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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended 001-12351
December 31, 1998 Commission file number
--------------------
METRIS COMPANIES INC.
(Exact name of registrant as specified in its charter)
Delaware 41-1849591
(State of Incorporation) (I.R.S. Employer Identification No.)
600 South Highway 169, Suite 1800, St. Louis Park, Minnesota 55426
(Address of principal executive offices)
(612) 525-5020
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to section 12(g) of the Act:
Common Stock, $.01 Par Value
Indicate by check mark whether 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 and (2) has been subject to such filing requirements for
the past 90 days.
Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
As of February 26, 1999, 19,261,195 shares of the Registrant's Common Stock were
outstanding and the aggregate market value of Common Stock held by
non-affiliates of the Registrant on that date was approximately $729,500,000,
based upon the closing price on The Nasdaq Stock Market(R) on February 26,
1999.
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the Annual Report to Shareholders for the year ended
December 31, 1998, are incorporated by reference in Parts II and IV.
Certain portions of the Proxy Statement for the Annual Meeting of Shareholders
of Metris Companies Inc. to be held on May 11, 1999, which will be filed with
the Securities and Exchange Commission within 120 days after December 31, 1998,
are incorporated by reference in Part III.
TABLE OF CONTENTS
PART I
Page
Item 1. Business......................................................3
Item 2. Properties...................................................26
Item 3. Legal Proceedings............................................26
Item 4. Submission of Matters to a Vote of Security Holders..........27
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters..........................................27
Item 6. Selected Financial Data......................................27
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations..........................27
Item 7A. Quantitative and Qualitative Disclosures About Market Risk....27
Item 8. Financial Statements and Supplementary Data..................28
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure..........................61
PART III
Item 10. Directors and Executive Officers of the Registrant...........61
Item 11. Executive Compensation.......................................61
Item 12. Security Ownership of Certain Beneficial
Owners and Management........................................61
Item 13. Certain Relationships and Related Transactions...............61
PART IV
Item 14. Exhibits, Financial Statement Schedules
and Reports on Form 8-K......................................61
Signatures..............................................................63
Exhibit Index...........................................................65
PART I
Item 1. Business
Metris Companies Inc. ("MCI" and collectively with its subsidiaries,
the "Company") is an information-based direct marketer of consumer credit
products and fee-based services primarily to moderate income consumers. The
Company's consumer credit products are primarily unsecured credit cards issued
by its subsidiary, Direct Merchants Credit Card Bank, National Association
("Direct Merchants Bank"). The Company's customers and prospects include
individuals for whom credit bureau information is available ("External
Prospects") and existing customers of a former affiliate, Fingerhut Corporation
("Fingerhut" or "Fingerhut Customers") from the Fingerhut database. The Company
markets its fee-based services, including debt waiver programs, membership
clubs, extended service plans, and third party insurance, to its credit card
customers and customers of third parties.
MCI was incorporated in Delaware on August 20, 1996. The Company became
a publicly held company in October 1996 after completing an initial public
offering. The Company's principal subsidiaries are Direct Merchants Bank, and
Metris Direct, Inc. Prior to its name change in August 1996, Metris Direct, Inc.
was known as Fingerhut Financial Services Corporation. During the third quarter
of 1998, Fingerhut Companies, Inc. ("FCI") received written approval from the
Internal Revenue Service to distribute its interest in the Company to FCI's
shareholders in a tax free spin off (the "Spin Off").
Business Segments
In June 1997, the Financial Accounting Standards Board ("FASB") issued
the Statement of Financial Accounting Standards ("SFAS") No. 131 "Disclosures
about Segments of an Enterprise and Related Information." This statement
establishes standards for the way public enterprises report information about
operating segments. SFAS 131, which was adopted by the Company for the year
ended December 31, 1998, requires management to describe the factors used to
identify the segments.
Management has concluded that the Company measures performance and
operates in two business segments.
o Consumer Credit Products, which are primarily unsecured credit cards
issued by Direct Merchants Bank; and
o Fee-Based Services, which include debt waiver programs, membership
clubs and third party insurance offered to its credit card
customers and customers of third parties. In addition, the Company
includes within this operating segment the Company's extended
service plans.
The Company receives income from its consumer credit products through:
interest charges and other finance charges assessed on outstanding credit card
loans; credit card fees (including annual membership, cash advances, overlimit
fees, and past due fees); and interchange fees. The primary expenses of this
business are the costs of funding the loans, provisions for loan losses and
operating expenses including employee compensation, account solicitation and
marketing expenses and data processing and servicing expenses. Profitability is
affected by response rates to solicitation efforts, loan growth, interest
spreads on loans, credit card usage, credit quality (delinquencies and charge
offs), card cancellations and fraud losses.
The fee-based services business derives benefits from the Company's
consumer credit products business because the Company cross sells fee-based
products to its credit card holders. Nonetheless, the two business segments are
different with respect to the factors that affect profitability, including how
income is generated and how expenses are incurred. These differences require
management to manage their operations separately.
The Company receives revenue from its fee-based services through fees
and commissions for such services. Expenses include costs of solicitation,
underwriting and claims servicing expenses, fees paid to third parties and other
operating expenses. Profitability for this business is affected by response
rates to solicitation efforts, returns or cancel rates, claims rates, and other
factors.
The Company primarily targets moderate income consumers whom the
Company believes are underserved by traditional providers of many of the
Company's products and services. The Company intends to serve this target market
using its proprietary scoring techniques together with information from credit
bureaus and Fingerhut's database to determine a potential customer's
creditworthiness. The Company uses sophisticated modeling techniques to evaluate
the expected risk, responsiveness, and profitability of each prospective
customer and to offer and price the products and services it believes to be
appropriate for each customer. (See more detailed discussion following under
"Business Lines.")
Strategy
The principal components of the Company's strategy are the following:
Identify and solicit additional External Prospects for credit cards.
The Company intends to continue adding moderate income consumers who are
currently not Fingerhut Customers through the use of its own internally
developed risk models. The Company has developed its own proprietary credit risk
modeling system (the "Proprietary Modeling System"). By incorporating individual
credit information from the major credit bureaus into this Proprietary Modeling
System and eliminating those individuals contained in the Fingerhut suppression
and bad debt file (the "Suppress File"), the Company expects to generate
additional customer relationships from External Prospects.
Use risk-based pricing. The specific pricing for an individual's credit
card offer is determined by the prospective customer's risk profile and expected
responsiveness prior to solicitation, a practice known as "risk-based pricing."
Management believes the use of risk-based pricing allows it to maximize the
profitability of a customer relationship.
Pursue acquisitions of credit card portfolios or other businesses. The
Company expects to continue to pursue acquisitions of credit card portfolios
and/or other businesses whose customers fit the Company's product and target
market profile or which otherwise strategically fit with the Company's business.
Increase the number of Fingerhut Customers using the Company's products
and services. The Company's strategy is to continue to use its proprietary risk,
response and profitability models to solicit Fingerhut Customers for credit
cards, and to focus its cross-selling activities in order to increase the volume
of fee-based services and extended service plans purchased by these customers.
Cross-sell multiple products and services to each customer. The Company
intends to maximize the profitability of each customer relationship by
cross-selling additional products, thereby leveraging its account acquisition
costs and infrastructure. Currently the Company focuses its cross-selling
efforts on selling fee-based services to its credit card customers and customers
of third parties.
Access additional customers by establishing relationships with third
parties. The Company will seek to access additional customers for the Company's
products and services by establishing relationships with third parties.
Diversify product offerings to our customers. The Company intends to
segment markets to expand the success of our existing credit and fee-based
products. To do so, the Company plans to maximize our information advantage and
analyze data to determine the needs of our customers, then develop, test and
effectively introduce the right products to the right people.
Spin Off
During the third quarter of 1998, FCI received formal written approval
from the Internal Revenue Service to complete the tax-free "Spin Off" of FCI's
remaining 83% interest in the Company. The FCI Board of Directors approved the
Spin Off and completed the distribution of Metris shares on September 25, 1998
to FCI shareholders.
The Company believes that it will be able to pursue expansion of its
business and operations without certain limitations that existed as a result of
FCI's ownership of the Company, including limitations on the Company's ability
to issue additional common equity. As a result of the Spin Off, the Company
believes that it will be able to more effectively develop relationships with
retailers other than Fingerhut with respect to its extended service plans
because the Company will no longer be viewed as affiliated with a competitor of
such retailers. In addition, on March 12, 1999, the Company's shareholders
approved an amendment to the Company's Amended and Restated Certificate of
Incorporation ("The Certificate of Incorporation") to eliminate the detailed
restrictions concerning the business activities in which the Company is
permitted to engage. These restrictions were originally adopted to address
certain potential conflicts of interest between FCI and the Company.
Each of the agreements between the Company and Fingerhut or FCI, other
than the tax sharing agreement, remain in effect after the Spin Off. Although
the administrative services agreement remains in effect, it is expected that the
only continuing administrative services to be provided by FCI to the Company
will be information systems, and that these services will continue to be
provided for no longer than 18 months following the Spin Off.
Each of the agreements between the Company and Fingerhut or FCI may
terminate early due to a Change of Control of the Company. The Spin Off itself
did not constitute a Change of Control. However, now that FCI does not own the
stock of the Company, it is possible for a Change of Control to occur, thus
causing early terminations of these agreements.
Specifically, the Company has a contract with Fingerhut to use the
information in the Fingerhut database for marketing its financial services
products, including general purpose credit cards. This contract expires October
2003 and is renewable thereafter upon mutual agreement between Fingerhut and the
Company unless there has been a change in control of the Company. A change of
control (the "Change of Control") shall be deemed to have occurred if (a) any
person or group (within the meaning of Rule 13d-5 of the Securities Exchange Act
of 1934, as in effect), other than FCI, shall own beneficially or of record,
shares representing more than 25% of the aggregate ordinary voting power
represented by the issued and outstanding capital stock of the Company, (b) a
majority of the seats (other than vacant seats) on the Board of Directors of the
Company shall at anytime be occupied by persons who were neither (i) nominated
by FCI, or by the Board of Directors of the Company nor (ii) appointed by
directors so nominated, or (c) any person or group other than FCI shall
otherwise directly or indirectly have the power to exercise a controlling
influence over management or policies of the Company. However, after the Spin
Off, the Company cannot make any predictions as to whether a change in control
might occur.
On November 13, 1998, the Company entered into agreements with
affiliates of the Thomas H. Lee Company (the "Lee Company") to invest $300
million in the Company. The terms of the transaction provided that the Lee
Company investment would convert into 0.8 million shares of Series C Perpetual
Convertible Preferred Stock (the "Series C Preferred") upon shareholder approval
and receipt of notice that there was no regulatory objection to the transaction.
The Company determined that this conversion might result in a "Change of
Control" as defined in certain agreements between the Company and Fingerhut,
which would permit Fingerhut to terminate any or all of the agreements.
Therefore, on December 8, 1998, the Company obtained an agreement (the "Waiver
Agreement") from Fingerhut to waive its right to terminate the agreements if a
Change of Control occurred as a result of the conversion.
Pursuant to the Waiver Agreement, the Company and Fingerhut amended
certain of their other agreements. The most significant change occurred in the
database access agreement. The Company's exclusive license to use Fingerhut's
customer database to market financial service products will become non-exclusive
after October 31, 2001.
On March 12, 1999, the Company's shareholders approved the conversion
of the Lee Company investment into the Series C Preferred. If the Company
receives notice that there is no regulatory objection to the transaction, the
conversion will occur and the Lee Company will own approximately 30% of the
Company on a diluted basis.
Following the Spin Off, no individual holds titles of officer or
director at both FCI and the Company, except for Theodore Deikel, who is
Chairman of the Board and Chief Executive Officer of FCI and Non-Executive
Chairman of the Board of the Company.
Business Lines
The Company operates primarily through two businesses: consumer credit
products and fee-based services.
Consumer credit products
Products. The Company's consumer credit products are primarily
unsecured credit cards, including the Direct Merchants Bank MasterCard(R) and
Visa(R). In the future, the Company may offer co-branded credit cards and may
also offer other consumer credit products either directly or through alliances
with other companies. At December 31, 1998, the Company had approximately 3.0
million credit card accounts with over $5.3 billion in managed credit card
loans. Fingerhut Customers represented approximately 35% of the accounts and
managed loans. According to the Nilson Report, at December 31, 1998, the Company
was the 10th largest MasterCard issuer in the United States based on the number
of cards issued, and the 14th largest credit card issuer in the United States
based on managed credit card loan balances.
The Fingerhut Database. One of the Company's primary sources of names
to solicit for credit card offers is a database maintained by Fingerhut, a
wholly owned subsidiary of FCI. Fingerhut is a database marketing firm that
sells a broad range of products and services via catalogs, telemarketing,
television, and other media. Substantially all of Fingerhut's sales are made
using closed-end and revolving credit card loans. As customers make payments and
order new products, Fingerhut enters a variety of payment, behavioral, and other
data into its database (the "Fingerhut Database"). Fingerhut uses this database,
along with sophisticated and highly automated proprietary modeling techniques,
to evaluate each customer's creditworthiness. The Fingerhut Database contains
information on more than 31 million individuals. This database contains up to
3,500 potential data items in a customer record, including names, addresses,
behavioral characteristics, general demographic information and other
information provided by the customer. Fingerhut uses information in the
Fingerhut Database, along with sophisticated proprietary credit scoring models,
to produce its proprietary credit scores (the "Fingerhut Scores") for Fingerhut
Customers. The Fingerhut Database also includes Fingerhut's Suppress File, which
contains information on individuals about whom it has information relating to
indicators of unacceptably high risk. Fingerhut periodically updates the
information in the Fingerhut Database. Fingerhut does not report its credit
information to the credit bureaus, which means this information is not publicly
available.
Credit Scoring. The Company uses the Fingerhut Database to identify
potential customers. Fingerhut uses the information in the Fingerhut Database,
along with its proprietary credit scoring models to create the Fingerhut Score.
The Company also acquires credit bureau information, including risk scores
provided by Fair, Isaac & Company ("FICO scores"), for all Fingerhut Customers.
For those Fingerhut Customers who have FICO scores, the Company uses the
Fingerhut Score to further segment Fingerhut Customers into narrower ranges
within each FICO score subsegment, allowing the Company to better evaluate
credit risk and to tailor its risk-based pricing accordingly. Additionally, the
Fingerhut Score is used to target individuals who have no credit bureau
information, and consequently no FICO scores, allowing the Company to target
Fingerhut Customers who would not typically be solicited by other credit card
issuers. The Fingerhut Score has been effective in enhancing the Company's
ability to select which Fingerhut customers to solicit and in rank ordering
Fingerhut customers according to their likelihood of delinquency.
The Company uses internally and externally developed proprietary models
in enhancing its evaluation of External Prospects. These models help segment
External Prospects into narrower ranges within each FICO Score subsegment,
allowing the Company to better evaluate individual credit risk and to tailor its
risk-based pricing accordingly. The Company also uses this segmentation along
with the Suppress File to exclude certain individuals from its marketing
solicitations.
The Company generates External Prospects from lists obtained from the
major credit bureaus based on criteria established by the Company. The Company
uses proprietary models and additional analysis in conjunction with files
obtained from the credit bureaus to further segment External Prospects based
upon their likelihood of delinquency. The Company also eliminates any names
which are included in the Fingerhut Suppress File. The Company currently does
not solicit External Prospects who do not have FICO Scores.
The Company believes that the proprietary models in conjunction with
additional analysis is effective in further segmenting and evaluating risk
within FICO score bands. However, for certain campaigns the models and
additional analysis were less effective in doing so than in other campaigns. The
Company has and continues to use the results of its analysis of External
Prospects to adjust the proprietary models to determine the pricing for various
segments and to exclude certain segments from subsequent direct marketing
efforts. While the Company believes that the proprietary models and additional
analysis are valuable tools in analyzing relative risks, it is not possible to
accurately predict which consumers will default or the overall level of
defaults, and the Company cannot assure you as to the levels of actual
delinquencies or losses.
The Company believes that both the Fingerhut Score and the proprietary
models, in conjunction with the Fingerhut Suppress File, give it a competitive
advantage in evaluating the credit risk of moderate income consumers. Management
believes that due to the amount and type of credit information available in the
Fingerhut Database, the Fingerhut Score is currently more effective than the
proprietary models in allowing the Company to evaluate the credit risk of
prospects having lower FICO Scores. Therefore, the Company has been willing to
solicit consumers who have lower FICO Scores if they also have an appropriate
Fingerhut Score. As a result, the Company's Fingerhut-sourced credit card
customers generally have lower initial FICO Scores than do External Prospects.
After every marketing campaign, the Company monitors the performance of the
proprietary models and continually re-evaluates the effectiveness of these
models in segmenting credit risk, resulting in further refinements to its
selection criteria for External Prospects. Over time, the Company believes that
it will capture additional credit information on the behavioral characteristics
of External Prospects which will allow it to further increase the effectiveness
of the proprietary models.
Solicitation. Prospects for solicitation include both Fingerhut
Customers and External Prospects. Prospects are contacted on a nationwide basis
primarily through pre-screened direct mail and telephone solicitations. The
Company receives responses to its prescreened solicitations, performs fraud
screening, verifies name and address changes, and obtains any information which
may be missing from the application. Applications are sent to third party data
entry providers, which key the application information and process the
applications based on the criteria provided by the Company. The Company then
makes the credit decisions and approves, denies or begins exception processing.
The Company processes exceptions for, among other things, derogatory credit
bureau information and fraud warnings. Exception applications are processed
manually by credit analysts based on policies approved by the Company's Credit
Committee.
Pricing. Through risk-based pricing, the Company prices credit card
offers based upon a prospect's risk profile prior to solicitation. The Company
evaluates a prospect to determine credit needs, credit risk, and existing credit
availability and then develops a customized offer that includes the most
appropriate product, brand, pricing and credit line. The Company currently
offers over 100 different pricing structures on its credit card products, with
annual fees ranging from $0 to $75 and annual interest rates up to 26.9%. After
credit card accounts are opened, the Company periodically monitors customers'
internal and external credit performance and periodically recalculates behavior,
revenue, attrition and bankruptcy predictors. As customers evolve through the
credit life cycle and are regularly rescored, the lending relationship can
evolve to include more competitive (or more restrictive) pricing and product
configurations.
Age of Portfolio. The following table sets forth, as of December 31,
1998, the number of total accounts and amount of outstanding loans based upon
the age of the managed accounts.
Percentage of
Number Percentage Loans Loans
of Accounts of Accounts Outstanding Outstanding
Age Since Origination (Dollars in thousands)
0-6 Months ................... 411,051 13.8% $ 477,384 9.0%
7-12 Months .................. 372,549 12.5% 650,758 12.2%
13-18 Months ................. 389,385 13.1% 719,050 13.5%
19-24 Months ................. 350,258 11.8% 650,379 12.2%
25-36 Months ................. 668,870 22.5% 1,323,253 24.9%
37+ Months ................... 779,756 26.3% 1,494,218 28.2%
------- ---- --------- ----
Total ................... 2,971,869 100.0% $5,315,042 100.0%
========= ===== ========== =====
Geographic Distribution. The Company solicits credit card customers on
a national basis and, therefore, maintains a geographically diversified
portfolio. The following table shows the distribution of total accounts and
amount of outstanding loans by state, as of December 31, 1998.
Percentage of
Number Percentage Loans Loans
of Accounts of Accounts Outstanding Outstanding
State (Dollars in thousands)
California ................... 341,314 11.5% $ 663,726 12.5%
Texas ........................ 296,171 10.0% 537,479 10.1%
Florida ...................... 214,436 7.2% 401,222 7.5%
New York ..................... 208,643 7.0% 387,829 7.3%
Ohio ......................... 128,214 4.3% 224,256 4.2%
Illinois ..................... 104,422 3.5% 189,552 3.6%
Pennsylvania ................. 92,214 3.1% 160,069 3.0%
Michigan ..................... 79,947 2.7% 144,486 2.7%
Missouri ..................... 78,150 2.6% 135,589 2.6%
Georgia ...................... 76,770 2.6% 139,817 2.6%
Virginia ..................... 75,635 2.5% 135,860 2.6%
All others (1) 1,275,953 43.0% 2,195,157 41.3%
--------- ---- --------- ----
Total ................... 2,971,869 100.0% $5,315,042 100.0%
========= ===== ========== =====
(1) No other state accounts for more than 2.5% of loans outstanding.
Credit Lines. Once an account is approved, an initial credit line is
established based on the individual's risk profile using automated screening and
credit scoring techniques. This process results in a portfolio (excluding
portfolio acquisitions) with average credit lines that are below the industry
average due to the higher average risk inherent in the Company's target market.
The Company may elect, at any time and without prior notice to the cardholder,
to preclude or restrict further credit card use by the cardholders, usually as a
result of poor payment performance or the Company's concern over the
creditworthiness of the cardholders. Credit lines are managed based on the
results of the behavioral scoring analysis in accordance with criteria
established by the Company. The
following table sets forth information with respect to account balance and
credit limit ranges of the Company's managed portfolio, as of December 31, 1998.
Credit Limit Range Number Percentage Loans Percentage of
of Accounts of Accounts Outstanding Loans Outstanding
(Dollars in thousands)
$1,000 or Less......... 279,095 9.4% $ 164,167 3.1%
$1,001-$2,000 ......... 647,278 21.8% 817,808 15.4%
$2,001-$3,500 ......... 719,134 24.2% 1,308,876 24.6%
$3,501-$5,000 ......... 577,659 19.4% 1,295,052 24.4%
Over $5,000 ........... 748,703 25.2% 1,729,139 32.5%
------- ---- --------- ----
Total ........... 2,971,869 100.0% $5,315,042 100.0%
========= ===== ========== =====
Account Balance Range Number Percentage Loans Percentage of
of Accounts of Accounts Outstanding Loans Outstanding
(Dollars in thousands)
Credit Balance ....... 44,720 1.5% $ (4,743) (.1%)
No Balance ........... 471,135 15.9%
$1,000 or Less ....... 707,600 23.8% 321,546 6.0%
$1,001-$2,000 ........ 647,906 21.8% 976,959 18.4%
$2,001-$3,500 ........ 627,816 21.1% 1,656,469 31.2%
Over $3,500 .......... 472,692 15.9% 2,364,811 44.5%
------- ---- --------- ----
Total ........... 2,971,869 100.0% $ 5,315,042 100.0%
========= ===== =========== =====
The Adaptive Control System. The Company uses First Data Resources
Inc.'s ("FDR") adaptive control system (the "Adaptive Control System"), which
uses statistical models and basic account financial information to automatically
and regularly assign credit line increases and decreases to individual
customers, as well as to determine the systematic collection steps to be taken
at the various stages of delinquency. The Adaptive Control System manages the
authorization of each transaction; in addition, it implements the collections
strategies determined by the Company to be used for non-delinquent accounts that
have balances above their assigned credit line (referred to as "overlimit"
accounts).
Delinquency, Collections and Charge-offs. The Company considers an
account delinquent if a payment due is not received by the Company within 25
days from the closing date of the statement. Collection activities are
determined by the Adaptive Control System, which continually monitors all
delinquent accounts. The collections function is handled internally. Accounts
that become 60 days contractually delinquent are closed, but not necessarily
charged off. Accounts are charged off and taken as a loss either within 60 days
after formal notification of bankruptcy or at the end of the month during which
they become contractually 180 days past due. Accounts identified as fraud losses
are immediately reserved for and charged off no later than 90 days after the
last activity. Charged-off accounts are referred to the Company's recovery unit
for coordination of collection efforts to recover the amounts owed. When
appropriate, accounts are placed with external collection agencies or attorneys.
Servicing, Billing and Payment. The Company has established a
relationship with FDR for cardholder processing services. FDR is a subsidiary of
First Data Corporation, a provider of information processing and related
services including cardholder processing (services for financial institutions
which issue credit cards to cardholders), and merchant processing (services for
financial institutions which make arrangements with merchants for the acceptance
of credit cards as methods of payment). FDR provides data processing, credit
card reissuance, monthly statements, some inbound customer service telephone
calls and interbank settlement for the Company. Effective February 1998, the
Company extended its processing services agreement with FDR for an additional
six years, expiring 2006. Applications processing and back office support for
mail inquiries and fraud management are handled internally by the Company. In
addition the Company handles in-bound customer service telephone calls for a
part of its customer base.
The Company generally assesses periodic finance charges on an account
if the cardholder has not paid the balance in full from the previous billing
cycle. These finance charges are based upon the average daily balance
outstanding on the account during the monthly billing cycle. Payments by
cardholders to the Company on the accounts are processed by a third party
servicer and applied first to any billed and unpaid fees, next to billed and
unpaid finance charges and then to billed and unpaid transactions in the order
determined by the Company. If a payment in full is not received prior to 25 days
after the statement cycle date (the "Pay by Date"), finance charges are imposed
on all purchases from the date of the transaction to the statement cycle date.
Finance charges are also imposed on each cash advance from the day such advance
is made until the advance is paid in full. The finance charge is applied to the
average daily balance. For most cardholders, if the entire balance on the
account is paid by the due date a finance charge on purchases is not imposed.
The Company assesses an annual fee on some credit card accounts. The
Company may waive the annual membership fees, or a portion thereof, in
connection with the solicitation of new accounts depending on the credit terms
offered, which are determined by the prospect's risk profile prior to
solicitation or when the Company determines a waiver to be appropriate
considering the account's overall profitability. In addition to the annual fee,
the Company charges accounts certain other fees including: (i) a late fee with
respect to any unpaid monthly payment if the Company does not receive the
required minimum monthly payment by the Pay by Date, (ii) a cash advance fee for
each cash advance, (iii) a fee with respect to each check submitted by a
cardholder in payment of an account which is not honored by the cardholder's
bank, and (iv) an overlimit charge if, at any time during the billing cycle, the
total amount owed exceeds the cardholder's credit line by at least $30.
Each cardholder is subject to an agreement governing the terms and
conditions of the accounts. Pursuant to such agreements, the Company reserves
the right to change or terminate certain terms, conditions, services and
features of the account (including periodic finance charges, late fees, returned
check charges and any other charges or the minimum payment), subject to the
conditions set forth in the account agreement.
Monthly billing statements are sent to cardholders by FDR on behalf of
the Company. When an account is established, it is assigned a billing cycle.
Currently, there are 20 billing cycles and each such cycle has a separate
monthly billing date based on the respective business day the cycle represents
in each calendar month. Each month, a statement is sent to all accounts with an
outstanding balance greater than $1. All cardholders with open accounts must
make a minimum monthly payment generally of the greater of $15, 2.5% of the
outstanding balance, the finance charge or the balance of the account if the
balance is less than $15. If the minimum payment is not collected by the Pay by
Date, the account is considered delinquent.
Most merchant transactions by cardholders are authorized online. The
remaining transactions generally are low dollar amounts, typically below $50.
All authorizations are handled through the Adaptive Control System.
Fee-Based Services
The Company sells or offers fee-based services, including (i) debt
waiver protection for unemployment, disability, and death, (ii) membership
programs such as card registration, purchase protection and other club
memberships, and (iii) third-party insurance, directly to its credit card
customers and customers of third parties. The Company currently administers its
extended service plans sold through a third-party retailer, and the customer
pays the retailer directly. In addition, the Company develops customized
targeted mailing lists from information contained in both the Company's and
Fingerhut's databases for use by unaffiliated companies in their own financial
services product solicitation efforts that do not directly compete with those of
the Company. In 1998, the Company consolidated the fee-based services and
extended service plan businesses.
The Company currently markets the following programs:
Debt Waiver. Account Protection Plus(TM) , is a program the Company has
developed that protects customers from interest charges on the Company's credit
cards in the event that they become disabled or unemployed. The customer's
account is "frozen" for six months, with no payments due or interest accruing
during this time. In the event of death, the amount due, up to the credit limit,
is waived and the account is closed. Because this is an internally administered
program, the Company is responsible for all of the program's associated costs.
The Company also offers Account Benefit Plan which forgives the customer's
balance due in the event of death but offers no protection in the event of
disability or unemployment.
Extended Service Plans. The Company administers extended service plans
sold by retailers. Extended service plans provide warranty coverage beyond the
manufacturer's warranty. In general, the extended service plans administered by
the Company provide customers with the right to have their covered purchases
repaired, replaced, or in certain circumstances, the purchase price of the
product refunded, within certain parameters determined by the Company. Within
the warranty industry, extended service plans are available for a wide variety
of products including consumer electronics and appliances, furniture, jewelry,
automotives, and household mechanical systems such as heating, plumbing and
electrical systems. The Company currently administers extended service plans for
consumer electronics, appliances, furniture and jewelry purchased from
third-party retailers.
ServiceEdgeSM is the Company's extended service plan administered by
the Company for consumer electronics and all other electro-mechanical items.
ServiceEdge customers have the right to have their purchases repaired or
replaced in the event of electrical or mechanical failure or defects in
materials and workmanship for coverable events after the manufacturer's warranty
expires.
Quality Furniture Care is the Company's extended service plan program
for furniture. The services provided to Quality Furniture Care customers include
stain cleaning, structural defect or damage repair, or replacement if the
merchandise cannot be repaired.
Quality Jewelry Care(R) is the extended service plan administered by
the Company for jewelry. The services provided to Quality Jewelry Care customers
include repair, soldering, ring sizing, prong re-tipping, and cleaning. The
Company has third-party jewelers perform such services for the Company.
Most of the extended service plans administered by the Company continue
for two years from the date of the product purchase (three to five years in
limited cases). The customer pays the retail company a one-time fee for this
coverage based on the price of the product, the term of coverage and the loss
risk of the product. Customers may also be offered the opportunity to renew
their coverage in one-year extensions, presently up to six years from the date
of purchase, upon payment of an additional fee for each renewal.
Through the end of 1996, claims risk and claims processing for
electro-mechanical items were the responsibility of a third party. At the
beginning of 1997, the Company internalized the claims processing operations
related to extended service plans for electro-mechanical items and has incurred
the resulting claims risk for extended service plans sold on or after January 1,
1997. The Company is responsible for claims risk and claims processing for
furniture and jewelry.
Purchase Protection. During 1997, the Company developed a new
membership program, PurchaseShieldSM, which offers various levels of purchase
protection to its members. Eligible purchases made on members' credit cards are
protected with the following benefits: warranty extension, sale price protection
and product return guarantee. In addition, PurchaseShield offers its members a
household repair rebate that can be used on certain existing in-home
electro-mechanical item repairs. Because this is an internally administered
program, the Company receives all revenues and is responsible for all of the
program's associated costs. The Company currently offers purchase protection to
its credit card customers and credit card customers of third parties.
Card Registration. Card registration protects members from fraudulent
charges if their credit cards are lost or stolen and provides emergency cash and
airline tickets, change of address notification and lost or stolen card
notification, valuable property and document registration, a messaging service
and car rental discounts. The Company currently offers card registration service
under the name Fraud Alert Services(TM) to its credit card customers and
customers of third parties. The Company internalized this program in September
1996 and is responsible for all of its associated costs and revenues. Prior to
September 1996, the Company had an agreement with a third party vendor to offer
card registration services to its credit card customers.
Accidental Death Insurance. The Company earns a fee from a third-party
insurance administrator for the marketing and billing of the third-party's
accidental death insurance program. The Company markets the insurance program to
its credit card customers. Although the Company markets the program, the
third-party insurance company fulfills and underwrites the policies.
Other Membership Clubs. The Company has cooperative marketing
arrangements with several third parties to market the third party's memberships
in clubs that do not compete with the Company's services or clubs. Additionally,
the Company has other arrangements with third parties, which it assumed from
acquired credit card portfolios, that provide it with revenue from ongoing
membership fees billed to the Company's acquired credit card holders.
Tailored List Development. The Company currently works with several
companies to develop targeted mailing lists and earns revenue for each name that
is solicited by these companies from the Company's customer databases. The
Company also earns revenue from the sale of advertising space included in its
monthly billing statements.
Liquidity, Funding and Capital Resources
One of the Company's primary financial goals is to maintain an adequate
level of liquidity through active management of assets and liabilities. Because
the pricing and maturity characteristics of the Company's assets and liabilities
change, liquidity management is a dynamic process, affected by changes in short-
and long-term interest rates. The Company uses a variety of financing sources to
manage liquidity, refunding, rollover and interest rate risks.
The Company finances the growth of its credit card loan portfolio
through cash flow from operations, asset securitization, bank financing,
long-term debt issuance, and equity issuance.
Asset Securitization
A significant source of funding for the Company is the securitization
of credit card loans. Securitization involves packaging and selling both current
and future receivable balances of pools of credit card card accounts while
retaining the servicing of such receivables. The Company's securitizations are
treated as sales under generally accepted accounting principles. As a result,
the securitized receivables are removed from the Company's balance sheet and
treated as managed loans.
The Company primarily securitizes receivables by selling such
receivables either to its proprietary trust, the Metris Master Trust, or to
bank-sponsored multi-seller conduits which purchase such assets from a variety
of issuers.
The Metris Master Trust. The Metris Master Trust (the "Trust") was
formed in May 1995 pursuant to a pooling and servicing agreement, which was
amended on July 30, 1998. Metris Receivables, Inc., a subsidiary of the Company,
transfers receivables in designated accounts to the Trust in exchange for
proceeds and an interest in the Trust. Metris Receivables, Inc. may then
exchange portions of this interest for one or more series of securities which it
may then sell publicly or privately to third-party investors. The securities
each represent undivided interests in all of the receivables in the Trust, and
may be split into separate classes which have different terms. The different
classes of an individual series are structured to obtain specific credit
ratings. As of December 31, 1998, seven series of securities have been issued by
the Trust. The Company currently retains the most subordinated class of
securities in each series and sells all the other classes.
Generally, each series involves an initial reinvestment period (a
"revolving period") in which principal payments on receivables allocated to such
series are returned to Metris Receivables, Inc. and reinvested in new
receivables arising in the accounts. After the revolving period ends, principal
payments allocated to the series are then used to repay the investors. This
period is referred to as the amortization period. Currently, the Trust has one
series which is in a controlled amortization period. The scheduled amortization
period is set in the agreements governing each series. However, all the series
set forth certain events by which amortization can be accelerated (early
amortization). Usually, this would occur if the portfolio collections less
charge-offs for bad debt, financing costs and operational costs drop below a
minimum amount. As new receivables in designated accounts cannot be funded while
a series is in amortization, early amortization would accelerate the Company's
funding requirements for new receivables in the accounts. The Company does not
have any series that are in early amortization.
Each month, each series is allocated its share of finance charge
collections which is used to pay investors interest on their securities, to
reimburse them for their share of losses due to charge-offs and to pay their
share of servicing fees. Amounts remaining may be deposited in cash accounts of
the Trust as additional protection for future losses. Once each of these
obligations is fully met, any remaining finance charge collections, if any, are
returned to the Company.
Bank-Sponsored Conduit Programs. The Company also maintains
flexibility in its current securitization program by negotiating with
bank-sponsored conduits (the "Conduits"). These Conduits purchase an interest in
receivables arising in designated accounts. These transactions also feature a
revolving period in which principal payments on receivables allocated to the
Conduits are returned to the Company and reinvested in new receivables. These
agreements also have early amortization triggers. Finance charge collections are
used to pay certain obligations, including servicing fees, interest on the
principal amount of the Conduit's investment in the applicable receivables, and
recouping charge-offs. After such allocation, remaining finance charge
collections, if any, are returned to the Company.
At December 31, 1998 and 1997, the Company had received cumulative net
proceeds of approximately $4.6 billion and $3.1 billion, respectively from sales
of credit card loans to the Trust and Conduits. Cash generated from these
transactions was used to reduce short-term borrowings and to fund credit card
loan portfolio growth. The Company relies upon the securitization of its credit
card loans to fund portfolio growth and, to date, has completed securitization
transactions on terms that it believes are satisfactory. The Company's ability
to securitize its assets depends on favorable investor demand, legal, regulatory
and tax conditions for securitization transactions, as well as continued
favorable performance of the Company's securitized portfolio of receivables. Any
adverse change could force the Company to rely on other potentially more
expensive funding sources and, in the worst case scenario, could create
liquidity risks if other funding is unavailable.
During 1998, as part of a scheduled amortization of previously
securitized loans, the Company's owned loan portfolio, increased by $34.6
million. The following table presents the amounts, at December 31, 1998 of
investor principal in securitized receivables scheduled to amortize in future
years. The amortization amounts are based upon estimated amortization periods
which are subject to change based on Trust and Conduit performance.
(Dollars in thousands)
1999..................................... $1,847,538
2000..................................... 608,333
2001..................................... 2,102,272
Thereafter............................... 0
----------
Total Securitized Loans at December 31, 1998 $4,558,143
===========
The Company's lower independent credit ratings, due to the Spin Off,
reduced the advance rate on a portion of the sale of receivables to the Trust.
This required approximately $40 million in additional funding by the Company to
finance the unsold loans.
Bank Financing
On June 30, 1998, the Company executed a new $200 million, three-year
revolving credit facility and a $100 million five-year term loan (the "New
Credit Facility") with a syndicate of banks and money market mutual funds. This
agreement became effective upon the Spin Off from FCI on September 25, 1998. The
New Credit Facility, which is not guaranteed by FCI, replaced the Company's $300
million, five-year revolving credit facility (the "Old Credit Facility"). The
New Credit Facility is secured by receivables and subsidiary stock and
guaranteed by a Company subsidiary. Financial covenants in the New Credit
Facility include, but are not limited to, requirements concerning minimum net
worth, minimum tangible net worth to net managed receivables and tangible net
worth plus reserves to delinquent receivables. The minimum tangible net worth to
net managed receivables ratio requirement increased to 5.0% from 4.0% on
December 24, 1998. At December 31, 1998, the Company was in compliance with all
financial covenants under this agreement. At December 31, 1998, the Company had
outstanding borrowings of $110 million under the New Credit Facility. At
December 31, 1997, the Company had outstanding borrowings of $144 million under
the Old Credit Facility. As a result of the Spin Off and the removal of the FCI
guarantee, the Company is no longer able to borrow at an investment grade rate.
The interest rate under the New Credit Facility is higher than the interest rate
under the Old Credit Facility due to the Company's lower independent credit
rating.
Long-Term Debt and Equity Issuance
In addition to asset securitizations and bank funding, the Company uses
long term debt and equity to fund continued credit card growth. While the
Company planned to issue common equity shares in a public offering after the
Spin Off during the fourth quarter of 1998, volatility in the stock market and
in the Company's stock price caused the Company to seek alternatives to public
issuance through either private issuance of equity or public or private issuance
of equity-like securities. On November 13, 1998, after a review of several
alternatives and discussions with several advisors and investors, the Company
entered into agreements with affiliates of the Thomas H. Lee Company, (the "Lee
Company") to purchase $200 million in Series B Perpetual Preferred Stock (the
"Series B Preferred") and $100 million in 12% Senior Notes due 2006 (the "Lee
Senior Notes"). The Company also issued the Lee Company 3.75 million ten-year
warrants to purchase shares of the Company's common stock for $30, subject to
adjustment in certain circumstances. The Series B Preferred had a 12.5% dividend
payable in additional shares of Series B Preferred for ten years, then
converting to payable in cash. The proceeds from the issuance of the Series B
Preferred and the Lee Senior Notes were used to fund the PNC portfolio
acquisition and general corporate purposes.
On March 12, 1999, shareholders' approved conversion of the Series B
Preferred and Lee Senior Notes into Series C Perpetual Convertible Preferred
stock (the "Series C Preferred"). If notice is received that there is no
regulatory objection to the conversion to the Series C Preferred, the Series B
Preferred and the Lee Senior Notes will be converted into 0.8 million shares of
Series C Preferred at a conversion price of $37.25 and the warrants will be
canceled. The Series C Preferred has a 9% dividend payable in additional shares
of Series C Preferred and will also receive any dividends paid on the Company's
Common Stock on an as converted basis. The cumulative payment-in-kind dividends
are effectively guaranteed for a seven-year period. Assuming conversion of the
Series C Preferred into common stock in the first quarter of 1999, the Lee
Company would own approximately 30% of the Company on a diluted basis.
Converting to the Series C Preferred will cause a one-time, non-cash
accounting adjustment for retiring the Series B Preferred and the Lee Senior
Notes. The excess of the fair value of the Series C Preferred over the carrying
value of the Series B Preferred and the Lee Senior Notes at the time of the
conversion must be allocated to the Lee Senior Notes and the Series B Preferred
based upon their initial fair values. To arrive at net income available to
common stockholders in the calculation of earnings per share, the amount
allocated to the Lee Senior Notes would be recognized as an extraordinary loss
from the early extinguishment of debt and the amount allocated to the Series B
Preferred would be recognized as a reduction of net income available to common
stockholders. The extraordinary loss attributable to the Lee Senior Notes will
not be recorded net of taxes. These adjustments will not have an impact on total
stockholders' equity. At the time of the printing of this annual report on Form
10-K, the fair value of the Series C Preferred was not determined.
In November 1997, the Company privately issued and sold $100 million of
10% Senior Notes due 2004 pursuant to an exemption under the Securities Act of
1933, as amended. The net proceeds were used to reduce borrowings under the Old
Credit Facility. In January 1998, the Company commenced an exchange offer for
the Senior Notes pursuant to a registration statement. The terms of the new
Senior Notes are identical in all material respects to the original private
issue. The Senior Notes are unconditionally guaranteed on a senior basis,
jointly and severally, by Metris Direct, Inc., a subsidiary of Metris Companies
Inc., and all future subsidiaries of the Company that guarantee any of the
Company's indebtedness, including the New Credit Facility. The guarantee is an
unsecured obligation of Metris Direct, Inc. and ranks pari passu with all
existing and future unsubordinated indebtedness.
General
The Federal Reserve Act imposes various legal limitations on the extent
to which banks that are members of the Federal Reserve System can finance or
otherwise supply funds to certain of their affiliates. In particular, Direct
Merchants Bank is subject to certain restrictions on any extensions of credit to
the Company or its subsidiaries. Additionally, Direct Merchants Bank is limited
in its ability to declare dividends to the Company. Therefore, Direct Merchants
Bank's investments in federal funds sold are generally not available for the
general liquidity needs of the Company or its subsidiaries. These restrictions
were not material to the operations of the Company at December 31, 1998 and
1997.
As the portfolio of credit card loans grows, or as the Trust and
Conduit certificates amortize or are otherwise paid, the Company's funding needs
will increase accordingly. The Company believes that its cash flow from
operations, asset securitization programs, together with the New Credit
Facility, long term debt issuance and equity issuance, will provide adequate
liquidity to the Company for meeting anticipated cash needs, although no
assurance can be given to that effect.
Competition
As a marketer of consumer credit products, the Company competes with
numerous providers of financial services, many of which have greater resources
than the Company. In particular, the Company's credit card business competes
with national, regional and local bank card issuers as well as other general
purpose credit and debit card issuers. In general, customers are attracted to
credit card issuers largely on the basis of price, credit limit and other
product features; as a result, customer loyalty is often limited. However, the
Company believes that its strategy of focusing on an underserved market and its
exclusive access to information from the Fingerhut Database will allow it to
compete effectively in the market for moderate income cardholders to market
financial services products.
There are numerous competitors in the fee-based services market,
including insurance companies, financial services institutions and other
membership-based or enhancement consumer services providers, many of which are
larger, better capitalized and more experienced than the Company. However, the
Company believes that its agreements with FCI, including its exclusive right to
use the Fingerhut Database to market financial services products and its right
to be the exclusive provider of extended service plans to Fingerhut customers,
will allow it to compete effectively in this market. As the Company continues to
expand its business to market extended service plans to the customers of
third-party retailers, it will also compete with manufacturers, financial
institutions, insurance companies and a number of independent administrators,
many of which have greater operating experience and financial resources than the
Company.
Regulation
The Company and Direct Merchants Bank
Direct Merchants Bank is a limited purpose credit card bank chartered
as a national banking association. It is a member of the Federal Reserve System.
Its deposits are insured by the Bank Insurance Fund which is administered by the
Federal Deposit Insurance Corporation ("FDIC") and it is subject to
comprehensive regulation and periodic examination by the Office of the
Comptroller of the Currency ("OCC"), its primary regulator. It is also subject
to regulation by the Board of Governors of the Federal Reserve System and the
FDIC, as back-up regulators. Direct Merchants Bank is not a "bank" as defined
under the Bank Holding Company Act of 1956, as amended (the "BHCA") because it
(i) engages only in credit card operations, (ii) does not accept demand deposits
or deposits that the depositor may withdraw by check or similar means for
payment to third parties or others, (iii) does not accept any savings or time
deposit of less than $100,000, except for deposits pledged as collateral for
extensions of credit, (iv) maintains only one office that accepts deposits and
(v) does not engage in the business of making commercial loans. As a result, the
Company is not a bank holding company under the BHCA. If Direct Merchants Bank
failed to meet the credit card bank criteria described above, Direct Merchants
Bank's status as an insured bank would make the Company subject to the
provisions of the BHCA. The Company believes that becoming a bank holding
company would limit the Company's ability to pursue future opportunities.
Exportation of Interest Rates and Fees
Under current judicial interpretations of federal law, national banks
such as Direct Merchants Bank may charge interest at the rate allowed by the
laws of the state where the bank is located and may "export" those interest
rates on loans to borrowers in other states, without regard to the laws of such
other states.
In 1996, the Supreme Court of the United States held that national
banks may also impose late payment fees allowed by the laws of the state where
the national bank is located on borrowers in other states, without regard to the
laws of such other states. The Supreme Court based its opinion largely on its
deference to a regulation adopted by the OCC that includes certain fees,
including late fees, overlimit fees, annual fees, cash advance fees and
membership fees, within the term "interest" under the provision of the National
Bank Act that has been interpreted to permit national banks to export interest
rates. As a result, national banks such as Direct Merchants Bank may export such
fees.
Dividends and Transfers of Funds
There are various federal law limitations on the extent to which Direct
Merchants Bank can finance or otherwise supply funds to the Company and its
affiliates through dividends, loans or otherwise. These limitations include:
minimum regulatory capital requirements; restrictions concerning the payment of
dividends out of net profits or surplus; and Sections 23A and 23B of the Federal
Reserve Act governing transactions between a bank and its affiliates. In
general, Federal law prohibits a national bank such as Direct Merchants Bank
from making dividend distributions on common stock if the dividend would exceed
currently available undistributed profits. In addition, Direct Merchants Bank
must get OCC prior approval for a dividend, if such distribution would exceed
current year net income combined with retained earnings from the prior two
years. Direct Merchants Bank cannot make a dividend if the distribution would
cause the bank to fail to meet applicable capital adequacy standards. Finally,
although not a regulatory restriction, the terms of certain debt agreements
prohibit the payment of dividends in certain circumstances.
Comptroller of the Currency
Capital Adequacy. The Federal Deposit Insurance Corporation Improvement
Act of 1991 ("FDICIA"), requires the banking agencies to prescribe certain
non-capital standards for safety and soundness relating generally to operations
and management, asset quality and executive compensation. FDICIA also provides
that regulatory action may be taken against a bank that does not meet such
standards.
The OCC has adopted regulations that define the five capital categories
(well capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized and critically undercapitalized) identified by FDICIA, using
the total risk-based capital, Tier 1 risk-based capital and leveraged capital
ratios as the relevant capital measures. Such regulations establish various
degrees of corrective action to be taken when an institution is considered
undercapitalized. Under the regulations, a "well capitalized" institution must
have a Tier 1 capital ratio of at least 6 percent, a total capital ratio of at
least 10 percent and a leverage ratio of at least 5 percent and not be subject
to a capital directive order. An "adequately capitalized" institution must have
a Tier 1 capital ratio of at least 4 percent, a total capital ratio of at least
8 percent and a leverage ratio of at least 4 percent (3 percent in some cases).
Under these guidelines, Direct Merchants Bank is considered well capitalized.
The OCC's risk-based capital standards explicitly consider a bank's
exposure to declines in the economic value of its capital due to changes in
interest rates when evaluating a bank's capital adequacy. Interest rate risk is
the exposure of a bank's current and future earnings and equity capital arising
from adverse movements in interest rates. The evaluation will be made as a part
of the institution's regular safety and soundness examination.
FDICIA. FDICIA requires the FDIC to implement a system of risk-based
premiums for deposit insurance pursuant to which the premiums paid by a
depository institution will be based on the probability that the FDIC will incur
a loss in respect of such institution. The FDIC has adopted a system that
imposes insurance premiums based upon a matrix that takes into account a bank's
capital level and supervisory rating. Given Direct Merchants Bank's capital
level and supervisory rating, Direct Merchants Bank pays the lowest rate on
deposit insurance premiums.
Under FDICIA, only "well capitalized" and "adequately capitalized"
banks may accept brokered deposits. "Adequately capitalized" banks, however,
must first obtain a waiver from the FDIC before accepting brokered deposits and
such deposits may not pay rates that significantly exceed the rates paid on
deposits of similar size and maturity accepted from the bank's normal market
area or the national rate on deposits of comparable maturity, as determined by
the FDIC, for deposits from outside the bank's normal market area. Direct
Merchants Bank may accept brokered deposits as part of its funding; however, it
does not presently rely on brokered deposits to fund its operations.
Lending Activities
Direct Merchants Bank's activities as a credit card lender are also
subject to regulation under various federal consumer protection laws including
the Truth-in-Lending Act, the Equal Credit Opportunity Act, the Fair Credit
Reporting Act, the Community Reinvestment Act (the "CRA") and the Soldiers' and
Sailors' Civil Relief Act. Regulators are authorized to impose penalties for
violations of these statutes and, in certain cases, to order Direct Merchants
Bank to pay restitution to injured cardholders. Cardholders may also bring
actions for certain alleged violations of such regulations. Federal and state
bankruptcy and debtor relief laws also affect Direct Merchants Bank's ability to
collect outstanding balances owed by cardholders who seek relief under these
statutes.
The OCC's CRA regulations subject limited purpose banks, including
Direct Merchants Bank, to a "community development" test for evaluating required
CRA compliance. The community development performance of a limited purpose bank
is evaluated pursuant to various criteria involving community development
lending, qualified investments and community development services.
Legislation
From time to time legislation has been proposed in Congress to limit
interest rates and fees that could be charged on credit card accounts or
otherwise restrict practices of credit card issuers.
If this or similar legislation is proposed and adopted, the Company's
ability to collect on account balances or maintain previous levels of finance
charges and other fees could be adversely affected. Additionally, changes have
been proposed to the federal bankruptcy laws. Changes in federal bankruptcy laws
and any changes to state debtor relief and collection laws could adversely
affect the Company if such changes result in, among other things, accounts being
charged off as uncollectible and additional administrative expenses. It is
unclear at this time whether and in what form any legislation will be adopted
or, if adopted, what its impact on the Company would be. Congress may in the
future consider other legislation that would materially affect the credit card
and related fee-based services industries.
Consumer and Debtor Protection Laws
Various federal and state consumer protection laws limit the Company's
ability to offer and extend credit. In addition, the U.S. Congress and the
states may decide to regulate further the credit card industry by enacting laws
or amendments to existing laws to reduce finance charges or other fees or
charges applicable to credit card and other consumer revolving loan accounts.
These laws may adversely affect the Company's ability to collect on account
balances or maintain established levels of periodic rate finance charges and
other fees and charges with respect to the accounts. Similarly, Congress and the
states may decide to regulate further the Company's fee-based services.
Certain existing laws and regulations permit class action lawsuits on
behalf of customers in the event of violations, and such class lawsuits can be
very expensive to defend, even without any violation. The Company is a party to
various legal proceedings resulting from its ordinary business activities. One
proceeding, filed in Alabama in April 1998, seeks certification as a class. The
Company intends to defend this action vigorously, but if this action, or any
other class action, is determined adversely, such decision could have a
significant adverse economic impact on the Company.
Investment in the Company and Direct Merchants Bank
Certain acquisitions of capital stock may be subject to regulatory
approval or notice under federal law. Investors are responsible for insuring
that they do not directly or indirectly acquire shares of capital stock of the
Company in excess of the amount which can be acquired without regulatory
approval.
Interstate Taxation
Several states have passed legislation which attempts to tax the income
from interstate financial activities, including credit cards, derived from
accounts held by local state residents. The Company believes that this
legislation will not materially affect it. The Company's belief is based upon
the following: current interpretations of the enforceability of legislation;
prior court decisions; and the volume of business in states that have passed
legislation.
Fair Credit Reporting Act
The Fair Credit Reporting Act ("FCRA") regulates "consumer reporting
agencies." Under the FCRA, an entity risks becoming a consumer reporting agency
if it furnishes "consumer reports" to third parties. A "consumer report" is a
communication of information which bears on a consumer's creditworthiness,
credit capacity, credit standing or certain other characteristics and which is
collected or used or expected to be used to determine the consumer's eligibility
for credit, insurance, employment or certain other purposes. The FCRA explicitly
excludes from the definition of "consumer report" a report containing
information solely as to transactions or experiences between the consumer and
the entity making the report. An entity may share consumer reports with any of
its affiliates so long as that entity provides consumers with an appropriate
disclosure and an opportunity to opt out of such "affiliate sharing".
It is the objective of the Company to conduct its operations in a
manner which would fall outside the definition of "consumer reporting agency"
under the FCRA. If the Company were to become a consumer reporting agency,
however, it would be subject to a number of complex and burdensome regulatory
requirements and restrictions. Such restrictions could have a significant
adverse economic impact on the Company. The Company's agreements with Fingerhut
provide that neither will provide information that causes either to become a
consumer reporting agency. Failure to comply with this limitation could result
in termination of the agreements and have an adverse impact on the Company.
Employees
As of December 31, 1998, the Company had over 1,900 employees located
in Arizona, Illinois, Maryland, Minnesota, and Oklahoma. None of the Company's
employees are represented by a collective bargaining agreement. The Company
considers its relations with its employees to be good.
Trademarks and Tradenames
MCI and its subsidiaries have registered and continue to register, when
appropriate, various trademarks, tradenames and service marks used in connection
with its business and for private label marketing of certain of its products.
The Company considers these trademarks and service marks to be readily
identifiable with, and valuable to, its business.
Executive Officers of the Registrant
The following table sets forth certain information concerning the
persons who currently serve as executive officers of the Company. Each executive
officer serves at the discretion of the Board of Directors of the Company.
Name Age Position
Ronald N. Zebeck 44 President, Chief Executive Officer and Director
Z. Jill Barclift 41 Executive Vice President, General Counsel and
Secretary
Douglas B. McCoy 51 Executive Vice President, Operations
Douglas L. Scaliti 41 Executive Vice President, Fee-Based Products
David D. Wesselink 56 Executive Vice President, Chief Financial
Officer
Patrick J. Fox 43 Senior Vice President, Business Development
Joseph A. Hoffman 41 Senior Vice President, Consumer Credit Marketing
David R. Reak 40 Senior Vice President, Credit Risk
Paul T. Runice 39 Senior Vice President, Treasurer
Jean C. Benson 31 Vice President, Finance, Corporate Controller
Ronald N. Zebeck has been the President and Chief Executive Officer and
a director of the Company since its incorporation in August 1996. Mr. Zebeck has
been President of Metris Direct, Inc. since March 1994 and has served as
Chairman of the Board of Direct Merchants Bank since August 1995. Prior to
joining the Company, Mr. Zebeck was Managing Director, GM Card Operations of
General Motors Corporation from 1991 to 1993, Vice President, Marketing and
Strategic Planning of Advanta Corporation (Colonial National Bank USA) from 1987
to 1991, Director of Strategic Planning of TSO Financial (later Advanta
Corporation) from 1986 to 1987 and held various credit card and credit-related
positions at Citibank affiliates from 1976 to 1986.
Z. Jill Barclift has been Executive Vice President, General Counsel and
Secretary of the Company since November 1998. Ms. Barclift was appointed Vice
President, General Counsel in December 1996 and served as Assistant General
Counsel from April 1996 to December 1996. Prior to joining the Company, Ms.
Barclift held various positions at Household International, Inc. and Household
Credit Services, Inc. from October 1989 to April 1996, most recently as
Associate General Counsel. Prior to that, she was Senior Counsel at Dean Witter
Financial Services, Inc. from January 1984 to October 1989.
Douglas B. McCoy has been Executive Vice President, Operations of the
Company since November 1998. Mr. McCoy was appointed Senior Vice President,
Operations of the Company in December 1996 and served as Vice President,
Operations of Metris Direct, Inc. from January 1995 to November 1996. In
addition, Mr. McCoy has been President of Direct Merchants Bank since July 1995.
Prior to joining the Company, he was Vice President, Credit Administration of
USAA Federal Savings Bank from September 1984 to January 1995, Assistant Vice
President, Credit Administration of Bank of Oklahoma from July 1984 to September
1984, Assistant Vice President, Operations of First National Bank of Tulsa from
May 1982 to July 1984 and Assistant Vice President, Credit Card Marketing of The
Bank of New Orleans from April 1978 to April 1982.
Douglas L. Scaliti has been Executive Vice President, Fee-Based
Products of the Company since November 1998. Mr. Scaliti previously held the
position Senior Vice President, Fee-Based Services since March 1998. Mr. Scaliti
was appointed Senior Vice President, Marketing of the Company in December 1996
and served as Vice President, Marketing of the Company from August 1996 to
November 1996 and held that same position at Metris Direct, Inc. since September
1994. Prior to joining the Company, he held several positions at Advanta
Corporation in its marketing and operations area, including Senior Marketing
Manager, Credit Cards from 1987 to 1994, Operations Consultant, Profit
Improvement from 1985 to 1987 and Credit Operations Manager from 1982 to 1985.
Mr. Scaliti also serves on the First Data Resources Market Area Advisory Group.
David D. Wesselink has been Executive Vice President, Chief Financial
Officer of the Company since December 1998. Prior to joining the Company, Mr.
Wesselink was Senior Vice President and Chief Financial Officer of Advanta
Corporation since 1993. Prior to Advanta Corporation, he held several positions
at Household Finance Corp. and Household International, Inc. from 1971 to 1993,
including Senior Vice President from 1986 to 1993 and Chief Financial Officer
from 1982 to 1993.
Patrick J. Fox has been Senior Vice President, Business Development
since March 1998. Prior to joining the Company, Mr. Fox held executive positions
in the credit card group of Bank of America from September 1994 to March 1998.
Most recently he was the Director of Product Management and Business
Development. Previous to Bank of America, Mr. Fox held various marketing and
sales management positions with Bank One, which he joined in 1990, Comerica Bank
and Citibank.
Joseph A. Hoffman has been Senior Vice President, Consumer Credit
Marketing since April 1998. Prior to joining the Company, Mr. Hoffman was Vice
President of Marketing at Advanta Corporation from June 1994 to April 1998,
where he held a variety of positions including Directors of Brand Management and
Affinity and Co-Brand Marketing. Before that, Mr. Hoffman was Vice President,
Area Director, in Citibank's Card Product Group, which he joined in 1980. During
his fourteen-year tenure with Citibank, Mr. Hoffman held a variety of Marketing
and Operations positions with Citibank's Bankcard and Private Label businesses.
David R. Reak has been Senior Vice President, Credit Risk of the
Company since November 1998. Mr. Reak was appointed Vice President, Credit Risk
of the Company in October 1996 and previously served as Senior Director, Credit
Risk of Metris Direct, Inc. from December 1995 to October 1996. Prior to joining
the Company, he had several positions at American Express Travel Related
Services Company, including Senior Manager, Credit Risk Management Europe and
Middle East from 1994 to December 1995, Senior Manager, Credit Risk Management
U.S. Consulting Group from 1992 to 1994, and Project Manager, Credit Research
and Analysis from 1990 to 1992.
Paul T. Runice has been Senior Vice President, Treasurer of the Company
since November 1998. Mr. Runice previously was Vice President, Treasurer of the
Company from January 1998 to October 1998. Prior to joining the Company, Mr.
Runice was with the Bank of America for nine years, most recently as Vice
President in the U.S. Corporate Finance Group. Prior to Bank of America, he was
employed by Grand Metropolitan, Inc. and The Pillsbury Company as Manager of
Treasury Operations, as well as in corporate development and financial analysis
roles.
Jean C. Benson has been Vice President, Finance, Corporate Controller
of the Company since May 1998 and has been Corporate Controller since August
1996. In addition, Ms. Benson held various finance positions at the Company and
FCI since October 1994. Prior to that, she held various positions at Deloitte &
Touche LLP (public accounting), specializing in the financial services industry
from 1990 to 1994.
Officers of the Company are elected by, and hold office at the will of,
the Board of Directors and do not serve a "term of office" as such.
Risk Factors
This annual report on Form 10-K contains certain forward-looking
statements and information relating to the Company that are based on the beliefs
of management as well as assumptions made by, and information currently
available to, management. These forward-looking statements involve risks and
uncertainties that could cause our actual results to differ materially from such
statements. You should not place undue reliance on these forward-looking
statements as they speak only of the Company's views as of the date the
statement was made and are not a guarantee of future performance.
Forward-looking statements include statements and information as to our
strategies and objectives, growth in earnings per share, return on equity,
growth in our managed loan portfolio, net interest margins, funding costs,
operating costs and marketing expenses, delinquencies and charge offs and
industry comparisons or projections. Forward-looking statements may be
identified by the use of terminology such as "may," "will," "believes," "does
not believe," "no reason to believe," "expects," "plans," "intends,"
"estimates," "anticipated," or "anticipates" and similar expressions, as they
relate to the Company or our management. These statements reflect management's
current views with respect to future events and are subject to certain risks,
uncertainties and assumptions.
The factors discussed below, among others, could cause our actual
results to differ materially from those expressed in any forward-looking
statements. Though the Company has attempted to list comprehensively these
important factors, the Company cautions you that other factors may in the future
prove to be important in affecting the Company's results of operations. New
factors emerge from time to time and it is not possible for management to
predict all of such factors, nor can it assess the impact of each such factor on
the business or the extent to which any factor, or combination of factors, may
cause actual results to differ materially from those contained in any
forward-looking statement.
Risks Related to Higher Default and Bankruptcy Rates of the Target
Market for Consumer Credit Products
The primary risk associated with unsecured lending to moderate income
consumers is higher default or bankruptcy rates than other income classes of
consumers, resulting in more accounts being charged-off as uncollectible. In
addition, general economic factors, such as the rate of inflation, unemployment
levels and interest rates may result in greater delinquencies and credit losses
among moderate income consumers than among other income classes of consumers.
The Company cannot assure you that it will be able to successfully identify and
evaluate the creditworthiness of its target customers to minimize the expected
higher delinquencies and losses. The Company also cannot assure you that its
risk-based pricing system can offset the negative impact on profitability that
the expected greater delinquencies and losses may have.
Lack of Seasoning of Credit Card Portfolio Creates a Risk of Increasing
Loss Levels
The Company's growth strategy is likely to produce a continued flow of
unseasoned accounts into the Company's portfolio. The average age of a credit
card issuer's portfolio of accounts generally affects the level and stability of
delinquency and loss rates of that portfolio. For example, a portfolio
containing mostly older accounts generally behaves more predictably than a newly
originated portfolio. At December 31, 1998, 74% of the Company's credit card
accounts were less than 36 months old and 14% of its credit card accounts were
less than six months old. At December 31, 1998, 7.4% of the Company's managed
credit card loans were 30 days or more delinquent, compared to 7.1% at December
31, 1997 and 5.5% at December 31, 1996. For the year ended December 31, 1998,
the Company had annualized net charge-offs of 10.8%, compared to 9.3% and 6.2%
for the years ended December 31, 1997 and 1996, respectively. As a result, until
the accounts become more seasoned, the Company expects the delinquency and loss
levels of the Company's portfolio to continue to increase. Any material
increases in delinquencies and losses beyond the Company's expectations could
have a material adverse impact on the Company and the value of its net retained
interests in loans securitized.
Limited Operating History as a Stand-Alone Entity Makes Predicting
Future Performance Difficult
In connection with the Spin Off in September 1998 described above, the
Company significantly changed its funding sources to stand-alone financing
without guarantees from FCI. See "Business - Liquidity and Funding." The Company
expects higher borrowing expense under its New Credit Facility because of the
Company's lower independent credit rating. Our relatively short existence as a
stand-alone company makes it difficult to apply historical operating results and
trends to assess our future performance.
No Assurance Can be Given of the Company's Ability to Sustain and
Manage Growth
In order to meet its strategic objectives, the Company plans to
continue to expand its credit card loan portfolio. Continued growth in this area
depends largely on:
o the Company's ability to attract new cardholders;
o growth in both existing and new account balances;
o the degree to which the Company loses accounts and account balances to
competing card issuers;
o levels of delinquencies and losses;
o the availability of funding, including securitizations, on favorable terms;
o general economic and other factors such as the rate of inflation,
unemployment levels and interest rates, which are beyond the Company's
control; and
o the Company's ability to acquire and integrate portfolios; and
o stability and growth in management.
The Company's continued growth also depends on its ability to manage
such growth effectively. Factors that affect the Company's ability to
successfully manage growth include: retaining and recruiting experienced
management personnel, finding and adequately training new employees,
cost-effectively expanding its facilities, growing and updating its management
systems and obtaining capital when needed. The Company cannot give assurances as
to the future growth in its loan portfolio or its ability to manage any such
growth.
Successful Integration of Portfolio Acquisitions Depends on Limited or
Unreliable Historical Information
As previously mentioned, the Company's growth depends in part on its
ability to acquire and successfully integrate new portfolios of credit card
customers. Since the Company's risk-based pricing system depends on information
regarding customers, limited or unreliable historical information on customers
within an acquired portfolio may impact the Company's ability to successfully
and profitably integrate that portfolio. The Company's success also depends on
whether the desirable customers of an acquired portfolio close their accounts
after transfer of the portfolio. A large attrition rate would result in a lower
borrowing base upon which to assess fees, higher costs for the Company relating
to closing accounts and less potential for marketing fee-based services. In
addition, if customers reduce their borrowings after the transfer of accounts,
the acquired portfolio may be less profitable than originally expected. To date,
the Company's portfolio acquisitions have experienced attrition rates consistent
with the rate estimated at the time of acquisition.
Risks Related to Fee-Based Services Include the Uncertainty of
Successful Marketing Efforts and Signing Additional Marketing Alliances
The Company targets its fee-based services to its credit card customers
and customers of third parties. Because of the variety of offers provided and
the diversity of the customers targeted, the Company is uncertain about how many
customers will respond to the Company's offers for these fee-based services. The
Company may experience higher than anticipated costs in connection with the
internal administration and underwriting of these fee-based services and lower
than anticipated response or retention rates.
Furthermore, the Company may not be able to expand the fee-based
services business or maintain historical growth and stability levels if:
o the Company cannot successfully market credit cards to new customers;
o existing credit card customers close accounts voluntarily or involuntarily;
o existing fee-based services customers cancel their services;
o the Company cannot form marketing alliances with other third parties; or
o new or restrictive state regulations limit the Company's ability to market or
sell fee-based services.
The Unavailability or Increased Cost of Funding Could Negatively
Affect the Company's Profitability and Ability to Grow
The Company depends on cash flow from operations, asset securitization,
and the issuance of long-term debt and equity to fund its operations. The loss
of any of these sources of funding could adversely affect the Company's ability
to operate. If the Company breaches any of its covenants in the long-term debt
indenture or under its credit facility, including various financial covenants,
the lenders may terminate the facility. In addition, because of the Company's
limited operating history and relatively unseasoned loan portfolio, FCI
historically guaranteed the Company's credit facility, as well as several
letters of credit and two interest rate swap transactions. Prior to the Spin
Off, however, the Company refinanced all funding and derivative transactions
without a guarantee from FCI. Absent FCI's guarantee, the Company's stand-alone
financing is significantly more expensive and subject to more restrictive terms
and conditions. Any material increase in the Company's costs of financing beyond
the Company's expectations could have a negative impact on the Company.
The Company also depends heavily upon the securitization of its credit
card loans to fund its operations and, to date, has completed securitization
transactions on terms that it believes are satisfactory. The Company cannot
assure you that the securitization market will continue to offer suitable
funding alternatives. Furthermore, the Company's ability to securitize its
assets depends on the continued availability of credit enhancement on acceptable
terms and the continued favorable legal, regulatory, accounting and tax
environment for securitization transactions. Any adverse change could force the
Company to rely on other potentially more expensive funding sources.
In addition, poor performance of the Company's securitized assets,
including increased delinquencies and credit losses, could result in a downgrade
or withdrawal of the ratings on the outstanding securities issued in the
Company's securitization transactions, cause early amortization of such
securities or result in higher required credit enhancement levels. This could
jeopardize the Company's ability to complete other securitization transactions
on acceptable terms, decrease the Company's liquidity and force the Company to
rely on other potentially more expensive funding sources to the extent
available.
The Company plans to continue to expand its credit card portfolio by
soliciting customers directly and by purchasing credit card portfolios from
third parties. The Company will depend on securitization and other funding
sources to finance the portfolio's acquisitions. At times it may be necessary
for the Company to issue debt or equity to fund the new loan growth. The
Company's ability to secure favorable financing depends on third parties
willingness to lend to the Company. There can be no assurance that the Company
will be able to secure funds to support its growth on terms as favorable as past
transactions. Any adverse change in the funding sources used by the Company
could force the Company to rely on other potentially more expensive funding
sources.
Interest Rate Fluctuations Impact the Yield on Company Assets and
Funding Expense
A reduction in market interest rates may reduce the yield on the
Company's assets while fixed rate funding expenses stay flat, compressing the
interest spread on which the Company profits. A rise in market interest rates
will directly increase floating rate funding expense and may indirectly impact
the payment performance of the Company's customers. Management tries to minimize
the impact of changes in market interest rates on the Company's cash flow, asset
value and net income primarily by funding variable rate assets with variable
rate funding sources and by using interest rate derivatives to match asset and
liability repricings. However, changes in market interest rates may have a
negative impact on the Company.
Current and Proposed Regulation and Legislation Limits the Company's
Business Activities, Product Offerings and Fees Charged
Various federal and state laws and regulations significantly limit the
activities in which the Company and Direct Merchants Bank are permitted to
engage. Such laws and regulations, among other things, limit the fees and other
charges that the Company is allowed to charge, limit or prescribe certain other
terms of the Company's products and services, require specified disclosures to
consumers, govern the sale and terms of products and services offered by the
Company and require that the Company maintain certain licenses, qualifications,
or capital requirements (see "Business - Regulations"). In some cases, the
precise application of these statutes and regulations is not clear. In addition,
the regulatory framework at the state and federal level regarding some of the
Company's fee-based products is evolving. The regulatory framework, as well as
changes in legal interpretation which may result from the Spin Off, could affect
the design or profitability of such products and the Company's ability to sell
certain products. In addition, numerous legislative and regulatory proposals are
advanced each year which, if adopted, could adversely affect the Company's
profitability or further restrict the manner in which the Company conducts its
activities. The failure to comply with, or adverse changes in the laws or
regulations to which the Company's business is subject, or adverse changes in
the interpretation thereof, could adversely affect the Company's ability to
collect its receivables and generate fees on the receivables which could have a
material adverse effect on the Company's business.
Other Industry Risks Related to Consumer Credit Products and Fee-Based
Services Could Negatively Impact the Company
The Company faces the risk of fraud by cardholders and third parties,
as well as the risk that increased criticism from consumer advocates and the
media could hurt consumer acceptance of its products. There is also a risk of
litigation, including class action litigation, challenging the Company's product
terms, rates, disclosures, collections or other practices, under state and
federal consumer protection statutes and other laws (see "Business -
Regulation").
As a Result of Intense Competition in the Company's Consumer Credit
Products and Fee-Based Services Businesses, There is no Assurance that the
Company Can Compete Successfully
The Company faces intense and increasing competition from numerous
financial services providers, many of which have greater resources than the
Company. In particular, the Company's credit card business competes with
national, regional and local bank card issuers, as well as other general purpose
and private label credit card issuers. There has been a recent increase in
solicitations to moderate income consumers, as competitors have increasingly
focused on this market. Customers are attracted to credit card issuers largely
on the basis of price, credit limit and other product features; as a result,
customer loyalty is often limited. According to published reports, as of
December 1998, the 20 largest issuers accounted for approximately 90% (based on
receivables outstanding) of the market for general purpose credit cards. Many of
these issuers are substantially larger, have more seasoned credit card
portfolios than the Company and often compete for customers by offering lower
interest rates and/or fee levels than the Company. The Company cannot assure you
that it will be able to compete successfully in this environment.
The Company also faces competition from numerous fee-based services
providers, including insurance companies, financial services institutions and
other membership-based or consumer services providers, many of which are larger,
better capitalized and more experienced than the Company. As the Company
continues to expand its extended service plan business to the customers of
third-party retailers, it competes with manufacturers, financial institutions,
insurance companies and a number of independent administrators, many of which
have greater operating experience and financial resources than the Company.
Changes in the Relationship With FCI Could Materially Impact the
Company's Business
Upon a Change of Control of the Company, Fingerhut can Terminate the
Company's Access to the Vital Database and Repurchase Credit Cards Bearing the
Fingerhut Name and Logo
The Company and FCI or Fingerhut have entered into a number of
agreements for the purpose of defining the ongoing relationship between them,
some of which are material to the Company's business. As previously discussed,
the Company relies on its access to the Fingerhut Database, including the
Fingerhut Suppress File, to market financial services products. As of December
31, 1998, Fingerhut customers in the Fingerhut Database represented 35% of the
Company's credit card accounts and all of the purchasers of the Company's
extended service plans. Until the Company develops its own significant database
and extended service plan marketing relationships with other companies, its
success will depend largely on its exclusive rights to the Fingerhut Database to
market such service plans and its right to be the exclusive provider of certain
financial services products to Fingerhut customers. Fingerhut can terminate the
Company's contractual rights to this access in the event a third party acquires
control of the Company and, upon termination of the agreement, Fingerhut has the
right to repurchase any then-outstanding general purpose credit cards bearing
the Fingerhut name and logo. Any denial or delay of this access or any such
repurchase could have a significant economic impact on the Company.
Recent Acquisition of Fingerhut Could Negatively Impact the Company
On February 11, 1999, FCI announced that it had agreed to be acquired
by Federated Department Stores, Inc. This transaction was completed on March 18,
1999, and the separate corporate existence of FCI ceased. Although the Company's
agreements with FCI and Fingerhut will not be terminated by this transaction,
the Company cannot predict how this change in status for FCI may impact the
relationship of the Company with FCI and Fingerhut.
No Assurance that Conflicts of Interest Between the Company and FCI
will be Resolved in Favor of the Company
Conflicts of interest may arise in the future between the Company and
FCI due to the continuing contractual relationship between the Company and FCI
and the overlap of the Company's Non-Executive Chairman of the Board, Theodore
Deikel, who is also the Chairman of the Board and Chief Executive Officer of
FCI. The Company has not instituted any formal plan or arrangement to address
such potential conflicts of interest. Although the directors intend to exercise
reasonable judgment and take such steps as they deem necessary under the
circumstances in resolving any conflict that may occur, the Company cannot
assure you that any conflicts will be resolved in favor of the Company.
Risks Relating to Year 2000 Compliance
The "Year 2000 Problem" is a result of computer systems using two
digits rather than four digits to define the applicable year. The Company, like
all database marketing companies and financial services institutions, depends
heavily upon computer systems for all phases of its operations. The Company
processes data through its own systems and obtains data and processing services
from various vendors. The Company, therefore, must concern itself not only with
its own systems, but also with the status of Year 2000 compliance with respect
to those vendors that provide data and processing services to the Company.
Most of the Company's existing information systems are less than three
years old and were originally designed for Year 2000 compliance, but as a
cautionary measure, the Company has begun testing such internal systems for Year
2000 compliance. The Company also depends on databases maintained by FCI and
card and statement generation, among other services, provided by FDR. The
Company has created a Year 2000 project team to identify, address and monitor
internal systems and vendor issues related to Year 2000 problems. The project
team meets monthly with systems experts at FCI and works closely with the
Company's identified material vendors, including FDR, to determine the impact on
the Company's and the vendors' plans for becoming Year 2000 compliant. The
project team is striving to obtain test results showing compliance by vendors by
the end of the first quarter of 1999 and has developed high-level contingency
plans to address non-compliance by its material vendors, which may include
replacing vendors. The Company may have difficulty identifying acceptable
alternative vendors, many of which may be overburdened with requests from
similarly situated companies. If the Company is unable to identify acceptable
and available alternative vendors, the transition of services to such vendors
may be time consuming and costly.
Although the Company cannot ensure compliance by all of its vendors on
a timely basis, the Company believes that it is taking appropriate steps to
identify exposure to Year 2000 problems and to address them on a timely basis.
In addition, the Company believes that it has adequate resources to achieve Year
2000 compliance for its systems which currently may not be compliant and that
the costs of Year 2000 compliance will not be material to the Company. If,
however, compliance with Year 2000 issues is not completed on a timely basis or
is not fully effective, the most reasonably likely worst case scenario that may
impact the Company's results of operations, financial condition and prospects is
the failure of FDR, Visa and MasterCard to provide services. The Company's
cardholders would be unable to use their credit cards or otherwise access their
accounts. Due to several unknown contributing factors, and the scope of the Year
2000 issue, the impact this worst case scenario would have on the Company's
results of operations, financial condition and prospects, is an uncertainty. The
scenarios will be analyzed and addressed in the Company's contingency plans.
The risks relating to the "Year 2000 Problem" are more fully discussed
in "Management's Discussion and Analysis of Financial Condition and Results of
Operations" on pages 32 to 34 of the 1998 Annual Report.
Potential Volatility of Stock Price
The Company which began as a subsidiary of FCI, was incorporated in
1996 and prior to the Spin Off was 83% owned by FCI. Factors such as actual or
anticipated fluctuations in the Company's operating results, regulatory
developments, conditions and trends in the consumer credit industry, general
market conditions and other factors beyond the Company's control may
significantly affect the market price of the Common Stock. In addition, the
market has, from time to time, experienced significant price and volume
fluctuations that often have been unrelated to the operating performance of
particular companies. These broad fluctuations may adversely affect the market
price of the Common Stock.
Item 2. Properties
The Company currently leases its principal executive office space in
St. Louis Park, Minnesota, consisting of leases for approximately 75,000 and
18,000 square feet. These leases expire on November 30, 2000 and April 30, 2001,
respectively. Direct Merchants Bank leases office space in Phoenix, Arizona,
consisting of approximately 26,000 square feet. This lease expires on June 30,
2004, and may be terminated by the Company after June 30, 2001. In addition, the
Company leases facilities in Tulsa, Oklahoma, White Marsh, Maryland, and
Champaign, Illinois, consisting of 62,000, 100,000, and 9,000 square feet,
respectively. These leases expire on December 31, 1999, September 30, 2007, and
November 30, 2002, respectively. The Company has extended the lease on its
current facility in Oklahoma through 1999 and entered into leases for its new
Oklahoma and Jacksonville operations centers. These leases commence January 1,
2000 and June 1, 1999 and consist of approximately 100,000 and 150,000 square
feet, respectively. The leased properties in Oklahoma, Maryland, and
Jacksonville support the Company's collections, customer service and back office
operations. The Company believes its facilities are suitable to its businesses
and that it will be able to lease or purchase additional facilities as needed.
Item 3. Legal Proceedings
The Company is a party to various legal proceedings resulting from the
ordinary business activities relating to its operations. On February 25, 1998,
the Company announced that the claims against it in the shareholders lawsuits
filed in October 1998 in the United States District Court, District of Minnesota
have been dismissed with prejudice. The Complaints had alleged securities fraud
and other claims related to a decline in the Company's stock price. The lawsuits
were dismissed through a Stipulation and Order entered into by counsel for the
plaintiffs and defendants, and ordered by the Federal District Court. This
dismissal was agreed to and ordered prior to the case having been certified as a
class action and without payment to the named plaintiffs or their counsel.
Certain existing laws and regulations permit class action lawsuits on
behalf of customers in the event of violations, and such class lawsuits can be
very expensive to defend, even without any violation. One of these actions, an
Alabama action in the Circuit Court of Greene County [(Preston Davis, Sr. et.
al. v. Direct Merchants Credit Card Bank, N.A., et. al. (Civil Action No.
CV98-012)], seeks damages in an unascertained amount and purports to be a
class action, although no class has been certified. During the past several
years, the press has widely reported certain industry-related concerns which
may impact the Company. Some of these involve the amount of litigation
instituted against financial services and insurance companies operating in the
state of Alabama and the large punitive awards obtained from juries in that
state. The Alabama case, instituted in April 1998, generally alleges a
fraudulent sale of credit protection insurance without consent. Compensatory
damages are sought. The judicial climate in Alabama is such that the outcome
of this case is unpredictable. The Company's subsidiary believes it has
substantive legal defenses to this claim and is prepared to defend this case
vigorously. Due to the uncertainties in litigation and other factors, there is
no assurance that the Company's subsidiary will ultimately prevail. Should the
Company's subsidiary's case settle or otherwise be resolved, it believes the
amount, in the aggregate, will not be material to the Company's consolidated
financial condition. However, if this action, or any class action, is
determined adversely, such decision can have a significant adverse economic
impact on the Company.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of security holders during the fourth
quarter of the Company's fiscal year ended December 31, 1998.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The information required by Item 201 of Regulation S-K is set forth in
the "Summary of Consolidated Quarterly Financial Information and Stock Data" on
page 61 of the Company's Annual Report to Shareholders as of and for the year
ended December 31, 1998 (the "1998 Annual Report") and is incorporated herein by
reference.
During the period covered by this report, the Company sold securities
that were not registered under the Securities Act of 1933, as amended (the "1933
Act"), in reliance on Section 4(2) of the 1933 Act. The Company received
aggregate proceeds of $300 million and paid underwriting discounts, commissions
and related fees of $30 million. The additional information required by this
item is set forth in "Note 6 - Private Equity Placement" on page 48 of the 1998
Annual Report and is incorporated herein by reference.
Item 6. Selected Financial Data
The information required by this item is set forth under the caption
"Selected Financial Data" on page 18 of the 1998 Annual Report and is
incorporated herein by reference.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The information required by this item is set forth under the captions
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Forward Looking Statements" on pages 19 to 35 of the 1998
Annual Report and is incorporated herein by reference.
Item 7a. Quantitative And Qualitative Disclosures About Market Risk
The information required by this item is set forth under the captions
"Management's Discussion and Analysis-Market Risk" on pages 29 and 30 of the
1998 Annual Report and is incorporated herein by reference.
Item 8. Financial Statements and Supplementary Data
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(Dollars in thousands, except per share data)
December 31,
1998 1997
---- ----
Assets:
Cash and due from banks .................................... $ 22,114 $ 21,006
Federal funds sold ......................................... 15,060 27,089
Short-term investments ..................................... 173 128
-------- --------
Cash and cash equivalents ............................... 37,347 48,223
-------- --------
Retained interests in loans securitized .................... 753,469 471,831
Less: Allowance for loan losses ......................... 393,283 244,084
-------- --------
Net retained interests in loans securitized ................ 360,186 227,747
-------- --------
Loans held for securitization .............................. 3,430 8,795
Property and equipment, net ................................ 21,982 15,464
Accrued interest and fees receivable ....................... 6,009 4,310
Prepaid expenses and deferred charges ...................... 59,104 18,473
Deferred income taxes ...................................... 153,021 80,787
Customer base intangible ................................... 81,892 36,752
Other receivables due from credit card securitizations, net 185,935 77,486
Other assets ............................................... 36,813 20,625
-------- --------
Total assets ......................................... $945,719 $538,662
======== ========
Liabilities:
Debt ....................................................... $310,896 $244,000
Accounts payable ........................................... 19,091 35,356
Current income taxes payable ............................... 31,783 9,701
Deferred income ............................................ 124,892 49,204
Accrued expenses and other liabilities ..................... 26,075 24,363
-------- --------
Total liabilities ....................................... $512,737 $362,624
-------- --------
Stockholders' Equity:
Preferred stock, par value $.01 per share; 10,000,000 shares
authorized, 539,866 shares issued and outstanding ....... $201,100
Common stock, par value $.01 per share; 100,000,000 shares
authorized, 19,259,750 and 19,225,000 shares issued and
outstanding, respectively ............................... 193 $ 192
Paid-in capital ............................................ 107,615 107,059
Retained earnings .......................................... 124,074 68,787
-------- --------
Total stockholders' equity .............................. $432,982 $176,038
-------- --------
Total liabilities and stockholders' equity .............. $945,719 $538,662
======== ========
See accompanying Notes to Consolidated Financial Statements
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Statements of Income
(Dollars in thousands, except per share data)
Year Ended December 31,
1998 1997 1996
---- ---- ----
Interest Income:
Credit card loans and retained interests in loans securitized.................. $ 111,118 $ 66,695 $ 29,028
Federal funds sold ............................................................ 1,065 1,636 867
Other ......................................................................... 1,028 863 299
-------- -------- --------
Total interest income ...................................................... 113,211 69,194 30,194
Interest expense .............................................................. 30,513 11,951 4,106
-------- -------- --------
Net Interest Income ........................................................... 82,698 57,243 26,088
Provision for loan losses ..................................................... 77,770 43,989 18,477
-------- -------- --------
Net interest income after provision for loan losses 4,928 13,254 7,611
-------- -------- --------
Other Operating Income:
Net securitization and credit card servicing income............................ 138,221 79,533 49,921
Credit card fees, interchange and other credit card income..................... 68,136 43,731 26,028
Fee-based services revenues ................................................... 106,601 63,413 50,273
-------- -------- --------
312,958 186,677 126,222
-------- -------- --------
Other Operating Expense:
Credit card account and other product solicitation and
marketing expenses ......................................................... 40,949 30,503 29,297
Employee compensation ......................................................... 62,627 35,200 23,068
Data processing services and communications ................................... 35,445 20,087 12,757
Third-party servicing expense ................................................. 11,074 12,711 9,207
Warranty and debt waiver underwriting and claims servicing
expense .................................................................... 12,279 6,053 10,024
Credit card fraud losses ...................................................... 4,436 3,240 2,276
Other ......................................................................... 57,828 30,254 14,658
-------- -------- --------
224,638 138,048 101,287
-------- -------- --------
Income Before Income Taxes .................................................... 93,248 61,883 32,546
Income taxes .................................................................. 35,900 23,825 12,530
-------- -------- --------
Net Income .................................................................... $ 57,348 $ 38,058 $ 20,016
Preferred stock dividends ..................................................... 1,100 -- --
-------- -------- --------
Net Income Available to Common Stockholders ................................... $ 56,248 $ 38,058 $ 20,016
======== ======== ========
Earnings Per Share:
Basic ......................................................................... $ 2.92 $ 1.98 $ 1.21
Diluted ....................................................................... $ 2.82 $ 1.88 $ 1.17
Shares used to compute earnings per share (000's)
Basic ......................................................................... 19,232 19,225 16,572
Diluted ....................................................................... 19,968 20,238 17,129
See accompanying Notes to Consolidated Financial Statements.
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity
(Dollars in thousands)
Total
Preferred Common Paid-In Retained Stockholders'
Stock Stock Capital Earnings Equity
BALANCE, DECEMBER 31, 1995 ............... $ $ $ 60,028 $ 11,290 $ 71,318
Net income ............................ 20,016 20,016
Company reorganization ................ 160 (160)
Issuance of common stock .............. 32 47,352 47,384
--------- --------- --------- --------- ---------
BALANCE, DECEMBER 31, 1996 ............... $ $ 192 $ 107,220 $ 31,306 $ 138,718
Net income ............................ 38,058 38,058
Common stock dividends and other - cash (161) (577) (738)
--------- --------- --------- --------- ---------
BALANCE, DECEMBER 31, 1997 ............... $ $ 192 $ 107,059 $ 68,787 $ 176,038
Net income ............................ 57,348 57,348
Issuance of preferred stock ........... 200,000 200,000
Common stock dividends and
other - cash .................... (961) (961)
Preferred stock dividends -
in kind ......................... 1,100 (1,100)
Exercised stock options ............... 1 556 557
--------- --------- --------- --------- ---------
BALANCE, DECEMBER 31, 1998 ............... $ 201,100 $ 193 $ 107,615 $ 124,074 $ 432,982
========== ========= ========= ========= =========
See accompanying Notes to Consolidated Financial Statements.
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Dollars in thousands)
Year Ended December 31,
1998 1997 1996
---- ---- ----
Operating Activities:
Net income .................................................. $ 57,348 $ 38,058 $ 20,016
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization ............................ 48,678 15,942 7,329
Change in allowance for loan losses ...................... 149,199 148,415 73,450
Changes in operating assets and liabilities:
Accrued interest and fees receivable .................. (1,699) (1,368) (719)
Prepaid expenses and deferred charges ................. (61,163) (23,150) (6,045)
Deferred income taxes ................................. (72,234) (49,259) 0
Accounts payable and accrued expenses ................. (14,553) 28,246 8,110
Other receivables due from credit card securitizations, (112,170) (31,911) 3,436
net
Current income taxes payable .......................... 22,082 8,241 (3,718)
Deferred income ....................................... 75,688 26,021 13,096
Other ................................................. (26,264) (16,022) (31,302)
----------- ----------- -----------
Net cash provided by operating activities ................... 64,912 143,213 83,653
----------- ----------- -----------
Investing Activities:
Proceeds from sales of loans ................................ 1,491,832 1,665,700 952,055
Net loans originated or collected ........................... (901,740) (1,231,223) (1,072,321)
Credit card portfolio acquisitions .......................... (921,558) (738,104)
Additions to property and equipment ......................... (10,814) (11,705) (4,113)
----------- ----------- -----------
Net cash used in investing activities ....................... (342,280) (315,332) (124,379)
----------- ----------- -----------
Financing Activities:
Net increase (decrease) in debt ............................ 66,896 188,837 (9,319)
Net proceeds from issuance of common stock .................. 557 47,384
Cash dividends paid ......................................... (961) (577)
Net proceeds from issuance of preferred stock ............... 200,000
----------- ----------- -----------
Net cash provided by financing activities ................... 266,492 188,260 38,065
----------- ----------- -----------
Net (decrease) increase in cash and cash equivalents ........ (10,876) 16,141 (2,661)
Cash and cash equivalents at beginning of year .............. 48,223 32,082 34,743
----------- ----------- -----------
Cash and cash equivalents at end of year .................... $ 37,347 $ 48,223 $ 32,082
=========== =========== ===========
See accompanying Notes to Consolidated Financial Statements.
METRIS COMPANIES INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except as noted)
NOTE 1 - ORGANIZATION AND BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Metris
Companies Inc. ("MCI") and its subsidiaries (collectively, the "Company")
including Direct Merchants Credit Card Bank, N.A. ("Direct Merchants Bank"). The
Company is an information-based direct marketer of consumer credit products and
fee-based services primarily to moderate-income consumers.
Prior to September 1996, Metris Direct, Inc. (previously known as
Fingerhut Financial Services Corporation), a direct subsidiary of MCI, operated
as a division of Fingerhut Companies, Inc. ("FCI"). During September 1996, FCI
reorganized the business through the formation of MCI. The stock of some
subsidiaries, in addition to the assets, liabilities and equity of certain
portions of the extended service plan business, was contributed to the Company
from FCI and its subsidiaries. In October 1996, the Company completed an initial
public offering of its common stock (see Note 7). On September 25, 1998, FCI
distributed the remaining shares of the Company to shareholders of FCI in a tax
free distribution (the "Spin Off").
The consolidated financial statements also include an allocation of
expenses for certain data processing and information systems, audit, accounting,
treasury, legal, human resources, customer service and other administrative
support historically provided by FCI and its subsidiaries to the Company. Such
expenses were based on the actual use of such services or were based on other
allocation methods that, in the opinion of management, are reasonable. During
1996, FCI and the Company entered into an administrative services agreement that
covers such expense allocations and the provision of future services using
similar rates and allocation methods for various terms, the latest of which
expired at the end of 1998. The consolidated financial statements also reflect
the retroactive effects of agreements entered into during 1996, including
co-brand credit card, database access, data sharing and extended service plan
agreements with Fingerhut Corporation, and a tax sharing agreement with FCI.
These agreements have original terms ranging up to seven years, expiring no
later than October 2003.
All significant intercompany balances and transactions have been
eliminated in consolidation. Certain prior year amounts have been reclassified
to conform with the current year's presentation.
Pervasiveness of Estimates
The consolidated financial statements have been prepared in accordance
with generally accepted accounting principles, which require management to make
estimates and assumptions that affect the reported amount of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the consolidated financial statements as well as the reported amount of revenues
and expenses during the reporting periods. Actual results could differ from
these estimates.
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of the significant accounting and reporting
policies used in preparing the consolidated financial statements.
Federal Funds Sold
Federal funds sold are short-term loans made to banks through the
Federal Reserve System. It is the Company's policy to make such loans only to
banks that are considered to be in compliance with their regulatory capital
requirements.
Loans Held for Securitization
Loans held for securitization are credit card loans the Company intends
to securitize, generally no later than three months from origination and are
recorded at the lower of aggregate cost or market value.
Securitization, Retained Interests in Loans Securitized and Securitization
Income
The Company securitizes and sells a significant portion of its credit
card loans to both public and private investors through the Metris Master Trust
(the "Trust") and third party bank sponsored, multi-seller receivables conduits
(the "Conduits"). The Company retains participating interests in the credit card
loans under "Retained interests in loans securitized" on the consolidated
balance sheets. The Company's retained interests in loans securitized are
subordinate to the interests of investors in the Trust and Conduit portfolios.
Although the Company continues to service the securitized credit card accounts
and maintains the customer relationships, these transactions are treated as
sales for financial reporting purposes and the associated loans are not
reflected on the consolidated balance sheets.
Beginning in 1997, the sales of these loans have been recorded in
accordance with Statement of Financial Accounting Standards ("SFAS") No. 125,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities." The adoption of SFAS 125 did not have a material effect on the
Company's consolidated financial statements. Upon sale, the sold credit card
loans are removed from the balance sheet and the related financial and servicing
assets controlled and liabilities incurred are initially measured at fair value,
if practicable. SFAS 125 also requires that servicing assets and other retained
interests in the transferred assets be measured by allocating the previous
carrying amount between the assets sold, if any, and retained interests, if any,
based on their relative fair values at the date of the transfer.
Prior to January 1, 1997, the sales of these loans were recorded in
accordance with SFAS No. 77, "Reporting by Transferors for Transfers of
Receivables with Recourse." Upon sale, the loans were removed from the balance
sheet, and a gain on sale was recognized for the difference between the carrying
value of the loans and the adjusted sales proceeds. The adjusted sales proceeds
are based on a present value estimate of future cash flows to be received over
the life of the loans, net of certain funding and servicing costs. The resulting
gain was further reduced for estimated loan losses over the life of the related
loans under the limited recourse provisions.
The securitization and sale of credit card loans changes the Company's
interest in such loans from lender to servicer, with a corresponding change in
how revenue is reported in the statements of income. For securitized and sold
credit card loans, amounts that otherwise would have been recorded as interest
income, interest expense, fee income and provision for loan losses are instead
reported in other operating income as "Net securitization and credit card
servicing income." The Company has various receivables from the Trust or
Conduits and other assets as a result of securitizations, which primarily
consists of amounts deposited in investor reserve accounts held by the Trust or
Conduits for the benefit of the Trust's and Conduit's security holders. Other
components include amounts due from interest rate caps, swaps and floors;
accrued interest and fees on the securitized receivables; and various other
receivables. These amounts are reported as "other receivables due from credit
card securitizations, net" on the consolidated balance sheets. The provision for
loan losses reflected on the statements of income in "Net securitization and
credit card servicing income" was $456 million, $275 million, and $118 million
for the years ended December 31, 1998, 1997, and 1996, respectively.
Provisions for loan losses are made in amounts necessary to maintain
the allowance at a level estimated to be sufficient to absorb probable future
losses of principal and earned interest, net of recoveries, inherent in the
existing loan portfolio, effectively reducing the Company's retained interests
in loans securitized to fair value.
The Company securitized approximately $1.5 billion and $1.7 billion of
credit card loans in 1998 and 1997, respectively. At December 31, 1998, the
Company had approximately $4.6 billion of investors' interests in securitized
loans, with expected maturities from 1999 to 2001.
Allowance for Loan Losses
Provisions for loan losses are made in amounts necessary to maintain
the allowance at a level estimated to be sufficient to absorb probable future
losses of principal and earned interest, net of recoveries, inherent in the
existing managed loan portfolio. In evaluating the adequacy of the allowance for
loan losses, management considers several factors, including: historical
charge-off and recovery activity by age (vintage) of each loan portfolio (noting
any particular trends over recent periods); recent delinquency and collection
trends by vintage; current economic conditions and the impact such conditions
might have on borrowers' ability to repay; the risk characteristics of the
portfolios; and other factors. Significant changes in these factors could affect
the adequacy of the allowance for loan losses in the near term. Credit card
accounts are generally charged off at the end of the month during which the loan
becomes contractually 180 days past due, with the exception of bankrupt
accounts, which are charged off immediately upon formal notification of
bankruptcy, and accounts of deceased cardholders without a surviving,
contractually liable individual, or an estate large enough to pay the debt in
full, which are also charged off immediately upon notification.
Property and Equipment
Property and equipment, and computer hardware and software are stated
at cost and depreciated on a straight-line basis over their estimated economic
useful lives (three to ten years for furniture and equipment, three to five
years for computer hardware, up to five years for software; and over the shorter
of the estimated useful life or the term of the lease for leasehold
improvements). The Company capitalizes software developed for internal use that
represents major enhancements or replacements of operating and management
information systems. Amortization of such capitalized software begins when the
systems are fully developed and ready for implementation. Repairs and
maintenance are charged to expense as incurred.
Customer Base Intangible
The customer base intangible represents the excess of amounts paid for
portfolio acquisitions over the related credit card loan balances net of
reserves and discounts. The intangible assets are amortized over the estimated
periods of benefit, generally 5 to 7 years, in proportion to the expected
benefits to be recognized. The amount amortized for 1998, 1997 and 1996 were
$10.1 million, $2.5 million, and $0.3 million, respectively.
Interest Income on Credit Card Loans
Interest income on credit card loans is accrued and earned based on the
principal amount of the loans outstanding using the effective-yield method.
Accrued interest which has been billed to the customer but not yet received is
classified on the balance sheet with the related credit card loans. Accrued
interest which has not yet been billed to the customer is estimated and
classified on the balance sheet separate from the loan balance. Interest income
is generally recognized until a loan is charged off. At that time, the accrued
interest portion of the charged off balance is deducted from current period
interest income.
Fee-Based Services
Debt Waiver Products
Direct Merchants Bank offers various debt waiver products to its credit
card customers for which it retains the claims risk. Revenue for such products
is recognized ratably over the coverage period, generally one month, and
reserves are provided for pending claims based on Direct Merchants Bank's
historical experience with settlement of such claims. Revenues recorded for debt
waiver products are included in the consolidated statements of income under
"Fee-based services revenues" and were $73.8 million, $47.6 million and $25.5
million for the years ended December 31, 1998, 1997 and 1996, respectively.
Unearned revenues and reserves for pending claims are recorded in the
consolidated balance sheets in "Deferred revenues" and "Accrued expenses and
other liabilities" and amounted to $4.8 million and $4.0 million as of December
31, 1998 and 1997, respectively.
Membership Programs
During the quarter ended September 30, 1998, the Company changed its
method of recognizing revenue for certain fee-based services for which a
cancellation period with a full refund exists. This change was made to be
consistent with recent revenue recognition policy changes made by others in the
Company's industry. Previously, the Company had recognized a portion of the
revenue, net of estimated cancellations, associated with such services during
the refund period. The Company now defers the recognition of revenue until the
expiration of the cancellation period, at which time revenue relating to the
full refund period is recognized. The remaining revenue is recognized over the
remaining term of the membership. The Company continues to defer qualifying
direct-response advertising costs and amortizes these expenses in proportion to
revenue recognized. This change resulted in a cumulative one-time reduction in
revenues of approximately $3.0 million and a corresponding reduction in expenses
of approximately $3.1 million, or a $68,000 increase in net income. This
cumulative impact is reflected in the consolidated statement of income for the
year ended December 31, 1998.
Membership fees are generally billed through financial institutions,
including Direct Merchants Bank, and other cardholder based institutions and are
recorded as deferred membership income upon acceptance of membership and
pro-rated over the membership period beginning after the contractual
cancellation period is complete.
In accordance with the provisions of Statement of Position 93-7,
"Reporting on Advertising Costs," qualifying membership acquisition costs are
deferred and charged to expense as membership fees are recognized. These costs,
which relate directly to membership solicitations (direct response advertising
costs), principally include: postage, printing, mailings, and telemarketing
costs. Such costs are amortized on a straight-line basis as revenues are
realized over the membership period. Amortization of membership acquisition
costs amounted to $8.9 million, $2.3 million, and $0.1 million for the years
ended December 31, 1998, 1997, and 1996, respectively. If deferred membership
acquisition costs were to exceed the membership fee, an appropriate adjustment
would be made for impairment. Deferred membership acquisition costs amounted to
$22.4 million and $11.1 million as of December 31, 1998 and 1997, respectively.
Extended Service Plans
The Company coordinates the marketing activities for Fingerhut's sales
of extended service plans. The Company began performing administrative services
and retained the claims risk for all extended service plans sold on or after
January 1, 1997. As a result, extended service plan revenues and the incremental
direct acquisition costs are deferred and recognized on a straight-line basis
over the life of the related extended service plan contracts beginning after the
expiration of any manufacturers' warranty coverage. The provision for service
contract returns charged against revenues for the years ended December 31, 1998,
1997 and 1996 amounted to $4.8 million, $4.6 million and $4.5 million,
respectively. Additionally, the Company reimburses Fingerhut for the cost of its
marketing media and other services utilized in the sales of extended service
plans, based on contracts sold and on media utilization costs as agreed to by
the Company and Fingerhut.
Prior to January 1, 1997, the Company contracted with a third-party
underwriter and claims administrator to service and absorb the risk of loss for
most claims. These claims servicing contract costs were expensed as the service
contracts were sold, net of the related cost of anticipated service contract
returns. In addition, the revenues related to these contract sales were
recognized immediately.
Credit Card Fees and Origination Costs
Credit card fees include annual membership, late payment, overlimit,
returned check, and cash advance transaction fees. These fees are assessed
according to the terms of the related cardholder agreements.
The Company defers direct credit card origination costs associated with
successful credit card solicitations that it incurs in transactions with
independent third parties, and certain other costs that it incurs in connection
with loan underwriting and the preparation and processing of loan documents.
These deferred credit card origination costs are netted against the related
credit card annual fee, if any, and amortized on a straight-line basis over the
cardholder's privilege period, generally 12 months. Net deferred fees were $9.6
million and $9.2 million as of December 31, 1998 and 1997, respectively.
Solicitation Expenses
Credit card account costs, including printing, credit bureaus, list
processing costs, telemarketing and postage, are generally expensed as incurred
over the two to three month period during which the related responses to such
solicitation are received.
Credit Card Fraud Losses
The Company experiences credit card fraud losses from the unauthorized
use of credit cards. These fraudulent transactions are expensed when identified,
through the establishment of a reserve for the full amount of the transactions.
These amounts are charged off after 90 days, after all attempts to recover the
amounts from such transactions, including chargebacks to merchants and claims
against cardholders, are exhausted.
Interest Rate Risk Management Contracts
The nature and composition of the Company's assets and liabilities and
securitized loans expose the Company to interest rate risk. The Company enters
into a variety of interest rate risk management contracts such as interest rate
swap, floor, and cap agreements with highly rated counterparties in order to
hedge its interest rate exposure. The monthly interest rate differential to be
paid or received on these contracts is accrued and included in "Net
securitization and credit card servicing income" on the consolidated statements
of income. Premiums paid for such contracts and the related interest payable or
receivable under such contracts are classified under "Other receivables due from
credit card securitization, net," on the consolidated balance sheets. Premiums
paid for interest rate contracts are recorded at cost and amortized on a
straight-line basis over the life of the contract. During 1998, the Company
terminated swaps and used the proceeds to purchase new interest rate floors.
After purchasing these floors, the Company terminated one of the floors
resulting in $43.4 million of proceeds. The resulting $34.1 million gain is
being amortized into income over the shorter of the contract life or the
remaining life of the securities it was hedging (see Note 16).
Debt Issuance Costs
Debt issuance costs are the costs related to issuing new debt
securities and establishing new securitizations under the Trust or Conduits. The
costs are capitalized as incurred and amortized to expense over the term of the
new debt security.
Income Taxes
The Company determines deferred taxes based on the temporary
differences between the financial statement and the tax bases of assets and
liabilities that will result in future taxable or deductible amounts. The
deferred taxes are based on the enacted rate that is expected to apply when the
temporary differences reverse. For periods prior to the Spin Off, the Company
was included in the consolidated federal and certain state income tax returns of
FCI. Based on a tax sharing agreement between the Company and FCI, the provision
and deferred income taxes are computed based only on the Company's financial
results as if the Company filed its own federal and state tax returns.
Statements of Cash Flows
The Company prepares its consolidated statements of cash flows using
the indirect method, which requires a reconciliation of net income to net cash
from operating activities. In addition, the Company nets certain cash receipts
and cash payments from credit card loans made to customers, including principal
collections on those loans. For purposes of the consolidated statements of cash
flows, cash and cash equivalents include cash and due from banks, federal funds
sold, short-term investments, (mainly money market funds) and all other highly
liquid investments with original maturities of three months or less.
Cash paid for interest during the years ended December 31, 1998, 1997
and 1996 was $28.4 million, $9.4 million and $4.1 million, respectively. Cash
paid for income taxes for the same periods was $86.1 million, $64.8 million and
$41.6 million, respectively.
Earnings Per Share
Basic earnings per share ("EPS") excludes dilution and is computed by
dividing net income available to common stockholders by the weighted average
number of common shares outstanding for the period. Diluted EPS reflects the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock. The following table
presents the computation of basic and diluted weighted average shares used in
the per share calculations:
Year Ended
December 31,
1998 1997 1996
---- ---- ----
(In thousands, except EPS)
Net income .................................. $57,348 $38,058 $20,016
Preferred dividends ......................... 1,100
------- ------- -------
Net income available to common stockholders . $56,248 $38,058 $20,016
======= ======= =======
Weighted average common shares outstanding .. 19,232 19,225 16,572
Adjustments for dilutive securities:
Assumed exercise of outstanding stock options 736 1,013 557
------- ------- -------
Diluted common shares ....................... 19,968 20,238 17,129
Basic EPS ................................... $ 2.92 $ 1.98 $ 1.21
Diluted EPS ................................. 2.82 1.88 1.17
Comprehensive Income
During 1998, the Company adopted SFAS 130, "Reporting Comprehensive
Income." This statement does not apply to the Company's current financial
results and therefore, net income equals comprehensive income.
NOTE 3 - ALLOWANCE FOR LOAN LOSSES
The activity in the allowance for loan losses is as follows:
Year Ended December 31,
1998 1997 1996
---- ---- ----
Balance at beginning of year ............ $244,084 $ 95,669 $ 22,219
Allowance related to assets acquired, net 20,152 20,246
Provision for loan losses ............... 77,770 43,989 18,477
Provision for loan losses (1) ........... 456,354 275,310 117,827
Loans charged off ....................... 420,875 195,535 64,083
Recoveries .............................. 15,798 4,405 1,229
-------- -------- --------
Net loan charge-offs .................... 405,077 191,130 62,854
-------- -------- --------
Balance at end of year .................. $393,283 $244,084 $ 95,669
======== ======== ========
(1) Amounts are included in "Net securitizations and credit servicing income."
NOTE 4 - PROPERTY AND EQUIPMENT
The carrying value of property and equipment is as follows:
December 31,
1998 1997
---- ----
Furniture and equipment ....................... $10,974 $ 6,346
Computer software and equipment ............... 9,077 3,733
Construction in progress ...................... 2,013 4,937
Leasehold improvements ........................ 6,204 2,439
------- -------
Total ......................................... $28,268 $17,455
Less: Accumulated depreciation and amortization 6,286 1,991
------- -------
Balance at end of year ........................ $21,982 $15,464
======= =======
Depreciation and amortization expense for the years ended December 31,
1998, 1997 and 1996 was $4.4 million, $1.4 million, and $0.4 million,
respectively.
NOTE 5 - PORTFOLIO ACQUISITIONS
In December 1998, the Company acquired a $800 million credit card
portfolio from PNC Bank Corp. representing loans from customers outside of PNC's
normal banking relationship. A portion of these credit card receivables were
securitized and sold to investors through a conduit. The Company retains an
interest in the receivables which is financed by borrowings under a credit
facility and proceeds from the Thomas H. Lee Company investments discussed in
Note 6.
In September 1997, the Company acquired a $317 million credit card
portfolio from Key Bank USA, National Association. These credit card receivables
were securitized and sold to investors through a conduit. The Company retains an
interest in the receivables which is financed by borrowings under a credit
facility.
In October 1997, the Company acquired a $405 million credit card
portfolio from Mercantile Bank National Association. This portfolio was also
securitized and sold through a conduit. The Company retains an interest in the
receivables which is financed by borrowings under a credit facility.
NOTE 6 - PRIVATE EQUITY PLACEMENT
On November 13, 1998, the Company entered into agreements with
affiliates of the Thomas H. Lee Company, a private equity firm, (together with
its affiliates, the "Lee Company") to make a total private equity investment of
$300 million in the Company. The Lee Company has agreed to purchase 0.8 million
shares of Series C Perpetual Convertible Preferred Stock (the "Series C
Preferred") which will be convertible into common shares at a conversion price
of $37.25 per common share subject to adjustment in certain circumstances. The
Series C Preferred has a 9% dividend payable in additional shares of Series C
Preferred and will also receive any dividends paid on the Company's common stock
on an as converted basis. The cumulative payment-in-kind dividends are
effectively guaranteed for a seven year period. Assuming conversion of the
Series C Preferred into common stock, the Lee Company would initially own
approximately 30% of the Company on a diluted basis. The Company's Board of
Directors will be expanded to a total of 11 members and the Series C Preferred
will entitle the holders to elect four members subject to approval of the Office
of the Comptroller of the Currency ("OCC"). The Company determined that the
conversion to the Series C Preferred will result in a "change in control" in
certain of the Company's agreements with FCI and the New Credit Facility.
Therefore, the Company was required to either increase the change in control
ownership percentage from 30 to 35 or otherwise exempt the Lee Company from the
change in control provision.
In order to provide the Company funding for the PNC portfolio
acquisition (see Note 5) as well as for general corporate purposes prior to
shareholders' approval and the receipt of notice that there was no regulatory
objection to the transaction, the Lee Company agreed to purchase $200 million in
Series B Perpetual Preferred Stock (the "Series B Preferred") and $100 million
in 12% Senior Notes due 2006 (the "Lee Senior Notes"). The Company also issued
the Lee Company 3.75 million ten-year warrants to purchase shares of the
Company's common stock for $30 subject to adjustment in certain circumstances.
The Series B Preferred has a 12.5% dividend payable in additional shares of
Series B Preferred for ten years, then converting to a dividend payable in cash.
On March 12, 1999, shareholders' approved the conversion of the Series
B Preferred and Lee Senior Notes into Series C Preferred. If notice is received
that there is no regulatory objection to the conversion to the Series C
Preferred, the Series B Preferred and the Lee Senior Notes will be retired, and
the warrants will be canceled causing a one-time, non-cash accounting
adjustment. The excess of the fair value of the Series C Preferred over the
carrying value of the Series B Preferred and the Lee Senior Notes at the time of
the conversion must be allocated to the Lee Senior Notes and the Series B
Preferred based upon their initial fair values. To arrive at net income
available to common stockholders in the calculation of earnings per share, the
amount allocated to the Lee Senior Notes would be recognized as an extraordinary
loss from the early extinguishment of debt and the amount allocated to the
Series B Preferred would be recognized as a reduction of net income available to
common stockholders. The extraordinary loss attributable to the Lee Senior Notes
will not be recorded net of taxes. These adjustments will not have an impact on
total stockholders' equity. At the time of the printing of this annual report,
the fair value of the Series C Preferred was not determined.
NOTE 7 - INITIAL PUBLIC OFFERING
In October, 1996, the Company completed an initial public offering of
3,258,333 shares of its common stock at $16 a share. At that time, the
transaction reduced FCI's ownership interest in the Company to approximately
83%. The Company realized net cash proceeds of approximately $47.2 million from
the sale of such shares after underwriting discounts, commissions and expenses
of the offering.
NOTE 8 - STOCK OPTIONS
In connection with the initial public offering of the Company, the
Company adopted the Metris Companies Inc. Long-Term Incentive and Stock Option
Plan (the "Stock Option Plan"), which permits a variety of stock-based grants
and awards and gives the Company flexibility in tailoring its long-term
compensation programs. In 1998, the Company's Board of Directors adopted a
proposal to increase the number of shares from 1,860,000 shares of common stock
to 4,000,000 shares of common stock, subject to adjustment in certain
circumstances, to be available for awards of stock options or other stock-based
awards. This increase was approved by the Company's Stockholders at the 1998
annual meeting. As of December 31, 1998 and 1997, 1,495,675 and 303,925 shares,
respectively, were available for grant.
The Compensation Committee has the authority to determine the exercise
prices, vesting dates or conditions, expiration dates and other material
conditions upon which options or awards may be exercised, except that the option
price for Incentive Stock Options ("ISOs") may not be less than 100% of the fair
market value of the common stock on the date of grant (and not less than 110% of
the fair market value in the case of an ISO granted to any employee owning more
than 10% of the common stock) and the terms of nonqualified stock options may
not exceed 15 years from the date of grant (not more than 10 years for ISOs and
five years for ISOs granted to any employee owning more than 10% of the common
stock). Full or part-time employees, consultants or independent contractors to
the Company are eligible to receive nonqualified options and awards. Only full
or part-time employees are eligible to receive ISOs.
Effective March 1994, FCI granted the Company's Chief Executive Officer
("CEO") a tandem option (the "Tandem Option") for either (a) 55,000 shares of
FCI's common stock at an exercise price of $15 per share or (b) a 3.3% equity
interest in the portion of the Company that exceeds two times the estimated fair
value of the Company in March 1994. In connection with the initial public
offering, the 3.3% equity interest was converted into options for 656,075 shares
of the Company's common stock with an exercise price of $2.76 per share, which
vests over five years from the effective date. This option was granted pursuant
to the Company's Stock Option Plan. Compensation expense of $0.7 million and
$7.8 million related to these options was recorded for the years ended December
31, 1997 and 1996, respectively.
During 1998 and 1997, the Company granted 1,055,500 and 318,500
options, respectively, to officers and employees of the Company. At the time of
the initial public offering, the Company granted officers and employees of the
Company, Fingerhut, and others options to purchase an aggregate of 742,625
shares of common stock. Of these, 646,500 options were granted at an exercise
price of $16 and the balance were granted at a below-market exercise price per
share, for which expense of $1.2 million was recorded for the year ended
December 31, 1996. All options granted to current officers and employees of the
Company and Fingerhut were at the initial offering price.
The Company also adopted the Metris Companies Inc. Non-Employee
Director Stock Option Plan (the "Director Plan"). Originally, such plan
permitted up to 20,000 shares of common stock for awards of options, subject to
certain adjustments in certain circumstances. In 1997, the Board of Directors
amended the plan to provide up to 100,000 shares of common stock for awards of
options, subject to adjustments in certain circumstances. This Director Plan was
approved by the Company's stockholders at the 1998 annual meeting. During 1998
and 1997, the Company granted 25,000 and 20,000 options, respectively, and at
the time of the initial public offering the Company granted 10,000 options. At
December 31, 1998 and 1997, 45,000 and 70,000 shares, respectively, were
available for grant.
The Company has adopted the disclosure-only provisions of SFAS No. 123
"Accounting for Stock-Based Compensation." Accordingly, the Company continues to
account for stock-based compensation under the provisions of Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees."
Under the guidelines of Opinion 25, compensation cost for stock-based employee
compensation plans is recognized based on the difference, if any, between the
quoted market price of the stock on the date of grant and the amount an employee
must pay to acquire the stock. Had compensation cost for these plans been
determined based on the fair value methodology prescribed by
SFAS 123, the Company's net earnings and earnings per share would have been
reduced to the pro forma amounts indicated below:
Year Ended December 31,
1998 1997 1996
---- ---- ----
Net income as reported ............... $ 57,348 $ 38,058 $ 20,016
Net income pro forma ................. $ 47,264 $ 36,819 $ 17,395
Diluted earnings per share as reported $ 2.82 $ 1.88 $ 1.17
Diluted earnings per share pro forma . $ 2.37 $ 1.82 $ 1.02
The above pro forma amounts may not be representative of the effects on
reported net earnings for future years. The fair value of each option grant is
estimated on the date of grant using the Black-Scholes option-pricing model. The
following weighted-average assumptions were used for grants in 1998, 1997 and
1996, respectively: dividend yield of 0.10%, 0.11% and 0.17%; expected
volatility of 71.3%, 68.2% and 25.1%; risk-free interest rate of 4.72%, 6.34%
and 6.48%; and expected lives of 7 years, 7 years, and 6.5 years, respectively.
Information regarding the Company's stock option plans for 1998, 1997
and 1996 is as follows:
Year Ended December 31,
1998 1997 1996
---- ---- ----
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
Options outstanding,
beginning of year ....... 1,682,200 $15.03 1,408,700 $ 8.93 656,075 $ 2.76
Options exercised .......... 34,750 16.00
Options granted ............ 1,080,500 43.55 338,500 40.58 752,625 14.31
Options canceled/forfeited . 107,250 41.75 65,000 16.00
--------- ----- --------- ----- --------- ----
Options outstanding, end of
year .................... 2,620,700 25.68 1,682,200 15.03 1,408,700 8.93
Weighted-average fair value
of options granted during
the year ................ 32.32 28.29 11.54
The following table summarizes information about stock options
outstanding at December 31, 1998:
Options Outstanding Options Exercisable
Number Weighted-Average
Outstanding at Remaining Weighted-Average Number Exercisable Weighted Average
Exercise Price 12/31/98 Contractual Life Exercise Price at 12/31/98 Exercise Price
$ 2.76 752,200 5.6 $ 2.76 730,864 $ 2.76
$16.00-$36.50 1,046,000 8.8 22.58 423,000 16.19
$36.51-$55.50 352,500 8.8 41.12 15,000 44.50
$55.51-$69.38 470,000 9.4 57.67 30,000 56.33
NOTE 9 - EMPLOYEE BENEFIT PLANS
In January 1997, the Company adopted a defined contribution plan that
is intended to qualify under section 401(k) of the Internal Revenue Code (the
401(k) Plan"). The 401(k) Plan provides retirement benefits for eligible
employees. During 1997 and 1998, the Company's employees participated in the
401(k) Plan, which provides savings and investment opportunities. The 401(k)
Plan stipulates that eligible employees may elect to contribute to the 401(k)
Plan. The Company matches a portion of employee contributions and makes
discretionary contributions based upon the Company's financial performance. For
the years ended December 31, 1998 and 1997, the Company contributed $0.9 million
to the 401(k) for both periods.
Prior to 1997, employees of Direct Merchants Bank participated in a
defined contribution plan maintained by Direct Merchants Bank that covered
substantially all of its employees. This plan was merged with and into the
401(k) Plan and the funds transferred to the 401(k) Plan respective accounts.
Direct Merchants Bank employees were eligible to participate in the 401(k) Plan
as of January 1, 1997.
In 1998, the Company adopted a Non-Qualified Deferred Compensation Plan
to a select group of management or highly compensated employees. These employees
were excluded from participating in the 401(k) plan. This plan provided saving
and investment opportunities to those individuals who elected to defer a portion
of their salary. The Company matches a portion of the employee contribution and
makes discretionary contributions based on the Company's financial performance.
For the year ended December 31, 1998, the Company contributed $0.2 million to
the Plan.
NOTE 10 - INCOME TAXES
The components of the provision for income taxes consisted of the
following:
Year Ended December 31,
1998 1997 1996
---- ---- ----
Current:
Federal $ 98,428 $ 66,496 $ 38,914
State . 8,355 4,663 4,035
Deferred . (70,883) (47,334) (30,419)
-------- -------- --------
$ 35,900 $ 23,825 $ 12,530
======== ======== ========
A reconciliation of the Company's effective income tax rate compared
to the statutory federal income tax rate is as follows:
Year Ended December 31,
1998 1997 1996
---- ---- ----
Statutory federal income tax rate ............. 35.0 35.0 35.0%
State income taxes, net of federal benefit .... 3.2 3.2 3.2%
Other, net .................................... 0.3 0.3 0.3%
--- --- ---
Effective income tax rate ..................... 38.5 38.5 38.5%
==== ==== ====
The Company's deferred tax assets and liabilities are as follows:
December 31,
1998 1997
Deferred income tax assets resulting deductible temporary differences:
Allowance for loan losses ............................................................. $119,518 $ 71,240
Deferred revenues ..................................................................... 32,334 16,140
Other ................................................................................. 18,199 9,344
-------- --------
Total deferred tax assets ................................................................ $170,051 $ 96,724
Deferred income tax liabilities resulting from future taxable temporary differences:
Deferred costs ........................................................................ $ 10,672 $ 6,360
Accrued interest on credit card loans ................................................. 5,048 8,577
Accelerated depreciation .............................................................. 1,310 31
Other ................................................................................. 969
-------- --------
Total deferred tax liabilities ........................................................... $ 17,030 $ 15,937
-------- --------
Net deferred tax assets .................................................................. $153,021 $ 80,787
======== ========
Management believes, based on the Company's history of operating
earnings, expectations for operating earnings in the future, and the expected
reversal of taxable temporary differences, earnings will be sufficient to fully
utilize the deferred tax assets.
NOTE 11 - RELATED PARTY TRANSACTIONS
Prior to September 1998, FCI owned approximately 83% of the outstanding
common shares of the Company. In September 1998, FCI distributed the remaining
shares of the Company to shareholders of FCI in a tax free distribution.
FCI and its various subsidiaries have historically provided financial
and operational support to the Company. Direct expenses incurred by FCI and/or
its subsidiaries for the Company, and other expenses, have been allocated to the
Company using various methods (headcount, actual or estimated usage, etc.).
Since the Company has not historically operated as a separate stand-alone entity
for all periods presented, these allocations do not necessarily represent the
expenses and costs that would have been incurred directly by the Company had it
operated on a stand-alone basis. However, management believes such allocations
reasonably approximate market rates for the services performed. The direct and
allocated expenses represent charges for services such as data processing and
information systems, audit, certain accounting and other similar functions,
treasury, legal, human resources, certain customer service and marketing
analysis functions, certain executive time, and space and property usage
allocations. In addition, the Company has historically managed the sales of
credit insurance products for Fingerhut. In accordance therewith, the Company
has allocated back to Fingerhut certain direct and other expenses using methods
similar to those mentioned above. The historical expenses and cost allocations
have been agreed to by the management of both FCI and the Company, the terms of
which are summarized in an ongoing administrative services agreement between FCI
and the Company. This agreement provides for similar future services using
similar rates and cost allocation methods for various terms.
The financial statements also include an allocation of FCI interest
expense for the net borrowings of the Company from FCI, or a net interest credit
for the net cash flows of the Company loaned to FCI in 1996. These allocations
of interest expense or income for 1996 were based on the net loans made or
borrowings received between the Company and FCI, plus or minus the effects of
intercompany balances outstanding during 1996. The interest rate used to
calculate such expense or credit during 1996 was based on the average short-term
borrowing rates of FCI during 1996.
The Company and Fingerhut have also entered into several other
agreements that detail further business arrangements between the companies. The
retroactive effects of these additional business arrangements have been
reflected in the consolidated financial statements of the Company. The
agreements entered into include a co-brand credit card agreement and a data
sharing agreement, which provides for payment for every Fingerhut co-branded
credit card account booked, as defined, and a payment based on card usage from
such accounts. The parties have also entered into a database access agreement,
which provides the Company with the exclusive right to access and market
financial services products, as defined, to Fingerhut customers, in exchange for
a license fee. The agreement also calls for a solicitation fee per product
mailed to a Fingerhut customer, and a suppress file fee for each consumer name
obtained from a third party and matched to the Fingerhut suppress file before
its solicitation.
The Company and Fingerhut have also entered into an extended service
plan agreement, which provides the company with the exclusive right to provide
and coordinate the marketing of extended service plans to the customers of
Fingerhut. Revenues are received from Fingerhut from such sales, and the Company
reimburses Fingerhut and/or its subsidiaries for certain marketing costs.
Additionally, the Company and FCI have entered into a tax sharing agreement (see
Note 2) and a card registration agreement.
The following table summarizes the amounts of these direct expense
charges and cost allocations (including net interest income or expense), and the
costs to the Company of the agreements mentioned above, for each of the years
reflected in the financial statements of the Company:
Year Ended December 31,
1998 1997 1996
---- ---- ----
Revenues:
Fee-based services ............................................. $12,937 $ 7,911 $20,420
Expenses:
Interest expense ............................................... 3,178
Credit card account and other product solicitation and marketing
expenses .................................................... 8,274 8,432 9,335
Data processing services and communications .................... 2,344 1,837 1,324
Other .......................................................... 659 1,336 950
In the ordinary course of business, executive officers of the Company
or FCI may have credit card loans issued by the Company. Pursuant to the
Company's policy, such loans are issued on the same terms as those prevailing at
the time for comparable loans with unrelated persons and do not involve more
than the normal risk of collectibility.
On November 13, 1998, the Company entered into agreements with the Lee
Company to invest $300 million in the Company (see Note 6). The terms of the
transaction provided that the Lee Company investment would convert into 0.8
million shares of Series C Preferred upon shareholder approval and receipt of
notice that there was no regulatory objection to the transaction. The Company
determined that this conversion might result in a "Change of Control" as defined
in certain agreements between the Company and Fingerhut, which would permit
Fingerhut to terminate any or all of the agreements. Therefore, on December 8,
1998, the Company obtained an agreement (the "Waiver Agreement") from Fingerhut
to waive its right to terminate the agreements if a Change of Control occurred
as a result of the conversion.
Pursuant to the Waiver Agreement, the Company and Fingerhut amended
certain of their other agreements. The most significant change was made in the
database access agreement. The Company's exclusive license to use Fingerhut's
customer database to market financial service products will now become
non-exclusive after October 31, 2001.
On March 12, 1999, shareholders approved the conversion into the Series
C Preferred. If notice is received that there is no regulatory objection to the
conversion to the Series C Preferred, the Lee Company will own approximately 30%
of the Company on a diluted basis, assuming conversion of the Series C Preferred
into common stock.
NOTE 12 - COMMITMENTS AND CONTINGENCIES
Commitments to extend credit to consumers represents the unused credit
limits on open credit card accounts. These commitments amounted to $5.9 billion
and $4.1 billion as of December 31, 1998 and 1997, respectively. While these
amounts represent the total lines of credit available to the Company's
customers, the Company has not experienced and does not anticipate all of its
customers will exercise their entire available line at any given point in time.
The Company also has the right to increase, reduce, cancel, alter or amend the
terms of these available lines of credit at any time.
The Company leases certain office facilities and equipment under
various cancelable and non-cancelable operating lease agreements that provide
for the payment of a proportionate share of property taxes, insurance and other
maintenance expenses. These leases also may include scheduled rent increases and
renewal options. Rental expense for such operating leases for the years ended
December 31, 1998, 1997 and 1996 was $6.4 million, $3.9 million and $1.1
million, respectively.
Future minimum lease commitments at December 31, 1998 under cancelable
and non-cancelable operating leases are as follows:
1999 $ 7,884
2000 6,146
2001 3,371
2002 1,421
2003 1,127
Thereafter 4,485
-----
Total minimum lease payments $24,434
=======
NOTE 13 - CAPITAL REQUIREMENTS AND RESTRICTED PAYMENTS
In the normal course of business, the Company enters into agreements,
or is subject to regulatory requirements, that result in cash, debt and dividend
or other capital restrictions.
The Federal Reserve Act imposes various legal limitations on the extent
to which banks can finance or otherwise supply funds to certain of their
affiliates. In particular, Direct Merchants Bank is subject to certain
restrictions on any extensions of credit to or other covered transactions, such
as certain purchases of assets, with the Company or its affiliates. Such
restrictions limit Direct Merchants Bank's ability to lend to the Company and
its affiliates. Additionally, Direct Merchants Bank is limited in its ability to
declare dividends to the Company in accordance with the national bank dividend
provisions.
Direct Merchants Bank is subject to certain capital adequacy guidelines
adopted by the OCC. At December 31, 1998 and 1997, Direct Merchants Bank's Tier
1 risk-based capital ratio, risk-based total capital ratio and Tier 1 leverage
ratio exceeded the minimum required capital levels, and Direct Merchants Bank
was considered a "well capitalized" depository institution under regulations of
the OCC.
The Company is also bound by restrictions set forth in an indenture
related to the Senior Notes dated November 7, 1997 and the Lee Senior Notes (see
Note 6). Pursuant to those indentures, the Company may not make dividend
payments in the event of a default or if all such restricted payments would
exceed 25% of the aggregate cumulative net income of the Company.
NOTE 14 - CONCENTRATIONS OF CREDIT RISK
A concentration of credit risk is defined as significant credit
exposure with an individual or group engaged in similar activities or affected
similarly by economic conditions. The Company is active in originating credit
card loans throughout the United States, and no individual or group had a
significant concentration of credit risk at December 31, 1998 or 1997. The
following table details the geographic distribution of the Company's retained,
sold and managed credit card loans:
Retained Sold Managed
December 31, 1998
California ..................... $ 94,521 $ 569,205 $ 663,726
Texas .......................... 76,542 460,937 537,479
Florida ........................ 57,138 344,084 401,222
New York ....................... 55,231 332,598 387,829
Ohio ........................... 31,936 192,320 224,256
Illinois ....................... 26,994 162,558 189,552
Pennsylvania ................... 22,795 137,274 160,069
All others ..................... 391,742 2,359,167 2,750,909
------- --------- ---------
Total .................... $ 756,899 $4,558,143 $5,315,042
========== ========== ==========
Retained Sold Managed
December 31, 1997
Texas .......................... $ 61,844 $ 394,571 $ 456,415
California ..................... 58,098 370,652 428,750
Florida ........................ 35,654 227,477 263,131
New York ....................... 29,246 186,589 215,835
Ohio ........................... 17,961 114,589 132,550
Illinois ....................... 15,914 101,533 117,447
Pennsylvania ................... 15,681 100,048 115,729
All others ..................... 246,228 1,570,851 1,817,079
------- --------- ---------
Total ....................... $ 480,626 $3,066,310 $3,546,936
========== ========== ==========
The Company targets its consumer credit products primarily to moderate
income consumers. Primary risks associated with lending to this market are that
they may be more sensitive to future economic downturn, which may make them more
likely to default on their obligations.
At December 31, 1998 and 1997, the majority of federal funds sold were
made to one bank, which represents a concentration of credit risk to the
Company. The Company is able to monitor and mitigate this risk since all federal
funds are sold on a daily origination and repayment basis and therefore may be
recalled quickly should the credit risk of the counterparty bank increase above
certain limits set by the Company.
NOTE 15 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company has estimated the fair value of its financial instruments
in accordance with SFAS No. 107, "Disclosures About Fair Value of Financial
Instruments." Financial instruments include both assets and liabilities, whether
or not recognized in the Company's consolidated balance sheets, for which it is
practicable to estimate fair value. Additionally, certain intangible assets
recorded on the consolidated balance sheets, such as purchased credit card
relationships, and other intangible assets not recorded on the consolidated
balance sheets (such as the value of the credit card relationships for
originated loans and the franchise values of the Company's various lines of
business) are not considered financial instruments and, accordingly, are not
valued for purposes of this disclosure. The Company believes that there is
substantial value associated with these assets based on current market
conditions, including the purchase and sale of such assets. Accordingly, the
aggregate estimated fair value amounts presented do not represent the entire
underlying value of the Company.
Quoted market prices generally are not available for all of the
Company's financial instruments. Accordingly, in cases where quoted market
prices are not available, fair values were estimated using present value and
other valuation techniques that are significantly affected by the assumptions
used, including the discount rate and estimated future cash flows. Such
assumptions are based on historical experience and assessments regarding the
ultimate collectibility of assets and related interest, and estimates of product
lives and repricing characteristics used in the Company's asset/liability
management process. These assumptions involve uncertainties and matters of
judgment, and therefore, cannot be determined with precision. Thus, changes in
these assumptions could significantly affect the fair-value estimates.
A description of the methods and assumptions used to estimate the fair
value of each class of the Company's financial instruments is as follows:
Cash and cash equivalents and accrued interest and fees receivable
The carrying amounts approximate fair value due to the short-term
nature of these instruments.
Net retained interests in loans securitized and loans held for securitizations
Currently, credit card loans are originated with variable rates of
interest that adjust with changing market interest rates. Thus, carrying value,
which is net of the allowance for loan losses, approximates fair value. However,
this valuation does not include the value that relates to estimated cash flows
generated from new loans from existing customers over the life of the cardholder
relationship. Accordingly, the aggregate fair value of the credit card loans
does not represent the underlying value of the established cardholder
relationships.
Other receivables due from credit card securitizations, net
The following components of this net asset are as follows:
Interest-only strip
The fair value of the interest-only strip is estimated by discounting
the expected future cash flows from the Trust and each of the Conduits at rates
which management believes to be consistent with those that would be used by an
independent third party. However, because there is no active market for this,
the fair values presented may not be indicative of the value negotiated in an
actual sale. The future cash flows used to estimate fair value is limited to the
securitized receivables that exist at year end and does not reflect the value
associated with future receivables generated by cardholder activity. The
significant assumptions used to estimate fair value include: (i) discount rates;
(ii) customer payment rates; and (iii) anticipated charge-offs over the life of
the loans are summarized as follows:
December 31,
1998 1997
Discount rate 10% 10%
Payment rate 6% 5%
Default rate 16% 14%
Interest rate cap, swap, and floor agreements
The fair values of interest rate cap, swap, and floor agreements were
obtained from dealer quoted prices. These values generally represent the
estimated amounts the Company would receive or pay to terminate the agreements
at the reporting dates, taking into consideration current interest rates and the
current creditworthiness of the counterparties.
Other amounts
For the other components of other receivables due from credit card
securitizations, net, the carrying amount is a reasonable estimate of the fair
value.
Debt
Short-term borrowings are made with variable rates of interest that
adjust with changing market interest rates. Thus, carrying value approximates
fair value.
The fair value of long-term debt was obtained from quoted market
prices, when available.
The estimated fair values of the Company's financial instruments are
summarized as follows:
December 31,
1998 1997
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
Cash and cash equivalents ............. $ 37,347 $ 37,347 $ 48,223 $ 48,223
Retained interest in loans securitized, 360,186 360,186 227,747 227,747
net
Loans held for securitization ......... 3,430 3,430 8,795 8,795
Other receivables due from credit card
securitizations, net:
Interest-only strip ................ 2,449 2,449
Interest rate swap agreements ...... 21,667
Interest rate cap agreements ....... 2,912 2,925 3,497 170
Interest rate floor agreements ..... 187 3,233
Other amounts ...................... 182,836 182,836 71,540 71,540
Debt .................................. 310,896 317,666 244,000 245,750
NOTE 16 - DERIVATIVE FINANCIAL INSTRUMENTS
Prior to the Spin Off, the Company had entered into interest rate cap
and swap agreements to hedge the cash flow and earnings impact of fluctuating
market interest rates on the spread between the floating rate loans owned by the
Trust and the floating and fixed rate securities issued by the Trust to fund the
loans. In connection with the issuance of term asset-backed securities by the
Trust in 1998, the Company entered into term interest rate cap agreements with
highly-rated bank counterparties in a total notional amount of $1.8 billion
effectively capping the potentially negative impact to the Trust of increases in
the floating interest rate of the securities at approximately 9.2%. These
interest rate cap agreements are for terms ranging from six to eight years and
will terminate between October 2004 and April 2006. The Company also entered
into a term interest rate cap agreement in connection with the PNC portfolio
acquisition with highly-rated bank counterparties in a total notional amount of
$640 million, effectively capping the potentially negative impact of increases
in market interest rate of the securities at 7.35% through May 2002. Due to the
Spin Off, the Company terminated interest rate swap agreements guaranteed by FCI
related to two trust series fixed rate asset-backed securities issuances.
Proceeds were utilized to purchase interest rate floor contracts from
highly-rated counterparties which did not require a FCI guaranty. The floors
were in the same notional amounts, fixed interest rate strike rates, and
maturities as the previous swaps in order to hedge the potential impact on the
Company's cash flow and earnings of a low market interest rate environment in
which the yield on the Trust's floating rate loans might decline causing the
margin over the fixed rate funding to compress. During October 1998, the Company
terminated the interest rate floors related to one of the trust series. The gain
of approximately $34.1 million on this termination is being amortized into
income over the remaining life of the securities. The cash proceeds of
approximately $43.4 million were used to reduce borrowings under the New Credit
Facility.
Interest rate risk management contracts are generally expressed in
notional principal or contract amounts that are much larger than the amounts
potentially at risk for nonpayment by counterparties. Therefore, in the event of
nonperformance by the counterparties, the Company's credit exposure is limited
to the uncollected interest and contract market value related to the contracts
that have become favorable to the Company. Although the Company does not require
collateral from counterparties on its existing agreements, the Company does
control the credit risk of such contracts through established credit approvals,
risk control limits, and the ongoing monitoring of the credit ratings of
counterparties. The Company currently has no reason to anticipate nonperformance
by the counterparties.
NOTE 17 - SEGMENTS
The Company is organized based on the products and services that it
offers. Under this organizational structure, the Company operates in two
principal areas: consumer credit products and fee-based services. The Company's
primary consumer credit products are unsecured credit cards, including the
Direct Merchants Bank MasterCard and Visa. The Company's credit card accounts
include customers obtained from the Fingerhut Database and other customers for
whom general credit bureau information is available.
The Company markets its fee-based services, including (i) debt waiver
protection for unemployment, disability, and death, (ii) membership programs
such as card registration, purchase protection and other club memberships, and
(iii) third-party insurance, directly to its credit card customers and customers
of third parties. The Company currently administers its extended service plans
sold through a third-party retailer, and the customer pays the retailer
directly. In addition, the Company develops customized targeted mailing lists
from information contained in the Company's databases for use by unaffiliated
companies in their own financial services product solicitation efforts that do
not directly compete with those of the Company.
The information in the following tables is derived directly from
internal segment reporting used for management purposes. The expenses, assets
and liabilities attributable to corporate functions are not allocated to the
operating segments. There were no operating assets located outside of the United
States for the years presented.
The segment information reported below is presented on a managed basis.
Management uses this basis to review segment performance and to make operating
decisions. To do so, the income statement and balance sheet are adjusted to
reverse the effects of securitizations. Presentation on a managed basis is not
in conformity with generally accepted accounting principles. The reconciliation
column in the segment tables includes adjustments to present the information on
an owned basis in the consolidated column as reported in the financial
statements of this annual report.
Employee compensation, data processing services and communications,
third party servicing expenses, and other expenses including: occupancy,
depreciation and amortization, professional fees, other general and
administrative expenses, and income taxes have not been allocated to the
operating segments and are included in the reconciliation of the income before
income taxes for the reported segments to the consolidated total. The Company
does not allocate capital expenditures for leasehold improvements, capitalized
software and property and equipment to operating segments.
The fee-based services operating segment pays a commission to the
consumer credit products segment for successful marketing efforts to the
consumer credit products segment's cardholders at a rate similar to those paid
to the Company's other third parties. The fee-based services segment reports
interest income and the consumer credit products segment reports interest
expense at the Company's weighted average borrowing rate for the excess cash
flow generated by the fee-based services segment and used by the consumer credit
products segment to fund the growth of cardholder balances.
1998
Consumer Credit Fee-Based
Products Services Reconciliation (a) Consolidated
Interest income ...... $ 740,768 $ 2,754 $ (630,311) (b) $ 113,211
Interest expense ..... 237,710 (207,197) (c) 30,513
------- ------- -------- -------
Net interest income 503,058 2,754 (423,114) 82,698
Other operating income 239,597 106,601 (33,240) 312,958
Total revenue ........ 980,365 109,355 (663,551) 426,169
Income before income
taxes ............. 188,148 (d) 73,279 (d) (168,179) (e) 93,248
Income taxes ......... 35,900 35,900
Total assets ......... $5,375,925 $ 58,052 $ (4,488,258) (f) $ 945,719
1997
Consumer Credit Fee-Based
Products Services Reconciliation (a) Consolidated
Interest income ...... $ 435,833 $ 2,484 $ (369,123) (b) $ 69,194
Interest expense ..... 131,956 (120,005) (c) 11,951
---------- ------------ ----------- -------------
Net interest income 303,877 2,484 (249,118) 57,243
Other operating income 148,869 64,000 (26,192) 186,677
Total revenue ........ 584,702 66,484 (395,315) 255,871
Income before income
taxes .............. 110,973 (d) 49,162 (d) (98,252) (e) 61,883
Income taxes ......... 23,825 23,825
Total assets ......... $3,505,165 $ 30,488 $(2,996,991) (f) $ 538,662
1996
Consumer Credit Fee-Based
Products Services Reconciliation (a) Consolidated
Interest income ...... $ 198,633 $ 1,213 $ (169,652) (b) $ 30,194
Interest expense ..... 56,355 (52,249) (c) 4,106
---------- ------------- ----------- --------------
Net interest income 142,278 1,213 (117,403) 26,088
Other operating income 77,952 48,695 (425) 126,222
Total revenue ........ 276,585 49,908 (170,077) 156,416
Income before income
taxes .............. 61,503 30,733 (59,690) (e) 32,546
Income taxes ......... 12,530 12,530
Total assets ......... $1,612,234 $ 1,057 $(1,363,293) (f) $ 249,998
(a) The reconciliation column includes: intercompany eliminations; amounts not
allocated to segments; and adjustments to the amounts reported on a managed
basis to reflect the effects of securitization.
(b) The reconciliation to consolidated owned interest income includes the
elimination of $2.8 million, $2.5 million, and $1.2 million of intercompany
interest received by the fee based services segment from the consumer credit
products segment for 1998, 1997, and 1996, respectively.
(c) The reconciliation to consolidated owned interest expense includes the
elimination of $2.8 million, $2.5 million, and $1.2 million of intercompany
interest paid by the consumer credit products segment to the fee-based services
segment for 1998, 1997, and 1996, respectively.
(d) Income before income taxes includes intercompany commissions paid by the
fee-based services segment to the consumer credit products segment for
successful marketing efforts to consumer credit products cardholders of $3.3
million, and $4.4 million for 1998, and 1997, respectively.
(e) The reconciliation to the owned income before income taxes includes:
unallocated costs related to employee compensation; data processing and
communications; third party servicing expenses; and other expenses. The majority
of these expenses, although not allocated for the internal segment reporting
used by management, relate to the consumer credit product segment.
(f) Total assets include the assets attributable to corporate functions not
allocated to operating segments and the removal of investors' interest in
securitized loans to present total assets on an owned basis.
NOTE 18 - DEBT
On June 30, 1998, the Company executed a new $200 million, three-year
revolving credit facility and a $100 million five-year term loan (the "New
Credit Facility") with a syndicate of banks and money market mutual funds. This
agreement became effective upon the Spin Off from FCI on September 25, 1998. The
New Credit Facility which is not guaranteed by FCI replaced the Company's $300
million, five-year revolving credit facility (the "Old Credit Facility"). The
New Credit Facility is secured by receivables and subsidiary stock and
guaranteed by a Company subsidiary. Financial covenants in the New Credit
Facility include, but are not limited to, requirements concerning minimum net
worth, minimum tangible net worth to net managed receivables and tangible net
worth plus reserves to delinquent receivables. At December 31, 1998, the Company
was in compliance with all financial covenants under this agreement. At December
31, 1998, the Company had outstanding borrowings of $110 million under the New
Credit Facility. At December 31, 1997, the Company had outstanding borrowings of
$144 million under the Old Credit Facility. The weighted average interest rates
on the borrowings at December 31, 1998 and 1997, were 7.9% and 6.5%,
respectively.
In November 1997, the Company privately issued and sold $100 million of
10% Senior Notes due 2004 (the "Senior Notes") pursuant to an exemption under
the Securities Act of 1933, as amended. In January 1998, the Company commenced
an exchange offer for the Senior Notes pursuant to a registration statement. The
terms of the new Senior Notes are identical in all material respects to the
original private issue. The net proceeds of $97 million were used to pay down
borrowings under the Old Credit Facility. The Senior Notes are unconditionally
guaranteed on a senior basis, jointly and severally, by Metris Direct, Inc. (the
"Guarantor"), and all future subsidiaries of the Company that guarantee any of
the Company's indebtedness, including the New Credit Facility. The guarantee is
an unsecured obligation of the Guarantor and ranks pari passu with all existing
and future unsubordinated indebtedness. As part of the Lee Company investment,
the Company issued the Lee Senior Notes (see Note 6) which are similar in all
material respects to the Senior Notes. The Company also has approximately $0.9
million of debt with local governments to support growth in those areas.
Metris Direct, Inc. has various subsidiaries which have not guaranteed the
Senior Notes. The following condensed consolidating financial statements of the
Company, the Guarantor subsidiary and the non-guarantor subsidiaries are
presented for purposes of complying with SEC reporting requirements. Separate
financial statements of Metris Direct, Inc. and the non-guaranteeing
subsidiaries are not presented because management has determined that the
subsidiaries financial statements would not be material to investors.
METRIS COMPANIES INC.
Supplemental Consolidating Balance Sheets
December 31, 1998
(Dollars in thousands)
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
Assets:
Cash and due from banks ............. $ (5,010) $ (156) $ 27,280 $ $ 22,114
Federal funds sold .................. 15,060 15,060
Short-term investments .............. 3 170 173
------- ------- ------- -------
Cash and cash equivalents ........... (5,007) (156) 42,510 37,347
------- ------- ------- -------
Retained interests in loans securitized 753,469 753,469
Less: Allowance for loan losses ..... 97 393,186 393,283
------- ------- ------- -------
Net retained interests in loans securitized (97) 360,283 360,186
------- ------- ------- -------
Loans held for securitization ....... 1,876 1,554 3,430
Property and equipment, net ......... 18,243 3,739 21,982
Accrued interest and fees receivable (11) 6,020 6,009
Prepaid expenses and deferred charges 30,487 17,833 10,784 59,104
Deferred income taxes ............... 1,049 19,427 132,545 153,021
Customer base intangible ............ 81,892 81,892
Other receivables due from credit
card securitizations, net ........ 185,935 185,935
Other assets ........................ 6,000 6,989 23,824 36,813
Investment in subsidiaries .......... 756,455 774,986 (1,531,441)
------- ------- ------- ---------- -------
Total assets ........................ $ 790,752 $ 837,322 $ 849,086 $(1,531,441) $ 945,719
=========== =========== =========== =========== ===========
Liabilities:
Interest-bearing deposit from ....... $ (1,000) $ $ 1,000 $ $
affiliate
Debt ................................ 318,298 15,021 (22,423) 310,896
Accounts payable .................... 3,140 3,786 12,165 19,091
Current income taxes payable to
(receivable from) FCI .......... 3,722 (5,692) 33,753 31,783
Deferred income ..................... 31,753 47,515 45,624 124,892
Accrued expenses and other liabilities 1,857 20,237 3,981 26,075
------- ------- ------- -------
Total liabilities ................... 357,770 80,867 74,100 512,737
------- ------- ------- -------
Stockholders' Equity:
Preferred stock ..................... 201,100 201,100
Common Stock ........................ 193 1,002 1,052 (2,054) 193
Paid-in capital ..................... 107,615 651,863 628,339 (1,280,202) 107,615
Retained earnings ................... 124,074 103,590 145,595 (249,185) 124,074
------- ------- ------- ---------- -------
Total stockholders' equity .......... 432,982 756,455 774,986 (1,531,441) 432,982
------- ------- ------- ---------- -------
Total liabilities and stockholders'
equity $ 790,752 $ 837,322 $ 849,086 $(1,531,441) $ 945,719
=========== =========== =========== =========== ===========
METRIS COMPANIES INC.
Supplemental Consolidating Balance Sheets
December 31, 1997
(Dollars in thousands)
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
Assets:
Cash and due from banks ............ $ 320 $ 390 $ 20,296 $ $ 21,006
Federal funds sold ................. 27,089 27,089
Short-term investments 16 112 128
------- ------- ------- -------
Cash and cash equivalents........... 336 390 47,497 48,223
------- ------- ------- -------
Credit card loans:
Retained interests in loans
securitized...................... 471,831 471,831
Less: Allowance for loan losses..... 611 243,473 244,084
------- ------- ------- -------
Net credit card loans............... (611) 228,358 227,747
------- ------- ------- -------
Loans held for securitization ...... 8,140 655 8,795
Premises and equipment, net ........ 13,899 1,565 15,464
Accrued interest and fees receivable 9 4,301 4,310
Prepaid expenses and deferred ...... 138 15,075 3,260 18,473
charges
Deferred income taxes .............. 682 12,638 67,467 80,787
Customer base intangible ........... 1,567 35,185 36,752
Other assets ....................... 3,489 6,983 10,153 20,625
Other receivables due from credit
card securitizations, net ....... 66 77,420 77,486
Investment in subsidiaries ......... 349,731 366,977 (716,708)
------- ------- ------- -------- -------
Total assets ....................... $ 363,547 $ 415,962 $ 475,861 $(716,708) $ 538,662
========= ========= ========= ========= =========
Liabilities:
Debt ............................... $ 276,598 $ 7,975 $ (40,573) $ $ 244,000
Accounts payable ................... (1,086) 7,975 28,467 35,356
Current income taxes payable to
(receivable from) FCI ........... (90,003) (486) 100,190 9,701
Deferred income .................... 33 35,044 14,127 49,204
Accrued expenses and other
liabilities...................... 1,967 15,723 6,673 24,363
------- ------- ------- -------
Total liabilities .................. 187,509 66,231 108,884 362,624
------- ------- ------- -------
Stockholders' Equity:
Common stock ....................... 192 1,002 1,002 (2,004) 192
Paid-in capital .................... 107,059 279,842 279,815 (559,657) 107,059
Retained earnings .................. 68,787 68,887 86,160 (155,047) 68,787
------- ------- ------- -------- -------
Total stockholders' equity ......... 176,038 349,731 366,977 (716,708) 176,038
------- ------- ------- -------- -------
Total liabilities and stockholders'
equity .......................... $ 363,547 $ 415,962 $ 475,861 $(716,708) $ 538,662
========= ========= ========= ========= =========
METRIS COMPANIES INC.
Supplemental Consolidating Statements of Income
Year Ended December 31, 1998
(Dollars in thousands)
Non-
Metris Guarantor Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
Interest Income:
Credit card loans and retained
interests in loans securitized ...... $ 1,957 $ $ 109,161 $ $ 111,118
Federal funds sold ...................... 1,065 1,065
Other ................................... 215 813 1,028
--- ------ ------ ------
Total interest income .............. 2,172 111,039 113,211
Interest expense ........................ 8,725 24,444 (2,656) 30,513
----- ------ ------ ------
Net Interest Income/(Expense) ........... (6,553) (24,444) 113,695 82,698
Provision for loan losses ............... 532 77,238 77,770
----- ------ ------ ------
Net interest income/(expense) after
provision for loan losses ............ (7,085) (24,444) 36,457 4,928
Other Operating Income:
Net securitization and credit card
servicing income ..................... 9,668 (20) 128,573 138,221
Credit card fees, interchange and
other credit card income ............. 636 67,500 68,136
Fee-based services revenues 28,425 78,176 106,601
--- ------ ------ ------
10,304 28,405 274,249 312,958
Other Operating Expense:
Credit card account and other
product solicitation and
marketing expenses ................... 14,992 25,957 40,949
Employee compensation ................... 55,980 6,647 62,627
Data processing services and
communications ....................... 5,276 30,169 35,445
Third-party servicing expense ........... (51,565) 62,639 11,074
Warranty and debt waiver
underwriting and claims
servicing expense .................... 1,875 10,404 12,279
Credit card fraud losses ................ 18 4,418 4,436
Other ................................... 529 18,899 38,400 57,828
----- ------ ------ ------
547 45,457 178,634 224,638
----- ------ ------ ------
Income/(Loss) Before Income Taxes
and Equity in Income of
Subsidiaries ......................... 2,672 (41,496) 132,072 93,248
Income taxes ............................ 1,028 (16,768) 51,640 35,900
Equity in income of subsidiaries ........ 55,704 80,432 (136,136)
----- ------ ------ -------- ------
Net Income/(Loss) ....................... $ 57,348 $ 55,704 $ 80,432 $ (136,136) $ 57,348
========= ========= =========== ========== ===========
METRIS COMPANIES INC.
Supplemental Consolidating Statements of Income
Year Ended December 31, 1997
(Dollars in thousands)
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
Interest Income:
Credit card loans ................................ $ 1,063 $ $65,632 $ $ 66,695
Federal funds sold ............................... 1,636 1,636
Other ............................................ 184 679 863
------ ----- ------ ------
Total interest income ........................ 1,247 67,947 69,194
Interest expense ................................. 13,937 432 (2,418) 11,951
------ ----- ------ ------
Net interest income/(expense) .................... (12,690) (432) 70,365 57,243
Provision for loan losses ........................ 682 43,307 43,989
------ ----- ------ ------
Net interest income/(expense)
after provision for loan losses ............... (13,372) (432) 27,058 13,254
Other Operating Income:
Net securitization and credit card
servicing income .............................. 10,653 68,880 79,533
Credit card fees, interchange and
other credit card income ...................... 478 (21) 43,274 43,731
Fee-based services revenues ...................... 8,536 54,877 63,413
------ ----- ------ ------
11,131 8,515 167,031 186,677
Other Operating Expense:
Credit card account and other
product solicitation and
marketing expenses ............................ 1,783 28,720 30,503
Employee compensation ............................ 32,735 2,465 35,200
Data processing services and
communications ................................ 2,883 17,204 20,087
Third-party servicing expense .................... 51 (20,396) 33,056 12,711
Warranty and debt waiver
underwriting and claims
servicing expense ............................. 549 5,504 6,053
Credit card fraud losses ......................... 27 3,213 3,240
Other ............................................ 382 12,644 17,228 30,254
------ ------ ------ ------
460 30,198 107,390 138,048
------ ------ ------ ------
Income/(Loss) Before Income Taxes
and Equity in Income of
Subsidiaries .................................. (2,701) (22,115) 86,699 61,883
Income taxes ..................................... (1,040) (8,475) 33,340 23,825
Equity in income of subsidiaries ................. 39,719 53,359 (93,078)
------ ------ ------- -------- ---------
Net Income/(Loss) ................................ $ 38,058 $ 39,719 $ 53,359 $ (93,078) $ 38,058
========= ========= ========= ========= =========
METRIS COMPANIES INC.
Supplemental Consolidating Statements of Income
Year Ended December 31, 1996
(Dollars in thousands)
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
Interest Income:
Credit card loans ..................... $ 199 $ $ 28,829 $ $ 29,028
Federal funds sold .................... 867 867
Other ................................. 105 194 299
----- ------ ------- -------
Total interest income ........... 304 29,890 30,194
Interest expense ...................... 7,272 (2,575) (591) 4,106
----- ------ ------- -------
Net Interest Income/(Expense) ......... (6,968) 2,575 30,481 26,088
Provision for loan losses ............. 83 18,394 18,477
----- ------ ------- -------
Net interest income/(expense) after
provision for loan losses .......... (7,051) 2,575 12,087 7,611
Other Operating Income:
Net securitization and credit card
servicing income ................... 3,859 46,062 49,921
Credit card fees, interchange and other
credit card income ................. 49 107 25,872 26,028
Fee-based services revenues ........... 22,000 28,273 50,273
----- ------ ------- -------
3,908 22,107 100,207 126,222
Other Operating Expense:
Credit card account and other product
solicitation and marketing expenses 5,805 9,563 13,929 29,297
Employee compensation ................. 22,076 992 23,068
Data processing services and
communications ..................... 1,600 11,157 12,757
Third-party servicing expense ......... 3 (6,757) 15,961 9,207
Warranty and debt waiver underwriting
and claims servicing expense ....... 6,463 3,561 10,024
Credit card fraud losses .............. 10 2,266 2,276
Other ................................. 1 9,900 4,757 14,658
----- ------ ------- -------
5,819 42,845 52,623 101,287
----- ------ ------- -------
Income/(Loss) Before Income Taxes
and Equity in Income of Subsidiaries (8,962) (18,163) 59,671 32,546
Income taxes .......................... (3,450) (6,993) 22,973 12,530
Equity in income of subsidiaries ...... 25,528 36,698 (62,226)
----- ------ ------- -------- -------
Net Income/(Loss) ..................... $ 20,016 $ 25,528 $ 36,698 $ (62,226) $ 20,016
========= ========= ========= ========= ==========
METRIS COMPANIES INC.
Supplemental Condensed Consolidating Statements of Cash Flows
Year Ended December 31
(Dollars in thousands)
1998
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Consolidated
Operating Activities:
Net cash provided by (used in) operating activities .... $ 97,274 $ (22,625) $ (9,737) $ 64,912
----------- ------------- ------------- -----------
Investing Activities:
Proceeds from sales of loans ........................... 1,491,832 1,491,832
Net loans originated or collected ...................... 8,106 (909,846) (901,740)
Credit card portfolio acquisition ...................... (921,558) (921,558)
Additions to premises and equipment .................... (8,414) (2,400) (10,814)
----------- ------------- ------------- -----------
Net cash provided by (used in) investing activities .... 8,106 (8,414) (341,972) (342,280)
Financing Activities:
Net increase (decrease) in debt ........................ 40,700 7,046 19,150 66,896
Net proceeds from issuance of common stock ............. (371,464) 23,447 348,574 557
Cash dividends paid .................................... 20,039 (21,000) (961)
Net proceeds from issuance of preferred stock 200,000 200,000
----------- ------------- ------------- -----------
Net cash provided by (used in) financing activities .... (110,725) 30,493 346,724 266,492
----------- ------------- ------------- -----------
Net increase in cash and cash equivalents .............. (5,345) (546) (4,985) (10,876)
Cash and cash equivalents at beginning of year ......... 336 390 47,497 48,223
----------- ------------- ------------- -----------
Cash and cash equivalents at end of year ............... $ (5,009) $ (156) $ 42,512 $ 37,347
=========== ============= =============== ===========
1997
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Consolidated
Operating Activities:
Net cash provided by (used in) operating activities $ (51,357) $ (526) $ 195,096 $ 143,213
----------- ----------- ----------- -----------
Investing Activities:
Proceeds from sales of loans ....................... 1,665,700 1,665,700
Net loans originated or collected .................. 3,357 (1,234,580) (1,231,223)
Credit card portfolio acquisition .................. (738,104) (738,104)
Additions to premises and equipment (10,515) (1,190) (11,705)
----------- ----------- ----------- -----------
Net cash provided by (used in) investing activities 3,357 (10,515) (308,174) (315,332)
----------- ----------- ----------- -----------
Financing Activities:
Decrease in interest bearing deposit ............... (1,000) (1,000)
Net (decrease) increase in short-term borrowings ... 127,425 11,348 (48,936) 89,837
Issuance of senior notes ........................... 100,000 100,000
Cash dividends paid ................................ 15,350 (15,927) (577)
Capital contributions .............................. (197,814) 197,814
----------- ----------- ----------- -----------
Net cash provided by financing activities 43,961 11,348 132,951 188,260
----------- ----------- ----------- -----------
Net (decrease) increase in cash and cash equivalents (4,039) 307 19,873 16,141
Cash and cash equivalents at beginning of year 4,375 83 27,624 32,082
----------- ----------- ----------- -----------
Cash and cash equivalents at end of year ........... $ 336 $ 390 $ 47,497 $ 48,223
=========== =========== =========== ===========
METRIS COMPANIES INC.
Supplemental Condensed Consolidating Statements of Cash Flows
Year Ended December 31, 1996
(Dollars in thousands)
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Consolidated
Operating Activities:
Net cash provided by (used in) operating activities . $ (40,549) $ (4,991) $ 129,193 $ 83,653
----------- ----------- ------------ ---------------
Investing Activities:
Proceeds from sales of loans ........................ 952,055 952,055
Net loans originated or collected ................... (14,105) (1,058,216) (1,072,321)
Additions to premises and equipment (3,782) (331) (4,113)
----------- ----------- ------------ ---------------
Net cash (used in) investing activities ............. (14,105) (3,782) (106,492) (124,379)
----------- ----------- ------------ ---------------
Financing Activities:
Net (decrease) increase in short-term borrowings .... 50,172 8,856 (68,347) (9,319)
Net proceeds from issuance of common stock .......... 47,384 47,384
Capital contributions (38,527) 38,527
----------- ----------- ------------ ---------------
Net cash provided by (used in) financing activities . 59,029 8,856 (29,820) 38,065
----------- ----------- ------------ ---------------
Net increase (decrease) in cash and cash equivalents 4,375 83 (7,119) (2,661)
Cash and cash equivalents at beginning of year 34,743 34,743
----------- ----------- ------------ ---------------
Cash and cash equivalents at end of year ............ $ 4,375 $ 83 $ 27,624 $ 32,082
=========== ============ =========== ===========
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Metris Companies Inc.:
We have audited the accompanying consolidated balance sheets of Metris
Companies Inc. and subsidiaries as of December 31, 1998 and 1997, and the
related consolidated statements of income, changes in stockholders' equity and
cash flows for each of the years in the three-year period ended December 31,
1998. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Metris
Companies Inc. and subsidiaries as of December 31, 1998 and 1997, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1998, in conformity with generally accepted
accounting principles.
/s/ KPMG Peat Marwick LLP
KPMG Peat Marwick LLP
Minneapolis, Minnesota
January 20, 1999, except for the last paragraph of Note 6 and the last paragraph
of Note 11 which are as of March 12, 1999
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None
PART III
Item 10. Directors and Executive Officers of the Registrant
The information required by this item with respect to directors is set
forth under "Proposal One: Election of Directors," in the Company's proxy
statement for the annual meeting of shareholders to be held on May 11, 1999,
which will be filed within 120 days of December 31, 1998 (the "Proxy Statement")
and is incorporated herein by reference. The information required by this item
with respect to executive officers is, pursuant to instruction 3 of Item 401(b)
of Regulation S-K, set forth in Part I of this Form 10-K under "Executive
Officers of the Registrant." The information required by this item with respect
to reports required to be filed under Section 16(a) of the Securities Exchange
Act of 1934 is set forth under "Section 16(a) Beneficial Ownership Reporting
Compliance" in the Proxy Statement and is incorporated herein by reference.
Item 11. Executive Compensation
The information required by this item is set forth under "Compensation
Tables and Compensation Matters" in the Proxy Statement and is incorporated
herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this item is set forth under "Company Stock
Owned by Officers and Directors" and "Persons Owning More Than Five Percent of
Company Common Stock " in the Proxy Statement and is incorporated herein by
reference.
Item 13. Certain Relationships and Related Transactions
The information required by this item is set forth under "Corporate
Governance" in the Proxy Statement and is incorporated herein by reference.
With the exception of the information incorporated by reference in
Items 10-13 above, the Proxy Statement is not to be deemed filed as part of this
Form 10-K.
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) The following documents are made part of this report:
1. Consolidated Financial Statements - See Item 8 above.
2. Financial Statement Schedules
All schedules to the consolidated financial statements
normally required by Form 10-K are omitted since they are
either not applicable or the required information is shown
in the financial statements or the notes thereto.
(b) Reports on Form 8-K:
On December 22, 1998, the Company filed a Current Report
on Form 8-K to report the purchase of approximately
500,000 credit card accounts form PNC National Bank.
The Company also reported the issue and sale to the
Thomas H. Lee Company of $200 million of 12.5%
Series B Preferred Stock, $100 million aggregate
principal amount of 12% Senior Notes due 2006 and
warrants to purchase 3,750,000 shares of the
Company's Common Stock at an exercise price of $30
per share.
(c) Exhibits: See Exhibit Index on page 65 of this Report.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized on the 26th day of March,
1999.
METRIS COMPANIES INC.
(Registrant)
By /s/ Ronald N. Zebeck
-------------------------------
Ronald N. Zebeck
President and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of Metris Companies
Inc., the Registrant, and in the capacities and on the dates indicated.
Signature Title Date
Principal executive President, March 26, 1999
officer and director: Chief Executive Officer
and Director
/s/ Ronald N. Zebeck
- -------------------------------
Ronald N. Zebeck
Principal financial officer: Executive Vice President, March 26, 1999
Chief Financial Officer
/s/ David D. Wesselink
- -------------------------------
David D. Wesselink
Principal accounting officer: Vice President, Finance, March 26, 1999
Corporate Controller
/s/ Jean C. Benson
- -------------------------------
Jean C. Benson
Directors:
/s/ Theodore Deikel Director March 26, 1999
- -------------------------------
Theodore Deikel
/s/ Dudley C. Mecum Director March 26, 1999
- -------------------------------
Dudley C. Mecum
/s/ Frank D. Trestman Director March 26, 1999
- -------------------------------
Frank D. Trestman
/s/ Lee R. Anderson, Sr. Director March 26, 1999
- -------------------------------
Lee R. Anderson, Sr.
/s/ Derek V. Smith Director March 26, 1999
- --------------------------------
Derek V. Smith
/s/ John A. Cleary Director March 26, 1999
- --------------------------------
John A. Cleary
EXHIBIT INDEX
Exhibit
Number Description of Exhibit
Charter Documents:
3.1 Amended and Restated Certificate of Incorporation of the Company
(incorporated by reference to Exhibit 3.1 to the
Company's Registration Statement on Form S-1 (File No. 333-10831)).
3.2 Amended and Restated Bylaws of the Company.
Instruments Defining Rights:
4.1 Indenture, dated as of November 7, 1997, among the Company, Metris
Direct, Inc. as the Guarantor, and the First National Bank of Chicago,
as Trustee, including form of 10% Senior Note due 2004 and form of
Guarantee by Metris Direct, Inc. (incorporated by reference to Exhibit
4.a to the Company's Registration Statement on Form S-4 (File No.
333-43771)).
4.2 Certificate of Designation of Series B Perpetual Preferred Stock
(incorporated by reference to Exhibit 4.1 of the Company's
Current Report on Form 8-K dated December 22, 1998 (File No. 1-12351)).
4.3 Certificate of Designation of Series C Perpetual Preferred Stock
(incorporated by reference to Exhibit 4.2 of the
Company's Current Report on Form 8-K dated December 22, 1998
(File No. 1-12351)).
4.4 Certificate of Designation of Series D Junior Participating
Convertible Preferred Stock (incorporated by reference to
Exhibit 4.3 of the Company's Current Report on Form 8-K dated
December 22, 1998 (File No. 1-12351)).
4.5 Securities Purchase Agreement, dated as of November 13, 1998, among the
Company, the Thomas H. Lee Equity Fund IV, L.P. (the "Lee Fund") and
certain affiliates of the Lee Fund (incorporated by reference to Exhibit
10.2 to the Company's Current Report on Form 8-K dated December 22, 1998
(File No. 1-12351)).
4.6 Indenture, dated as of December 9, 1998, among the Company, the
Guarantors named therein and The Bank of New York,
as Trustee (incorporated by reference to Exhibit 4.4 to the Company's
Current Report on Form 8-K dated December 22, 1998 (File No. 1-12351)).
4.7 Registration Rights Agreement, dated as of December 9, 1998, between the
Company and the Investors named therein (incorporated by reference to
Exhibit 10.3 to the Company's Current Report on Form 8-K dated December
22, 1998 (File No. 1-12351)).
4.8 Warrant Agreement, dated as of December 9, 1998, between the
Company and the Purchasers named therein (incorporated by
reference to Exhibit 4.5 to the Company's Current Report on
Form 8-K dated December 22, 1998 (File No. 1-12351)).
Material Contracts
10.1 Amended and Restated Pooling and Servicing Agreement, dated as
of July 30, 1998, among Metris Receivables, Inc. ("MRI"), as
Transferor, Direct Merchants Credit Card Bank, National
Association ("DMCCB"), as Servicer, and The Bank of New York
(Delaware), as Trustee (incorporated by reference to Exhibit
4(a) to MRI's Registration Statement on Form S-3 (File No.
333-61343)).
10.2 Amended and Restated Bank Receivables Purchase Agreement,
dated as of July 30, 1998, between DMCCB and the Company
(incorporated by reference to Exhibit 4(c) to MRI's
Registration Statement on Form S-3 (File No. 333-61343)).
10.3 Amended and Restated Bank Receivables Purchase Agreement,
dated as of July 30, 1998, between the Company and MRI
(incorporated by reference to Exhibit 4(d) to MRI's
Registration Statement on Form S-3 (File No. 333-61343)).
10.4 Owner Trust Agreement, dated as of July 30, 1998, among MRI
and Wilmington Trust Company (incorporated by reference to
Exhibit 10.1(ii) to the Company's Quarterly Report on Form
10-Q for the period ended September 30, 1998 (File No.
1-12351)).
10.5 Liquidity Agreements, each dated July 30, 1998, among Metris Owner
Trust, the Lenders thereto and the Administrative
Agent (pursuant to Instruction 2 to Item 601, only one such agreement
has been filed) (incorporated by reference to Exhibit 10.1(iii) to the
Company's Quarterly Report on Form 10-Q for the period ended
September 30, 1998 (File No.1-12351)).
10.6* Stock Option and Valuation Rights Agreement, dated as of March 21,
1994, between Fingerhut Companies, Inc. and Ronald N. Zebeck
(incorporated by reference to Exhibit 10.l to Fingerhut Companies,
Inc.'s Annual Report on Form 10-K for the fiscal year ended
December 29, 1995 (File No. 1-8668)).
(i)* Amendment, dated October 25, 1996 (incorporated by
reference to Exhibit 10.4(i) to the Company's Annual
Report on Form 10-K for the year ended December 31,
1997 (File No. 1-12351)).
(ii)* Non-Qualified Stock Option Agreement pursuant to
Metris Companies Long-Term Incentive and Stock Option
Plan, dated as of October 25, 1996, by and between
the Company and Ronald N. Zebeck (incorporated by
reference to Exhibit 10.4(ii) to the Company's Annual
Report on Form 10-K for the year ended December 31,
1997 (File No. 1-12351)).
10.7 Change of Control Agreement, dated as of May 15, 1998, by and
between the Company and Ronald Zebeck and a schedule of
executive officers of the Company also having such an
agreement with the Company, indicating the differences from
the form of agreement filed (as permitted by Instruction 2 to
Item 601 of regulation S-K) (incorporated by reference to
Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1998 (File No.
1-12351)).
(i) Amendment to Change in Control Severance Agreement, dated
as of December 9, 1998.
(ii) Amended Schedule of Officers with Change of Control.
10.8* Metris Companies Inc. Long-Term Incentive and Stock Option
Plan, as amended (incorporated by reference to Exhibit 4.3 to
the Company's Registration Statement on Form S-8 filed May 14,
1998 (File No. 333-52627)).
(i)* Form of Non-Qualified Stock Option Agreement.
10.9* Metris Companies Inc. Non-Employee Director Stock Option Plan,
including form of option agreement (incorporated by reference
to Exhibit 10.9 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1997 (File No.
1-12351)).
10.10* Metris Companies Inc. Annual Incentive Plan for Designated
Corporate Officers.
10.11 Co-Brand Credit Card Agreement, dated as of October 31, 1996,
between the Company, Fingerhut Corporation, and Direct
Merchants Credit Card Bank, N.A. (incorporated by reference to
Exhibit 10.11 to the Company's Annual Report on Form 10-K for
the year ended December 31, 1997 (File No. 1-12351)).
10.12 Extended Service Plan Agreement, dated as of October 31, 1996,
between the Company, Fingerhut Corporation, and InfoChoice USA, Inc.
(incorporated by reference to Exhibit 10.12 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1997
(File No. 1-12351)).
10.13 Database Access Agreement, dated as of October 31, 1996, between the
Company and Fingerhut Corporation (incorporated by reference to
Exhibit 10.13 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1997 (File No. 1-12351)).
10.14 Tax Sharing Agreement, dated as of October 31, 1996, between the
Company and Fingerhut Companies, Inc. (incorporated by reference to
Exhibit 10.15 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1997 (File No. 1-12351)).
(i) Amendment to Tax Sharing Agreement, dated January 1, 1998,
between the Company and Fingerhut Companies, Inc.
10.15 Waiver Agreement, dated as of December 8, 1998, between Fingerhut
Corporation, Infochoice USA, Inc., Metris Direct, Inc., DMCCB and
Metris Direct Services, Inc. (incorporated by reference to Exhibit
10.4 to the Company's Current Report on Form 8-K dated December 22,
1998 (File No. 1-12351)).
10.16 Data Sharing Agreement, dated as of October 31, 1996, between
Fingerhut Corporation and DMCCB (incorporated by reference to Exhibit
10.17 to the Company's Annual Report on Form 10-K for the year ended
December 31, 1997 (File No. 1-12351)).
10.17 Amended and Restated Credit Agreement, dated as of June 30, 1998
among the Company and the lenders named therein
(incorporated by reference to Exhibit 10.18(a) to the Company's
Quarterly Report on Form 10-Q for the period ended
June 30, 1998 (File No. 1-12351)).
(i) Amendment, dated as of December 3, 1998, to the
Amended and Restated Credit Agreement, dated as of
June 30, 1998, among the Company, the lenders named
therein, NationsBank, N.A., as syndication agent,
Deutsche Bank, as documentation agent, U.S. Bank
National Association, as documentation agent,
Barclays Bank PLC, as co-agent, Bank of America
National Trust and Savings Association, as co-agent,
and The Chase Manhattan Bank, as administrative agent
(incorporated by reference to Exhibit 10.5 to the
Company's Current Report on Form 8-K dated December
22, 1998 (File No. 1-12351)).
(ii) Amendment, dated as of December 7, 1998, to the
Amended and Restated Credit Agreement, dated as of
June 30, 1998, among the Company, the lenders named
therein, NationsBank, N.A., as syndication agent,
Deutsche Bank, as documentation agent, U.S. Bank
National Association, as documentation agent,
Barclays Bank PLC, as co-agent, Bank of America
National Trust and Savings Association, as co-agent,
and The Chase Manhattan Bank, as administrative
agent.
10.18 Transfer and Administration Agreement, dated as of October 23,
1997, among Kitty Hawk Funding Corporation, Metris Funding
Co., as Transferor, Direct Merchants Credit Card Bank,
National Association as Collection Agent, and NationsBank,
N.A., as Agent and Bank Investor (incorporated by reference to
Exhibit 10.18(a) to the Company's Quarterly Report on Form
10-Q for the period ended September 30, 1998 (File No.
1-12351)).
10.19 Transfer and Administration Agreement, dated as of October 23,
1997, among Kitty Hawk Funding Corporation, Metris Funding
Co., as Transferor, DMCCB, as Collection Agent, and
NationsBank, N.A. as Agent and Bank Investor (incorporated by
reference to Exhibit 10.c to the Company's Quarterly Report on
Form 10-Q for the period ended September 30, 1997 (File No.
1-12351)).
(i) Amendment No. 4, dated October 22, 1998, to the
Transfer and Administration Agreement, dated as of
October 23, 1997, among Kitty Hawk Funding
Corporation, Metris Funding Co., as Transferor,
Direct Merchants Credit Card Bank, National
Association as Collection Agent, and NationsBank,
N.A., as Agent and Bank Investor.
10.20 Lease Agreement, dated as of March 28, 1997, between Nottingham
Village, Inc. and Metris Direct, Inc. (incorporated
by reference to Exhibit 10.21 to the Company's Annual Report on Form
10-K for the year ended December 31, 1997 (File No. 1-12351)).
(i) Guaranty of Lease, dated as of March 31, 1997, between
Nottingham Village, Inc. and Metris Direct, Inc.
(incorporated by reference to Exhibit 10.21(i) to the
Company's Annual Report on Form 10-K for the year
ended December 31, 1997 (File No. 1-12351)).
(ii) First Amendment and Lease Agreement, dated as of
October 15, 1997, among Nottingham Village, Metris
Direct, Inc., and the Company (incorporated by
reference to Exhibit 10.21(ii) to the Company's
Annual Report on Form 10-K for the year ended
December 31, 1997 (File No. 1-12351)).
(iii) Subordination, Non-Disturbance and Attornment
Agreement, dated as of March 17, 1998 (incorporated
by reference to Exhibit 10.21(iii) to the Company's
Quarterly Report on Form 10-Q for the period ended
March 31, 1998 (File No. 1-12351)).
(iv) Tenant Estoppel Certificate, dated as of March 3,
1998, to State Farm Life Insurance Company
(incorporated by reference to Exhibit 10.21(iv) to
the Company's Quarterly Report on Form 10-Q for the
period ended March 31, 1998 (File No. 1-12351)).
10.21 Lease Agreement, dated August 11, 1995, between The Equitable Life
Assurance Society of the United States and Fingerhut Financial
Services Corporation (incorporated by reference to Exhibit 10.22 to
the Company's Annual Report on Form 10-K for the year ended December
31, 1997 (File No. 1-12351)).
(i) Amendment Number One to Lease Agreement, dated August
1, 1996, between The Equitable Life Assurance Society
of the United States and Fingerhut Financial Services
Corporation (incorporated by reference to Exhibit
10.22(i) to the Company's Annual Report on Form 10-K
for the year ended December 31, 1997 (File No.
1-12351)).
(ii) Amendment Number Two to Lease Agreement, dated
January 16, 1997, between WHIOP Real Estate Limited
Partnership and Metris Direct, Inc. (incorporated by
reference to Exhibit 10.22(ii) to the Company's
Annual Report on Form 10-K for the year ended
December 31, 1997 (File No. 1-12351)).
(iii) Amendment Number Three to Lease Agreement, dated
December 4, 1997, between WHIOP Real Estate Limited
Partnership and Metris Direct, Inc. (incorporated by
reference to Exhibit 10.22(iii) to the Company's
Annual Report on Form 10-K for the year ended
December 31, 1997 (File No. 1-12351)).
(iv) Amendment Number Four to Lease Agreement, dated
January 29, 1997, between WHIOP Real Estate Limited
Partnership and Metris Direct, Inc. (incorporated by
reference to Exhibit 10.22(iv) to the Company's
Annual Report on Form 10-K for the year ended
December 31, 1997 (File No. 1-12351)).
(v) Tenant Estoppel Certificate to WCB Properties Limited
Partnership (incorporated by reference to Exhibit
10.22(v) to the Company's Annual Report on Form 10-K
for the year ended December 31, 1997 (File No.
1-12351)).
10.22 Lease Agreement, dated October 31, 1995, between Exchange
Limited Partnership and Fingerhut Financial Services
Corporation (incorporated by reference to Exhibit 10.23 to the
Company's Annual Report on Form 10-K for the year ended
December 31, 1997 (File No. 1-12351)).
(i) Addendum to Lease Agreement, dated October 31, 1995,
between 1991 Exchange Limited Partnership and
Fingerhut Financial Services Corporation
(incorporated by reference to Exhibit 10.23(i) to the
Company's Annual Report on Form 10-K for the year
ended December 31, 1997 (File No. 1-12351)).
(ii) Corporate Guaranty of Lease, dated October 31, 1995,
between 1991 Exchange Limited Partnership and
Fingerhut Financial Services Corporation
(incorporated by reference to Exhibit 10.23(ii) to
the Company's Annual Report on Form 10-K for the year
ended December 31, 1997 (File No. 1-12351)).
(iii) First Amendment to Lease, dated February 14, 1996,
between 1991 Exchange Limited Partnership and
Fingerhut Financial Services Corporation
(incorporated by reference to Exhibit 10.23(iii) to
the Company's Annual Report on Form 10-K for the year
ended December 31, 1997 (File No. 1-12351)).
(iv) Tenant Estoppel Certificate to Eagle Investments
Limited Liability Company, Bank One, Oklahoma City
and 1991 Exchange Limited Partnership, dated January,
1996, from Fingerhut Financial Services Corporation
(incorporated by reference to Exhibit 10.23(iv) to
the Company's Annual Report on Form 10-K for the year
ended December 31, 1997 (File No. 1-12351)).
(v) Third Amendment to Lease, dated December 22, 1998, between
Exchange Center, L.L.C. and Fingerhut Financial
Services Corporation.
10.23 Lease Agreement, dated December 11, 1996, between Koger Equity, Inc.
and Metris Direct, Inc. (incorporated by reference to Exhibit 10.24
to the Company's Annual Report on Form 10-K for the year ended
December 31, 1997 (File No. 1-12351)).
(i) Lease Amendment, dated June 27, 1997, between Koger Equity,
Inc. and Metris Direct, Inc. (incorporated by
reference to Exhibit 10.24(i) to the Company's Annual Report
on Form 10-K for the year ended December 31,
1997 (File No. 1-12351)).
(ii) Lease Amendment, dated October 15,1997, between Koger
Equity, Inc. and Metris Direct, Inc. (incorporated
by reference to Exhibit 10.24(ii) to the Company's Annual
Report on Form 10-K for the year ended December
31, 1997 (File No. 1-12351)).
(iii) Lease Amendment, dated July 10, 1998, between Koger Equity,
Inc. and Metris Direct, Inc.
10.24 Transfer and Administration Agreement, dated December 9, 1998,
among Enterprise Funding Corporation, Park Avenue Receivables
Corporation, Sheffield Receivables Corporation, Metris Asset
Funding Co., Direct Merchants Credit Card Bank, National
Association, N.A.
10.25 Receivables Purchase Agreement, dated December 9, 1998, between the
Company and Metris Asset Funding Co.
Other Exhibits
11 Computation of Earnings Per Share.
12(a) Computation of Ratio of Earnings to Fixed Charges.
12(b) Computation of Ratio of Earnings to Fixed Charges and
Preferred Dividends.
13 Pages 18 to 62 of the 1998 Annual Report to Shareholders. The
1998 Annual Report shall not be deemed to be filed
with the Commission except to the extent that information is
specifically incorporated herein by reference.
21 Subsidiaries of the Company.
23 Independent Auditors' Consent.
27 Financial Data Schedule.
* Management contract or compensatory plan or arrangement required to be filed
as an exhibit pursuant to Item 14(c) of Form 10-K.