**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

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**FORM 10-Q**

 

**QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 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 checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.

 

YES ý                    NOo

 

The number ofshares outstanding of the issuer’s only class of Common Stock, no par value,(the “Common Stock”), as of October 31, 2002, was 45,726,265 shares.

 

 

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**COMPUCREDIT CORPORATION**

 

**FORM 10-Q**

 

**TABLE OF CONTENTS**

 

September 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                                 |   |
|     |                  |                                                                                        |   |
|     | Item 4.               | Controls and Procedures                                                                     |   |
|     |                  |                                                                                        |   |
| 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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**CompuCreditCorporation and Subsidiaries**

**ConsolidatedBalance Sheets**

 
|                                                                                                       |   | **(Unaudited)**            |       |                     |       |
|------------------------------------------------------------------------------------------------------------|--------|----------------------------|------------|--------------------------|------------|
|                                                                                                       |   | **September 30,****2002**  |       | **December 31,****2001** | ** ** |
|                                                                                                       |   | **(Dollars in thousands)** | ** ** |
| **Assets**                                                                                                 |   |                       |       |                     |       |
| Cash and cash equivalents                                                                                  |   | $                          | 60,550     |                     | $          | 55,746 |   |
| Restricted cash                                                                                            |   | 10,055                     |       | —                   |       |
|                                                                                                       |   |                       |       |                     |       |
| Retained interests in credit card receivables  securitized                                                 |   | 312,525                    |       | 358,889                  |       |
| Accrued interest and fees                                                                                  |   | 16,596                     |       | 32,928                   |       |
| Net credit card receivables                                                                                |   | 329,121                    |       | 391,817                  |       |
|                                                                                                       |   |                       |       |                     |       |
| Amounts due from securitization                                                                            |   | 14,788                     |       | 20,996                   |       |
| Deferred costs, net                                                                                        |   | 9,061                      |       | 17,862                   |       |
| Software, furniture, fixtures and equipment, net                                                           |   | 30,651                     |       | 34,522                   |       |
| Prepaid expenses                                                                                           |   | 1,004                      |       | 1,540                    |       |
| Investment in equity-method investee                                                                       |   | 16,355                     |       | —                   |       |
| Investment in debt security                                                                                |   | 20,881                     |       | —                   |       |
| Other assets                                                                                               |   | 13,037                     |       | 13,974                   |       |
| Total assets                                                                                               |   | $                          | 505,503    |                     | $          | 536,457 |   |
|                                                                                                       |   |                       |       |                     |       |
| **Liabilities**                                                                                            |   |                       |       |                     |       |
| Accounts payable and accrued expenses                                                                      |   | $                          | 37,311     |                     | $          | 28,321 |   |
| Notes payable                                                                                              |   | 9,890                      |       | 16,517                   |       |
| Deferred revenue                                                                                           |   | 6,595                      |       | 13,820                   |       |
| Income tax liability                                                                                       |   | 19,925                     |       | 31,320                   |       |
| Total liabilities                                                                                          |   | 73,721                     |       | 89,978                   |       |
|                                                                                                       |   |                       |       |                     |       |
| **Shareholders’ equity**                                                                              |   |                       |       |                     |       |
| Preferred stock, no par value, 10,000,000 shares  authorized:                                              |   |                       |       |                     |       |
| Series A preferred stock, 30,000 shares issued and  outstanding atSeptember 30, 2002 and December 31, 2001 |   | 31,658                     |       | 29,512                   |       |
| Series B preferred stock, 10,000 shares issued and  outstanding atSeptember 30, 2002 and December 31, 2001 |   | 10,766                     |       | 10,000                   |       |
| Common stock, no par value:                                                                                |   |                       |       |                     |       |
| 150,000,000 shares authorized, 46,559,165 shares issued  at September 30, 2002 and December 31, 2001       |   | —                     |       | —                   |       |
| Additional paid-in capital                                                                                 |   | 240,352                    |       | 240,352                  |       |
| Treasury stock, at cost, 500,000 shares at September  30, 2002                                             |   | (2,614                     | )          | —                   |       |
| Note issued to purchase stock                                                                              |   | (500                       | )          | (500                     | )          |
| Retained earnings                                                                                          |   | 152,120                    |       | 167,115                  |       |
| Total shareholders’ equity                                                                            |   | 431,782                    |       | 446,479                  |       |
| Total liabilities and shareholders’ equity                                                            |   | $                          | 505,503    |                     | $          | 536,457 |   |

 

See accompanying notes.

 

1

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**CompuCredit Corporation andSubsidiaries**

**ConsolidatedStatements of Operations (Unaudited)**

 
|                                                                         |   | **For the three months ended  September 30,**       |   | **For the nine months ended  September 30,** |   |
|------------------------------------------------------------------------------|--------|-----------------------------------------------------|--------|----------------------------------------------|--------|
|                                                                         |   | **2002**                                            |   | **2001**                                     |   | **2002** |   | **2001** |   |
|                                                                         |   | ***(Dollars in thousands, except per share data)*** |   |
| Interest income                                                              |   | $                                                   | 754    |                                         | $      | 376 |   | $ | 1,414 |   | $ | 2,032 |   |
| Interest expense                                                             |   | (5,670                                              | )      | (105                                         | )      | (5,773 | ) | (116 | ) |
| Net interest (expense) income                                                |   | (4,917                                              | )      | 271                                          |   | (4,359 | ) | 1,916 |   |
|                                                                         |   |                                                |   |                                         |   |   |   |   |   |
| Other operating income:                                                      |   |                                                |   |                                         |   |   |   |   |   |
| Securitization (loss) income, net                                            |   | (18                                                 | )      | 571                                          |   | (18 | ) | 1,075 |   |
| Income (loss) from retained interests incredit  card receivables securitized |   | 23,708                                              |   | 19,159                                       |   | (33,511 | ) | 55,882 |   |
| Servicing income                                                             |   | 17,242                                              |   | 1,411                                        |   | 20,921 |   | 4,646 |   |
| Other credit card fees                                                       |   | 23,856                                              |   | 23,948                                       |   | 72,554 |   | 63,457 |   |
| Interchange fees                                                             |   | 3,912                                               |   | 6,212                                        |   | 11,934 |   | 17,114 |   |
| Ancillary products                                                           |   | 3,295                                               |   | 8,731                                        |   | 11,630 |   | 23,673 |   |
| Equity in income of equity-method investee                                   |   | 19,552                                              |   | —                                       |   | 24,097 |   | — |   |
| Total other operating income                                                 |   | 91,547                                              |   | 60,032                                       |   | 107,607 |   | 165,847 |   |
|                                                                         |   |                                                |   |                                         |   |   |   |   |   |
| Other operating expense:                                                     |   |                                                |   |                                         |   |   |   |   |   |
| Non-servicing salaries and benefits                                          |   | 5,663                                               |   | 3,330                                        |   | 12,287 |   | 8,373 |   |
| Credit card servicing                                                        |   | 29,385                                              |   | 15,650                                       |   | 65,273 |   | 44,830 |   |
| Marketing and solicitation                                                   |   | 4,361                                               |   | 7,670                                        |   | 9,402 |   | 27,528 |   |
| Professional fees                                                            |   | 2,261                                               |   | 837                                          |   | 3,691 |   | 2,647 |   |
| Data processing                                                              |   | 2,339                                               |   | 2,375                                        |   | 5,753 |   | 6,867 |   |
| Net occupancy                                                                |   | 1,365                                               |   | 1,112                                        |   | 3,714 |   | 2,519 |   |
| Ancillary product expense                                                    |   | 1,009                                               |   | 2,058                                        |   | 4,062 |   | 8,138 |   |
| Other                                                                        |   | 6,326                                               |   | 4,282                                        |   | 17,386 |   | 11,427 |   |
| Total other operating expense                                                |   | 52,709                                              |   | 37,314                                       |   | 121,568 |   | 112,329 |   |
| Income (loss) before income taxes                                            |   | 33,921                                              |   | 22,989                                       |   | (18,320 | ) | 55,434 |   |
| Income taxes                                                                 |   | (11,872                                             | )      | (8,049                                       | )      | 6,412 |   | (19,405 | ) |
| Net income (loss)                                                            |   | $                                                   | 22,049 |                                         | $      | 14,940 |   | $ | (11,908 | ) | 36,029 |   |
| Net income (loss) attributable to common shareholders                        |   | $                                                   | 20,995 |                                         | $      | 14,940 |   | $ | (14,995 | ) | 36,029 |   |
| Net income (loss) per common share-basic                                     |   | $                                                   | 0.43   |                                         | $      | 0.32 |   | $ | (0.32 | ) | $ | 0.77 |   |
| Net income (loss) per common share-assuming dilution                         |   | $                                                   | 0.43   |                                         | $      | 0.32 |   | $ | (0.32 | ) | $ | 0.77 |   |

 

See accompanying notes.

 

2

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**CompuCreditCorporation and Subsidiaries**

**ConsolidatedStatements of Shareholders’ Equity (Unaudited)**

**For the ninemonths ended September 30, 2002 and 2001**

 
|                                      |   | **Preferred  Stock**       |       | **Common Stock** |       | **Additional  Paid-In  Capital** |   | **Treasury  Stock** |   | **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                                |   | —                     |       | —           |       | —                           |   | —              |   | —                        |    | —                 |   | 36,029                                |   | 36,029 |   |
| Balance at September 30, 2001             |   | $                          | —     |             | 46,559,165 |                             | $      | —              |   | $                             | 240,352 |                   | $      | —                                |   | $ | (500 | ) | $ | 200,421 |   | $ | 440,273 |   |
|                                      |   |                       |       |             |       |                             |   |                |   |                          |    |                   |   |                                  |   |   |   |
| 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                       |   | —                     |       | —           |       | —                           |   | —              |   | —                        |    | —                 |   | (3,087                                | )      | (3,087 | ) |
| Accretion of preferred dividends          |   | 3,052                      |       | —           |       | —                           |   | —              |   | —                        |    | —                 |   | —                                |   | 3,052 |   |
| Treasury stock (500,000 shares, at cost)  |   | —                     |       | —           |       | —                           |   | —              |   | (2,614                        | )       | —                 |   | —                                |   | (2,614 | ) |
| Net loss                                  |   | —                     |       | —           |       | —                           |   | —              |   | —                        |    | —                 |   | (11,908                               | )      | (11,908 | ) |
| Balance at September 30, 2002             |   | $                          | 42,424     |             | 46,559,165 |                             | $      | —              |   | $                             | 240,352 |                   | $      | (2,614                                | )      | $ | (500 | ) | $ | 152,120 |   | $ | 431,782 |   |

 

See accompanying notes.

 

3

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**CompuCreditCorporation and Subsidiaries**

**ConsolidatedStatements of Cash Flows (Unaudited)**

 
|                                                                                      |   | **For the nine months ended  September 30,** |       |
|-------------------------------------------------------------------------------------------|--------|----------------------------------------------|------------|
|                                                                                      |   | **2002**                                     |       | **2001** | ** ** |
|                                                                                      |   | **(Dollars in thousands)**                   | ** ** |
| **Operating activities**                                                                  |   |                                         |       |   |   |
| Net (loss) income                                                                         |   | $                                            | (11,908    | ) | $ | 36,029 |   |
| Adjustments to reconcile net (loss) income to net cash  provided by operating activities: |   |                                         |       |   |   |
| Depreciation expense                                                                      |   | 10,940                                       |       | 6,482 |   |
| Amortization expense                                                                      |   | 15,646                                       |       | 5,142 |   |
| Securitization income                                                                     |   | 18                                           |       | (1,075 | ) |
| Retained interests income adjustment, net                                                 |   | 135,119                                      |       | 13,929 |   |
| Income from equity investee (net of distributions)                                        |   | (2,951                                       | )          | — |   |
| Changes in assets and liabilities:                                                        |   |                                         |       |   |   |
| Increase in restricted cash                                                               |   | (10,055                                      | )          | — |   |
| Decrease (increase) in accrued interest and fees                                          |   | 16,332                                       |       | (6,414 | ) |
| Decrease (increase) in amounts due from securitization                                    |   | 6,208                                        |       | (6,896 | ) |
| Increase in deferred costs                                                                |   | (9,916                                       | )          | (12,209 | ) |
| Decrease in prepaid expenses                                                              |   | 536                                          |       | 4,409 |   |
| Increase in accounts payable and accrued expenses                                         |   | 8,955                                        |       | 1,653 |   |
| (Decrease) increase in deferred revenue                                                   |   | (7,224                                       | )          | 2,450 |   |
| (Decrease) increase in income tax liability                                               |   | (11,395                                      | )          | 15,605 |   |
| Other                                                                                     |   | 937                                          |       | (4,682 | ) |
| Net cash provided by operating activities                                                 |   | 141,242                                      |       | 54,423 |   |
| **Investing activities**                                                                  |   |                                         |       |   |   |
| Investment in equity investee                                                             |   | (34,890                                      | )          | — |   |
| Proceeds from bond investment                                                             |   | 604                                          |       | — |   |
| Purchases of credit card portfolios and retained  interests                               |   | (75,247                                      | )          | — |   |
| Net loan payments (net loans originated)                                                  |   | (43,484                                      | )          | (358,029 | ) |
| Recoveries of loans previously charged off                                                |   | 16,709                                       |       | 18,114 |   |
| Net proceeds from securitization                                                          |   | 16,321                                       |       | 260,430 |   |
| Purchases and development of software, furniture,  fixtures and equipment                 |   | (7,070                                       | )          | (18,358 | ) |
| Net cash used in investing activities                                                     |   | (127,057                                     | )          | (97,843 | ) |
| **Financing activities**                                                                  |   |                                         |       |   |   |
| Net proceeds from issuance of preferred stock                                             |   | (140                                         | )          | 12,000 |   |
| Note issued to purchase stock                                                             |   | —                                       |       | (500 | ) |
| Net proceeds from issuance of common stock                                                |   | —                                       |       | 563 |   |
| Purchase of treasury stock                                                                |   | (2,614                                       | )          | — |   |
| Proceeds from short-term borrowings                                                       |   | 126,679                                      |       | — |   |
| Repayment of short-term borrowings                                                        |   | (133,306                                     | )          | — |   |
| Net cash (used in) provided by financing activities                                       |   | (9,381                                       | )          | 12,063 |   |
|                                                                                      |   |                                         |       |   |   |
| **Net increase (decrease) in cash**                                                       |   | 4,804                                        |       | (31,357 | ) |
| Cash and cash equivalents at beginning of period                                          |   | 55,746                                       |       | 68,980 |   |
| Cash and cash equivalents at end of period                                                |   | $                                            | 60,550     |   | $ | 37,623 |   |
|                                                                                      |   |                                         |       |   |   |
| **Supplemental cash flow information**                                                    |   |                                         |       |   |   |
| Cash paid for interest                                                                    |   | $                                            | 5,670      |   | $ | 82 |   |
| Cash paid for income taxes                                                                |   | $                                            | 4,983      |   | $ | 3,800 |   |
| Accretion of preferred stock dividends                                                    |   | $                                            | 3,052      |   | $ | — |   |
| Distribution of bonds from equity-method investee                                         |   | $                                            | 21,485     |   | $ | — |   |

 

See accompanying notes.

 

4

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**CompuCreditCorporation and Subsidiaries**

**Notes toCondensed Consolidated Financial Statements (Unaudited)**

**September 30, 2002**

 

**1.****                                     ****Organizationand Basis of Presentation**

 

The condensed consolidated financial statements include the accounts ofCompuCredit Corporation and its wholly owned subsidiaries (collectively, the“Company”). The Company was formed for the purpose of offering unsecured creditand fee-based products and services to a segment of the consumer credit market.The Company sources the accounts to which it offers these products and servicesthrough direct mail, telemarketing, television, the internet, and acquisitionfrom other credit card issuers.  Becauseonly financial institutions can issue general purpose credit cards, the Companyhas a contractual arrangement with a third party financial institution pursuantto which the financial institution issues general purpose Visa and MasterCardcredit cards, and the Company purchases the receivables relating to suchaccounts on a daily basis. Additionally, the Company has purchased thereceivables relating to accounts generated by other third party financialinstitutions from time to time as a further source for growth in its business.The Company markets to its cardholders other fee-based products including cardregistration, memberships in preferred buying clubs, travel services and creditlife, 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 of America for interim financial information and with theinstructions to Form 10-Q and Article 10 of Securities and Exchange Commission(“SEC”) Regulation S-X. Accordingly, they do not include all of the informationand notes required by accounting principles generally accepted in the UnitedStates for complete consolidated financial statements. In the opinion ofmanagement, all normal recurring adjustments considered necessary to fairlystate the results for the interim periods presented have been included. Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the condensedconsolidated financial statements, as well as the reported amount of revenuesand expenses during the reporting period. Actual results could differ fromthese estimates. Certain estimates such as credit losses, payments, discountrates and the yield earned on securitized receivables have a significant impacton the gains and losses recorded on securitizations and the value of retainedinterests in credit card receivables securitized. Operating results for thethree and nine months ended September 30, 2002, are not necessarily indicativeof the results for the year ended December 31, 2002. These condensed consolidatedfinancial statements should be read in conjunction with the notes to thefinancial statements for the year ended December 31, 2001, contained in theCompany’s Annual Report on Form 10-K filed with the SEC.

 

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

 

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

 

***Asset Securitization***

 

All of theCompany’s credit card receivables are securitized. When the Company sellsoriginated receivables in securitizations, it retains certain undividedownership interests, interest-only (“I/O”) strips and servicing rights.Although the Company continues to service the underlying credit card accountsand maintains the customer relationships, these securitizations are treated assales and the

 

5

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securitized receivablesare not reflected on the consolidated balance sheet. The retained ownershipinterests and the interest-only strips are included in Retained Interests inCredit Card Receivables 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 losseson sales of receivables depend in part on the previous carrying amount of thefinancial assets sold as well as the fair value of the assets and cash proceedsreceived. The cash flows used in measuring the gains and losses representestimates of finance charges and late fees, servicing fees, costs of funds paidto investors, payment rates, credit losses, and required amortization paymentsto investors. The Company recognizes a servicing liability for the projectedservicing costs that exceed projected servicing revenue. In accordance withStatement No. 140, the Company does not consolidate any of the qualifiedspecial purpose entities (“QSPEs”) in its securitizations. The retainedinterests are subsequently accounted for as trading securities and reported atestimated fair market value, with changes in fair value included in income inaccordance with Statement of Financial Accounting Standards No. 115,“Accounting for Certain Investments in Debt and Equity Securities” (“StatementNo. 115”). The estimates used in the determination of the gains and losses andthe related fair values of interest-only strips and retained ownershipinterests are influenced by factors outside the Company’s control, and, as aresult, such estimates could materially change from quarter to quarter.

 

Purchased retainedinterests are recorded at the lower of their amortized cost or estimated fairmarket value in accordance with Emerging Issues Task Force issue 99-20,“Recognition of Interest Income and Impairment on Purchased and RetainedBeneficial Interests in Securitized Financial Assets” (“EITF 99-20”).

 

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

 

***Accrued Interest and Fees***

 

Accrued interestand fees on our originated portfolio represent the estimated collectableportion of fees earned but not billed to the cardholder at any period end.  Prior to the second quarter of 2002, theCompany estimated accrued interest and fees using its estimates of totalaccrued interest and fees earned but not yet billed.  During the second quarter of 2002, the Company revised theaccrued balance to better estimate the collectible portion of these fees.  The Company believes its change in estimateis preferable, because it will more accurately reflect the cash it expects toreceive in the future from cardholders with respect to these fees.

 

***Equity Investment***

 

Investments areaccounted for using the equity method of accounting if the investment gives theCompany the ability to exercise significant influence, but not control, over aninvestee. Significant influence is generally deemed to exist if the Company hasan ownership interest in the voting stock of the investee of between 20% and50%, although other factors, such as representation on the investee’s board ofdirectors and the impact of commercial arrangements, are considered indetermining whether the equity method of accounting is appropriate. The Companyhas a 50% interest in a limited liability company and records its 50% interestin the income or loss of such investee within other operating income eachperiod. The carrying amount of theCompany’s investment is recorded on the balance sheet as investment inequity-method investee. There is no difference between the cost of theinvestment and the underlying equity in net assets of the equity-methodinvestee. The Company evaluates its investment in the equity-method investeefor impairment each quarter by comparing the carrying amount of the investmentto its fair value. Because no active market exists for the investment’s stock,the Company compares the carrying amount to the expected undiscounted

 

6

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future cash flows theinvestment is expected to produce. If the expected undiscounted future cashflows equal or exceed the carrying amount, the asset is not consideredimpaired; if, on the other hand, the undiscounted future cash flows are lessthan the carrying amount, the asset is considered impaired.

 

***Investments in Debt Securities***

 

During the thirdquarter of 2002, CSG, LLC (the Company's equity method investee; see Note 3,"Equity-Method Investment in CSG, LLC" below) distributed certainbonds to its members as a partial return of their initial investment in CSG,LLC. The Company recorded the bonds it received at their fair value.  In accordance with Statement No. 115, andbased on the Company’s intentions and ability to hold these bonds to maturity,the Company has classified these bonds as held-to-maturity and accounts forthese bonds at their amortized cost. Investments in debt securities areregularly reviewed for impairment.

 

***Servicing Income***

 

As of September 30, 2002,the Company is the servicer for the receivables underlying its securitizationstransactions, and is the servicer for 100% of the receivables underlying theCSG Trust (see Note 3, "Equity-Method Investment in CSG, LLC" below).The Company receives servicing fees equal to 0.1% of the originated principalreceivables. The Company receives between 2% and 5% on all other receivablesthe Company services, or 5% of cash collected, depending on the terms of thesecuritization structure. Servicing revenue is recognized as income on amonthly basis during the same period in which the servicing is performed. Totalassets being serviced by the Company were $3.7 billion as of September 30,2002, and $1.9 billion as of December 31, 2001.

 

**3.****                                     ****Equity-Method Investmentin CSG, LLC**

 

CSG, LLC (“CSG”) was formed during the second quarter of 2002 byaffiliates of Goldman, Sachs & Co. and Salomon Smith Barney and a whollyowned subsidiary of the Company to acquire notes and a certificated interestissued by a trust (“CSG Trust”) that owns a portfolio of credit cardreceivables. The Company accounts for its interest in CSG using theequity-method of accounting. The Company has a 50% interest in CSG and fundedits initial $34.9 million investment in CSG with cash of $3.5 million and byborrowing $31.4 million (see Note 8, Borrowings and Restricted Cash). CSG hadnet income before taxes of $39.1 million for the three months ended September30, 2002, and $48.2 million for the nine months ended September 30, 2002. Inexchange for servicing 100% of the receivables owned by the CSG Trust, theCompany receives a servicing fee from the securitization structure, thecompensation for which is considered adequate.

 

**4.****                                     ****Purchaseof Assets**

 

In July 2002, the Company closed a transaction with Federated DepartmentStores, Inc. (NYSE: FD) in which the Company purchased the retained interestsin a trust (the “Fingerhut Trust”) that owned approximately $1.0 billion inface amount of receivables. The receivables included in the trust are privatelabel revolving credit cards used to purchase items from the Fingerhut catalog.This portfolio will decrease in size over time because payments fromcardholders are expected to be significantly greater than purchases being madeby cardholders.  In accordance with EITF99-20, the Company will account for the retained interest it purchased at thelower of amortized cost or fair market value. The expected cash flows in excessof the cost of the purchased retained interests are being amortized into incomefrom retained interest using the effective interest method.

 

**5.****                                     ****Securitizations**

 

The Companysecuritizes all of its credit card receivables originated on a daily basisunder its primary third party financial institution relationship (the “originatedportfolio”) 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 has securitized twoportfolios of

 

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credit card receivablesrelating to pools purchased in 1998 through a securitization structure with athird party commercial paper conduit administered by a national bankinginstitution. Additionally, during the third quarter of 2002, the Companyacquired retained interests in a credit card receivables trust (see Note 4,“Purchase of Assets”).

 

Inaccordance with the above, all of the Company’s credit card receivables(whether from the originated portfolio or the purchased portfolio) are held bysecuritization trusts, and the exclusive interest of the Company in thesereceivables is in the form of retained interests in the trusts. Generallyaccepted accounting principles in the United States of America require theCompany to treat transfers of its receivables to the securitization trusts assales, and the receivables are removed from the Company’s consolidated balancesheet. Under Statement No. 140, an entityrecognizes the assets it controls and liabilities it has incurred, andderecognizes the financial assets for which control has been surrendered andall liabilities that have been extinguished. An entity is considered to havesurrendered control over the transferred assets and, therefore, to have soldthe assets, if the 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 doesnot maintain effective control over the transferred assets through either (a)an agreement that both entitles and obligates the transferor to repurchase orredeem them before their maturity or (b) the ability to unilaterally cause theholder to return specific assets, other than through a clean-up call.

 

The securitization transactions do not affect the relationship theCompany has with its customers and the Company continues to service the creditcard receivables.

 

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

 
|                                                                          |   | **For the three months ended********September 30,** |       | **For the nine months ended********September 30,** |       |
|-------------------------------------------------------------------------------|--------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
|                                                                          |   | **2002**                                            | ** ** | **2001**                                           | ** ** | **2002** | ** ** | **2001** | ** ** |
|                                                                          |   | **(in thousands)**                                  | ** ** |
| Securitization  Activity:                                                     |   |                                                |       |                                               |       |   |   |   |   |
| Gross amount of receivables securitized at period end                         |   | $                                                   | 2,509,136  |                                               | $          | 1,804,631 |   | $ | 2,509,136 |   | $ | 1,804,631 |   |
| Proceeds from securitizations                                                 |   | 12,000                                              |       | 114,903                                            |       | 16,321 |   | 260,430 |   |
| Excess cash flows received on retained interests                              |   | 184,232                                             |       | 42,455                                             |       | 280,689 |   | 135,964 |   |
| Pretax securitization (loss) income                                           |   | (18                                                 | )          | 571                                                |       | (18 | ) | 1,075 |   |
| Income (loss) from retained interests in credit card  receivables securitized |   | 23,708                                              |       | 19,159                                             |       | (33,511 | ) | 55,882 |   |
|                                                                               |        |                                                     |            |                                                    |            |  |  |  |  |  |  |  |  |

 

The investors in the Company’s securitization transactions have norecourse against the Company for cardholders’ failure to pay their credit cardloans. However, most of the Company’s retained interests are subordinated tothe investors’ interests until the investors have been fully paid. The grossamount of receivables securitized increased from September 30, 2001, toSeptember 30, 2002, due to the purchase of the retained interest in theFingerhut Trust (see Note 4, “Purchase of Assets”).

 

8

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All collections received from thecardholders underlying each securitization are included in the securitizationcash flows. This includes collections from the cardholders for interest, feesand other charges on the accounts and collections from the cardholders repayingthe principal portion of their account balances. The cash flows are thendistributed to us as servicer for our servicing fee, to the investors asinterest on their outstanding notes, to the investors to repay any portion oftheir outstanding notes that become due and payable, and to us as the seller tofund new purchases. Any collections from cardholders remaining each month aftermaking the payments noted above are paid to the Company on our retainedinterests.

 

The pretax securitization (loss) or income recorded by the Company andthe measurement of the Company’s retained interests are dependent upon management’sestimates of future cash flows using the cash-out method. Under the cash-outmethod, the future cash flows (including the release of any cash related tocredit enhancements) are recorded at a discounted value. The cash flows arediscounted based on the timing of when the Company expects to receive the cashflows. The discount rates are based on management’s estimates of returns thatwould be required by investors in an investment with similar terms and creditquality. Interest rates received on the credit card receivables are estimatedbased on the stated annual percentage rates in the credit card agreements.Estimated default and payment rates are based on historical results, adjustedfor expected changes based on the Company’s credit risk models. Credit cardreceivables are typically charged off when the receivable becomes 180 dayspast due, although earlier charge offs may occur specifically related toaccounts of bankrupt or deceased customers. Bankrupt and deceased customers’accounts are typically charged off within 30 days of verification.

 

Subsequent to each sale, the Company’s retained interests are carried atthe lower of amortized cost or estimated fair market value, and because theyare classified as trading securities, any changes in fair value are included inincome. Because quoted market prices for the Company’s retained interests inits originated portfolio are generally not available, the Company estimatesfair value for these retained interests based on the estimated present value offuture cash flows using management’s best estimates of key assumptions.

 

The retained interests in credit card receivables securitized includethe following:

 
|                                                       |   | **September 30,  2002** |       | **December 31,  2001** |   |
|------------------------------------------------------------|--------|-------------------------|------------|------------------------|--------|
|                                                       |   | **(In thousands)**      | ** ** |
| I/O strip                                                  |   | $                       | 102,372    |                   | $      | 84,390 |   |
| Fair value of Seller’s Interest                       |   | 333,906                 |       | 312,622                |   |
| Servicing liability                                        |   | (123,753                | )          | (38,123                | )      |
| Retained interests in credit card receivables  securitized |   | $                       | 312,525    |                   | $      | 358,889 |   |

 

The I/O strip reflects the fair value of our rights to future incomefrom our originated portfolio. The servicing liability reflects, for thosesecuritizations for which servicing compensation is not adequate, the fairvalue of the costs to service the receivables above and beyond the servicingincome the Company expects to receive from the securitizations. The fair valueof seller’s interest includes those interests the Company retains insecuritizations of the originated and purchased portfolio receivables.

 

Changes in any of the assumptions used to value our retained interestscould impact the fair value estimates. The weighted average key assumptionsused to estimate the fair value of the retained interest in receivables theCompany has securitized are included in the following table:

 
|                                   |   | **September 30,  2002** |   | **December 31,  2001** |   |
|----------------------------------------|--------|-------------------------|--------|------------------------|--------|
| Payment rate (monthly)                 |   | 6.7                     | %      | 8.0                    | %      |
| Expected credit loss rate (annualized) |   | 16.7                    | %      | 16.7                   | %      |
| Residual cash flows discount rate      |   | 22.5                    | %      | 34.9                   | %      |
| Servicing liability discount rate      |   | 14.1                    | %      | 14.0                   | %      |

 

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At September 30, 2002, the following illustrates the hypothetical effectan adverse 5 and 10 percent change in key economic assumptions has on theretained interests in credit card receivables securitized by the Company ($ inthousands):

 
|                                          |   | **Credit card********Receivables** |    |
|-----------------------------------------------|--------|------------------------------------|---------|
| **Payment rate (monthly)**                    |   | 6.7                                | %       |
| *Impact on  fair value of 5% adverse change*  |   | $                                  | (1,014  | ) |
| *Impact on fair value of 10% adverse  change* |   | $                                  | (1,556  | ) |
| **Expected credit loss rate (annualized)**    |   | 16.7                               | %       |
| *Impact on fair value of 5% adverse  change*  |   | $                                  | (8,029  | ) |
| *Impact on fair value of 10% adverse  change* |   | $                                  | (16,047 | ) |
| **Residual cash flows discount rate**         |   | 22.5                               | %       |
| *Impact on fair value of 5% adverse  change*  |   | $                                  | (2,900  | ) |
| *Impact on fair value of 10% adverse  change* |   | $                                  | (5,709  | ) |
| **Servicing discount rate**                   |   | 14.1                               | %       |
| *Impact on fair value of 5% adverse  change*  |   | $                                  | (140    | ) |
| *Impact on fair value of 10% adverse  change* |   | $                                  | (280    | ) |

 

These sensitivities are hypothetical and should be used with caution. Asthe figures indicate, changes in fair value based on a 5% and a 10% variationin assumptions generally cannot be extrapolated because the relationship of thechange in assumption to the change in fair value may not be linear. Also, inthis table, the effect of a variation in a particular assumption on the fairvalue of the retained interest is calculated without changing any otherassumptions; in reality, changes in one assumption may result in changes inanother. For example, increases in market interest rates may result in lowerprepayments and increased credit losses, which could magnify or counteract thesensitivities.

 

The retained interests purchased by the Company during 2002 are carriedat the lower of amortized cost or fair market value, net of a servicingliability. In accordance with EITF 99-20, expectedcash flows in excess of the cost of the purchased retained interests are beingamortized into income from retained interests using the effective interestmethod.

 

The Company’s managed receivables portfolio underlying itssecuritizations is comprised of retained interests in receivables securitizedand the investors’ share of securitized credit card receivables. The investors’share of securitized credit card receivables is not an asset of the Company,and as such, is not included in the Company’s consolidated balance sheets. Theprincipal balances outstanding as of September 30, 2002, and December 31, 2001,were $2.2 billion and $1.7 billion, respectively. The following tablesummarizes the balances included in the Company’s managed receivables portfoliounderlying its securitizations.

 
|                                   |   | **September 30,  2002** |       | **December 31,  2001** |   |
|----------------------------------------|--------|-------------------------|------------|------------------------|--------|
|                                   |   | **(in thousands)**      | ** ** |
| Total principal balance                |   | $                       | 2,228,840  |                   | $      | 1,711,755 |   |
| Total finance charge balance           |   | 280,296                 |       | 180,087                |   |
| Total receivables                      |   | $                       | 2,509,136  |                   | $      | 1,891,842 |   |
| Receivables delinquent 60 or more days |   | $                       | 373,668    |                   | $      | 210,382 |   |

 

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**6.****                                     ****Commitmentsand Contingencies**

 

The Company is anequity member of CSG. During the second quarter of 2002, CSG entered into anote purchase agreement whereby it has agreed to buy additional interests in aportfolio of credit card receivables owned by CSG Trust should there be net newgrowth in the receivables or should collections not be available, to fund newcardholder purchases. Measuring as of September 30, 2002, CSG has agreed to purchaseup to $200 million of new notes from the CSG Trust should this contingencyarise. In general, this contingency amount will decline as the amount of creditavailable to cardholders for future purchases declines. The portfolio has andis expected to continue to decline during the life of the CSG Trust as paymentsare expected to exceed new purchases each month.  As a member of CSG, theCompany has agreed to guarantee the payment of the purchase price of theaforementioned new notes if the events giving rise to this contingency arise,but only if CSG itself should fail to purchase the new notes under the notepurchase agreement. As of September 30, 2002, CSG had not and was not requiredto purchase any additional notes under the note purchase agreement. TheCompany’s guarantee is limited to its ownership percentage in CSG (which atSeptember 30, 2002, was 50%) times the total amount of the notes that CSG wouldbe required to purchase. Therefore, as of September 30, 2002, the maximumamount of the Company’s guarantee was $100 million. The Company currently doesnot have any liability recorded with respect to this guarantee.

 

In connection withthe third quarter of 2002 extension of the Company’s affinity agreement withits principal third-party originating financial institution through March 2006,the Company, through certain of its subsidiaries, has pledged retainedinterests valued at approximately $69.2 million to secure its obligations topurchase credit card receivables originated on a daily basis through thethird-party financial institution’s cardholder accounts.

 

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

 

The following table sets forth the computation of basic and dilutedincome (loss) per share:

 
|                                                                               |   | **For the three months ended********September 30,** |       | **For the nine months ended********September 30,** |       |
|------------------------------------------------------------------------------------|--------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
|                                                                               |   | **2002**                                            | ** ** | **2001**                                           | ** ** | **2002** | ** ** | **2001** | ** ** |
|                                                                               |   | **(in thousands)**                                  | ** ** |
| Numerator:                                                                         |   |                                                |       |                                               |       |   |   |   |   |
| Net income (loss)                                                                  |   | $                                                   | 22,049     |                                               | $          | 14,940 |   | $ | (11,908 | ) | $ | 36,029 |   |
| Preferred stock dividends                                                          |   | (1,054                                              | )          | —                                             |       | (3,087 | ) | — |   |
| Income (loss) attributable to common shareholders                                  |   | $                                                   | 20,995     |                                               | $          | 14,940 |   | $ | (14,995 | ) | $ | 36,029 |   |
| Denominator:                                                                       |   |                                                |       |                                               |       |   |   |   |   |
| Denominator for basic income (loss) per  share-weighted-average shares outstanding |   | 51,132                                              |       | 46,559                                             |       | 46,547 |   | 46,536 |   |
| Effect of dilutive stock options                                                   |   | 8                                                   |       | 103                                                |       | — |   | 103 |   |
| Denominator for diluted income (loss) per  share-adjusted weighted-average shares  |   | 51,140                                              |       | 46,662                                             |       | 46,547 |   | 46,639 |   |
| Basic income (loss) per share                                                      |   | $                                                   | 0.43       |                                               | $          | 0.32 |   | $ | (0.32 | ) | $ | 0.77 |   |
| Diluted income (loss) per share                                                    |   | $                                                   | 0.43       |                                               | $          | 0.32 |   | $ | (0.32 | ) | $ | 0.77 |   |

 

The Company’s preferred shares, plus dividends that have been accreted,are convertible into approximately 4.7 million shares of common stock at $9.14per share as of September 30, 2002. These shares were not included in the computation of diluted EPS for thenine months ending September 30, 2002, because including these shares wouldhave been anti-dilutive. Additionally, for the nine months ended September 30,2002, no stock options were included in the diluted earnings per sharecalculation because their inclusion would have been anti-dilutive.

 

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**8.****                                     ****Borrowingsand Restricted Cash**

 

During the second quarter of 2002, the Company entered into a loan inthe amount of $31.4 million to partially fund the purchase of its equityinterest in CSG (see Note 3, “Equity-Method Investment in CSG, LLC”). The loan bears interest at Prime plus 5% and isnon-recourse to the Company. Although the note has a stated maturity in 2007,it is payable only with the cash flows received from CSG and therefore does nothave any minimum payment amounts. The Company anticipates it will receive cashflows from CSG each month, and therefore, the Company anticipates repaying thisloan monthly. At September 30, 2002, $9.9 million was outstanding under theloan. The lender is also entitled to share in a portion of excess cash flowsreceived by the Company from CSG once the loan has been repaid.

 

During the first quarter of 2002, the Company entered into anirrevocable standby letter of credit agreement for $10.0 million with a bank,for the purposes of securing the Company’s obligations to the financialinstitution that issues the credit cards marketed by the Company. The purposeof the letter of credit is to protect the financial institution fromnon-payment by the Company of its obligation to purchase receivables arising inthe credit card accounts on a daily basis. The Company is required to maintaina cash balance of $10.0 million with the bank that has issued the letter ofcredit. Such cash has been disclosed as “Restricted cash” on the face of thebalance sheet.

 

**9.****                                           ****TreasuryStock Repurchases**

 

During the third quarter of 2002, the Company’s Board of Directorsauthorized a program to repurchase up to 5 million shares (approximately 11 percent)of its outstanding common stock. Under the repurchase plan, the Company may buyback shares of its common stock from time to time either on the open market orthrough privately negotiated transactions in compliance with SEC guidelines.  During the third quarter of 2002, theCompany repurchased 500,000 shares on the open market at a total cost ofapproximately $2.6 million.

 

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**ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

*The following discussion should be read in conjunctionwith our condensed consolidated financial statements and the related notesincluded herein.*

 

This Management’s Discussion and Analysis of Financial Condition andResults of Operations includes forward-looking statements. We have based theseforward-looking statements on our current plans, expectations and beliefs aboutfuture events. In light of the risks, uncertainties and assumptions discussedunder the caption “Forward-Looking Information” and others set forth under thecaption “Risk Factors” in “Item 1. Business” of our Annual Report onForm 10-K filed with the Securities and Exchange Commission and otherfactors discussed in that section, there is a risk that our actual results willdiffer materially from the expectations and beliefs reflected in the forward–lookingstatements in this section.

 

***General***

 

CompuCredit is a credit card company that originates and purchasescredit card receivables and markets products and services to its customers forwhich it earns fees. We market unsecured Visa and MasterCard credit cardsthrough direct mail, telemarketing, television and the internet.

 

Our revenues primarily consist of (1) securitization income, (2) incomefrom our retained interests in credit card receivables securitized, (3)servicing income, (4) other credit card fee income, (5) interchange fees, (6)ancillary product revenue and (7) equity in the income of our equity-methodinvestee.

 

Securitization income is gain or loss we recognize at the time of eachsale of our credit card receivables. Income or loss from retained interests incredit card receivables securitized is the income or loss we recognize fromcredit card receivables that have been securitized. See the “Credit Card Securitizations”and “Results of Operations” sections for additional information. Servicingincome consists of the fees we receive for servicing the various portfolios ofcredit card receivables. Other credit card fee income includes annual fees,over-limit fees, cash advance fees and other fees assessed to our cardholders.Interchange fees are the portion of the merchant fees assessed by Visa andMasterCard that are passed on to us and are a function of the purchase volumeof our cardholders. Ancillary product revenue consists of the fees earned byselling various fee-based products including various memberships, insurance,subscription and other products. Equity in the income of our equity-methodinvestee is discussed below.

 

Our primary operating costs include the costs of funding ourreceivables, credit losses and other operating expenses, such as employeecompensation, account solicitation and marketing expenses, data processing,servicing expenses and income taxes.

 

We originate the receivables in our originated portfolio through the useof our target marketing system and direct mail, television, telemarketing andinternet campaigns to obtain our customers. We also add accounts by purchasingportfolios of credit card receivables or by acquiring retained interests incredit card receivables securitized—either by ourselves or with entities formedthrough our partnership with others. With the exception of receivablespurchased or originated through accounts added in portfolio acquisitions, thesize of our receivables depends in part on the timing, size and success of ourmarketing campaigns. During periods of reduced marketing, our originatedreceivables portfolio may not grow and may decline. We continue to evaluateopportunities to purchase portfolios because we believe they may provide anattractive return on our investment.

 

During the second quarter of 2002, we purchased a 50% interest in CSG,LLC (“CSG”). CSG was formed during the second quarter of 2002 by affiliates ofGoldman, Sachs & Co. and Salomon Smith Barney and one of our wholly ownedsubsidiaries. CSG was formed to acquire notes and a certificated interestissued by a trust (“CSG Trust”). Equity in the income of our equity-methodinvestee is 50% of CSG’s income or loss,

 

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beforeincome taxes. See the “Results of Operations” and “Other Operating Income”sections for additional information on these revenues. We agreed to service theentire portfolio of credit card receivables underlying the CSG Trust. Inexchange for our servicing, we receive a fee. In our “Selected Credit CardData” section, we include information relating to the receivables underlyingour securitizations. Beginning with the second quarter of 2002, our datareflects the credit card receivables that we have securitized as well as 50% ofthe managed receivables underlying the CSG Trust (which reflects our 50%interest in CSG).

 

In July 2002, we closed a transaction with Federated Department Stores,Inc. (NYSE: FD) in which we purchased the retained interests in a trust (the“Fingerhut Trust”) that owned approximately $1.0 billion in face amount ofreceivables. The receivables included in the trust are private label revolvingcredit cards used to purchase items from the Fingerhut catalog. This portfoliowill decrease in size over time because payments from cardholders are expectedto be significantly greater than purchases being made by cardholders. We alsohired approximately 830 employees from Federated to service the receivables inthe trust.

 

We assumed a servicing liability in the Federated transaction becausethe contractual servicing fee from the trust is less than adequate compensationfor servicing the receivables. Our servicing liabilities, as well as why weaccept servicing revenues less than our anticipated servicing costs, are morefully described in our “Credit Card Securitizations” section below.

 

During the third quarter of 2002, we extended an Affinity Card Agreementwith Columbus Bank and Trust (“CB&T”), the subsidiary of Synovus FinancialCorporation that provides for the issuance of our credit cards.  This agreement was extended from December2003 to March 2006.

 

Our income is dependent upon the size and the quality of the credit cardreceivables underlying our securitizations. During the third quarter of 2002,we added approximately 72,000 accounts within our originated portfolio.Additionally, with the acquisition of the retained interests from Federated,the portfolio underlying all of our securitizations increased by approximately$0.9 billion.  The receivablesunderlying the Fingerhut Trust are expected to decline very rapidly. If we donot increase the growth of our portfolio either by originating more accounts orby acquiring additional portfolios, our income from retained interests infuture quarters may decrease relative to that experienced in this quarter.

 

***Credit CardSecuritizations***

 

We began marketingand servicing credit card accounts in February 1997. Columbus Bank&Trust (“CB&T”) originates Visa and MasterCard revolving credit cardaccounts under an agreement with us. On a daily basis, CB&T sells us aninterest in the receivables created that day in their accounts. Similarly, withrespect to the retained interests we acquired from Federated in July 2002, thecredit card accounts underlying the securitization are owned by Axsys NationalBank. Each day, upon our acquisition of that day’s receivables, we in turn sellour interest in the receivables to trusts or to multi-seller commercial paperconduits administered by national banking institutions. The trusts or conduitsissue notes to investors in order to obtain the cash to pay us for thereceivables.

 

After an initialpurchase of notes by the investors, there is usually a period during whichcollections from the receivables are used to purchase new receivables. This isreferred to as a revolving period. The revolving period typically begins on theissuance date of any particular series of notes and ends at the beginning of anamortization period. At the end of the revolving period, the investment ofcollections in new receivables ends, andcollections are instead used to repay the investors. The period during whichinvestors are being repaid is referred to as an amortization period. Therevolving periods have coincided with the maturity dates of each series, whichare either 364 days for our series issued to commercial paper conduits or noless than two years for our series placed with other investors. The maturitydate for each series is included in our “Liquidity, Funding and CapitalResources” section.

 

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All collections received from the cardholdersunderlying each securitization are included in the securitization cash flows.This includes collections from the cardholders for interest, fees and othercharges on the accounts and collections from the cardholders repaying theprincipal portion of their account balances. The cash flows are thendistributed in accordance with the securitization documents. Cash is distributedto us as servicer for our servicing fee, to the investors as interest on theiroutstanding notes, to the investors to repay any portion of their outstandingnotes that become due and payable, and to us as the seller to fund newpurchases. Any collections from cardholders remaining each month after makingthe payments noted above are paid to us on our retained interests.

 

In eachsecuritization transaction, we retain the risk of compliance with federal andstate laws and regulations regarding the securitized accounts and anyfraudulent activity with regard to the accounts. The fraud for which we areresponsible includes the unauthorized use of the credit cards, includingidentity theft or purchases on lost or stolen cards or account numbers. Weexpense these fraud losses in other operating expense. To date, we haveexperienced very little fraud for unauthorized use of the credit cards, and thetotal expense has consistently been below 0.20% of average managed receivables.

 

The investors inthe securitizations require us to provide credit support for the receivables toreduce the risk of loss to the investors resulting from cardholders notrepaying their credit card balances when due. We negotiate with each investorthe amount of the credit support, which is based on historical and expecteddelinquency and loss experience on the receivables. The credit support isusually in the form of over-collateralization, which means that we sell thereceivables for cash and a subordinated retained interest. Because the retainedinterest is subordinate to the investors’ investment, the investors get excesscollateral for their cash purchase price. As a result, the receivablesavailable to repay the investors exceed the total amount of the investors’interests in the receivables. This excess is the retained interest that we own,which is also referred to as a subordinated interest, or a seller’s interest.These retained interests represent the difference in the cash we receive fromthe investors when we sell our originated receivables in our securitizationsand the cash we paid to initially purchase the receivables.  Increases in retained interests are a use ofour cash.

 

The investors inthe securitized receivables have no recourse against us for the cardholders’failure to pay their credit card balances; however, substantially all of ourretained interests are subordinated to the investors’ interests until theinvestors have been fully repaid. This means that our retained interests willabsorb any losses due to cardholders’ failure to repay their balances firstbefore investors in the securitizations have to absorb these losses.

 

We will receiveadditional cash from the securitized receivables if collections from thereceivables exceed required interest and principal 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, fees and other charges paid on the receivables, andtheir delinquency and loss rates.

 

Oursecuritizations are treated as sales under generally accepted accountingprinciples in the United States of America (“GAAP”). As such, we remove thesecuritized receivables from our consolidated balance 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 suchseller’s interest after payments to investors are made. These amounts arerecorded as income from retained interests in credit card receivablessecuritized. Because quoted market prices are generally not available for theretained interests arising from securitizations of our originated portfolio,the fair values of our seller’s interests in our originated portfolio’s receivablesare based on the estimated present value of the future cash flows usingmanagement’s best estimates of key assumptions and the estimated collectibleportion of finance charge receivables. We also recognize an “interest-only”(“I/O”) strip, which is the present value of the projected excess cash flowsthe receivables will produce during their life. The excess cash flow is theexcess of the finance charges and late fees generated by the securitizedreceivables over related credit losses, interest paid to investors, servicingcosts and other expenses. The I/O strip and the seller’s interest are includedin “Retained Interests in Credit Card

 

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Receivables Securitized”on our consolidated balance sheet.

 

During July 2002,we acquired retained interests in a trust of credit card receivables.  The retained interests purchased by us fromthird parties during 2002 are carried at the lower of amortized cost or fairmarket value.  Expected cash flows inexcess of the cost of the purchased retained interests are being amortized intoincome from retained interests using the effective interest method.

 

Amounts Due fromSecuritization on our consolidated balance sheets include payments recentlyreceived on the securitized receivables that are still held by thesecuritization structure but are payable to us in the next 30 days.

 

Securitizationsare accounted for in accordance with Statement of Financial AccountingStandards No. 140, “Accounting for Transfers and Servicing of FinancialAssets and Extinguishments of Liabilities” (“Statement No. 140”), and,prior to April 1, 2001, were accounted for under Statement of FinancialAccounting Standards No. 125, “Accounting for Transfers and Servicing ofFinancial Assets and Extinguishments of Liabilities” (“StatementNo. 125”). Under these statements, gains or losses are recognized at thetime of each sale and they are recorded as securitization income or loss in ourconsolidated statement of operations. The gains or losses recognized on thesales of credit card receivables depend in part on the previous carrying amountof the financial assets sold as well as the fair value of the financial assetsand cash proceeds received.

 

We believe oursecuritizations satisfy the conditions of Statement No. 140 for sale accountingbecause each trust, as the issuer, is a qualified special purpose entity(“QSPE”). The activities of each trust are limited to (1) acquiring,owning and managing its assets and the proceeds of those assets; (2) issuingand making payments on notes; and (3) engaging in related activities. Inaddition, each holder of a beneficial interest in the notes has the right topledge or exchange its beneficial interest. Finally, the transferor transfersthe receivables to each trust or to a third party conduit and does not maintaincontrol over the receivables.

 

The securitizationtransactions do not affect the relationship we have with our customers, and wecontinue to service the credit card receivables. We either perform the servicingor contract with third party service providers. The fees we receive to servicecredit cards are included in our servicing income and are discussed in our“Results of Operations-Other Operating Income” section. In cases where we donot receive adequate compensation for servicing the credit cards, we haverecognized a servicing liability for the projected servicing costs that exceedour projected servicing revenue. See our “Net Securitization Income and Incomefrom Retained Interests” section for the assumptions used and the servicingliability amounts.  The amount ofservicing revenue we receive is dictated by the trust agreements in oursecuritizations. We accept servicing revenue that is less than the anticipatedservicing costs because during the revolving period, we receive all of theexcess cash flows from the securitizations, which represent collections on thereceivables in excess of the interest paid to the investors, the servicing feespaid to us as servicer, and required amortization payments. Because we receivethe residual or excess cash flows during the revolving period, the total cashwe expect to receive inclusive of both the servicing revenue as well as theexcess cash flows is expected to more than cover our servicing costs.

 

The table belowsummarizes our securitization activity:

 
|                                                                          |   | **For the three months ended  September 30,** |       | **For the nine months ended  September 30,** |   |
|-------------------------------------------------------------------------------|--------|-----------------------------------------------|------------|----------------------------------------------|--------|
|                                                                          |   | **2002**                                      |       | **2001**                                     |   | **2002** |   | **2001** | ** ** |
|                                                                          |   | **(in thousands)**                            | ** ** |
| Securitization  Activity:                                                     |   |                                          |       |                                         |   |   |   |   |   |
| Gross amount of receivables securitized at period end                         |   | $                                             | 2,509,136  |                                         | $      | 1,804,631 |   | $ | 2,509,136 |   | $ | 1,804,631 |   |
| Proceeds from securitizations                                                 |   | 12,000                                        |       | 114,903                                      |   | 16,321 |   | 260,430 |   |
| Excess cash flows received on retained interests                              |   | 184,232                                       |       | 42,455                                       |   | 280,689 |   | 135,964 |   |
| Pretax securitization (loss) income                                           |   | (18                                           | )          | 571                                          |   | (18 | ) | 1,075 |   |
| Income (loss) from retained interests in credit card  receivables securitized |   | 23,708                                        |       | 19,159                                       |   | (33,511 | ) | 55,882 |   |
|                                                                               |        |                                               |            |                                              |        |  |  |  |  |  |  |  |  |

 

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The gross amount of receivables securitized at September 30, 2002,increased from September 30, 2001, due to the receivables underlying theFingerhut Trust. Proceeds from securitizations decreased during that same timeperiod due to reduced growth in our originated portfolio. Also during this timeperiod, excess cash flows received on retained interests increased due to thecash flows generated from the retained interests in the Fingerhut Trust. Ourpretax securitization income is recognized when the receivables aresecuritized. Net securitization loss was approximately $18,000 for the threeand nine months ended September 30, 2002, compared to net securitization incomeof $0.6 million and $1.1 million for the three and nine months ended September30, 2001.  This income decreased from2001 to 2002 because of reduced growth in our originated portfolio.

 

The trusts or the conduits purchase receivables from us by raisingproceeds from investors. These proceeds are raised by the trusts or by theconduits by issuing notes to investors. We had the following total commitmentsand outstanding amounts in our securitizations for each period presented:

 
|                             |   | **As of September 30,  2002** |   | **As of December 31,  2001** |   |
|----------------------------------|--------|-------------------------------|--------|------------------------------|--------|
|                             |   | **(In millions)**             |   |
| Total commitments from investors |   | $                             | 2,410  |                         | $      | 2,046 |   |
| Total outstanding amounts        |   | 1,786                         |   | 1,524                        |   |
|                                  |        |                               |        |                              |        |  |  |

 

The maturities of these notes range from February2003 to July 2004, and are more fully detailed in the “–Liquidity, Funding andCapital Resources” section.  We try tostructure our securitization funding sources by having commitments in excess ofour current growth plans so that we have investors who will purchase notes fromthe trusts, which in turn allows the trusts to purchase receivables from us. Webelieve we have structured our securitization program to reduce our reliance onany one series of notes by staggering the maturity dates of the notes.

 

The payment terms of each securitization structure are negotiated withinvestors. Some facilities enter into accumulation periods at pre-determineddates prior to their maturity.  Duringan accumulation period, a portion of cash collected from the cardholders isrequired to be accumulated in an account for the benefit of the facility and isnot available to us to fund new purchases. We also have a facility associatedwith our portfolios that we purchased in 1998 that was structured to use apercentage of cash flows each month to pay down amounts outstanding to theinvestors. The structure was negotiated in this manner with the investors atits inception because the portfolio of receivables was decreasing very rapidly.This occurred because most of the accounts were making payments in excess ofnew purchases and no new accounts were being added to the portfolio. We detailthe maturity dates and describe our facilities and amounts being used to repay investorsin the “Liquidity, Funding and Capital Resources” section.

 

We include in our consolidated financial statements all of our whollyowned subsidiaries. However, in accordance with Statement No. 140, we do notconsolidate any of the trusts, which are QSPEs. We are required to service thereceivables that have been sold. We also perform the administrative functionsfor the trusts including preparing daily and monthly reports relating to thereceivables. We do this pursuant to an administration agreement between thetrustees of the trusts and us. The investors do not have any recourse againstus for the cardholders’ failure to pay their credit card balances; however,most of our retained interests are subordinate to the investors’ interests.Under our securitization agreements, our retained interests would

 

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absorblosses due to the cardholders’ failure to pay before the investors would haveto absorb these losses.

 

Our securitization documents require us, as servicer of the receivables,to covenant that we will maintain an acceptable ratio of tangible net worth tototal managed receivables or that we will not default in the payment ofmaterial indebtedness or reduce the periodic finance charges assessed on thereceivables below agreed upon levels. We have also agreed to service thereceivables in accordance with our servicing policies and procedures. Inaddition to the above, there are events described in our agreements that maytrigger an early amortization, which would cause all collections on thereceivables to go to the investors to pay the principal on the notes. Thiswould delay any cash being paid to us with respect to our seller’s interestsuntil the notes were paid in full. These events include our failure as servicerto remit the collections that we receive from cardholders to the appropriatesecuritization accounts within the required time frames, our failure to providereports regarding the activity in the accounts within required time frames, ora breach of our representations and warranties. These events also includefinancial performance measures on the underlying receivables. As servicer ofthe accounts, we do not covenant or make any representation or warrantyregarding the collectibility of the receivables in the accounts.

 

Our securitization documents require us, as the seller of thereceivables, to make representations and warranties relating to the validityand the enforceability of the agreements pursuant to which the receivables werecreated. We also make other standard representations and warranties includingour ability to enter into the agreements and the accuracy of the informationprovided by us to investors. If we breach any of these representations, we maycause an early amortization event, and we may not be able to sell additionalreceivables into our securitization structures. 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 any representations or warranties or otherwisecaused an early redemption event, and the underlying performance of thereceivables has not caused an early amortization event in any of oursecuritizations.

 

***Results of Operations***

 

Net income attributable to common shareholders for the three monthsended September 30, 2002, was $21.0 million, or $0.43 per diluted share,compared to net income of $14.9 million, or $0.32 per diluted share forthe three months ended September 30, 2001. We have substantially increased thesize of the total receivables that underly our securitizations, which increasedour net income during the third quarter of this year as compared to the thirdquarter of last year. At September 30, 2002, we had total managed receivablesof $3.0 billion (including 50% of the receivables underlying the retainedinterest owned by the CSG Trust), as compared to $1.8 billion at the end ofSeptember 30, 2001. This $1.2 billion increase is due to $0.5 billion ofreceivables underlying our equity investment in CSG, which we acquired in Juneof 2002, as well as $0.8 billion of receivables underlying the retainedinterests we acquired in July 2002. During the third quarter of 2002, werecorded $19.6 million of pretax income from our equity investment in CSG. Wedid not have this income during the comparable quarter of the prior year.

 

In connection with both the CSG investment and the Federatedacquisition, we agreed to service 100% of the receivables underlying thesecuritizations. We receive servicing fees, which have increased our servicingincome to $17.2 million during the three months ended September 2002, ascompared to $1.4 million during these same three months in 2001. Because we areservicing these assets, our credit card servicing expense increased from $15.7million in the third quarter of 2001 to $29.4 million in the third quarter of2002.

 

Net loss attributable to common shareholders for the nine months endedSeptember 30, 2002 was $15.0 million, or $0.32 per diluted share, comparedto net income attributable to common shareholders of $36.0 million, or$0.77 per diluted share for the nine months ended September 30, 2001. Althoughwe had an increase in our net income during the third quarter of 2002 ascompared to the third quarter of 2001, our year-to-date income from 2002 isless than 2001. This is primarily due to our year-to-date loss from retainedinterests in credit card receivables securitized during 2002 of $33.5 millionas compared to

 

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incomefrom retained interests during this same period of 2001 of $55.9 million. Thedecrease in this income is due to a decrease during the second quarter of 2002of our estimate of the fair value of our retained interests in finance chargereceivables of approximately $54.7 million. Prior to the second quarter of2002, we estimated the fair value of our retained interests in finance chargereceivables using our estimates of total finance charges billed to cardholders.Our new estimates better reflect our expectation of just the collectibleportion of these finance charges. We believe our change in estimate waspreferable as it more accurately reflects the cash we expect to receive in thefuture from cardholders with respect to these fees. We made this change in ourestimate during the second quarter based in part on proposed regulatoryguidelines, which affect many other companies in the credit card industry.Although we are not a bank and are not directly regulated by any financialregulator, we believe other credit card companies either have or will beadopting this change in estimate.

 

Our income from retained interests also decreased during 2002 ascompared to 2001 due to a reduction in the profitability of the credit cardreceivables underlying our retained interests. This is due to an increase inthe charge offs of the receivables, which is due to a larger percentage of ourreceivables aging through the second year of their life. When credit cardreceivables are first originated, they tend to have low charge off rates intheir first twelve months. The charge off rate then dramatically increasesduring year two and then moderates in year three and beyond. We have seen thistrend in the performance of our receivables and believe it is typical in othercredit card portfolios in the industry. For the first nine months of 2002, weincurred charge offs of $199.1 million, as compared to $169.8 million duringthe first nine months of 2001. We further describe the receivables portfolio inthe “Selected Credit Card Data” section.

 

The largest component of our income comes from the profit generated fromthe credit card receivables underlying our securitizations. Growth in managedreceivables cannot be predicted with certainty. In general, it is a product ofour marketing, portfolio acquisitions, and other strategic efforts. In general,our growth is a product of (1) the growth in the number of accounts, and (2)the amount of usage – balances – on accounts. Our growth also is dependent upona number of factors that we are not able to control, such as levels of consumerspending, competition and general economic conditions.  Growth in the number of accounts is aproduct of several factors, primarily the level of our marketing efforts, ourcompetition, the general economy and our portfolio acquisition efforts. Ourmarketing and solicitation expenses decreased to $4.4 million for thethree months ended September 30, 2002, from $7.7 million for the threemonths ended September 30, 2001. We decreased our marketing in 2002 because webelieved that we had limited access to liquidity, and we did not want ourportfolio to grow beyond what we may be able to fund in the future.Additionally, during the third quarter of 2002, we concentrated on addingaccounts through portfolio acquisition rather than through marketing efforts tooriginate a significant number of new accounts.

 

***Net Interest Income***

 

Net interest expense or income consists of interest income earned oncash and cash equivalents less interest expense. Net interest expense totaled$4.9 million for the three months ended September 30, 2002, compared tonet interest income of $0.3 million for the three months ended September 30,2001; net interest expense totaled $4.4 million for the nine months endedSeptember 30, 2002, compared to net interest income of $1.9 million for thenine months ended September 30, 2001. The decrease in net interest incomeduring 2002 is attributable to the interest expense and fees from the loans weentered into to finance our acquisitions in the second and third quarters of2002.

 

During the second quarter of 2002, we entered into a loan in the amountof $31.4 million to partially fund the purchase of our equity interest in CSG.The loan bears interest at Prime plus 5% and is non-recourse to the Company.Although the note has a stated maturity in 2007, it is payable only with thecash flows received from CSG and therefore does not have any minimum paymentamounts. It is anticipated that we will receive cash flows from CSG each month,and therefore, we anticipate repaying this loan monthly. At September 30, 2002,$9.9 million was outstanding under the loan. 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 third quarter of 2002 and in connection with ouracquisition of the retained interests from Federated, we entered into a loan inthe amount

 

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of$95.3 million. The loan was repaid during the third quarter of 2002.

 

***NetSecuritization (Loss) Income and Income (Loss) from Retained Interests***

 

Retained interests in credit card receivables securitized are valued inaccordance with the provisions of Statement No. 140. These retainedinterests are subsequently accounted for as trading securities and reportedestimated fair market value in accordance with Statement of FinancialAccounting Standard No. 115, “Accounting for Certain Investments in Debtand Equity Securities” (“Statement No. 115”).  Purchased retained interests are recorded at the lower of theiramortized cost or estimated fair market value in accordance with EITF 99-20, “Recognition of InterestIncome and Impairment on Purchased and Retained Beneficial Interests inSecuritized Financial Assets” (“EITF 99-20”).See the “Credit Card Securitizations” section.

 

Net securitization (loss) income is recognized under StatementNo. 140 at the time the receivables are securitized. Gains or losses onsales of receivables depend in part on the previous carrying amount of thefinancial assets sold as well as the fair value of the assets and cash proceedsreceived. In a sale, we receive cash, retain an interest in the receivablessold (Seller’s Interest) and retain rights to receive cash in the future (the“I/O” interest only, or “I/O strip”). Net securitization loss was $18,000 forthe three and nine months ended September 30, 2002, compared to netsecuritization income of $0.6 million and $1.1 million for the three andnine months ended September 30, 2001. This income decreased from 2001 to 2002 because of the lack of growth inour originated portfolio during 2002.

 

Income (loss) from retained interests in credit card receivablessecuritized includes the income earned on the retained interests and anychanges in the fair value of the retained interest in credit card receivablessecuritized in accordance with Statement No. 115 and EITF 99-20. Incomefrom retained interests in credit card receivables securitized for the threemonths ended September 30, 2002, was $23.7 million, compared to income of$19.2 million for the three months ended September 30, 2001.  The increase in our income from retainedinterests is primarily due to the increase in our managed receivablesunderlying our securitizations. At September 30, 2002, we had total managedreceivables underlying our securitizations of $2.5 billion as compared to $1.8billion at September 30, 2001. This $0.7 billion increase is primarily due tothe acquisition of the retained interests from Federated, the managed receivablesunderlying which were $0.9 billion at the time of acquisition and $0.8 billionas of September 30, 2002. We recorded the retained interests acquired at cost,and we are carrying these interests at the lower of amortized cost or fairmarket value.  Expected cash flows inexcess of the cost of the retained interests are being amortized into incomefrom retained interests in credit card receivables securitized using theeffective interest method.

 

Loss from retained interests in credit card receivables securitized forthe nine months ended September 30, 2002, was $33.5 million, compared toincome of $55.9 million for the nine months ended September 30, 2001. Thedecrease in our income from retained interests in credit card receivablessecuritized for the nine months ended September 30, 2002, compared to September30, 2001, was due primarily to (a) a decrease in our estimate of the fair valueof our retained interests in finance charge receivables of our originatedportfolio of approximately $62.0 million; (b) a decrease in our estimate ofaccrued interest and fees earned but not billed of approximately $13.1 millionto better estimate the collectible portion of these fees; and (c) an increasein the charge offs of the receivables. This increase is due to a larger percentage of our receivables agingthrough the second year of their life. When credit cards are first originated, they tend to have low charge offrates in their first twelve months.  Thecharge off rate then dramatically increases during year two and then moderatesin year three and beyond. These decreases in our income from retained interestswere partially offset, however, by (a) an approximate $22.8 million increase inour retained interest due to decreasing our residual cash flows discount rate from34.9%to 22.5%; and (b) income from the retained interests we acquired duringJuly 2002.

 

The fair value of our retained interests in our originated portfolio incredit card receivables securitized is estimated by discounting the expectedfuture cash flows from the securitized receivables at rates we believe areconsistent with those that would be used by an independent third party. Theserates historically reflect (a) prior transactions completed by us,(b) average rates disclosed by our peers, (c) average rates we havereviewed

 

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fromtransactions where the total interest rate to the investor has been disclosedand (d) an independent financial advisory firm’s evaluation of the residualcash flow discount rate during the second quarter of 2002. Because quotedmarket prices are generally not available for retained interests in ouroriginated portfolio, 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 the “Critical Accounting Policies” section.)

 

Thefollowing table shows the assumptions used to estimate the fair value of theretained interests of the receivables the Company has securitized:

 
|                                           |   | **At or for the  Three Months Ended** |       |
|------------------------------------------------|--------|---------------------------------------|------------|
|                                           |   | **2002**                              |       | **2001** | ** ** |
|                                           |   | **Sep. 30**                           |       | **Jun. 30** |   | **Mar. 31** |   | **Dec. 31** |   | **Sep. 30** |   | **Jun. 30** | ** ** |
|                                           |   |                                  |       |   |   |   |   |   |   |   |   |   | ** ** |
|                                           |   | **Assumptions**                       | ** ** |
|                                           |   |                                  | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Payment rate (monthly)                         |   | 6.7                                   | %          | 7.1 | % | 7.1 | % | 8.0 | % | 9.5 | % | 9.4 | % |
| Expected credit loss rate (annualized)         |   | 16.7                                  | %          | 16.6 | % | 16.7 | % | 16.7 | % | 14.4 | % | 13.6 | % |
| Residual cash flows discount rate (annualized) |   | 22.5                                  | %          | 22.5 | % | 34.9 | % | 34.9 | % | 14.2 | % | 14.2 | % |
| Servicing liability discount rate (annualized) |   | 14.1                                  | %          | 14.1 | % | 14.1 | % | 14.0 | % | 14.2 | % | 14.2 | % |

 

The payment ratedecreased from June 30, 2002, to September 30, 2002, primarily due to theseasoning of the originated portfolio. Expected credit loss rates have remainedrelatively flat since December 31, 2002, due to the economic climate and due toweighted average age of the accounts. We compare historical loss rates on each vintageof our portfolio at comparable points in their lives to project our expectedcredit loss rate. Estimated default rates are based on historical results,adjusted for expected changes based on our credit risk models. The returns tothe investors in the securitizations are based on management’s estimates.

 

Our retained interests in credit card receivables securitized includethe following:

 
|                                                       |   | **September 30,********2002** |    | **December 31,********2001** |   |
|------------------------------------------------------------|--------|-------------------------------|---------|------------------------------|--------|
|                                                       |   | **(In thousands)**            |    |
| I/O strip                                                  |   | $                             | 102,372 |                         | $      | 84,390 |   |
| Fair value of Seller’s Interest                       |   | 333,906                       |    | 312,622                      |   |
| Servicing liability                                        |   | (123,753                      | )       | (38,123                      | )      |
| Retained interests in credit card receivables  securitized |   | $                             | 312,525 |                         | $      | 358,889 |   |

 

The I/O strip reflects the estimated fair value of our rights to futureincome from the originated portfolio. The servicing liability reflects, forthose securitizations for which servicing compensation is not adequate, theestimated fair value of the costs to service receivables above and beyond theservicing income we expect to receive from the securitizations. The fair valueof seller’s interests includes all of the retained interests we own in thesecuritizations. Our I/O Strip increased from December 31, 2001, primarily dueto a decrease in our residual cash flows discount rate from 34.9% at December31, 2001, to 22.5% at September 30, 2002, as discussed in our Quarterly Reporton Form 10-Q for the three months ended June 30, 2002. Our servicing liabilityincreased due to the servicing liability we assumed when we purchased theretained interests from Federated in July 2002. The fair value of seller’sinterest increased due to the acquisition of the retained interests wepurchased from Federated in July 2002, offset however by a decrease during 2002

 

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inour estimate of the fair value of our retained interests in finance chargereceivables.

 

Prior to the second quarter of 2002, we estimated the fair value of ourretained interests in finance charge receivables using our estimates of totalfinance charges billed to cardholders. Our new estimates better reflect ourexpectation of just the collectible portion of these finance charges. Webelieve our change in estimate is preferable, as it will more accuratelyreflect the cash we expect to receive in the future from cardholders withrespect to these fees. We also believe our revised estimates are preferablebased in part on proposed regulatory guidelines which affect many othercompanies in the credit card industry. Although we are not a bank, and we are not directly regulated by anyfinancial regulator, we believe other credit card companies either have or willbe adopting this change in estimate.

 

***Equity-Method Investment in CSG***

 

CSG was formed during the second quarter of 2002 by affiliates of Goldman,Sachs & Co., Salomon Smith Barney and a wholly owned subsidiary of theCompany to acquire notes and a certificated interest issued by the CSG Trust,which owns a portfolio of credit card receivables. We account for our interestin CSG using the equity-method of accounting. We have a 50% interest in CSG,and we funded our initial $34.9 million interest in CSG with cash of $3.5million and by borrowing $31.4 million. In exchange for servicing 100% of thereceivables owned by the CSG Trust, we receive a servicing fee from thesecuritization structure. The servicing fee is considered adequatecompensation.

 

Under our equity method of accounting for our CSG investment, werecorded approximately $19.6 million and $24.1 million of pretax income duringthe three and nine months ended September 30, 2002. This income primarilyconsisted of income from retained interests in credit card receivablessecuritized that CSG acquired in the second quarter of 2002 from the CSG Trust.During the three months ended September 30, 2002, we received approximately$21.1 million in distributions from our investment in CSG.

 

***Other Operating Income***

 

Other operating income, excluding securitization (loss) income, income(loss) from retained interests in credit card receivables securitized andequity in income of equity-method investee, consists of the following:

 
|                         |   | **Three months ended********September 30,** |       | **Nine months ended********September 30,** |   |
|------------------------------|--------|---------------------------------------------|------------|--------------------------------------------|--------|
|                         |   | **2002**                                    |       | **2001**                                   |   | **2002** |   | **2001** | ** ** |
|                         |   | **(In thousands)**                          | ** ** |
| Servicing income             |   | $                                           | 17,242     |                                       | $      | 1,411 |   | $ | 20,921 |   | $ | 4,646 |   |
| Other credit card fees       |   | 23,856                                      |       | 23,948                                     |   | 72,554 |   | 63,457 |   |
| Interchange fees             |   | 3,912                                       |       | 6,212                                      |   | 11,934 |   | 17,114 |   |
| Ancillary products           |   | 3,295                                       |       | 8,731                                      |   | 11,630 |   | 23,673 |   |
| Total other operating income |   | $                                           | 48,305     |                                       | $      | 40,302 |   | $ | 117,039 |   | $ | 108,890 |   |

 

Other operating income increased to $48.3 million for the threemonths ended September 30, 2002, from $40.3 million for the three monthsended September 30, 2001, and increased to $117.0 million for the ninemonths ended September 30, 2002, from $108.9 million for the nine monthsended September 30, 2001. Our servicing income increased for the three and ninemonths ended September 30, 2002, compared to the same periods in 2001 primarilydue to the servicing fees we earned as the servicer of receivables of the CSGTrust and the Fingerhut Trust. Other credit card fees were $23.9 millionfor both the three months ended September 30, 2002, and 2001, and includeannual, over-limit, cash advance, insufficient funds, maintenance and othermiscellaneous fees. Interchange fees are the portion of the merchant feeassessed by Visa and MasterCard and passed on to us on the purchase volume onour credit card receivables.Interchange feesdecreased to $3.9 million from $6.2 million due to a decrease in thepurchase volume on the credit card receivables.

 

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Ancillaryproduct revenue decreased to $3.3 million from $8.7 million due tofewer customers purchasing our products and because we have decreased growth innew accounts within our originated portfolio during the past four quarters. Ourancillary product income is very sensitive to the number of new accounts weoriginate as sales of our fee–based products are higher to new customersthan to existing cardholders. Within our originated portfolio, we addedapproximately 148,000 new accounts through September 30, 2002, versusapproximately 549,000 new accounts through September 30, 2001. Because we havedecreased the number of new accounts we have added through our originated portfolioduring 2002, our ancillary product income may continue to decline in 2002.

 

***Other Operating Expense***

 

Other operating expense consists of the following for the periodsindicated:

 
|                                |   | **Three months ended********September 30,** |       | **Nine months ended********September 30,** |   |
|-------------------------------------|--------|---------------------------------------------|------------|--------------------------------------------|--------|
|                                |   | **2002**                                    |       | **2001**                                   |   | **2002** |   | **2001** | ** ** |
|                                |   | **(In thousands)**                          | ** ** |
| Non-servicing salaries and benefits |   | $                                           | 5,663      |                                       | $      | 3,330 |   | $ | 12,287 |   | $ | 8,373 |   |
| Credit card servicing               |   | 29,385                                      |       | 15,650                                     |   | 65,273 |   | 44,830 |   |
| Marketing and solicitation          |   | 4,361                                       |       | 7,670                                      |   | 9,402 |   | 27,528 |   |
| Professional fees                   |   | 2,261                                       |       | 837                                        |   | 3,691 |   | 2,647 |   |
| Data processing                     |   | 2,339                                       |       | 2,375                                      |   | 5,753 |   | 6,867 |   |
| Net occupancy                       |   | 1,365                                       |       | 1,112                                      |   | 3,714 |   | 2,519 |   |
| Ancillary product expense           |   | 1,009                                       |       | 2,058                                      |   | 4,062 |   | 8,138 |   |
| Other                               |   | 6,326                                       |       | 4,282                                      |   | 17,386 |   | 11,427 |   |
| Total other operating expense       |   | $                                           | 52,709     |                                       | $      | 37,314 |   | $ | 121,568 |   | $ | 112,329 |   |

 

Other operating expense for the three months ended September 30, 2002,increased to $52.7 million, from $37.3 million for the three monthsended September 30, 2001, and increased to $121.6 million for the nine monthsended September 30, 2002, compared to $112.3 million for the nine months endedSeptember 30, 2001. This increase is due primarily to servicing expensesassociated with servicing receivables of the CSG Trust and the Fingerhut Trust.  Credit card servicing costs primarilyinclude collections and customer service expenses. These expenses includein-house collections and customer service expenses as well as costs associatedwith corresponding with our cardholders. Servicing expense also includesoutsourced collections and customer service expenses.

 

In 2002, marketing and solicitation costs decreased due to reducedbudgeted levels of direct mail, television, telemarketing and internetcampaigns. Ancillary product expense decreased due to a decrease in ancillaryproduct marketing and a decrease in ancillary products sold.

 

Other expenses include depreciation, fraud, travel and entertainment,insurance, hiring expense, corporate communications, leased equipment expenses,office supplies and other miscellaneous expenses. During 2002, expenses in thiscategory, other than fraud, increased incrementally as we added infrastructureto support the growth in managed receivables. Our fraud expense includes theexpense of unauthorized use of the credit cards including identity theft orpurchases on lost or stolen cards. To date, we have experienced very littlefraud for unauthorized use, and the total expense has consistently been below0.20% of average managed receivables.

 

***Income Taxes***

 

Income tax expense was $11.9 million for the three months endedSeptember 30, 2002, compared to income tax expense of $8.0 million for thethree months ended September 30, 2001. Income tax benefit was

 

23

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$6.4 millionfor the nine months ended September 30, 2002, and income tax expense was$19.4 million for the nine months ended September 30, 2001. Our effectivetax rate was 35.0% for each of the three and nine months ended September 30,2002, and 2001. Substantially all of our income tax liabilities at September30, 2002, were deferred tax liabilities.

 

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

 

In August 1997, we began securitizing our credit card receivables.In each securitization, we receive cash, retain an interest in the receivablesthat are securitized, retain the rights to receive cash in the future, andretain the rights and obligations associated with servicing the accounts.Securitizations are treated as sales under GAAP. As such, we remove thesecuritized receivables from our consolidated balance sheet. During the secondquarter of 2002, we purchased a 50% interest in CSG, which was formed toacquire notes and a certificated interest in CSG Trust, which owns a portfolioof credit card receivables. The performance of the underlying credit cardreceivables will affect the future cash flows we actually receive. Theinformation in the following table is presented to reflect credit cardreceivables that we have securitized and 50% of the managed receivablesunderlying the CSG Trust (which reflects our ownership percentage in CSG).  We have included 50% of the managedreceivables underlying the CSG Trust because we have a 50% interest in the CSG,which owns the retained interest in the CSG Trust.  CSG’s cash flows and income are dependent on how the receivablesin the CSG Trust perform, and therefore, our cash flows and income aredependent upon 50% of the managed receivables. In addition to owning our 50%interest in CSG, we are the servicer for 100% of the receivables in the CSG Trust,and we receive a servicing fee from the CSG Trust which we believe to beadequate compensation for the servicing we perform.

 
|                           |   | **At or for the Three Months Ended**               |       |
|--------------------------------|--------|----------------------------------------------------|------------|
|                           |   | **2002**                                           |       | **2001** |   | **2000** | ** ** |
|                           |   | **Sep. 30**                                        |       | **Jun. 30** |   | **Mar. 31** |   | **Dec. 31** |   | **Sep. 30** |   | **Jun. 30** |   | **Mar. 31** |   | **Dec. 31** | ** ** |
|                           |   | **(Dollars in thousands; percentages annualized)** | ** ** |
| Period-end managed receivables |   | $                                                  | 3,028,500  |   | $ | 2,260,442 |   | $ | 1,809,070 |   | $ | 1,891,842 |   | $ | 1,804,631 |   | $ | 1,671,762 |   | $ | 1,589,584 |   | $ | 1,528,372 |   |
| Period-end managed accounts    |   | 4,070                                              |       | 2,285 |   | 2,057 |   | 2,185 |   | 2,163 |   | 2,300 |   | 2,256 |   | 2,178 |   |
| Average managed receivables    |   | $                                                  | 3,090,254  |   | $ | 1,945,024 |   | $ | 1,860,209 |   | $ | 1,838,873 |   | $ | 1,745,136 |   | $ | 1,623,730 |   | $ | 1,574,554 |   | $ | 1,398,041 |   |
| Net interest margin            |   | 21.4                                               | %          | 13.1 | % | 16.9 | % | 19.0 | % | 21.5 | % | 22.0 | % | 21.6 | % | 21.8 | % |
| Other credit card income ratio |   | 4.9                                                | %          | 7.3 | % | 7.3 | % | 8.5 | % | 9.2 | % | 8.5 | % | 8.3 | % | 9.3 | % |
| Operating ratio                |   | 8.0                                                | %          | 7.6 | % | 9.0 | % | 9.8 | % | 8.8 | % | 8.4 | % | 9.1 | % | 7.9 | % |

 

The net interest margin includes all net interest and late fee income onall outstanding receivables, less the interest expense paid to the investorsand finance charge charge offs. Our other credit card income ratio includesother credit card fees, such as over-limit fees, cash advance fees, maintenancefees, miscellaneous fees, interchange income and ancillary product income. Ouroperating ratio includes all expenses associated with our business, net of anyservicing income we receive as servicer for the CSG Trust, other than marketingand solicitation and ancillary product expenses, and is expressed as apercentage of average managed receivables.

 

The portfolios we acquired in 1998 were acquired at substantialdiscounts. The portfolio of credit card receivables owned by the CSG Trust andthe portfolio of credit card receivables underlying the retained interests weacquired from Federated were also acquired at substantial discounts. Thepresented credit card data excludes some of the acquired receivables and therelated accounts which, at the time of purchase, were in a late delinquencystatus. Our belief is that these receivables were either in the process ofbeing charged off by the seller due to delinquency or were likely to be chargedoff in the near term. In each purchase, these receivables were purchased aspart of the portfolio as the sellers desired to sell the entire portfolio. Thesame representations and warranties from the sellers were made

 

24

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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 balances. There is no recourse toany seller in the event the cardholders simply do not pay the account balancesthat have been acquired.

 

The following summarizes the receivables purchased and the relatedaccounts and those excluded from our credit card data:

 
|                 |   | **Purchases occurring in** |       |
|----------------------|--------|----------------------------|------------|
|                 |   | **2002**                   |       | **1998** | ** ** |
|                 |   | **(In thousands)**         | ** ** |
| Acquired accounts    |   | 2,828                      |       | 201 |   |
| Acquired receivables |   | $                          | 1,652,559  |   | $ | 579,700 |   |
| Excluded accounts    |   | 269                        |       | 52 |   |
| Excluded receivables |   | $                          | 219,778    |   | $ | 137,200 |   |

 

The portfolios acquired during 1998 and 2002 were acquired atsubstantial discounts. A portion of each discount related to the excludedreceivables noted above. A portion of each discount related to the creditquality of the remaining acquired receivables and was calculated as thedifference between the face amount of the receivables purchased (less theexcluded receivables described above) and the expected future cash flowsexpected to be collected. The balance of the discount for each purchase is notneeded for credit quality, is referred to as accretable yield, and is beingamortized into net interest margin, using the interest method over theestimated life of each acquired portfolio for purposes of reporting ourselected credit card data. The following table summarizes the discountsassociated with the acquired portfolios:

 
|                                  |   | **Purchases occurring in** |       |
|---------------------------------------|--------|----------------------------|------------|
|                                  |   | **2002**                   |       | **1998** |   |
|                                  |   | **(In millions)**          | ** ** |
| Total face value acquired             |   | $                          | 1,652.5    |   | $ | 579.7 |   |
| Total discount                        |   | 759.6                      |       | 284.5 |   |
| Portion used for excluded receivables |   | 219.8                      |       | 137.2 |   |
| Portion needed for credit quality     |   | 516.8                      |       | 87.5 |   |
| Portion reflecting accretable yield   |   | 23.0                       |       | 59.8 |   |
|                                       |        |                            |            |  |  |  |  |

 

Our net interest margins are influenced by a number of factors,including the level of finance charges and late fees billed, the weightedaverage cost of funds and the level of our finance charge charge offs. Our netinterest margin for the three months ended September 30, 2002, was 21.4% ascompared to 13.1% for the three months ended June 30, 2002. The increase in ournet interest margin is due to a decrease in our finance charge charge offs. Thereceivables acquired during 2002 have higher yields and lower finance chargecharge offs than the receivables we had outstanding prior to theseacquisitions. Because certain accounts in late delinquency status and those ator near charge-off at the time of acquisition were excluded from our data, therecently acquired portfolios experienced less finance charge charge offs in thethird quarter than they will in future quarters. We would expect an increase infinance charge charge offs in the future as the accounts we acquired age intolater delinquency buckets and charge-off. This will decrease our net interestmargins in the future. Additionally, the reported net interest margin of 13.1%for the quarter ending June 2002 is low due to changes we made during thesecond quarter in how we estimate accrued interest and fees earned but not yetbilled. During the second quarter of 2002, we revised our accrued balance tobetter estimate the collectible portion of these fees. The change resulted in areduction in our second quarter net interest margin of approximately 2.1%.

 

Each quarter, we re-underwrite our portfolio to price our products toappropriately reflect the level of each customer’s credit risk. As part of thisunderwriting process, existing customers may be offered increased or decreasedpricing depending on their credit risk as well as their supply and demand forcredit. Increases in

 

25

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pricingmay increase our net interest margin, while decreases in pricing may reduce ournet interest margin.

 

Our other credit card income ratio is calculated by dividing the cashadvance fees, membership fees, overlimit fees, interchange, ancillary productfees by the average managed receivables. This ratio decreased from the secondquarter to the third quarter of 2002 primarily due to the addition of thereceivables underlying the Federated Trust, which do not have a significantamount of these other types of credit card fees.

 

Our operating ratio includes all costs of operating our business, otherthan marketing expenses and ancillary product expenses. Our operating ratiofluctuates based on our rate of receivables growth and the level of ourexpenditures on our infrastructure, our personnel, our collections and customerservice operations, our Internet technology and our database management system.The operating ratio increased to 8.0% during the three months ended September30, 2002, as compared to 7.6% during the three months ended June 30, 2002. Thisoperating ratio increase is due primarily to additional expenses and conversioncosts associated with the integration of the increase in the receivables we areservicing.

 

***Asset Quality***

 

Our delinquency and net charge off rates at any point in time reflectthe credit performance of our receivables. The average age of our credit cardaccounts, the timing of portfolio purchases, the success of our collection andrecovery efforts and general economic conditions affect our delinquency andcharge off rates. The average age of our credit card account portfolio alsoaffects the stability of delinquency and loss rates of the portfolio.

 

Our strategy for managing delinquency and credit losses consists ofactive account management throughout the customer relationship. This strategyincludes credit line management and pricing based on each customer’s creditrisk.

 

*Delinquencies.* Delinquencies have the potentialto impact net income in the form of net credit losses. Delinquencies are alsocostly in terms of the personnel and resources dedicated to resolving them. Acredit card account is contractually delinquent if the minimum payment is notreceived by the specified date on the customer’s statement. It is our policy tocontinue to bill interest and fee income on all credit card accounts, except inlimited circumstances, until the account and all related receivables, interestand other fees are charged off. See “the Net Charge Offs” section.

 

The following table presents the delinquency trends of all of the creditcard receivables underlying our securitizations, as well as, 50% of thereceivables underlying the CSG Trust:

 
|                                                   |   | **At or for the Three Months Ended**   |       |
|--------------------------------------------------------|--------|----------------------------------------|------------|
|                                                   |   | **2002**                               |       | **2000** |   | **2000** |   |
|                                                   |   | **Sep. 30**                            |       | **Jun. 30** |   | **Mar. 31** |   | **Dec. 31** |   | **Sep. 30** |   | **Jun. 30** |   | **Mar. 31** |   | **Dec. 31** | ** ** |
|                                                   |   | **(Dollars in thousands; % of total)** | ** ** |
| **Total**                                              |   |                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Receivables delinquent:                                |   |                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 30 to 59 days past due                                 |   | $                                      | 155,897    |   | $ | 104,337 |   | $ | 68,423 |   | $ | 86,501 |   | $ | 70,280 |   | $ | 69,602 |   | $ | 63,338 |   | $ | 59,138 |   |
| 60 to 89 days past due                                 |   | 120,868                                |       | 67,154 |   | 57,227 |   | 62,975 |   | 55,967 |   | 55,084 |   | 42,953 |   | 47,118 |   |
| 90 or more days past due                               |   | 252,800                                |       | 136,501 |   | 163,715 |   | 147,407 |   | 141,467 |   | 121,494 |   | 107,253 |   | 98,568 |   |
|                                                   |   |                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total 30 or more days past due                         |   | $                                      | 529,565    |   | $ | 307,992 |   | $ | 289,365 |   | $ | 296,883 |   | $ | 267,714 |   | $ | 246,180 |   | $ | 213,544 |   | $ | 204,824 |   |
| Total 60 or more days past due                         |   | $                                      | 373,668    |   | $ | 203,655 |   | $ | 220,942 |   | $ | 210,382 |   | $ | 197,434 |   | $ | 176,578 |   | $ | 150,206 |   | $ | 145,686 |   |
|                                                   |   |                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Receivables delinquent as % of period-end receivables: |   |                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 30 to 59 days past due                                 |   | 5.1                                    | %          | 4.6 | % | 3.8 | % | 4.6 | % | 3.9 | % | 4.2 | % | 4.0 | % | 3.9 | % |
| 60 to 89 days past due                                 |   | 4.0                                    |       | 3.0 |   | 3.2 |   | 3.3 |   | 3.1 |   | 3.3 |   | 2.7 |   | 3.1 |   |
| 90 or more days past due                               |   | 8.3                                    |       | 6.0 |   | 9.0 |   | 7.8 |   | 7.8 |   | 7.3 |   | 6.7 |   | 6.4 |   |
|                                                   |   |                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total 30 or more days past due                         |   | 17.4                                   | %          | 13.6 | % | 16.0 | % | 15.7 | % | 14.8 | % | 14.8 | % | 13.4 | % | 13.4 | % |
| Total 60 or more days past due                         |   | 12.3                                   | %          | 9.0 | % | 12.2 | % | 11.1 | % | 10.9 | % | 10.6 | % | 9.4 | % | 9.5 | % |

 

26

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Our 60 or more days past due delinquency rates have increased from 9.0%at June 30, 2002, to 12.3% at September 30, 2002, primarily due to higherdelinquency rates in the receivables relating to our recent acquisitions anddue to a seasonal increase that is expected going into each holidayseason.  We expect the portfoliodelinquencies to increase as the receivables acquired in connection with our2002 acquisitions age into later delinquency status during the fourth quarterof 2002 and into 2003.

 

The following table presents the delinquency trends of our originatedportfolio:

 
|                                                   |   | **At or for the Three Months Ended**   |       |
|--------------------------------------------------------|--------|----------------------------------------|------------|
|                                                   |   | **2002**                               |       | **2001** |   | **2000** |   |
|                                                   |   | **Sep. 30**                            |       | **Jun. 30** |   | **Mar. 31** |   | **Dec. 31** |   | **Sep. 30** |   | **Jun. 30** |   | **Mar. 31** |   | **Dec. 31** | ** ** |
|                                                   |   | **(Dollars in thousands; % of total)** | ** ** |
| **Originated Portfolio**                               |   |                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Receivables Delinquent:                                |   |                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 30 to 59 days past due                                 |   | $                                      | 71,630     |   | $ | 75,024 |   | $ | 63,423 |   | $ | 79,820 |   | $ | 64,938 |   | $ | 62,910 |   | $ | 54,943 |   | $ | 48,147 |   |
| 60 to 89 days past due                                 |   | 57,930                                 |       | 53,101 |   | 54,273 |   | 59,613 |   | 52,633 |   | 50,050 |   | 37,857 |   | 40,491 |   |
| 90 or more days past due                               |   | 147,070                                |       | 130,996 |   | 157,866 |   | 141,168 |   | 133,599 |   | 111,598 |   | 96,386 |   | 87,044 |   |
|                                                   |   |                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total 30 or more days past due                         |   | $                                      | 276,630    |   | $ | 259,121 |   | $ | 275,562 |   | $ | 280,601 |   | $ | 251,170 |   | $ | 224,558 |   | $ | 189,186 |   | $ | 175,682 |   |
| Total 60 or more days past due                         |   | $                                      | 205,000    |   | $ | 184,097 |   | $ | 212,139 |   | $ | 200,781 |   | $ | 186,232 |   | $ | 161,648 |   | $ | 134,243 |   | $ | 127,535 |   |
|                                                   |   |                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Receivables delinquent as % of period-end receivables: |   |                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 30 to 59 days past due                                 |   | 4.4                                    | %          | 4.6 | % | 3.7 | % | 4.5 | % | 3.9 | % | 4.1 | % | 3.8 | % | 3.5 | % |
| 60 to 89 days past due                                 |   | 3.5                                    |       | 3.2 |   | 3.2 |   | 3.4 |   | 3.1 |   | 3.3 |   | 2.6 |   | 3.0 |   |
| 90 or more days past due                               |   | 9.0                                    |       | 8.0 |   | 9.3 |   | 7.9 |   | 7.9 |   | 7.3 |   | 6.7 |   | 6.4 |   |
|                                                   |   |                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total 30 or more days past due                         |   | 16.9                                   | %          | 15.8 | % | 16.2 | % | 15.8 | % | 14.9 | % | 14.7 | % | 13.1 | % | 12.9 | % |
| Total 60 or more days past due                         |   | 12.5                                   | %          | 11.2 | % | 12.5 | % | 11.3 | % | 11.0 | % | 10.6 | % | 9.3 | % | 9.4 | % |

 

The 60 or more days past duedelinquency rates in our originated portfolio increased to 12.5% at September30, 2002, from 11.2% at June 30, 2002. This increase is primarily reflected inthe 90 or more days past due category. We anticipate this increase to increaseour charge off rate for the fourth quarter of 2002 as these receivables forwhich we do not receive a payment will charge off when they age past 180 days.We anticipate fairly stable delinquency rates in our originated portfolio goingforward. Our delinquency rates have increased in general due primarily to theseasoning of receivables that were originated during 2000 and 1999 and thegeneral economic conditions that prevailed during 2001 and the nine monthsended September 30, 2002. As the average age of an originated credit cardreceivables portfolio increases, delinquency rates can be expected to be lowduring the first six months of their life; dramatically increase and peak towardsthe rest of the first year and during the second year; and then decrease andstabilize after year two. We have observed this trend in

 

27

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theindustry as well as within our own originated portfolio.

 

The following table presents the delinquency trends of our purchasedportfolio:

 
|                                                   |   | **At or for the Three Months Ended**   |       |
|--------------------------------------------------------|--------|----------------------------------------|------------|
|                                                   |   | **2002**                               |       | **2001** |   | **2000** |   |
|                                                   |   | **Sep. 30**                            |       | **Jun. 30** |   | **Mar. 31** |   | **Dec. 31** |   | **Sep. 30** |   | **Jun. 30** |   | **Mar. 31** |   | **Dec. 31** | ** ** |
|                                                   |   | **(Dollars in thousands; % of total)** | ** ** |
| **Purchased Portfolio**                                |   |                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Receivables Delinquent:                                |   |                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 30 to 59 days past due                                 |   | $                                      | 59,770     |   | $ | 4,937 |   | $ | 5,000 |   | $ | 6,681 |   | $ | 5,342 |   | $ | 6,692 |   | $ | 8,395 |   | $ | 10,991 |   |
| 60 to 89 days past due                                 |   | 44,612                                 |       | 2,900 |   | 2,954 |   | 3,362 |   | 3,334 |   | 5,034 |   | 5,096 |   | 6,627 |   |
| 90 or more days past due                               |   | 67,516                                 |       | 5,253 |   | 5,849 |   | 6,239 |   | 7,868 |   | 9,896 |   | 10,867 |   | 11,524 |   |
|                                                   |   |                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total 30 or more days past due                         |   | $                                      | 171,898    |   | $ | 13,090 |   | $ | 13,803 |   | $ | 16,282 |   | $ | 16,544 |   | $ | 21,622 |   | $ | 24,358 |   | $ | 29,142 |   |
| Total 60 or more days past due                         |   | $                                      | 112,128    |   | $ | 8,153 |   | $ | 8,803 |   | $ | 9,601 |   | $ | 11,202 |   | $ | 14,930 |   | $ | 15,963 |   | $ | 18,151 |   |
|                                                   |   |                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Receivables delinquent as % of period-end receivables: |   |                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 30 to 59 days past due                                 |   | 6.8                                    | %          | 5.7 | % | 4.8 | % | 5.9 | % | 4.4 | % | 5.0 | % | 5.7 | % | 6.7 | % |
| 60 to 89 days past due                                 |   | 5.1                                    |       | 3.4 |   | 2.9 |   | 3.0 |   | 2.7 |   | 3.8 |   | 3.5 |   | 4.1 |   |
| 90 or more days past due                               |   | 7.7                                    |       | 6.1 |   | 5.7 |   | 5.5 |   | 6.4 |   | 7.4 |   | 7.4 |   | 7.1 |   |
|                                                   |   |                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total 30 or more days past due                         |   | 19.6                                   | %          | 15.2 | % | 13.4 | % | 14.4 | % | 13.5 | % | 16.2 | % | 16.6 | % | 17.9 | % |
| Total 60 or more days past due                         |   | 12.8                                   | %          | 9.5 | % | 8.6 | % | 8.5 | % | 9.1 | % | 11.2 | % | 10.9 | % | 11.2 | % |

 

The60 or more days past due delinquency rate in our purchased portfolio increasedto 12.8% at September 30, 2002, compared to 9.5% at June 30, 2002. Thisincrease is due to the higher delinquency rates of the receivables in theFingerhut Trust.  We expected and continue to expect anincrease in delinquencies in the future as the accounts age into laterdelinquency buckets during the fourthquarter of 2002 and into 2003.

 

Thefollowing table represents 50% of the receivables underlying the CSG Trust:

 
|                                                   |   | **At or for the Three Months Ended**   |   |
|--------------------------------------------------------|--------|----------------------------------------|--------|
|                                                   |   | **2002**                               |   |
|                                                   |   | **Sep. 30**                            |   | **Jun. 30** |   |
|                                                   |   | **(Dollars in thousands; % of total)** |   |
| **50% of CSG Trust**                                   |   |                                   |   |   |   |
| Receivables delinquent:                                |   |                                   |   |   |   |
| 30 to 59 days past due                                 |   | $                                      | 24,497 |   | $ | 24,376 |   |
| 60 to 89 days past due                                 |   | 18,326                                 |   | 11,153 |   |
| 90 or more days past due                               |   | 38,214                                 |   | 252 |   |
|                                                   |   |                                   |   |   |   |
| Total 30 or more days past due                         |   | $                                      | 81,037 |   | $ | 35,781 |   |
| Total 60 or more days past due                         |   | $                                      | 56,540 |   | $ | 11,405 |   |
|                                                   |   |                                   |   |   |   |
| Receivables delinquent as % of period-end receivables: |   |                                   |   |   |   |
| 30 to 59 days past due                                 |   | 4.7                                    | %      | 4.5 | % |
| 60 to 89 days past due                                 |   | 3.5                                    |   | 2.1 |   |
| 90 or more days past due                               |   | 7.4                                    |   | 0.0 |   |
|                                                   |   |                                   |   |   |   |
| Total 30 or more days past due                         |   | 15.6                                   | %      | 6.6 | % |
| Total 60 or more days past due                         |   | 10.9                                   | %      | 2.1 | % |
|                                                        |        |                                        |        |  |  |  |  |  |  |  |

 

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The 60 or more days past due delinquencies increased to 10.9% atSeptember 30, 2002, as compared to 2.1% at June 30, 2002.  The increase is due to an increase inaccounts 90 or more days past due. At June 30, 2002, the majority of theaccounts were less than 90 days past due, due to the fact that we excludedaccounts that were at or near charge off at the time of acquisition. Weexpected and continue to expect an increase in delinquencies in the future asthe accounts age into later delinquency buckets during the fourth quarter of 2002 and into 2003.

 

We are using our account management strategies on our portfolio, whichare intended to reduce the expected increase in delinquency rates as ourportfolio 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. We measure the success of these efforts bymeasuring delinquency rates.

 

*Net Charge Offs.* Net charge offs include theprincipal amount of losses from customers unwilling or unable to pay theiraccount balance, as well as bankrupt and deceased customers, less currentperiod recoveries. Net charge offs exclude accrued finance charges and fees,which are charged against the related income at the time of charge off. Lossesfrom fraudulent activity in accounts are also excluded from net charge offs andare included 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 reporting adjusted charge off ratios on managedreceivables below, the discount related to credit quality discussed earlier inthis section was utilized to offset a portion of actual net charge offs.

 

The following table presents the charge off data for all of the creditcard receivables underlying our securitizations as well as 50% of thereceivables underlying the CSG Trust:

 

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|                           |   | **For the Three Months Ended**                     |       |
|--------------------------------|--------|----------------------------------------------------|------------|
|                           |   | **2002**                                           |       | **2001** |   | **2000** |   |
|                           |   | **Sep. 30**                                        |       | **Jun. 30** |   | **Mar. 31** |   | **Dec. 31** |   | **Sept. 30** |   | **Jun. 30** |   | **Mar. 31** |   | **Dec. 31** | ** ** |
|                           |   | **(Dollars in thousands; percentages annualized)** | ** ** |
| **Total**                      |   |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Selected Credit Card Data:** |   |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net charge offs                |   | $                                                  | 71,621     |   | $ | 72,979 |   | $ | 68,407 |   | $ | 70,207 |   | $ | 63,759 |   | $ | 59,807 |   | $ | 58,229 |   | $ | 46,552 |   |
| Adjusted net charge offs       |   | $                                                  | 64,080     |   | $ | 72,979 |   | $ | 68,407 |   | $ | 70,207 |   | $ | 63,759 |   | $ | 59,434 |   | $ | 58,126 |   | $ | 46,132 |   |
| Net charge off ratio           |   | 9.3                                                | %          | 15.0 | % | 14.7 | % | 15.3 | % | 14.6 | % | 14.7 | % | 14.8 | % | 13.3 | % |
| Adjusted charge off ratio      |   | 8.3                                                | %          | 15.0 | % | 14.7 | % | 15.3 | % | 14.6 | % | 14.6 | % | 14.8 | % | 13.2 | % |

 

The adjustedcharge off ratio decreased to 8.3% at September 30, 2002, from 15.0% at June30, 2002, primarily due to the impact of the portfolios associated with our2002 acquisitions and how the receivables at or near charge off have beenexcluded as described above. Because certain receivables that were at or nearcharge off at the time of acquisition were excluded from our data, theseportfolios experienced less charge offs in the third quarter than they will infuture quarters. We expect our charge off rate to increase over the next twoquarters. 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.

 

The following table presents the charge off data for our originatedportfolio:

 
|                           |   | **For the Three Months Ended**                     |       |
|--------------------------------|--------|----------------------------------------------------|------------|
|                           |   | **2002**                                           |       | **2001** |   | **2000** |   |
|                           |   | **Sep. 30**                                        |       | **Jun. 30** |   | **Mar. 31** |   | **Dec. 31** |   | **Sept. 30** |   | **Jun. 30** |   | **Mar. 31** |   | **Dec. 31** | ** ** |
|                           |   | **(Dollars in thousands; percentages annualized)** | ** ** |
| **Originated Portfolio**       |   |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Selected Credit Card Data:** |   |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net charge offs                |   | $                                                  | 62,409     |   | $ | 70,347 |   | $ | 66,364 |   | $ | 68,455 |   | $ | 60,653 |   | $ | 55,755 |   | $ | 53,434 |   | $ | 41,684 |   |
| Adjusted net charge offs       |   | $                                                  | 62,409     |   | $ | 70,347 |   | $ | 66,364 |   | $ | 68,455 |   | $ | 60,653 |   | $ | 55,755 |   | $ | 53,434 |   | $ | 41,684 |   |
| Net charge off ratio           |   | 15.2                                               | %          | 16.8 | % | 15.2 | % | 15.9 | % | 15.0 | % | 15.0 | % | 15.1 | % | 13.5 | % |
| Adjusted charge off ratio      |   | 15.2                                               | %          | 16.8 | % | 15.2 | % | 15.9 | % | 15.0 | % | 15.0 | % | 15.1 | % | 13.5 | % |

 

Our charge off rate decreased to 15.2% at September 30, 2002, from 16.8%at June 30, 2002, primarily due to a lower percentage of accounts 90 days ormore days past due at June 30, 2002. Since our 90 or more days past due ratehas increased at September 30, 2002, we expect our charge off rate to increaseduring the fourth quarter of 2002.

 

As described above under the “Delinquency” subheading, as our portfoliomatures, we expect charge off rates to also increase and then stabilize. Ourcharge off ratio increased during 2001 and 2002 due primarily to seasoning ofour portfolio and a general slowing of the economy. Typically, as our accountsmature, there are very few charge offs during the first 180 days, then thecharge offs are expected to increase and peak in the second year and thenstabilize in the third year.

 

The following table presents the charge off data for our purchasedportfolios:

 

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|                           |   | **For the Three Months Ended**                     |       |
|--------------------------------|--------|----------------------------------------------------|------------|
|                           |   | **2002**                                           |       | **2001** |   | **2000** | ** ** |
|                           |   | **Sep. 30**                                        |       | **Jun. 30** |   | **Mar. 31** |   | **Dec. 31** |   | **Sept. 30** |   | **Jun. 30** |   | **Mar. 31** |   | **Dec. 31** | ** ** |
|                           |   | **(Dollars in thousands; percentages annualized)** | ** ** |
| **Purchased Portfolio**        |   |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Selected Credit Card Data:** |   |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net charge offs                |   | $                                                  | 4,960      |   | $ | 2,222 |   | $ | 2,043 |   | $ | 1,752 |   | $ | 3,106 |   | $ | 4,052 |   | $ | 4,795 |   | $ | 4,868 |   |
| Adjusted net charge offs       |   | $                                                  | 1,671      |   | $ | 2,222 |   | $ | 2,043 |   | $ | 1,752 |   | $ | 3,106 |   | $ | 3,679 |   | $ | 4,692 |   | $ | 4,448 |   |
| Net charge off ratio           |   | 2.2                                                | %          | 9.5 | % | 7.5 | % | 6.0 | % | 9.8 | % | 11.6 | % | 12.4 | % | 11.5 | % |
| Adjusted charge off ratio      |   | 0.7                                                | %          | 9.5 | % | 7.5 | % | 6.0 | % | 9.8 | % | 10.5 | % | 12.1 | % | 10.5 | % |

 

Our net and adjusted charge off ratios declined at September 30, 2002,as compared to June 30, 2002, primarily due to the fact that at June 30, 2002,there were very few accounts 90 days or more past due. This was becausereceivables that were at or near charge off at the time of the acquisition ofretained interests were excluded (see our discussion in the “-Selected CreditCard Data” section). The difference between net charge offs and adjusted chargeoffs is due to the amortization of the discount related to credit qualitydiscussed at the beginning of this “Asset Quality” section. As the portfoliohas aged to later delinquencies during this quarter, we expect higher netcharge offs during the fourth quarter of 2002, and during 2003. As we utilizethe entire discount ascribed to credit quality, we would expect our adjustedcharge rate to increase during the second half of 2003.

 

The following table presents the charge off data for 50% of thereceivables underlying the CSG Trust:

 
|                           |   |   | **For the Three Months Ended**                     |   |
|--------------------------------|--------|--------|----------------------------------------------------|--------|
|                           |   |   | **2002**                                           |   |
|                           |   |   | **Sep. 30**                                        |   | **Jun. 30** |   |
|                           |   |   | **(Dollars in thousands; percentages annualized)** |   |
| **50% of the CSG Trust**       |   |   | ** **                                         |   | ** ** |
| **Selected Credit Card Data:** |   |   |                                               |   |   |
| Net charge offs                |   | $      | 4,252                                              |   | $ | 410 |   |
| Adjusted net charge offs       |   | $      | 0                                                  |   | $ | 410 |   |
| Net charge off ratio           |   | 3.2    | %                                                  | 0.9    | % |
| Adjusted charge off ratio      |   | 0.0    | %                                                  | 0.9    | % |
|                                |        |        |                                                    |        |  |  |  |  |  |

 

Our net and adjusted charge off ratios declined at September 30, 2002,as compared to June 30, 2002, primarily due to the fact that at June 30, 2002,there were very few accounts 90 days or more past due. This was becausereceivables that were at or near charge off at the time of acquisition wereexcluded. The difference between net charge offs and adjusted charge offs isdue to the amortization of the discount related to credit quality discussed atthe beginning of this “Asset Quality” section. Because the portfolio has agedto later delinquencies during this quarter, we expect higher net charge offsduring the fourth quarter of 2002, and during 2003.  As we utilize the entire discount ascribed to credit quality, wewould expect our adjusted charge rate to increase during the second half of2003.

 

*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.

 

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***Liquidity, Funding and CapitalResources***

 

A primary financial goal is to maintain an adequate level of liquiditythrough active management of assets and liabilities. Because thecharacteristics of our assets and liabilities change, liquidity management is adynamic process affected by the pricing and maturity of our assets andliabilities.

 

We finance our business through cash flows from operations, assetsecuritizations and the issuance of equity:

 

•                  During the nine months ended September 30, 2002,we generated approximately $141.2 million in cash from operations comparedto generating approximately $54.4 million in cash flow from operations duringthe nine months ended September 30, 2001. The $86.8 million increase is dueprimarily to the increase in our managed receivables and the collections thereon,which have been favorably affected by our acquisition of the retained interestfrom Federated.

 

•                  During the third quarter of 2002 and in connectionwith our acquisition of the retained interests from Federated, we entered intoa loan in the amount of $95.3 million. The loan was repaid during the thirdquarter of 2002.

 

•                  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 repurchaseplan, we may buy back shares of our outstanding common stock from time to timeeither on the open market or through privately negotiated transactions incompliance with the Securities and Exchange Commission guidelines. During thethird quarter of 2002, we repurchased 500,000 shares in the open market at atotal cost of approximately $2.6 million.

 

•                  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 bears interest at Prime plus 5% and isnon-recourse to the Company. Although the note has a stated maturity in 2007,it is payable only with the cash flows received from CSG, and therefore, doesnot have any minimum payment amounts. It is anticipated that we will receivecash flows from CSG each month, and therefore, we anticipate repaying this loanmonthly. At September 30, 2002, $9.9 million was outstanding under the loan.The lender is entitled to share in certain excess cash flows we receive fromour investment 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, we entered intoan irrevocable standby letter of credit agreement for $10.0 million with abank, for the purposes of securing our obligations to the financial institutionthat issues the credit cards we market. The purpose of the letter of credit isto protect the financial institution from non-payment by us of our obligationto purchase newly generated credit card receivables arising in the credit cardaccounts on a daily basis. We are required to maintain a cash balance of $10.0million with the bank that has issued the letter of credit. Such cash has beendisclosed as “Restricted cash” on the face of the balance sheet.

 

*Securitization Facilities.*As of September 30,2002, we had total securitization facilities of $2.4 billion and had usedapproximately $1.8 billion of these facilities. These facilities includethe outstanding amounts on floating rate three-year term securitizations ofapproximately $441.5 million that were issued during July 2001,approximately $627.4 million that were issued during August 2000, andapproximately $427.5 million that were issued by the Fingerhut Trust in April1998.  Repayment for each one-yearsecuritization facility begins

 

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onits maturity date. In the case of our three-year term securitizations, cash maybe accumulated as early as one year prior to the scheduled maturity date. Onceaccumulation or repayment on any facility begins and until the facility ispaid, cash may be accumulated within the trust or paid to investors and notpaid to us to provide for the repayment of such facility. We have noted thefacilities and the maturity dates below.

 

| **Maturity Date** |   | **Facility Limit** |    |
|-------------------|--------|--------------------|---------|
|              |   | **(in millions)**  |    |
| October 2002(1)   |   | $                  | 306.0   |   |
| February 2003(2)  |   | 57.6               |    |
| March 2003        |   | 250.0              |    |
| July 2003         |   | 300.0              |    |
| September 2003(3) |   | 627.4              |    |
| April 2004(4)     |   | 427.5              |    |
| July 2004(5)      |   | 441.5              |    |
|              |   | $                  | 2,410.0 |   |

 

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(1)                      Subsequent toSeptember 30, 2002, this facility was renewed until October 2003.

 

(2)                      This facility isassociated with our portfolios that 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$4.3 million for the three months ended September 30, 2002, and$3.1 million for the three months ended September 30, 2001. Under theterms of the securitization, the investors are paid with a percentage of thecash collected less servicing fees that we receive to service the accounts andcredit balance refunds. Beginning in April 2002, 100% of all the excess cash isbeing paid to the investors. Once the investors are repaid, all cash collectedon any remaining receivables is payable to us.

 

(3)                      Represents the expected principalpayment date; however, we expect to begin accumulating approximately $67million per month beginning in December 2002 to redeem the $600 million ofClass A notes in September 2003 and the $27.4 million of class B-1 notes inOctober 2003.

 

(4)                      This facility is theSeries 1998-2 issued by the Fingerhut Trust. In August of 2002, this seriesentered into a controlled amortization period associated with this series’ expectedmaturity date of April 15, 2004. During this period, in addition to theinterest payments to investors, we are required to remit $22.5 million ofcollections received from cardholders to the investors each month towardsprincipal. The receivables in this portfolio are decreasing very rapidly aspayments from cardholders significantly exceed new purchases and, as such,there are sufficient collections to make these required payments to investors.We anticipate this facility will enter into an early amortization period sometime during the first quarter of 2003, at which point all payments fromcardholders, less a servicing fee, will be used to pay principal and interestto the investors. Once the investors are repaid in full, all remaining paymentsreceived from cardholders will be remitted to us as holders of the retainedinterests. At the time we acquired the retained interests in the FingerhutTrust, we had factored in both the controlled amortization period that began inAugust 2002, as well as the early amortization of this facility beginning sometime during the first quarter of 2003. We believe collections from cardholderswill be sufficient to completely repay the investors in the securitization.Except for fees that we will receive as servicer, we did not and do notanticipate receiving any cash from this facility while it is in its earlyamortization period.

 

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(5)                      Represents the expected principalpayment date; however, as early as July 2003, collections on the receivablescould be accumulated for the benefit of this facility and not be available tous to fund new purchases.

 

During the nine months ended September 30, 2002, we generatedapproximately $141.2 million in cash from the company operations. Cashgenerated or used by Company’s operations is dependent on the performance ofour managed portfolio including charge off rates, net interest margin, paymentrates and operating expenses. We generated positive cash flow in the thirdquarter and based on our current expectations of our managed portfolioperformance and our expected growth rates during the fourth quarter of thisyear, we expect to generate positive cash flow from operations during thefourth quarter as well.

 

We continue to explore a wide range of options for liquidity in orderfor us to maintain 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.

 

Our most significant source of liquidity is the securitization of creditcard receivables. The maturity terms of our securitizations vary. We have twothree-year securitizations that we completed in July 2001 andAugust 2000, several one-year securitizations, and, through the FingerhutTrust, an amortizing term securitization. Once repayment begins, payments fromcustomers on credit card receivables are accumulated to repay the investors andare no longer reinvested in new credit card receivables. At that time, ourfunding requirements for new credit card receivables will increase accordingly.The occurrence of adverse events may also cause the securitization transactionsto amortize earlier than scheduled or may require additional enhancements.These events include a decline in the portfolio’s annualized net yield or adecline in the payment rate, in each case, below set rates, or an increase in delinquenciesor charge offs, in each case, above set rates. The portfolio’s annualized netyield typically includes monthly finance charges and past due fees earned onthe receivables less monthly servicing fees, credit losses and cost of funds.These events would accelerate the need to utilize alternative funding sources.If our securitization facilities begin to trap cash flows or otherwise increasetheir required credit enhancement and we are unable to obtain additionalsources of liquidity (such as other securitization facilities structurallysubordinate to those facilities that are trapping cash or are in theiramortization period, other debt or the issuance of additional equity), we wouldbegin to close the credit card accounts that are open to new purchases and thussignificantly reduce our need for any additional cash. Under each of oursecuritization structures, there has not been an early amortization period;however, and as noted above we expect the Fingerhut Trust Series 1998-2issuance to begin an early amortization during the first quarter of 2003. Inline with our expectations at the time of our acquisition and projections uponwhich we based our purchase price for the Fingerhut Trust retained interests,the Fingerhut Trust Series 1998-2 is expected to trigger an early amortizationas a result of either one or both of the following factors. First, we expectthat the principal balance of receivables in the trust will fall below theminimum balance required by this series. Secondly, we expect that thethree-month average annualized net yield will fall below the minimum levelsrequired by this series. As each facility expires or comes up for renewal,there can be no assurance that the facility will be renewed or if renewed therecan be no assurance that the terms will be as favorable as the terms thatcurrently exist. Either of these events could significantly increase our needfor additional liquidity. For additional information regarding oursecuritization practice, see the “Credit Card Securitizations” section.

 

Our most significant uses of cash are marketing expenses, operatingexpenses and the purchase of the credit card receivables that arise in theaccounts that are issued through our relationship with Columbus Bank &Trust. We raise cash by selling the credit card receivables into oursecuritization programs. When we sell the receivables we receive cash and aseller’s interest (a portion of which is regularly referred to as a “retainedinterest”). Because the amount of cash that we receive is less than the faceamount of the receivables, this seller’s interest is a use of cash for us. Thereceivables in the securitization programs then generate cash as thecardholders make payments on their accounts. This cash is allocated by thesecuritization agreements to pay for servicing the receivables, to pay intereston the investor’s notes, to cover charge offs, and to repay any portion of theinvestor’s notes that are due. Any excess cash after the above allocations isremitted to us.

 

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During periods of rapid receivables growth, the cash that we raise fromselling the credit card receivables and from our retained interests is not byitself enough to cover our uses of cash. During periods of decline in thereceivables, there typically would be enough cash flow to cover our costs andwe would generate excess cash flow (depending on the performance of theunderlying receivables). To fund our use of cash associated with oursignificant growth during 1999, 2000 and 2001, we used the proceeds from ourinitial public offering and our follow-on offering. During the fourth quarterof 2001, we used a portion of our revolving credit facility, and we also raisedadditional cash by selling retained interests and preferred stock that wedescribed more fully in our 2001 Annual Report on Form 10-K. During 2002, weused our cash proceeds from our fourth quarter 2001 transactions and two notes,of which one is repaid, to fund our operations.

 

Absent changes in the manner in which we securitize credit cardreceivables, we believe that our asset securitizations, cash flow fromoperations and cash flows from our investment in CSG generally will provideadequate liquidity for our business at its current level. However, in order forus to continue growing our business, we will need additional sources ofliquidity to fund our retained interest portion of the growth. In addition,should the terms of the securitizations available to us become less favorable,we also will need additional sources of liquidity to fund our retainedinterests. We are particularly concerned about the continued availability ofsecuritizations on terms previously available to us given the recent poorperformance of several of our competitors and the impact of their performanceon the marketplace for securitizations.

 

***Stock Repurchase Plan***

 

During the third quarter of 2002, our Board of Directors authorized aprogram to repurchase up to 5 million shares (approximately 11 percent) of ouroutstanding common stock. Under the repurchase plan, we may buy back shares ofour common stock from time to time either on the open market or throughprivately negotiated transactions in compliance with the Securities andExchange Commission guidelines. We repurchased 500,000 shares on the openmarket at a total cost of $2.6 million during the third quarter of 2002.

 

***Critical Accounting Policies***

 

Our financial statements are prepared in accordance with GAAP. Theseprinciples are numerous and complex. Our significant accounting policies aresummarized in the notes to our financial statements. In many instances, theapplication of GAAP requires management to make estimates or to applysubjective principles to particular facts and circumstances. A variance in theestimates used or a variance in the application or interpretation of GAAP couldyield a materially different accounting result. It is impracticable for us tosummarize every accounting principle that requires us to use judgment orestimates in its application. In our Annual Report on Form 10-K for the yearended December 31, 2001, we discuss the two areas, valuation of retainedinterests and non-consolidation of special purpose entities, where we believethat the estimations, judgments or interpretations that we have made, ifdifferent, would have yielded the most significant differences in our financialstatements, and we urge you to review that discussion. In addition, in Note 5,“Securitizations” to the financial statements included in this report weupdated our sensitivity analysis with respect to valuations.

 

***Forward-Looking Information***

 

All statements in this quarterly report concerning our operating andearnings expectations for fiscal year 2002 and our liquidity expectations, andall other statements regarding our future performance (including those usingwords such as “believe,” “estimate,” “project,” “anticipate, or “predict”), areforward-looking statements. These forward-looking statements are not guaranteesof future performance and are subject to various assumptions, risks, and otherfactors that could cause our actual results to differ materially from thosesuggested by these forward-looking statements. These factors include, amongothers, the following risks and others set forth under the caption “RiskFactors” in our Annual Report 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

 

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dependent upon the cash flows received on thecredit card receivables underlying our securitizations. 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 theextent we have over estimated collectibility, in all likelihood we have overestimated our financial performance;

 

(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 securitizationfacilities are of finite duration (and ultimately will need to be extended orreplaced) and contain conditions that must be fulfilled in order for funding tobe available. In the event that advance rates for securitizations are reduced,investors in securitizations require a greater rate of return, we fail to meetthe requirements for continued funding, or large-scale securitizationsotherwise become unavailable to us, we may not be able to maintain or grow ourbase of credit card receivables or it may be more 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 andavailability of equity and borrowed funds is dependent upon our financialperformance, the performance of our industry generally, and general economicand market conditions, and recently has been both expensive and difficult toobtain;

 

(3) Our financial performance is,in part, a function of the aggregate amount of credit card receivables that wehave outstanding. In turn, this is a function of many factors includinginterest rates, seasonality, general economic conditions, competition fromother credit card issuers and other sources of consumer financing, access tofunding as noted above, and the success of our marketing efforts. To the extentthat we have over-estimated the size or growth of our credit card receivables,in all 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 the portfolio.One of our servicing agreements causes us to make additional payments if weoverestimate the size or growth of our business. These additional payments areto compensate the servicer for increased staffing expenses it incurs inanticipation of our growth. If we grow slower thananticipated, we maystill have higher servicing expenses than we actually need, thus reducing ournet income. We generally have sufficient office space, customer servicerepresentatives, collectors and computer capacity to accommodate expectedgrowth. However, we are dependent on labor markets to supply qualifiedemployees at appropriate compensation when needed. To the extent that growthoccurs unexpectedly, or the labor markets are tight at that time, we mayencounter difficulties in accommodating that growth effectively;

 

(5) We operate in a heavilyregulated industry. Changes in bankruptcy, privacy or other consumer protectionlaws may adversely affect our ability to collect credit card account balancesor otherwise adversely affect our business or expose us to litigation.Similarly, regulatory changes could adversely affect our ability to marketcredit cards and other products and services to our customers. The accountingrules that govern our business are exceedingly complex, difficult to apply, andin a state of flux. As a result, how we value our credit card receivables andotherwise account for our business (including whether we consolidate oursecuritizations) is subject to change depending upon the interpretation of, andchanges 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 attendantto any acquisition, including the possibility that we will overvalue the assetsto 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 aresult, the impact of any acquisition on our future performance may not be asfavorable as expected and actually may be adverse.

 

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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 required by law.

 

**ITEM 3.**** ****QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Interest rate sensitivity is comprised of basis risk, gap risk andmarket risk. Basis risk is caused by the difference in the interest rateindices used to price assets and liabilities. Gap risk is caused by thedifference in repricing intervals between assets and liabilities. Market riskis the risk of loss from adverse changes in market prices and rates. Ourprincipal market risk is related to changes in interest rates. This riskaffects us directly in our lending and borrowing activities, as well asindirectly as interest rates may impact the payment performance of ourcustomer.

 

We incur basis risk because we fund managed assets at a spread over thecommercial paper rate or LIBOR while the rates on the underlying assets areindexed to the prime rate. This basis risk results from the potentialvariability in the spread between the prime rate and the commercial paper rate,on the one hand, and LIBOR, on the other hand, over time. We have not hedgedour basis risk due to the cost of hedging this risk versus the benefits fromelimination of this risk.

 

We attempt to minimize the impact of market interest rate fluctuationson net interest income and net income by regularly evaluating the risk inherentin our asset and liability structure, especially our off-balance sheet assetsand liabilities such as securitized receivables. The impact of market interestrate fluctuations on our securitized receivables is reflected in the valuationof our retained interests in credit card receivables securitized. This riskarises from continuous changes in our asset and liability mix, changes inmarket interest rates, including changes affected by fluctuations in prevailinginterest rates, payment trends on our interest-earning assets and paymentrequirements on our interest-bearing liabilities, and the general timing of allother cash flows. To manage our direct risk to market interest rates,management actively monitors market interest rates and the interest sensitivecomponents of our securitization structures. Management seeks to minimize theimpact of changes in interest rates on the fair value of assets, net income andcash flow primarily by matching asset and liability repricings. There can be noassurance that management will be successful in its attempt to manage suchrisks.

 

At September 30, 2002, all of our credit card receivables and otherinterest-earning assets had variable rate pricing, with receivables carryingannual percentage rates at a spread over the prime rate, subject to interestrate floors. At September 30, 2002, our securitizations had $1.8 billionin variable rate, interest-bearing liabilities payable to investors, comparedto $1.4 billion as of September 30, 2001. Because both our managedinterest-earning assets and substantially all of our managed interest-bearingliabilities reprice approximately every 30 days, we believe that theimpact of a change in interest rates would not be material to our financialperformance.

 

We believe we are not exposed to any material foreign currency exchangerate risk or commodity price risk.

 

**ITEM 4. CONTROLSAND PROCEDURES**

 

(a) Evaluation ofdisclosure controls and procedures. Our chief executive officer and our chieffinancial officer, after evaluating the effectiveness of our “disclosurecontrols and procedures” (as defined in the Securities Exchange Act of 1934Rules 13a-14(c) and 15d-14(c)) as of a date (the “Evaluation Date”) within 90days before the filing date of this quarterly report, have concluded that as ofthe Evaluation Date, our disclosure controls and procedures were adequate anddesigned to ensure that material information relating to us and ourconsolidated subsidiaries would be made known to our chief executive officerand our chief financial officer by others within those entities.

 

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(b) Changes ininternal controls. There were no significant changes in our internal controlsor in other factors that could significantly affect our internal controls andprocedures subsequent to the Evaluation Date.

 

**PARTII – OTHER INFORMATION**

 

**Item 1.            Legal Proceedings**

 

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

 

**Item 2.            Changes in Securities and Use of Proceeds.**

 

(a) Not applicable.

 

(b) Not applicable.

 

(c) Not applicable.

 

**Item 3.            DefaultsUpon Senior Securities.**

 

None.

 

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

 

No matters were submitted to avote of our security holders during the three months ended September 30,2002.

 

**Item 5.            Other Information.**

 

None.

 

**Item6.            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                  |   | Amendment  to Affinity Agreement, dated as of September 23, 2002, among Columbus Bank  and Trust Company, CompuCredit Corporation and CompuCredit Acquisition  Corporation. |   | Filed  herewith                                                                                             |
| 10.2                  |   | Pledge  and Security Agreement, dated as of September 23, 2002, between CompuCredit  Corporation and Columbus Bank and Trust Company                                        |   | Filed  herewith                                                                                             |
| 10.3                  |   | Receivables  Purchase and Security Agreement, dated as of September 23, 2002, by and  between CFC LLC and Columbus Bank and Trust Company                                   |   | Filed  herewith                                                                                             |
| 10.4                  |   | Receivables  Purchase and Security Agreement, dated as of September 23, 2002, by and  between CFC II LLC and Columbus Bank and Trust Company                                |   | Filed  herewith                                                                                             |
| 10.5                  |   | Shareholders  Agreement, dated as of September 23, 2002, by and between Columbus Bank and  Trust Company and CompuCredit Corporation                                        |   | Filed  herewith                                                                                             |
| 10.6                  |   | Employment  Agreement between CompuCredit Corporation and J.Paul Whitehead, III                                                                                             |   | Filed  herewith                                                                                             |
| 10.7                  |   | First  Amendment to Amended and Restated Employment Agreement between CompuCredit  Corporation and Ashley L. Johnson                                                        |   | Filed  herewith                                                                                             |

 

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(b)Reports on Form8-K

 

Current Report onForm 8-K dated August 14, 2002, including Exhibit 2.1, which containscertain information regarding the purchase of certain assets from FederatedDepartment Stores by a subsidiary of the Registrant.

 

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**SIGNATURES**

 

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

 
|              | CompuCredit Corporation |
|-------------------|-------------------------|
|              |                    |
| November 14, 2002 | By                      | /s/ J.Paul Whitehead III |
|              |                    | J.Paul Whitehead III |
|              |                    | Chief Financial Officer  (duly authorized officer and principal financial officer) |

 

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**CERTIFICATIONS**

 

I, David G. Hanna, certify that:

 

1.             I have reviewed this quarterlyreport on Form 10-Q of CompuCredit Corporation;

 

2.             Based on my knowledge, thisquarterly report does not contain any untrue statement of a material fact oromit to state a material fact necessary to make the statements made, in lightof the circumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

 

3.             Based on my knowledge, thefinancial statements, and other financial information included in thisquarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4.                                       The registrant’s other certifyingofficers and I are responsible for establishing and maintaining disclosurecontrols and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)for the registrant and we have:

 

a)                                     designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this quarterly reportis being prepared;

 

b)                                    evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this quarterly report (the “Evaluation Date”); and

 

c)                                     presented in this quarterly report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

5.                                       The registrant’s other certifyingofficers and I have disclosed, based on our most recent evaluation, to theregistrant’s auditors and the audit committee of registrant’s board ofdirectors (or persons performing the equivalent function):

 

a)                                     all significant deficiencies in the designor operation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

 

b)                                    any fraud, whether or not material, thatinvolves management or other employees who have a significant role in theregistrant’s internal controls; and

 

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6.                                       The registrant’s other certifyingofficers and I have indicated in this quarterly report whether or not therewere significant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 
| Date: November 14,  2002 |   | /s/ David G. Hanna |
|-------------------------------|--------|--------------------|
|                          |   |               | David G. Hanna |
|                          |   |               | Chairman and Chief  Executive Officer |

 

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I, J.Paul Whitehead, III, certify that:

 

1.                                       I have reviewed this quarterly report onForm 10-Q of CompuCredit Corporation;

 

2.                                       Based on my knowledge, this quarterlyreport does not contain any untrue statement of a material fact or omit tostate a material fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

 

3.                                       Based on my knowledge, the financialstatements, and other financial information included in this quarterly report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this quarterly report;

 

4.                                       The registrant’s other certifyingofficers and I are responsible for establishing and maintaining disclosurecontrols and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)for the registrant and we have:

 

a)                                     designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this quarterly reportis being prepared;

 

b)                                    evaluated the effectiveness of the registrant’sdisclosure controls and procedures as of a date within 90 days prior to thefiling date of this quarterly report (the “Evaluation Date”); and

 

c)                                     presented in this quarterly report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

5.                                       The registrant’s other certifyingofficers and I have disclosed, based on our most recent evaluation, to theregistrant’s auditors and the audit committee of registrant’s board ofdirectors (or persons performing the equivalent function):

 

a)                                     all significant deficiencies in the designor operation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and have identifiedfor the registrant’s auditors any material weaknesses in internal controls; and

 

b)                                    any fraud, whether or not material, thatinvolves management or other employees who have a significant role in theregistrant’s internal controls; and

 

6.                                       The registrant’s other certifyingofficers and I have indicated in this quarterly report whether or not therewere significant changes in internal controls or in other factors that couldsignificantly affect

 

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internal controlssubsequent to the date of our most recent evaluation, including any correctiveactions with regard to significant deficiencies and material weaknesses.

 
| Date: November 14,  2002 |   | /s/ J. Paul Whitehead,  III |
|-------------------------------|--------|-----------------------------|
|                          |   |                        | J.Paul Whitehead, III |
|                          |   |                        | Chief Financial Officer |

 

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