**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

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** **

**FORM 10-Q**

 

 
|   |   | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002.** |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                       |
|   |

 

**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**

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

 

YES  ý                   NO  o

 

The number of shares outstanding of the issuer’s only class of CommonStock, no par value, (the “Common Stock”), as of August 1, 2002 was 46,559,165shares.

 

 

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**COMPUCREDIT CORPORATION**

 

**FORM 10-Q**

 

**TABLE OF CONTENTS**

 

June 30, 2002

 
| PART I.  |     | FINANCIAL INFORMATION                                                                       |
|----------|----------|---------------------------------------------------------------------------------------------|
|     |     |                                                                                        |   |
|     | Item 1.  | Financial Statements (Unaudited)                                                            |
|     |     |                                                                                        | Condensed Consolidated  Balance Sheets |
|     |     |                                                                                        | Condensed  Consolidated Statements of Operations |
|     |     |                                                                                        | Condensed  Consolidated Statements of Shareholders’ Equity |
|     |     |                                                                                        | Condensed  Consolidated Statements of Cash Flows |
|     |     |                                                                                        | Notes  to Condensed Consolidated Financial Statements |
|     |     |                                                                                        |   |
|     | Item  2. | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
|     |     |                                                                                        |   |
|     |     |                                                                                        |   |
|     | Item  3. | Quantitative  and Qualitative Disclosures About Market Risk                                 |
|     |     |                                                                                        |   |
| PART II. |     | OTHER INFORMATION                                                                           |
|     |     |                                                                                        |   |
|     | Item  1. | Legal Proceedings                                                                           |
|     |     |                                                                                        |   |
|     | Item  2. | Changes in  Securities and Use of Proceeds                                                  |
|     |     |                                                                                        |   |
|     | Item  3. | Defaults Upon Senior  Securities                                                            |
|     |     |                                                                                        |   |
|     | Item  4. | Submission  of Matters to a Vote of Security Holders                                        |
|     |     |                                                                                        |   |
|     | Item  5. | Other Information                                                                           |
|     |     |                                                                                        |   |
|     | Item  6. | Exhibits and Reports  on Form 8-K                                                           |
|     |     |                                                                                        |   |
|     |     | Signatures                                                                                  |

 

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**CompuCredit Corporation and Subsidiaries**

**Consolidated Balance Sheets**

 
|                                                                                                                                   |   | **June 30,****2002**       |    | **December 31,****2001** |   |
|----------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------|---------|--------------------------|--------|
|                                                                                                                                   |   | **(Unaudited)**            |    |                     |   |
|                                                                                                                                   |   | **(Dollars in thousands)** |    |
| **Assets**                                                                                                                             |   |                       |    |                     |   |
| Cash and cash equivalents                                                                                                              |   | $                          | 27,829  |                     | $      | 55,746 |   |
| Restricted cash                                                                                                                        |   | 10,000                     |    | —                   |   |
|                                                                                                                                   |   |                       |    |                     |   |
| Retained interests in credit card receivables  securitized                                                                             |   | 310,074                    |    | 358,889                  |   |
| Accrued interest and fees                                                                                                              |   | 18,262                     |    | 32,928                   |   |
| Net credit card receivables                                                                                                            |   | 328,336                    |    | 391,817                  |   |
|                                                                                                                                   |   |                       |    |                     |   |
| Amounts due from securitization                                                                                                        |   | 14,263                     |    | 20,996                   |   |
| Deferred costs, net                                                                                                                    |   | 11,632                     |    | 17,862                   |   |
| Software, furniture, fixtures and equipment, net                                                                                       |   | 30,490                     |    | 34,522                   |   |
| Prepaid expenses                                                                                                                       |   | 1,349                      |    | 1,540                    |   |
| Investment in equity-method investee                                                                                                   |   | 39,434                     |    | —                   |   |
| Other assets                                                                                                                           |   | 13,562                     |    | 13,974                   |   |
| Total assets                                                                                                                           |   | $                          | 476,895 |                     | $      | 536,457 |   |
|                                                                                                                                   |   |                       |    |                     |   |
| **Liabilities**                                                                                                                        |   |                       |    |                     |   |
| Accounts payable and accrued expenses                                                                                                  |   | $                          | 15,952  |                     | $      | 28,321 |   |
| Notes payable                                                                                                                          |   | 31,443                     |    | 16,517                   |   |
| Deferred revenue                                                                                                                       |   | 8,114                      |    | 13,820                   |   |
| Income tax liability                                                                                                                   |   | 9,036                      |    | 31,320                   |   |
| Total liabilities                                                                                                                      |   | 64,545                     |    | 89,978                   |   |
|                                                                                                                                   |   |                       |    |                     |   |
| **Shareholders’ equity**                                                                                                          |   |                       |    |                     |   |
| Preferred stock, no par value, 10,000,000 shares  authorized:                                                                          |   |                       |    |                     |   |
| Series A preferred stock, 30,000 and 30,000 shares  issued and outstanding atJune 30,  2002 and December 31, 2001, respectively        |   | 30,871                     |    | 29,512                   |   |
| Series B preferred stock, 10,000 and 10,000 shares  issued and outstanding atJune 30,  2002 and December 31, 2001, respectively        |   | 10,503                     |    | 10,000                   |   |
| Common stock, no par value:                                                                                                            |   |                       |    |                     |   |
| 150,000,000 shares authorized, 46,559,165 and  46,559,165 issued and outstanding at June 30, 2002 and December 31, 2001,  respectively |   | —                     |    | —                   |   |
| Additional paid-in capital                                                                                                             |   | 240,352                    |    | 240,352                  |   |
| Note issued to purchase stock                                                                                                          |   | (500                       | )       | (500                     | )      |
| Retained earnings                                                                                                                      |   | 131,124                    |    | 167,115                  |   |
| Total shareholders’ equity                                                                                                        |   | 412,350                    |    | 446,479                  |   |
| Total liabilities and shareholders’ equity                                                                                        |   | $                          | 476,895 |                     | $      | 536,457 |   |

 

See accompanying notes.

 

1

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**CompuCredit Corporation and Subsidiaries**

**Consolidated Statements of Operations (Unaudited)**

 
|                                                                        |   | **For the three months ended  June 30,**            |     | **For the six months ended  June 30,** |   |
|-----------------------------------------------------------------------------|--------|-----------------------------------------------------|----------|----------------------------------------|--------|
|                                                                        |   | **2002**                                            |     | **2001**                               |   | **2002** |   | **2001** |   |
|                                                                        |   | ***(Dollars in thousands, except per share data)*** | * * |
| Interest income                                                             |   | $                                                   | 295      |                                   | $      | 648 |   | $ | 660 |   | $ | 1,657 |   |
| Interest expense                                                            |   | (43                                                 | )        | (12)                                   |   | (103 | ) | (12) |   |
| Net interest income                                                         |   | 252                                                 |     | 636                                    |   | 557 |   | 1,645 |   |
| Other operating income:                                                     |   |                                                |     |                                   |   |   |   |   |   |
| Securitization income, net                                                  |   | —                                              |     | 238                                    |   | — |   | 504 |   |
| (Loss) income from retained interests incredit card receivables securitized |   | (62,921                                             | )        | 21,278                                 |   | (57,219 | ) | 36,723 |   |
| Servicing income                                                            |   | 2,394                                               |     | 1,548                                  |   | 3,679 |   | 3,235 |   |
| Other credit card fees                                                      |   | 23,858                                              |     | 20,796                                 |   | 48,698 |   | 39,509 |   |
| Interchange fees                                                            |   | 4,065                                               |     | 5,541                                  |   | 8,022 |   | 10,902 |   |
| Ancillary products                                                          |   | 3,852                                               |     | 7,372                                  |   | 8,335 |   | 14,942 |   |
| Equity in income of equity-method investee                                  |   | 4,544                                               |     | —                                 |   | 4,544 |   | — |   |
| Total other operating income                                                |   | (24,208                                             | )        | 56,773                                 |   | 16,059 |   | 105,815 |   |
| Other operating expense:                                                    |   |                                                |     |                                   |   |   |   |   |   |
| Non-servicing salaries and benefits                                         |   | 3,028                                               |     | 2,760                                  |   | 6,624 |   | 5,043 |   |
| Credit card servicing                                                       |   | 15,817                                              |     | 15,051                                 |   | 35,887 |   | 29,180 |   |
| Marketing and solicitation                                                  |   | 2,417                                               |     | 7,727                                  |   | 5,041 |   | 19,858 |   |
| Professional fees                                                           |   | 647                                                 |     | 828                                    |   | 1,430 |   | 1,810 |   |
| Data processing                                                             |   | 1,813                                               |     | 1,875                                  |   | 3,413 |   | 4,492 |   |
| Net occupancy                                                               |   | 1,158                                               |     | 602                                    |   | 2,350 |   | 1,407 |   |
| Ancillary product expense                                                   |   | 1,054                                               |     | 2,113                                  |   | 3,053 |   | 6,080 |   |
| Other                                                                       |   | 5,602                                               |     | 3,817                                  |   | 11,060 |   | 7,145 |   |
| Total other operating expense                                               |   | 31,536                                              |     | 34,773                                 |   | 68,858 |   | 75,015 |   |
| (Loss) income before income taxes                                           |   | (55,492                                             | )        | 22,636                                 |   | (52,242 | ) | 32,445 |   |
| Income taxes                                                                |   | 19,422                                              |     | (7,923                                 | )      | 18,284 |   | (11,356 | ) |
| Net (loss) income                                                           |   | $                                                   | (36,070  | )                                      | $      | 14,713 |   | $ | (33,958 | ) | $ | 21,089 |   |
| Net (loss) income attributable to common shareholders                       |   | $                                                   | (37,099  | )                                      | $      | 14,713 |   | $ | (35,991 | ) | $ | 21,089 |   |
| Net (loss) income per common share-basic                                    |   | $                                                   | (0.80    | )                                      | $      | 0.32 |   | $ | (0.77 | ) | $ | 0.45 |   |
| Net (loss) income per common share-assuming dilution                        |   | $                                                   | (0.80    | )                                      | $      | 0.32 |   | $ | (0.77 | ) | $ | 0.45 |   |

 

See accompanying notes.

 

2

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**CompuCredit Corporation and Subsidiaries**

**Consolidated Statements of Shareholders’ Equity(Unaudited)**

**For the six months ended June 30, 2002 and 2001**

 
|                                      |       | **Preferred  Stock** |       | **Common Stock** |       | **Additional********Paid-In********Capital** |       | **Other********Changes  In Equity** |       | **Retained  Earnings** |       | **Total  Shareholders’********Equity** |   |
|-------------------------------------------|------------|----------------------|------------|------------------|------------|----------------------------------------------|------------|-------------------------------------|------------|------------------------|------------|---------------------------------------------|--------|
|                                      | **Shares** |                 | **Amount** |
|                                      |       |                 | ** ** |             | ** ** | **(Dollars in thousands)**                   | ** ** |                                | ** ** |                   | ** ** |
| Balance at December 31, 2000              |       | $                    | —     |             | 46,514,639 |                                         | $          | —                              |       | $                      | 239,789    |                                        | — |   | $ | 164,392 |   | $ | 404,181 |   |
| Issuance of common stock                  |       | —               |       | 44,526           |       | —                                       |       | 563                                 |       | —                 |       | —                                      |   | 563 |   |
| Note issued to purchase stock             |       | —               |       | —           |       | —                                       |       | —                              |       | (500                   | )          | —                                      |   | (500 | ) |
| Net income                                |       | —               |       | —           |       | —                                       |       | —                              |       | —                 |       | 21,089                                      |   | 21,089 |   |
| Balance at June 30, 2001                  |       | $                    | —     |             | 46,559,165 |                                         | $          | —                              |       | $                      | 240,352    |                                        | $      | (500 | ) | $ | 185,481 |   | $ | 425,333 |   |
|                                      |       |                 |       |             |       |                                         |       |                                |       |                   |       |                                        |   |   |   |
| Balance at December 31, 2001              |       | $                    | 39,512     |             | 46,559,165 |                                         | $          | —                              |       | $                      | 240,352    |                                        | $      | (500 | ) | $ | 167,115 |   | $ | 446,479 |   |
| Issuance cost of Series A preferred stock |       | (140                 | )          | —           |       | —                                       |       | —                              |       | —                 |       | —                                      |   | (140 | ) |
| Preferred dividends                       |       | —               |       | —           |       | —                                       |       | —                              |       | —                 |       | (2,033                                      | )      | (2,033 | ) |
| Accretion of preferred dividends          |       | 2,002                |       | —           |       | —                                       |       | —                              |       | —                 |       | —                                      |   | 2,002 |   |
| Net loss                                  |       | —               |       | —           |       | —                                       |       | —                              |       | —                 |       | (33,958                                     | )      | (33,958 | ) |
| Balance at June 30, 2002                  |       | $                    | 41,374     |             | 46,559,165 |                                         | $          | —                              |       | $                      | 240,352    |                                        | $      | (500 | ) | $ | 131,124 |   | $ | 412,350 |   |

 

See accompanying notes.

 

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**CompuCredit Corporation and Subsidiaries**

**Consolidated Statements of Cash Flows (Unaudited)**

 
|                                                                                                |   | **For the six months ended********June 30,** |       |
|-----------------------------------------------------------------------------------------------------|--------|----------------------------------------------|------------|
|                                                                                                |   | **2002**                                     |       | **2001** |   |
|                                                                                                |   | **(Dollars in thousands)**                   | ** ** |
| **Operating activities**                                                                            |   |                                         |       |   |   |
| Net (loss) income                                                                                   |   | $                                            | (33,958    | ) | $ | 21,089 |   |
| Adjustments to reconcile net (loss) income to net cash  (used in) provided by operating activities: |   |                                         |       |   |   |
| Depreciation expense                                                                                |   | 7,190                                        |       | 3,848 |   |
| Amortization expense                                                                                |   | 7,331                                        |       | 3,224 |   |
| Securitization income                                                                               |   | —                                       |       | (504 | ) |
| Retained interests income adjustment, net                                                           |   | 45,715                                       |       | 6,802 |   |
| Income from equity investee                                                                         |   | (4,544                                       | )          | — |   |
| Changes in assets and liabilities:                                                                  |   |                                         |       |   |   |
| Increase in restricted cash                                                                         |   | (10,000                                      | )          | — |   |
| Decrease (increase) in accrued interest and fees                                                    |   | 14,707                                       |       | (2,840 | ) |
| Decrease in amounts due from securitization                                                         |   | 6,733                                        |       | 1,487 |   |
| Increase in deferred costs                                                                          |   | (2,954                                       | )          | (2,529 | ) |
| Decrease in prepaid expenses                                                                        |   | 191                                          |       | 4,632 |   |
| Decrease in accounts payable and accrued expenses                                                   |   | (12,399                                      | )          | (8,024 | ) |
| Decrease in deferred revenue                                                                        |   | (5,706                                       | )          | (1,723 | ) |
| (Decrease) increase in income tax liability                                                         |   | (22,284                                      | )          | 7,556 |   |
| Other                                                                                               |   | 411                                          |       | 2,704 |   |
| Net cash (used in) provided by operating activities                                                 |   | (9,567                                       | )          | 35,722 |   |
| **Investing activities**                                                                            |   |                                         |       |   |   |
| Investment in equity investee                                                                       |   | (34,890                                      | )          | — |   |
| Net loan payments (net loans originated or purchased)                                               |   | (12,970                                      | )          | (199,387 | ) |
| Recoveries of loans previously charged off                                                          |   | 13,602                                       |       | 12,381 |   |
| Net proceeds from securitization                                                                    |   | 4,321                                        |       | 145,527 |   |
| Purchases and development of software, furniture,  fixtures and equipment                           |   | (3,158                                       | )          | (12,309 | ) |
| Net cash used in investing activities                                                               |   | (33,095                                      | )          | (53,788 | ) |
| **Financing activities**                                                                            |   |                                         |       |   |   |
| Preferred stock issuance costs                                                                      |   | (140                                         | )          | — |   |
| Note issued to purchase stock                                                                       |   | —                                       |       | (500 | ) |
| Net proceeds from issuance of common stock                                                          |   | —                                       |       | 563 |   |
| Proceeds from short-term borrowings                                                                 |   | 31,401                                       |       | — |   |
| Repayment of short-term borrowings                                                                  |   | (16,516                                      | )          | — |   |
| Net cash provided by financing activities                                                           |   | 14,745                                       |       | 63 |   |
|                                                                                                |   |                                         |       |   |   |
| **Net decrease in cash**                                                                            |   | (27,917                                      | )          | (18,003 | ) |
| Cash and cash equivalents at beginning of period                                                    |   | 55,746                                       |       | 68,980 |   |
| Cash and cash equivalents at end of period                                                          |   | $                                            | 27,829     |   | $ | 50,977 |   |
| **Supplemental cash flow information**                                                              |   |                                         |       |   |   |
| Cash paid for interest                                                                              |   | $                                            | 116        |   | $ | — |   |
| Cash paid for income taxes                                                                          |   | $                                            | 4,000      |   | $ | 3,800 |   |
| Accretion of preferred stock dividends                                                              |   | $                                            | 2,002      |   | $ | — |   |

 

See accompanying notes.

 

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** **

**CompuCredit Corporation and Subsidiaries**

**Notes to Condensed Consolidated Financial Statements(Unaudited)**

**June 30, 2002**

 

**1.             Organizationand Basis of Presentation**

 

Thecondensed consolidated financial statements include the accounts of CompuCreditCorporation and its wholly owned subsidiaries (collectively, “the Company”).The Company was formed for the purpose of offering unsecured credit and feebased products and services to a segment of the consumer credit market. The Companymarkets unsecured general purpose Visa and MasterCard credit cards throughdirect mail, telemarketing, television and on the internet. Because onlyfinancial institutions can issue general purpose credit cards, the Company hasa contractual arrangement with a third party financial institution pursuant towhich the financial institution issues general purpose credit cards, and theCompany purchases the receivables relating to such accounts. The Company alsomarkets to its cardholders other fee-based products including cardregistration, memberships in preferred buying clubs, magazines, travel servicesand credit life, disability and unemployment insurance.

 

The accompanyingunaudited condensed consolidated financial statements of the Company have beenprepared in accordance with accounting principles generally accepted in theUnited States for interim financial information and with the instructions toForm 10-Q and Article 10 of Regulation S-X. Accordingly, they do not includeall of the information and notes required by accounting principles generallyaccepted in the United States for complete consolidated financial statements.In the opinion of management, all normal recurring adjustments considerednecessary to fairly state the results for the interim periods presented havebeen included. The preparation of financial statements in conformity withaccounting principles generally accepted in the United States requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the condensed consolidated financial statements as well as thereported amount of revenues and expenses during the reporting period. Actualresults could differ from these estimates. Certain estimates such as creditlosses, payment and discount rates have a significant impact on the gains andlosses recorded on securitizations and the value of retained interests incredit card receivables securitized. Operating results for the three and sixmonths ended June 30, 2002 are not necessarily indicative of the results forthe year ended December 31, 2002.  Thesecondensed consolidated financial statements should be read in conjunction withthe notes to the financial statements for the year ended December 31, 2001contained in the Company’s Annual Report on Form 10-K filed with the Securitiesand Exchange Commission.

 

Certainamounts in prior period financial statements have been reclassified to conformto the current period presentation. All significant intercompany balances andtransactions have been eliminated for financial reporting purposes. 

 

**2.             Equity-MethodInvestment in CSG, LLC**

 

CSG,LLC (“CSG”) was formed during the second quarter of 2002 by affiliates ofGoldman, Sachs & Co., Salomon Smith Barney and a wholly owned subsidiary ofthe Company to acquire notes and a certificated interest issued by a trust(“CSG Trust”) that owns a portfolio of credit card receivables.  The Company accounts for its interest in CSGusing the equity-method of accounting. The Company has a 50% interest in CSG and funded its interest in CSGwith cash and a loan.  In exchange forservicing the receivables owned by the CSG Trust, the Company will receive aservicing fee from the securitization structure.

 

**3.             SignificantAccounting Policies**

 

Thefollowing is a summary of significant accounting policies followed in thepreparation of the condensed consolidated financial statements.

 

5

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*Asset Securitization*

 

The Company hassecuritized all of its credit card receivables. When the Company sellsreceivables in securitizations, it retains certain undivided ownershipinterests, interest-only (“I/O”) strips and servicing rights. Although theCompany continues to service the underlying credit card accounts and maintainsthe customer relationships, thesesecuritizations are treated as sales and the securitized receivables are notreflected on the consolidated balance sheet. The retained ownership interestsand the interest-only strips are included in Retained Interests in Credit CardReceivables Securitized.

 

Under Statement ofFinancial Accounting Standards No. 140, “Accounting for Transfers and Servicingof Financial Assets and Extinguishments of Liabilities” (“Statement No. 140”),gains and losses are recognized at the time of each sale.  These gains or losses on sales ofreceivables depend in part on the previous carryingamount of the financial assets sold as well as the fair value of the assets andcash proceeds received. These cash flows represent estimates of finance chargesand late fees, servicing fees, costs of funds paid to investors, payment rates,credit losses, and required amortization payments to investors.  The Company recognizes a servicing liabilityfor the projected servicing costs that exceed projected servicing revenue.  In accordance with Statement No. 140, theCompany does not consolidate any of the qualified special purpose entities(“QSPEs”) in their securitizations.

 

The retained interestsare subsequently accounted for as trading securities and reported at estimatedfair market value with changes in fair value included in income in accordancewith Statement of Financial Accounting Standards No. 115, “Accounting forCertain Investments in Debt and Equity Securities” (“Statement No. 115”). Someof these estimates used in the determination of the gains and losses and therelated fair values of interest-only strips and retained ownership interestsare influenced by factors outside the Company’s control, and, as a result, suchestimates could materially change in the near term.

 

Amounts due fromsecuritization include payments recently received on the securitizedreceivables that are still held by the securitization structure but are payableto the Company within the next 30 days.

 

*Accrued Interest and Fees*

 

Accrued interest and feesrepresent fees earned but not billed to the cardholder at any period end.  During the second quarter of 2002, werevised the accrued balance to better estimate the collectible portion of thesefees.  This change resulted in anaggregate reduction of approximately $12.0 million in our accrued interest andfees at June 30, 2002.

 

*Equity Investments*

 

Investments are accountedfor using the equity method of accounting if the investment gives the Companythe ability to exercise significant influence, but not control, over aninvestee.  Significant influence isgenerally deemed to exist if the Company has an ownership interest in the voting stock of the investee of between20% and 50%, although other factors, such as representation on the investee’sboard of directors and the impact of commercial arrangements, are considered indetermining whether the equity method of accounting is appropriate.  The Company records its equity in the incomeor loss of its investee within other operating income each period.

 

*ServicingIncome*

 

As of June 30th, theCompany is the servicer for the receivables underlying its securitizationstransactions.  The Company receivesservicing fees equal to 0.1% of the originated principal receivables or 5% ofthe cash collected on the portfolios it purchased in 1998.  TheCompany is also the servicer for the receivables that underlie thesecuritization from which CSG purchased notes and a certificated interest issuedby a trust.  The Company receives aservicing fee associated with that securitization equal to 4.8% of the totalaverage receivables in the trust. Servicing revenue is recognized as income on a monthly basis 

 

6

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during the same period inwhich the servicing is performed.  Totalassets being serviced by the Company were $2.9 billion as of June 30, 2002 and$1.9 billion as of December 31, 2001.

 

**4.              Securitizations**

 

The Company securitizesall of its originated credit card receivables through Master Trusts.  Credit card receivables are transferred tothe Master Trusts, which issue notes representing undivided ownership interestsin the assets of the Master Trusts. The Company also securitized two purchased portfolios of credit card receivablesthrough a securitization structure with a third party commercial paper conduitadministered by a national banking institution. Generally Accepted AccountingPrinciples require the Company to treat the transfers as sales and thereceivables are removed from the consolidated balance sheet.  UnderStatement No. 140, an entity recognizes the assets it controls and liabilitiesit has incurred, and derecognizes the financial assets for which control hasbeen surrendered and all liabilities that 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 putpresumptively beyond 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; and

 

3.             The transferor does not maintain effective control overthe transferred assets through either (a) an agreement that both entitles andobligates the transferor to repurchase or redeem them before their maturity or(b) the ability to unilaterally cause the holder to return specific assets,other than through a clean-up call.

 

The securitization transactionsdo not affect the relationship the Company has with its customers and theCompany continues to service the credit card receivables.

 

Thetable below summarizes all of the Company’s securitization activity:

 
|                                                                          |   | **For the three months ended  June 30,** |       | **For the six months ended********June 30,** |   |
|-------------------------------------------------------------------------------|--------|------------------------------------------|------------|----------------------------------------------|--------|
|                                                                          |   | **2002**                                 |       | **2001**                                     |   | **2002** |   | **2001** |   |
|                                                                          |   | **(in thousands)**                       | ** ** |
| Securitization  Activity:                                                     |   |                                     |       |                                         |   |   |   |   |   |
| Gross amount of receivables securitized at period end                         |   | $                                        | 1,723,057  |                                         | $      | 1,671,762 |   | $ | 1,723,057 |   | $ | 1,671,762 |   |
| (Distributions to) proceeds from securitizations                              |   | (58,185                                  | )          | 66,733                                       |   | (114,779 | ) | 145,527 |   |
| Excess cash flows received on retained interests                              |   | 44,089                                   |       | 43,605                                       |   | 96,457 |   | 93,509 |   |
| Pretax securitization income                                                  |   | —                                   |       | 238                                          |   | — |   | 504 |   |
| (Loss) income from retained interests in credit card  receivables securitized |   | (62,921                                  | )          | 21,278                                       |   | (57,219 | ) | 36,723 |   |
|                                                                               |        |                                          |            |                                              |        |  |  |  |  |  |  |  |  |

 

The investors in the Company’ssecuritization transactions have no recourse against the Company for itscustomers’ failure to pay their credit card loans. However, most of theCompany’s retained interests are subordinated to the investors’ interests untilthe investors have been fully paid.

 

The pretax securitization incomerecorded by the Company and the measurement of the Company’s retained interestsare dependent upon management’s estimates of future cash flows using thecash-out method. Under the cash-out method, the future cash flows (includingthe release of any cash related to credit 

 

7

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enhancements) are recorded at a discounted value.The cash flows are discounted based on the timing of when the Company expectsto receive the cash flows. The discount rates are based on management’sestimates of returns that would be required by investors in an investment withsimilar terms and credit quality. Interest rates received on the credit cardreceivables are estimated based on the stated annual percentage rates in thecredit card agreements. Estimated default and payment rates are based onhistorical results, adjusted for expected changes based on the Company’s creditrisk models. Credit card receivables are typically charged off when the loanbecomes 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.

 

                Subsequentto each sale, the Company’s retained interests are carried at estimated fairmarket value with changes in fair value included in income as they areclassified as trading securities. Since quoted market prices are generally notavailable, the Company estimates fair value based on the estimated presentvalue of future cash flows using management’s best estimates of keyassumptions.

 

                TheCompany has decreased its fair value estimate of its retained interests tobetter estimate the collectible portion of finance charge receivables.  Prior to the second quarter of 2002, accruedinterest and fees were deducted from income from retained interests when therelated receivables were charged off. This change in estimate was based in part on proposed bank regulatoryguidelines, which affect many other companies in the credit card industry.  The effect of this change in estimate was todecrease the value of our retained interests by approximately $54.7 million.

 

                The retained interests in creditcard receivables securitized include the following:

 
|                                                       |   | **June 30,  2002** |       | **December 31,  2001** |   |
|------------------------------------------------------------|--------|--------------------|------------|------------------------|--------|
|                                                       |   | **(In thousands)** | ** ** |
| I/O strip                                                  |   | $                  | 98,593     |                   | $      | 84,390 |   |
| Servicing liability                                        |   | (40,501            | )          | (38,123                | )      |
| Net I/O strip                                              |   | 58,092             |       | 46,267                 |   |
| Fair value of Seller’s Interest                       |   | 251,982            |       | 312,622                |   |
| Retained interests in credit card receivables  securitized |   | $                  | 310,074    |                   | $      | 358,889 |   |

 

Our net I/O strip is comprised ofthe I/O strip and the related servicing liability. The I/O strip reflects thefair value of our rights to future income from the portfolio. The servicingliability reflects the fair value of the cost to service the portfolio aboveand beyond the servicing income we expect to receive from the securitization.

 

Changes in any of theseassumptions used to value our retained interests could impact the fair valueestimates and the realization of future cash flows. The weighted average keyassumptions used to estimate the fair value of the Company’s retained intereststhat were not purchased in the open market as of the end of each period arepresented below:

 
|                                   |   | **June 30,  2002** |   | **December 31,  2001** |   |
|----------------------------------------|--------|--------------------|--------|------------------------|--------|
| Payment rate (monthly)                 |   | 7.1                | %      | 8.0                    | %      |
| Expected credit loss rate (annualized) |   | 16.6               |   | 16.7                   |   |
| Residual cash flows discount rate (1)  |   | 22.5               |   | 34.9                   |   |
| Servicing liability discount rate      |   | 14.1               |   | 14.0                   |   |

 

(1)  During the second quarter of 2002, the Company hired anindependent financial advisory firm to evaluate its residual cash flow discountrate.  The independent financial advisoryfirm concluded that the 

 

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appropriate residual cash flow discount rate was22.5%.  During the second quarter of2002, the Company adopted their recommendation and revised the estimatedresidual cash flow discount rate to 22.5% from 34.9% at March 31, 2002.  This resulted in an increase in theCompany’s retained interests of approximately $22.8 million.

 

At June 30, 2002, the followingillustrates the hypothetical effect an adverse 5 and 10 percent change inkey economic assumptions has on the retained interests in credit cardreceivables securitized ($ in thousands):

 
|                                          |   | **Credit card********loans** |    |
|-----------------------------------------------|--------|------------------------------|---------|
| **Payment rate (monthly)**                    |   | 7.1                          | %       |
| *Impact on fair value of 5% adverse  change*  |   | $                            | (1,464  | ) |
| *Impact on fair value of 10% adverse  change* |   | $                            | (1,810  | ) |
| **Expected credit loss rate (annualized)**    |   | 16.6                         | %       |
| *Impact on fair value of 5% adverse  change*  |   | $                            | (7,596  | ) |
| *Impact on fair value of 10% adverse  change* |   | $                            | (15,184 | ) |
| **Residual cash flows discount rate**         |   | 22.5                         | %       |
| *Impact on fair value of 5% adverse  change*  |   | $                            | (2,732  | ) |
| *Impact on fair value of 10% adverse change*  |   | $                            | (5,374  | ) |
| **Servicing discount rate**                   |   | 14.1                         | %       |
| *Impact on fair value of 5% adverse  change*  |   | $                            | (125    | ) |
| *Impact on fair value of 10% adverse  change* |   | $                            | (251    | ) |

 

These sensitivities arehypothetical and should be used with caution. As the figures indicate, changesin fair value based on a 5% and a 10% variation in assumptions generally cannotbe extrapolated because the relationship of the change in assumption to thechange in fair value may not be linear. Also, in this table, the effect of avariation in a particular assumption on the fair value of the retained interestis calculated without changing any other assumptions; in reality, changes inone assumption may result in changes in another. For example, increases inmarket interest rates may result in lower prepayments and increased creditloses, which could magnify or counteract the sensitivities.

 

The Company’s managed loanportfolio underlying its securitizations is comprised of retained interests inloans securitized and the investor’s share of securitized credit card loans.The investor’s share of securitized credit card loans is not an asset of theCompany. Therefore, they are not included in the Company’s consolidated balancesheets. The principal balances outstanding as of June 30, 2002 and December 31,2001, were $1.6 billion and $1.7 billion, respectively. The followingtable summarizes the balances included in the CompuCredit’s managed loanportfolio underlying its securitizations.

 
|                             |   | **June 30,  2002** |       | **December 31,  2001** |   |
|----------------------------------|--------|--------------------|------------|------------------------|--------|
|                             |   | **(In thousands)** | ** ** |
| Total principal balance          |   | $                  | 1,575,689  |                   | $      | 1,711,755 |   |
| Total finance charge balance     |   | 147,368            |       | 180,087                |   |
| Total loans                      |   | $                  | 1,723,057  |                   | $      | 1,891,842 |   |
| Loans delinquent-60 or more days |   | $                  | 192,250    |                   | $      | 210,382 |   |

 

**5.             Commitments and Contingencies**

 

The Company is an equity memberof CSG.  During the second quarter of2002, CSG entered into a note purchase agreement whereby it has agreed to buyadditional interests in a portfolio of credit card receivables owned by CSGTrust in the event there is net new growth in the receivables or collectionsare not available to fund any new purchases by cardholders.  As of June 30, 2002, 

 

9

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CSG Trust had total receivables of approximately$1.2 billion.  The portfolio has and isexpected to continue to decline during the life of the Trust as payments areexpected to exceed new purchases each month. As of June 30, 2002, if future purchases were to exceed paymentsavailable to fund purchases, CSG has agreed to purchase up to $200 million ofnew notes from the trust.  In general,the amount CSG has agreed to purchase declines as the amount of creditavailable to cardholders for future purchases declines.

 

As a member of CSG, the Companyhas agreed to guarantee the payment of the purchase price of the new notes ifin fact purchases were to exceed payments available to fund purchases and if infact CSG itself failed to purchase the new notes under the note purchaseagreement described above.  As of June30, 2002, CSG had not and was not required to purchase any additional notesunder the note purchase agreement.  TheCompany’s guarantee is limited to its ownership percentage in CSG (which atJune 30, 2002 was 50%) times the total amount of the notes that CSG would berequired to purchase.  Therefore, as ofJune 30, 2002, the maximum amount of the Company’s guarantee was $100million.  The Company currently does nothave any liability recorded with respect to this guarantee.

 

**6.              (Loss)Income Per Share**

 

The following table sets forththe computation of basic and diluted (loss) income per share:

 
|                                                                               |   | **For the three months ended********June 30,** |       | **For the six months ended  June 30,** |   |
|------------------------------------------------------------------------------------|--------|------------------------------------------------|------------|----------------------------------------|--------|
|                                                                               |   | **2002**                                       |       | **2001**                               |   | **2002** |   | **2001** |   |
|                                                                               |   | **(in thousands)**                             | ** ** |
| Numerator:                                                                         |   |                                           |       |                                   |   |   |   |   |   |
| Net (loss) income                                                                  |   | $                                              | (36,070    | )                                      | $      | 14,713 |   | $ | (33,958 | ) | $ | 21,089 |   |
| Preferred stock dividends                                                          |   | (1,029                                         | )          | —                                 |   | (2,033 | ) | — |   |
| (Loss) income attributable to common shareholders                                  |   | $                                              | (37,099    | )                                      | $      | 14,713 |   | $ | (35,991 | ) | $ | 21,089 |   |
| Denominator:                                                                       |   |                                           |       |                                   |   |   |   |   |   |
| Denominator for basic (loss) income per  share-weighted-average shares outstanding |   | 46,559                                         |       | 46,535                                 |   | 46,559 |   | 46,525 |   |
| Effect of dilutive stock options                                                   |   | 26                                             |       | 120                                    |   | 16 |   | 102 |   |
| Denominator for diluted (loss) income per  share-adjusted weighted-average shares  |   | 46,585                                         |       | 46,655                                 |   | 46,575 |   | 46,627 |   |
| Basic (loss) income per share                                                      |   | $                                              | (0.80      | )                                      | $      | 0.32 |   | $ | (0.77 | ) | $ | 0.45 |   |
| Diluted (loss) income per share                                                    |   | $                                              | (0.80      | )                                      | $      | 0.32 |   | $ | (0.77 | ) | $ | 0.45 |   |

 

The preferred shares were notincluded in the denominator because their inclusion would have beenanti-dilutive.

 

**7.            Borrowings and Restricted Cash**

 

During the second quarter of2002, the Company entered into a loan in the amount of $31.4 million topartially fund the purchase of its equity interest in CSG.  The loan bears interest at Prime + 5%, isnon-recourse to the Company, and is only payable with cash flows received fromCSG.  The lender is entitled to share ina portion of excess cash flows received by the Company from CSG once the loanhas been repaid.

 

During the first quarter of 2002,the Company entered into an irrevocable standby letter of credit agreement for$10.0 million with a bank.  Theagreement contains provisions allowing the sub-servicer of the Company to drawunder the letter of credit as needed. The Company is required to maintain a cash balance of $10.0 million withthe lender. Such cash has been disclosed as “Restricted cash” on the face ofthe balance sheet.

 

10

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**8.             SubsequentEvents**

 

On July 12, 2002, a wholly ownedsubsidiary of the Company closed a transaction with Federated DepartmentStores, Inc. (NYSE: FD) to purchase certain assets, which included retainedinterests in a trust that owns approximately $1.1 billion in face amount ofcredit card receivables, which represents approximately 2.4 millionaccounts.  The Company also hiredapproximately 830 employees from Federated, who will continue to service thereceivables in the trust.  Total cashconsideration paid was approximately $90 million.  The Company will use the purchase method of accounting to recordthese transactions, and is still evaluating the factors which affect thevarious components of assets acquired and liabilities assumed.

 

During the third quarter of 2002,the Company's board of directors authorized a program to repurchase up to 5million shares (approximately 11 percent) of it's outstanding commonstock.  Under the repurchase plan, theCompany may buy back shares of it's common stock from time to time either onthe open market or through privately negotiated transactions in compliance withthe Securities and Exchange Commission guidelines.

 

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

 

*The following discussion should be read in conjunction withour condensed consolidated financial statements and the related notes includedherein.*

 

This Management’s Discussion andAnalysis of Financial Condition and Results of Operations includes forward–lookingstatements. We have based these forward–looking statements on our currentplans, expectations and beliefs about future events. In light of the risks,uncertainties and assumptions discussed under the caption “Risk Factors” in“Item 1. Business” of our Annual Report on Form 10-K filed with theSecurities and Exchange Commission and other factors discussed in that section,there is a risk that our actual results will differ materially from theexpectations and beliefs reflected in the forward–looking statements inthis section.

 

**General**

 

CompuCredit is a credit card companythat originates and purchases credit card receivables and markets products andservices to its customers for which it earns fees. We market unsecured Visa andMasterCard credit cards through direct mail, telemarketing, television and theinternet.

 

Our revenues primarily consist of(1) securitization income, (2) income from our retained interest in credit cardreceivables securitized, (3) servicing income, (4) other credit card feeincome, (5) interchange fees, (6) ancillary product revenue and (7) equity inthe income of our equity-method investee.

 

Securitization income is gain orloss we recognize at the time of each sale. Income or loss from retained interests in credit card receivablessecuritized is the income or loss we recognize from the credit card receivableswe have securitized.  See “-Credit CardSecuritizations” and “-Results of Operations” for additional information.  Servicing income consists of the fees we receivefor servicing the various portfolios of credit card loans.  Other credit card fee income includes annualfees, over-limit fees, cash advance fees and other fees assessed to ourcardholders.  Interchange fees are theportion of the merchant fees assessed by Visa and MasterCard and passed on tous and are a function of the purchase volume of our cardholders.  Ancillary product revenue consists of thefees earned by selling various fee-based products including variousmemberships, insurance, subscription and other products. Equity in the incomeof our equity — method investee is discussed below.

 

Our primary operating costsinclude the costs of funding our receivables, credit losses and other operatingexpenses, such as employee compensation, account solicitation and marketingexpenses, data processing, servicing expenses and income taxes.

 

We originate our receivablesportfolio through the use of our target marketing system to originate customersthrough direct mail, television, telemarketing and internet campaigns. We alsoadd accounts by purchasing portfolios of credit card receivables or by formingentities with other partners to acquire retained interests in credit cardreceivables securitized.  Absentportfolio acquisitions, the size of our receivables depends in part on thetiming, size and success of our marketing campaigns. During periods of reducedmarketing our originated receivables portfolio may not grow and may decline. Wehave reduced our marketing growth plans for 2002 as compared to 2001.  We believe this is prudent for us given ourconcerns relating to the availability of financing, general economic conditionsand uncertainty regarding credit quality of accounts we historically havetargeted.

 

We intend to grow our existingportfolio through marketing campaigns during 2002, although at a much slowerrate than 2001.  During 2001 we addedbetween 125,000 and 200,000 accounts per quarter, while in 2002 we intend toadd approximately 25,000 to 50,000 accounts per quarter, excluding anyportfolio acquisitions.

 

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During the second quarter of2002, we purchased a 50% interest in CSG, LLC (“CSG”).  CSG was formed during the second quarter of2002 by affiliates of Goldman, Sachs & Co., Salomon Smith Barney and one ofour wholly owned subsidiaries.  CSG wasformed to acquire notes and a certificated interest issued by a trust.  Equity in the income of our equity-methodinvestee is 50% of CSG’s income or loss, before income taxes.  See “-Results of Operations” and “— OtherOperating Income” for additional information on these revenues.  We agreed to service the entire portfolio ofcredit card receivables underlying the trust. In exchange for our servicing, we receive a fee.  This acquisition increased the totalportfolio that we service by approximately $1.2 billion as of June 30, 2002.  In our “Selected Credit Card Data,” weinclude information relating to the receivables underlying oursecuritizations.  Beginning with thesecond quarter of 2002, our data reflects the credit card receivables that wehave securitized as well as 50% of the managed receivables underlying the CSGtrust (which reflects our 50% interest in CSG).

 

Additionally, on July 12, 2002,one of our a wholly owned subsidiaries closed a transaction with FederatedDepartment Stores, Inc. (NYSE: FD) to purchase various assets, which includedretained interests in a trust that owns approximately $1.1 billion in faceamount of credit card receivables, which represents approximately 2.4 millionaccounts.  We also hired approximately 830employees from Federated and we will continue to service the receivables in thetrust.  Total cash consideration paidwas approximately $90 million.  We willuse the purchase method of accounting to record these transactions, and we arestill evaluating the factors which affect the various components of assetsacquired and liabilities assumed.

 

Our income is dependent upon thesize and the quality of the credit card receivables in the credit card accountsunderlying our securitizations.  When wereduce our marketing, we add fewer accounts and this decreases the size of ourexpected growth in the portfolio of the credit card receivables.  The result of not adding accounts that weotherwise were planning to add cannot be predicted with certainty and would bevery subjective to estimate; however we believe that when there is less growthin the portfolio, there will be less growth and possibly a reduction in our netincome as compared to years with higher growth.

 

We have decreased our expectationof growth in our originated credit card receivables during 2002 as a result ofthe decrease in our marketing plans.  Webelieve that our originated managed loan portfolio may not grow during 2002 andat the end of 2002 will be fairly comparable to the balance at the end of2001.  Our experience is that typicallyduring the first quarter of the year, consumers spend less and make higherpayments, possibly due to bonuses or tax refunds.   We have found that consumers spend more in the fall, prior tothe start of the school year and during the holidays.

 

Reducing our marketing plans alsoallowed us to make staff reductions in our marketing and professional servicesdepartments in January 2002 as we focused on reducing our operatingexpenses.  If we see improvements in thefinancial markets, we may increase our marketing plans during the last half of2002, which we believe would in turn increase our receivables portfolio.Additionally, any additional portfolio acquisitions during 2002 would increaseour receivables portfolio.

 

##### **Credit Card Securitizations**

 

We began marketing and servicing credit card accountsin February 1997.  Columbus Bank&Trust (“CB&T”) originates VISA and MasterCard revolving credit cardaccounts under an agreement with us.  Ona daily basis, CB&T sells us an interest in the receivables created thatday.  Each day, we in turn sell ourinterest in the receivables to trusts or to multi-seller commercial paperconduits administered by national banking institutions.  The trusts or conduits issue notes toinvestors in order to obtain the cash to pay us for the receivables.

 

After an initial purchase of notes by the investors,there is usually a period during which collections from the receivables areused to purchase new receivables.  Thisis referred to as a revolving period. The revolving period typically begins on the closing date of anyparticular series of notes and ends at the beginning of the amortizationperiod.  At the end of the revolvingperiod, the investment of collections in 

 

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new receivables ends and collectionsare instead used to repay the investors. The period during which investors are being repaid is referred to as anamortization period.  Therevolving periods have coincided with the maturity dates of each series whichare either 364 days for series issued to commercial paper conduits or threeyears for our series placed with other investors.  The maturity date for each series is included in our “Liquidity,Funding and Capital Resources” section.

 

All collections received from the cardholdersunderlying each securitization are included in the securitization cashflows.  This includes collections fromthe cardholders for fees and other charges on the accounts and collections fromthe cardholders repaying the principal portion of their account balances.  The cash flows are then distributed inaccordance with the securitization documents. Cash is distributed to us as servicer for our servicing fee, to theinvestors for their interest on their outstanding notes, to us as the seller tofund new purchases during the revolving period and to the investors to repayany portion of their outstanding notes that become due and payable.  Any collections from cardholders remainingeach month after making the payments noted above are paid to us on our retainedinterests.

 

In each securitization transaction, we retain the riskof compliance with federal and state laws and regulations regarding thesecuritized accounts and any fraudulent activity with regard to theaccounts.  The fraud that we are responsiblefor includes the unauthorized use of the credit cards including identity theftor purchases on lost or stolen cards or account numbers.  We expense these fraud losses in otheroperating expense.  To date, we haveexperienced very little fraud for unauthorized use of the credit cards.

 

The investors in the securitizations require us toprovide credit support for the receivables to reduce the risk of loss to theinvestors resulting from cardholders not repaying their credit card balanceswhen due.  We negotiate with eachinvestor the amount of the credit support, which is based on historical andexpected delinquency and loss experience on the receivables.  The credit support is usually in the form ofover-collateralization, which means that we sell the receivables for cash and asubordinate retained interest.  Sincethe retained interest is subordinate to the investor’s investment, theinvestors get excess collateral for their cash purchase price.  As a result, the receivables available torepay the investors exceed the total amount of the investors’ interests in thereceivables.  This excess is theretained interest that we own, which is also referred to as a subordinatedinterest, or a seller’s interest.

 

The investors in the securitized receivables have norecourse against us for our cardholders’ failure to pay their credit cardloans; however, substantially all of our seller’s interests are subordinated tothe investors’ interests until the investors have been fully repaid.  This means that our seller’s interests willfirst absorb any losses due to cardholders’ failure to repay their balancesbefore investors in the securitizations have to absorb these losses.

 

We will receive additional cash from the securitizedreceivables if collections from the receivables exceed required interest andprincipal payments to the investors. The collections from the receivables depend on the performance of thereceivables, which includes the timing and amount of payments on thereceivables, the interest rates, fees and other charges paid on thereceivables, and their delinquency and loss rates.

 

Our securitizations are treated as sales underGenerally Accepted Accounting Principles. As such, we remove the securitized receivables from our consolidatedbalance sheet.  As noted above, weretain a seller’s interest in the pool of assets included in eachsecuritization, with the right to receive collections allocated to suchsubordinated interest after payments to investors are made.  These amounts are recorded as income fromretained interests in credit card receivables securitized.  The fair value of our seller’s interests arebased on the estimated present value of the future cash flows usingmanagement’s best estimates of key assumptions and the estimated collectible portionof finance charge receivables.  We alsorecognize an “interest-only” (“I/O”) strip, which is the present value of theprojected excess cash flows the receivables will produce during its life.  The excess cash flow is the excess of thefinance charges and late fees generated by the securitized receivables over therelated credit losses, interest paid to investors, servicing 

 

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costs and other expenses.  TheI/O strip and the seller’s interest are included in “Retained Interests inCredit Card Receivables Securitized” on our consolidated balance sheet.

 

Amounts Due from Securitization on our consolidatedbalance sheet include payments recently received on the securitized receivables that are still held by thesecuritization structure but are payable to us in the next 30 days.

 

Securitizations are accounted for under Statement ofFinancial Accounting Standards No. 140, “Accounting for Transfers andServicing of Financial Assets and Extinguishments of Liabilities” (“StatementNo. 140”), and, prior to April 1, 2001, were accounted for underStatement of Financial Accounting Standards No. 125, “Accounting forTransfers and Servicing of Financial Assets and Extinguishments of Liabilities”(“Statement No. 125”).  Under thesestatements, gains or losses are recognized at the time of each sale and as theyare recorded as securitization income or loss in our consolidated statement ofoperations.  The gains or lossesrecognized on the sales of credit card receivables depend in part on theprevious carrying amount of the financial assets sold as well as the fair valueof the financial assets and cash proceeds received.

 

We believe our securitizations satisfy the conditionsof Statement No. 140 for sale accounting because each trust, as the issuer, isa qualified special purpose entity (“QSPE”). The activities of each trust are limited to (1) acquiring, owningand managing its assets and the proceeds of those assets; (2) issuing andmaking payments on notes; and (3) engaging in related activities.  In addition, each holder of a beneficialinterest in the notes has the right to pledge or exchange its beneficialinterest.  Finally, the transferortransfers the receivables to each trust or to a third party conduit and doesnot maintain control over the receivables.

 

Thesecuritization transactions do not affect the relationship we have with ourcustomers and we continue to service the credit card receivables.  We either perform the servicing or contractwith third party service providers.  Thefees we receive to service credit cards are included in our servicing incomeand are discussed in our “Results of Operations-Other Operating Income.”  We recognize a servicing liability for theprojected servicing costs that exceed our projected servicing revenue.  Although separately valued from ourinterest-only strip, this amount is reported with our interest-only strip onour consolidated balance sheet for financial reporting purposes.  See “—Net Securitization Income and Incomefrom Retained Interests” for the assumptions used and the servicing liabilityamounts.

 

The table below summarizes our securitization activity.

 
|                                                                          |   | **For the three months ended  June 30,** |       | **For the six months ended  June 30,** |   |
|-------------------------------------------------------------------------------|--------|------------------------------------------|------------|----------------------------------------|--------|
|                                                                          |   | **2002**                                 |       | **2001**                               |   | **2002** |   | **2001** |   |
|                                                                          |   | **(in thousands)**                       | ** ** |
| Securitization  Activity:                                                     |   |                                     |       |                                   |   |   |   |   |   |
| Gross amount of receivables securitized at period end                         |   | $                                        | 1,723,057  |                                   | $      | 1,671,762 |   | $ | 1,723,057 |   | $ | 1,671,762 |   |
| (Distributions to) proceeds from securitizations                              |   | (58,185                                  | )          | 66,733                                 |   | (114,779 | ) | 145,527 |   |
| Excess cash flows received on retained interests                              |   | 44,089                                   |       | 43,605                                 |   | 96,457 |   | 93,509 |   |
| Pretax securitization income                                                  |   | —                                   |       | 238                                    |   | — |   | 504 |   |
| (Loss) income from retained interests in credit card  receivables securitized |   | (62,921                                  | )          | 21,278                                 |   | (57,219 | ) | 36,723 |   |
|                                                                               |        |                                          |            |                                        |        |  |  |  |  |  |  |  |  |

 

The decrease in net proceeds fromsecuritizations is the result of repayment to third party investors due to adecline in the receivables underlying the securitizations.  These proceeds or distributions fluctuatebased on the growth or decline of the principal portion of thereceivables.  During the three 

 

15

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and six months ended June 30, 2002, thereceivables decreased, which resulted in cash flows being paid to theinvestors.  During the three and sixmonths ended June 30, 2001, the receivables grew, which allowed us to draw fromthe investors in our securitizations, which created the proceeds fromsecuritization.  The excess cash flowsreceived on our retained interests are a function of the size and average ageof the receivables.  Our pretaxsecuritization income is recognized when the receivables are securitized.  We did not earn any securitization incomeduring the three or six months ended June 30, 2002 because the receivablesdecreased in size.

 

The trusts or the conduitspurchase receivables from us by raising proceeds from investors.  These proceeds are raised by the trusts orissued by the conduits by issuing notes to investors.  The proceeds from the investors are then remitted to us as partof the purchase price of the receivables. We had the following total commitments and outstanding amounts in oursecuritizations for each period presented:

 
|                             |   | **As of June 30,** |       | **As of December 31,** |   |
|----------------------------------|--------|--------------------|------------|------------------------|--------|
|                             |   | **2002**           |       | **2001**               |   |
|                             |   | **(In millions)**  | ** ** |
| Total commitments from investors |   | $                  | 1,693      |                   | $      | 2,046 |   |
| Total outstanding amounts        |   | 1,376              |       | 1,524                  |   |
|                                  |        |                    |            |                        |        |  |  |

 

The maturities of these notesvary and are more fully detailed in “—Liquidity, Funding and CapitalResources.”  We try to structure oursecuritization funding source by having commitments in excess of our currentgrowth plans so that we have investors who will purchase notes from the trusts,which in turn allows the trusts to purchase the receivables from us.  We believe we have structured oursecuritization program to reduce our reliance on any one series of notes bystaggering the maturity dates of the notes and by also having excess capacityif one particular series of notes is not renewed at its maturity date.  One of the reasons we have slowed our growthplans for 2002 is because we do not have any assurance that when any series ofnotes mature, they will be renewed on terms that are favorable to us, or atall.  This is more fully discussed in“—Liquidity, Funding and Capital Resources.”

 

We include in our consolidatedfinancial statements all of our wholly owned subsidiaries.  However, in accordance with Statement No.140, we do not consolidate any of the trusts, which are QSPEs.  We are required to service the receivablesthat have been sold.  We also performthe administrative functions for the trusts including preparing daily andmonthly reports relating to the receivables. We do this pursuant to an administration agreement between us and thetrustees of the trusts.  The investorsdo not have any recourse against us for the cardholders’ failure to pay theircredit card balances; however, most of our retained interests are subordinateto the investor’s interests. Under our securitization agreements, our retainedinterests would absorb losses due to the cardholders’ failure to pay before theinvestors would have to absorb these losses.

 

Our securitization documentsrequire us, as servicer of the receivables, to covenant that we will maintainan acceptable ratio of tangible net worth to total managed loans or that wewill not default in the payment of material indebtedness or reduce the periodicfinance charges assessed on the receivables below agreed upon levels.  We have also agreed to service thereceivables in accordance with our servicing policies and procedures.  In addition to the above, there are eventsdescribed in our agreements that may trigger an early redemption, which wouldcause all collections on the receivables to go to the investors to pay theprincipal on the notes.  This woulddelay any cash being paid to us with respect to our seller’s interests untilthe notes were paid in full.  Theseevents include our failure as servicer to remit the collections that we receivefrom cardholders to the appropriate securitization accounts within the requiredtime frames, our failure to provide reports regarding the activity in theaccounts within required time frames, or a breach of our representations andwarranties.  These events also includefinancial performance measures on the underlying receivables.  As servicer of the accounts, we do notcovenant or make any representation or warranty regarding the collectibility ofthe receivables in the accounts.

 

Our securitization documentsrequire us, as the seller of the receivables, to make representations andwarranties relating to the validity and the enforceability of the agreementspursuant to which the receivables 

 

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were created. We also make other standard representations and warranties including ourability to enter into the agreements and the accuracy of the informationprovided by us to investors.  If webreach any of these representations, we may cause an early redemption event andwe may not be able to sell additional receivables into our securitizationstructures.  As seller of the receivables,we do not make any representation or warranty regarding the collectibility ofthe receivables in the accounts.

 

We have not breached anyrepresentations or warranties or otherwise caused an early redemption event,and the underlying performance of the receivables has not caused an earlyredemption event in any of our securitizations.

 

In our securitization structureassociated with our portfolios which we purchased during 1998, each month apercentage of the excess cash collected from the cardholders is paid to theinvestors to decrease their remaining invested amount.  This excess cash totaled $5.0 millionfor the three months ended June 30, 2002, and $3.1 million for the threemonths ended June 30, 2001.  Under theterms of the securitization, the investors are paid with a percentage of thecash collected less (a) servicing fees that we receive to service the accounts,and (b) credit balance refunds. Beginning in April 2002, 100% of all the excess cash is being paid tothe investors.  Once the investors arerepaid, all cash collected on any remaining receivables is payable to us, whichmanagement estimates to occur during the later half of 2004.

 

**Results of Operations**

 

Net loss attributable to commonshareholders for the three months ended June 30, 2002 was $37.1 million,or $0.80 per diluted share, compared to net income of $14.7 million, or$0.32 per diluted share for the three months ended June 30, 2001.  Net loss for the six months ended June 30,2002 was $36.0 million, or $0.77 per diluted share, compared to net incomeof $21.1 million, or $0.45 per diluted share for the six months ended June30, 2001.

 

Other operating income includes(loss) income from retained interests in credit card receivables securitized,which decreased to a loss of $62.9 million for the three months ended June30, 2002 compared to income of $21.3 million for the three months endedJune 30, 2001.  (Loss) income fromretained interests in credit card receivables securitized decreased to a lossof $57.2 million for the six months ended June 30, 2002 compared to incomeof $36.7 million for the six months ended June 30, 2001.  These decreases are due primarily to (a) adecrease in our estimate of the fair value of our retained interests in financecharge receivables of approximately $54.7 million based in part on proposedbank regulatory guidelines and (b) a decrease in our estimate of accruedinterest and fees earned but not billed of approximately $12.0 million tobetter estimate the collectible portion of these fees, partially offset by (c)an approximately $22.8 million increase in the fair value of our retainedinterest due to a decrease of our residual cash flows discount rate to 22.5%.

 

During the second quarter of2002, we hired an independent financial advisory firm to evaluate the residualcash flow discount rate.  Theindependent financial advisory firm concluded that the appropriate residualcash flow discount rate was 22.5%. During the second quarter of 2002, we adopted their recommendation andrevised the estimated residual cash flow discount rate to 22.5% from 34.9% atMarch 31, 2002.

 

Our income from retainedinterests also decreased due to a reduction in the profitability and cash flowsfrom the credit card receivables underlying our retained interests.  This is due to an increase in the chargeoffs of the receivables, which is due to a larger percentage of our receivablesaging through the second year of their life. When credit card receivables are first originated, they tend to have lowcharge off rates in their first twelve months. The charge off rate then dramatically increases during year two and thenmoderates in year three and beyond.  Wehave seen this trend in the performance of our receivables and believe that itis typical in other credit card portfolios in the industry.  We further describe the receivablesportfolio in “Selected Credit Card Data.”

 

17

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During the second quarter of2002, bank regulators required various financial institutions to evaluate themanner in which they estimate the fair value of their retained interests and inparticular how accrued finance charges and fees are treated in theirestimate.  Based on proposed regulatoryguidelines and review of the results of agreements with other credit cardcompanies and the regulators, we changed the manner in which we estimate thefair value of our retained interest and now only include the estimatedcollectible portion of finance charges and fees that have been billed to thecardholders account.  As noted above,the impact of this change was to decrease our income from retained interests byapproximately $54.7 million. Additionally, we also accrued only the estimated collectible portion ofthe accrued interest and fees earned but not yet billed to the cardholders,which decreased our income from retained interest by $10.3 million and ourother credit card fees by $1.7 million.

 

The largest component of ourincome comes from the profit generated from the credit card receivablesunderlying our securitizations. Growth in managed receivables cannot bepredicted with certainty. In general, it is a product of our marketing andother strategic efforts. In general, our growth is a product of (1) the growthin the number of accounts, and (2) the amount of usage – balances – onaccounts.  Our growth also is dependentupon a number of factors that we are not able to control, such as levels ofconsumer spending, competition and general economic conditions.  During the second quarter of 2002, thecredit card receivables underlying our securitizations decreased byapproximately 4.8% due primarily to normal attrition.  During the second quarter of 2002, we added approximately 40,000new accounts from our marketing efforts compared to approximately 167,000 newaccounts during the second quarter of 2001.

 

Growth in the number of accountsis a product of several factors, primarily the level of our marketing efforts,our competition, the general economy and our portfolio acquisitionefforts.  Our marketing and solicitationexpenses decreased to $2.4 million for the three months ended June 30,2002 from $7.7 million for the three months ended June 30, 2001.  We decreased our marketing in 2002 becausewe believed that we had limited access to liquidity and we did not wantour portfolio to grow beyond what we may be able to fund in the future.  Additionally, during the second quarter of2002, we concentrated on acquiring portfolios instead of originating asignificant number of new accounts.

 

Other operating income, excludingsecuritization income, (loss) income from retained interests in credit cardreceivables securitized, and equity in income of equity-method investee,decreased slightly to $34.2 million for the three months ended June 30,2002 from $35.3 million for the three months ended June 30, 2001 andincreased slightly to $68.7 million for the six months ended June 30, 2002from $68.6 million for the six months ended June 30, 2001.

 

Other operating expensesdecreased to $31.5 million for the three months ended June 30, 2002 from$34.8 million for the three months ended June 30, 2001 and decreased to$68.9 million for the six months ended June 30, 2002 from$75.0 million for the six months ended June 30, 2001.  The decrease is due primarily to thedecrease in our marketing and solicitation expenses.

 

***Net Interest Income***

 

Net interest income consists ofinterest income earned on cash and cash equivalents less interest expense. Netinterest income totaled $0.3 million for the three months ended June 30, 2002and $0.6 million for the three months ended June 30, 2001. Net interest incometotaled $0.6 million for the six months ended June 30, 2002 and $1.6million for the six months ended June 30, 2001.  The decrease in net interest income during 2002 is attributableto the reduction of the prime rate, as well as a reduction in our average cashand cash equivalents.

 

During the second quarter of2002, we entered into a loan in the amount of $31.4 million to partially fundthe purchase of an equity interest in CSG. The loan bears interest at Prime + 5%, is non-recourse to the Company,and is only payable from the cash flows received from CSG.  Interest expense associated with this loanwas nominal for the three months ended June 30, 2002.  Until January 2002, $15.0 million was outstanding under our$25.0 million one-year revolving credit facility and $10.0 millionwas reserved for a 

 

18

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letter of credit in favor of a third partyservicer. The revolving credit facility expired in January 2002 and waspaid in full.  During the three and sixmonths ended June 30, 2001, we had nominal interest expense.

 

***Net SecuritizationIncome and (Loss) Income from Retained Interests***

 

Retained Interests in Credit CardReceivables Securitized are valued in accordance with the provisions ofStatement No. 140. These retained interests are subsequently accounted foras trading securities and reported at estimated fair market value in accordancewith Financial Accounting Standard No. 115, “Accounting for CertainInvestments in Debt and Equity Securities” (“Statement No. 115”). See“Credit Card Securitizations.”

 

Net securitization income isrecognized under Statement No. 140 at the time the receivables aresecuritized. Gains or losses on sales of receivables depend in part on theprevious carrying amount of the financial assets sold as well as the fair valueof the assets and cash proceeds received. In a sale, we receive cash, retain aninterest in the receivables sold (Seller’s Interest) and retain rights toreceive cash in the future (the “interest only, or I/O strip”). We did not earnany net securitization income during the three and six months ended June 30,2002 because our portfolio decreased in size. Net securitization income was $0.2 million and $0.5 million for thethree and six months ended June 30, 2001.

 

(Loss) income from retainedinterests in credit card receivables securitized includes the income earned onthe retained interests and any changes in the fair value of the retainedinterest in credit card receivables securitized in accordance with StatementNo. 115.  Loss from retainedinterests in credit card receivables securitized for the three months endedJune 30, 2002 was $62.9 million, compared to income of $21.3 millionfor the three months ended June 30, 2001. Loss from retained interests in credit card receivables securitized forthe six months ended June 30, 2002 was $57.2 million, compared to incomeof $36.7 million for the six months ended June 30, 2001.  The decrease in our income from retainedinterests in credit card receivables securitized is due primarily to (a) adecrease in our estimate of the fair value of our retained interests in financecharge receivables of approximately $54.7 million based in part on proposedbank regulatory guidelines, and (b) a decrease in our estimate of accruedinterest and fees earned but not billed of approximately $12.0 million tobetter estimate the collectible portion of these fees, partially offset by (c)an approximately $22.8 million increase in our retained interest due todecreasing our residual cash flows discount rate to 22.5%. The remainder of the$62.9 million loss was primarily due to an increase in charge offs.

 

The fair value of our retainedinterests in credit card receivables securitized is estimated by discountingthe expected future cash flows from the securitized receivables at rates whichwe believe are consistent with those that would be used by an independent thirdparty. These rates historically reflect (a) prior transactions completed by us,(b) average rates disclosed by our peers and (c) average rates wehave reviewed from transactions where the total interest rate to the investorhas been disclosed.  During the secondquarter of 2002, we hired an independent financial advisory firm to evaluatethe residual cash flow discount rate. The independent financial advisory firm concluded that the appropriateresidual cash flow discount rate was 22.5%. During the second quarter of 2002, we adopted the recommendation of theindependent financial advisory firm and revised the estimated residual cashflow discount rate to 22.5% from 34.9% at March 31, 2001.  Because quoted market prices are generallynot available, the fair value of our retained interests is based on theestimated present value of future cash flows from the receivables that havebeen securitized using management’s best estimates of finance charges and latefees, servicing fees, costs of funds paid to investors, payment rates, creditlosses, discount rates and required amortization payments to investors. Theweighted average key assumptions used as of the end of each period arepresented below. Changes in any of these assumptions could impact the estimatesof the fair value of our retained interest as well as the realization ofexpected future cash flows (see “Critical Accounting Policies.”)

 

19

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|                                   |   | **At or for the Three Months Ended** |       |
|----------------------------------------|--------|--------------------------------------|------------|
|                                   |   | **2002**                             |       | **2001** |   |
|                                   |   | **Jun. 30**                          |       | **Mar. 31** |   | **Dec. 31** |   | **Sep. 30** |   | **Jun. 30** |   | **Mar. 31** | ** ** |
|                                   |   | **(Percentages annualized)**         | ** ** |
|                                   |   |                                 | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
|                                   |   | **Assumptions**                      | ** ** |
|                                   |   |                                 | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Payment rate (monthly)                 |   | 7.1                                  | %          | 7.1 | % | 8.0 | % | 9.5 | % | 9.4 | % | 9.0 | % |
| Expected credit loss rate (annualized) |   | 16.6                                 | %          | 16.7 | % | 16.7 | % | 14.4 | % | 13.6 | % | 11.8 | % |
| Residual cash flows discount rate      |   | 22.5                                 | %          | 34.9 | % | 34.9 | % | 14.2 | % | 14.2 | % | 16.4 | % |
| Servicing liability discount rate      |   | 14.1                                 | %          | 14.1 | % | 14.0 | % | 14.2 | % | 14.2 | % | 16.4 | % |

 

The payment rate remained unchanged from March 31,2002 to June 30, 2002.  We comparehistorical loss rates on each vintage of our portfolio at comparable points intheir lives to project our expected credit loss rate.  Estimated default rates are based on historical results, adjustedfor expected changes based on our credit risk models. The returns to theinvestors in the securitizations are based on management’s estimates.

 

Our retained interests in creditcard receivables securitized include the following:

 
|                                                       |   | **June 30,  2002** |       | **December 31,  2001** |   |
|------------------------------------------------------------|--------|--------------------|------------|------------------------|--------|
|                                                       |
|                                                       |   | **(In thousands)** | ** ** |
| I/O strip                                                  |   | $                  | 98,593     |                   | $      | 84,390 |   |
| Servicing liability                                        |   | (40,501            | )          | (38,123                | )      |
| Net I/O strip                                              |   | 58,092             |       | 46,267                 |   |
| Fair value of Seller’s Interest                       |   | 251,982            |       | 312,622                |   |
| Retained interests in credit card receivables  securitized |   | $                  | 310,074    |                   | $      | 358,889 |   |

 

Our net I/O strip is comprised ofthe I/O strip and the related servicing liability. The I/O strip reflects theestimated fair value of our rights to future income from the portfolio. Theservicing liability reflects the estimated fair value of the cost to servicethe portfolio above and beyond the servicing income we expect to receive fromthe securitization. The decrease in our retained interests at June 30, 2002from December 31, 2001 is a function of the decrease in the total receivablessecuritized at the end of each of the stated periods and a change in theestimates used to value our retained interest in credit card receivablessecuritized.

 

***Equity-Method Investment in CSG, LLC***

 

CSG, LLC (“CSG”) was formedduring the second quarter of 2002 by affiliates of Goldman, Sachs & Co.,Salomon Smith Barney and a wholly owned subsidiary of the Company to acquirenotes and a certificated interest issued by a trust (“CSG Trust”) that owns aportfolio of credit card receivables. We have a 50% interest in CSG and funded our interest in CSG with cash.  We borrowed a portion of our required investment.We are accounting for our interest in CSG using the equity method ofaccounting.  We recorded approximately$4.5 million of income during the second quarter of 2002.  This income primarily consisted of interestincome earned by CSG on the notes and the certificated interest it acquired inthe second quarter of 2002 from the CSG Trust.

 

***Other Operating Income***

 

Other operating income, excludingsecuritization income, (loss) income from retained interests in credit cardreceivables securitized, and equity in income of equity-method investeeconsists of the following:

 

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|                         |   | **Three months ended  June 30,** |       | **Six months ended  June 30,** |   |
|------------------------------|--------|----------------------------------|------------|--------------------------------|--------|
|                         |
|                         |   | **2002**                         |       | **2001**                       |   | **2002** |   | **2001** |   |
|                         |   | **(In thousands)**               | ** ** |
| Servicing income             |   | $                                | 2,394      |                           | $      | 1,548 |   | $ | 3,679 |   | $ | 3,235 |   |
| Other credit card fees       |   | 23,858                           |       | 20,796                         |   | 48,698 |   | 39,509 |   |
| Interchange fees             |   | 4,065                            |       | 5,541                          |   | 8,022 |   | 10,902 |   |
| Ancillary products           |   | 3,852                            |       | 7,372                          |   | 8,335 |   | 14,942 |   |
| Total other operating income |   | $                                | 34,169     |                           | $      | 35,257 |   | $ | 68,734 |   | $ | 68,588 |   |

 

Other operating income decreasedto $34.2 million for the three months ended June 30, 2002 from$35.3 million for the three months ended June 30, 2001 and increased to$68.7 million for the six months ended June 30, 2002 from $68.6 millionfor the six months ended June 30, 2001. The receivables underlying the securitizations remained relativelyunchanged at approximately $1.7 billion at June 30, 2002 and June 30,2001.  Our servicing income increasedfor the three and six months ended June 30, 2002 compared to the same periodsin 2001 primarily due to the servicing revenue we earned as the servicer ofreceivables associated with the CSG Trust. Other credit card fees increased to $23.9 million from$20.8 million due to increases in annual, over-limit, cash advance,insufficient funds, maintenance and other miscellaneous fees.  Interchange fees are the portion of themerchant fee assessed by Visa and passed on to us on the purchase volume on thecredit card receivables. Interchange fees decreased to $4.1 million from$5.5 million due to a decrease in the purchase volume on the credit cardreceivables. Ancillary product revenue decreased to $3.9 million from$7.4 million due to fewer customers purchasing our products and because wehave decreased our growth in new accounts during the past three quarters.  Our ancillary product income is verysensitive to our new account growth as sales of our fee-based products arehigher to new customers than to existing cardholders.  Because we have decreased our growth plans for new accounts in2002, our ancillary product income may continue to decline in 2002.

 

***Other Operating Expense***

 

Other operating expense consistsof the following for the periods indicated:

 
|                                |   | **Three months ended********June 30,** |       | **Six months ended********June 30,** |   |
|-------------------------------------|--------|----------------------------------------|------------|--------------------------------------|--------|
|                                |   | **2002**                               |       | **2001**                             |   | **2002** |   | **2001** |   |
|                                |   | **(In thousands)**                     | ** ** |
| Non-servicing salaries and benefits |   | $                                      | 3,028      |                                 | $      | 2,760 |   | $ | 6,624 |   | $ | 5,043 |   |
| Credit card servicing               |   | 15,817                                 |       | 15,051                               |   | 35,887 |   | 29,180 |   |
| Marketing and solicitation          |   | 2,417                                  |       | 7,727                                |   | 5,041 |   | 19,858 |   |
| Professional fees                   |   | 647                                    |       | 828                                  |   | 1,430 |   | 1,810 |   |
| Data processing                     |   | 1,813                                  |       | 1,875                                |   | 3,413 |   | 4,492 |   |
| Net occupancy                       |   | 1,158                                  |       | 602                                  |   | 2,350 |   | 1,407 |   |
| Ancillary product expense           |   | 1,054                                  |       | 2,113                                |   | 3,053 |   | 6,080 |   |
| Other                               |   | 5,602                                  |       | 3,817                                |   | 11,060 |   | 7,145 |   |
| Total other operating income        |   | $                                      | 31,536     |                                 | $      | 34,773 |   | $ | 68,858 |   | $ | 75,015 |   |

 

Other operating expense for threemonths ended June 30, 2002 decreased to $31.5 million from$34.8 million for the three months ended June 30, 2001 and decreased to$68.9 million for the six months ended June 30, 2002 compared to $75.0 millionfor the six months ended June 30, 2001. This decrease is due primarily to a decrease in marketing andsolicitation expenses, data processing expenses and ancillary product expenses,offset by increases in credit card servicing, non-servicing salaries andbenefits, and other expenses. Credit card servicing costs primarily includecollections and customer service expenses. These expenses include in-house collections and customer service expensesas well as costs associated with corresponding with our 

 

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cardholders. Servicing expense also includes outsourced collections and customerservice expenses.

 

During 2001, based on anticipatedgrowth in our managed receivables, we increased our infrastructure, customerservice and collection personnel. Salaries and benefits, net occupancy andother expenses increased as our operations expanded to service the increase inmanaged loans.  In 2002, marketing andsolicitation costs decreased due to reduced budgeted levels of direct mail,television, telemarketing and internet campaigns.  Data processing expenses decreased due to the realization ofcertain cost cutting efforts implemented in January of 2002.  Ancillary product expense decreased due to adecrease in ancillary product marketing and a decrease in ancillary productssold.

 

Other expenses includedepreciation, fraud, travel and entertainment, insurance, hiring expense,corporate communications, leased equipment expenses, office supplies and othermiscellaneous expenses. During 2001, expenses in this category, other thanfraud, increased incrementally as we added infrastructure to support the growthin managed receivables.  Our fraudexpense includes the expense of unauthorized use of the credit cards includingidentity theft or purchases on lost or stolen cards.  To date, we have experienced very little fraud for unauthorizeduse and the total expense was approximately 0.17% of the average managed receivablesfor the three months ended June 30, 2002 and approximately 0.16% for the threemonths ended June 30, 2001.

 

***Income Taxes***

 

Income tax benefit was$19.4 million for the three months ended June 30, 2002 compared to incometax expense of $7.9 million for the three months ended June 30, 2001. Incometax benefit was $18.3 million for the six months ended June 30, 2002 andincome tax expense was $11.4 million for the six months ended June 30,2001. Our effective tax rate was 35.0% for each of the three and six monthsended June 30, 2002 and 2001. Substantially all of our income tax liabilities at June 30, 2002 weredeferred tax liabilities.

 

##### **Selected Credit Card Data**

 

In August 1997, we begansecuritizing our credit card receivables. In each securitization, we receivecash, retain an interest in the receivables that are securitized, retain therights to receive cash in the future and service the accounts. Securitizationsare treated as sales under Generally Accepted Accounting Principles ("GAAP").As such, we remove the securitized loans from our consolidated balance sheet.During the second quarter of 2002, we purchased a 50% interest in CSG, LLC,which was formed to acquire notes and a certificated interest in a trust (“CSGTrust”) that owns a portfolio of credit card receivables.  The performance of the underlying creditcard receivables will affect the future cash flows we actually receive. Theinformation in the following table and in this entire Selected Credit Card Datasection is presented to reflect credit card receivables that we havesecuritized and 50% of the managed receivables underlying the CSG Trust (whichreflects our ownership percentage in CSG, LLC).

 
|                           |   | **At or for the Three Months Ended**       |       |
|--------------------------------|--------|--------------------------------------------|------------|
|                           |   | **2002**                                   |       |   |   | **2001** |   |   |   | **2000** |   |
|                           |   | **Jun. 30**                                |       | **Mar. 31** |   | **Dec. 31** |   | **Sep. 30** |   | **Jun. 30** |   | **Mar. 31** |   | **Dec. 31** |   | **Sep. 30** | ** ** |
|                           |   | **(In thousands; percentages annualized)** | ** ** |
| Period-end managed loans       |   | $                                          | 2,260,442  |   | $ | 1,809,070 |   | $ | 1,891,842 |   | $ | 1,804,631 |   | $ | 1,671,762 |   | $ | 1,589,584 |   | $ | 1,528,372 |   | $ | 1,321,128 |   |
| Period-end managed accounts    |   | 2,285                                      |       | 2,057 |   | 2,185 |   | 2,163 |   | 2,300 |   | 2,256 |   | 2,178 |   | 1,891 |   |
| Average managed loans          |   | $                                          | 1,945,024  |   | $ | 1,860,209 |   | $ | 1,838,873 |   | $ | 1,745,136 |   | $ | 1,623,730 |   | $ | 1,574,554 |   | $ | 1,398,041 |   | $ | 1,256,239 |   |
| Net interest margin            |   | 13.1                                       | %          | 16.9 | % | 19.0 | % | 21.5 | % | 22.0 | % | 21.6 | % | 21.8 | % | 23.4 | % |
| Other credit card income ratio |   | 7.3                                        | %          | 7.3 | % | 8.5 | % | 9.2 | % | 8.5 | % | 8.3 | % | 9.3 | % | 8.7 | % |
| Operating ratio                |   | 7.6                                        | %          | 9.0 | % | 9.8 | % | 8.8 | % | 8.4 | % | 9.1 | % | 7.9 | % | 7.6 | % |

 

                The net interest margin includes all net interestand late fee income on all outstanding loans, less the

 

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interest expense paid to the investors and financecharge charge offs. Our other credit card income includes other credit cardfees, such as over-limit fees, cash advance fees, maintenance fees,miscellaneous fees, interchange income and ancillary product income.  Our operating ratio includes all expensesassociated with our business, net of any servicing income we receive asservicer for the CSG Trust, other than marketing and solicitation and ancillaryproduct expenses, and is expressed as a percentage of average managed loans.

 

We acquired portfolios during1998 at substantial discounts.  Theportfolio of credit card receivables owned by the CSG Trust was also acquiredat a substantial discount.  Thepresented credit card data excludes some of the acquired receivables and therelated accounts, which at the time of purchase, were closed accounts or in alate delinquency status.  Our belief isthat these accounts were either in the process of being charged off by theseller due to delinquency or were likely to be charged off in the nearterm.  In each purchase, the accountsand the receivables were purchased as part of the portfolio as the sellersdesired to sell the entire portfolio. The same representations and warranties from the sellers were made onthese receivables that were made on the entire portfolio; however, the sellersdid not provide any representations or warranties as to the ability orwillingness of the cardholders to repay their accounts.  There is no recourse to any seller in theevent the cardholders simply do not pay on accounts that have been acquired.

 

The following summarizes theaccounts and receivables purchased and those excluded from our credit carddata:

 
|                 |   | **Purchases occurring in** |       |
|----------------------|--------|----------------------------|------------|
|                 |   | **2002**                   |       | **1998** |   |
|                 |   | **(In thousands)**         | ** ** |
| Acquired accounts    |   | 383                        |       | 201 |   |
| Acquired receivables |   | $                          | 615,721    |   | $ | 579,700 |   |
| Excluded accounts    |   | 38                         |       | 52 |   |
| Excluded receivables |   | $                          | 74,388     |   | $ | 137,200 |   |

 

The portfolios acquired during1998 and the portfolio acquired during 2002 by the CSG Trust were acquired atsubstantial discounts.  A portion ofeach discount related to the excluded accounts noted above.  A portion of each discount related to thecredit quality of the remaining acquired receivables and was calculated as thedifference between the face amount of the receivables purchased (less theexcluded accounts described above) and the expected future cash flows expectedto be collected.  The balance of thediscount for each purchase is not needed for credit quality, is referred to asaccretable yield, and is being amortized into net interest margin, using theinterest method over the estimated life of each acquired portfolio for purposesof reporting our selected credit card data. At June 30, 2002, $10.5 million of the accretable yield remained.  The following table summarizes the discountsassociated with the acquired portfolios:

 
|                                  |   | **Purchases occurring in** |       |
|---------------------------------------|--------|----------------------------|------------|
|                                  |   | **2002**                   |       | **1998** |   |
|                                  |   | **(In millions)**          | ** ** |
| Total face value acquired             |   | $                          | 615.7      |   | $ | 579.7 |   |
| Total discount                        |   | 249.0                      |       | 284.5 |   |
| Portion used for excluded receivables |   | 74.4                       |       | 137.2 |   |
| Portion needed for credit quality     |   | 169.9                      |       | 87.5 |   |
| Portion reflecting accretable yield   |   | 4.7                        |       | 59.8 |   |
|                                       |        |                            |            |  |  |  |  |

 

Our net interest margins areinfluenced by a number of factors, including the level of finance charges andlate fees billed, the weighted average cost of funds and the level of ourfinance charge charge offs. Our net interest margin for the three months endedJune 30, 2002 was 13.1% as compared to 16.9% for the three months ended March31, 2002. The decrease in our net interest margin is due to a decrease in latefee income billed to our cardholders and an increase in the finance chargecharge offs on the portfolio, partially offset by an increase in billed financecharges.  The net effect of thesechanges was to decrease our net interest margin by approximately $10.3 million.

 

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Each quarter, we re-underwriteour portfolio to price our products to appropriately reflect the level of eachcustomer’s credit risks. As part of this underwriting process, existingcustomers may be offered increased or decreased pricing depending on theircredit risk as well as their supply and demand for credit. Increases in pricingmay increase our net interest margin, while decreases in pricing may reduce ournet interest margin. We expect our net interest margin to begin to increaseduring the third quarter of 2002 due primarily to expected decreases in financecharge charge offs for the remainder of 2002. The increase in finance chargecharge offs is based on the current economic environment as well as theexpected seasoning of the credit card accounts.

 

Our operating ratio includes allcosts of operating our business, other than marketing expenses and ancillaryproduct expenses. Our operating ratio fluctuates based on our rate of loangrowth and the level of our expenditures on our infrastructure, our personnel,our collections and customer service operations, our internet technology and ourdatabase management system. The operating ratio decreased to 7.6% during thethree months ended June 30, 2002 as compared to 9.0% during the three monthsended March 31, 2002 as we continued to implement cost cutting initiatives,including automation projects.  Weexpect to continue to reduce our operating ratio as a percentage of averagemanaged loans during the second half of 2002. Included in our operating expenses for the second quarter of 2002 wasapproximately $3.7 million paid to our primary subservicer to reimburse themfor servicing fewer accounts than previously projected.

 

**Asset Quality**

 

Our delinquency and net loancharge off rates at any point in time reflect the credit performance of ourreceivables. The average age of our credit card accounts, the timing ofportfolio purchases, the success of our collection and recovery efforts andgeneral economic conditions affect our delinquency and charge off rates. Theaverage age of our credit card account portfolio also affects the stability ofdelinquency and loss rates of the portfolio.

 

Our strategy for managingdelinquency and loan losses consists of active account management throughoutthe customer relationship. This strategy includes credit line management andpricing based on the risk of the credit card accounts.

 

*Delinquencies.*  Delinquencies have thepotential to impact net income in the form of net credit losses. Delinquenciesare also costly in terms of the personnel and resources dedicated to resolvingthem. A credit card account is contractually delinquent if the minimum paymentis not received by the specified date on the customer’s statement. It is ourpolicy to continue to bill 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 “–Net Charge offs.”

 

The following table presents thedelinquency trends of the credit card receivables:

 
|                                       |   | **At or for the Three Months Ended** |       |
|--------------------------------------------|--------|--------------------------------------|------------|
|                                       |   | **2002**                             |       | **2001** |   | **2000** |   |
|                                       |   | **Jun. 30**                          |       | **Mar. 31** |   | **Dec. 31** |   | **Sep. 30** |   | **Jun. 30** |   | **Mar. 31** |   | **Dec. 31** |   | **Sep. 30** | ** ** |
|                                       |   | **(In thousands;% of total)**        | ** ** |
| Loans delinquent:                          |   |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 30 to 59 days past due                     |   | $                                    | 104,337    |   | $ | 68,423 |   | $ | 86,501 |   | $ | 70,280 |   | $ | 69,602 |   | $ | 63,338 |   | $ | 59,138 |   | $ | 50,313 |   |
| 60 to 89 days past due                     |   | 67,154                               |       | 57,227 |   | 62,975 |   | 55,967 |   | 55,084 |   | 42,953 |   | 47,118 |   | 37,324 |   |
| 90 or more days past due                   |   | 136,501                              |       | 163,715 |   | 147,407 |   | 141,467 |   | 121,494 |   | 107,253 |   | 98,568 |   | 78,753 |   |
|                                       |   |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total 30 or more days past due             |   | $                                    | 307,992    |   | $ | 289,365 |   | $ | 296,883 |   | $ | 267,714 |   | $ | 246,180 |   | $ | 213,544 |   | $ | 204,824 |   | $ | 166,390 |   |
| Total 60 or more days past due             |   | $                                    | 203,655    |   | $ | 220,942 |   | $ | 210,382 |   | $ | 197,434 |   | $ | 176,578 |   | $ | 150,206 |   | $ | 145,686 |   | $ | 116,077 |   |
|                                       |   |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans delinquent as % of period-end loans: |   |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 30 to 59 days past due                     |   | 4.6                                  | %          | 3.8 | % | 4.6 | % | 3.9 | % | 4.2 | % | 4.0 | % | 3.9 | % | 3.8 | % |
| 60 to 89 days past due                     |   | 3.0                                  |       | 3.2 |   | 3.3 |   | 3.1 |   | 3.3 |   | 2.7 |   | 3.1 |   | 2.8 |   |
| 90 or more days past due                   |   | 6.0                                  |       | 9.0 |   | 7.8 |   | 7.8 |   | 7.3 |   | 6.7 |   | 6.4 |   | 6.0 |   |
|                                       |   |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total 30 or more days past due             |   | 13.6                                 | %          | 16.0 | % | 15.7 | % | 14.8 | % | 14.8 | % | 13.4 | % | 13.4 | % | 12.6 | % |
| Total 60 or more days past due             |   | 9.0                                  | %          | 12.2 | % | 11.1 | % | 10.9 | % | 10.6 | % | 9.4 | % | 9.5 | % | 8.8 | % |

 

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The following table separatelyreports our loan delinquency trends for our originated portfolio and for  purchased portfolios:

 
|                           |   | **At or for the Three Months Ended** |       |
|--------------------------------|--------|--------------------------------------|------------|
|                           |   | **2002**                             |       | **2001** |   | **2000** |   |
|                           |   | **Jun. 30**                          |       | **Mar. 31** |   | **Dec. 31** |   | **Sep. 30** |   | **Jun. 30** |   | **Mar. 31** |   | **Dec. 31** |   | **Sep. 30** |   |
|                           |   | **(% of Total)**                     | ** ** |
| **Originated Portfolio**       |   |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans Delinquent:              |   |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 30 to 59 days past due         |   | 4.6                                  | %          | 3.7 | % | 4.5 | % | 3.9 | % | 4.1 | % | 3.8 | % | 3.5 | % | 3.6 | % |
| 60 to 89 days past due         |   | 3.2                                  |       | 3.2 |   | 3.4 |   | 3.1 |   | 3.3 |   | 2.6 |   | 3.0 |   | 2.7 |   |
| 90 or more days past due       |   | 8.0                                  |       | 9.3 |   | 7.9 |   | 7.9 |   | 7.3 |   | 6.7 |   | 6.4 |   | 6.0 |   |
| Total 30 or more days past due |   | 15.8                                 | %          | 16.2 | % | 15.8 | % | 14.9 | % | 14.7 | % | 13.1 | % | 12.9 | % | 12.3 | % |
| Total 60 or more days past due |   | 11.2                                 | %          | 12.5 | % | 11.3 | % | 11.0 | % | 10.6 | % | 9.3 | % | 9.4 | % | 8.7 | % |
|                           |   |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Purchased Portfolios**       |   |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans Delinquent:              |   |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 30 to 59 days past due         |   | 4.7                                  | %          | 4.8 | % | 5.9 | % | 4.4 | % | 5.0 | % | 5.7 | % | 6.7 | % | 5.4 | % |
| 60 to 89 days past due         |   | 2.3                                  |       | 2.9 |   | 3.0 |   | 2.7 |   | 3.8 |   | 3.5 |   | 4.1 |   | 3.6 |   |
| 90 or more days past due       |   | 0.9                                  |       | 5.7 |   | 5.5 |   | 6.4 |   | 7.4 |   | 7.4 |   | 7.1 |   | 5.7 |   |
|                           |   |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total 30 or more days past due |   | 7.9                                  | %          | 13.4 | % | 14.4 | % | 13.5 | % | 16.2 | % | 16.6 | % | 17.9 | % | 14.7 | % |
| Total 60 or more days past due |   | 3.2                                  | %          | 8.6 | % | 8.5 | % | 9.1 | % | 11.2 | % | 10.9 | % | 11.2 | % | 9.3 | % |

 

In general, as the average age ofan originated credit card receivables portfolio increases, delinquency ratescan be expected to first be low during the first six months of their life;dramatically increase and peak towards the rest of the first year and duringthe second year; and then decrease and stabilize after year two. We haveobserved this trend in the industry as well as within our own originatedportfolio. Our delinquency rates have increased due primarily to the seasoningof receivables that were originated during 

 

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2000 and 1999 and the general economic conditionsthat prevailed during 2001 and the six months ended June 30, 2002. Ourdelinquency rates have improved in the originated portfolio from March 31, 2002to June 30, 2002 primarily due to successful collection efforts and due to ourbelief that our originated portfolio has experienced its peak charge off ratesrelating to seasoning as mentioned above. The average age of our originated portfolio was 27 months at June 30,2002.  The purchased portfoliosdelinquencies improved from March 31, 2002 compared to June 30, 2002 primarilybecause of the inclusion of our 50% interest in the managed receivablesunderlying the CSG Trust. We expect purchased portfolio delinquencies toincrease as the receivables acquired by the CSG Trust age into laterdelinquency statuses; the majority of the CSG Trust accounts at June 30, 2002(after excluding accounts at or near charge off, as previously discussed) aregenerally less than 60 days past due. This is consistent with our observations relating to the portfolios weacquired in 1998.

 

We are using our accountmanagement strategies on our portfolio, which are intended to reduce the expectedincrease in delinquency rates as our portfolio continues to mature.  Examples of management strategies includeconservative credit line management, purging of inactive accounts andcollection strategies intended to optimize the effective account to collectorratio across delinquency buckets.  Wemeasure the success of these efforts by measuring delinquency rates.

 

*Net Charge offs.*  Net charge offs include theprincipal amount of losses from customers unwilling or unable to pay their loanbalance, as well as bankrupt and deceased customers, less current periodrecoveries. Net charge offs exclude accrued finance charges and fees, which arecharged against the related income at the time of charge off. Losses fromfraudulent activity in accounts are also excluded from net charge offs and areincluded separately in other operating expenses. We generally charge offreceivables when they become contractually 180 days past due. However,bankrupt accounts and the accounts of deceased customers without a surviving,contractually liable individual or an estate large enough to pay the debt infull are charged off within 30 days of notification of the customer’sbankruptcy or death and subsequent confirmation, if applicable.

 

For purposes of reportingadjusted charge off ratios on managed loans below, the discount related tocredit quality discussed earlier in this section was utilized to offset aportion of actual net charge offs. This amount relating to the portfoliosacquired in 1998 was fully amortized as of June 30, 2001 and therefore,beginning with the quarter ended September 30, 2001, the actual andadjusted charge off ratios were the same. Beginning in the third quarter of2002, the credit related discount associated with the receivables owned by theCSG Trust will be used to offset a portion of the actual net charges offs.  The following table presents our net chargeoffs for the periods indicated on a managed loan portfolio basis:

 
|                           |   | **For the Three Months Ended**                     |       |
|--------------------------------|--------|----------------------------------------------------|------------|
|                           |   | **2002**                                           |       | **2001** |   | **2000** |   |
|                           |   | **Jun. 30**                                        |       | **Mar. 31** |   | **Dec. 31** |   | **Sept. 30** |   | **Jun. 30** |   | **Mar. 31** |   | **Dec. 31** |   | **Sept. 30** | ** ** |
|                           |   | **(Dollars in thousands; percentages annualized)** | ** ** |
| **Selected Credit Card Data:** |   |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net charge offs                |   | $                                                  | 72,979     |   | $ | 68,407 |   | $ | 70,207 |   | $ | 63,759 |   | $ | 59,807 |   | $ | 58,229 |   | $ | 46,552 |   | $ | 35,678 |   |
| Adjusted net charge offs       |   | $                                                  | 72,979     |   | $ | 68,407 |   | $ | 70,207 |   | $ | 63,759 |   | $ | 59,434 |   | $ | 58,126 |   | $ | 46,132 |   | $ | 34,525 |   |
| Net charge off ratio           |   | 15.0                                               | %          | 14.7 | % | 15.3 | % | 14.6 | % | 14.7 | % | 14.8 | % | 13.3 | % | 11.4 | % |
| Adjusted charge off ratio      |   | 15.0                                               | %          | 14.7 | % | 15.3 | % | 14.6 | % | 14.6 | % | 14.8 | % | 13.2 | % | 11.0 | % |

 

As described above under the"Delinquency" subheading, as our portfolio matures, we expect chargeoff rates to also increase and then stabilize. Our charge off ratio increasedduring 2001 and 2000 due primarily to seasoning of our portfolio and a generalslowing of the economy. Typically, as our accounts mature, there are very fewcharge offs during the first 180 days, then the charge offs are expectedto increase and peak in the second year and then stabilize in the third year.We expect our charge off rates to level off and then decrease over the secondhalf of 2002. We plan to continue to focus our resources on refining our creditunderwriting standards for new accounts and to increase our focus on collectionand post charge off recovery efforts to minimize losses.

 

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*Credit Losses.*  For securitized receivables,anticipated credit losses are reflected in the calculations of netsecuritization income and the fair value of our retained interests in creditcard receivables securitized while the actual charge offs are included inincome from retained interests in credit card receivables securitized. Inevaluating credit losses, we take into consideration several factors, including(1) historical charge off and recovery activity by receivables portfolio,(2) recent and expected delinquency and collection trends by receivablesportfolio, (3) the impact of current economic conditions and recenteconomic trends on the customers’ ability to repay and (4) the riskcharacteristics of the portfolios. All of our credit card receivables have beensecuritized. As we have securitized our receivables, we have removed them fromour balance sheet.

 

**Liquidity, Funding and Capital Resources**

 

A primary financial goal is tomaintain an adequate level of liquidity through active management of assets andliabilities. Because the characteristics of our assets and liabilities change,liquidity management is a dynamic process affected by the pricing and maturityof our assets and liabilities.

 

We finance our business throughcash flows from operations, asset securitizations and the issuance of equity:

 

•                  During the six months ended June 30, 2002, we usedapproximately $9.6 million in cash to operate the company compared togenerating approximately $35.7 million in cash flow from operations during thesix months ended June 30, 2001.  The$45.3 million decrease is due primarily to (a) reduced cash collections due tohigher charge offs, and (b) $10.0 million being used to cash collateralize theirrevocable standby letter of credit we entered into during the first quarterof 2002, as further explained below.

 

•                  During the second quarter of 2002, we entered intoa loan in the amount of $31.4 million to partially fund the purchase of anequity interest in CSG.  The loan bearsinterest at Prime + 5%, is non-recourse to the Company, and is only payablewith cash flows received from CSG.  Thelender is entitled to share in certain excess cash flows we receive from ourinvestment in CSG once the loan has been repaid.

 

•                  Until January 2002, we had a$25.0 million one-year revolving credit facility, of which$15.0 million was outstanding under this facility and $10.0 millionwas reserved for a letter of credit in favor of a sub-servicer of the Company.This agreement expired in January 2002 and was paid in full.

 

•                  During the first quarter of 2002, the Companyentered into an irrevocable standby letter of credit agreement for $10.0million with a bank.  The letter ofcredit allows the subservicer of the receivables to draw under the letter ofcredit as needed.  We are required tomaintain a cash balance of $10.0 million with the lender. Such cash isreflected as “Restricted cash” on the face of the balance sheet.

 

•                  During the third quarter of 2002, our board ofdirectors authorized a program to repurchase up to 5 million shares(approximately 11 percent) of our outstanding common stock.  Under the repurchase plan, we may buy backshares of our outstanding common stock from time to time either on the openmarket or through privately negotiated transactions in compliance with theSecurities and Exchange Commission guidelines. 

 

•                  As of June 30, 2002, we had total securitizationfacilities of $1.7 billion and had used approximately $1.4 billion ofthese facilities. These facilities include the outstanding amounts on twofloating rate three-year term securitizations of approximately$441.5 million that we

 

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completed during July 2001 and approximately$627.4 million that we completed during August 2000.  Repayment for each one-year securitizationfacility begins on its maturity date. In the case of our three-year term securitizations,cash may be accumulated as early as one year prior to the scheduled maturitydate. Once repayment on any facility begins and until the facility is paid,cash may be accumulated within the trust and not paid to us to provide for therepayment of such facility. We have noted those facilities below.

 
| **Maturity Date** |   | **Facility Limit****** |    |
|-------------------|--------|------------------------|---------|
|              |   | **(in millions)**      |    |
| August 2002(1)    |   | $                      | 67.9    |   |
| October 2002      |   | 306.0                  |    |
| March 2003        |   | 250.0                  |    |
| September 2003(2) |   | 627.4                  |    |
| July 2004(3)      |   | 441.5                  |    |
|              |   | $                      | 1,692.8 |   |

 

----

 

(1)                          Subsequent to June 30, 2002, this facility was renewed until February2003.

 

(2)                          Represents the expected principal payment date; however, as early asSeptember 2002, collections on the receivables could be accumulated for thebenefit of this facility and not be available to us to fund new purchases.

 

(3)                          Represents the expected principal payment date; however, as early asJuly 2003, collections on the receivables could be accumulated for the benefitof this facility and not be available to us to fund new purchases.

 

•                  Subsequent to June 30, 2002, we entered into anadditional $300.0 million facility, which will expire in July 2003.

 

Duringthe six months ended June 30, 2002, we used approximately $9.6 million in cashoperating the company.  Our cash used byoperating the company is dependent on the performance of our managed portfolioincluding charge off rates, net interest margin, payment rates and operatingexpenses.  Based on our currentexpectations of our managed portfolio performance and our expected growth ratesduring the third and fourth quarter of this year, we expect to have positivecash flow from operations during these quarters.

 

Wecontinue to explore a wide range of options for liquidity in order for us tomaintain our growth and to be prepared for adverse changes in thesecuritization marketplace. These options may include revolving lines ofcredit, selling a subordinated interest in one or more of our securitizations,or the issuance of debt or equity. We may explore other options as well. Therecannot, however, be any assurances that we will be able to obtain liquidity onsatisfactory terms. Should we not obtain additional liquidity, we will need tosignificantly limit our growth and will be more susceptible to adverse changesin the securitization marketplace.

 

Ourmost significant source of liquidity is the securitization of credit cardreceivables. The maturity terms of our securitizations vary. With the exceptionof the three-year securitizations that we completed in July 2001 andAugust 2000, most are one-year securitizations. Once repayment begins, paymentsfrom customers on credit card receivables are accumulated to repay theinvestors and are no longer reinvested in new credit card receivables. At thattime, our funding requirements for new credit card receivables will increaseaccordingly. The occurrence of events may also cause the securitizationtransactions to amortize earlier than scheduled or may require additionalenhancements. These events include a decline in the portfolio’s annual yield ora decline in the payment rate, in each case below set rates, or an increase indelinquencies or charge offs, in each case above set rates.  The portfolio’s annual yield typicallyincludes finance 

 

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chargesand past due fees earned on the receivables less servicing fees and creditlosses. These events would accelerate the need to utilize alternative fundingsources.  If our securitizationfacilities begin to trap cash flows to repay the investors and we are unable toobtain additional sources of liquidity such as other securitization facilities,other debt or we are unable to issue additional equity, we would begin to closethe credit card accounts that are open to new purchases and thus significantlyreduce our need for any additional cash. Under each of our securitizationstructures, there has not been an early amortization period. As each facilityexpires or comes up for renewal, there can be no assurance that the facilitywill be renewed or if renewed there can be no assurance that the terms will beas favorable as the terms that currently exist. Either of these events couldsignificantly increase our need for additional liquidity. For additionalinformation regarding our securitization practice, see the information underthe caption “Credit Card Securitizations.”

 

Ourmost significant uses of cash are marketing expenses, operating expenses andthe purchase of the credit card receivables that arise from the accounts thatare issued through our relationship with Columbus Bank & Trust.  We raise cash by selling the credit cardreceivables into our securitization programs. When we sell the receivables we receive cash and a seller’s interest (aportion of which is regularly referred to as a “retained interest”).  Since the amount of cash that we receive isless than the face amount of the receivables, this seller’s interest is a useof cash for us.  The receivables in thesecuritization programs then generate cash as the cardholders make payments ontheir accounts.  This cash is allocatedby the securitization agreements to pay for servicing the receivables, to payinterest on the investor’s notes, to cover charge offs, and to repay anyportion of the investor’s notes that are due. Any excess cash after the above allocations is remitted to us.

 

Duringperiods of rapid receivables growth, the cash that we raise from selling thecredit card receivables and from our interests in the trusts is not by itselfenough to cover our uses of cash. During periods of decline in the receivables, there typically would beenough cash flow to cover our costs and we would generate excess cash flow(depending on the performance of the underlying receivables).  To fund our use of cash associated with oursignificant growth during 1999, 2000 and 2001, we used the proceeds from our initialpublic offering and our follow-on offering. During the fourth quarter of 2001, we used a portion of our revolvingcredit facility, and we also raised additional cash by selling retainedinterests and preferred stock that we described more fully in our 2001 AnnualReport on Form 10-K.  During 2002, weused our cash flows from our fourth quarter 2001 transactions and a note tofund our operations.

 

Absentchanges in the manner in which we securitize credit card receivables, webelieve that our asset securitizations, cash flow from operations and cashflows from our investment in CSG generally will provide adequate liquidity forour business at its current level. However, in order for us to continue growingour business, we will need additional sources of liquidity to fund our retainedinterest portion of the growth. In addition, should the terms of thesecuritizations available to us become less favorable, we also will needadditional sources of liquidity to fund our retained interests. We are particularlyconcerned about the continued availability of securitizations on termspreviously available to us given the recent poor performance of several of ourcompetitors and the impact of their performance on the marketplace forsecuritizations.

 

**Critical Accounting Policies**

 

Ourfinancial statements are prepared in accordance with Generally AcceptedAccounting Principles ("GAAP"). These principles are numerous andcomplex. Our significant accounting policies are summarized in the notes to ourfinancial statements. In many instances, the application of GAAP requiresmanagement to make estimates or to apply subjective principles to particularfacts and circumstances. A variance in the estimates used or a variance in theapplication, or interpretation of GAAP could yield a materially differentaccounting result. It is impracticable for us to summarize every accountingprinciple that requires us to use judgment or estimates in itsapplication.  In our Annual Report onForm 10-K for the year ended December 31, 2001, we discuss the two areas,valuation of retained interests and non-consolidation of special purposeentities, where we believe that the estimations, judgments or interpretationsthat we have made, if different, would have yielded the most significant differencesin our financial statements and we urge you to review that discussion.  In addition, in Note 4 to the financialstatements included in this report we updated our sensitivity analysis withrespect to valuations.

 

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**Forward-LookingInformation**

 

All statements in this quarterlyreport concerning our operating and earnings expectations for fiscal year 2002and our liquidity expectations, and all other statements regarding our futureperformance (including those using words such as “believe,” “estimate,”“project,” “anticipate, or “predict”), are forward-looking statements. Theseforward-looking statements are not guarantees of future performance and aresubject to various assumptions, risks, and other factors that could cause ouractual results to differ materially from those suggested by theseforward-looking statements. These factors include, among others, the followingrisks and others set forth under the caption “Risk Factors” in our AnnualReport on Form 10-K for the year ended December 31, 2001:

 

(1) The cash flows we receivefrom our retained interests drive our financial performance and are dependentupon the cash flows received on the credit card receivables underlying oursecuritizations.  The collectibility ofthe receivables underlying our securitizations is a function of many factorsincluding the criteria used to select who is issued a credit card, the pricingof the credit products, the length of the relationship with each cardholder,general economic conditions, the rate at which cardholders repay theiraccounts, and the rate at which cardholders change or become delinquent.  To the extent we have over estimatedcollectibility, in all likelihood we have over estimated our financialperformance;

 

(2) We are substantiallydependent upon securitizations and other borrowed funds in order to fund thecredit card receivables that we originate or purchase.  All of our securitization facilities are offinite duration (and ultimately will need to be extended or replaced) andcontain conditions that must be fulfilled in order for funding to beavailable.  In the event that advancerates for securitizations are reduced, investors in securitizations require agreater rate of return, we fail to meet the requirements for continued funding,or large-scale securitizations otherwise become unavailable to us, we may notbe able to maintain or grow our base of credit card receivables or it may bemore expensive for us to do so.  Inaddition, a portion of our credit card receivables cannot be financed throughsecuritizations because of advance rate limitations and must be financedthrough equity that either is the result of profitable operations or is raisedfrom third parties or through funds borrowed elsewhere.  The cost and availability of equity andborrowed funds is dependent upon our financial performance, the performance ofour industry generally, and general economic and market conditions, andrecently has been both expensive and difficult to obtain;

 

(3) Our financial performance is,in part, a function of the aggregate amount of credit card receivables that wehave outstanding.  In turn, this is afunction of many factors including interest rates, seasonality, general economicconditions, competition from other credit card issuers and other sources ofconsumer financing, access to funding as noted above, and the success of ourmarketing efforts.  To the extent thatwe have over-estimated the size or growth of our credit card receivables, inall likelihood we have over-estimated our future performance;

 

(4) Our operating expenses andour ability to effectively service our credit card accounts is dependent on ourability to estimate the future size and general growth rate of theportfolio.  One of our servicing agreementscauses us to make additional payments if we overestimate the size or growth ofour business.  These additional paymentsare to compensate the servicer for increased staffing expenses it incurs inanticipation of our growth.  If we growslower thananticipated, we may still havehigher servicing expenses than we actually need, thus reducing our netincome.  We generally have sufficientoffice space, customer service representatives, collectors and computer capacityto accommodate expected growth.  However,we are dependent on labor markets to supply qualified employees at appropriatecompensation when needed.  To the extentthat growth occurs unexpectedly, or the labor markets are tight at that time,we may encounter difficulties in accommodating that growth effectively;

 

(5) We operate in a heavilyregulated industry.  Changes inbankruptcy, privacy or other consumer protection laws may adversely affect ourability to collect credit card account balances or otherwise adversely 

 

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affect our business or expose us tolitigation.  Similarly, regulatorychanges could adversely affect our ability to market credit cards and otherproducts and services to our customers. The accounting rules that govern our business are exceedingly complex,difficult to apply, and in a state of flux. As a result, how we value our credit card receivables and otherwiseaccount for our business (including whether we consolidate our securitizations)is subject to change depending upon the interpretation of, and changes in,those rules; and

 

(6) We routinely explore variousopportunities to grow our business, including the purchase of credit cardreceivable portfolios and other businesses. There are a number of risks attendant to any acquisition, including thepossibility that we will overvalue the assets to be  purchased, that we will not be able to successfully integrate theacquired business or assets, and that we will not be able to produce theexpected level of profitability from the acquired business or assets.  As a result, the impact of any acquisitionon our future performance may not be as favorable as expected and actually maybe adverse.

 

We expressly disclaim any obligation to update orrevise any forward-looking statements, whether as a result of new information,future events or otherwise, except as requiredby law.

 

**ITEM 3****. QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

Interest rate sensitivity iscomprised of basis risk, gap risk and market risk. Basis risk is caused by thedifference in the interest rate indices used to price assets and liabilities.Gap risk is caused by the difference in repricing intervals between assets andliabilities. Market risk is the risk of loss from adverse changes in marketprices and rates. Our principal market risk is related to changes in interestrates. This risk affects us directly in our lending and borrowing activities,as well as indirectly as interest rates may impact the payment performance ofour customer.

 

We incur basis risk because wefund managed assets at a spread over the commercial paper rate or LIBOR whilethe rates on the underlying assets are indexed to the prime rate. This basisrisk results from the potential variability in the spread between the primerate and the commercial paper rate, on the one hand, and LIBOR, on the otherhand, over time. We have not hedged our basis risk due to the cost of hedgingthis risk versus the benefits from elimination of this risk.

 

We attempt to minimize the impactof market interest rate fluctuations on net interest income and net income byregularly evaluating the risk inherent in our asset and liability structure,especially our off-balance sheet assets and liabilities such as securitizedreceivables. The impact of market interest rate fluctuations on our securitizedreceivables is reflected in the valuation of our retained interests in creditcard receivables securitized. This risk arises from continuous changes in ourasset and liability mix, changes in market interest rates, including changesaffected by fluctuations in prevailing interest rates, payment trends on ourinterest–earning assets and payment requirements on our interest–bearingliabilities, and the general timing of all other cash flows. To manage our directrisk to market interest rates, management actively monitors market interestrates and the interest sensitive components of our securitization structures.Management seeks to minimize the impact of changes in interest rates on thefair value of assets, net income and cash flow primarily by matching asset andliability repricings. There can be no assurance that management will besuccessful in its attempt to manage such risks.

 

At June 30, 2002, all of ourcredit card receivables and other interest–earning assets had variablerate pricing, with receivables carrying annual percentage rates at a spreadover the prime rate, subject to interest rate floors. At June 30, 2002, oursecuritizations had $1.8 billion in variable rate, interest–bearingliabilities, payable to investors compared to $1.3 billion as of June 30,2001. Since both our managed interest–earning assets and substantiallyall of our managed interest–bearing liabilities reprice approximatelyevery 30 days, we believe that the impact of a change in interest rateswould not be material to our financial performance.

 

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We believe we are not exposed toany material foreign currency exchange rate risk or commodity price risk.

 

**PART II****– OTHER INFORMATION**

 

**Item 1****.****                                 Legal Proceedings**

 

CompuCredit is not presentlysubject to any material litigation and to our knowledge, no material litigationis threatened against us.  Routinelitigation arising from the ordinary course of business is not expected toresult in material losses to us.

 

**Item 2****.****                                    Changesin Securities and Use of Proceeds.**

 

(a)  Not applicable.

 

(b)  Not applicable.

 

(c)          Not applicable.

 

**Item 3.****                                    DefaultsUpon Senior Securities.**

 

None.

 

**Item 4****.****                                    Submissionof Matters to a Vote of Security Holders.**

 

As previously reported in ourQuarterly Report on Form 10-Q for the quarter ended March 31, 2002, we held ourannual shareholders meeting on May 9, 2002 for the purpose of electing ninemembers of our Board of Directors and to remove the conversion limitations onthe Series A Preferred Stock and the Series B Preferred Stock.  Proxies for the meeting were solicitedpursuant to Section 14(a) of the Securities Exchange Act of 1934, and there wasno solicitation in opposition to management’s solicitations.

 

(1)           Votes regarding the election of ninedirectors to hold office for a term of one year and until their respectivesuccessors are elected and qualified were as follows:

 
| **DIRECTOR**          |   | **FOR**    |   | **ABSTAIN/BROKER  NON-VOTES** |   |
|-----------------------|--------|------------|--------|-------------------------------|--------|
| David G. Hanna        |   | 39,172,782 |   | 3,034,453                     |   |
| Peter L. Briger, Jr.  |   | 42,158,168 |   | 49,067                        |   |
| Richard W. Gilbert    |   | 39,166,482 |   | 3,040,753                     |   |
| Frank J. Hanna, III   |   | 41,948,468 |   | 258,767                       |   |
| Richard R. House, Jr. |   | 39,796,082 |   | 2,411,153                     |   |
| Richard E. Huddleston |   | 42,145,468 |   | 61,767                        |   |
| Gail Coutcher-Hughes  |   | 42,145,468 |   | 61,767                        |   |
| Mack F. Mattingly     |   | 42,157,168 |   | 50,067                        |   |
| Thomas G. Rosencrants |   | 42,143,968 |   | 63,267                        |   |

 

 

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                (2)           Votes regarding the removal ofconversion limitations on the Series A Preferred Stock and the Series BPreferred Stock were as follows:

 
| **FOR**    |   | **AGAINST** |   | **ABSTAIN/BROKER  NON-VOTES** |   |
|------------|--------|-------------|--------|-------------------------------|--------|
| 36,315,421 |   | 216,347     |   | 5,675,440                     |   |

 

**Item 5****.****                                    Other Information.**

 

                None.

 

**Item 6.****                                    Exhibits and Reports on Form 8-K.**

 

(a)          Exhibits

 
| **Exhibit**

**Number** |   | **Description of  Exhibit**                                                                                                                                                                                                                                                                                                           |   | **Incorporated by  reference from**

**CompuCredit's  SEC filings unless**

**otherwise  indicated:** |
|-------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------|
| 10.1                    |   | CSGQ Trust Master Indenture, dated as of June  25, 2002, among CSG Trust, as Issuer, CitiBank, N.A., as Note Administrator,  and U.S. Bank National Bank, as Indenture Trustee.                                                                                                                                                       |   | Filed herewith                                                                                        |
| 10.2                    |   | Series 2002-1 Indenture Supplement, Term Notes,  dated as of June 25, 2002, among CSG Trust, as Issuer, CitiBank, N.A., as  Note Administrator, and U.S. Bank National Bank, as Indenture Trustee.                                                                                                                                    |   | Filed herewith                                                                                        |
| 10.2(a)                 |   | Series 2002-A Indenture Supplement, Variable  Funding Notes, dated as of June 25, 2002, among CSG Trust, as Issuer,  CitiBank, N.A., as Note Administrator, and U.S. Bank National Bank, as  Indenture Trustee.                                                                                                                       |   | Filed herewith                                                                                        |
| 10.3                    |   | CSGQ Trust, Series 2002-A Variable Funding Notes  Purchase Agreement, dated as of June 25, 2002, among PACCT LLC, as Seller,  Providian National Bank, in its capacity and as Accounts Owner, CSG, LLC, as  Purchaser, and MTGLQ Investors, L.P., SB Funding Corp. and CompuCredit  Acquisition Corporation, as Secondary Purchasers. |   | Filed herewith                                                                                        |
| 10.4                    |   | Transfer and Servicing Agreement, dated as of  June 25, 2002, among PACCT LLC, as Transferor, CompuCredit Corporation, as  Servicer, and CSG Funding, LLC, as O/C Holder.                                                                                                                                                             |   | Filed herewith                                                                                        |
| 10.5                    |   | Trust Agreement, dated as of June 25, 2002,  among PACCT LLC, as Transferor, CSG Funding, LLC, as O/C Holder, and  Wilmington Trust Company, as Owner Trustee.                                                                                                                                                                        |   | Filed herewith                                                                                        |
| 10.6                    |   | CSGQ Trust, Series 2002-1 Class B Notes, Series  2002-1 O/C Certificates, dated June 25, 2002, and PACCT, LLC as Seller                                                                                                                                                                                                               |   | Filed herewith                                                                                        |
| 10.7                    |   | Sale and Purchase Agreement, dated as of July 2,  2002, among Minnesota Telemarketing, Inc., as Seller, Fingerhut Companies,  Inc., as Seller and Licensor, FACS Group, Inc., as Subservicer and Licensor, Axsys  National Bank, as Licensor, and CompuCredit Acquisition Corporation III, as  Purchaser.                             |   | August 14, 2002, Form 8–K, exhibit  2.1                                                     |

 

(b)         Reports on Form 8-K

 

Current Report on Form 8-K/A datedApril 4, 2002, including Exhibit 99.1, which contains certain informationregarding Changes in Registrant’s Certifying Accountant.

 

Current Report on Form 8-K dated April 19, 2002,including Exhibit 99.1, which contains certain information regardingChanges in Registrant’s Certifying Accountant.

 

Current Report on Form 8-K datedJuly 12, 2002, including Exhibit 2.1, which contains certain informationregarding the purchase of certain assets from Federated Department Stores by asubsidiary of the Registrant.

 

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
|            | CompuCredit Corporation |
|-----------------|-------------------------|
|            |                    |
| August 14, 2002 | By                      | /s/ Ashley L. Johnson |   |
|            |                    | Ashley L. Johnson |
|            |                    | Chief Financial Officer (duly authorized officer and  principal financial officer) |

 

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