsin Previously Charged Off Receivables.***  For the three months ended March 31,2005, the following table shows a roll-forward of the Company’s investments inpreviously charged off receivables activities (in thousands of dollars):

 
| Unrecovered  balance at December 31, 2004                                                                                                                                                        |   | $       | 15,094 |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------|--------|--------|
| Acquisitions  of defaulted accounts                                                                                                                                                                   |   | 10,323  |   |
| Cash  collections                                                                                                                                                                                     |   | (24,791 | )      |
| Income  recognized on defaulted accounts (included as a component of fees and other  income on non-securitized earning assets on the Company’s condensed  consolidated statements of operations) |   | 17,508  |   |
| Balance at March 31,  2005                                                                                                                                                                       |   | $       | 18,134 |   |
| Estimated  remaining collections (“ERC”)                                                                                                                                                    |   | $       | 64,616 |   |

 

At the time of acquisition, the life of eachpool generally is estimated to be between 24 and 36 months based upon theproprietary models of the Company. The Company anticipates collectingapproximately 60.0% of the ERC over the next twelve months, with the balance tobe collected thereafter.

 

***Investmentsin Debt Securities.*** The Company periodicallyinvests in the open market in debt securities that the Company feels willprovide it with an adequate return. Generally, these debt securities will bepurchased outright or partially funded using existing margin accounts (seeNote 9, “Notes Payable,” below). The Company’s purchased debt securitiesgenerally are classified as trading securities. Additionally, the Company hasoccasionally received distributions of debt securities from its equity-methodinvestees; the Company has classified such distributed debt securities as heldto maturity.

 

***Stock Options***

 

The Company has five stock-based employeecompensation plans (an employee stock purchase plan, three stock option plansand a restricted stock plan). As permitted by Statement of Financial AccountingStandards No. 123, “Accounting for Stock-Based Compensation” (“StatementNo. 123”), the Company accounts for its stock option plans under therecognition and measurement principles of Accounting Principles Board OpinionNo. 25, “Accounting for Stock Issued to Employees” (“APB 25”), and itsrelated interpretations. Because all options granted under the Company’s stockoption plans had an exercise price equal to the market value of the underlyingcommon stock on the date of grant, no stock-based compensation cost isreflected in net income under the Company’s application of APB 25. The Companyissued no stock options during the three months ended March 31, 2005.

 

The following table presents the effects onnet income and net income per share if the Company had recognized compensationexpense under the fair value recognition provisions of Statement No. 123:

 

7

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| ** **                                                                               | ** ** | **For the three months  ended March 31,** | ** ** |
|------------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                               | ** ** | **2005**                                       | ** ** | **2004** | ** ** |
| ** **                                                                               | ** ** | **(In thousands, except   per share data)**    | ** ** |
| Net income  attributable to common shareholders, as reported                             |       | $                                              | 49,180     |   | $ | 17,718 |   |
| Stock-based  employee compensation expense determined under fair value basis, net of tax |       | (189                                           | )          | (165 | ) |
| Pro-forma  net income (loss)                                                             |       | $                                              | 48,991     |   | $ | 17,553 |   |
| Earnings per  share:                                                                     |       |                                           |       |   |   |
| Basic—as  reported                                                                  |       | $                                              | 0.96       |   | $ | 0.36 |   |
| Basic—pro-forma                                                                     |       | $                                              | 0.96       |   | $ | 0.36 |   |
| Diluted—as  reported                                                                |       | $                                              | 0.94       |   | $ | 0.36 |   |
| Diluted—pro-forma                                                                   |       | $                                              | 0.93       |   | $ | 0.35 |   |

 

**Due to avariety of factors, including the timing and number of awards, the abovepro-forma results may not be indicative of the future effect of stock optionexpensing on the Company’s results of operations. The Company issued no stockoptions during the three months ended March 31, 2005.**

 

In December 2004, the FASB issued arevised Statement of Financial Accounting Standards 123, “Share Based Payment”(“Statement No. 123R”), to address the accounting for stock-based employeeplans. The statement eliminates the ability to account for share-basedcompensation transactions using APB 25 and instead requires that suchtransactions be accounted for using a fair-value-based method of accounting.The adoption of this statement will result in income statement effects similarto those reflected in the above pro-forma computations. Statement No. 123Ris effective for interim and annual reporting beginning after December 15,2005, and the adoption of this statement is not expected to have a materialeffect on the Company’s financial statements.

 

**3.****                                      SegmentReporting**

 

The Company operates primarily within oneindustry consisting of four reportable segments by which it manages itsbusiness. The Company’s four reportable segments are: Credit Cards; Investmentsin Previously Charged Off Receivables; Retail Micro-Lending and Servicing; andOther.

 

The Company measures the profitability of itsreportable segments based on their income after allocation of specific costsand corporate overhead. Overhead costs are allocated based on headcounts andother applicable measures in order to better align costs with the associatedrevenues. Summary operating segment information is as follows (in thousands ofdollars):

 
| **As of and for three months ending March 31, 2005**                     | ** ** | **Credit Cards** | ** ** | **Investments   in   Previously  Charged  Off  Receivables** | ** ** | **Retail Micro-  Lending and  Servicing** | ** ** | **Other** | ** ** | **Total** | ** ** |
|-------------------------------------------------------------------------------|------------|------------------|------------|--------------------------------------------------------------|------------|-------------------------------------------|------------|-----------|------------|-----------|------------|
| Net interest  income, fees and other income on non-securitized earning assets |       | $                | 64,010     |                                                         | $          | 17,508                                    |       | $         | 14,315     |      | $          | 236 |   | $ | 96,069 |   |
| Total other  operating income                                                 |       | 92,868           |       | —                                                       |       | 5,435                                     |       | —    |       | 98,303    |       |
| **Income  before income taxes**                                               |       | $                | 75,263     |                                                         | $          | 7,071                                     |       | $         | 890        |      | $          | (5,776 | ) | $ | 77,448 |   |
| ** **                                                                    |       |             |       |                                                         |       |                                      |       |      |       |      |       |
| **Total  assets**                                                             |       | $                | 819,472    |                                                         | $          | 19,069                                    |       | $         | 158,414    |      | $          | 11,618 |   | $ | 1,008,573 |   |

 

8

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| **As of and for three months ending March 31, 2004**                     | ** ** | **Credit  Cards** | ** ** | **Investments in  Previously  Charged Off  Receivables** | ** ** | **Retail Micro-  Lending and  Servicing** | ** ** | **Other** | ** ** | **Total** | ** ** |
|-------------------------------------------------------------------------------|------------|-------------------|------------|----------------------------------------------------------|------------|-------------------------------------------|------------|-----------|------------|-----------|------------|
| Net interest  income, fees and other income on non-securitized earning assets |       | $                 | 15,238     |                                                     | $          | 14,019                                    |       | $         | —     |      | $          | 17 |   | $ | 29,274 |   |
| Total other  operating income                                                 |       | 69,965            |       | —                                                   |       | —                                    |       | —    |       | 69,965    |       |
| **Income  before income taxes**                                               |       | $                 | 27,696     |                                                     | $          | 5,259                                     |       | $         | —     |      | $          | (2,879 | ) | $ | 30,076 |   |
| ** **                                                                    |       |              |       |                                                     |       |                                      |       |      |       |      |       |   |   |   |   |   |
| **Total  assets**                                                             |       | $                 | 758,154    |                                                     | $          | 24,616                                    |       | $         | —     |      | $          | 1,090 |   | $ | 783,860 |   |

 

**4.****                                      Shareholders’Equity**

 

***Treasury Stock***

 

At its discretion, the Company will usetreasury shares to satisfy option exercises and restricted stock grants. TheCompany uses the cost approach when accounting for the repurchase andreissuance of its treasury stock. During the three months ended March 31,2005, the Company reissued 68,865 treasury shares in satisfaction of optionexercises at an approximate cost of $0.4 million.

 

As part of the Company’s share repurchaseprogram, the Company has written and, contingent upon favorable marketconditions, may continue to write put options on its own shares. The putoptions allow the Company to settle the options in either stock or cash. As of March 31,2005, the Company is obligated to purchase 250,000 shares under these putoption contracts, none of which represented a liability to the Company based onthe then-existing share price.  Thesecontracts are set to expire during the second quarter of 2005.

 

***Restricted Share Awards***

 

During the quarter ended March 31, 2005,the Company granted 193,685 shares of restricted stock under its 2004Restricted Stock Plan. The fair market value of granted restricted shares as ofrespective grant dates is shown net of amortization as deferred compensationwithin consolidated shareholders’ equity as of the close of each accountingperiod. The Company’s restricted share grants generally vest over a range of 24to 36 months and are being amortized to compensation expense ratably overthe vesting period.

 

**5.****                                      Investmentsin Equity-Method Investees**

 

In January 2005, the Company purchased a47.5% interest in a joint venture for approximately $10.9 million,including transaction costs. A wholly owned subsidiary of the Company and twounaffiliated investors formed this entity in connection with the acquisition ofapproximately $376.3 million (face amount) in credit card receivables.These receivables were then transferred to a subsidiary of the joint venture,and then on to a trust pursuant to a Statement of Financial AccountingStandards No. 140, “Accounting for Transfers and Servicing of FinancialAssets and Extinguishments of Liabilities” (“Statement No. 140”), transferin exchange for notes and a subordinated, certificated interest issued by thetrust.  The Company accounts for itsinvestment in this joint venture and other similar investments in existence asof December 31, 2004 under the equity method of accounting, and theseinvestments are included in investment in equity-method investees on theCompany’s condensed consolidated balance sheets.

 

**6.****                                      De-SecuritizedFingerhut Receivables**

 

Total income recognized relating to cashreceived on de-securitized Fingerhut receivables was $26.9 million and$0.0 for the three months ended March 31, 2005 and 2004, respectively,such amounts being included as a component of fees and other income onnon-securitized earning assets on the Company’s condensed consolidatedstatements of operations. The remaining excess cash flows that the Companyexpects to receive from the de-securitized Fingerhut 

 

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receivables through December of 2008 are currently estimated to be$81.2 million, with the Company expecting to receive approximately 62.4%of these collections within the next 12 months.

 

The deferred gain associated with theFingerhut receivables is being amortized into fees and other income onnon-securitized earning assets in the Company’s condensed consolidatedstatements of operations in a manner that corresponds with actual andanticipated future cash collections on the de-securitized Fingerhutreceivables; the income associated with amortization of this deferred gaintotaled approximately $5.8 million and $0.0 for the three months ended March 31,2005 and 2004, respectively.

 

**7.****                                      CreditCard Receivables Acquisition**

 

In January 2005, one of the Company’smajority-owned subsidiaries purchased $72.1 million (face amount) incredit card receivables for approximately $42.0 million, includingtransaction costs. These receivables were then transferred to a trust pursuantto a Statement No. 140 transfer in exchange for notes and a subordinated,certificated interest issued by the trust, thereby resulting in securitizationincome of $1.6 million. To fund this purchase, the Company contributedapproximately $2.0 million into its majority-owned subsidiary. The assetsand liabilities of the majority-owned subsidiary, and its associated earningsfrom operations, are presented as part of the Company’s condensed consolidatedfinancial statements with a minority interest being shown to reflect theunaffiliated investor’s portion of the operations. The minority interestassociated with this subsidiary is not shown net of tax because the subsidiaryis a pass-through entity for income tax purposes. For a fee that representsadequate compensation for servicing, the Company has agreed to service theentire portfolio of credit card receivables underlying the trust.

 

See separately the discussion of credit cardreceivables acquired by the Company’s equity-method investee in Note 5, “Investmentsin Equity-Method Investees,” above.

 

**8.****                                      OffBalance Sheet Arrangements**

 

The Company securitizes through a mastertrust all of its credit card receivables originated on a daily basis under itsprimary third-party financial institution relationship (the “originatedportfolio”), except for those credit card receivables underlying the Company’ slargely fee-based card offering to consumers at the lower end of the FICOscoring range. The securitized credit card receivables are transferred to amaster trust, which issues notes representing undivided ownership interests inthe assets of the master trust. Additionally, during the first quarter of 2005,the Company acquired receivables from a third party and subsequentlysecuritized them. (See Note 7, “Credit Card Receivables Acquisition,” fora discussion of the first quarter of 2005 acquisition.)

 

All of the Company’s credit card receivables,with the exception of the de-securitized Fingerhut receivables (seeNote 6, “De-Securitized Fingerhut Receivables”) and as noted above thosereceivables associated with its largely fee-based card offering to consumers atthe lower end of the FICO scoring range, are held by securitizationtrusts.  The exclusive interest of theCompany in these securitized receivables is in the form of retained interests.GAAP requires the Company to treat its transfers to the securitization trustsas sales, and the receivables are removed from the Company’s condensedconsolidated balance sheets. Under Statement No. 140, an entity recognizesthe assets it controls and liabilities it has incurred, and derecognizes thefinancial assets for which control has been surrendered and all liabilitiesthat have been extinguished. An entity is considered to have surrenderedcontrol over the transferred assets and, therefore, to have sold the assets ifthe following conditions are met:

 

1.                                       Thetransferred assets have been isolated from the transferor and put presumptivelybeyond the reach of the transferor and its creditors.

 

2.                                       Eachtransferee has the right to pledge or exchange the assets it has received, andno condition both constrains the transferee from taking advantage of its rightto pledge or exchange and provides more than a trivial benefit to thetransferor.

 

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3.                                       Thetransferor does not maintain effective control over the transferred assetsthrough either (i) an agreement that both entitles and obligates thetransferor to repurchase or redeem them before their maturity, or (ii) theability to unilaterally cause the holder to return specific assets, other thanthrough a clean-up call.

 

The securitization transactions do not affectthe relationship the Company has with its customers, and the Company continuesto service the securitized credit card receivables.

 

The table below summarizes the Company’ssecuritization activity for the periods presented. As with other tablesincluded herein, it does not include the securitization activity of the Company’sequity-method investees:

 

| ** **                                                                | ** ** | **For the three months  ended March 31,** | ** ** |
|---------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                | ** ** | **2005**                                       | ** ** | **2004** | ** ** |
| ** **                                                                | ** ** | **(In thousands)**                             | ** ** |
| Gross amount  of receivables securitized at period end                    |       | $                                              | 1,609,863  |   | $ | 1,654,285 |   |
| Proceeds  from collections reinvested in revolving-period securitizations |       | $                                              | 248,298    |   | $ | 197,967 |   |
| Excess cash  flows generated on securitized receivables                   |       | $                                              | 65,865     |   | $ | 73,257 |   |
|                                                                      |       |                                           |       |   |   |   |   |
| Pretax  securitization income                                             |       | $                                              | 1,587      |   | $ | — |   |
| Income from  retained interests in credit card receivables securitized    |       | 25,869                                         |       | 19,392 |   |
| Fees on  securitized receivables                                          |       | 16,036                                         |       | 21,251 |   |
| Total fees  and other income on securitized earning assets                |       | $                                              | 43,492     |   | $ | 40,643 |   |

 

The investors in the Company’s securitizationtransactions have no recourse against the Company for its customers’ failure topay their credit card receivables. However, most of the Company’s retainedinterests are subordinated to the investors’ interests until the investors havebeen fully paid.

 

Generally, all collections received from thecardholders underlying each securitization are included in the securitizationcash flows. This includes collections from the cardholders for interest, feesand other charges on the accounts and collections from the cardholders repayingthe principal portion of their account balances. In general, the cash flows arethen distributed to the Company as servicer for its servicing fee, to theinvestors as interest on their outstanding notes, to the investors to repay anyportion of their outstanding notes that becomes due and payable and to theCompany as the seller to fund new purchases. Any collections from cardholdersremaining each month after making the various payments noted above generallyare paid to the Company on its retained interests.

 

The retained interests associated with thecredit card receivables that the Company has securitized are carried atestimated fair market value within the securitized earning assets category onthe Company’s condensed consolidated balance sheets, and because they areclassified as trading securities, any changes in fair value are included inincome. Because quoted market prices for the Company’s retained interests aregenerally not available, the Company estimates fair value based on theestimated present value of future cash flows using management’s best estimatesof key assumptions.

 

The measurements of retained interestsassociated with Company-arranged securitizations are dependent upon management’sestimates of future cash flows using the cash-out method. Under the cash-outmethod, the future cash flows (including the release of any cash related tocredit enhancements) are recorded at a discounted value. The cash flows arediscounted based on the timing of when the Company expects to receive the cashflows. The discount rates are based on management’s estimates of returns thatwould be required by investors in an investment with similar terms and creditquality. Yields on the credit card receivables are estimated based on thestated annual percentage rates in the credit card 

 

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agreements. Estimated default and payment rates are based on historicalresults, adjusted for expected changes based on the Company’s credit riskmodels. Credit card receivables are typically charged off when the receivablesbecome 180 days past due, although earlier charge offs may occurspecifically related to accounts of bankrupt or deceased customers. Bankruptand deceased customers’ accounts are typically charged off within 30 daysof verification.

 

The Company’s retained interests in creditcard receivables securitized (labeled as securitized earning assets on thecondensed consolidated balance sheets) include the following:

 
| ** **                        | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|-----------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                        | ** ** | **(In thousands)**       | ** ** |
| I/O strip                         |       | $                        | 118,627    |                        | $          | 106,131 |   |
| Accrued  interest and fees        |       | 11,886                   |       | 12,603                      |       |
| Servicing  liability              |       | (21,424                  | )          | (20,813                     | )          |
| Amounts due  from securitization  |       | 9,357                    |       | 6,511                       |       |
| Fair value  of retained interests |       | 354,921                  |       | 432,286                     |       |
|                              |       |                     |       |                        |       |
| Securitized  earning assets       |       | $                        | 473,367    |                        | $          | 536,718 |   |

 

The I/O strip reflects the fair value of theCompany’s rights to future income from Company-arranged securitizations andincludes certain credit enhancements. The I/O strip increased during the threemonths ended March 31, 2005 principally due a decrease in the expectedcredit loss rate and a slight increase in the yield (both of which areillustrated on the table below), offset to some degree, however, by a slightincrease in the payment rate, coupled with net reductions in receivables levelsprincipally within the trust underlying the Company’s 2003 Providian portfolio acquisition(the “Embarcadero Trust”). The slight decrease in accrued interest and feesalso corresponds with the net reductions in receivables levels principallywithin the Embarcadero Trust. The servicing liability reflects, for thosesecuritization structures for which servicing compensation is not adequate, thefair value of the costs to service the receivables above and beyond theservicing income the Company expects to receive from the securitizations. Theslight servicing liability increase as of March 31, 2005 is primarily dueto the additional acquisition made by the Company during the first quarter of2005. The fair value of retained interests includes the Company’s interests inits securitizations. The fair value of retained interests decreased between December 31,2004 and March 31, 2005, principally due to the effects of increased drawsof cash against the Company’s originated portfolio securitization facilitiesrelated to the Company’s $67.0 million tax payment made during the firstquarter of 2005, its first quarter 2005 acquisitions, and in anticipation of anacquisition completed on April 1, 2005, coupled with net reductions inreceivables levels principally within the Embarcadero Trust.

 

Changes in any of the assumptions used tovalue the Company’s retained interests in its securitizations could impact theCompany’s fair value estimates. The weighted-average key assumptions used toestimate the fair value of the Company’s retained interests in the receivablesit has securitized are presented below:

 
| ** **                              | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** | **March 31,  2004** | ** ** |
|-----------------------------------------|------------|--------------------------|------------|-----------------------------|------------|--------------------------|------------|
| Yield  (annualized)                     |       | 29.8                     | %          | 29.4                        | %          | 28.7                     | %          |
| Payment rate  (monthly)                 |       | 6.4                      |       | 6.3                         |       | 6.0                      |       |
| Expected  credit loss rate (annualized) |       | 12.7                     |       | 13.7                        |       | 13.3                     |       |
| Residual  cash flows discount rate      |       | 20.0                     |       | 17.4                        |       | 22.5                     |       |
| Servicing  liability discount rate      |       | 14.0                     |       | 14.0                        |       | 14.0                     |       |

 

The increase in the residual cash flowsdiscount rate corresponds with the Company’s first quarter 2005 draws againstits securitization facilities to fund its acquisitions and March 2005 taxpayment as also noted above.  With thesedraws, the Company’s collateral enhancement levels within the originatedportfolio master trust have declined. The Company’s Statement No. 140 models recognize in computing theresidual cash flows discount rate that variations in collateral enhancementlevels affect the returns that investors require within securitizationstructures.  Accordingly, because theCompany’s collateral enhancement levels have dropped between December 31,2004 and March 31, 2005, the Company’s March 31, 2005 residual cashflows discount rate is higher than it was at December 31, 2004. Although 

 

12

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less significant to the increase in the residual cash flows discountrate between December 31, 2005 and March 31, 2005, the Company’sStatement No. 140 models are also sensitive to changes in LIBOR, whichincreased between December 31, 2004 and March 31, 2005.

 

At March 31, 2005, the followingillustrates the hypothetical effect of an adverse 5 and 10 percent changein key economic assumptions on the retained interests in credit cardreceivables securitized (dollars in thousands):

 
| ** **                                   | ** ** | **Credit Card  Receivables** | ** ** |
|----------------------------------------------|------------|------------------------------|------------|
| **Yield  (annualized)**                      |       | 29.8                         | %          |
| *Impact on fair value of 5% adverse change*  |       | $                            | (13,158    | ) |
| *Impact on fair value of 10% adverse change* |       | $                            | (26,317    | ) |
| **Payment  rate (monthly)**                  |       | 6.4                          | %          |
| *Impact on fair value of 5% adverse change*  |       | $                            | (1,677     | ) |
| *Impact on fair value of 10% adverse change* |       | $                            | (3,241     | ) |
| **Expected  credit loss rate (annualized)**  |       | 12.7                         | %          |
| *Impact on fair value of 5% adverse change*  |       | $                            | (5,495     | ) |
| *Impact on fair value of 10% adverse change* |       | $                            | (10,989    | ) |
| **Residual  cash flows discount rate**       |       | 20.0                         | %          |
| *Impact on fair value of 5% adverse change*  |       | $                            | (2,110     | ) |
| *Impact on fair value of 10% adverse change* |       | $                            | (4,200     | ) |
| **Servicing  discount rate**                 |       | 14.0                         | %          |
| *Impact on fair value of 5% adverse change*  |       | $                            | (75        | ) |
| *Impact on fair value of 10% adverse change* |       | $                            | (150       | ) |

 

These sensitivities are hypothetical andshould be used with caution. As the figures indicate, changes in fair value basedon a 5% and a 10% variation in assumptions generally cannot be extrapolatedbecause the relationship of the change in assumption to the change in fairvalue of the retained interests in credit card receivables securitized may notbe linear. Also, in this table, the effect of a variation in a particularassumption on the fair value of the retained interest is calculated withoutchanging any other assumptions; in reality, changes in one assumption mayresult in changes in another. For example, increases in market interest ratesmay result in lower prepayments and increased credit losses, which couldmagnify or counteract the sensitivities.

 

The Company’s managed receivables portfoliounderlying its securitizations (including only those of its consolidated subsidiaries)is comprised of the Company’s retained interests in the credit card receivablessecuritized and other investors’ shares of these securitized receivables. Theinvestors’ shares of securitized credit card receivables are not assets of theCompany. The following table summarizes the balances included within, andcertain operating statistics associated with, the Company’s managed receivablesportfolio underlying both the outside investors’ shares of and the Company’sretained interests in credit card receivables securitizations.

 
| ** **                                     | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                     | ** ** | **(In thousands)**       | ** ** |
| Total  managed principal balance               |       | $                        | 1,460,839  |                        | $          | 1,493,903 |   |
| Total  managed finance charge balance          |       | 149,024                  |       | 160,382                     |       |
| Total  managed receivables                     |       | $                        | 1,609,863  |                        | $          | 1,654,285 |   |
| Receivables  delinquent — 60 or more days |       | $                        | 125,356    |                        | $          | 144,715 |   |
| Net charge  offs for the three months ended    |       | $                        | 42,843     |                        | $          | 44,770 |   |

 

**9.****                                      NotesPayable**

 

As of March 31, 2005, the Company’snotes payable balances included approximately $6.5 million related tomargin borrowings underlying the Company’s investments in debt securities whichcharged an interest rate of 4.75% as of 

 

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March 31, 2005, as well as approximately $8.5 million ofborrowings associated with certain vendor-financed acquisitions of software andequipment which have various interest rates ranging from 3% to 7%.

 

Also included in notes payable are certaindebt instruments associated with the acquisition of and ongoing working capitalneeds of the Company’s Retail Micro-Lending and Servicing segment. As of March 31,2005, the following debt was outstanding under these arrangements (in thousandsof dollars):

 
| ** **                 | ** ** | **Balance at  March 31, 2005** | ** ** | **Applicable Interest  Rate as of****March 31, 2005** | ** ** |
|----------------------------|------------|-------------------------------------|------------|------------------------------------------------------------|------------|
| Term Loan A                |       | $                                   | 23,000     |                                                       | 7.56       | % |
| Term Loan B                |       | 31,500                              |       | 13.06                                                      | %          |
| Revolving  Credit Facility |       | 5,000                               |       | 8.12                                                       | %          |
| Seller Note                |       | 5,000                               |       | 10.00                                                      | %          |
| Total Debt                 |       | $                                   | 64,500     |                                                       |       |   |

 

The interest rates associated with the term loan facilities and therevolving credit facility are adjusted periodically based on an index overLIBOR or Prime.

 

**10.****                               Commitmentsand Contingencies**

 

In the normal course of business through theorigination of unsecured credit card receivables, the Company incurs offbalance sheet risks. The Company’s off balance sheet risks, with respect to thereceivables the Company manages, include commitments to extend credit totalingapproximately $1.5 billion at March 31, 2005. These instruments involve,to varying degrees, elements of credit risk in excess of the amountssecuritized. The principal amount of these instruments reflects the maximumexposure the Company has in the instruments. The Company has not experiencedand does not anticipate that all of its customers will exercise their entireavailable line of credit at any given point in time. The Company has the rightto reduce or cancel these available lines of credit at any time.

 

The Company is an equity member of CSG.  During the second quarter of 2002, CSGentered into a note purchase agreement whereby it agreed to buy additionalinterests in a portfolio of credit card receivables owned by CSG Trust shouldthere be net new growth in the receivables or should collections not beavailable to fund new cardholder purchases. As of March 31, 2005, CSGwould be obligated to purchase up to approximately $53.0 million of newnotes from the CSG Trust should this contingency arise. In general, thiscontingency amount will decline as the amount of credit available tocardholders for future purchases declines. The portfolio has declined and isexpected to continue to decline during the life of the CSG Trust as paymentsare expected to exceed new purchases each month. As a member of CSG, theCompany has agreed to guarantee the payment of the purchase price of the aforementionednew notes if the events giving rise to this contingency arise, but only if CSGitself should fail to purchase the new notes under the note purchase agreement.As of March 31, 2005, CSG had not purchased and was not required topurchase any additional notes under the note purchase agreement. The Company’sguarantee is limited to its ownership percentage in CSG (which at March 31,2005 was 50%) times the total amount of the notes that CSG would be required topurchase. Therefore, as of March 31, 2005, the maximum amount of theCompany’s guarantee was approximately $26.5 million. The Company currentlydoes not have any liability recorded with respect to this guarantee, but itwill record one if events occur that make payment probable under the guarantee.The fair value of this guarantee is not material.

 

The Company has entered into similar notepurchase agreements (and related guarantees) to that described with respect toCSG above with respect to various other receivables portfolio investments it hasmade through majority-owned subsidiaries and equity-method investees. As of March 31,2005, none of these majority-owned subsidiaries or equity-method investees hadpurchased nor were they required to purchase any additional notes under thenote purchase agreements. The Company’s guarantee is limited to its respectiveownership percentages in the various majority-owned subsidiaries andequity-method investees multiplied times the total amount of the notes thateach of the majority-owned subsidiaries and equity-method investees could berequired to purchase. As of March 31, 2005, the maximum amount of theCompany’s collective guarantees related to all of these other majority-ownedsubsidiaries and equity-method investees 

 

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was approximately $318.7 million. The Company currently does nothave any liability recorded with respect to these guarantees, but it willrecord one if events occur that make payment probable under the guarantees. Thefair value of these guarantees is not material.

 

The Company’s agreement with its principalthird-party originating financial institution requires the Company to purchaseon a daily basis the credit card receivables that are originated in theaccounts maintained for the Company’s benefit. To secure this obligation, theCompany provides the financial institution a $10.0 millioncash-collateralized letter of credit and has pledged retained interests carriedat approximately $92.9 million. These arrangements prevent the Company fromusing the $10.0 million of cash for any other purpose, although theCompany can substitute other collateral for the pledged retained interests. TheCompany’s arrangements with the financial institution expire in March 2006.If the Company were to terminate a sub- service agreement under which thisinstitution also provides certain services for the Company, there would bepenalties of approximately $1.1 million as of March 31, 2005. TheCompany currently does not have any liability recorded with respect to theguarantees discussed in this paragraph, but it will record one if events occurthat make payment probable under the guarantees. The fair value of theseguarantees is not material.

 

A subsidiary of the Company has an agreementwith another third-party financial institution pursuant to which the subsidiaryservices loans on behalf of the financial institution in exchange for servicingfees. Either party can cancel this contract with 30 days notice. TheCompany believes that the entities that conduct this business are adequatelycapitalized. Nevertheless, to further growth plans for the operationsunderlying the Company’s Retail Micro-Lending and Servicing segment, theCompany has guaranteed up to $15.0 million of potential indebtedness tothe financial institution under its servicing program with subsidiaries of theCompany. The Company currently does not have any liability recorded withrespect to the guarantee discussed in this paragraph, but it will record one ifevents occur that make payment probable under the guarantee. The fair value ofthis guarantee is not material.

 

The Company’s most significant source ofliquidity is the securitization of credit card receivables. The maturity termsof the Company’s securitizations vary. As of March 31, 2005, the Companyhad:  a six-year term securitizationfacility, a five-year term securitization facility, a two-year variable fundingsecuritization facility with renewal options and two one-year conduitsecuritization facilities with renewal options issued out of its originatedportfolio master trust; a ten-year amortizing term securitization facilityissued out of the Embarcadero Trust; and a one-year variable fundingsecuritization facility issued out of the a trust associated with the Company’ssecuritization of approximately $92.0 million and $72.1 million (faceamount) in credit card receivables acquired during 2004 and in the firstquarter of 2005, respectively. While the Company has never triggered an earlyamortization within any of the series underlying Company-arrangedsecuritization facilities, and while the Company does not believe that it will,the Company may trigger an early amortization of one or more of the outstandingseries within its securitization trusts. As each securitization facility expiresor comes up for renewal, there can be no assurance that the facility will berenewed, or if renewed, there can be no assurance that the terms will be asfavorable as the terms that currently exist. Either of these events couldsignificantly increase the Company’s need for additional liquidity.

 

The Company is subject to various legalproceedings and claims that arise in the ordinary course of business. In one ofthese legal proceedings, CompuCredit Corporation and five of the Company’ssubsidiaries are defendants in a purported class action lawsuit entitled Knox,et al. vs. First Southern Cash Advance, et al, No 5 CV 0445,filed in the Superior Court of New Hanover county, North Carolina, on February 8,2005. The plaintiffs allege that in conducting a so-called “payday lending”business, certain of our Retail Micro-Lending and Servicing segmentsubsidiaries violated various laws governing consumer finance, lending, checkcashing, trade practices and loan brokering. The plaintiffs further allege thatCompuCredit is the alter ego of its subsidiaries and is liable for theiractions. The plaintiffs are seeking damages of up to $75,000 per class member.The Company intends to vigorously defend this lawsuit. These claims are similarto those that have been asserted against several other market participants intransactions involving small balance, short-term loans made to consumers inNorth Carolina.

 

There are no other material pending legalproceedings to which the Company is a party.

 

**11.****                               EarningsPer Share**

 

The following table sets forth thecomputation of earnings per share:

 

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| ** **                                                                      | ** ** | **For the three months   ended March 31,** | ** ** |
|---------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                      | ** ** | **2005**                                        | ** ** | **2004** | ** ** |
| ** **                                                                      | ** ** | **(In thousands, except   per share data)**     | ** ** |
| Numerator:                                                                      |       |                                            |       |   |   |
| Net income                                                                      |       | $                                               | 49,180     |   | $ | 18,788 |   |
| Preferred  stock dividends                                                      |       | —                                          |       | (1,070 | ) |
| Income  attributable to common shareholders                                     |       | $                                               | 49,180     |   | $ | 17,718 |   |
| Denominator:                                                                    |       |                                            |       |   |   |
| Denominator  for basic earnings per share (weighted-average shares outstanding) |       | 51,277                                          |       | 51,726 |   |
| Effect of  dilutive stock options and warrants                                  |       | 1,239                                           |       | 955 |   |
| Denominator  for diluted earnings per share (adjusted weighted-average shares)  |       | 52,516                                          |       | 52,681 |   |
| Basic  earnings per share                                                       |       | $                                               | 0.96       |   | $ | 0.36 |   |
| Diluted  earnings per share                                                     |       | $                                               | 0.94       |   | $ | 0.36 |   |

 

Excluded from the March 31, 2005earnings per share calculations were 44,700 stock options as their effects wereanti-dilutive. Excluded from March 31, 2004 earnings per sharecalculations are 2.4 million warrants and 0.2 million stock options as theireffects then were anti-dilutive.

 

**12.****                               SubsequentEvents**

 

On April 1, 2005, the Company completedthe acquisition of Wells Fargo Financial’s “Consumer Auto Receivables” businessunit. This acquisition included all of Consumer Auto Receivable’s assets,business operations and employees for approximately $120.5 million includingtransaction costs. The acquisition was financed using approximately $88.2million in debt with the remainder in cash. As of March 31, 2005, ConsumerAuto Receivables had approximately $129.5 million in assets and operatedin thirty-eight states through its twelve branches, three regional processingcenters and national collection center at its Lake Mary, FL headquarters. Thisbusiness has approximately 300 employees, and the Company expects to conductthis business through a separate business segment.

 

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**ITEM 2.**        MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

*The following discussionshould be read in conjunction with our condensed consolidated financialstatements and the related notes included therein and our Annual Report on Form10-K for the year ended December 31, 2004 where certain terms (includingtrust, subsidiary and other entity names and financial, statistical andoperating measures) have been defined.*

* *

ThisManagement’s Discussion and Analysis of Financial Condition and Results ofOperations includes forward-looking statements. We have based theseforward-looking statements on our current plans, expectations and beliefs aboutfuture events. Actual results could differ materially because of factorsdiscussed in “Forward-Looking Information” in this item and elsewhere in thisreport.

 

**OVERVIEW**

 

We are a provider of various credit andrelated financial services and products to or associated with the underserved,or sub-prime, consumer credit market, as well as to “un-banked” consumers.Historically, we have served this market through our marketing and solicitationof credit card accounts and our servicing of various credit card receivablesunderlying both our originated accounts and our portfolio acquisitions. Wegenerally have financed our credit card activities through the securitizationof the receivables underlying the accounts we originate and the portfolios thatwe purchase. The leverage (i.e., the percentage on a dollar that lenders willlend us, or the “advance rate”) that our securitization facilities provideagainst our credit card receivables is a critical factor in our ability toobtain the desired returns on equity for our shareholders.

 

More recently, we have diversified ourbusiness operations to include the purchase and recovery of previously chargedoff receivables, as well as the marketing and servicing of micro-loans throughvarious channels, including retail branch locations, grocery and conveniencestores, direct marketing, telemarketing and the Internet. We also serveun-banked consumers through our offering of a stored-value (or debit) cardthrough various retail branch locations. Finally, on April 1, 2005, wecompleted our acquisition of a portfolio of consumer receivables secured byautomobiles and a platform for the origination and servicing of these loans.

 

With respect to the first quarter of 2005, wepartnered with others to complete two credit card portfolio acquisitions.  The first acquisition of approximately $72.1million (face amount) in credit card receivables was through a majority-ownedsubsidiary, while the second involved the purchase of approximately $376.3million (face amount) of credit card receivables through a 47.5% equity-methodinterest in a joint venture with other unaffiliated investors. Additionally, wecontinued our micro-lending expansion by acquiring substantially all of theassets of another micro-lender for approximately $11.9 million includingtransaction costs.

 

Throughout 2005 and beyond, our shareholdersshould expect us to continue to evaluate and pursue additional credit cardreceivables portfolios and other business activities and asset classes that arecomplementary to our historic sub-prime credit card business, including furtheracquisitions of sub-prime lenders.

 

We remain focused on making good economicdecisions that will result in high returns on equity to our shareholders over along-term horizon. While our decisions may make economic sense, they may alsoresult in volatile earnings under GAAP as a result of the accountingrequirements for securitizations under Statement of Financial AccountingStandards No. 140, “Accounting for Transfers and Servicing of FinancialAssets and Extinguishments of Liabilities” (“Statement No. 140”). To theextent that we grow our overall portfolio of credit card receivables (throughorigination, acquisition or other new channels) and then securitize theseassets, we will have securitization income or loss, 

 

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which may be material. For further discussion of our historic resultsand the impact of securitization accounting on our results, see the “Results ofOperations” and “Liquidity, Funding and Capital Resources” sections below, aswell as our condensed consolidated financial statements and the notes thereto.

 

**RESULTS OF OPERATIONS**

 

**Three Months Ended March 31, 2005,Compared to Three Months Ended March 31, 2004**

 

***Totalinterest income.*** Total interest income consists primarily of finance charges and latefees earned on our largely fee-based card offering to consumers at the lowerend of the FICO scoring range. The approximate $9.2 million increase whencomparing the three months ended March 31, 2005 to 2004 is due to growthin our credit card receivables associated with this product, none of which wehave securitized. Also included within total interest income (under the othercategory) is the interest income that we have earned on our various investmentsin debt securities, including interest earned on bonds distributed to us fromour equity-method investees, and on our subordinated, certificated interest inthe Embarcadero Trust. Principal amortization has caused reductions in interestincome levels associated with some of our bonds and the Embarcadero Trustsubordinated, certificate interest. Nevertheless, our other interest income levels have remained relativelyconsistent between 2004 and 2005 due to other bond investments that we havemade (typically in bonds issued by other third-party asset backedsecuritizations) throughout 2004 and the first quarter of 2005.

 

As we continue to grow our largely fee-basedcredit card offering to consumers at the lower end of the FICO scoring range,and assuming that we do not securitize the credit card loans receivableunderlying this product offering in an off balance sheet arrangement, we expectto see continued growth in our total interest income throughout 2005.

 

***InterestExpense.***  Interestexpense increased approximately $2.3 million principally due to interestcosts associated with our Retail Micro-Lending and Servicing segmentacquisition and working capital-related debt, which added approximately$2.1 million in interest costs between the first quarter of 2004 and thefirst quarter of 2005.

 

***Feesand other income on non-securitized earning assets.***  The following table details the components offees and other income on non-securitized earning assets for the three monthsended March 31, 2005 and 2004:

 
| ** **                                                | ** ** | **For the three months   ended March 31,** | ** ** |
|-----------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                | ** ** | **2005**                                        | ** ** | **2004** | ** ** |
| ** **                                                | ** ** | **(In thousands)**                              | ** ** |
| Fees and  other income on non-securitized earning assets: |       |                                            |       |   |   |
| Retail  micro-lending fees                                |       | $                                               | 17,876     |   | $ | — |   |
| Fees on  non-securitized credit card receivables          |       | 29,729                                          |       | 16,745 |   |
| De-securitized  Fingerhut receivables                     |       | 32,732                                          |       | — |   |
| Investments  in previously charged off receivables        |       | 17,508                                          |       | 14,019 |   |
| Other                                                     |       | 2,921                                           |       | 11 |   |
| Total                                                     |       | $                                               | 100,766    |   | $ | 30,775 |   |

 

The increase of approximately$70.0 million in fees and other income on non-securitized earning assetswas largely attributable to: (1) growth in our largely fee-based credit card offering toconsumers at the lower end of the FICO scoring range, which contributed approximately$13.0 million; (2) the addition of our Retail Micro-Lending andServicing segment (during the second quarter of 2004), which contributedapproximately $17.9 million; (3) income associated with thede-securitized Fingerhut receivables (including the amortization of theassociated deferred gain) of approximately $32.7 million; and (4) thegrowth in income within our Investments In Previously Charged Off Receivablessegment of approximately $3.5 million. The other category above includesgains on put options that we wrote on our stock and fees associated with ourstored-value card, merchant credit and on-line micro-lending operations, noneof which represent significant activities for us. We expect to see continuedgrowth in our retail micro-lending, non-securitized credit card, investments inpreviously charged off receivables, and other fee categories throughout 2005.

 

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The $32.7 million of first quarter 2005income from de-securitized Fingerhut receivables relates to the repayment of aFingerhut securitization facility in its entirety in August 2004, therebyresulting in a de-securitization of the Fingerhut receivables. Accordingly,during the third quarter of 2004, we resumed on balance sheet ownership ofthese receivables at a $0.0 carryover basis corresponding to our then-existingbasis in the Fingerhut retained interests. We have no plans to re-securitizethe receivables underlying the Fingerhut Trust, and the remaining excess cashflows that we expect to receive from the Fingerhut receivables through December 2008are currently estimated to be $81.2 million. Because of our $0.0 basis inthe de-securitized Fingerhut receivables, as we receive our expected$81.2 million in cash flows from the Fingerhut receivables, we essentiallywill be reporting into GAAP income (as fees and other income on non-securitizedearning assets) all of the cash flows that we receive in any particularaccounting period. Total cash income recognized relating to the de-securitizedFingerhut receivables for the three months ended March 31, 2005 was$26.9 million; this amount should decline in successive quartersthroughout 2005 as we continue our liquidation of the Fingerhut receivablesportfolio.

 

 

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Also reflected in the $32.7 million offirst quarter 2005 income from de-securitized Fingerhut receivables is $5.8million of post-de-securitization-related deferred gain amortization. Ouroriginal servicing liability associated with an original Fingerhut Trust wasconverted into a deferred gain upon a third quarter of 2003 Fingerhut retainedinterests exchange. This deferred gain is now being amortized into fees andother income on non-securitized earning assets on our condensed consolidatedstatements of operations in a manner that corresponds with actual andanticipated future cash collections on the de-securitized Fingerhutreceivables. As of March 31, 2005, an additional $17.6 million of thisdeferred gain on Fingerhut receivables remains to be amortized into fees andother income in future periods.  Insuccessive quarters throughout 2005, the level of this deferred gain’samortization into income should decline relative to the $5.8 million firstquarter 2005 amount as we continue with our liquidation of the Fingerhutreceivables portfolio.

 

***Provisionfor loan losses.*** Our provision for loan losses increased to $19.2 million for thethree months ended March 31, 2005, from $9.1 million for the threemonths ended March 31, 2004. The $10.1 million increase is principally dueto our significant year-over-year growth in our on balance sheet loans and feesreceivable related to our largely fee-based credit card offering to consumersat the lower end of the FICO scoring range and the introduction of our micro-lendingactivities.

 

The provision for loan losses is provided tocover aggregate loss exposures on (1) principal receivable balances, (2) financecharges and late fees receivable underlying income amounts included within ourtotal interest income category, and (3) fees receivable underlying feeincome included within our fees and other income on non-securitized assetscategory. Although we do not expect to see any degradation in credit quality in2005 and while current delinquency and credit loss trends look favorable, we doexpect that our provision for loan losses will increase throughout 2005 basedon the loans and fees receivable growth that we are planning throughout 2005.

 

***Feesand other income on securitized earning assets.***  Fees and other income on securitized earningassets include (1) annual membership, over-limit, cash advance, returnedcheck and other fees associated with our credit card products, (2) securitizationgains and losses, and (3) income from retained interests in credit cardreceivables securitized, each of which is detailed in the following table forthe three months ended March 31, 2005 and 2004.

 
| ** **                                                             | ** ** | **For the three months  ended March 31,** | ** ** |
|------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                             | ** ** | **2005**                                       | ** ** | **2004** | ** ** |
| ** **                                                             | ** ** | **(In thousands)**                             | ** ** |
| Securitization income                                                  |       | $                                              | 1,587      |   | $ | — |   |
| Income from retained interests in credit  card receivables securitized |       | 25,869                                         |       | 19,392 |   |
| Fees on securitized receivables                                        |       | 16,036                                         |       | 21,251 |   |
| Total fees and other income on securitized  earning assets             |       | $                                              | 43,492     |   | $ | 40,643 |   |

 

The increase of approximately$2.8 million reflects:  (1) securitizationincome related to our first quarter 2005 acquisition of approximately $72.1million (face amount) in credit card receivables for approximately $42.0million, including transaction costs, through one of our majority-ownedsubsidiaries; (2) an increase in income from retained interests in creditcard receivables securitized of $6.5 million, principally due to (a) improvementsin the credit quality and performance of our retained interests in theoriginated portfolio master trust and purchased portfolio trusts, (b) cashdraws that we made against originated portfolio master trust securitizationfacilities during the first quarter of 2005 to fund acquisitions and taxpayments, and (c) the acquisition of two additional securitized portfoliossince March 31, 2004, all of which caused higher income from retainedinterests in credit card receivables securitized notwithstanding a slight netreduction in the level of securitized receivables between the first quarter of2004 and the first quarter of 2005; offset by (3) a decline in fees onsecuritized receivables associated with lower 2005 over-limit fees reflectinggeneral economic environment and credit quality improvements for oursecuritized receivables, as well as slight net receivables declines between thefirst quarter of 2004 and the first quarter of 2005.

 

Further details concerning delinquency andcredit quality trends, which affect the level of our income from retainedinterests in credit card receivables securitized, are provided in thediscussion of our Credit Cards segment below.

 

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***Servicingincome.*** Servicing income increased an anticipated $5.2 million, pre-tax,due to: (1) the addition of approximately $5.4 million of retailmicro-loan processing and servicing fees for the three months ended March 31,2005 with no corresponding amount for the three months ended March 31,2004; (2) the addition of servicing income related to the approximately$92.0 million (face amount) in receivables that we acquired and securitizedduring the third quarter of 2004, the $996.5 million (face amount) inreceivables that our equity-method investee, Transistor, acquired during thefourth quarter of 2004, the $376.3 million (face amount) in receivablesthat our newest equity-method investee acquired during the first quarter of2005 and $72.1 million (face amount) in receivables that we acquiredduring the first quarter of 2005; and (3) two new term securitizationfacilities issued out of the originated portfolio master trust in October 2004.These two term securitization facilities permitted an increase in our servicingrates to 4% (i.e., from the .10% level that we have historically experiencedfor facilities issued out of our originated portfolio master trust).

 

These increases were offset partially bydeclines in the originated portfolio master trust, Embarcadero Trust and CSGTrust managed receivables and the de-securitization of the Fingerhutreceivables. The de-securitization of the Fingerhut receivables had the effectof eliminating servicing income as a revenue source related to the Fingerhutreceivables.

 

We expect servicing income levels during the remainderof 2005 that will be higher than 2004 levels based on the new, higher termsecuritization facility servicing rates, coupled with anticipated originatedportfolio master trust receivables growth in 2005 and the new servicingopportunities that have arisen for us associated with the credit cardreceivables portfolio acquisitions mentioned above. To the extent that ourservicing income rises associated with increased servicing rates on the tworecent term securitization facilities issued out of the originated portfoliomaster trust, we will experience an offsetting reduction in income fromretained interests in credit card receivables securitized (a component of feesand other income on securitized earning assets).

 

***Ancillaryand interchange revenues.***  Ancillary and interchange revenues increasedapproximately $1.3 million primarily due to growth in both categories as aresult of the addition of new accounts in our core portfolio, growth in ourlargely fee-based credit card offering to consumers at the lower end of theFICO scoring range, as well as the addition of new purchased portfolios. Wetypically experience higher purchasing volumes and higher associatedinterchange fees for newer cardholders than for more mature cardholders withinour managed receivables portfolios. As such, our emphasis during 2004 on newaccount additions to replace older more stagnant accounts has produced higherinterchange revenues.

 

***Equityin income of equity-method investees.***  Equity in income of equity-method investeesincreased $19.0 million primarily due to income associated with ourinvestments in our Transistor and Capacitor (33.3% each) equity-methodinvestees made during the fourth quarter of 2004 and our first quarter 2005investment in another 47.5%-owned equity-method investee that acquired creditcard receivables portfolio during the first quarter of 2005.  We expect these new investees to contributesignificantly to our 2005 equity in income of equity-method investees.

 

***Totalother operating expense.***  Total other operating expense increased byapproximately $44.9 million due to:  (1) anapproximate $12.4 million increase in marketing and solicitation costsprincipally associated with (a) increased marketing efforts aimed atgrowing account originations within our originated portfolio master trust andwith respect to our largely fee-based credit card offering to consumers at thelower end of the FICO scoring range, and (b) the addition of our RetailMicro-Lending and Servicing segment; (2) the addition of approximately$10.1 million in loan servicing costs associated with our micro-lendingactivities; (3) an $11.9 million increase in servicing costs related toincreases in receivables associated with our largely fee-based credit cardoffering to consumers at the lower end of the FICO scoring range and theaddition of several new portfolios; and (4) an overall increase ofapproximately $9.1 million in other expenses, including occupancy andrelated expenses, due primarily to the addition of our Retail Micro-Lending andServicing segment.

 

While we incur certain base levels of fixedcosts associated with the infrastructure that we have built to support ourgrowth and diversification into new products and services for our under-servedand un-banked customers, the vast majority of our operating costs are highlyvariable based on the levels of receivables that we service (both for our ownaccount and for others) and the pace and breadth of our search for, acquisitionof and introduction of new business lines,

 

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products and services. Weexpect to continue growing and diversifying our business in 2005, and whilecertain unique expenses undertaken in 2004 may not be repeated in 2005 andwhile we continue to derive cost reductions through our outsourcing and othercost-control efforts, we do expect to see continued growth in our total otheroperating expense levels (on a year-over-year comparative basis relative to2004) based on growth that we plan to undertake in 2005.

 

***MinorityInterest.*** The ownership interests of minority holders of equity in our twomajority-owned subsidiaries are reflected as minority interests in ourcondensed consolidated statements of operations. The minority interests expenseassociated with these subsidiaries totaled $9.2 million and $6.3 million forthe three months ended March 31, 2005 and 2004, respectively, with theyear-over-year increase based principally on the third quarter of 2004 additionof our second majority-owned subsidiary (and growth in its operations throughits acquisition and securitization of a second credit card receivablesportfolio growth early in the first quarter of 2005).

 

***IncomeTaxes.***  Oureffective tax rate was 36.5% for the three months ended March 31, 2005compared to 37.5% for the three months ended March 31, 2004. The decreaseof approximately 1.0% in our effective tax rate between 2005 and 2004 isprincipally due to the favorable state income tax effects of acquisitionscompleted throughout 2004 and during the first quarter of 2005.

 

**Credit Cards Segment**

 

Our Credit Cards segment consists of ourcredit card investment and servicing activities, as conducted with respect toreceivables underlying accounts originated and portfolios purchased by us. Thissegment represents aggregate activities associated with all of our credit cardproducts, including our largely fee-based card offering to consumers at thelower end of the FICO scoring range. Revenues associated with our largelyfee-based offering to consumers at the lower end of the FICO scoring rangeinclude interest income (along with late fees), fees and other income, as wehave not securitized the receivables associated with this offering. Withrespect to our securitized credit card receivables (which represent asubstantial majority of our receivables), our fees and other income onsecuritized earnings assets within the Credit Cards segment include (1) securitizationincome, (2) income from retained interests in credit card receivablessecuritized, and (3) fees and other income. Also within our Credit Cardssegment are equity in the income of equity-method investees and servicingincome revenue sources. We earn servicing income from the trusts underlying oursecuritizations and the securitizations of our equity-method investees. Ourrevenue categories most affected by delinquency and credit loss trends are thenet interest income, fees and other income on non-securitized earnings assets(which are net of a provision for loan losses) and the income from retainedinterests in credit card receivables securitized categories. Details of ourincome from retained interests in credit card receivables securitized for thethree months ended March 31, 2005 and 2004 are as follows:

 
| ** **                                                              | ** ** | **Three Months  Ended March 31,** | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                              | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| ** **                                                              | ** ** | **(In millions)**                      | ** ** |
| Income from retained interests in credit  card receivables securitized: |       |                                   |       |   |   |
| Originated portfolio                                                    |       | $                                      | 7.4        |   | $ | 6.1 |   |
| Purchased portfolios(1)                                                 |       | 18.5                                   |       | 13.3 |   |
| Total                                                                   |       | $                                      | 25.9       |   | $ | 19.4 |   |

 

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(1)           Thisamount includes approximately $1.8 million for the three months ended March 31,2004 related to the Fingerhut Trust. It also includes $11.4 million for thethree months ended March 31, 2005 and 2004 related to the EmbarcaderoTrust and $7.1 million for the three months ended March 31, 2005associated with portfolios of receivables acquired from the same seller andsecuritized in separate transactions in the third quarter of 2004 and early inthe first quarter of 2005, respectively.

 

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***Background***

 

All of our credit card securitizations aretreated as sales under GAAP. As such, we remove the securitized receivablesfrom our condensed consolidated balance sheet. The performance of theunderlying credit card receivables will nevertheless affect the future cash flowswe actually receive. Various references within this section are to ourmanaged receivables, which include our non-securitized credit card receivables,as well as the credit card receivables underlying our off balance sheetsecuritization facilities. Managed receivables data also include our equityinterest in the receivables that we manage for our equity-method investees andexclude minority interest holders’ shares of the receivables that we manage forour majority-owned subsidiaries.

 

Financial, operating and statistical databased on these aggregate managed receivables are key to any evaluation of ourperformance in managing (including underwriting, valuing purchased receivables,servicing and collecting) the aggregate of the portfolios of credit cardreceivables reflected on our balance sheet and underlying our securitizationfacilities. In allocating our resources and managing our business, managementrelies heavily upon financial data and results prepared on a so-called “managedbasis.” It is also important to analysts, investors and others that we provideselected financial, operating and statistical data on a managed basis becausethis allows a comparison of us to others within the specialty finance industry.Moreover, our management, analysts, investors and others believe it is criticalthat they understand the credit performance of the entire portfolio of ourmanaged receivables because it reveals information concerning the quality ofloan originations and the related credit risks inherent within the securitizedportfolios and our retained interests in our securitization facilities. It alsofacilitates comparison of us to others within the specialty finance industry.

 

Managed receivables data assume that none ofthe credit card receivables underlying our off balance sheet securitizationfacilities were ever transferred to securitization facilities and present thenet credit losses and delinquent balances on the receivables as if we stillowned the receivables. Reconciliation of the managed receivables data to ourGAAP financial statements requires: (1) recognition that a significantmajority of our loan and fee receivables (i.e., all but $135.1 million ofGAAP credit card loan and fee receivables at gross face value) had been sold insecuritization transactions as of March 31, 2005; (2) a look-throughto our economic share of (or equity interest in) the receivables that we managefor our three equity-method investees; (3) removal of our minorityinterest holders’ interests in the managed receivables underlying our GAAPconsolidated results; and (4) recognition that the de-securitizedFingerhut managed receivables are recorded at a $0.0 basis in our GAAPfinancial statements.

 

The period-end and average managedreceivables data (as well as delinquency and charge-off statistics) that followwithin this section exclude the receivables associated with all accountsin late delinquency status in sellers’ hands as of the dates of ouracquisitions of the receivables or interests therein. Pursuant to this treatment,the only activity within the following statistical data associated with theseexcluded accounts are recoveries, which we include within the numerator of theother income ratio computation, as well as the costs of pursuing theserecoveries, which we include within the numerator of the operating ratiocomputation. Summarized below are the managed accounts underlying our firstquarter of 2005 acquisitions, as well as those acquired accounts that have beenexcluded from our credit card data because at the time of purchase, they werein a late delinquency status (in thousands):

 
| Acquired accounts |   | 243 |   |
|-------------------|--------|-----|--------|
| Excluded accounts |   | 9   |   |

 

The credit card receivables portfolios thatwe acquire are typically acquired at substantial discounts. A portion of eachacquisition discount is related to the excluded receivables and accounts notedabove. Another portion of each discount relates to the credit quality of theremaining acquired receivables and is calculated as the difference between theface amount of the receivables purchased (less the excluded receivablesdescribed above) and the future cash flows expected to be collected from thereceivables. We refer to the balance of the discount for each purchase notneeded for credit quality as accretable yield, which we amortize into netinterest margin using the interest method over the estimated life of eachacquired portfolio. As of the close of each financial reporting period, weevaluate the appropriateness of the credit quality discount component of ouracquisition discount and the accretable yield component of our acquisitiondiscount based on actual and projected future results. The following tablesummarizes the discount components associated with our economic interests in2004 and first quarter of 2005 acquired portfolios as they were computed at thedate of acquisition:

 

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| ** **                            | ** ** | **Purchases occurring**                 | ** ** |
|---------------------------------------|------------|-----------------------------------------|------------|
| ** **                            | ** ** | **Three months  ended March  31, 2005** | ** ** | **Year ended  December  31, 2004** | ** ** |
| ** **                            | ** ** | **(In millions)**                       | ** ** |
| Total face value acquired             |       | $                                       | 228.1      |   | $ | 401.6 |   |
| Total discount                        |       | 46.8                                    |       | 77.2 |   |
| Portion used for excluded receivables |       | 13.1                                    |       | 26.9 |   |
| Portion needed for credit quality     |       | 21.5                                    |       | 35.1 |   |
| Portion reflecting accretable yield   |       | 12.1                                    |       | 15.2 |   |
|                                       |            |                                         |            |  |  |  |  |

 

***Asset Quality***

 

Our delinquency and charge off data at any pointin time reflects the credit performance of our managed receivables. The averageage of our credit card accounts, the timing of portfolio purchases, the successof our collection and recovery efforts and general economic conditions allaffect our delinquency and charge off rates. The average age of our credit cardreceivables portfolio also affects the stability of our delinquency and lossrates. The delinquency and charge-off data reflected herein are considered bymanagement in determining our allowance for uncollectible loans and fees withrespect to our non-securitized earning assets, net on our condensedconsolidated balance sheets, as well as the valuation of our retained interestsin credit card receivables securitized, which is a component of securitizedearning assets on our condensed consolidated balance sheets. As receivables arecharged off, the charge offs of non-securitized receivables are reflectedwithin our provision for loan losses, and the charge offs of securitizedreceivables are reflected as an offset in determining income from retainedinterest in credit card receivables securitized (within our fees and otherincome on securitized earning assets) on our condensed consolidated statementsof operations.

 

Our strategy for managing delinquency andreceivables losses consists of account management throughout the customerrelationship. This strategy includes credit line management and pricing basedon the risk of the credit card accounts.

 

*Delinquencies.*  Delinquencies have the potential to impactnet income in the form of net credit losses. Delinquencies are also costly interms of the personnel and resources dedicated to resolving them. A credit cardaccount is contractually delinquent if the cardholder’s minimum payment is notreceived by the specified date on the cardholder’s statement. It is our policyto continue to accrue interest and fee income on all credit card accounts,except in limited circumstances, until the account and all related receivables,interest and other fees are charged off. See the “Charge offs” discussion aswell.

 

The account management strategies that we useon our portfolio are intended to manage and to the extent possible reduce thehigher delinquency rates that can be expected in a more mature managedportfolio such as ours. These account management strategies includeconservative credit line management, purging of inactive accounts andcollection strategies (as described under the heading “How Do We Collect fromOur Customers?” in “Item 1. Business” of our Annual Report on Form 10-Kfor the year ended December 31, 2004) intended to optimize the effectiveaccount-to-collector ratio across delinquency buckets. We measure the successof these efforts by measuring delinquency rates. These rates exclude accountsthat have been charged off.

 

The following table presents the delinquencytrends of the credit card receivables that we manage:

 
| ** **                                        | ** ** | **As of**                             | ** ** |
|---------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                        | ** ** | **2005**                              | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                        | ** ** | **Mar. 31**                      | ** ** | **Dec. 31** | ** ** | **Sep. 30** | ** ** | **Jun. 30** | ** ** | **Mar. 31** | ** ** | **Dec. 31** | ** ** | **Sep. 30** | ** ** | **Jun. 30** | ** ** |
| ** **                                        | ** ** | **(Dollars in thousands;% of total)** | ** ** |
| Period-end  managed receivables                   |       | $                                     | 2,246,256  |   | $ | 2,166,489 |   | $ | 1,931,514 |   | $ | 1,942,059 |   | $ | 2,090,644 |   | $ | 2,340,898 |   | $ | 2,518,822 |   | $ | 2,242,542 |   |
| Period-end  managed accounts                      |       | 2,943                                 |       | 2,888 |   | 2,317 |   | 2,222 |   | 2,276 |   | 2,416 |   | 2,637 |   | 2,707 |   |
| Receivables  delinquent:                          |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 30 to 59 days  past due                           |       | $                                     | 70,558     |   | $ | 80,419 |   | $ | 76,028 |   | $ | 84,474 |   | $ | 71,108 |   | $ | 104,380 |   | $ | 118,300 |   | $ | 111,452 |   |
| 60 to 89 days  past due                           |       | 54,505                                |       | 61,408 |   | 61,144 |   | 60,780 |   | 58,188 |   | 79,347 |   | 87,205 |   | 74,330 |   |
| 90 or more days  past due                         |       | 143,416                               |       | 167,863 |   | 148,132 |   | 126,505 |   | 160,055 |   | 200,965 |   | 187,526 |   | 162,463 |   |
| Total 30 or more  days past due                   |       | $                                     | 268,479    |   | $ | 309,690 |   | $ | 285,304 |   | $ | 271,759 |   | $ | 289,351 |   | $ | 384,692 |   | $ | 393,031 |   | $ | 348,245 |   |
| Total 60 or more days  past due                   |       | $                                     | 197,921    |   | $ | 229,271 |   | $ | 209,276 |   | $ | 187,285 |   | $ | 218,243 |   | $ | 280,312 |   | $ | 274,731 |   | $ | 236,793 |   |
| Receivables  delinquent as % of period-end loans: |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 30 to 59 days  past due                           |       | 3.1                                   | %          | 3.7 | % | 3.9 | % | 4.3 | % | 3.4 | % | 4.5 | % | 4.7 | % | 5.0 | % |
| 60 to 89 days  past due                           |       | 2.4                                   |       | 2.8 |   | 3.2 |   | 3.1 |   | 2.8 |   | 3.4 |   | 3.5 |   | 3.3 |   |
| 90 or more days  past due                         |       | 6.4                                   |       | 7.7 |   | 7.7 |   | 6.5 |   | 7.7 |   | 8.6 |   | 7.4 |   | 7.2 |   |
| Total 30 or more  days past due                   |       | 11.9                                  | %          | 14.2 | % | 14.8 | % | 13.9 | % | 13.9 | % | 16.5 | % | 15.6 | % | 15.5 | % |
| Total 60 or more  days past due                   |       | 8.8                                   | %          | 10.5 | % | 10.9 | % | 9.6 | % | 10.5 | % | 12.0 | % | 10.9 | % | 10.5 | % |

 

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A comparison of our lower delinquency ratesin all categories as of March 31, 2005 to those as of March 31, 2004supports our belief that we are seeing credit quality improvements within ourportfolios. We believe this to be the case despite our marketing and additionof new accounts underlying our originated portfolio master trust during 2004,which tend to have lower delinquency rates than more mature accounts. Thefavorable effects of this phenomenon are offset by the growth in our largelyfee-based credit card offering to consumers at the lower end of the FICOscoring range, the receivables of which experience greater delinquency andcharge-off levels.

 

*Charge offs.*  We generally charge off credit cardreceivables when they become contractually 180 days past due or within30 days of notification and confirmation of a customer’s bankruptcy ordeath. In some cases of death, however, receivables are not charged off if,with respect to the deceased customer’s account, there is a surviving,contractually liable individual or an estate large enough to pay the debt infull. Other loans and fees receivable generally are charged off when theybecome contractually 90 days past due.

 

The following table presents the charge offdata for:  (1) all of the creditcard receivables underlying the securitizations of our consolidatedsubsidiaries (adjusted to exclude the receivables associated with minorityinterest holders’ equity in our consolidated subsidiaries); (2) ourrespective 50.0%, 33.3% and 47.5% shares of the receivables that we manage onbehalf of our equity-method investees; (3) the de-securitized Fingerhutreceivables; and (4) the $135.1 million face amount of receivablesassociated with our largely fee-based credit card offering to consumers at thelower end of the FICO scoring range, which have not been securitized.

 
| ** **                      | ** ** | **For the Three Months Ended**                     | ** ** |
|---------------------------------|------------|----------------------------------------------------|------------|
| ** **                      | ** ** | **2005**                                           | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                      | ** ** | **Mar. 31**                                   | ** ** | **Dec. 31** | ** ** | **Sep. 30** | ** ** | **Jun. 30** | ** ** | **Mar. 31** | ** ** | **Dec. 31** | ** ** | **Sep. 30** | ** ** | **Jun. 30** | ** ** |
| ** **                      | ** ** | **(Dollars in thousands; percentages annualized)** | ** ** |
| Average managed receivables     |       | $                                                  | 2,307,471  |   | $ | 2,039,235 |   | $ | 1,924,520 |   | $ | 2,001,489 |   | $ | 2,219,537 |   | $ | 2,419,674 |   | $ | 2,469,194 |   | $ | 2,359,513 |   |
| Gross yield ratio               |       | 28.2                                               | %          | 29.3 | % | 29.8 | % | 29.6 | % | 30.3 | % | 31.3 | % | 32.1 | % | 33.0 | % |
| Combined gross charge offs      |       | $                                                  | 117,924    |   | $ | 131,061 |   | $ | 121,498 |   | $ | 140,573 |   | $ | 165,815 |   | $ | 169,482 |   | $ | 161,746 |   | $ | 206,451 |   |
| Net charge offs                 |       | $                                                  | 52,432     |   | $ | 58,270 |   | $ | 61,255 |   | $ | 74,087 |   | $ | 87,331 |   | $ | 90,446 |   | $ | 95,629 |   | $ | 123,062 |   |
| Adjusted charge offs            |       | $                                                  | 39,053     |   | $ | 39,899 |   | $ | 38,343 |   | $ | 43,934 |   | $ | 45,294 |   | $ | 47,304 |   | $ | 54,798 |   | $ | 64,744 |   |
| Combined gross charge off ratio |       | 20.4                                               | %          | 25.7 | % | 25.3 | % | 28.1 | % | 29.9 | % | 28.0 | % | 26.2 | % | 35.0 | % |
| Net charge off ratio            |       | 9.1                                                | %          | 11.4 | % | 12.7 | % | 14.8 | % | 15.7 | % | 15.0 | % | 15.5 | % | 20.9 | % |
| Adjusted charge off ratio       |       | 6.8                                                | %          | 7.8 | % | 8.0 | % | 8.8 | % | 8.2 | % | 7.8 | % | 8.9 | % | 11.0 | % |
| Net interest margin             |       | 21.1                                               | %          | 20.4 | % | 22.4 | % | 20.8 | % | 20.1 | % | 22.1 | % | 22.4 | % | 18.3 | % |
| Other income ratio              |       | 6.8                                                | %          | 5.4 | % | 7.4 | % | 6.9 | % | 6.2 | % | 5.9 | % | 5.1 | % | 5.5 | % |
| Operating ratio                 |       | 8.6                                                | %          | 10.3 | % | 8.2 | % | 7.6 | % | 7.1 | % | 8.6 | % | 7.3 | % | 7.4 | % |

 

The principal factor contributing to thelower gross yield ratio experienced during the first quarter of 2005 is ourimproved across-the-board delinquency rates within each of our managedreceivables portfolios. Lower delinquencies have translated directly into lowerlate fee billings. Observations with respect to the remaining categories in theabove table are as follows:

 

•                  While all of our charge-off levels and ratiosbenefit from our marketing of new accounts underlying our originated portfoliomaster trust, which was renewed during mid to late 2004 and continued into2005, the favorable effects of this phenomenon are offset by the growth in ourlargely fee-based credit card offering to consumers at the lower end of theFICO scoring range, the receivables of which experience greater charge-offlevels than we experience within our originated portfolio master trust and withrespect to purchased receivables.

 

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•                  While our net interest margin benefits from lowerfinance charge and late fee charge off levels within newly added accountsunderlying our originated portfolio master trust, the favorable effects of thisphenomenon are offset partially by the growth in our largely fee-based creditcard offering to consumers at the lower end of the FICO scoring range, thereceivables of which experience lower APRs and have greater charge-off levelsthan we experience within our originated portfolio master trust and withrespect to purchased receivables.

 

•                  The significant trending seasonally adjusted declinein combined gross charge offs and combined gross charge off ratios principallyreflects credit quality improvements within our portfolios.

 

•                  Both credit quality improvements within ourportfolios and our lower delinquencies have contributed to trending lower netcharge offs and adjusted charge offs, as well as a lower net charge off ratio.

 

•                  Our first quarter of 2005 combined gross charge off,net charge off and adjusted charge off ratios all benefit from the effects ofthree acquisitions that occurred late in the fourth quarter of 2004 and earlyin the first quarter of 2005. That is to say that our March 31, 2005 managedreceivables data exclude all receivables associated with accounts that were ator near charge off at the time the receivables portfolios were acquired. Theexclusion of these late stage or severely delinquent accounts at the time ofacquisition means that there are no charge-offs on the acquire portfolios’receivables until the acquired portfolios season through their delinquencybuckets in the months following the acquisitions. Magnifying this beneficialeffect is the fact that while there are no charge-offs of these receivablesuntil the portfolios season through their delinquency buckets, the denominatorof the various charge off ratio computations is increased to include all of theacquired portfolios’ receivables that were not at or near charge off at thetimes of acquisition. In prior filings we have sometimes referred to thiseffect as the “denominator effect.” These beneficial effects will carry over into future 2005 quarters untilthe acquired portfolios’ receivables season through their delinquency buckets.

 

•                  The gap between our net charge offs and adjustedcharge offs, as well as their associated ratios, has narrowed in recentquarters. Given our efforts to grow our account originations and receivableslevels for both our traditional credit card product and our largely fee-basedcredit card offering to consumers at the lower end of the FICO scoring rangeand given cardholder purchase activities and the commensurate generation of newreceivables by customers underlying our portfolio acquisitions, thepre-acquisition receivables balances within our acquired portfolios (to whichour credit quality discount at acquisition applies) have fallen as a relativepercentage of our total portfolio of managed receivables. Our first quarter2005 receivables acquisitions should serve to diminish somewhat the pace ofthis trend over the next few quarters.

 

•                  Our first quarter 2005 net interest margin has beenfavorably influenced by the effects of our recent acquisitions and lowerfinance charge and late fee charge offs. Our lower finance charge and late feecharge offs are consistent with the absolute improvements that we are seeingyear over year in the credit quality of our portfolios. We expect to see somefurther improvements in our net interest margin throughout the balance of 2005.

 

•                  The general trend of year over year improvements inthe other income ratio results principally from increased fee income (net offee charge offs) associated with our largely fee-based credit card productoffering to consumers at the lower end of the FICO scoring range. Alsocontributing is improved credit quality overall, which has had the effect ofreducing the level of fee charge offs netted against fee income associated withour originated portfolio master trust and purchased portfolio managedreceivables.

 

•                  The decline in the first quarter 2005 operatingratio relative to the fourth quarter of 2004 principally reflects the effectsour $9.0 million charitable contribution in the fourth quarter of 2004.

 

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***Definitions ofFinancial, Operating and Statistical Measures***

 

We refer readers to our Annual Report on Form 10-Kfor the year ended December 31, 2004 for the definitions of adjustedcharge offs, combined gross charge offs, the gross yield ratio, net chargeoffs, the net interest margin, and the other income ratio, none of which havechanged from the definitions provided in that Annual Report on Form 10-K.Our operating ratio represents an annualized fraction, the numerator of whichincludes the expenses associated with our Credit Cards segment (net of anyservicing income we receive in our capacity as servicer for other parties withseparate economic interests in the trusts that we service), other thanmarketing and solicitation and ancillary product expenses, and the denominatorof which is average managed receivables.

 

# **Investments in Previously Chargedoff Receivables Segment**

#  

For first quarter of 2005, the followingtable shows a roll-forward of our investments in previously charged offreceivables activities (in thousands of dollars):

 
| ** **                                        | ** ** | **March 31,** | ** ** |
|---------------------------------------------------|------------|--------------------|------------|
| ** **                                        | ** ** | **2005**           | ** ** |
| Unrecovered balance at beginning of period        |       | $                  | 15,094     |   |
| Acquisitions of defaulted accounts                |       | 10,323             |       |
| Cash collections                                  |       | (24,791            | )          |
| Income recognized on defaulted accounts           |       | 17,508             |       |
| Balance at the end of the period                  |       | $                  | 18,134     |   |
| Estimated remaining collections (“ERC”) |       | $                  | 64,616     |   |

 

At the time of acquisition, the life of eachpool of previously charged off receivables generally is estimated under ourproprietary models to be between 24 and 36 months for our contractualcharge off purchases and between 24 and 60 months for Chapter 13bankruptcy charge off purchases. We anticipate collecting approximately 60.0%of the ERC over the next twelve months, with the balance to be collectedthereafter.

 

The above table reflects our use of the costrecovery method of accounting for our investments in previously charged offreceivables. Under this method, static pools consisting of homogenous accountsand receivables are established for each portfolio acquisition. Once a staticpool is established, the receivables within the pool are not changed. Eachstatic pool is recorded at cost and is accounted for as a single unit forpayment application and income recognition purposes. Under the cost recoverymethod, income associated with a particular portfolio is not recognized untilcash collections have exceeded the investment. Additionally, until such time ascash collected for a particular portfolio exceeds our investment in theportfolio, we will incur commission costs and other internal and externalservicing costs associated with the cash collections on the portfolioinvestment that will be charged as an operating expense without any offsettingincome amounts.

 

We expect our Investments in PreviouslyCharged Off Receivables segment to continue its revenue and income growththroughout 2005.

 

**Retail Micro-Lending and Servicing Segment**

 

The Retail Micro-Lending and Servicingsegment consists of a network of storefront locations that provide, eitherdirectly or on behalf of a lending bank, small-denomination, short-term,unsecured cash advances that are typically due on the customer’s next payday.The assets associated with our Retail Micro-Lending and Servicing operationswere principally acquired in two separate transactions completed during 2004.During the second quarter of 2004, certain of our subsidiaries acquiredsubstantially all of the assets of First American, including over 300 retaillocations in 11 states, for approximately $108.9 million. Representing aninitial market entry into micro-lending and servicing activities, the FirstAmerican acquisition provided a platform for future growth in this market.Subsequently, during the third quarter of 2004, our subsidiaries acquiredsubstantially all of the assets of another micro-lender, Venture Services,including 166 retail locations in 7 states, for approximately$33.9 million. The Venture Services acquisition provided complementarylocations in 4 existing states and added 3 new states.  Also in January 2005, one of oursubsidiaries acquired substantially

 

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all of the assets of anothermicro-lender for approximately $11.9 million, including transaction costs;with this acquisition, we added an additional 39 stores in the State of Ohio.As of March 31, 2005, our subsidiaries operated a total of 516 micro-lendingand servicing locations in 14 states.

 

The micro-lending market emerged in the early1990s in response to a shortage of available short-term consumer creditalternatives from traditional banking institutions. We believe customers seekmicro-loans as a simple, quick and confidential way to meet short-term cashneeds between paydays while avoiding the potentially higher costs and negativecredit consequences of other financing alternatives, which include overdraftprivileges or bounced check protection, late bill payments, checks returned forinsufficient funds and short-term collateralized loans.

 

In most of the states in which our subsidiariesoperate our micro-lending business, loans are made directly to customers.However, in certain other states, they act only as a processing and servicingagent for a state-chartered, FDIC insured bank that issues loans to customerspursuant to the authority of the laws of the state in which the bank is locatedand federal interstate banking laws, regulations and guidelines. Unlike manycompetitors, our subsidiaries have structured their processing and servicingagreements with the lending bank so that the bank bears the entire credit riskassociated with the loans. Additionally, unlike many competitors, oursubsidiaries do not purchase overdue loans from the lending bank. As of March 31,2005, our subsidiaries were making micro-loans directly to customers in 389 ofthe 516 locations in 10 states, and they were acting as a processing andservicing agent for the lending bank in the remaining 127 locations in 4states. For the three months ended March 31, 2005, direct storefront micro-lendinggenerated revenues of $17.9 million, and revenues through processing andservicing activities for the lending bank were $5.4 million.

 

In addition to the 39 locations acquiredduring the three months ended March 31, 2005, three new locations wereopened during the quarter ended March 31, 2005. The capital cost ofopening a new branch location varies depending on the size and location of thebranch, but typically averages approximately $30,000. This capital costincludes leasehold improvements, signage, fixtures, furniture, computerequipment and security. Historically, it typically takes approximately ninemonths for a micro-loan location to generate sufficient revenues to cover itsbranch expenses, excluding management fees paid to its parent. During thequarter ended March 31, 2005, eight of the branch locations were closed inorder to better allocate our resources.

 
| ** **                    | ** ** | **For the Three  Months Ended  March 31, 2005** | ** ** | **Year Ended  December 31, 2004** | ** ** |
|-------------------------------|------------|------------------------------------------------------|------------|----------------------------------------|------------|
| Beginning number of locations |       | 482                                                  |       | —                                 |       |
| Acquired locations            |       | 39                                                   |       | 468                                    |       |
| Opened locations              |       | 3                                                    |       | 16                                     |       |
| Closed locations              |       | (8                                                   | )          | (2                                     | )          |
| Ending locations              |       | 516                                                  |       | 482                                    |       |

 

Pre-tax net income within our RetailMicro-Lending and Servicing segment was $0.9 million for the first quarter of2005. Historically, the first quarter of each calendar year includes theslowest lending months of the year for the micro-lending sector as manyconsumers have the benefit of income tax refunds during this period, whichallows them to repay their outstanding micro-lending obligations and to meettheir day-to-day cash flow needs without the necessity of micro-lendingproducts. Also relevant to our first quarter 2005 results is the fact that wecompleted our 39-store acquisition in January 2005, which resultedin higher operating costs for us during a period of relatively low seasonalrevenues. Notwithstanding the above factors, we expect greater pre-tax netincome levels for our Retail Micro-Lending and Servicing segment throughout thebalance of 2005—levels which we expect will represent meaningful growth relativeto our 2004 pre-tax net income levels. We have these expectationsnotwithstanding guidance recently published by the FDIC, which seeks to limitthe frequency of borrower usage of micro-loans offered by FDIC-supervisedinstitutions and the period a customer may have micro-loans outstanding fromany lender to three months during the previous twelve-month period. We arecurrently assessing the effects of this guidance on our business as wellformulating new lending approaches to satisfy the new FDIC guidelines.

 

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**Liquidity, Funding and Capital Resources**

 

At March 31, 2005, we had approximately$78.6 million in unrestricted cash. Because the characteristics of ourassets and liabilities change, liquidity management is a dynamic processaffected by the pricing and maturity of our assets and liabilities. We financeour business through cash flows from operations, asset backed securitizationsand the issuance of debt and equity:

 

•                  During the three months ended March 31, 2005,we generated $22.4 million in cash flow from operations, compared to using$49.1 million in cash flow from operations during the three months ended March 31,2004. The $71.5 million increase is due primarily to (1) the$26.9 million first quarter 2005 cash flows associated with our zero-basisde-securitized Fingerhut receivables, all of which are reflected in our netincome; (2) improved first quarter 2005 performance of the credit cardreceivables within our securitization trusts, which has in turn resulted inhigher collections of finance charges and fees as a component of our netincome; and (3) higher first quarter 2005 income associated withcollections on our previously charged off receivables investments.

 

•                  During the three months ended March 31, 2005,we generated $12.4 million of cash in investing activities, compared togenerating approximately $5.8 million of cash for the three months ended March 31,2004. The $6.6 million increase is due primarily to a $43.0 millionincrease in our proceeds from (net of investments in) securitized earningassets based on significantly reduced collateral enhancement requirements andthe fact that, unlike the first quarter of 2004, we currently have no principalfunding account deposit requirements within our originated portfolio mastertrust.  This was offset partially by a$9.6 million greater net investment in non-securitized earning assets forthe three months ended March 31, 2005 than for the corresponding period in2004, our previously mentioned portfolio and asset acquisitions made during thefirst quarter of 2005 and increased purchases of software, furniture, fixturesand equipment related to our continued growth and expansion.

 

•                  During the three months ended March 31, 2005,we used  $12.7 million in cash fromfinancing, compared to generating $0.0 in cash from financing activitiesduring the same period in 2004. The $12.7 million increase in cash flow used isprimarily due increased net distributions to minority interest-holders in our consolidatedsubsidiaries and higher net debt repayments in the first quarter of 2005.

 

To avoid incurring costs on funds notcurrently needed to fund investments or operations, we have focused on reducingour unrestricted cash balances to the minimal levels necessary to meet ourdaily operations and investment needs. Having said this, we note that our March 31,2005 unrestricted cash balances are higher than they have typically been at theclose of our recent prior accounting periods given our need to have cash onhand to fund the completion of our automobile lending acquisition on April 1,2005. We have managed our cash balances by managing our draws under oursecuritization facilities in a way that allows us to meet our cash needs on an “asneeded” basis. Given the completion of our $1.25 billion 2-yearvariable funding facility in January of 2004 (which has now been expandedto $1.5 billion), we are confident in our ability to draw additional cashfrom this facility (as well as our conduit facilities) to meet our operatingneeds as they arise throughout 2005. As of March 31, 2005, our collateralbase within our originated portfolio master trust was sufficient to allow foradditional cash draws of $116.2 million against our existingsecuritization facilities.

 

While our current cash flows and availabledraws under our existing securitization facilities are more than adequate tomeet our operating needs throughout 2005, we expect to explore several newacquisition opportunities throughout 2005 and beyond through our effortsto acquire other credit card receivables portfolios and our expansion intoproduct and service offerings complementary to our sub-prime consumer market.While we anticipate using some of our existing cash reserves (and drawpotential against our existing variable funding and conduit securitizationfacilities) to fund acquisitions, it is likely that acquisitions may requirethe use of substantial amounts of cash or may require us to incur substantialacquisition-related debt financing. Based on the pace and magnitude of priorrecent acquisitions coupled with our desire to complete further acquisitions,some of which may be substantial, in 2005 and beyond, we have been evaluatinghigh-yield and convertible debt market transactions and other potential capitalsources. To the extent that we find the markets attractive enough to us toallow us to obtain long-term committed funding for future growth andacquisitions on terms that we consider favorable, we expect to issue theappropriate debt, equity-linked or equity securities, possibly in the nearfuture.

 

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On April 1, 2005, we completed theacquisition of Wells Fargo Financial’s Consumer Auto Receivables businessunit.  This acquisition included all ofConsumer Auto Receivables’ assets, business operations and approximately 300employees for approximately $120.5 million including transaction costs.  As of March 31, 2005 Consumer Auto Receivableshad approximately $129.5 million in assets and operated in thirty-eight statesthrough its twelve branches, three regional processing centers and nationalcollection center at its Lake Mary, FL headquarters.  The acquisition was financed using approximately$88.2 million in debt with the remainder paid in cash.  The $88.2 million in debt was financedthrough an asset securitization transaction. In that transaction a newly-formed special purpose subsidiary purchasedthe receivables and supporting collateral from the business and financed thatacquisition through a secured lending facility with a bank.  The debt incurred under that facility isrecourse only to the assets that are pledged to the lender.  We intend to finance any receivables growthin the business through this same process. The sale of receivables and supporting collateral to Funding does notqualify for gain on sale treatment under Statement No. 140.

 

In January 2005, we purchased a 47.5%interest in a joint venture for approximately $10.9 million, includingtransaction costs. One of our wholly owned subsidiaries and two unaffiliatedinvestors formed this entity in connection with the acquisition ofapproximately $376.3 million (face amount) in credit card receivables.These receivables were then transferred to a subsidiary of the joint venture, andthen on to a trust pursuant to a Statement No. 140 transfer in exchangefor notes and a subordinated, certificated interest issued by the trust.  We account for our investment in this jointventure under the equity method of accounting, and it is included in investmentin equity-method investees on our condensed consolidated balance sheet as of March 31,2005. For a fee that represents adequate compensation for servicing, we haveagreed to service this entire portfolio of securitized credit card receivables.

 

Our Board of Directors has authorized a program torepurchase up to 10 million shares (approximately 18.8 percent of theoutstanding total) of our outstanding common stock. Under the plan, werepurchase shares of our common stock from time to time either on the openmarket or through privately negotiated transactions in compliance with SECguidelines. At our discretion, we may use the treasury shares to satisfy optionexercises and restricted stock grants. We will continue to evaluate our stockprice relative to other investment opportunities and, to the extent we believethat the repurchase of our stock represents an appropriate return of capital,we will repurchase additional shares of our stock.

 

As part of our share repurchase program, we havewritten and, contingent upon favorable market conditions, may continue to writeput options on our own shares. The put options allow us to settle the optionsin either stock or cash. As of March 31, 2005, we are obligated topurchase 250,000 shares under these put option contracts, none of whichrepresented a liability based on the then-existing share price.

 

***Securitization Facilities***

 

Our most significant source of liquidity is thesecuritization of credit card receivables. As of March 31, 2005, we hadtotal securitization facilities of approximately $3.0 billion and had usedapproximately $1.1 billion of these facilities. The weighted-average borrowingrate on these facilities at March 31, 2005 was approximately 3.9%. Thematurity terms of our securitizations vary.

 

In the table below, we have noted the securitizationfacilities (along with their maturity dates) with respect to which asubstantial majority of our managed credit card receivables served ascollateral as of March 31, 2005 (i.e., all credit card receivables otherthan the de-securitized Fingerhut receivables and the receivables associatedwith our largely fee-based credit card offering to consumers at the lower endof the FICO scoring range). Following the table are further details concerningeach of the facilities.

 
| **Maturity date**      | ** ** | **Facility Limit(1)**     | ** ** |
|------------------------|------------|---------------------------|------------|
| ** **             | ** ** | **(Dollars in millions)** | ** ** |
| August 2005(2)    |       | $                         | 95.5       |   |
| September 2005(3) |       | 306.0                     |       |
| October 2005(4)   |       | 200.0                     |       |
| January 2006(5)   |       | 1,500.0                   |       |
| October 2009(6)   |       | 299.5                     |       |
| October 2010(6)   |       | 299.5                     |       |
| January 2014(7)   |       | 335.3                     |       |
| Total                  |       | $                         | 3,035.8    |   |

 

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(1)                                  Excludes securitization facilities related toreceivables managed by CSG because such receivables and their relatedsecuritization facilities relate to CSG, our 50%-owned equity-method investee,and therefore are appropriately excluded from direct presentation in thecondensed consolidated statement of operations or condensed consolidatedbalance sheet items included herein. For similar reasons, excludes thesecuritization facilities underlying Transistor’s on-balance-sheet structuredfinancing of its credit card receivables acquisition and the securitizationfacility of our 47.5%-owned equity-method investee, the investment in which wecompleted in January of 2005.

 

(2)                                  Represents the conduit notes associated withour 75.1% membership interest in Bluestem.

 

(3)                                  Represents the end of the revolving periodfor a $306.0 million conduit facility.

 

(4)                                  Represents the end of the revolving periodfor a $200.0 million conduit facility.

 

(5)                                  This facility also contains one-year renewalperiods (subject to certain conditions precedent) at the expiration of theinitial two-year term and an orderly amortization of the facility atexpiration.

 

(6)                                  On October 8, 2004, we completed twonew, term securitization facilities, which were issued out of our originatedportfolio master trust: a 5-year facility represented by $299.5 millionaggregate principal notes and a 6-year facility also represented by$299.5 million aggregate principal notes. For each of these facilities, theseprincipal note balances exclude $22.5 million of principal notes that wecurrently retain but may choose to sell during the life of the facilities.

 

(7)                                  Represents a ten-year amortizing term seriesissued out of the Embarcadero Trust.

 

For each portfolio of credit card receivables thatwe have securitized, there has never been an early amortization period. We haveexperienced, however, early amortization events associated with each of thesecuritization structures represented by the Fingerhut retained interests thatwe acquired in 2002 and the retained interests that CSG acquired in 2002—bothof which were contemplated and planned for in connection with our establishmentof purchase prices for the respective acquisitions. While the Fingerhut earlyamortization event was made inconsequential to us first by a Fingerhut retainedinterests exchange during the third quarter of 2003 and then again by our thirdquarter 2004 de-securitization of the Fingerhut receivables, the CSG early amortizationevent has ongoing consequences for us. Due to a reduction in the principalbalance of the receivables within the CSG Trust (the retained interests inwhich are owned by our equity-method investee, CSG), a principal balancetrigger occurred, and hence early amortization began, during the second quarterof 2003. The occurrence of this event caused CSG to cease its cashdistributions to us in June 2003, although we expect that the CSG Trustwill continue to provide adequate compensation to us in cash for servicing theportfolio of receivables underlying the CSG Trust and will continue to makepayments to us in respect of our investment in CSG Trust bonds held.

 

While we have never triggered an early amortizationwithin any of the series underlying our originated portfolio master trust securitizationand while we do not believe that we will, it is conceivable that, even withclose management, we may trigger an early amortization of one or more of theoutstanding series within this trust. Early amortization for any of theoriginated portfolio master trust securitization series would have adverseeffects on our liquidity, certainly during the early amortization period andpotentially beyond repayment of any such series because potential investorscould tend to shy away from future CompuCredit-backed issuances.

 

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**Contractual Obligations, Commitments and OffBalance Sheet Arrangements**

 

SeeItem 7, “Management’s Discussion and Analysis of Financial Condition andResults of Operations” in our Annual Report on Form 10-K for theyear ended December 31, 2004. There have been no new material commitmentsentered into since December 31, 2004 other than:

 

•                  On April 1,2005, we completed our acquisition of Wells Fargo Financial’s “Consumer AutoReceivables” business unit for approximately $120.5 million includingtransaction costs. The acquisition was financed using approximately $88.2million in debt with the remainder paid in cash.  The $88.2 million in debt was financedthrough an asset securitization transaction described above under “Liquidity,Funding and Capital Resources.

 

***Commitments andContingencies***

 

We have certain contractual arrangements thatwould require us to make payments or provide funding if certain circumstancesoccur (“contingent commitments”). We do not currently expect that thesecontingent commitments will result in any amounts being paid by us. SeeNote 10, “Commitments and Contingencies,” to our condensed consolidatedfinancial statements for further discussion of these matters.

 

**Recent Accounting Pronouncements**

 

See Note 2, “Significant AccountingPolicies,” to our condensed consolidated financial statements for a discussionof recent accounting pronouncements.

 

**Critical Accounting Estimates**

 

In many instances, the application of GAAPrequires management to make estimates or to apply subjective principles toparticular facts and circumstances. A variance in the estimates used or avariance in the application or interpretation of GAAP could yield a materiallydifferent accounting result. It is impracticable for us to summarize everyaccounting principle that requires us to use judgment or estimates in itsapplication. In our Annual Report on Form 10-K for the year ended December 31,2004, we discuss the four areas (valuation of retained interests, investmentsin previously charged off receivables, non-consolidation of qualifying specialpurpose entities and allowance for uncollectible loans and fees) where webelieve that the estimations, judgments or interpretations that we have made,if different, would have yielded the most significant differences in ourfinancial statements, and we urge you to review that discussion. In addition,in Note 8, “Off Balance Sheet Arrangements,” to the condensed consolidatedfinancial statements included in this report, we have updated a portion of oursensitivity analysis with respect to retained interest valuations.

 

**RelatedParty Transactions**

** **

Since 2001, we have beensubleasing 7,316 square feet of excess office space to Frank J. Hanna, Jr.,for $21.50 per square foot. Frank J. Hanna, Jr. is the father of ourChairman and Chief Executive Officer, David G. Hanna, and one of our directors,Frank J. Hanna, III. The sublease rate is the same as the rate that we payon the prime lease. Total rent for the three months ended March 31, 2005for the sublease was approximately $40,000.

 

See Note 2, “SignificantAccounting Policies,” to the consolidated financial statements included withinour Annual Report on Form 10-K for the year ended December 31,2004 for a discussion of the acquisition of previously defaulted receivables byJefferson Capital from trusts serviced by us.

 

**Forward-LookingInformation**

** **

All statements in thisquarterly report concerning our operations, earnings and liquidity expectationsfor 2005 and all other statements regarding our future performance (includingthose

 

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using words such as “believe,”“estimate,” “project,” “anticipate, or “predict”) are forward-lookingstatements. These types of statements are used in our discussions of: Totalinterest income; Fees and other income on loan-securitized earning assets;Provision for loan losses; Servicing income; Equity in income of equity-methodinvestees; net interest margin; Investments in Previously Charged offReceivables; Retail Micro-Lending and Servicing Segment and Liquidity, Fundingand Capital Resources among others. These forward-looking statements are notguarantees of future performance and are subject to various assumptions, risksand other factors that could cause our actual results to differ materially fromthose suggested by these forward-looking statements. These factors include,among others, the following risks and others set forth under the caption “Risk Factors”in our Annual Report on Form 10-K for the year ended December 31,2004:

 

(1)          The cashflows we receive from our retained interests are a critical component of ourfinancial performance and are dependent upon the cash flows received on thereceivables underlying our securitizations. The collectibility of thereceivables underlying our securitizations is a function of many factorsincluding the criteria used to select to whom credit is extended, the pricingof the credit products, the length of the relationship with each customer,general economic conditions, the rate at which customers repay their accountsand the rate at which customers change or become delinquent. To the extent wehave over estimated collectibility, in all likelihood we have over estimatedour financial performance.

 

(2)          We aresubstantially dependent upon securitizations and other borrowed funds to fundthe receivables that we originate or purchase. All of our securitizationfacilities are of finite duration (and ultimately will need to be extended orreplaced) and contain conditions that must be fulfilled in order for funding tobe available. In the event that advance rates for securitizations are reduced,investors in securitizations require a greater rate of return, we fail to meetthe requirements for continued funding or large-scale securitizations otherwisebecome unavailable to us, we may not be able to maintain or grow our base ofreceivables or it may be more expensive for us to do so. In addition, a portionof our receivables cannot be financed through securitizations because ofadvance rate limitations and must be financed through equity that either is theresult of profitable operations or is raised from third parties or throughfunds borrowed elsewhere. The cost and availability of equity and borrowedfunds is dependent upon our financial performance, the performance of ourindustry generally, and general economic and market conditions, and recentlyhas been both expensive and difficult to obtain.

 

(3)          Our financialperformance is, in part, a function of the aggregate amount of receivables thatwe have outstanding. In turn, this is a function of many factors includinginterest rates, seasonality, general economic conditions, competition fromother credit card issuers and other sources of consumer financing, access tofunding as noted above and the success of our marketing efforts. To the extentthat we have over-estimated the size or growth of our receivables, in alllikelihood we have over-estimated our future performance.

 

(4)          Ouroperating expenses and our ability to effectively service receivables isdependent on our ability to estimate the future size and general growth rate ofthe portfolio. One of our servicing agreements causes us to make additional paymentsif we overestimate the size or growth of our business. These additionalpayments are to compensate the servicer for increased staffing expenses itincurs in anticipation of our growth. If we grow slower than anticipated, wemay still have higher servicing expenses than we actually need, thus reducingour net income. We generally have sufficient office space, customer servicerepresentatives, collectors and computer capacity to accommodate expectedgrowth. However, we are dependent on labor markets to supply qualifiedemployees at appropriate compensation when needed. To the extent that growthoccurs unexpectedly, or the labor markets are tight at that time, we mayencounter difficulties in accommodating that growth effectively.

 

(5)          We operatein a heavily regulated industry. Changes in bankruptcy, privacy or otherconsumer protection laws, including laws that regulate the creation andenforcement of consumer loans, or changes in the interpretation thereof, mayadversely affect our ability to collect credit card account, micro-loans andother loan and fee balances or otherwise adversely affect our business orexpose us to litigation. Similarly, regulatory changes or changes ininterpretation of existing regulations could adversely affect our ability to marketcredit cards, stored-value cards, micro-loans or other products and services toour customers.  The Retail Micro-Lendingand Servicing segment of our business operates in an increasingly hostileregulatory environment, and there currently is a purported class action lawsuitpending against us with respect to this business. Lastly, our operationsroutinely are subject to review by various governmental authorities, which mayor may not subject us to fines, penalties or requirements that we change our operations.

 

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(6)          Theaccounting rules that govern our business are exceedingly complex,difficult to apply and in a state of flux. As a result, how we value our creditcard receivables and otherwise account for our business (including whether weconsolidate our securitizations) is subject to change depending upon theinterpretation of, and changes in, those rules.

 

(7)          We routinelyexplore various opportunities to grow our business, including the purchase ofreceivable portfolios and other businesses.  We have acquired several businesses within thepast year and expect to acquire others in the future.  There are a number of risks attendant to anyacquisition, including the possibility that we will overvalue the assets to bepurchased, that we will not be able to successfully integrate the acquiredbusiness or assets, and that we will not be able to produce the expected levelof profitability from the acquired business or assets. As a result, the impactof any acquisition on our future performance may not be as favorable asexpected and actually may be adverse.

 

We expressly disclaim any obligation to update or revise any forward-lookingstatements, whether as a result of new information, future events or otherwise,except as required by law.

 

**ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISK**

 

**Interest Rate Sensitivity and Market Risk**

 

Interest rate sensitivity is comprised ofbasis risk, gap risk and market risk. Basis risk is caused by the difference inthe interest rate indices used to price assets and liabilities. Gap risk iscaused by the difference in repricing intervals between assets and liabilities.Market risk is the risk of loss from adverse changes in market prices andrates. Our principal market risk is related to changes in interest rates. Thisaffects us directly in our lending and borrowing activities, as well asindirectly as interest rates may impact the payment performance of ourcustomers.

 

We incur basis risk because we fund managedassets at a spread over commercial paper rates or LIBOR, while the rates on theunderlying managed assets are indexed to the prime rate. This basis riskresults from the potential variability over time in the spread between theprime rate on the one hand, and commercial paper rates and LIBOR on the otherhand. We have not hedged our basis risk because we believe that the cost ofhedging this risk is greater than the benefits we would get from elimination ofthis risk. We incur gap risk because the debt underlying our securitizationtrust facilities reprices monthly; whereas, our receivables do not adjustunless we specifically adjust them with appropriate notification. This gaprisk, however, is relatively minor as we can reprice the substantial majorityof our receivables very quickly in response to a rate change.

 

As to the issue of market risk, we attempt tominimize the impact of interest rate fluctuations on net income by regularlyevaluating the risk inherent within our asset and liability structure,especially our off balance sheet assets (such as securitized receivables) andtheir corresponding liabilities. The impact of interest rate fluctuations onour securitized receivables is reflected in the valuation of our retainedinterests in credit card receivables securitized. This risk arises fromcontinuous changes in our asset and liability mix, changes in market interestrates (including such changes that are caused by fluctuations in prevailinginterest rates, payment trends on our interest-earning assets and paymentrequirements on our interest-bearing liabilities) and the general timing of allother cash flows. To manage our direct risk to interest rates, managementactively monitors interest rates and the interest sensitive components of oursecuritization structures. Management seeks to minimize the impact of changesin interest rates on the fair value of assets, net income and cash flowsprimarily by matching asset and liability repricings. There can be noassurance, however, that we will be successful in our attempts to manage suchrisks.

 

At March 31, 2005, a substantial portionof our managed credit card receivables, including those related to ourequity-method investees, and other interest-earning assets had variable ratepricing, with receivables carrying annual percentage rates at a spread over theprime rate (5.75% at March 31, 2005), subject to interest rate floors. At March 31,2005, approximately $69.8 million of our total managed receivables werepriced at their floor rate, of which, $45.1 million of these receivableswere closed and therefore ineligible to be repriced and the remaining $24.7were open and eligible to be repriced. Every 10% increase in LIBOR that weexperience until the accounts underlying these $69.8 million in receivablesreach their floor rate would result in an approximate $78,000 after-taxnegative impact on our

 

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annual cash flows.  Nevertheless, to the extent we choose toreprice any of the $24.7 million of receivables underlying the openaccounts that are below their floor rate, we can mitigate against any possibleadverse impact on our cash flows.

 

We believe we are not exposed to any materialforeign currency exchange rate risk or commodity price risk.

 

**ITEM 4.  CONTROLS AND PROCEDURES**

** **

(a)                    Disclosurecontrols and procedures.

 

Asof the end of the period covered by this report, we carried out an evaluation,under the supervision and with the participation of our Chief Executive Officerand Chief Financial Officer, of the effectiveness of disclosure controls andprocedures as defined in Rules 13a-15(e) and 15d-15(e) ofthe Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based onsuch evaluation, our Chief Executive Officer and Chief Financial Officer haveconcluded that as of the end of the period covered by this report, ourdisclosure controls and procedures were effective at meeting their objectives.

 

(b)                   Internalcontrol over financial reporting.

 

There were not any changes in our internalcontrol over financial reporting (as such term is defined in Rules 13a-15(f) and15d-15(f) under the Exchange Act) during the fiscal quarter to whichthis report relates that have materially affected, or are reasonably likely tomaterially affect, our internal control over financial reporting.

 

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**PART II**—OTHERINFORMATION

** **

**ITEM 1.  LEGAL PROCEEDINGS**

** **

We are involved in various legal proceedingsthat are incidental to the conduct of our business. In one of these legalproceedings, CompuCredit Corporation and five of our subsidiaries aredefendants in a purported class action lawsuit entitled Knox, et al. vs. FirstSouthern Cash Advance, et al, No 5 CV 0445, filed in theSuperior Court of New Hanover county, North Carolina, on February 8, 2005.The plaintiffs allege that in conducting a so-called “payday lending” business,certain of our Retail Micro-Lending and Servicing segment subsidiaries violatedvarious laws governing consumer finance, lending, check cashing, tradepractices and loan brokering. The plaintiffs further allege that CompuCredit isthe alter ego of our subsidiaries and is liable for their actions. Theplaintiffs are seeking damages of up to $75,000 per class member. We intend tovigorously defend this lawsuit. These claims are similar to those that havebeen asserted against several other market participants in transactionsinvolving small balance, short-term loans made to consumers in North Carolina.

 

**ITEM 2.  CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUERPURCHASES OF EQUITY SECURITIES**

** **

None.

 

**ITEM 3.  DEFAULTS UPON SENIOR SECURITIES**

** **

None.

 

**ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS**

** **

None

 

**ITEM 5.  OTHER INFORMATION**

** **

None.

 

**ITEM 6.  EXHIBITS**

** **

(a)          Exhibits

 
| **Exhibit  Number** | ** ** | **Description  of Exhibit**                                                                                   | ** ** | **Incorporated  by  reference from  CompuCredit’s SEC  filings unless  otherwise  indicated:** |
|---------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|
| 31.1                |       | Certification per Section 302 of the Sarbanes-Oxley Act of 2002 for  David G. Hanna                           |       | Filed herewith                                                                                      |
| 31.2                |       | Certification per Section 302 of the Sarbanes-Oxley Act of 2002 for  J.Paul Whitehead, III                    |       | Filed herewith                                                                                      |
| 32.1                |       | Certification per Section 906 of the Sarbanes-Oxley Act of 2002 for  David G. Hanna and J.Paul Whitehead, III |       | Filed herewith                                                                                      |

 

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**SIGNATURES**

** **

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|        | COMPUCREDIT  CORPORATION |
|-------------|--------------------------|
|        |                     |   |
|        |                     |   |
| May 4, 2005 | By                       | /s/ J.PAUL WHITEHEAD, III |
|        |                     | J.Paul Whitehead, III |
|        |                     | *Chief Financial Officer* |
|        |                     | *(duly authorized officer and principal  financial officer)* |

 

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