COMPUCREDIT CORP - 10-Q Quarterly Report

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

The registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

The registrant is an accelerated filer (as defined by Rule 12b-2 of the Exchange Act).

46,805,302 shares of the issuer's Common Stock, no par value were outstanding as of August 1, 2003.

		June 30, 2003			December 31, 2002
		(Unaudited)
		(Dollars in thousands)
Assets
Cash and cash equivalents		$	100,333		$	120,416
Restricted cash			10,127			10,112
Retained interests in credit card receivables securitized			373,204			291,439
Amounts due from securitization			14,245			7,235
Deferred costs, net			4,609			8,314
Software, furniture, fixtures and equipment, net			25,782			29,296
Investment in equity-method investee			6,810			15,593
Investment in previously charged off receivables			12,164			—
Investment in debt securities			23,910			18,819
Prepaid expenses and other assets			15,474			17,691

Total assets		$	586,658		$	518,915

Liabilities
Accounts payable and accrued expenses		$	25,078		$	32,570
Notes payable			7,506			—
Deferred revenue			9,943			8,979
Income tax liability			38,021			29,498

Total liabilities			80,548			71,047

Shareholders' equity
Preferred stock, no par value, 10,000,000 shares authorized:
	Series A preferred stock, 25,192 and 30,000 shares issued and outstanding at June 30, 2003 and December 31, 2002, respectively		28,572			32,466
	Series B preferred stock, 10,000 and 10,000 shares issued and outstanding at June 30, 2003 and December 31, 2002, respectively		11,593			11,035
Common stock, no par value:
	150,000,000 shares authorized, 47,676,802 and 46,809,165 issued at June 30, 2003 and December 31, 2002, respectively		—			—
Additional paid-in capital			249,022			241,400
Treasury stock, at cost, 872,900 and 832,900 shares at June 30, 2003 and December 31, 2002, respectively			(4,586	)		(4,338	)
Deferred compensation			(803	)		(1,013	)
Note issued to purchase stock			—			(500	)
Retained earnings			222,312			168,818

Total shareholders' equity			506,110			447,868

Total liabilities and shareholders' equity		$	586,658		$	518,915

CompuCredit Corporation and Subsidiaries
Condensed Consolidated Statements of Operations (Unaudited)

		For the three months ended June 30,						For the six months ended June 30,
		2003			2002			2003			2002
		(Dollars in thousands except per share data)
Interest income		$	1,577		$	295		$	2,786		$	660
Interest expense			(2,981	)		(43	)		(6,279	)		(103	)

Net interest (expense) income			(1,404	)		252			(3,493	)		557

Other operating income:
	Income (loss) from retained interests in credit card receivables securitized		10,766			(62,921	)		47,073			(57,219	)
	Servicing income		24,863			2,394			52,529			3,679
	Other credit card fees and other income		38,718			31,775			72,492			65,055
	Equity in income of equity-method investee		13,612			4,544			27,908			4,544

Total other operating income			87,959			(24,208	)		200,002			16,059

Other operating expense:
	Salaries and benefits		4,428			3,028			8,769			6,624
	Credit card servicing		33,456			15,817			71,503			35,887
	Marketing and solicitation		2,827			2,417			4,414			5,041
	Depreciation		3,905			3,620			7,770			7,190
	Other		8,783			6,654			17,322			14,116

Total other operating expense			53,399			31,536			109,778			68,858

Income (loss) before income taxes			33,156			(55,492	)		86,731			(52,242	)
Income taxes			(11,736	)		19,422			(31,023	)		18,284

Net income (loss)		$	21,420		$	(36,070	)	$	55,708		$	(33,958	)

Net income (loss) attributable to common shareholders		$	20,314		$	(37,099	)	$	53,494		$	(35,991	)

Net income (loss) per common share—basic		$	0.42		$	(0.80	)	$	1.09		$	(0.77	)

Net income (loss) per common share—diluted		$	0.42		$	(0.80	)	$	1.08		$	(0.77	)

CompuCredit Corporation and Subsidiaries
Condensed Consolidated Statement of Shareholders' Equity (Unaudited)
For the Six Months Ended June 30, 2003

CompuCredit Corporation and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Unaudited)

			For the six months ended June 30,
			2003			2002
			(Dollars in thousands)
Operating activities
Net income (loss)			$	55,708		$	(33,958	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
	Depreciation expense			7,770			7,190
	Amortization expense			3,401			7,331
	Amortization of acquired servicing liability			(26,238	)		—
	Amortization of deferred compensation			210			—
	Retained interests income adjustment, net			17,725			45,715
	Income from equity investee, net			8,785			(4,544	)
	Changes in assets and liabilities:
		Increase in restricted cash		—			(10,000	)
		(Increase) decrease in accrued interest and fees		(25	)		14,707
		(Increase) decrease in amounts due from securitization		(7,010	)		6,733
		Increase in deferred costs		(2,932	)		(2,954	)
		(Increase) decrease in prepaid expenses		(659	)		191
		Decrease in accounts payable and accrued expenses		(7,478	)		(12,399	)
		Increase (decrease) in deferred revenue		964			(5,706	)
		Increase (decrease) in income tax liability		8,523			(22,284	)
		Other		15,058			411

Net cash provided by (used in) operating activities				73,802			(9,567	)

Investing activities
Investment in equity investee				—			(34,890	)
Proceeds from bond investment				3,650			—
Purchase of charged off accounts				(24,339	)		—
Purchase of bonds				(1,300	)		—
Net loan payments (purchases)				52,164			(12,970	)
Recoveries of loans previously charged off				11,321			13,602
Net proceeds from securitization				—			4,321
Net increase in retained interests				(133,333	)		—
Purchases and development of software, furniture, fixtures and equipment				(4,257	)		(3,158	)

Net cash used in investing activities				(96,094	)		(33,095	)

Financing activities
Preferred stock issuance costs				—			(140	)
Repayment of note issued to purchase stock				398			—
Proceeds from exercise of stock options				2,059			—
Purchase of treasury stock				(248	)		—
Proceeds from borrowings				—			31,401
Repayment of short-term borrowings				—			(16,516	)

Net cash provided by financing activities				2,209			14,745

Net decrease in cash				(20,083	)		(27,917	)
Cash and cash equivalents at beginning of period				120,416			55,746

Cash and cash equivalents at end of period			$	100,333		$	27,829

Supplemental cash flow information
Cash paid for interest			$	6,279		$	116

Cash paid for income taxes			$	22,500		$	4,000

Accretion of preferred stock dividends			$	2,227		$	2,002

CompuCredit Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
June 30, 2003

The condensed consolidated financial statements include the accounts of CompuCredit Corporation and its wholly owned subsidiaries (collectively, the "Company"). The Company was formed for the purpose of offering unsecured credit and 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 services through direct mail, telemarketing, television, the internet and acquisition from other credit card issuers. Because only financial institutions can issue general purpose credit cards, the Company has a contractual arrangement with a third-party financial institution pursuant to which the financial institution issues general purpose Visa and MasterCard credit cards, and the Company purchases the receivables relating to such credit card accounts on a daily basis. Additionally, the Company has purchased the receivables relating to accounts generated by other third-party financial institutions from time to time as a further source for growth in its business. The Company markets to its cardholders other fee-based products including card registration, memberships in preferred buying clubs, travel services and credit life, disability and unemployment insurance.

The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Securities and Exchange Commission ("SEC") Regulation S-X. Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States of America for complete consolidated financial statements. In the opinion of management, all normal recurring adjustments considered necessary to fairly state the results for the interim periods presented have been included. The preparation of condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. Certain estimates, such as credit losses, payments, discount rates and the yield earned on securitized receivables, have a significant impact on the gains and losses recorded on securitizations and the value of retained interests in credit card receivables securitized. Operating results for the three and six months ended June 30, 2003 are not necessarily indicative of the results for the year ending December 31, 2003. These condensed consolidated financial statements should be read in conjunction with the notes to the consolidated financial statements for the year ended December 31, 2002 contained in the Company's Annual Report on Form 10-K filed with the SEC.

Certain amounts in prior period financial statements have been reclassified to conform to the current period presentation. All significant intercompany balances and transactions have been eliminated for financial reporting purposes.

The following is a summary of significant accounting policies followed in the preparation of the condensed consolidated financial statements.

Cash and cash equivalents consist of cash, money market investments and overnight deposits. The Company considers all other highly liquid cash investments with low interest rate risk and maturities of

three months or less to be cash equivalents. Cash equivalents are valued at cost, which approximates market.

The Company provides an irrevocable standby letter of credit agreement for $10.0 million to the financial institution that issues the credit cards marketed by the Company. The purpose of the letter of credit is to protect the financial institution from non-payment by the Company of its obligation to purchase receivables arising in the credit card accounts on a daily basis. The Company is required to maintain a minimum cash balance of $10.0 million with the bank that has issued the letter of credit. Such cash, and certain interest earnings thereon, have been disclosed as restricted cash on the face of the consolidated balance sheet.

Substantially all of the Company's credit card receivables are securitized. When the Company sells originated receivables in securitizations, it retains certain undivided ownership interests, interest-only ("I/O") strips and servicing rights. Although the Company continues to service the underlying credit card accounts and maintains the customer relationships, these securitizations are treated as sales, and the securitized receivables are not reflected on the consolidated balance sheet. The retained ownership interests and the interest-only strips are included in retained interests in credit card receivables securitized on the face of the consolidated balance sheet.

Under Statement of Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("Statement No. 140"), gains and losses are recognized at the time of each sale. These gains or losses on sales of receivables depend in part on the previous carrying amount of the financial assets sold, as well as the fair value of the assets and cash proceeds received. The cash flows used in measuring the gains and losses represent estimates of finance charges and late fees, servicing fees, costs of funds paid to investors, payment rates, credit losses, and required amortization payments to investors. The Company initially records a servicing liability within a securitization structure when the servicing fees the Company expects to receive do not provide adequate compensation for servicing the receivables. The initial servicing liability is recorded at estimated fair market value. The servicing liability is then evaluated each quarter and carried at its estimated fair value. Changes in fair value are included as a component of the Company's income (loss) from retained interests in credit card receivables securitized, with actual expenses being recorded into operations as incurred. Because quoted market prices are generally not available, the Company estimates fair value based on the estimated present value of future cash flows using management's best estimates of key assumptions as outlined in Note 5, "Off Balance Sheet Arrangements." The servicing liability is netted against the value of the I/O strip and included in retained interests in credit card receivables securitized on the Company's balance sheet. In accordance with Statement No. 140, the Company does not consolidate any of the qualified special purpose entities ("QSPEs") in its securitizations.

The retained interests for portfolios securitized by the Company are accounted for as trading securities and reported at estimated fair market value, with changes in fair value included in operations in accordance with Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("Statement No. 115"). The estimates used to determine the gains and losses and the related fair values of I/O strips and retained ownership interests are influenced by factors outside of the Company's control, and such estimates could materially change from quarter to quarter.

Retained interests purchased by the Company during 2002 are carried at the lower of amortized cost or fair market value, net of a servicing liability. In accordance with Emerging Issues Task Force

Issue 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets" ("EITF 99-20"), expected cash flows in excess of the costs of the purchased retained interests are being amortized into income (loss) from retained interests in credit card receivables securitized using the effective interest method.

Amounts due from securitization include payments recently received on the securitized receivables that are still held by the securitization structure but are due and payable to the Company within the next 30 days.

Accrued interest and fees represent the estimated collectable portion of fees earned on the Company's originated portfolios but not billed to the cardholder at any period end. Prior to the second quarter of 2002, the Company estimated accrued interest and fees using its estimates of total accrued interest and fees earned but not yet billed. The Company's current estimates, however, better reflect the Company's expectations of the collectible portion of these interest and fees and are in response to evolving regulatory guidance within the industry.

Included within the Company's retained interests in credit card receivables securitized on its consolidated balance sheet at each period end is the estimated collectible portion of finance charges and fees billed to cardholders within the originated portfolio but not collected (the Company's "retained interests in finance charge receivables"). Prior to the second quarter of 2002, the Company estimated its retained interests in finance charge receivables using its estimates of total finance charges and fees billed but not collected. The Company's current estimates, however, better reflect the Company's expectations of the collectible portion of these finance charges and fees and are in response to evolving regulatory guidance within the industry.

In late 2002, the Company formed a new debt collections subsidiary and began the process of obtaining the appropriate licenses from among the 50 states and meeting all applicable regulatory requirements necessary for the Company to hold itself out as a debt collector and a buyer of defaulted credit card accounts. Through this new subsidiary, the Company has pursued, competitively bid for, and closed acquisitions of previously charged off credit card receivables during the first two quarters of 2003. All but one of the Company's acquisitions of previously charged off credit card receivables during the first two quarters of 2003 were from the securitization trusts underlying the Company's retained interests investments ($23.9 million in purchase price). The Company is continually evaluating acquisition opportunities, but only at appropriate pricing and only pursuant to a strict competitive bid process involving other potential portfolio purchasers to ensure that all acquisitions have been at fair market prices.

The Company accounts for its investment in previously charged off receivables using the interest method under the guidance of Practice Bulletin 6, "Amortization of Discounts on Certain Acquired Loans." Static pools consisting of homogenous accounts and receivables are established for each acquisition. Once a static pool is established, the receivables within the pool are not changed. Each static pool is recorded at cost, and is accounted for as a single unit for payment application and income recognition purposes. Income associated with each static pool is accrued monthly based on each static pool's effective interest rate. This effective interest rate is estimated based on the timing and amount of anticipated cash flows from the pool using the Company's proprietary pricing and collection models. Monthly cash flows greater than the monthly interest accrual will reduce the carrying value of the static pool. Likewise, monthly cash flows that are less than the monthly interest accrual will increase the

carrying value. Each pool is reviewed monthly and compared to the Company's models to ensure complete amortization of the carrying value by the end of each pool's projected life. In the event that cash collections would be inadequate to amortize the carrying value, an impairment charge would be taken with a corresponding write-off of the receivable balance. Accordingly, the Company does not maintain an allowance for credit losses against the carrying value of each static pool.

For the three and six months ended June 30, 2003, the following table shows a roll-forward of the Company's new investment in previously charged off receivables activities:

At the time of acquisition, the life of each pool generally is estimated to be between 24 and 36 months based upon the proprietary models of the Company. The Company anticipates collecting approximately 67% of the ERC over the next twelve months, with the balance collected thereafter.

During the second quarter of 2003, the Company acquired $10 million in bonds for a total purchase price of approximately $8.7 million and has included this amount in investment in debt securities. The Company is accreting the discount into interest income over the estimated life of the bonds. The stated maturity date of the bonds is February 15, 2007, and the bonds earn interest at LIBOR plus 95 basis points (2.13% at June 30, 2003). The Company financed the purchase of these bonds with $6.09 million in borrowed funds that accrue interest at the average money call rate for the month plus 0.75% (3.5% at June 30, 2003). These borrowed funds are included in notes payable along with borrowings associated with certain vendor-financed acquisitions of software, furniture and fixtures and equipment.

During the second quarter of 2003, Paladin Capital Partners Fund, L.P., the then holder of 4,808 shares of Series A Preferred Stock, converted its shares into 608,684 shares of common stock.

During the third quarter of 2002, the Company's Board of Directors authorized a program to repurchase up to 5 million shares (approximately 11 percent of the outstanding total) of its outstanding common stock. Under the repurchase plan, the Company repurchases shares of its common stock from time to time either on the open market or through privately negotiated transactions in compliance with SEC guidelines. These shares are carried at cost in the accompanying condensed consolidated balance sheet. During the first quarter of 2003, the Company repurchased 40,000 shares on the open market for $247,800. No shares were repurchased during the second quarter of 2003.

During the second quarter of 2003, the Company settled with the holder of the note issued to purchase common stock for cash proceeds of approximately $398,000. The Company recorded the difference between the carrying value of the note and the cash proceeds received (approximately $102,000) as a charge to other operating expense for the three months ended June 30, 2003.

The Company has two stock-based employee compensation plans. As permitted by Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("Statement No. 123"), the Company accounts for those plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), and its related interpretations. Because all options granted under the Company's plans had an exercise price equal to the market value of the underlying common stock on the date of grant, no stock-based compensation cost is reflected in net income under the Company's application of APB 25. Additionally, the Company did not issue any options to non-employees who were not directors for the three and six months ended June 30, 2003 and 2002, respectively. During the quarter ended June 30, 2003, options to purchase 258,953 common shares were exercised for total proceeds of approximately $2.1 million.

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

				Page
PART I.	FINANCIAL INFORMATION
	Item 1.	Financial Statements (Unaudited)
			Condensed Consolidated Balance Sheets	1
			Condensed Consolidated Statements of Operations	2
			Condensed Consolidated Statement of Shareholders' Equity	3
			Condensed Consolidated Statements of Cash Flows	4
			Notes to Condensed Consolidated Financial Statements	5
	Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations		19
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk		47
	Item 4.	Controls and Procedures		48
PART II.	OTHER INFORMATION
	Item 1.	Legal Proceedings		48
	Item 2.	Changes in Securities and Use of Proceeds		48
	Item 3.	Defaults Upon Senior Securities		48
	Item 4.	Submission of Matters to a Vote of Security Holders		48
	Item 5.	Other Information		49
	Item 6.	Exhibits and Reports on Form 8-K		49
		Signatures		50

	Three Months Ended June 30, 2003			Six Months Ended June 30, 2003
	(Dollars in thousands)
Balance at March 31, 2003	$	7,034		$	—
Acquisitions of defaulted accounts		9,443			24,339
Cash collections		(17,147	)		(34,417	)
Income recognized on defaulted accounts		12,834			22,242

Balance at June 30, 2003	$	12,164		$	12,164

Estimated remaining collections ("ERC")	$	49,703		$	49,703

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

					Common Stock
		Preferred Stock			Common Stock		Additional Paid-In Capital		Treasury Stock			Deferred Compensation			Other Changes In Equity			Retained Earnings			Total Shareholders' Equity
		Preferred Stock			Shares	Amount	Additional Paid-In Capital		Treasury Stock			Deferred Compensation			Other Changes In Equity			Retained Earnings			Total Shareholders' Equity
		(Dollars in thousands)
Balance at December 31, 2002 (audited)		$	43,501		46,809,165	—	$	241,400	$	(4,338	)	$	(1,013	)	$	(500	)	$	168,818		$	447,868
	Conversion of preferred stock		(5,563	)	608,684	—		5,563		—			—			—			—			—
	Preferred dividends		—		—	—		—		—			—			—			(2,214	)		(2,214	)
	Accretion of preferred dividends		2,227		—	—		—		—			—			—			—			2,227
	Exercise of stock options		—		258,953	—		2,059		—			—			—			—			2,059
	Purchase of treasury stock		—		—	—		—		(248	)		—			—			—			(248	)
	Repayment of note receivable		—		—	—		—		—			—			500			—			500
	Amortization of deferred compensation		—		—	—		—		—			210			—			—			210
	Net income		—		—	—		—		—			—			—			55,708			55,708

Balance at June 30, 2003		$	40,165		47,676,802	—	$	249,022	$	(4,586	)	$	(803	)	$	—		$	222,312		$	506,110