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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

  
For The Quarterly Period Ended March 31, 2004

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

        CompuCredit has (1) 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) been subject to such filing requirements for the past 90 days.

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

        As of April 30, 2004, there were 47,980,408 outstanding shares of CompuCredit's Common Stock, no par value (the "Common Stock").

COMPUCREDIT CORPORATION

FORM 10-Q

TABLE OF CONTENTS

March 31, 2004

CompuCredit Corporation and Subsidiaries

Consolidated Balance Sheets

See accompanying notes.

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CompuCredit Corporation and Subsidiaries

Consolidated Statements of Operations (Unaudited)

See accompanying notes.

2

CompuCredit Corporation and Subsidiaries

Consolidated Statement of Shareholders' Equity (Unaudited)

For the Three Months Ended March 31, 2004

See accompanying notes.

3

CompuCredit Corporation and Subsidiaries

Consolidated Statements of Cash Flows (Unaudited)

See accompanying notes.

4

CompuCredit Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

March 31, 2004

1.     Organization and Basis of Presentation

General

        The condensed consolidated financial statements include the accounts of CompuCredit Corporation and its wholly owned subsidiaries (collectively, the "Company"). The Company is a provider of various credit and related financial services and products to or associated with the underserved, or sub-prime, consumer credit market. Historically, the Company has served this market through its marketing and solicitation of credit card accounts and its servicing of various credit card receivables underlying both its originated accounts and its portfolio acquisitions. Because only financial institutions can issue general purpose credit cards, the Company has a contractual arrangement with a third-party financial institution pursuant to which the financial institution issues general purpose Visa and MasterCard credit cards, and the Company purchases the receivables relating to such accounts on a daily basis. The Company markets to its cardholders other fee-based products including card registration, memberships in preferred buying clubs, travel services and credit life, disability and unemployment insurance.

        The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Securities and Exchange Commission ("SEC") Regulation S-X. Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States of America ("GAAP") for complete consolidated financial statements. In the opinion of management, all normal recurring adjustments considered necessary to fairly state the results for the interim periods presented have been included. The preparation of condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. Certain estimates, such as credit losses, payments, discount rates and the yield earned on securitized receivables, have a significant impact on the gains and losses recorded on securitizations and the value of retained interests in credit card receivables securitized. Operating results for the three months ended March 31, 2004 are not necessarily indicative of the results for the year ending December 31, 2004. These condensed consolidated financial statements should be read in conjunction with the notes to the consolidated financial statements for the year ended December 31, 2003 contained in the Company's Annual Report on Form 10-K filed with the SEC.

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

2.     Significant Accounting Policies

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

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Restricted Cash

        The Company provides an irrevocable standby letter of credit agreement for $10.0 million to the financial institution that issues the credit cards marketed by the Company. The purpose of the letter of credit is to protect the financial institution from non-payment by the Company of its obligation to purchase receivables arising in the credit card accounts on a daily basis. The Company is required to maintain a minimum cash balance of $10.0 million with the bank that has issued the letter of credit. Such cash has been disclosed as restricted cash on the face of the consolidated balance sheet. Additionally, as of December 31, 2003, the restricted cash balance included a portion ($1.9 million) of the servicing fee associated with the Embarcadero Trust (see Note 5, "Embarcadero Acquisition") that was then contingent on the Company achieving certain milestones; these milestones were achieved, and the Company received these proceeds in January 2004.

Asset Securitization

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

        Under Statement of Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("Statement No. 140"), gains and losses are recognized at the time of each sale. These gains or losses on sales of receivables depend in part on the previous carrying amount of the financial assets sold, as well as the fair value of the assets and cash proceeds received. The cash flows used to measure the gains and losses represent estimates of finance charges and late fees, servicing fees, costs of funds paid to investors, payment rates, credit losses and any required amortizing principal payments to investors. The Company initially records a servicing liability within a securitization structure when the servicing fees the Company expects to receive do not provide adequate compensation for servicing the receivables. The initial servicing liability is recorded at estimated fair market value. The servicing liability is then evaluated each quarter and carried at its estimated fair value. Changes in servicing liability fair value are included as a component of the Company's income from retained interests in credit card receivables securitized, with actual servicing expenses being recorded into operations as incurred. Because quoted market prices are generally not available for the Company's servicing liabilities, the Company estimates fair value based on the estimated present value of future cash flows using management's best estimates of key assumptions as outlined in Note 6, "Off Balance Sheet Arrangements." The servicing liability is netted against the value of the I/O strip and included in retained interests in credit card receivables securitized on the Company's consolidated balance sheet. In accordance with Statement No. 140 and FASB interpretation No. 46, "Consolidated Financial Statements" ("Interpretation No. 46"), the Company does not consolidate any of the qualifying special purpose entities ("QSPEs") in its securitizations.

        The retained interests for portfolios securitized by the Company are accounted for as trading securities and reported at estimated fair market value, with changes in fair value included in operations in accordance with Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("Statement No. 115"). The estimates used to determine

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the gains and losses and the related fair values of I/O strips and retained ownership interests are influenced by factors outside of the Company's control, and such estimates could materially change from quarter to quarter.

        Retained interests purchased by the Company during 2002 are carried at the lower of amortized cost or fair market value, net of a servicing liability. In accordance with Emerging Issues Task Force Issue 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets" ("EITF 99-20"), expected cash flows in excess of the costs of the purchased retained interests are being amortized into income from retained interests in credit card receivables securitized using the effective interest method.

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

Loans Receivable, Net

        Loans receivable, net represent credit card receivables that the Company has not securitized. These receivables are derived principally from the Company's largely fee-based card offering to consumers at the lower end of the FICO scoring system and consist of finance charges and fees, as well as principal balances receivable from this class of customer. In addition to finance charges on principal balances, the fees associated with this particular product offering consist principally of activation, annual and monthly fees. The activation fees are recognized over the estimated life of a customer (approximately one year). The annual fees are recognized over the year to which they apply. Loans receivable are presented net of unearned fees in accordance with Statement of Financial Accounting Standards No. 91, "Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Receivables and Initial Direct Costs of Leases." The allowance for uncollectible loans is provided for that portion of the loans receivable that management believes will not ultimately be collected based on historical experience. The components of loans receivable, net are as follows (in millions):

        Reflected in interest income on the consolidated statement of operations is $6.0 million and $0 of interest (or finance charge) income and reflected in fees and other income is $16.4 million and $0 of fee income associated with these loans receivable for the three months ended March 31, 2004 and 2003, respectively. The weighted average remaining vesting period for the deferred revenue for this product at March 31, 2004 was 8 months.

Investment in Previously Charged Off Receivables

        In late 2002, the Company formed a new debt collections subsidiary and began the process of obtaining the appropriate state licenses and meeting the applicable regulatory requirements necessary

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for the Company to hold itself out as a debt collector and a buyer of defaulted credit card accounts. Through this subsidiary, the Company now pursues, competitively bids for and acquires previously charged off credit card receivables. All of the Company's acquisitions of previously charged off credit card receivables thus far during 2004 and all but one of the acquisitions during 2003 have been from the securitization trusts underlying the Company's retained interests investments. The Company is continually evaluating acquisition opportunities, but only at appropriate pricing. Further, the sales of the receivables serviced by the Company are subject to a strict competitive bid process involving other potential third-party portfolio purchasers to ensure that all acquisitions have been at fair market prices; the Company has also participated with and under the same terms as other third-party purchasers to acquire some of its previously charged off receivables, thereby allowing the third-party purchasers to establish a market for the purchases.

        Static pools consisting of homogenous accounts and receivables are established for each acquisition. Once a static pool is established, the receivables within the pool are not changed. Each static pool is recorded at cost and is accounted for as a single unit for payment application and income recognition purposes. The Company accounts for its investment in previously charged off receivables by applying the cost recovery method on a portfolio-by-portfolio basis under the guidance of Practice Bulletin 6, "Amortization of Discounts on Certain Acquired Loans" ("PB 6"). Under the cost recovery method, income associated with a particular portfolio is not recognized until cash collections have exceeded the investment. Additionally, until such time as cash collected for a particular portfolio exceeds the Company's investment in the portfolio, the Company will incur commission costs and other servicing costs associated with the cash collections on the portfolio investment that will be charged as an operating expense without any offsetting income amounts.

        The Company will use the cost recovery method for each particular static pool until such time that its experience with that pool is sufficient to justify use of the PB 6 interest method (such method being one by which income associated with each static pool is accrued monthly based on each static pool's effective interest rate) based on criteria communicated to the Company during 2003 by the Staff of the SEC. The Company does not anticipate meeting these criteria for use of the interest method for any particular acquired pool for the foreseeable future.

        For the three months ended March 31, 2004, the following table shows a roll-forward of the Company's investment in previously charged off receivables activities (in thousands):

        At the time of acquisition, the life of each pool generally is estimated to be between 24 and 36 months based upon the proprietary models of the Company. The Company anticipates collecting approximately 76% of the ERC over the next twelve months, with the balance to be collected thereafter.

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Investment in Debt Securities and Notes Payable

        In addition to the CSG Trust bonds held by the Company and discussed in its Annual Report on Form 10-K for the year ended December 31, 2003, during the first quarter of 2004, the Company acquired $6.7 million in Class A and B bonds issued by the First Consumer Credit Card Master Business Trust in the open market for a total purchase price of approximately $5.6 million and has included this amount in investment in debt securities. The bonds earn interest at 1.40% and 2.19%, respectively. The Company financed the purchase of these bonds with $2.8 million in borrowed funds that accrue interest at 3.5%. These borrowed funds are included in notes payable along with borrowings associated with certain vendor-financed acquisitions of software and equipment. These bonds have been classified as trading securities.

        Applying the principles of Statement No. 115, the Company has classified all of its bonds purchased prior to its first quarter of 2004 purchase as held-to-maturity. Given the absence of an active market for these bonds and the gradual repayment of the bonds combined with the Company's lack of a requirement for additional liquidity, management is of the opinion that held-to-maturity is the appropriate classification.

Warrant

        In connection with a new securitization facility that was entered into during the first quarter of 2004, the Company issued to the investor a warrant to acquire 2.4 million shares of the Company's common stock at a strike price of $22.45. The costs associated with this warrant were recorded within deferred costs, net, on the Company's consolidated balance sheet at fair value (approximately $16.5 million determined using the Black-Scholes model), and the initial deferred cost amount is being amortized as an additional component of expense over the two-year term of the securitization facility.

Stock Options

        The Company has three stock-based employee compensation plans—one of which is subject to shareholder approval in May 2004. As permitted by Statement of Financial Accounting Standards No. 123, "Accounting for Stock- Based Compensation" ("Statement No. 123"), the Company accounts for those plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), and its related interpretations. Because all options granted under the Company's plans had an exercise price equal to the market value of the underlying common stock on the date of grant, no stock-based compensation cost is reflected in net income under the Company's application of APB 25. Additionally, the Company did not issue any options to non-employees who were not directors for the three months ended March 31, 2004 and March 31, 2003, respectively.

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

        The pro forma results may not be indicative of the future effect on the results of operations due to a variety of factors including the timing and number of awards. The following table summarizes the Black-Scholes value of the Company's outstanding stock options on a per share basis, as well as the key assumptions used in the Black-Scholes model.

Fees and Other Income

        Fees and other income consists of the following:

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        Fees include annual membership, overlimit, returned check, cash advance transaction fees and other fees. Fees are assessed on credit card accounts according to the terms of the related cardholder agreements and, except for annual fees, are recognized as revenue when charged to the cardholder's account. Annual fees are amortized into revenue on a straight-line basis over the cardholder privilege period, which is twelve months. Direct receivables origination costs are amortized against fee income.

        The Company offers various fee-based products and services (ancillary products) to its customers, including memberships, insurance products and subscription services. When the Company markets its own products, the fees, net of estimated cancellations, are recorded as deferred revenue upon the customer's acceptance of the product and are amortized on a straight-line basis over the life of the product (which ranges from one to twelve months). When the Company markets products for third parties under commission arrangements, the revenue is recognized when earned, which is generally during the same month the product is sold to the customer. The Company considers revenue to be earned once delivery has occurred (i.e., when there is no further performance obligation), the commission is fixed and collectibility is reasonably assured. Once these conditions are satisfied, the Company recognizes its commission as ancillary product revenue.

Recent Accounting Pronouncements

        In January 2003, the FASB issued Interpretation No. 46, which addresses consolidation by business enterprises of variable interest entities that have certain characteristics. In general, Interpretation No. 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity's activities or is entitled to receive a majority of the entity's residual returns or both. An entity that meets this definition is considered the "primary beneficiary." Interpretation No. 46 requires disclosures about variable interest entities by the primary beneficiary and an enterprise that holds significant variable interests in a variable interest entity but is not the primary beneficiary. Interpretation No. 46 provides for exceptions to the scope of this interpretation including transfers to qualifying special purpose entities subject to the reporting of Statement No. 140, which would not be consolidated. Interpretation No. 46 applies immediately to variable interest entities created after January 31, 2003 and to variable interest entities in which an enterprise obtains an interest after January 31, 2003. Interpretation No. 46 applies in the first fiscal year, or interim period, beginning after December 15, 2003 to variable interests entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. This statement did not have a material impact on the Company's consolidated financial statements.

        In June 2003, the FASB issued an Exposure Draft for a proposed Statement of Financial Accounting Standards entitled "Qualifying Special Purpose Entities and Isolation of Transferred Assets, an Amendment of Statement No. 140" ("The Exposure Draft"). The Exposure Draft is a proposal that is subject to change and, as such, is not yet authoritative. If the proposal is promulgated in its current form, it will amend and clarify Statement No. 140. Under the Exposure Draft, the renewal of certain commercial paper facilities underlying the Company's securitizations could cause the Company to have to record on its books the assets and liabilities related to the securitizations.

        In December 2003, the American Institute of Certified Public Accountants Accounting Standards Executive Committee issued Statement of Position 03-3, "Accounting for Certain Loans or Debt Securities Acquired in a Transfer" ("SOP 03-3"). SOP 03-3 addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor's initial investment in loans or debt securities (loans) acquired in a transfer if those differences are attributable,

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at least in part, to credit quality. It applies to loans acquired in business combinations, but does not apply to loans originated by the entity. SOP 03-3 is effective for loans acquired in fiscal years beginning after December 15, 2004, with early adoption encouraged. The Company does not anticipate that the adoption of SOP 03-3 will have a material impact on its financial statements.

3.     Equity Method Investment in CSG, LLC

        CSG, LLC ("CSG") was formed during the second quarter of 2002 by affiliates of Goldman, Sachs & Co., Salomon Smith Barney and a wholly owned subsidiary of the Company to acquire notes and a subordinated, certificated interest issued by a trust ("CSG Trust") that owns a portfolio of credit card receivables, which were initially purchased by the trust from Providian National Bank. The Company accounts for its interest in CSG using the equity method of accounting. The Company has a 50% interest in CSG and funded its initial $34.9 million investment in CSG with cash of $3.5 million and by borrowing $31.4 million, which was repaid during the fourth quarter of 2002. Notwithstanding the Company's repayment of this loan's principal, the lender continues to receive a portion of excess cash flows received by the Company from CSG. These payments are classified as interest expense.

        During the three months ended March 31, 2004 and 2003, the Company received $0 and $19.6 million, respectively, in cash distributions from CSG. During the second quarter of 2003, and as expected at the time of CSG's acquisition of its interests in the CSG Trust, a principal balance trigger occurred, and hence an early amortization began. While CSG made distributions to the Company through June 2003, the occurrence of this trigger event caused CSG to cease its cash distributions to the Company, and it will not resume these distributions until approximately the middle of 2006. Accordingly, all significant income from the Company's equity-method investment will cease until distributions resume in 2006.

        The following represents condensed results of operations of CSG as of March 31, 2004 and December 31, 2003, respectively, and for the three-months ended March 31, 2004 and March 31, 2003, respectively (in thousands):

        In exchange for servicing 100% of the receivables owned by the CSG Trust, the Company receives a servicing fee from the securitization structure, which the Company considers adequate compensation for servicing.

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4.     Purchase of Assets

        In July 2002, the Company completed a transaction with Federated Department Stores, Inc. in which the Company purchased for $75.2 million plus an assumed $95.8 million servicing liability the retained interests in a trust (the "Original Fingerhut Trust") that owned approximately $1.0 billion in face amount of receivables. The receivables included in the trust were those generated by private label revolving credit cards used to purchase items from the Fingerhut catalog. This portfolio will decrease over time because payments and charge-offs from cardholders are expected to be significantly greater than purchases and interest charges. In accordance with EITF 99-20, the Company has accounted for the retained interests it purchased at the lower of amortized cost or fair market value, and the Company has amortized remaining expected cash flows in excess of the costs of the purchased retained interests into income from retained interests in credit card receivables securitized using the effective interest method. Also, pursuant to EITF 99-20, the Company has updated its EITF 99-20 model when there has been a change in its estimate of projected future cash flows. These updates can result in the Company either (1) adjusting the prospective yield that it will realize over future periods, or (2) reducing the carrying value of the Company's investment to fair value if a significant adverse change occurs. To date, none of these updates has resulted in a reduction in the carrying value of the Company's investment.

        The gross cash flows that were available to the Company through the securitization structure associated with the Fingerhut trust retained interests were $1.8 million and $86.3 million during the three months ended March 31, 2004 and 2003, respectively. From date of acquisition through the third quarter of 2003, the portion of expected cash flows that exceeded the cost of the purchased retained interests was amortized into income from retained interests in credit card receivables securitized using the effective interest method ($65.4 million pre-tax was amortized into income during the three months ended March 31, 2003). During the third quarter of 2003, a third party acquired the Company's retained interest in the Original Fingerhut Trust in exchange for $27.3 million and a retained interest in a new trust (the "Fingerhut Trust"), which owns a collateral security interest in the Original Fingerhut Trust. Subsequent to this third quarter 2003 transaction, the effective interest method is also being used to record income associated with the Company's retained interest in the new Fingerhut Trust; $1.8 million of such pre-tax income is reflected in income from retained interests in credit card receivables securitized during the three months ended March 31, 2004. For further discussion of this third quarter 2003 transaction and the Company's accounting for its investment in the Fingerhut retained interests, see Note 6, "Off Balance Sheet Arrangements."

5.     Embarcadero Acquisition

        On August 1, 2003, the Company purchased a 62.5% interest in Embarcadero Holdings, LLC ("Embarcadero") for $26.5 million. Embarcadero was formed by an affiliate of Merrill Lynch and one of the Company's wholly owned subsidiaries in connection with the acquisition of approximately $824 million (face amount) in credit card receivables from Providian Bank. These receivables were then transferred to a trust pursuant to a Statement No. 140 transfer in exchange for notes and a subordinated, certificated interest issued by the trust ("Embarcadero Trust"), thereby resulting in securitization income of $31.4 million. (See Note 6, "Off Balance Sheet Arrangements," for further discussion.) Embarcadero retained the subordinated, certificated interest originally issued by the Embarcadero Trust until the initial conduit facility underlying the securitization was replaced in January 2004 with a new 10-year amortizing term facility; Embarcadero now owns the subordinated, certificated interest underlying the new 10-year amortizing term facility. The assets and liabilities of

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Embarcadero, and its associated earnings from operations, are presented as part of the Company's consolidated financial statements with a minority interest being shown to reflect the Merrill Lynch affiliate's portion of the operations. The minority interest on the statements of operations is not shown net of tax because Embarcadero is a pass-through entity for income tax purposes. For a fee that represents adequate compensation for servicing, the Company has agreed to service the entire portfolio of credit card receivables underlying the Embarcadero Trust. In addition, Embarcadero is obligated to provide for the purchase of receivables in the unlikely event that the Embarcadero Trust is unable to fund such receivables. To date, there have been no, and management does not expect any, borrowings related to this obligation.

6.     Off Balance Sheet Arrangements

        The Company securitizes substantially all of its credit card receivables originated on a daily basis under its primary third-party financial institution relationship (the "originated portfolio") through a master trust. Credit card receivables are transferred to a master trust, which issues notes representing undivided ownership interests in the assets of the master trust. Additionally, during the third quarter of 2002, the Company acquired retained interests in a credit card receivables trust. (See Note 4, "Purchase of Assets.") Further, during the third quarter of 2003, the Company acquired receivables from a third-party and subsequently securitized them. (See Note 5, "Embarcadero Acquisition.")

        In accordance with the above, substantially all of the Company's credit card receivables are held by securitization trusts, and the exclusive interest of the Company in these receivables is in the form of retained interests. GAAP requires the Company to treat its transfers to the securitization trusts as sales, and the receivables are removed from the Company's consolidated balance sheet. Under Statement No. 140, an entity recognizes the assets it controls and liabilities it has incurred, and derecognizes the financial assets for which control has been surrendered and all liabilities that have been extinguished. An entity is considered to have surrendered control over the transferred assets and, therefore, to have sold the assets if the following conditions are met:

1.

The transferred assets have been isolated from the transferor and put presumptively beyond the reach of the transferor and its creditors.



2.

Each transferee has the right to pledge or exchange the assets it has received, and no condition both constrains the transferee from taking advantage of its right to pledge or exchange and provides more than a trivial benefit to the transferor.



3.

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

        The securitization transactions do not affect the relationship the Company has with its customers, and the Company continues to service the credit card receivables.

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        The table below summarizes the Company's securitization activity for the periods presented. It does not include any of the receivables managed by or the securitization facility of CSG, the Company's 50%-owned equity-method investee:

(1)

Excludes CSG receivables of $478 million (or $239 million attributable to the Company's 50% CSG ownership percentage) and $803 million (or $402 million attributable to the Company's 50% CSG ownership percentage) at March 31, 2004 and 2003, respectively, because such amounts are included in the Company's equity method investment and are therefore not reflected in the consolidated statement of operations or balance sheet items included herein.

        The investors in the Company's securitization transactions have no recourse against the Company for its customers' failure to pay their credit card receivables. However, most of the Company's retained interests are subordinated to the investors' interests until the investors have been fully paid.

        Generally, all collections received from the cardholders underlying each securitization are included in the securitization cash flows. This includes collections from the cardholders for interest, fees and other charges on the accounts and collections from the cardholders repaying the principal portion of their account balances. In general, the cash flows are then distributed to the Company as servicer for its servicing fee, to the investors as interest on their outstanding notes, to the investors to repay any portion of their outstanding notes that become due and payable and to the Company as the seller to fund new purchases. Any collections from cardholders remaining each month after making the various payments noted above are paid to the Company on its retained interests.

        The measurements of retained interests associated with Company-arranged securitizations are dependent upon management's estimates of future cash flows using the cash-out method. Under the cash-out method, the future cash flows (including the release of any cash related to credit enhancements) are recorded at a discounted value. The cash flows are discounted based on the timing of when the Company expects to receive the cash flows. The discount rates are based on management's estimates of returns that would be required by investors in an investment with similar terms and credit quality. Yields on the credit card receivables are estimated based on the stated annual percentage rates in the credit card agreements. Estimated default and payment rates are based on historical results, adjusted for expected changes based on the Company's credit risk models. Credit card receivables are typically charged off when the receivables become 180 days past due, although earlier charge offs may occur specifically related to accounts of bankrupt or deceased customers. Bankrupt and deceased customers' accounts are typically charged off within 30 days of verification.

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        The retained interests associated with the credit card receivables that the Company has securitized are carried at estimated fair market value, and because they are classified as trading securities, any changes in fair value are included in income. Because quoted market prices for the Company's retained interests are generally not available, the Company estimates fair value based on the estimated present value of future cash flows using management's best estimates of key assumptions.

        The Company's retained interests in credit card receivables securitized include the following:

        The I/O strip reflects the fair value of the Company's rights to future income from Company-arranged securitizations and includes certain credit enhancements. The I/O strip increased during the first three months of 2004 principally due to the effects of the new Embarcadero 10-year amortizing term securitization facility completed in January 2004, combined with improved yield and lower charge offs, partially offset by a lower payment rates, experienced within the Embarcadero Trust. The decrease in accrued interest and fees corresponds with reductions in receivables balances within the portfolios underlying the Company's securitizations. The servicing liability reflects, for those securitization structures for which servicing compensation is not adequate, the fair value of the costs to service the receivables above and beyond the servicing income the Company expects to receive from the securitizations. The servicing liability decrease experienced thus far in 2004 corresponds with reductions in receivables levels within the Company's originated portfolio. The fair value of retained interests includes those interests in Company-arranged securitizations, as well as the Company's purchased interests in securitizations. The fair value of retained interests decreased between December 31, 2003 and March 31, 2004, principally due to the currently liquidating nature of the Company's managed receivables portfolios, partially offset, however, by the improved performance of the portfolios' receivables in the first quarter of 2004.

        During the third quarter of 2003, a third party acquired the Company's retained interest in the Original Fingerhut Trust in exchange for $27.3 million and a retained interest in a new Fingerhut Trust, which owns a collateral security interest in the Original Fingerhut Trust representing an undivided interest in the receivables held by the Original Fingerhut Trust. For accounting purposes, this transaction had no ramifications other than its effect on the timing of income recognition under the effective interest method of EITF 99-20 based on revised cash flow timing. As a result of this transaction, with the exception of servicing fees, the Company will receive only negligible further cash flows from the Fingerhut Trust until the holders of all senior notes issued by the Fingerhut Trust are repaid (currently estimated to be the third quarter of 2004). The remaining excess cash flows from the Fingerhut investment are currently estimated to be $127.4 million. Once the Fingherhut Trust senior note holders are repaid, the Company will again realize material income amounts associated with its Fingerhut investment. Because the Company is now receiving adequate compensation for servicing the portfolio of credit card receivables underlying the Fingerhut Trust, the Company no longer has the

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servicing liability associated with the Original Fingerhut Trust, but rather, a deferred gain associated with the exchange of the Fingerhut retained interests, which currently is being amortized into income using the EITF 99-20 effective interest method.

        Changes in any of the assumptions used to value the Company's retained interests could impact the fair value estimates. The weighted average key assumptions used to estimate the fair value of the Company's retained interests in receivables the Company has securitized are presented below:

        At March 31, 2004, the following illustrates the hypothetical effect of an adverse 5 and 10 percent change in key economic assumptions on the retained interests in credit card receivables securitized ($ in thousands):

        These sensitivities are hypothetical and should be used with caution. As the figures indicate, changes in fair value based on a 5% and a 10% variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value of the retained interests in credit card receivables securitized may not be linear. Also, in this table, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated without changing any other assumptions; in reality, changes in one assumption may result in changes in another. For example, increases in market interest rates may result in lower prepayments and increased credit losses, which could magnify or counteract the sensitivities.

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        As noted above, the Fingerhut Trust retained interests are carried at the lower of amortized cost or fair market value, net of any applicable servicing liability. In accordance with EITF 99-20, expected cash flows in excess of the cost of the purchased retained interests are being amortized into income from retained interests in credit card receivables securitized using the effective interest method.

        The Company's managed receivables portfolio underlying its securitizations (including its 50% and 62.5% ownership shares in the CSG and Embarcadero managed receivables, respectively) is comprised of retained interests in the credit card receivables securitized and the investors' shares of these securitized receivables. The investors' shares of securitized credit card receivables are not assets of the Company. The following table summarizes the balances included in the Company's managed receivables portfolio underlying its retained interests in the securitizations.

7.     Earnings Per Share

        The following table sets forth the computation of basic and diluted earnings per share:

18

        The Company's preferred shares, plus dividends that have been accreted thereon, are convertible into approximately 4.8 million shares of common stock at $9.14 per share as of March 31, 2004. These 4.8 million shares of common stock have been included in the weighted average shares outstanding in the above computations. Excluded from the March 31, 2004 calculation are 2.4 million warrants and 0.2 million stock options as their effect is anti-dilutive.

8.     Commitments and Contingencies

        In the normal course of business through the origination of unsecured credit card receivables, the Company incurs off balance sheet risks. These financial instruments consist of commitments to extend credit totaling approximately $2.2 billion and $2.3 billion at March 31, 2004 and December 31, 2003, respectively. These instruments involve, to varying degrees, elements of credit risk in excess of the amounts securitized. The principal amount of these instruments reflects the maximum exposure the Company has in the instruments. The Company has not experienced and does not anticipate that all of its customers will exercise their entire available line of credit at any given point in time. The Company has the right to reduce or cancel these available lines of credit at any one time.

        The Company is an equity member of CSG. (See Note 4, "Equity Method Investment in CSG, LLC.") During the second quarter of 2002, CSG entered into a note purchase agreement whereby it agreed to buy additional interests in a portfolio of credit card receivables owned by CSG Trust should there be net new growth in the receivables or should collections not be available to fund new cardholder purchases. As of March 31, 2004, CSG would be obligated to purchase up to approximately $61.1 million of new notes from the CSG Trust should this contingency arise. In general, this contingency amount will decline as the amount of credit available to cardholders for future purchases declines. The portfolio has declined and is expected to continue to decline during the life of the CSG Trust as payments are expected to exceed new purchases each month. As a member of CSG, the Company has agreed to guarantee the payment of the purchase price of the aforementioned new notes if the events giving rise to this contingency arise, but only if CSG itself should fail to purchase the new notes under the note purchase agreement. As of March 31, 2004, CSG had not purchased and was not required to purchase any additional notes under the note purchase agreement. The Company's guarantee is limited to its ownership percentage in CSG (which at March 31, 2004 was 50%) times the total amount of the notes that CSG would be required to purchase. Therefore, as of March 31, 2004, the maximum amount of the Company's guarantee was approximately $30.6 million. The Company currently does not have any liability recorded with respect to this guarantee, but it will record one if events occur that make payment probable under the guarantee. The fair value of this guarantee is not material.

        The Company's agreement with its principal third-party originating financial institution requires the Company to purchase on a daily basis the credit card receivables that are originated in the accounts maintained for the Company's benefit. To secure this obligation, the Company provides the financial institution a $10.0 million cash-collateralized letter of credit and has pledged retained interests carried at approximately $80.5 million. These arrangements prevent the Company from using the $10.0 million of cash for any other purpose, although the Company can substitute other collateral for the pledged retained interests. The Company's arrangements with the financial institution expire in March 2006. If the Company were to terminate its service agreement with this institution, there would be penalties of approximately $1.5 million as of March 31, 2004. The Company currently does not have any liability recorded with respect to the guarantees discussed in this paragraph, but it will record one if events

19

occur that make payment probable under the guarantees. The fair value of these guarantees is not material.

        The Company's most significant source of liquidity is the securitization of credit card receivables. The maturity terms of the Company's securitizations vary. As of March 31, 2004, the Company had a three-year term securitization facility that it completed in July 2001, a two-year variable funding securitization facility with renewal options and a one-year conduit securitization facility issued out of its originated portfolio master trust, a ten-year amortizing term securitization facility issued out of the Embarcadero Trust and a three-year amortizing term securitization issued out of the Fingerhut Trust.

        For each portfolio of credit card receivables securitized by the Company, there has never been an early amortization period. The Company has experienced, however, early amortization events associated with each of the securitization structures represented by the retained interests that the Company and CSG acquired in 2002—both of which were fully contemplated in connection with the Company's establishment of purchase prices for the respective acquisitions. In March 2003, the credit card receivables underlying the Original Fingerhut Trust dropped below a minimum receivables balance threshold, thereby causing the series issued by the Original Fingerhut Trust to begin an early amortization period. Also, due to a reduction in the principal balance of the receivables within the CSG Trust (the retained interests in which are owned by the Company's equity-method investee, CSG), a principal balance trigger occurred, and hence early amortization began, during the second quarter of 2003. The occurrence of this event caused CSG to cease its cash distributions to the Company in June 2003, although the Company expects that the CSG Trust will continue to provide adequate compensation to the Company in cash for servicing the portfolio of receivables underlying the CSG Trust and will continue to make payments to the Company in respect of the Company's investment in CSG Trust bonds.

        Finally, while the Company has never triggered an early amortization within any of the series underlying Company-arranged securitization facilities, and while the Company does not believe that it will, it is conceivable that, even with close management, the Company may trigger an early amortization of one or more of the outstanding series within its securitization trusts.

        As each securitization facility expires or comes up for renewal, there can be no assurance that the facility will be renewed, or if renewed, there can be no assurance that the terms will be as favorable as the terms that currently exist. Either of these events could significantly increase the Company's need for additional liquidity.

        The Company is subject to various legal proceedings and claims that arise in the ordinary course of business. There are no material pending legal proceedings to which the Company is a party.

9.     Subsequent Event

        During the second quarter of 2004, the Company entered into an agreement to acquire a sub-prime lender for approximately $106 million including transaction costs. The acquisition is expected to close in the second quarter of 2004, but is subject to financing, due diligence and various other customary conditions precedent to closing. The Company anticipates financing this acquisition with 50% cash and 50% debt financing.

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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

        The following discussion should be read in conjunction with our condensed consolidated financial statements and the related notes included therein.

        This Management's Discussion and Analysis of Financial Condition and Results of Operations includes forward-looking statements. We have based these forward-looking statements on our current plans, expectations and beliefs about future events. In light of the risks, uncertainties and assumptions discussed under the caption "Risk Factors" in "Item 1. Business" of our Annual Report on Form 10-K for the year ended December 31, 2003 filed with the Securities and Exchange Commission ("SEC") and other factors discussed in that section, there is a risk that our actual experience will differ materially from the expectations and beliefs reflected in the forward-looking statements in this section and elsewhere in this report.

Overview

        We are a provider of various credit and related financial services and products to or associated with the underserved, or sub-prime, consumer credit market. Historically, we have served this market through our marketing and solicitation of credit card accounts and our servicing of various credit card receivables underlying both our originated accounts and our portfolio acquisitions.

        We generally have financed our credit card origination activities through the securitization of the receivables underlying the accounts we originate and the portfolios that we purchase. The leverage (i.e., the percentage on a dollar that lenders will lend us, or the "advance rate") that our securitization facilities provide against our originated credit card receivables is a critical factor in our ability to obtain the desired returns on equity for our shareholders. From the latter part of 2001 through the end of 2003, the advance rates that securitization lenders were willing to provide us were not adequate enough for us to earn the returns on equity that we demand for our shareholders. Accordingly, we did not originate a significant number of accounts during that time period.

        In January 2004, however, we completed a two-year securitization facility in connection with our originated portfolio master trust at advance rates that allow us to earn acceptable returns on equity from account originations to our traditional customer base. This facility provides for an initial one-year committed funding level of $1.25 billion, growth in that committed funding level to $1.5 billion in the second year (subject to certain conditions precedent), one-year renewal periods (subject to certain conditions precedent) at the expiration of the initial two-year term and an orderly amortization of the facility at expiration in a manner that we expect will allow us to receive cash flows that will adequately cover our servicing costs while amounts borrowed under the facility are repaid by the originated portfolio master trust. Accordingly, we have begun to market our card offerings so that we can begin growing our traditional originated credit card business in 2004.

        During the intervening period between late 2001 through the end of 2003 while we were not originating significant numbers of accounts, we sought to diversify our product offerings. We initially focused on portfolio acquisition as a significant growth channel for our overall credit card receivables portfolio. Through this channel, we were able to obtain sufficient leverage against our discounted purchase prices to allow us to earn our desired returns on equity. We completed two significant acquisitions in 2002 and one in 2003. Further, we also decided to expand our business into the purchase and recovery of previously charged off receivables.

        Our portfolio acquisitions and our charged off receivables recovery operations have been very successful and have fit within our longstanding strategy of maximizing shareholder returns through high return business activities, while growing only to the extent that we have the liquidity in place to profitably do so. We believe that we have achieved our goals to date by maintaining flexibility and

21

seeking opportunities where others might not, and we believe that these traits are essential for our continued success. Thus, our focus is on how we can efficiently deploy our risk modeling, underwriting, servicing and collection platform and expertise, irrespective of the particular vehicle through which we obtain the receivables to which we apply our skill set. Accordingly, we are looking for new applications of our abilities, and we believe that we can successfully extend our platform and expertise into other sub-prime asset classes and activities beyond credit card receivables. Throughout 2004 and beyond, our shareholders should expect us to evaluate and pursue other business activities and asset classes that are complementary to our historic sub-prime credit card business, including potential acquisitions of sub-prime lenders. As evidence of this, we began rolling out a stored-value or debit card initiative during the first quarter of 2004; through this initiative, we believe that we can nurture a platform for transactional and other fee income growth and for possible expansion into further lending opportunities to our debit card customer base. We also entered into an agreement in April of this year to acquire a complementary sub-prime lender in a transaction that we expect to complete either late in our second quarter or early during our third quarter of 2004.

        We remain focused on making good economic decisions that will result in high returns on equity to our shareholders over a long-term horizon. While our decisions may make economic sense, they may also result in volatile earnings under GAAP as a result of the accounting requirements for securitizations under Statement of Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("Statement No. 140"). To the extent that we grow our overall portfolio of credit card receivables (either through origination, acquisition channels or other new channels) and then securitize these assets, we will have securitization income (loss), which may be material. (This occurred, for example, in the third quarter of 2003.) For further discussion of our historic results and the impact of securitization accounting on our results, see the "Results of Operations" and "Liquidity and Capital Resources" sections below, as well as our condensed consolidated financial statements and the notes thereto.

Results of Operations

Three Months Ended March 31, 2004, Compared to Three Months Ended March 31, 2003

        Our results of operations were as follows for the three months ended March 31, (in thousands except per share data):

        The decrease in our net income as compared to the first quarter of 2003 was principally due to:

•

the anticipated performance of our acquired Fingerhut retained interests as a result of our third quarter 2003 retained interest exchange transaction (only $1.8 million of Fingerhut pre-tax income from retained interests in credit card receivables securitized for 2004, compared with $65.4 million for 2003);



•

as anticipated at the date of purchase, a decline in income associated with our equity-method investment in CSG ($(0.2) million pre-tax loss for 2004, versus $14.3 million in pre-tax income for 2003); and



•

an anticipated $4.3 million pre-tax decline in credit card fees associated with the receivables within our originated portfolio master trust due to the decrease in the receivable balances.

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        These negative effects were partially offset, however, by:

•

the improved performance of our retained interests in the originated portfolio master trust ($1.3 million of originated portfolio master trust pre-tax income from retained interests in credit card receivables securitized for 2004, versus a $30.0 million pre-tax loss for 2003);



•

the performance of our new largely fee-based credit card product offering to consumers at the lower end of the FICO scoring system ($13.4 million of pre-tax income for 2004 with no corresponding income for 2003);



•

the performance of the acquired receivables in the Embarcadero Trust ($11.4 million Embarcadero pre-tax income from retained interests in credit card receivables and $5.6 million of pre-tax credit card fee income in 2004, both such amounts being offset by $6.3 million pre-tax Embarcadero minority interest in 2004, with no corresponding income amounts or minority interest offsets for 2003);



•

a decline in interest expense associated with our investment in CSG (no interest expense for 2004, versus $3.1 million of pre-tax interest expense for 2003); and



•

the performance of our operations in connection with our purchases of previously charged off credit card receivables ($5.2 million pre-tax income for 2004, versus $(1.3) million pre-tax (loss) for 2003).

        Our 2004 results were also reduced by the additional costs to service the Embarcadero portfolio; however, these were more than offset by the income generated by this portfolio as noted above.

Net Interest Expense After Provision for Loan Losses

        Net interest expense after provision for loan losses represents interest income earned on cash, cash equivalents and investments and finance charges and late fees earned on any loans receivable that we have not securitized, less interest expense and a provision for loan losses. Exclusive of our provision for loan losses we had net interest income of $7.6 million for the three months ended March 31, 2004 versus net interest expense of $2.1 million for the three months ended March 31, 2003. The factors accounting for this shift to net interest income exclusive of the provision for loan losses in 2004 from net interest expense in 2003 include:

•

growth during the latter quarters of 2003 in our credit card receivables associated with our principally fee-based credit card product offering to consumers at the lower end of the FICO scoring system, none of which we have securitized;



•

interest income that we have received in 2004 on our subordinated, certificated interest in the Embarcadero Trust; and



•

the suspension of interest expense payments associated with debt that we undertook in 2002 to acquire our interest in CSG, such suspension occurring in connection with the early amortization trigger experienced on the CSG Trust securitization facility during the second quarter of 2003 (as discussed in further detail in the "Liquidity, Funding, and Capital Resources" section of our Annual Report on Form 10-K for the year ended December 31, 2003).

        As we continue to grow our principally fee-based credit card offering to consumers at the lower end of the FICO scoring system, and assuming that we do not securitize the credit card loans receivable underlying this product offering, we expect to see continued growth in our interest income.

        Our $9.1 million provision for loan losses in 2004 relates to those non-securitized receivables associated with our largely fee-based card offering to consumers at the lower end of the FICO scoring system and is provided to cover aggregate loss exposures on (1) principal loans receivable balances, (2) finance charges and late fees receivables underlying income amounts included within our interest

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income category, and (3) fees receivable underlying fee income included within our fees and other income category. Prior to the third quarter of 2003, all of our receivables were securitized in off-balance sheet qualifying securitizations.

Income from Retained Interests in Credit Card Receivables Securitized

        See Note 6, "Off Balance Sheet Arrangements," to our condensed consolidated financial statements for a description of our securitizations.

        Income (loss) from retained interests in credit card receivables securitized includes the income earned on the retained interests and any changes in the fair value of the retained interest in credit card receivables securitized in accordance with Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities," as follows:

(1)

This amount includes approximately $1.8 million in 2004 related to the Fingerhut Trust and $65.4 million in 2003 related to the Original Fingerhut Trust (as discussed below). It also includes $11.4 million for 2004 related to the Embarcadero Trust.

        The expected decrease in total income from retained interests in credit card receivables securitized is attributable to the performance of our acquired Fingerhut retained interests (only $1.8 million of Fingerhut pre-tax income from retained interests in credit card receivables securitized for 2004, compared with $65.4 million for 2003), offset, however, by:

•

the performance of our retained interests in the Embarcadero Trust, the receivables underlying which we acquired during the third quarter of 2003 ($11.4 million in 2004); and



•

improved performance of our retained interests in the originated portfolio master trust associated with (1) improved collection efforts with respect to the receivables underlying the trust, (2) an improvement in the economy, and (3) an acceleration of a portion of our "cash-out method" cash flows within our Statement No. 140 discounting model, such acceleration being associated with the higher advance rates that we have been able to achieve on the new 2-year variable funding securitization facility that we completed in January 2004.

        For discussion of a third quarter 2003 Fingerhut retained interests exchange and our accounting for our investment in the Fingerhut retained interests, see Note 6, "Off Balance Sheet Arrangements," to our condensed consolidated financial statements. While cash flows within the Fingerhut Trust are being used, as they currently are, to repay the outstanding securitization facility underlying the trust, we do not expect to receive any material income associated with the Fingerhut Trust. Once the debt is repaid, however, which we expect will occur during the third quarter of 2004, we anticipate the resumption of cash flows to us, which will cause us to again recognize material income associated with the Fingerhut investment. We currently estimate that we will receive $127.4 million in future cash flows associated with the Fingerhut investment.

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Equity Method Investment in CSG

        Under the equity method of accounting for our CSG investment, we recorded approximately $(0.2) million of pretax loss and $14.3 million of pretax income during the three months ended March 31, 2004 and 2003, respectively. This change relates to the principal balance trigger that occurred, and hence, the early amortization that began during the second quarter of 2003 for the securitization facility underlying the CSG Trust, the retained interest in which was the principal income earning asset of CSG during the first quarter of 2003. While we received distributions from CSG through June 2003, the occurrence of the trigger event has caused CSG to cease its cash distributions to us, and distributions will not resume until approximately the middle of 2006. Accordingly, all significant income from our equity-method investment will cease until the distributions resume. The occurrence of this trigger event should not impact, however, our expected future cash flows associated with our servicing of the CSG Trust receivables or our investment in CSG Trust notes.

Servicing Income and Fees and Other Income

        The remaining components of our other operating income (i.e., beyond the income from retained interests in credit card receivables securitized and equity in income of equity-method investee items discussed above) are as follows:

        Our servicing income is typically based on negotiated servicing rates applied to the principal balances of the receivables that we manage on behalf of our securitization trusts. Fundamentally, the decline in servicing income between 2003 and 2004 results from reductions in managed receivables balances underlying the CSG and Fingerhut trusts, partially offset, however, by our management of additional receivables balances associated with our third quarter 2003 Embarcadero Trust securitization transaction.

        Unless we acquire additional receivables portfolios and securitize them or acquire additional retained interests in existing securitization structures, our servicing income should gradually decline during the remainder of 2004 as we liquidate the receivables underlying the Fingerhut CSG and Embarcadero trusts. We do not anticipate that servicing income associated with our planned growth of receivables in the originated portfolio master trust will be sufficient to fully offset the servicing income reductions that we anticipate associated with these other trusts.

        Fees and other income have risen in 2004 due to: (1) the performance of our new largely fee-based credit card product offering to consumers at the lower end of the FICO scoring system ($16.4 million of fees in 2004 with no corresponding fees in 2003); and (2) the performance of our purchase and recovery of previously charged off receivables operations ($14.0 million income in 2004 versus $3.6 million in 2003). These fees and other income increases were partially offset, however, by relative reductions in managed credit card receivables levels between 2003 and 2004.

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Other Operating Expense

        Other operating expense consists of the following for the periods indicated:

        The slight increase in other operating expense for the three months ended March 31, 2004 versus the same period for 2003 reflects investments (e.g., salaries and benefits associated with new hiring, capital expenditures resulting in greater depreciation levels and marketing and solicitation) that we are making to renew growth in the receivables underlying our originated master trust and to diversify into other complementary products and services (like our new stored value or debit card offering) that we can market to our sub-prime customer base. Notwithstanding the higher expense levels associated with these efforts, we have realized reductions in credit card servicing expenses, which have declined along with the expected decline in our managed credit card receivables between the first quarter of 2003 and the first quarter of 2004. While our credit card servicing costs have been trending down in recent months along with the decline in our managed receivables, this downward trend is also reflective of our renegotiation of certain outsourced rates, our utilization of greater outsourcing opportunities due to reduced rates and lower overall delinquencies.

        As we see the results of our renewed marketing efforts to grow the number of accounts and the associated receivables levels within the originated portfolio master trust, we anticipate that the current downward trends in monthly credit card servicing costs will eventually reverse as growth in the receivables underlying the originated portfolio master trust outstrips the reductions in receivables levels within the Embarcadero, CSG and Fingerhut trusts. As we continue to aggressively market our largely fee-based product offering to consumers at the lower end of the FICO scoring system and our traditional credit card offering within our originated portfolio master trust, we expect a continued trend of heightened marketing and solicitation costs throughout 2004.

        The other expense category above includes professional fees, net occupancy costs, ancillary product expense, fraud, travel and entertainment, insurance, hiring expense, corporate communications, leased equipment expenses, office supplies and other miscellaneous expenses. These expenses have generally increased incrementally because we are adding infrastructure to support our growth and diversification into other sub-prime products and services complementary to our traditional credit card activities. Our cardholder fraud expense includes the expense of unauthorized use of the credit cards, including identity theft and purchases on lost or stolen cards. To date, we have experienced very little fraud for unauthorized use, and the total expense has approximated 0.03% of our average managed receivables in any given year.

Minority Interest

        The 37.5% ownership interest of the Merrill Lynch affiliate in Embarcadero is reflected as a minority interest in the operating results. The $6.3 million recorded in 2004 reflects Merrill Lynch's portion of the Embarcadero results of operations. Prior to the third quarter of 2003, we did not have any minority interest.

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Income Taxes

        Our effective tax rate was 37.5% for 2004 and 36.0% for 2003. The increase was due to certain of our operations now being subject to various state income taxes, as well as an increase in our non-deductible expenses.

Selected Credit Card Data

        As noted above, our securitizations are treated as sales under GAAP. As such, we remove the securitized receivables from our consolidated balance sheet. The performance of the underlying credit card receivables will nevertheless affect the future cash flows we actually receive.

        Various references within this report are to the managed credit card receivables underlying our off balance sheet securitization facilities. Performance metrics and data based on these managed receivables are key to any evaluation of our performance in managing (including underwriting, valuing purchased receivables, servicing and collecting) the portfolios of receivables underlying our securitization facilities. Indeed, management allocates our resources and manages our business using financial data and results prepared on a so-called "managed basis." It is also important to analysts, investors and others that we provide selected metrics and data on a managed basis because this allows a comparison of CompuCredit to others within the specialty finance industry. Moreover, our management, analysts, investors and others believe it is critical that they understand the credit performance of the entire portfolio of our managed credit card receivables because it reveals information concerning the quality of loan originations and the related credit risks inherent within the securitized portfolios and our retained interests in our securitization facilities.

        Managed receivables data assumes that none of the credit card receivables underlying our off balance sheet securitization facilities were ever transferred to securitization facilities and presents the net credit losses and delinquent balances on the receivables as if we had still owned the receivables. Reconciliation of the managed receivables data to our GAAP financial statements requires recognition that substantially all of our credit card receivables had been sold in securitization transactions as of March 31, 2004 (i.e., all but $59.1 million of our originated credit card receivables as of March 31, 2004); this reconciliation requires the removal of all but $59.1 million of the managed receivables data from our books and records to yield only the $59.1 million of originated credit card receivables and associated statistics under GAAP, coupled with the recording under GAAP of our retained interests in various securitization structures.

        The information in the following tables is presented to reflect the credit card receivables, or portions thereof, in which we have an economic interest—that is, the receivables underlying our interest in Company-arranged securitizations (e.g., 100% of the credit card receivables of the originated portfolio master trust and 62.5% of the credit card receivables underlying the Embarcadero Trust, which reflects our ownership percentage in Embarcadero), the credit card receivables associated with retained interests that we have acquired (e.g., from Federated in 2002), 50% of the credit card receivables underlying the CSG Trust (which reflects our ownership percentage in CSG) and the $59.1 million of originated receivables associated with our largely fee-based card offering to consumers at the lower end of the FICO scoring system which have not been securitized—together, our "managed receivables" as discussed above. For example, we have included 50% of the managed receivables underlying the CSG Trust because we have a 50% economic interest in CSG, which owns the retained interest in the CSG Trust. CSG's cash flows and income are dependent on how the receivables in the CSG Trust perform, and therefore, our cash flows and income (other than with respect to our servicing fee, which we earn with respect to 100% of the receivables underlying the CSG Trust) are dependent upon 50% of the managed receivables.

        We provide the selected credit card data included within this section so that readers can evaluate our performance as a servicer with respect to the portfolios of credit card receivables that we manage.

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As noted above, performance metrics and data based on these managed receivables are key to any evaluation of our performance in managing (including underwriting, valuing purchased receivables, servicing and collecting) the portfolios of receivables underlying our off balance sheet securitization facilities, as well as to any comparison of our Company to others within the specialty finance industry.

        The period-end and average managed receivables data (as well as delinquency and charge-off statistics) that follow within this section exclude the receivables associated with all accounts in late delinquency status in sellers' hands as of the dates of our acquisitions of the receivables or interests therein. Pursuant to this treatment, the only activity within the following statistical data associated with these excluded accounts are recoveries, which we include within the numerator of the other income ratio computation, as well as the costs of pursuing these recoveries, which we include within the numerator of the operating ratio computation. Also, because acquisition prices for previously charged off credit card receivables range from less than a penny to just a few pennies to the dollar of face amount of the receivables, we exclude from the period-end and average managed receivables data the face amount of the previously charged off credit card receivables that our subsidiary, Jefferson Capital, acquires. The recovery income from Jefferson Capital's recovery operations (like that of our excluded late-delinquency-stage receivables at acquisition) has been included within the numerator of the other income ratio computation. Likewise, the costs associated with pursuing these recoveries are included within the numerator of the operating ratio computation. For a more detailed discussion of the rationale for both of these exclusions from our managed receivables data, see the "Selected Credit Card Data" section within Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2003.

        The following are definitions related to the table above:

•

Net interest margin represents an annualized fraction, the numerator of which includes all accrued finance charge and late fee income billed on all outstanding receivables, plus amortization of the accretable yield component of our acquisition discounts for portfolio purchases (discussed below), less interest expense as well as accrued finance charge and fee charge offs, and the denominator of which is average managed receivables;



•

Other income ratio represents an annualized fraction, the numerator of which includes other credit card fees billed, such as over-limit fees, cash advance fees, maintenance fees, miscellaneous fees, interchange income, ancillary product income, and recoveries of acquired defaulted receivables, and the denominator of which is average managed receivables; and



•

Operating ratio represents an annualized fraction, the numerator of which includes all expenses associated with our business, net of any servicing income we receive as servicer for the CSG Trust and the Embarcadero Trust, other than marketing and solicitation and ancillary product expenses, and the denominator of which is average managed receivables.

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        Our net interest margins are influenced by a number of factors, including (1) the level of accrued finance charges and late fees billed, (2) the weighted average cost of funds within our securitization structures, (3) amortization of the accretable yield component of our acquisition discounts for portfolio purchases and (4) the level of our accrued finance charge and fee charge offs. Factors contributing to the expected decline in the net interest margin during the first quarter of 2004 as compared to the fourth quarter of 2003 included:

•

lower accrued finance charges and late fees on the managed receivables within each of our portfolios, due in part to significantly improved delinquency trends for the receivables which tend to diminish late fee charges; and



•

higher finance charge and fee charge offs, corresponding principally with the expected seasoning of the acquired receivables that we securitized into the Embarcadero Trust during the third quarter of 2003, which is to say that the accounts that were not excluded at the time of acquisition have now aged into later delinquency buckets and have begun to charge off. (For further details underlying this phenomenon, we refer readers to our Annual Report on Form 10-K for the year ended December 31, 2003.)

        On a routine basis, generally no less frequently than quarterly, we re-underwrite our portfolio to price our products to appropriately reflect the level of each customer's credit risk. As part of this underwriting process, existing customers may be offered increased or decreased pricing depending on their credit risk, as well as their supply of and demand for credit. Increases in pricing may increase our net interest margin, while decreases in pricing may reduce our net interest margin.

        Now that the Embarcadero acquisition has seasoned during its immediate post-acquisition period, we anticipate greater stability in our net interest margin during the remainder of 2004, with perhaps some improvements based on repricing and the effects of expected account additions within the originated portfolio master trust.

        The other income ratio increased during the first quarter of 2004 relative to the fourth quarter of 2004 due to:

•

higher fee income associated with our credit card product offering to consumers at the lower end of the FICO scoring system;



•

new fees associated with our debit card product offering which we rolled out during the first quarter of 2004; and



•

higher income from our previously charged off credit card receivable recovery operations.

        This increase was partially offset, however, by:

•

a decrease in ancillary product revenue given that we have not yet begun to see the positive effects on ancillary product revenue of our renewed growth in accounts and receivables underlying the originated portfolio master trust; and



•

lower fees (principally overlimit and interchange) from our managed receivables within the originated portfolio master trust and the CSG Trust.

        We also saw a higher operating ratio in the first quarter of 2004 based on the investments we are making in pursuing other complementary sub-prime financial service-related activities and products. With our planned growth in receivables within the originated portfolio master trust and our planned expansion into other complementary sub-prime financial service-related activities and products during the remainder of 2004 and beyond, we expect increases in both our other income ratio and our operating ratio. These respective ratios should rise as our focus on these other complementary products and activities (e.g., our stored value or debit card offering) is not expected to produce a corresponding increase in our average managed receivables denominator used in these ratio calculations. Finally, with

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new account additions, we should see an increase in ancillary product revenues as a component of our other income ratio.

Asset Quality

        Our delinquency and charge off data at any point in time reflects the credit performance of our managed receivables. The average age of our credit card accounts, the timing of portfolio purchases, the success of our collection and recovery efforts and general economic conditions all affect our delinquency and charge off rates. The average age of our credit card account portfolio also affects the stability of our delinquency and loss rates.

        Our strategy for managing delinquency and receivables losses consists of account management throughout the customer relationship. This strategy includes credit line management and pricing based on the risk of the credit card accounts. See also our discussion of collection strategies under the heading "How Do We Collect From Our Customers?" in Item I of our Annual Report on Form 10-K for the year ended December 31, 2003.

        The discussion below focuses on the change in our delinquency and charge off data as of and for the three months ended March 31, 2004.

        Delinquencies.    Delinquencies have the potential to impact net income in the form of net credit losses. Delinquencies are also costly in terms of the personnel and resources dedicated to resolving them. A credit card account is contractually delinquent if the minimum payment is not received by the specified date on the customer's statement. It is our policy to continue to accrue interest and fee income on all credit card accounts, except in limited circumstances, until the account and all related receivables, interest and other fees are charged off. See the "Charge offs" discussion as well.

        The account management strategies that we use on our portfolio are intended to manage and, to the extent possible, reduce the higher delinquency rates that can be expected in a more mature managed portfolio such as ours. Examples of management strategies include conservative credit line management, purging of inactive accounts and collection strategies (described under the heading "How Do We Collect From Our Customers?" in Item I of our Annual Report on Form 10-K for the year ended December 31, 2003) intended to optimize the effective account-to-collector ratio across delinquency buckets. We measure the success of these efforts by measuring delinquency rates. These rates exclude accounts that have been charged off.

        The following table presents the delinquency trends of our credit card receivables on a managed receivables portfolio basis: