Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
Amendment No. 2
x
|
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
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|
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For
the quarterly period ended August 31, 2009
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|
OR
|
|
|
o
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TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
|
For the
transition period
from to
Commission File Number 0-22972
CLST HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
Delaware
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75-2479727
|
(State or other
jurisdiction of
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(I.R.S. Employer
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incorporation or
organization)
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Identification
No.)
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17304
Preston Road, Dominion Plaza, Suite 420
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Dallas,
Texas
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75252
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(Address of
principal executive offices)
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(Zip Code)
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(972) 267-0500
(Registrants telephone number, including area code)
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 (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes
o
No
x
Indicate by check mark
whether the registrant has submitted electronically and posted on its corporate
Web site, if any, every Interactive Data File required to be submitted and
posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter)
during the preceding 12 months (or for such shorter period that the registrant
was required to submit and post such files). * Yes
o
No
o
* The registrant is not
subject to the requirements of Rule 405 of Regulation S-T at this time.
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definitions of large accelerated filer, accelerated filer, and smaller
reporting company in Rule 12b-2 of the Exchange Act.
Large accelerated filer
o
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|
Accelerated filer
o
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Non-accelerated filer
o
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Smaller reporting company
x
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(Do not check if a smaller
reporting company)
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|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2
of the Exchange Act.). Yes
o
No
x
On October 14,
2009, there were 23,949,282
outstanding
shares of common stock, $0.01 par value per share.
Table of Contents
EXPLANATORY
NOTE
We are filing this Amendment No. 2 on Form 10-Q/A
(
Form 10-Q/A
)
to our Quarterly Report on Form 10-Q for the quarterly period ended August 31,
2009 originally filed with the Securities and Exchange Commission (the
SEC
) on October 15, 2009 (the
Original Form 10-Q
),
as amended by Amendment No. 1 on Form 10-Q/A filed with the SEC on November 5,
2009, in response to comments we have received from the SEC. For convenience, we have repeated the
Original Form 10-Q in its entirety.
This amendment does not reflect events occurring after
the filing of the Original Form 10-Q, and does not modify or update the
disclosures therein in any way other than as required to reflect the matters
described above.
CLST HOLDINGS, INC.
INDEX TO
FORM 10-Q/A
2
Table of Contents
PART IFINANCIAL INFORMATION
Item 1. Financial Statements
CLST HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
|
|
August 31,
|
|
November 30,
|
|
|
|
2009
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|
2008
|
|
ASSETS
|
|
|
|
|
|
Current assets:
|
|
|
|
|
|
Cash and cash
equivalents
|
|
$
|
5,670
|
|
$
|
9,754
|
|
Notes receivable, net -
current
|
|
7,653
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|
8,698
|
|
Accounts receivable -
other
|
|
815
|
|
893
|
|
Prepaid expenses and
other current assets
|
|
168
|
|
177
|
|
Total current assets
|
|
14,306
|
|
19,522
|
|
Notes receivable, net -
long-term
|
|
34,940
|
|
31,547
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|
Property and equipment,
net
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8
|
|
12
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|
Deferred income taxes
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|
4,786
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|
4,786
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|
Other assets
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|
966
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|
863
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|
|
|
$
|
55,006
|
|
$
|
56,730
|
|
|
|
|
|
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|
LIABILITIES
AND STOCKHOLDERS EQUITY
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
Loan payable - current
|
|
$
|
7,330
|
|
$
|
7,436
|
|
Notes payable - related
parties
|
|
365
|
|
|
|
Accounts payable
|
|
14,354
|
|
14,512
|
|
Income taxes payable
|
|
82
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|
207
|
|
Accrued expenses
|
|
567
|
|
473
|
|
Total current
liabilities
|
|
22,698
|
|
22,628
|
|
|
|
|
|
|
|
Loans payable - long
term
|
|
26,588
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|
26,902
|
|
Notes payable - related
parties
|
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311
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|
|
|
Total liabilities
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49,597
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49,530
|
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|
|
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Commitments and
contingencies
|
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|
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Stockholders equity:
|
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|
|
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Preferred stock, $.01
par value, 5,000,000 shares authorized; none issued
|
|
|
|
|
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Common stock, $.01 par
value, 200,000,000 shares authorized; 24,583,306 and 21,187,229
shares issued, respectively, and 23,949,282 and 20,553,205 shares
outstanding, respectively
|
|
246
|
|
212
|
|
Additional paid-in
capital
|
|
126,999
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|
126,034
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|
Accumulated other
comprehensive incomeforeign currency translation adjustments
|
|
217
|
|
217
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|
Accumulated deficit
|
|
(120,406
|
)
|
(117,616
|
)
|
|
|
7,056
|
|
8,847
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|
Less: Treasury stock
(634,024 shares at cost)
|
|
(1,647
|
)
|
(1,647
|
)
|
|
|
5,409
|
|
7,200
|
|
|
|
$
|
55,006
|
|
$
|
56,730
|
|
See accompanying notes to unaudited consolidated financial statements.
3
Table of Contents
CLST HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Three and nine months ended August 31, 2009 and 2008
(unaudited)
(In thousands, except per share data)
|
|
Three
months ended
|
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Nine
months ended
|
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August 31,
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August 31,
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2009
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2008
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2009
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2008
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|
Revenues:
|
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|
|
|
|
|
|
|
|
Interest income
|
|
$
|
1,655
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|
$
|
|
|
$
|
4,830
|
|
$
|
|
|
Other
|
|
102
|
|
|
|
335
|
|
|
|
Total revenues
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|
1,757
|
|
|
|
5,165
|
|
|
|
|
|
|
|
|
|
|
|
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Loan servicing fees
|
|
231
|
|
|
|
613
|
|
|
|
Trust administrative
fees
|
|
4
|
|
|
|
8
|
|
|
|
Provision for doubtful
accounts
|
|
654
|
|
|
|
1,957
|
|
|
|
Interest expense
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|
508
|
|
|
|
1,590
|
|
|
|
General and
administrative expenses
|
|
1,517
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|
433
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|
3,780
|
|
1,402
|
|
Operating loss
|
|
(1,157
|
)
|
(433
|
)
|
(2,783
|
)
|
(1,402
|
)
|
|
|
|
|
|
|
|
|
|
|
Other income (expense):
|
|
|
|
|
|
|
|
|
|
Other, net
|
|
1
|
|
110
|
|
10
|
|
331
|
|
Total other income
|
|
1
|
|
110
|
|
10
|
|
331
|
|
Loss from continuing
operations before income taxes
|
|
(1,156
|
)
|
(323
|
)
|
(2,773
|
)
|
(1,071
|
)
|
Income tax expense
(benefit)
|
|
9
|
|
|
|
17
|
|
(5
|
)
|
Loss from continuing
operations, net of taxes
|
|
(1,165
|
)
|
(323
|
)
|
(2,790
|
)
|
(1,066
|
)
|
Discontinued
operations, net of taxes of $5 for 2008
|
|
|
|
|
|
|
|
10
|
|
Net loss
|
|
$
|
(1,165
|
)
|
$
|
(323
|
)
|
$
|
(2,790
|
)
|
$
|
(1,056
|
)
|
Net loss per share:
|
|
|
|
|
|
|
|
|
|
Basic and diluted:
|
|
|
|
|
|
|
|
|
|
Loss from continuing
operations, net of taxes
|
|
$
|
(0.05
|
)
|
$
|
(0.02
|
)
|
$
|
(0.12
|
)
|
$
|
(0.05
|
)
|
Discontinued
operations, net of taxes
|
|
|
|
|
|
|
|
|
|
Net loss per share
|
|
$
|
(0.05
|
)
|
$
|
(0.02
|
)
|
$
|
(0.12
|
)
|
$
|
(0.05
|
)
|
|
|
|
|
|
|
|
|
|
|
Weighted average number
of shares:
|
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
23,349
|
|
20,553
|
|
22,662
|
|
20,553
|
|
See accompanying notes to unaudited consolidated financial statements.
4
Table of Contents
CLST HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY AND
COMPREHENSIVE INCOME
Nine months ended August 31, 2009 and 2008
(Unaudited)
(In thousands)
|
|
Common Stock
|
|
Treasury Stock
|
|
Additional
|
|
Accumulated
other
comprehensive
|
|
Accumulated
|
|
|
|
|
|
Shares
|
|
Amount
|
|
Shares
|
|
Amount
|
|
paid-in capital
|
|
income
|
|
deficit
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at November 30,
2008
|
|
21,187
|
|
$
|
212
|
|
(634
|
)
|
$
|
(1,647
|
)
|
$
|
126,034
|
|
$
|
217
|
|
$
|
(117,616
|
)
|
$
|
7,200
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive loss:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2,790
|
)
|
(2,790
|
)
|
Total comprehensive loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2,790
|
)
|
Grant of restricted
stock
|
|
1,200
|
|
12
|
|
|
|
|
|
(12
|
)
|
|
|
|
|
|
|
Cancellation of
restricted stock
|
|
(300
|
)
|
(3
|
)
|
|
|
|
|
3
|
|
|
|
|
|
|
|
Amortization of
restricted stock
|
|
|
|
|
|
|
|
|
|
100
|
|
|
|
|
|
100
|
|
Stock issuance for notes
receivable
|
|
2,496
|
|
25
|
|
|
|
|
|
874
|
|
|
|
|
|
899
|
|
Balance at
August 31, 2009
|
|
24,583
|
|
$
|
246
|
|
(634
|
)
|
$
|
(1,647
|
)
|
$
|
126,999
|
|
$
|
217
|
|
$
|
(120,406
|
)
|
$
|
5,409
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at November
30, 2007
|
|
21,187
|
|
$
|
212
|
|
(634
|
)
|
$
|
(1,647
|
)
|
$
|
126,034
|
|
$
|
217
|
|
$
|
(115,953
|
)
|
$
|
8,863
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive loss:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,056
|
)
|
(1,056
|
)
|
Total comprehensive loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,056
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at
August 31, 2008
|
|
21,187
|
|
$
|
212
|
|
(634
|
)
|
$
|
(1,647
|
)
|
$
|
126,034
|
|
$
|
217
|
|
$
|
(117,009
|
)
|
$
|
7,807
|
|
See accompanying notes to unaudited consolidated financial statements.
5
Table of Contents
CLST HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine months ended August 31, 2009 and 2008
(Unaudited)
(In thousands)
|
|
2009
|
|
2008
|
|
|
|
|
|
|
|
Cash flows from
operating activities:
|
|
|
|
|
|
Net loss
|
|
$
|
(2,790
|
)
|
$
|
(1,056
|
)
|
Adjustments to
reconcile net loss to net cash provided by (used in) operating activities:
|
|
|
|
|
|
Stock based
compensation
|
|
100
|
|
|
|
Provision for doubtful
accounts
|
|
1,957
|
|
|
|
Depreciation
|
|
4
|
|
1
|
|
Non-cash interest
expense
|
|
81
|
|
|
|
Amortization of notes
receivable acquisition costs
|
|
81
|
|
|
|
Changes in operating
assets and liabilities:
|
|
|
|
|
|
Accounts receivable -
other
|
|
(258
|
)
|
5,309
|
|
Prepaid expenses and
other current assets
|
|
9
|
|
346
|
|
Other assets
|
|
(185
|
)
|
373
|
|
Accounts payable
|
|
(158
|
)
|
(32
|
)
|
Income taxes payable
|
|
(125
|
)
|
|
|
Accrued expenses
|
|
94
|
|
(581
|
)
|
Net cash provided by
(used in) operating activities
|
|
(1,190
|
)
|
4,360
|
|
|
|
|
|
|
|
Cash flows from
investing activities:
|
|
|
|
|
|
Purchases of property
and equipment
|
|
|
|
(10
|
)
|
Notes receivable
collections
|
|
8,137
|
|
|
|
Acquisition of notes
receivable
|
|
(4,028
|
)
|
|
|
Additions to notes
receivable acquisition costs
|
|
(155
|
)
|
|
|
Net cash provided by
(used in) investing activities
|
|
3,954
|
|
(10
|
)
|
|
|
|
|
|
|
Cash flows from
financing activities:
|
|
|
|
|
|
Payments on notes
payable
|
|
(6,848
|
)
|
|
|
Net cash used in
financing activities
|
|
(6,848
|
)
|
|
|
|
|
|
|
|
|
Net increase (decrease)
in cash and cash equivalents
|
|
(4,084
|
)
|
4,350
|
|
Cash and cash
equivalents at beginning of period
|
|
9,754
|
|
11,799
|
|
Cash and cash
equivalents at end of period
|
|
$
|
5,670
|
|
$
|
16,149
|
|
|
|
|
|
|
|
Non-Cash Investing and
Financing Activities:
|
|
|
|
|
|
Acquisition of notes
receivable for common stock
|
|
$
|
899
|
|
$
|
|
|
Acquisition of notes
receivable for debt
|
|
$
|
7,273
|
|
$
|
|
|
Acquisition of notes
receivable for accounts receivable, other
|
|
$
|
336
|
|
$
|
|
|
Returned notes
receivable in exchange for reduction of debt
|
|
$
|
170
|
|
$
|
|
|
See accompanying notes to unaudited consolidated financial statements.
6
Table of Contents
CLST HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(1) Summary
of Significant Accounting Policies
(a)
Basis for Presentation
Although the interim
consolidated financial statements of CLST Holdings, Inc., formerly
CellStar Corporation, and subsidiaries (the
Company
)
are unaudited, Company management is of the opinion that all adjustments
(consisting of only normal recurring adjustments) necessary for a fair
presentation of the results have been reflected therein. Net income (loss) for
any interim period is not necessarily indicative of results that may be
expected for any other interim period or for the entire year.
On November 10,
2008, we purchased all of the outstanding equity interests of FCC Investment
Trust I (
Trust I
), and on December 12,
2008 we purchased
certain receivables, installment sales contracts and
related assets owned by
SSPE
Investment Trust I (
SSPE Trust
)
and SSPE, LLC (
SSPE
). On February 13,
2009, we purchased assets owned by Fair Finance Company, an Ohio corporation (
Fair
), James F. Cochran,
Chairman and Director of Fair, and by Timothy S. Durham, Chief Executive
Officer and Director of Fair and an officer, director and stockholder of our
Company. Messrs. Durham and Cochran own all of the outstanding equity of
Fair. The Board of Directors (the
Board
)
believes that each of these acquisitions will be a better investment return for
our stockholders when compared to the recent changes to interest rates and
other investment alternatives. Although we are now engaged in the business of
holding and collecting consumer notes receivable, we have not abandoned our
plan of dissolution. We believe that should we decide that continuing with the
plan of dissolution is in the best interest of our stockholders, we will be
able to dispose of these assets, if properly marketed, within the timeframe
necessary to complete the winding down of the Company prior to final
dissolution of the Company.
The Company has reclassified to discontinued
operations, for all periods presented, the results and related charges for the
North American and Latin American Regions. (See footnote 2.)
(b)
Notes
Receivable
Notes receivable
are recorded at the historical cost paid at the date of acquisition net of any
purchase discounts. Subsequent to the date of acquisition, notes receivable are
reduced by any principal payments made by the customer. Purchase discounts are
recorded based on the negotiated difference between the face value and the
amount paid for the notes receivable. Purchase discounts are recognized as
revenue, using the effective interest method, as principal payments are
collected.
The Company
establishes an allowance for doubtful accounts for receivables where the
customer has not made a payment for the most recent 120 day period. The Company specifically analyzes notes
receivable using historical activity, current economic trends, changes in its
customer payment terms, recoveries of previously reserved notes and collection
trends when evaluating the adequacy of its allowance for doubtful accounts. Any
change in the assumptions used in analyzing a specific note receivable may
result in an additional allowance for doubtful accounts being recognized in the
period in which the change occurs. The
Company may from time to time make additional increases to the allowance based
on the foregoing factors. Once a note receivable has been reserved due to
nonpayment, the Company will no longer accrue, for financial reporting
purposes, interest earned on the note receivable. Should the note receivable
return to a performing status, then the Company will resume accruing interest
on the note receivable. The majority of the notes receivable have collateral in
various forms, which may include a second lien position on the borrowers home
or property. Actual results could differ
from those estimates. Recoveries are recorded against the allowance when
payments are received. Recoveries of notes
receivable, which were previously charged off, are recorded to income when
payments are received. Notes receivable are charged off against the allowance
after all means of collection have been exhausted and a legal determination has
been rendered that less than the full amount of the note receivable will be
collected.
7
Table of Contents
The
following table details the activity in the allowance for doubtful accounts for
the three months ended August 31, 2009 and the nine months ended August 31,
2009:
|
|
Three
Months
ended
August 31,
2009
|
|
Nine
Months
ended
August 31,
2009
|
|
|
|
|
|
|
|
Beginning balance
|
|
$
|
1,447,000
|
|
$
|
144,000
|
|
Additions to allow for doubtful accounts
|
|
654,000
|
|
1,957,000
|
|
Recoveries
|
|
|
|
|
|
Charge offs
|
|
|
|
|
|
|
|
|
|
|
|
Ending balance
|
|
$
|
2,101,000
|
|
$
|
2,101,000
|
|
(c) Revenue Recognition
Revenues consist of
interest earned, late fees and other miscellaneous charges. Revenues are not
accrued on accounts over 120 days without payment activity, unless payment
activity resumes.
(d) Deferred Costs
We have recorded
acquisition costs related to the purchase of certain notes receivables and
deferred loan costs associated with certain Company obligations. The
acquisition costs are amortized over the remaining principal balance of the
notes receivable and are recorded as contra revenue. The deferred loan costs
are amortized over the remaining outstanding balance of the Company obligation
and are recorded in operating interest expense. Any impact of prepayment of the
balances by either the Company or our customers would be recognized in the
period of prepayment.
(2) Discontinued
Operations
During fiscal year
2007 we sold all of our U.S. operations, including our Miami-based Latin
American operations, Mexico operations and Chile operations. For more
information on these transactions, please see the Companys Annual Report on Form 10-K/A
for the fiscal year ended November 30, 2008.
The results of
discontinued operations for U.S., Miami, Mexico and Chile for the three and
nine months ended August 31, 2009 and 2008 are as follows (in thousands):
|
|
Three months ended
|
|
Nine months ended
|
|
|
|
August 31,
|
|
August 31,
|
|
|
|
2009
|
|
2008
|
|
2009
|
|
2008
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
|
|
$
|
|
|
$
|
|
|
$
|
|
|
Cost of sales
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
|
|
|
|
|
|
|
Selling, general and
administrative expenses
|
|
|
|
|
|
|
|
|
|
Operating income (loss)
|
|
|
|
|
|
|
|
|
|
Other income (expense):
|
|
|
|
|
|
|
|
|
|
Interest expense
|
|
|
|
|
|
|
|
|
|
Loss on sale of
accounts receivable
|
|
|
|
|
|
|
|
|
|
Minority interest
|
|
|
|
|
|
|
|
|
|
Gain on transactions
|
|
|
|
|
|
|
|
|
|
Other, net
|
|
|
|
|
|
|
|
15
|
|
Total other income
|
|
|
|
|
|
|
|
15
|
|
|
|
|
|
|
|
|
|
|
|
Income before income
taxes
|
|
|
|
|
|
|
|
15
|
|
|
|
|
|
|
|
|
|
|
|
Provision for income
taxes
|
|
|
|
|
|
|
|
5
|
|
|
|
|
|
|
|
|
|
|
|
Total discontinued
operations
|
|
$
|
|
|
$
|
|
|
$
|
|
|
$
|
10
|
|
8
Table of Contents
(3) Stock-Based
Compensation
On December 1,
2008, our Board approved the Companys 2008 Long Term Incentive Plan. Effective
September 11, 2009, the Board amended and restated the 2008 Long Term
Incentive Plan to decrease the number of shares of common stock of the Company
that may be issued under the 2008 Long Term Incentive Plan from 20,000,000 to
2,000,000. The following is a brief description of the material terms of the
2008 Long Term Incentive Plan:
·
The plan is administered by the Board of the Company.
·
The plan permits the grant of restricted stock, stock
options and other stock-based awards to employees, officers, directors,
consultants and advisors of the Company and its subsidiaries.
·
The aggregate number of shares of Common Stock of the
Company that may be issued under the plan is 2,000,000 shares.
·
The plan provides that the administrator of the plan
may determine the terms and conditions applicable to each award and each award
will be evidenced by a stock option agreement or restricted stock agreement.
·
The plan will terminate on December 1, 2018.
In addition, on December 1,
2008 the Board approved the grant of 300,000 shares of restricted stock to each
of Timothy S. Durham, Robert A. Kaiser and Manoj Rajegowda. On February 24,
2009, Mr. Rajegowda forfeited all stock issuances provided to him during
the course of his Board membership in connection with his resignation from the
Board. On
March 5, 2009, our Board approved the grant of 300,000 shares of
restricted stock to David Tornek, our director who was appointed to fill the
vacancy on the Board
.
Of each restricted stock grant, 100,000
shares vested on the date of grant and the remaining 200,000 of the shares vest
in two equal annual installments on each anniversary of the date of grant. The
restricted stock grants will be evidenced by restricted stock agreements to be
approved by the Board. The total value of the awards using a grant date price
of $0.22 per share for 600,000 shares and $0.16 per share for 300,000 shares is
$180,000 and will be expensed over the vesting period.
For the three and
nine months ended August 31, 2009, the Company recognized $14,000 and
$100,000, respectively, of expense related to the restricted stock grants.
(4) Acquisition
of new business
(a)
CLST Asset I
On November 10, 2008, we, through CLST Asset I,
LLC (
CLST Asset I
), a wholly
owned subsidiary of CLST Financo, Inc. (
Financo
), which is one of our direct, wholly owned
subsidiaries, entered into a purchase agreement to acquire all of the
outstanding equity interests of Trust I from a third party for approximately
$41.0 million (the
Trust I
Purchase Agreement
). Our
Board unanimously approved the transaction. Our acquisition of Trust I was
financed by approximately $6.1 million of cash on hand and by a non-recourse,
term loan of approximately $34.9 million by an affiliate of the seller of Trust I, pursuant to the terms and
conditions set forth in the credit agreement, dated November 10, 2008,
among Trust I, Fortress Credit Co LLC, as lender (
Fortress
),
FCC Finance, LLC (
FCC
), as the initial
servicer, the backup servicer, and the collateral custodian (the
Trust I
Credit Agreement
). The Company is now responsible for the
collection of the receivables included in the trust through its wholly owned
subsidiary Financo.
The
repayment terms on the accounts are standardized, but are dependent on the form
of agreement used by the originator.
Customers are required to make monthly payments until the loans are paid
in full. At the time of purchase of the CLST Asset I portfolio, the remaining
time to maturity was in a range of 8-10 years, not including prepayments, if
any.
Financo has
historically conducted our financing business, including ownership of receivables
generated by our businesses and providing internal financing to our other
operating subsidiaries. Substantially all of the assets acquired by Trust I
consisted of a portfolio of home improvement consumer receivables, some of
which are collateralized or otherwise secured by interests in real estate. We
are engaging in the business of holding and collecting the receivables with the
intention of generating a higher rate of return on our assets than we currently
receive on our cash and cash equivalents balances. At the same time, we will
continue to review the relative benefits to our stockholders of continuing to
wind down our business pursuant to our plan of dissolution or continuing to do
9
Table of Contents
business in one or more
of our historic lines of business or related businesses or in a new line of
business. Although we are now
engaged in the business of holding and collecting
consumer notes receivable, we have not abandoned our plan of dissolution. We
believe that should we decide that continuing with the plan of dissolution is
in the best interest of our stockholders, we will be able to dispose of Trust
I, if properly marketed, whether through the use of reputable brokers or
investment bankers, through an auction process or other strategies for
maximizing proceeds from an asset disposition, within the timeframe necessary
to complete the winding down of the Company prior to final dissolution of the
Company.
The cut-off date
for the receivables acquired was October 31, 2008, with all collections
subsequent to that date inuring to our benefit. As of October 31, 2008,
the portfolio consisted of approximately 6,000 accounts with an aggregate
outstanding balance of approximately $41.5 million and an average outstanding
balance per account of approximately $6,900. These loans are all home
improvement, repair and other home related loans to homeowners of which
approximately 63% were secured with a second lien on the property, with the
remainder being unsecured. Approximately
89% of the loans are in the Northeast with the remainder in Texas, Georgia and
Missouri. As of October 31, 2008,
the weighted average interest rate of the portfolio was 14.4%. We have the
right to require the seller to repurchase any accounts, for the original
purchase price applicable to such account, that do not satisfy certain
specified eligibility requirements set out in the Trust I Purchase Agreement as
of the October 31, 2008 cut-off date. If it is discovered by a party that
a receivable account was not an Eligible Receivable as of the cut-off date of
October 31, 2008, the seller is required to repurchase such receivable
account unless such breach is remedied within thirty business days of notice of
such breach. An account is not an Eligible Receivable if, as of October 31,
2008, such receivable account is, among other things, a defaulted receivable,
subject to litigation, dispute or rights of rescission, setoff or counterclaim,
or is not subject to a duly recorded and perfected lien, the seller must
repurchase the account. For the quarterly period ended August 31, 2009,
there had not been a determination that any receivables failed to meet the
eligibility requirements set out in the Trust I Purchase Agreement.
When we purchased Trust I, the historical default rate for the previous
three years for the portfolio was approximately 4%, which was the basis for
assessing the creditworthiness of the assets included in CLST Asset I. During the third quarter of 2009, we have
seen the default rate increase to the 6-7% range; accordingly, we have been
increasing our allowances to reflect this change.
The Trust I Credit
Agreement provides for a non-recourse, term loan of approximately $34.9
million, maturing on November 10, 2013. The term loan bears interest at an
annual rate of 5.0% over the LIBOR Rate (as defined in the Trust I Credit
Agreement). The obligations under the Trust I Credit Agreement are secured by a
first priority security interest in substantially all of the assets of Trust I,
including portfolio collections.
The Trust I Credit
Agreement provides the material terms and conditions for the services to be
performed by the servicer. In return, Trust I pays the servicer a monthly
servicing fee equal to 1.5%, per annum of the then aggregate outstanding
principal balance of the receivables.
Portfolio
collections are distributed on a monthly basis. Absent an event of default,
after payment of the servicing fee and other fees and expenses due under the
Trust I Credit Agreement and the required principal and interest payments to
the lender under the Trust I Credit Agreement, all remaining amounts from
portfolio collections are paid to Trust I and are available for distribution to
CLST Asset I and subsequently to Financo.
Principal payments
on the term loan are due monthly to the extent that the aggregate principal
amount of the term loan outstanding exceeds the sum of (a) the sum for
each outstanding receivable of the product of (1) 85%, (2) the
then-current aggregate unpaid principal balance of such receivable and (3) a
percentage specified in the Trust I Credit Agreement based upon the aging of
such receivable, and (b) amounts on deposit in the collection account for
the receivables net of any accrued and unpaid interest on the loan and fees due
to the servicer, the backup servicer, the collateral custodian and the owner
trustee (the
Maximum Advance Amount
).
Principal payments are also due within
five business days of any time that the aggregate principal amount of the term
loan outstanding exceeds the Maximum Advance Amount. The remaining outstanding
principal amount of the loan plus all accrued interest, fees and expenses are
due on the maturity date. Interest payments on the term loan are due monthly.
The Trust I Credit
Agreement contains customary covenants for facilities of its type, including
among other things covenants that restrict Trust Is ability to incur
indebtedness, grant liens, dispose of property, pay dividends, make certain
acquisitions or to take actions that would negatively affect Trust Is special
purpose vehicle status. Generally, these covenants do not impact the activities
that may be undertaken by the Company. The Trust I Credit Agreement contains
various events of default, including failure to pay principal and interest when
due, breach of covenants, materially incorrect representations, default under
certain other agreements of Trust I, bankruptcy or insolvency of Trust I, the
occurrence of an event which causes a material adverse effect on Trust I, the
occurrence of certain defaults by the servicer, entry of certain material
judgments against Trust I, and the occurrence of a change of control or certain
material events and the issuance of a qualified audit opinion with respect to
Trust Is financials.
10
Table of Contents
In addition, an
event of default occurs if the three-month rolling average delinquent accounts
rate exceeds 10.0% or the three-month rolling average annualized default rate
exceeds 7.0%. If an event of default occurs, all of Trust Is obligations under
the Trust I Credit Agreement could be accelerated by the lender, causing the
entire remaining outstanding principal balance plus accrued and unpaid interest
and fees to be declared immediately due and payable.
The purchase price
of $41 million consisted of the following:
·
cash paid to the sellers in the amount of $6.1
million; and
·
debt financing of $34.9 million.
The
following unaudited pro forma information presents for the three and nine
months ended August 31, 2008, combined results of operations of Trust I and the Company as if the
acquisition had occurred on December 1, 2007. The unaudited pro forma results are for
informational purposes and are not necessarily indicative of results that would
have occurred had the acquisition been in effect for the periods presented, nor
are they necessarily indicative of future results. The unaudited proforma information was
prepared from the historical financial information of Trust I and the Company.
(unaudited, in thousands, except per
share data)
|
|
Pro
forma
|
|
|
|
Three
months
|
|
Nine
months
|
|
|
|
ended
|
|
ended
|
|
|
|
August 31,
|
|
August 31,
|
|
|
|
2008
|
|
2008
|
|
|
|
|
|
|
|
Revenues
|
|
|
|
|
|
Interest income
|
|
$
|
2,111
|
|
$
|
6,333
|
|
Other
|
|
7
|
|
21
|
|
Total revenues
|
|
2,118
|
|
6,354
|
|
|
|
|
|
|
|
Loan servicing fees
|
|
21
|
|
63
|
|
Management fees
|
|
249
|
|
747
|
|
Interest expense
|
|
1,237
|
|
3,711
|
|
General and
administrative expenses
|
|
564
|
|
1,795
|
|
Operating income
|
|
47
|
|
38
|
|
|
|
|
|
|
|
Other expense:
|
|
|
|
|
|
Realized loss on sale
of assets
|
|
(1,071
|
)
|
(3,213
|
)
|
Other, net
|
|
110
|
|
331
|
|
|
|
|
|
|
|
Total other expenses
|
|
(961
|
)
|
(2,882
|
)
|
|
|
|
|
|
|
Loss from continuing
operations before income taxes
|
|
(914
|
)
|
(2,844
|
)
|
|
|
|
|
|
|
Income tax expense
(benefit)
|
|
|
|
(5
|
)
|
|
|
|
|
|
|
Loss from continuing
operations, net of taxes
|
|
(914
|
)
|
(2,839
|
)
|
|
|
|
|
|
|
Discontinued
operations, net of taxes of $5
|
|
|
|
10
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
(914
|
)
|
$
|
(2,829
|
)
|
|
|
|
|
|
|
Net income (loss) per
share:
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted:
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) per
share
|
|
$
|
(0.04
|
)
|
$
|
(0.14
|
)
|
|
|
|
|
|
|
Weighted average number
of shares:
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
20,553
|
|
20,553
|
|
(b)
CLST Asset II
On December 12, 2008, we, through CLST Asset Trust II (the
Trust II
), a newly formed
trust wholly owned by CLST Asset II, LLC (
CLST Asset II
),
a wholly owned subsidiary of Financo, which is one of our direct, wholly
owned subsidiaries,
11
Table of Contents
entered
into a purchase agreement, effective as of December 10, 2008, to acquire
from time to time certain receivables, installment sales contracts and related
assets owned by third parties (the
Trust II
Purchase Agreement
). Our
Board unanimously approved the transaction. We have fulfilled our original
commitment to purchase from the sellers receivables of at least $2 million
pursuant to the Trust II Purchase Agreement. We or the sellers under the Trust
II Purchase Agreement can terminate the Trust II Purchase Agreement at any time
(with notice) after March 29, 2009.
Also, pursuant to the
second amended and restated
revolving credit agreement, effective as of December 10, 2008, among the
Trust II
, FCC, the originator, SSPE
Trust and SSPE, the co-borrowers (who are the sellers under the
Trust II Purchase Agreement
), Fortress
Credit Corp., the lender, FCC, the initial servicer, Lyons Financial Services, Inc.,
the backup servicer, Eric J. Gangloff, the guarantor, and U.S. Bank National
Association, the collateral custodian (the
Trust
II
Credit Agreement
)
, we have the right to require the
sellers to repurchase any accounts, for the original purchase price applicable
to such account plus interest accrued thereon, that do not satisfy certain
specified eligibility requirements set out in the Trust II Credit Agreement as
of the purchase date. If it is discovered by a party that a receivable account
was not an Eligible Receivable as of the purchase date, the seller is
required to repurchase such receivable account. An account is not an Eligible
Receivable if, as of the purchase date, such receivable account is, among other
things, a defaulted receivable, a delinquent receivable, subject to litigation,
dispute or rights of rescission, setoff or counterclaim, or is not subject to a
duly recorded and perfected lien, the seller must repurchase the account. For the quarterly period ended August 31,
2009, there had not been a determination that any receivables failed to meet
the eligibility requirements set out in the Trust II Credit Agreement.
These
receivables represent primarily home improvement loans originated through FCC,
the service provider of CLST Asset I. The loans represent new originations with
an average term of 9 years. Since these are new loans, the Company has managed
the originations such that almost 65% of the new loans have credit scores
higher than 680, with a portfolio average of 676. As of June 2009, the
Company is no longer originating new loans under the credit agreement.
The
purchases of receivables by the
Trust II
from the sellers under the
Trust II Purchase Agreement
and other
approved sellers or dealers will be financed by cash on hand and by advances
under a non-recourse, revolving facility provided by a third party lender. The
revolving facility was initially established by an affiliate of the sellers
under the
Trust II
Purchase Agreement
. The
Trust II
has become a co-borrower
under that facility and has pledged its assets to secure performance by the
borrowers thereunder. The revolving facility permits an aggregate borrowing of
all co-borrowers thereunder of up to $50,000,000. Financo has the ability to
direct that not less than $15 million to be borrowed under the revolving
facility be utilized by the
Trust II
to purchase receivables, installment sales
contracts and related assets for the
Trust II
. With the consent of its
co-borrowers, the
Trust
II
may utilize more than $15,000,000 of the aggregate availability under
the revolving facility. Receivables purchased by the
Trust II
will be owned by the
Trust II
, and the
Trust II
will receive the benefits
of collecting them, subject to the third party lenders rights in those assets
as collateral under the revolving facility. The terms and conditions of the
revolver are set forth in the Trust II Credit Agreement and the letter
agreement, effective as of December 10, 2008, among the
Trust II
, Financo, the originator,
the co-borrowers, the initial servicer, and the guarantor (the
Letter Agreement
). Advances
under the revolver are limited to an amount equal to, net of certain
concentration limitations set forth in the Trust II Credit Agreement, (a) the
lesser of (1) the product of 85% and the purchase price being paid for
eligible receivables with a credit score greater than or equal to 650 (
Class A Receivables
) or
(2) the product of 80% and the then-current aggregate balance of principal
and accrued and unpaid interest outstanding for Class A Receivables plus (b) the
lesser of (1) the product of 75% and the purchase price being paid for
eligible receivables with a credit score less than 650 (
Class B Receivables
) or
(2) the product of 50% and the then-current aggregate balance of principal
and accrued and unpaid interest outstanding for Class B Receivables (
Maximum Advance
).
The revolver
matures on September 28, 2010. The revolver bears interest at an annual
rate of 4.5% over the LIBOR Rate (as defined in the
Trust II Credit Agreement
). The Trust II pays an additional fee to
the co-borrowers equal to an annual rate of 0.5% for loans attributable to the
Trust II equal to or below $10 million and an annual rate of 1.5% for loans
attributable to the Trust II in excess of $10 million. In addition, a
commitment fee is due to the lender equal to an annual rate of 0.25% of the
unused portion of the maximum committed amount. The obligations under the
Trust II Credit
Agreement
are secured
by a first priority security interest in substantially all of the assets of the
Trust II and the co-borrowers, including portfolio collections.
The
Trust II Credit
Agreement
provides
the material terms and conditions for the services to be performed by the
servicer. In return, the Trust II pays the servicer a monthly servicing fee
equal to an annual rate of 1.5% of the then aggregate outstanding principal
balance of the receivables and a 2% loan origination fee on each new loan
originated.
Portfolio
collections are distributed on a monthly basis. Absent an event of default,
after payment of the servicing fee and other amounts, fees and expenses due
under the
Trust II Credit Agreement
and the required principal, interest, unused
commitment fee payments to the lenders under the
Trust II Credit Agreement
and fees due to the co-borrowers under
the Letter Agreement, all remaining amounts from portfolio collections are paid
to the Trust II and are available for distribution to CLST Asset II and
subsequently to Financo.
12
Table of Contents
Principal payments
on the revolver are due monthly to the extent that the aggregate principal
amount of the loan outstanding exceeds the lesser of (1) $50 million or (2) the
Maximum Advance plus the amount on deposit in the collection account net of any
accrued and unpaid interest on the loan and fees due to the lenders, the
servicer, the backup servicer, the collateral custodian and the owner trustee
(the
Maximum Outstanding Loan Amount
).
The borrowers are also required to either make principal payments or add
additional eligible receivables as collateral within 5 business days of any
time that the aggregate principal amount of the revolver exceeds the Maximum
Outstanding Loan Amount. The remaining outstanding principal amount of the loan
plus all accrued interest, fees and expenses is due on the maturity date. The
Trust II may, at its option, repay in whole or in part borrowings under the
revolver but prepayments made before September 28, 2010 are subject to a
prepayment premium equal to 2.0%. Interest payments on the term loan are due
monthly.
The Trust II Credit Agreement contains customary covenants for
facilities of its type, including among other things maintenance of the Trust
IIs special purpose vehicle status and covenants that restrict the Trust IIs
ability to incur indebtedness, grant liens, dispose of property, pay dividends,
and make certain acquisitions. Generally, these covenants do not impact the
activities that may be undertaken by the Company. The Trust II Credit Agreement
contains various events of default, including failure to pay principal and
interest when due, breach of covenants, materially incorrect representations,
default under certain other agreements of the Trust II, bankruptcy or
insolvency of the Trust II, the occurrence of an event which causes a material
adverse effect on the Trust II, the occurrence of certain defaults by the
servicer, entry of certain material judgments against the Trust II, and the
occurrence of a change of control or certain material events and the issuance
of a qualified audit opinion with respect to the Trust IIs financials. In
addition, an event of default occurs if the three-month rolling average
delinquent accounts rate exceeds 15.0% for Class A Receivables or 30.0%
for Class B Receivables, or the three-month rolling average annualized
default rate exceeds 5.0% for Class A Receivables or 12.0% for Class B
Receivables. If an event of default occurs, all of the Trust IIs obligations
under the Trust II Credit Agreement could be accelerated by the lender, causing
the entire remaining outstanding principal balance plus accrued and unpaid
interest and fees to be declared immediately due and payable.
During the nine
months ended August 31, 2009, Trust II purchased $9.6 million of
receivables with an aggregate purchase discount of $0.8 million. These
receivables represent primarily home improvement loans originated through FCC,
the service provider of CLST Asset I.
Trust II borrowed $6.4 million utilizing the revolving facility.
Approximately 54% of these loans were secured through a second lien on
the property, with the remainder being unsecured. The loans are through the 48 mainland states
with the top five concentration as follows:
State
|
|
Percentage
|
|
|
|
|
|
Michigan
|
|
23
|
%
|
Ohio
|
|
19
|
%
|
Massachusetts
|
|
7
|
%
|
Florida
|
|
5
|
%
|
New York
|
|
5
|
%
|
(c)
CLST Asset III
Effective February 13,
2009, we, through CLST Asset III, LLC (
CLST Asset
III
), a newly formed, wholly owned subsidiary of Financo, which
is one of our direct, wholly owned subsidiaries, purchased certain receivables,
installment sales contracts and related assets owned by Fair, James F. Cochran,
Chairman and Director of Fair, and by Timothy S. Durham, Chief Executive
Officer and Director of Fair and an officer, director and stockholder of our
Company (the
Trust III Purchase Agreement
).
Messrs. Durham and Cochran own all of the outstanding equity of Fair. In
return for assets acquired under the Trust III Purchase Agreement, CLST Asset
III paid the sellers total consideration of $3,594,354 as follows:
(1)
cash in the amount of $1,797,178 of which
$1,417,737 was paid to Fair, $325,440 was paid to Mr. Durham and $54,000
was paid to Mr. Cochran,
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Table of Contents
(2)
2,496,077 newly issued shares of our
common stock, par value $.01 per share (
Common
Stock
) at a price of $0.36 per share, of which 1,969,077 shares
of Common Stock were issued to Fair, 452,000 shares of Common Stock were issued
to Mr. Durham and 75,000 shares of Common Stock were issued to Mr. Cochran
and
(3)
six promissory notes (the
Notes
) issued by CLST Asset
III in an aggregate original stated principal amount of $898,588, of which two
promissory notes in an aggregate original principal amount of $708,868 were
issued to Fair, two promissory notes in an aggregate original principal amount
of $162,720 were issued to Mr. Durham and two promissory notes in an
aggregate original principal amount of $27,000 were issued to Mr. Cochran.
We received a
fairness opinion of Business Valuation Advisors (
BVA
) stating that BVA is of the opinion that the
consideration paid by us pursuant to the Trust III Purchase Agreement is fair,
from a financial point of view, to our nonaffiliated stockholders. A copy
of the fairness opinion was filed as an exhibit to our Current Report on Form 8-K
filed with the SEC on February 20, 2009. The shares of Common Stock
were issued by us in a transaction exempt from registration pursuant to Section 4(2) of
the Securities Act of 1933, as amended. As additional inducement for CLST
Asset III to enter into the Trust III Purchase Agreement, Fair agreed to use
its best efforts to facilitate negotiations to add CLST Asset III or one of its
affiliates as a co-borrower under one of Fairs existing lines of credit with
access to at least $15,000,000 of credit for our own purposes. To date we have
not been added as a co-borrower.
Substantially all
of the assets acquired by CLST Asset III are in one of two portfolios.
Portfolio A is a mixed pool of receivables from several asset classes,
including health and fitness club memberships, membership resort memberships,
receivables associated with campgrounds and timeshares, in-home food sales and
services, buyers clubs, delivered products and home improvement and
tuitions. Portfolio B is made up entirely of receivables related to the
sale of tanning bed products. Only 2% of these portfolios are home
improvement loans and none of the loans are secured. The loans are through the 48 mainland states
with the top five concentration as follows:
State
|
|
Percentage
|
|
|
|
|
|
Ohio
|
|
17
|
%
|
Florida
|
|
8
|
%
|
Colorado
|
|
8
|
%
|
Texas
|
|
6
|
%
|
Pennsylvania
|
|
6
|
%
|
At least
initially, Fair will continue to act as servicer for these receivables.
Fair will receive no additional consideration for acting as servicer.
As of February 13,
2009, the portfolios of receivables acquired pursuant to the Trust III Purchase
Agreement collectively consisted of approximately 3,000 accounts with an
aggregate outstanding balance of approximately $3,709,500 and an average
outstanding balance per account of approximately $1,015 for Portfolio A and
approximately $5,740 for Portfolio B. As of February 13, 2009, the
weighted average interest rate of the portfolios exceeded 18%. We have
the right to require the seller to repurchase any accounts, for the original
purchase price applicable to such account, that do not satisfy certain
specified eligibility requirements set out in the Trust III Purchase Agreement
as of February 13, 2009. If it is discovered by a party that a receivable
account was not an Eligible Receivable as of February 13, 2009, the
closing date of the acquisition, the seller is required to repurchase such
receivable account. An account is not an Eligible Receivable if, as of February 13,
2009, such receivable account is a delinquent receivable, a defaulted receivable
subject to litigation, dispute or rights of rescission, setoff or counterclaim,
or is not subject to a duly recorded and perfected lien, the seller must
repurchase the account. For the
quarterly period ended August 31, 2009, there had not been a determination
that any receivables failed to meet the eligibility requirements set out in the
Trust III Purchase Agreement.
Additionally, the
Trust III Purchase Agreement provides that each of the sellers jointly and
severally guarantee to CLST Asset III, up to the aggregate stated principal
amount of the Notes issued to such seller, that the outstanding receivable
balance of each receivable as of the closing date will be collectible in
full. For each receivable that becomes a
defaulted receivable following the closing date, the sellers are obligated to
pay to CLST Asset III an amount equal to the outstanding receivable balance of
such receivable and CLST Asset III has the right to offset such amount against
the amount due to the seller under the promissory notes issued to the sellers
on the closing date. The aggregate
amount of each sellers guarantee obligation is limited to the aggregate stated
principal amount of the promissory note issued to such seller representing
approximately 25% of the total purchase price of the portfolio of approximately
$3.6 million. Since the principal
balance of the notes declines over time as payments are made by the Company to
the sellers, future defaulted receivables can be offset only against the then
remaining balance of the notes issued to the
14
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sellers. Any future defaults of receivables will be
offset against any remaining amounts owed the sellers pursuant to these
notes. Defaults of $170,000 during the
nine months ended August 31, 2009 were applied to the notes payable to the
sellers.
The Notes issued
by CLST Asset III in favor of the sellers are full-recourse with respect to CLST
Asset III and are unsecured. The three Notes relating to Portfolio A (the
Portfolio A Notes
)
are payable in 11 quarterly installments, each consisting of equal principal
payments, plus all interest accrued through such payment date at a rate of 4.0%
plus the LIBOR Rate (as defined in the Portfolio A Notes). The three
Notes relating to Portfolio B (the
Portfolio
B Notes
) are payable in 21 quarterly installments, each
consisting of equal principal payments, plus all interest accrued through such
payment date at a rate of 4.0% plus the LIBOR Rate (as defined in the Portfolio
B Notes).
(5) Net Loss Per Share
Options to
purchase 0.1 million shares of Common Stock for the three and nine months ended
August 31, 2009 and 2008, were not included in the computation of diluted
earnings per share because the exercise price was higher than the average
market price. Restricted Stock of 0.6
million shares were not included in the computation of diluted earnings per
share for the three and nine months ended August 31, 2009, because their
inclusion would have been anti-dilutive as the Company had a net loss.
(6) Fair
Value Measurements
In April 2009,
the Financial Accounting Standards Board (the
FASB
)
issued FASB Staff Position No. FAS 107-1 and APB 28-1,
Interim Disclosures about Fair Value of Financial
Instruments
(
Staff Position
).
The Staff Position requires disclosures about the fair value of financial
instruments whenever a public company issues financial information for interim
reporting periods. The Staff Position is effective for interim reporting
periods ending after June 15, 2009.
The carrying amounts of accounts receivable, accounts payable and accrued
liabilities as of August 31, 2009 and 2008 approximate fair value due to
the short maturity of these instruments.
The carrying value of notes receivable and notes payable also
approximate fair value since these instruments bear market rates of interest,
and notes receivable are net of allowances and purchase discounts.
(7) Commitments
and Contingencies
On
February 13, 2009, we filed a lawsuit in the United States District Court
for the Northern District of Texas against Red Oak Fund, L.P., Red Oak
Partners, LLC, and David Sandberg (the
Federal Court Action
). Our Original Complaint and Application for
Injunctive Relief alleges that Red Oak Fund, L.P., Red Oak Partners, LLC, and
David Sandberg have engaged in numerous violations of federal securities laws
in making purchases of our common stock and sought to enjoin any future
unlawful purchases of our stock by them, their agents, and persons or entities
acting in concert with them. We believe the Red Oak Group violated federal
securities laws as follows:
(i)
violating Rule 14(e)-5 of the Exchange Act by
not truly abandoning its tender offer and instead directly or indirectly
purchasing or arranging to purchase shares not in connection with its tender
offer and without complying with the procedural, disclosure and anti-fraud
requirements applicable to tender offers regulated under Section 14 of the
Exchange Act;
(ii)
violating Exchange Act Rule 14d-5(f) by
failing to return the Companys stockholder list, which we provided to Red Oak
upon its request, and by using such list for a purpose other than in connection
with the dissemination of tender offer materials in connection with its tender
offer;
(iii)
violating Exchange Act Rule 14(d)-10 by
purchasing shares pursuant to its tender offer at varying prices rather than
paying consideration for securities tendered in the tender offer at the highest
consideration paid to any stockholder for securities tendered; and
(iv)
violating Section 13(d) of the Exchange
Act by not timely filing a Schedule 13D and disclosing the information required
therein.
According to a Schedule
13D filed by David Sandberg, Red Oak Partners, LLC and certain other reporting
persons on August 24, 2009, Red Oak Partners beneficially owns 4,561,554
shares of the Companys Common Stock representing approximately 19.05% of the
Companys outstanding Common Stock.
15
Table of Contents
On
March 2, 2009, certain members of the Red Oak Group and Jeffrey S. Jones (
Jones
) filed a derivative lawsuit
against Robert A. Kaiser, Timothy S. Durham and David Tornek in the 134th
District Court of Dallas County, Texas (the
State
Court Action
). The petition alleges that Messrs. Kaiser,
Durham, and Tornek entered into self-dealing transactions at the expense of the
Company and its stockholders and violated their fiduciary duties of loyalty,
independence, due care, good faith, and fair dealing. The petition asks
the Court to order, among other things, a rescission of the alleged
self-interested transactions by Messrs. Kaiser, Durham, and Tornek; an
award of compensatory and punitive damages; the removal of Messrs. Kaiser,
Durham and Tornek from the Board; and that the Company hold an Annual Meeting
of stockholders, or that the Company appoint a conservator to oversee and
implement the dissolution plan approved by stockholders in 2007.
On
April 6, 2009, we filed our First Amended Complaint and Application for
Injunctive Relief in the Federal Court Action against defendants Red Oak Fund,
L.P., Red Oak Partners, LLC, David Sandberg, Pinnacle Partners, LLC, Pinnacle
Fund LLLP, and Bear Market Opportunity Fund, L.P. alleging the same and other
violations of federal securities laws, including:
(i)
filing a materially false and misleading Schedule
13D and failing to amend the same after delivering to the Company a Notice of
Director Nominations and proposal for business at the Annual Meeting;
(ii)
violating Section 14(d) of the Exchange
Act by engaging in fraudulent, deceptive and manipulative acts in connection
with its tender offer by failing to abide by Section 14(d)s timing
requirements and by failing to make required filings with the SEC; and
(iii)
that any attempt to solicit proxies from our
stockholders with respect to director nominations or notice of business would
be misleading in light of the defendants illegal activities in accumulating
Company stock.
Through
this lawsuit, we seek to obtain various declaratory judgments that the
defendants have failed to comply with federal securities laws and to enjoin the
defendants from, among other things, further violating federal securities laws
and from voting any and all shares or proxies acquired in violation of such
laws. Also on April 6, 2009,
because, among other reasons, we do not expect the litigation, which bears
directly upon our Annual Meeting of stockholders, to be resolved for some
months, our Board postponed the Annual Meeting of stockholders previously
scheduled for May 22, 2009 until September 25, 2009. On August 14,
2009, our Board again postponed the Annual Meeting of stockholders from September 25,
2009 to October 27, 2009.
On
April 30, 2009, the Red Oak Group and Jones amended their petition in the
State Court Action. In addition to the
relief already requested, the petition seeks to compel the Company to hold its
2008 and 2009 annual stockholders meetings within sixty days; to enjoin Messrs. Kaiser,
Durham, and Tornek from any interference or hindrance of such meetings or the
election of directors; to enjoin Messrs. Kaiser, Durham, and Tornek from
voting any shares of stock acquired in the alleged self-interested
transactions; and to appoint a special master.
On June 3, 2009 and again on June 12, 2009, pursuant to court
order, Red Oak Partners, LLC, Pinnacle Fund, LLLP, Red Oak Fund, LP, and
Jeffrey S. Jones amended their petition in the State Court Action to, among
other things, remove Bear Market Opportunity Fund, L.P. as a plaintiff and add
Red Oak Fund, L.P. as a plaintiff.
Discovery is ongoing in both the Federal Court Action and State Court
Action.
On
May 5, 2009, the Red Oak Group and Jones filed a motion in the State Court
Action seeking to compel the Company to hold its 2008 and 2009 stockholders
meetings on June 30, 2009 and to appoint a special master and requested an
expedited hearing on both. Hearings were
held on May 8, 2009 and May 29, 2009, but no ruling was reached.
On July 24, 2009, we
filed our Brief in Support of Application for Preliminary Injunction in the
Federal Court Action. The Red Oak Group
filed its Opposition on August 7, 2009, and we filed our Reply Brief in Support
on August 14, 2009.
On August 25, 2009, the Court in the State Court
Action set an evidentiary hearing on the plaintiffs Application for Temporary
Injunction, which had yet to be filed, for October 7 and 8, 2009. The
plaintiffs request for injunctive relief concerns Messrs. Kaiser, Durham,
and Tornek voting any shares of stock acquired in the alleged self-interested
transactions. The plaintiffs Motion and Memorandum for Injunctive Relief was
filed on September 15, 2009; the defendants response was filed on September 29,
2009; and the plaintiffs reply was filed on October 2, 2009.
On
August 28, 2009, the parties to the State Court Action executed a
Stipulation Regarding the Companys Annual Meeting of Stockholders (
Stipulation
). The Court approved the Stipulation the same
day and entered an Order identical to the Stipulations terms. Pursuant to the Stipulation, absent a
determination by the Court of good cause shown, the Company must hold its
annual stockholders meeting for the election of one Class I director and
one Class II director and consideration of any properly submitted
proposals that are proper subjects for consideration at an annual meeting of a
Delaware corporation on October 27, 2009, with a record date for that
meeting of September 25, 2009. Good
cause for delaying the Annual Meeting beyond October 27, 2009 and
correspondingly amending the September 25, 2009 record date, includes
among other things, situations where reasonable delay is
16
Table of Contents
necessary:
(1) for the Board to avoid breaching any of their fiduciary duties to the
Company or the Companys stockholders; (2) to assure compliance with the
Companys certificate of incorporation and bylaws; (3) for the Company or
the Board to comply with state or federal law; or (4) to assure compliance
with any order of any court or regulatory authority having jurisdiction over
the Company or members of its Board.
We received a letter dated September 22, 2009
from the Red Oak Group seeking, pursuant to Section 220 of the Delaware
General Corporation Law, to inspect the books and records of the Company,
including among other things a stockholder list as of the record date. The
letter states that the purpose of such request is to enable the Red Oak Group
to solicit proxies to elect directors at the 2009 Annual Meeting and to
communicate with stockholders. Our counsel responded by letter dated September 30,
2009 that the Company was aware of its obligations under Section 220 of
the Delaware General Corporation Law but believed that the demand letter did
not comply with the inspection requirements under Section 220. We received
another letter dated September 29, 2009 from the Red Oak Group pursuant to
Section 220 of the Delaware General Corporation Law in which the Red Oak
Group requests to inspect the books and records of the Company pertaining to,
among other things, all analyses performed with respect to our net operating
losses and a list of all business ventures and dealings Messrs. Tornek and
Durham have evaluated or commenced in the past ten years and a list of all
investments they currently share. Our counsel responded by letter dated October 6,
2009 that (i) the commencement of the Red Oak Groups derivative action
bars it from using a Section 220 demand as a substitute for discovery
permissible in litigation; (ii) the stated purposes of the demand letter
do not constitute proper purposes under Section 220; and (iii) the
scope of information requested in the demand letter is overly broad and not
limited to books and records that are essential and sufficient to accomplish
the Red Oak Groups stated purposes.
The evidentiary hearing for the State Court Action was
held October 7 and 8, 2009. On October 9,
2009, the Court denied the plaintiffs Application for Temporary Injunction. In
addition, the Court dismissed the derivative claims asserted by the plaintiffs
and granted the defendants Motion to Stay on all remaining non-derivative
claims the plaintiffs asserted against Messrs. Kaiser, Tornek and Durham.
On October 14, 2009,
the court denied the Companys application for preliminary injunction in the
Federal Court Action. The Federal Court Action remains pending.
The Company has expended a
significant amount of management time and resources in connection with Federal
Court Action and the State Court Action. The Company has had settlement
discussions with certain of the plaintiffs regarding the Federal Court Action
and the State Court Action. The Company may have further settlement
discussions in the future. No assurance can be given that any settlement
agreement could be reached if the Company undertakes further discussions or if
a settlement agreement is entered into that the terms of any such settlement
would not have a material adverse effect on the Company, its financial position
or its results of operations.
(8) New Accounting Pronouncements
In December 2007, the FASB released Statement No. 141
R, Business Combinations (
SFAS 141R
),
which establishes principles for how the acquirer shall recognize acquired
assets, assumed liabilities and any non-controlling interest in the acquiree,
recognize and measure the acquired goodwill in the business combination, or
gain from a bargain purchase, and determines disclosures associated with
financial statements. This statement replaces SFAS 141 but retains the
fundamental requirements in SFAS 141 that the acquisition method of accounting
(which SFAS 141called the purchase method) be used for all business
combinations and for an acquirer to be identified for each business
combination. The requirements of SFAS 141R apply to business combinations for
which the acquisition date is on or after the beginning of the first annual
reporting period beginning on or after December 15, 2008. Early
application is not permitted.
In
February 2008, the FASB issued FASB Staff Position FSP 157-2,
Effective Date of FASB Statement No. 157
(
FSP 157-2
). FSP 157-2 delayed the
effective date of SFAS 157 for all nonfinancial assets and nonfinancial
liabilities, except for items recognized or disclosed at fair value in the
financial statements on a recurring basis (at least annually), until the
beginning of the first quarter 2009. Application of SFAS 157 did not have a
material impact on our results of operations and financial position upon
adoption on January 1, 2009.
In
April 2009, the FASB issued FASB Staff Position No. FAS 107-1 and APB
28-1,
Interim Disclosures about Fair Value
of Financial Instruments
(
FSP FAS 107-1
).
FSP FAS 107-1 requires disclosures about the fair value of financial
instruments whenever a public company issues financial information for interim
reporting periods. FSP FAS 107-1 is effective for interim reporting periods
ending after June 15, 2009. The Company adopted this staff position upon
its issuance, and it had no material impact on its consolidated financial
statements. See Note 6 Fair Value Measurements for these disclosures.
In May 2009, the FASB issued SFAS No. 165, Subsequent
Events (
SFAS 165
), which establishes
general standards of accounting for, and requires disclosure of, events that
occur after the balance sheet date but before financial statements are issued
or
17
Table of Contents
are available to be issued. The Company adopted the
provisions of SFAS 165 as of August 31, 2009. The adoption of these provisions
did not have a significant impact on the Companys consolidated financial
statements.
In
June 2009, the FASB issued SFAS 168,
The
FASB Accounting Standards Codification and the Hierarchy of Generally Accepted
Accounting Principles.
SFAS 168 identifies the FASB Accounting
Standards Codification as the authoritative source of
generally accepted accounting principles (
GAAP
) in the United States. Rules and
interpretive releases of the SEC under federal securities laws are also sources
of authoritative GAAP for SEC registrants. SFAS 168 is
effective for financial statements issued
for interim and annual periods ending after September 15, 2009. We do not
expect adoption to
have a
material impact on our consolidated financial statements.
From time to time,
new accounting pronouncements are issued by the FASB or other standards setting
bodies which we adopt as of the specified effective date. Unless otherwise
discussed, our management believes the impact of recently issued standards
which are not yet effective will not have a material impact on our consolidated
financial statements upon adoption.
(9) Subsequent
Events.
On October 16,
2009, we received a notice of default from Fortress stating that an event of
default has occurred and is continuing under the Trust I Credit Agreement. The
Fortress notice states that the three-month rolling average annualized default
rate of the Trust I portfolio has exceeded 7.0%. As a result of the default,
pursuant to the Trust I Credit Agreement, the interest rate payable by Trust I
has increased by an additional 2% per annum, and all collections by Trust I
above amounts retained to pay interest, fees, principal amortizations, and
other charges that are normally remitted to the Company, are instead being
applied to outstanding principal under the Trust I Credit Agreement until the
amount due has been reduced to zero. In
addition, Fortress is entitled to foreclose on the assets of Trust I and sell
them to satisfy amounts due it under the Trust I Credit Agreement. Only Trust I is liable for amounts due
Fortress under the Trust I Credit Agreement.
Thus, although the Company could lose some or all of its investment in
Trust I, the Company will not be obligated to pay any amounts due Fortress
under the Trust I Credit Agreement. All
Trust I collections are being retained by Fortress and applied to pay interest
and reduce indebtedness while the Company discusses amending the Trust I Credit
Agreement, but Fortress has not sought to foreclose on the assets of Trust
I. Those discussions are ongoing. The Company does not expect that Fortress
will foreclose on the assets of Trust I while negotiations are proceeding.
On December 15,
2009, we received a notice of default from Fortress stating that a servicer
default has occurred and is continuing under the Trust II Credit Agreement, as
a result of a material adverse effect with respect to the servicer. The Fortress notice states that Fair, in its
capacity as a sub-servicer for assets held by the SSPE Trust, has failed to
perform its servicing duties with respect to that portion of the receivables
portfolio owned by SSPE Trust for which Fair has been retained as a
sub-servicer by the SSPE Trust. This
failure, the Fortress notice asserts, results from the ongoing federal
investigation of Fair and Timothy Durham, and constitutes a material adverse
effect with respect to the servicer and thus a breach of a covenant under the
Trust II Credit Agreement. We are
reviewing the matters described in Fortress notice, and have not formed an opinion
as to whether a default under the Trust II Credit Agreement has occurred and
remains uncured. Fair is not a
sub-servicer for receivables purchased by Trust II. However, Trust II is a co-borrower with SSPE
Trust under the Trust II Credit Agreement, and all of its assets are pledged to
secure obligations to Fortress under the Trust II Credit Agreement. If a default in the covenants has occurred
under the Trust II Credit Agreement, the interest rate payable by Trust II will
increase by an additional 2% per annum, and Fortress will be entitled to
accelerate and declare immediately due all of Trust IIs obligations under the
Trust II Credit Agreement. In addition,
if a default under the Trust II Credit Agreement exists and is continuing,
Fortress is entitled to foreclose on the assets of Trust II and sell them to
satisfy amounts due it under the Trust II Credit Agreement. In the event of such foreclosure, pursuant to
the Letter Agreement, Trust II may have certain rights against SSPE Trust in
the event of a default by SSPE Trust under the Trust II Credit Agreement that
permit Trust II to receive an amount equal to what Trust II would have received
on assets owned by Trust II which are foreclosed upon due to the default by
SSPE Trust. Only Trust II is liable for
amounts due Fortress under the Trust II Credit Agreement. Thus, although the
Company could lose some or all of its investment in Trust II, we will not be
obligated to pay any amounts due Fortress under the Trust II Credit Agreement.
The Company continues
to evaluate the circumstances and applicable information and has not formed an
opinion as to whether a default under the Trust II Credit Agreement has
occurred and remains uncured. The
negotiations, to prevent the foreclosure on the assets in the trust, between
Fortress and the Company are ongoing. With regards to Trust I, the Company has
discovered that a number of receivables purchased were ineligible at the time
of purchase. The Company has notified Fortress that approximately $2.2 million
of the accounts purchased, were by definition not eligible receivables at the
time of their purchase. Of the ineligible receivables purchased, approximately
$680,000 have become defaulted receivables. The Company believes that if the
ineligible accounts are excluded from the calculations, no event of default is
likely to have occurred as of September 2009. The Companys discussions with Fortress are
ongoing and the Company cannot predict when or if these matters will be
resolved favorably or at all.
18
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Management has performed
an evaluation of the Companys activity through January 29, 2010, and has
concluded there are no other significant subsequent events requiring disclosure
through the date these financial statements were issued.
19
Table of Contents
Item 2. Managements Discussion
and Analysis of Financial Condition and Results of Operations
The following
discussion and analysis should be read in conjunction with the Managements
Discussion and Analysis of Financial Condition and Results of Operations
section and audited consolidated financial statements and related notes thereto
included in our Annual Report on Form 10-K/A filed with the SEC for the
year ended November 30, 2008 and with the unaudited consolidated financial
statements and related notes thereto presented in this Quarterly Report on Form 10-Q/A.
Cautionary
Statement Regarding Forward-Looking Statements
Certain of the matters discussed in this Quarterly Report on Form 10-Q/A
may constitute forward-looking statements for purposes of the Securities Act
of 1933, as amended (the
Securities Act
),
and the Securities Exchange Act of 1934, as amended (the
Exchange
Act
), and, as such, may involve known and unknown risks,
uncertainties and other factors that may cause the actual results, performance
or achievements of CLST Holdings, Inc., formerly CellStar Corporation, and
subsidiaries (the
Company
) to be materially
different from future results, performance or achievements expressed or implied
by such forward-looking statements. When used in this report, the words anticipates,
estimates, believes, continues, expects, intends, may, might, could,
should, likely, and similar expressions are intended to be among the
statements that identify forward-looking statements. When we make
forward-looking statements, we are basing them on our managements beliefs and
assumptions, using information currently available to us. Although we believe
that the expectations reflected in the forward-looking statements are reasonable,
these forward-looking statements are subject to risks, uncertainties and
assumptions. Statements of various factors that could cause the actual results,
performance or achievements of the Company to differ materially from the
Companys expectations (
Cautionary Statements
)
are disclosed in this report, including, without limitation, those statements
discussed in the Item 1A, Risk Factors of our
Annual Report on Form 10-K/A for the
fiscal year ended November 30, 2008
, those statements made in
conjunction with the forward-looking statements and otherwise herein. All
forward-looking statements attributable to the Company are expressly qualified
in their entirety by the Cautionary Statements. We have no intention, and
disclaim any obligation, to update or revise any forward-looking statements,
whether as a result of new information, future results or otherwise.
Overview
Sales Transactions
On December 18, 2006,
we entered into a definitive agreement (the
U.S.
Sale Agreement
) with a wholly owned subsidiary of Brightpoint, Inc.,
an Indiana corporation (
Brightpoint
),
providing for the sale of substantially all of our United States and
Miami-based Latin American operations (the
U.S.
Sale
) and for the buyer to assume certain liabilities related
to those operations. Our operations in Mexico and Chile and other businesses or
obligations of the Company were excluded from the transaction.
Our Board of Directors (the
Board
) and Brightpoint unanimously
approved the proposed transaction set forth in the U.S. Sale Agreement. The
purchase price was $88 million in cash, subject to adjustment based on
changes in net assets from December 18, 2006 to the closing date. The U.S.
Sale Agreement also required the buyers to deposit $8.8 million of the
purchase price into an escrow account for a period of six months from the
closing date.
Also on December 18,
2006, we entered into a definitive agreement (the
Mexico
Sale Agreement
) with Soluciones Inalámbricas, S.A. de C.V.
(
Wireless Solutions
) and Prestadora
de Servicios en Administración y Recursos Humanos, S.A. de C.V. (
Prestadora
), two affiliated Mexican
companies, providing for the sale of all of the Companys Mexico operations
(the
Mexico Sale
). The Mexico
Sale was structured as the sale of all of the outstanding shares of our Mexican
subsidiaries, and included our interest in
Comunicación Inalámbrica Inteligente, S.A. de
C.V.
(
CII
), our joint venture with
Wireless Solutions. Under the terms of the transaction, we received
$20 million in cash, and were entitled to receive our pro rata share of
CII profits for the first quarter 2007 and up to the consummation of the
transaction, within 150 days from the closing date. Our Board unanimously
approved the proposed transaction set forth in the Mexico Sale Agreement. We
had not received any pro rata share of the CII profits and other terms required
as of 150 days from the closing date. A demand for payment of up to
$1.7 million, the amount we believe is our pro rata share of CII profits
for such period, was sent to the purchasers on September 11, 2007, as well
as a demand that the sellers comply with other required terms of the agreement.
While we believe that CII was profitable and therefore the purchasers owe the
Company its pro rata share, the purchasers are disputing this claim.
Therefore, we are pursuing claims against
the buyers from the Mexico Sale in an ICC arbitration proceeding, which is
currently scheduled for October 21 and 22, 2009.
We cannot make any estimates
regarding future amounts that we may be able to collect or the timing of any
collections on this matter.
We filed a proxy statement
with the SEC on February 20, 2007, which more fully describes the U.S. and
Mexico Sale transactions. Both of the transactions were subject to customary
closing conditions and the approval of our stockholders, and the transactions
were not dependent upon each other. The proxy statement also included a plan of
dissolution, which provides for the
20
Table of Contents
complete liquidation and dissolution of the Company
after the completion of the U.S. Sale, and a proposal to change the name of the
Company from CellStar Corporation to CLST Holdings, Inc.
On March 28, 2007, our stockholders approved the U.S. Sale, the
Mexico Sale, the plan of dissolution, and a name change from CellStar
Corporation to CLST Holdings, Inc. We continue to follow the plan of
dissolution. Consistent with the plan of dissolution and its fiduciary duties,
our Board will continue to consider the proper implementation of the plan of
dissolution and the exercise of the authority granted to it thereunder,
including the authority to abandon the plan of dissolution.
The U.S. Sale closed on March 30,
2007. At closing we received cash of approximately $53.6 million and
$4.5 million was included in Accounts ReceivableOther in the
accompanying balance sheet for November 30, 2007. We recorded a pre-tax
gain of $52.7 million on the transaction during the twelve months ended November 30,
2007. The buyer of our U.S. business previously asserted total claims for
indemnity against the escrow of approximately $1.4 million, and the
remainder, approximately $7.6 million, including accrued interest, was
distributed to the Company on October 4, 2007. On December 21, 2007,
the Company and Brightpoint entered into a Letter Agreement which settled the
dispute concerning the additional escrow amount. All currently outstanding
disputes between the parties regarding the determination of the purchase price
under the U.S. Sale Agreement have been resolved, and payments of funds have
been made in accordance with the terms described in the Letter Agreement. In January 2008
the Company received approximately $3.2 million from Brightpoint plus
accrued interest and less transition expenses, and approximately
$1.4 million from the escrow agent. These are the final amounts to be
received under the U.S. Sale Agreement.
The Mexico Sale closed on April 12,
2007, and we recorded a loss on the transaction of $7.0 million primarily
due to accumulated foreign currency translation adjustments as well as expenses
related to the transaction. We had approximately $9.1 million of
accumulated foreign currency translation adjustments related to Mexico. As the
proposed sale did not meet the criteria to classify the operations as held for
sale under SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets, as of February 28, 2007, we recognized the
$9.1 million as a charge upon the closing of the Mexico Sale. As disclosed
above, we have not received any pro-rata share of profits and other terms
required as of 150 days from the closing date under the Mexico Sale.
On
March 22, 2007, we signed a letter of intent to sell our operations in
Chile (the
Chile Sale
) to a group that
included local management for approximately book value. On June 11, 2007,
we completed the Chile Sale. The purchase price and cash transferred from the
operations in Chile prior to closing totaled $2.5 million, and we recorded
a pre-tax gain of $0.6 million on the transaction during the quarter ended
August 31, 2007. With the completion of the Chile Sale, we no longer have
any operating locations outside of the U.S. Currently only a small administrative
staff remains to wind up our business.
Plan of Dissolution
As we have previously
disclosed, the proxy statement we filed with the SEC on February 20, 2007
describes a proposal for a plan of dissolution, which provides for the complete
liquidation and dissolution of the Company after the completion of the U.S.
Sale (subject to abandonment by the Board in the exercise of their fiduciary
duties). On March 28, 2007, our
stockholders approved the plan of dissolution in addition to the U.S. Sale and
the Mexico Sale. In the plan of
dissolution approved by our stockholders, we stated that no distribution of
proceeds from the U.S. Sale and Mexico Sale would be made until the
investigation by the SEC was resolved. On June 26, 2007, we received a
letter from the staff of the SEC giving notice of the completion of their
investigation with no enforcement action recommended to the SEC. Therefore, on June 27,
2007, our Board declared a cash distribution of $1.50 per share on Common Stock
to stockholders of record as of July 9, 2007. On July 19, 2007, we
issued the $1.50 per share dividend in the total amount of $30.8 million.
Then, on November 1, 2007 we paid an additional $0.60 per share dividend
to stockholders which brings the cumulative dividends paid to stockholders to
$2.10 per share or approximately $43.2 million. The amount and timing of
any additional distributions paid to stockholders in connection with the
liquidation and dissolution of the Company are subject to uncertainties and
depend on the resolution of certain contingencies more fully described in this
quarterly report on Form 10-Q/A, in the proxy statement and elsewhere in
our Annual Report on Form 10-K/A for the fiscal year ended November 30,
2008.
We
have continued to wind down aspects of our businesses, including dissolving
some of our subsidiaries and continuing to try to collect our remaining
non-cash assets. In addition, we have
continued to review our liabilities and seek to satisfy or resolve those that
we can in a favorable manner. See Recent
Developments below and Item 1 Business 2008 Business of our Annual Report
on Form 10-K/A for the fiscal year ended November 30, 2008 for
further discussion with respect to our activities in this regard. We expect that it will take several years to
implement the plan of dissolution because of the lengthy process of obtaining
sufficient information regarding all of our liabilities to pay and
appropriately provide for them as required under the plan of dissolution
.
Given this and the time necessary to complete the governmental
requirements for dissolution, our Board focused on ways to generate higher
returns on the Companys cash and other assets in order to better offset the
Company expenses and to take advantage of the favorable tax treatment provided
by our net operating losses (
NOLs
). Section 3 of the plan of dissolution
states that we may not engage in any business activities except to the extent
necessary to preserve the value of the Companys assets, wind up the Companys
affairs, and distribute the Companys assets.
As further described below under Recent Developments, our Board determined to acquire several
portfolios of receivables with the intention of generating a higher rate of
return on our assets than we were receiving on our cash and
21
Table of Contents
cash
equivalents balances which were held in money market accounts or short term
certificates of deposit, earning approximately 1% (current interest rates are
now close to 0%). Our Board believed
that each of these acquisitions would provide a better investment return for
our stockholders when compared to the low interest rates available on our cash
investments and other investment alternatives although the acquisition would
involve a higher risk profile than traditional cash deposits and other cash
equivalents positions. At the time we
began looking at purchasing these portfolios during the second and third
quarters of 2008, the credit markets became significantly impaired, and the
viability of many banks and other financial institutions was in question. The Companys cash was held in one bank
subject to the limited protection of FDIC coverage. The Board considered, among other things,
spreading the Companys cash among over a dozen financial institutions. However, the Board did not believe spreading
the Companys cash among many different banks to be practical or cost
efficient. In addition, the Board
considered various cash strategies including investing in a ladder of U.S.
Treasury securities (securities of varying maturities) which would have
resulted in higher yields than cash deposits, but would have required the
Company to hold those securities in a brokerage firm and pay that firm a fee to
arrange the transactions. The Board did
not believe that the increased yield provided by a ladder of U.S. Treasury
securities, after associated fees and administrative costs, was likely to be
significantly better than that of cash deposits, and did not believe that
interest from U.S. Treasury securities would allow the Company to use its NOLs
to shield income from taxes. Finally,
the Board was unsure how to assess the brokerage and custody risks associated
with holding a ladder of U.S. Treasury securities through third parties, and
felt that the risk was similar to that associated with commercial banks at the
time.
Our
Board understood that to obtain higher returns on its investments, the Company
would have to assume a higher risk of loss.
The Board believed that the opportunity offered by these purchases to
earn higher returns than offered by cash and demand deposits, would offset the
increased risks, and offer the Board a way of maximizing the value of the
Company for the stockholders. In
addition, these investments offered the Company an opportunity to utilize its
NOLs if the returns resulted in positive income for the Company. The purchases the Company made utilized
borrowed money. Using borrowed money to
purchase an income generating asset increases the return on investment, but
increases the risk of loss on that investment.
The Board carefully considered the amount of leverage in each of its
purchases, believing each investment would be able to generate sufficient
income to pay interest and principal on the debt, and still produce an
attractive return for the Company and its stockholders. In considering the risk associated with
leverage, the Board considered a number of different scenarios for performance
of the investments, including the risk associated with increased default
rates. The Board did not expect default
rates to increase to current levels, but did consider that and other
possibilities. In addition, the Board
considered the costs associated with investments in our portfolios, including
the ongoing costs of paying a servicer to service the portfolio, as part of its
consideration of the overall potential return associated with those
investments.
When we purchased FCC Investment Trust I (
Trust
I
), the historical default rate for the previous three years
for the portfolio was approximately 4%, which was the basis for assessing the
creditworthiness of the assets included in CLST Asset I, LLC (
CLST Asset I
). During the third quarter of 2009, we have
seen the default rate increase to the 6-7% range; accordingly, we have been
increasing our allowances to reflect this change.
Upon
examination of CLST Asset Trust II (
Trust II
)
and CLST Asset III, LLC (
CLST Asset III
),
we believe that the circumstances of these portfolios are different from those
of Trust I. As of the date we acquired
Trust I, approximately 39% of the receivables in the Trust I portfolio had
credit scores higher than 676. Trust II
contains new originations with higher credit requirements than the requirements
for the Trust I portfolio. Since Trust
II is comprised of new loans, the Company has managed the originations such
that almost 65% of the new loans have credit scores higher than 680. Further, we acquired the Trust I portfolio at
a discount of approximately 3% and acquired the Trust II portfolio at a
discount of approximately 10%. Therefore
the Trust II portfolio has a very different risk profile when compared to Trust
I, and we anticipate that as a result of holding receivables from borrowers
with higher credit scores, Trust II will experience lower rates of
default. The sellers of the CLST Asset
III portfolio have retained the risk of collectability of the receivables in
that portfolio for up to an amount equal to the principal amount of the notes
issued by the Company to the sellers. At
the time of the closing of the acquisition of the CLST Asset III portfolio, the
notes issued to the sellers represented approximately 25% of the total purchase
price of the portfolio of approximately $3.6 million. Since the principal balance of the notes
declines over time as payments are made by the Company to the sellers, future
defaulted receivables can be offset only against the then remaining balance of
the notes issued to the sellers. Any
future defaults of receivables will be offset against any remaining amounts
owed the sellers pursuant to these notes.
The difference in the purchase discounts between CLST Asset I and CLST
Asset II, LLC (
CLST Asset II
) was impacted by
the tightening of the credit markets between the time of these two
acquisitions.
The
Company has not performed a market check and, as a result, cannot give any
assurance that the portfolios can be sold on favorable terms or within any
particular time frame given the risk and uncertainties associated with current
economic conditions. Our Board believes
that a quick sale of our portfolio assets at the current time is unlikely to
yield the same value to the Company as a sale in an orderly course in the future. Among other things, our Board believes
economic conditions will improve over the next few years, along with credit
market conditions and conditions affecting consumer default rates. Because the Companys winding up will take
several years, the Company has the ability to wait until economic conditions
improve before it sells its portfolio assets.
For the same reason, the Company has the ability to market those assets,
in the future, in an orderly fashion designed to enhance any sales proceeds
over what could be received in a quicker sale at the current time. While the Company continues its winding up
activities, it will
22
Table of Contents
receive
collections on the portfolios, and its overall book investment in the
portfolios will decline. At the same
time, the size of the portfolios and the debt associated with them will also
decline as the assets and related indebtedness liquidate themselves. For those reasons, the Board believes that,
based upon the assumptions above, a sale of the Companys portfolio assets in
the future will likely result in greater value to the Company than a rapid sale
at the current time.
Consistent with the plan of dissolution and their
fiduciary duties, our Board and Executive Committee continue to consider the
amendment or abandonment of our plan of dissolution, and continue to consider
the timing of any filing of a certificate of dissolution if the plan of
dissolution is to be carried out. The
plan of dissolution contemplates the filing of a certificate of dissolution not
later than March 28, 2010. If our
Board decides it is in the best interests of the Company and its stockholders
to file a certificate of dissolution, it will likely do so before March 28,
2010. If the Company files a certificate
of dissolution, (1) the Companys stock transfer books will be closed and
no further stock transfers will be recognized, (2) trading of the Companys
common stock will cease and (3) and the Companys existence under Delaware
law will continue only for the limited purpose of winding up its affairs and
discharging or making provision for the discharge of its liabilities with its
creditors.
Discussion of Critical Accounting Policies and Estimates
Our
discussion and analysis of our financial condition and results of operations is
based upon our consolidated financial statements, which have been prepared in
accordance with accounting policies that are described in the notes to the
consolidated financial statements. The preparation of the consolidated
financial statements requires management to make estimates and judgments that
affect the reported amounts of assets, liabilities, revenues and expenses, and
related disclosure of contingent assets and liabilities. We continually
evaluate our judgments and estimates in determination of our financial
condition and operating results. Estimates are based on information available
as of the date of the financial statements and, accordingly, actual results
could differ from these estimates, sometimes materially. Critical accounting
policies and estimates are defined as those that are both most important to the
portrayal of our financial condition and operating results and require
managements most subjective judgments. The most critical accounting policies
and estimates are described below.
Revenue Recognition
Revenues are recorded as
earned from notes receivable. Revenues
consist of interest earned, late fees and other miscellaneous charges. Revenues are not accrued on accounts over 120
days without payment activity, unless payment activity resumes.
Notes Receivable
Notes receivable are
recorded at the historical cost paid at the date of acquisition net of any
purchase discounts. Subsequent to the date of acquisition, notes receivable are
reduced by any principal payments made by the customer. Purchase discounts are
recorded based on the negotiated difference between the face value and the
amount paid for the notes receivable. Purchase discounts are recognized as
revenue, using the effective interest method, as principal payments are
collected.
The Company
establishes an allowance for doubtful accounts for receivables where the
customer has not made a payment for the most recent 120 day period. The Company specifically analyzes notes
receivable using historical activity, current economic trends, changes in its
customer payment terms, recoveries of previously reserved notes and collection
trends when evaluating the adequacy of its allowance for doubtful accounts. Any
change in the assumptions used in analyzing a specific note receivable may
result in an additional allowance for doubtful accounts being recognized in the
period in which the change occurs. The
Company may from time to time make additional increases to the allowance based
on the foregoing factors. Once a note receivable has been reserved due to
nonpayment, the Company will no longer accrue, for financial reporting
purposes, interest earned on the note receivable. Should the note receivable
return to a performing status, then the Company will resume accruing interest
on the note receivable. The majority of the notes receivable have collateral in
various forms, which may include a second lien position on the borrowers home
or property. Actual results could differ
from those estimates. Recoveries are recorded against the allowance when
payments are received. Recoveries of
notes receivable, which were previously charged off, are recorded to income
when payments are received. Notes receivable are charged off against the
allowance after all means of collection have been exhausted and a legal
determination has been rendered that less than the full amount of the note
receivable will be collected.
Stock-Based Compensation
On December 1, 2008, our Board approved the Companys 2008 Long
Term Incentive Plan (the
2008 Plan
).
Effective September 11, 2009, the Board amended and restated the 2008 Plan
to decrease the number of shares of common stock of the Company that may be
issued under the 2008 Plan from 20,000,000 to 2,000,000. We intend to seek
stockholder ratification of the 2008 Plan, as amended, at our upcoming annual
meeting on October 27, 2009. The 2008 Plan, which is administered by the
Board, permits the grant of restricted stock, stock options and other
stock-based awards to employees, officers, directors, consultants and advisors
of the Company and its subsidiaries. The 2008 Plan provides that the
administrator of the plan may determine the terms and
23
Table of Contents
conditions
applicable to each award, and each award will be evidenced by a stock option
agreement or restricted stock agreement.
The
2008 Plan
will terminate on December 1, 2018.
In addition, on December 1,
2008 our
Board
approved the grant of 300,000 shares of restricted stock to each of Timothy S.
Durham, Robert A. Kaiser and Manoj Rajegowda. On February 24, 2009, Mr. Rajegowda
forfeited all stock issuances provided to him during the course of his Board
membership in connection with his resignation from the Board. On
March 5,
2009, our Board approved the grant of 300,000 shares of restricted stock to
David Tornek, our director who was appointed to fill the vacancy on the Board
.
Of each restricted stock grant, 100,000 shares issued
vested on the date of grant, and the remaining 200,000 of the shares issued
vest in two equal annual installments on each anniversary of the date of
grant.
The restricted stock becomes 100% vested if any of
the following occurs: (i) the participants death or (ii) the
disability of the participant while employed or engaged as a director or
consultant by the Company. The total value of the awards using a grant date
price of $0.22 per share for 600,000 shares and $0.16 for 300,000 shares is
$180,000, of which $100,000 was expensed in the nine months ended August 31,
2009, and the rest is being expensed over a two year vesting period. The 2008
Plan permits withholding of shares by the Company upon vesting to pay
withholding tax. These withheld shares are considered as treasury stock and are
available to be re-issued under the 2008 Plan.
Recent
Developments
CLST
Asset I
On November 10, 2008, our
Board unanimously approved the acquisition of all of the outstanding equity
interest of Trust I from Drawbridge Special Opportunities Fund LP through CLST
Asset I, a wholly owned subsidiary of CLST Financo, Inc. (
Financo
), which is one of
our direct, wholly owned subsidiaries through entry into a purchase agreement
to acquire all of the outstanding equity interests of Trust I from a third
party (the
Trust I Purchase Agreement
). The purchase price was approximately $41.0
million, which was financed by $6.1 million of cash on hand
and by a non-recourse, term loan of
approximately $34.9 million by
an affiliate of the seller of Trust I, pursuant to the terms and conditions set
forth in the credit agreement, dated November 10, 2008, among Trust I,
Fortress Credit Co LLC, as lender (
Fortress
),
FCC Finance, LLC (
FCC
), as the initial
servicer, the backup servicer, and the collateral custodian (the
Trust I
Credit Agreement
)
. The primary business of
Trust I is to hold and collect certain receivables.
The approximate 6,000
receivables included in CLST Asset I are all consumer home improvement, repair
and other related loans to homeowners. All loans represent loans to single
family dwellings. As of the purchase date, a approximately 63% of the loans
were secured through a second lien on the property, with the remainder being
unsecured. Approximately 89% of the
loans are in the Northeastern part of the United States with the remainder in
Texas, Georgia and Missouri, and at the time of purchase of the portfolio, the
remaining time to maturity was in a range of 8-10 years, not including
prepayments, if any.
The following table reflects the loan origination year
as of the purchase date:
Year
of origination
|
|
% of CLST Asset I
|
|
2000
2004
|
|
8.4
|
%
|
2005
|
|
8.1
|
%
|
2006
|
|
17.3
|
%
|
2007
|
|
36.4
|
%
|
2008
|
|
29.8
|
%
|
Total
|
|
100.0
|
%
|
For CLST Asset I, there were no loans originated in
2009, as this was the purchase of a historical portfolio.
CLST
Asset II
On December 12, 2008,
we, through
Trust II,
a newly formed trust wholly owned by CLST Asset II, a wholly owned subsidiary
of Financo
, entered into a purchase agreement, effective as of December 10,
2008 (the
Trust II Purchase Agreement
),
to acquire from time to time certain receivables, installment sales contracts
and related assets owned by
SSPE Investment Trust I (the
SSPE
Trust
) and SSPE,
LLC (
SSPE
)
.
The Board unanimously approved the
establishment of the Trust II and the purchase agreement.
Under the terms of a non-recourse,
revolving loan, which Trust II entered into with Summit Consumer Receivables
Fund, L.P. (
Summit
), as
originator, and SSPE and SSPE Trust, as co-borrowers, Summit and Eric J.
Gangloff, as Guarantors, Fortress Credit Corp. (
Fortress
Corp
.), as the lender, Summit Alternative Investments, LLC, as
the initial servicer, and various other parties (
Trust
II Credit Agreement
), Trust II committed to purchase
receivables of at least $2.0 million. In
conjunction with this agreement, Trust II became a co-borrower under a $50
million credit agreement that permits Trust II to use more than $15 million of
the aggregate availability under the revolving facility. Trust IIs commitment to purchase $2.0
million of receivables was fulfilled in the first quarter of 2009, when Trust
II purchased $5.8 million of receivables with an aggregate purchase discount of
$0.5 million that
24
Table of Contents
are
secured by a second mortgage or the personal property itself. These receivables
represent primarily home improvement loans originated through FCC, the service
provider of CLST Asset I.
The loans represent new originations with an
average term of 9 years and a current average interest rate of 14.7%.
Since these are new
loans, the Company has managed the originations such that almost 65% of the new
loans have credit scores higher than 680, with a portfolio average of 676. As
of June 2009, the Company is no longer originating new loans under the
credit agreement.
Approximately 54% of these loans were
secured through a second lien on the property, with the remainder being
unsecured. The loans are through the 48
mainland states with the top five concentration as follows:
State
|
|
Percentage
|
|
|
|
|
|
Michigan
|
|
23
|
%
|
Ohio
|
|
19
|
%
|
Massachusetts
|
|
7
|
%
|
Florida
|
|
5
|
%
|
Pennsylvania
|
|
5
|
%
|
During the second quarter
of 2009 we were informed by Summit that the credit facility we entered into
with Trust II, Summit and various other parties had been reduced by $20 million
to $30 million. Summit did not indicate
the specific reasons for the reduction in the credit facility other than it was
part of a negotiation with Fortress regarding a default on another Summit
portfolio. This reduction has no impact
on the Company because during the third quarter of 2009, we ceased purchasing
any new receivables under the facility and are no longer originating new loans
under the credit agreement and, as a result, the Company is no longer drawing
additional funds under the credit agreement.
Because we are no longer originating new loans under this credit
agreement, FCC is no longer providing origination services to the Company. The
origination services performed by FCC included loan documentation, collateral
documentation where applicable, credit verification, and other required
activities to secure loan approval per the Companys standards. FCC was paid a one-time fee of 2% of the
original principal amount of loans originated for performing these
services. Once a loan was approved, FCC
would perform the monthly servicing activities, which would include
collections, reporting, lock box services, customer service, and other related
services. FCC was paid 1.5%, per annum, of the outstanding principal balance
for these services. As of August 31,
2009, Trust II had an outstanding balance of approximately $5.2 million.
CLST
Asset III
Effective
February 13, 2009, we, through CLST Asset III, a newly formed, wholly
owned subsidiary of Financo, purchased certain receivables, installment sales
contracts and related assets owned by Fair Finance Company, an Ohio corporation
(
Fair
), James F.
Cochran, Chairman and Director of Fair, and Timothy S. Durham, Chief Executive
Officer and Director of Fair and an officer, director and stockholder of our
Company (the
Trust III Purchase Agreement
).
Messrs. Durham and Cochran own all of the outstanding equity of Fair. In
return for assets acquired under the Trust III Purchase Agreement, CLST Asset
III paid the sellers total consideration of $3,594,354, consisting of cash,
common stock of the Company and six promissory notes. Additionally, Fair agreed
to use its best efforts to facilitate negotiations to add CLST Asset III or one
of its affiliates as a co-borrower under one of Fairs existing lines of credit
with access to at least $15,000,000 of credit for our own purposes.
To date, we
have not been added as a co-borrower.
Substantially all of the assets acquired by CLST Asset
III are in one of two portfolios. Portfolio A is a mixed pool of receivables
from several asset classes, including health and fitness club memberships,
resort memberships, receivables associated with campgrounds and timeshares,
in-home food sales and services, buyers clubs, delivered products and home
improvement and tuitions. Portfolio B is made up entirely of receivables
related to the sale of tanning bed products. Only 2% of these portfolios are
home improvement loans and none of the loans are secured. The loans are through the 48 mainland states
with the top five concentration as follows:
State
|
|
Percentage
|
|
|
|
|
|
Ohio
|
|
17
|
%
|
Florida
|
|
8
|
%
|
Colorado
|
|
8
|
%
|
Texas
|
|
6
|
%
|
Pennsylvania
|
|
6
|
%
|
During the second
quarter of 2009 we began implementing the servicing, collection and other
procedures relating to management of CLST Asset III contemplated by the
agreements between us and the servicer of the portfolio. The implementation of
the procedures required several meetings with the servicer and were implemented
during the third quarter of 2009 with the exception
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Table of
Contents
of securing a lock box to
receive payments, which we expect to have in place during the fourth quarter of
2009. Fair is the servicer of the CLST Asset III portfolio and is an affiliate
of Mr. Durham.
Now
that the Company has acquired these receivable portfolios, most of the
activities of the Company with respect to the portfolios are conducted on its
behalf by the servicers of these portfolios.
The servicers, on behalf of the Company, receive payments from account
debtors and pursue other collection activities with respect to the receivables,
monitor collection disputes with individual account debtors, prepare and submit
claims to the account debtors, maintain servicing documents, books and records
relating to the receivables and prepare and provide reports to the lenders and
the Company with respect to the receivables and related activity, maintain the
security interest of the lenders in the receivables, and direct the collateral
custodian to make payments out of the proceeds of the portfolios to, among
others, the Company, the lenders, the servicers and/or backup servicers, and
the collateral custodians pursuant to the terms of the relevant servicing
agreements.
Subsidiaries
We
are working steadily to complete a long list of actions necessary to complete
the wind down of our historical business in an orderly fashion. Completing the wind down is a cumbersome task
that requires many steps and may take a significant amount of time. These steps
include dissolving numerous subsidiaries, resolving pending litigation and
completing various regulatory filings and other requirements. We cannot predict
how long, how time-consuming or how costly resolution of the litigation matters
will be. To date, we have completed and filed final sales tax returns and
franchise tax returns for most of our entities. We have also completed the
requirements to withdraw most of our entities from doing business in multiple
state jurisdictions in the U.S. Furthermore, we are continuing to dissolve our
foreign and domestic subsidiaries pursuant to the plan of dissolution. However,
in order to protect the Companys cash and other assets from any actual or
potential liabilities of the Companys direct and indirect subsidiaries, we
will not dissolve our inactive direct or indirect domestic or foreign
subsidiaries until the actual and contingent liabilities of each such
subsidiary have been resolved or contingency reserves have been set aside
sufficient to pay or make reasonable provision to pay all such subsidiarys
claims and obligations in accordance with applicable law. Specifically, we will
not dissolve
Audiomex
Export Corp., National Auto Center, Inc. and CLST-NAC, Ltd., which are
direct parties to, and NAC Holdings, Inc., which is an indirect party to,
the arbitration proceeding for our claim in Mexico against the purchasers of
the Mexico Sale, which is currently scheduled for October 21 and
22, 2009, until resolution of that claim.
In addition, in certain jurisdictions, the dissolution process is an
extended one.
We
completed the dissolution of our subsidiaries in the United Kingdom and
Guatemala in February 2008 and March 2009, respectively, and of
CLST-NAC Fulfillment, Ltd., a Texas limited partnership and indirect subsidiary
of the Company, in September 2009.
Furthermore, we completed the merger of CLST Fulfillment, Inc., a
Delaware corporation, into its parent, National Auto Center, Inc., a
Delaware corporation and our wholly owned subsidiary, effective September 10,
2009. In addition we have made demands on the purchaser of our former Colombian
subsidiary for the documents needed to divest our remaining minority interest
in that subsidiary. Further, we have
submitted documents to several governmental authorities in El Salvador as
required to dissolve our dormant entity in El Salvador. For our Netherlands
subsidiary, we have collected VAT tax refunds and are in the process of
preparing tax returns that are required to complete the dissolution process.
There
are a number of actions required by governmental regulations in order to
dissolve our Philippines subsidiary, and we have made substantial progress
toward its dissolution. We obtained a Formal Entry of Judgment in two
longstanding lawsuits. We have also
settled a claim for 1999 withholding tax and obtained a determination from the
Bureau of Internal Revenue that no taxes are owed on a 2004 transaction. We are now completing audits that are
required to be submitted for regulatory approval prior to dissolution, and have
taken various other actions required by the Bureau of Internal Revenue and the
Philippines Securities and Exchange Commission.
Colombia
During
the second quarter of 2009 we completed the collection of the previously written-off
receivable from the 2004 sale of our Colombia operations. During the previous quarter we collected
$61,000, representing the final payment of the original note amount of
$720,869. The note had been fully reserved and the payment received was recorded
in general and administrative expenses. We are now in the process of releasing
the 19% interest that we retained in the Colombia operation, per the terms of
the purchase agreement.
Results of Operations
The Company
reported a net loss of $1.2 million or $0.05 per basic and diluted share, for
the third quarter of 2009, compared to a net loss of $0.3 million, or $0.02 per
basic and diluted share for the same quarter last year. The increase is
primarily attributable to
26
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the costs of the actions
taken by Red Oak, which has led to the costs incurred in connection with the
Federal Court Action and State Court Action, offset slightly by the income (net
of expenses) generated by our portfolios.
The
following table shows certain information as of August 31, 2009 for each
of CLST Asset I, CLST Asset II and CLST Asset III. A more detailed description
of the results for each of these entities is provided below.
|
|
CLST Asset I
|
|
CLST Asset II
|
|
CLST Asset III
|
|
|
|
|
|
|
|
|
|
Aggregate
Outstanding Principal Balance of Receivables
|
|
$
|
35.9 million
|
|
$
|
7.7 million
|
|
$
|
2.3 million
|
|
|
|
|
|
|
|
|
|
Reserves
|
|
$
|
2.1 million
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unamortized
Purchase Discounts
|
|
$
|
0.6 million
|
|
$
|
0.7 million
|
|
$
|
0.1 million
|
|
|
|
|
|
|
|
|
|
Deferred
Acquisition Costs
|
|
$
|
0.1 million
|
|
|
|
$
|
0.1 million
|
|
|
|
|
|
|
|
|
|
Net
Receivables
|
|
$
|
33.3 million
|
|
$
|
7.0 million
|
|
$
|
2.3 million
|
|
|
|
|
|
|
|
|
|
Notes
Payable and Loans Outstanding
|
|
$
|
28.7 million
|
|
$
|
5.2 million
|
|
$
|
0.7 million
|
|
|
|
|
|
|
|
|
|
Approximate
Number of Customer Accounts
|
|
5,295
|
|
1,015
|
|
1,911
|
|
|
|
|
|
|
|
|
|
Average
Outstanding Principal Balance per Account
|
|
$
|
6,787
|
|
$
|
7,561
|
|
$
|
1,088
|
|
Three Months Ended August 31, 2009, Compared to Three Months Ended
August 31, 2008
Consolidated
Revenues
.
Revenues for the third quarter of 2009
were $1.8 million compared to zero in 2008.
The third quarter of 2009 results reflected interest and other charges
from CLST Asset I of $1.3 million, CLST Asset II of $0.4 million and CLST Asset
III of $0.1 million. There were no
revenues recorded in the third quarter of 2008.
Loan
Servicing Fees.
Loan servicing fees for the third quarter of 2009 were $231,000. There were no loan servicing fees recorded in
the third quarter of 2008. We do not incur additional servicing fees with
respect to CLST Asset III other than the initial cost of acquiring the
portfolio.
Provision
for Doubtful Accounts.
Provision for doubtful accounts for the third quarter of 2009 were
$654,000, reflecting accounts greater than 120 days past due in CLST Asset I of
$634,000 and CLST Asset II of $20,000.
CLST Asset III had no provision for doubtful accounts and any defaulted receivables
under CLST Asset III were offset per the requirement that the sellers must
jointly and severally pay CLST Asset III the outstanding balance of any
defaulted receivable, within the parameters of the Trust III Purchase
Agreement. We did not make a provision
for doubtful accounts in the third quarter of 2008.
Interest
Expense.
Interest
expense for the second quarter of 2009 was $508,000 under the credit facilities
of CLST Asset I and CLST Asset II and the notes issued in connection with the
CLST Asset III acquisition. We had no
interest expense in the second quarter of 2008.
General and Administrative Expenses
.
Our general and administrative expenses were $1.5 million for the third quarter
of 2009 compared to $0.4 million for the third quarter of 2008. This increase
is the result of increased legal and professional fees offset in part by
decreases in operating expenses, resulting from managements successful cost
cutting efforts.
Our legal and professional expenses during the third
quarter of 2009 were $1.3 million. Those
fees relate primarily to defending against claims brought by the Red Oak Group
against us and our directors in the State Court Action. We also incurred substantial professional
fees in the third quarter relating to the Federal Court Action and to our
arbitration claims against Wireless Solutions for monies we believe are due us
from the Mexico Sale. We have made a
claim under our directors and officers liability insurance policy for
reimbursement of amounts we are obligated under our certificate of
incorporation and bylaws to advance to our directors for their defense costs in
the State Court Action. Our carrier has
agreed to reimburse us for those expenses in excess of our $1 million self
retention under the policy, subject to certain reservations of rights. We expect to exceed our self retention amount
in the fourth quarter, after which point the carrier should begin to reimburse
us for amounts advanced to Messrs. Durham, Kaiser and Tornek in connection
with their defense against claims brought by the Red Oak Group. Any reimbursements received will offset the
legal expenses incurred in general and administrative
27
Table of
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expenses.
With respect to the Mexico Sale, we believe
that Wireless Solutions owes us amounts relating to the sale of our interest in
CII. Therefore, we are pursuing claims
against the buyers from the Mexico Sale in an ICC arbitration proceeding, which
is currently scheduled for
October 21 and 22, 2009
. We believe we are owed up to $1.7 million
from the Mexico Sale. In addition, the lower expenses we experienced
during the third quarter 2008 were a result of reduced staff, relocation of our
headquarters, the elimination of our 401K and benefits plans, and reduced
expenses in general.
Net
Operating Loss.
The net operating loss for the third quarter
of 2009 was a loss of $1.2 million compared to $433,000 for the third quarter
of 2008. The third quarter of 2009
includes $1.3 million of legal and professional fees, primarily due to legal
and professional fees related to the Federal Court Action and the State Court
Action, including amounts paid on behalf of our directors, and the pursuit of
claims against Wireless Solutions in connection with the Mexico Sale.
Total
Other Income
. Our total other income for the
third quarter of 2009 was $1,000, compared to $110,000 for the third quarter
2008. Virtually all of our other income is interest earned on our cash balance,
and the decrease is a result of lower interest rates due to the current U.S.
economic crisis and lower cash balances.
Income
taxes
. The
Company recorded tax expense of $9,000 for the third quarter of 2009 compared
to zero for 2008, which includes the impact of continuing and discontinued
operations.
Net Loss.
Net loss for the third quarter of 2009 was $1.2 million compared to $0.3
million for the same quarter in 2008, as interest earned on our cash last year
generated $107,000 of interest income.
The increase in net loss is primarily attributable to the costs of the
actions taken by Red Oak, which has led to the costs of approximately $1.3
million incurred in connection with the Federal Court Action and State Court
Action, offset slightly by the income (net of expenses) generated by our
portfolios.
CLST
Asset I
Trust
Is collections for the third quarter of 2009 were approximately $2.9 million,
representing $1.6 million of principal payments and $1.3 million of interest
and other charges. As of August 31,
2009, the aggregate outstanding principal balance of the notes receivables net
of reserves was $33.9 million, which represents 82.7% of the original purchase
price of $41.0 million. The ending
balance consists of approximately 5,295 customer accounts, with an average
outstanding principal balance per account of approximately $6,787. The average interest rate for these accounts
was 14.3%. Total assets of Trust I at
the end of the quarter net of reserves were $33.9 million, excluding certain
accrued interest and deferred costs.
Total
revenues for the third quarter of 2009 were approximately $1.3 million and
primarily consisted of interest income collected from the notes
receivable. Operating expenses for the
quarter were $1.3 million, which included $0.6 million provision for doubtful
accounts, $0.4 million of interest expense to Fortress, our lender, and $0.2
million of servicing expense to FCC.
As of August 31, 2009, Trust I owed $28.7
million to Fortress, representing 81.5% of the original loan amount.
When we purchased Trust I, the historical default rate for the previous
three years for the portfolio was approximately 4%, which was the basis for
assessing the creditworthiness of the assets included in CLST Asset I. During the third quarter of 2009, we have
seen the default rate increase to the 6-7% range; accordingly, we have been
increasing our allowances to reflect this change.
CLST
Asset II
Trust II had collections
of approximately $0.9 million
during the
third quarter of 2009, reflecting principal payments of $608,000 and interest
and other fees of $304,000. For the
quarter, revenues were $356,000. The
results include $20,000 of provision for doubtful accounts. Interest expense under the credit facility
was $74,000 while our servicing costs were $37,000.
Trust II did not purchase
any receivables during the third quarter of 2009.
During the quarter, Trust
II paid down the credit facility by $488,000.
As of August 31, 2009, Trust II had $7.7 million of receivables and
an outstanding balance on the credit line of over $5.2 million.
CLST
Asset III
Collections for the third
quarter of 2009 were $441,000, representing $347,000 of principal and $94,000
of interest and fees. For the quarter,
CLST Asset III also recorded revenues of $96,000, reflecting interest and other
fees collected from customers. Defaults of $46,000 during the quarter were
applied to the notes payable to the seller per our purchase agreement.
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As of August 31,
2009, our outstanding balance of receivables was $2.1 million, representing in
excess of 1,900 accounts. The average
principal balance per account was approximately $1,088.
Nine Months Ended August 31,
2009, Compared to Nine Months Ended August 31, 2008
Consolidated
Revenues
.
Our revenues for the nine months ended August 31,
2009 were $5.2 million compared to zero in 2008. The results for 2009 reflected
interest and other charges from CLST Asset I of $4.2 million, CLST Asset II of
$0.8 million and CLST Asset III of $0.2 million. There were no revenues recorded in the first
nine months of 2008.
Loan
Servicing Fees.
Loan servicing fees for the nine months ended August 31, 2009 were
$613,000. There were no loan servicing fees recorded in the first nine months
of 2008. We do not incur additional servicing fees with respect to CLST Asset
III other than the initial cost of acquiring the portfolio.
Provision
for Doubtful Accounts.
Provision for doubtful accounts for the nine months ended August 31,
2009 were $2.0 million, all of which was attributable to CLST Asset I and CLST
Asset II.
CLST
Asset III had no provision for doubtful accounts, and any defaulted receivables
under CLST Asset III were offset per the requirement that the sellers must
jointly and severally pay CLST Asset III the outstanding balance of any
defaulted receivable, within the parameters of the Trust III Purchase
Agreement. We had no provision for
doubtful accounts for the same period of 2008.
Interest
Expense.
Interest
expense for the nine months ended August 31, 2009 was $1.6 million under
the credit facilities of CLST Asset I and CLST Asset II and the notes issued in
connection with the CLST Asset III acquisition. We had no interest expense for
the same period of 2008.
General
and Administrative Expenses
. Our general and administrative expenses
were $3.8 million for the nine months ended August 31, 2009 compared to
$1.4 million for the nine months ended August 31, 2008.
This increase is the result of increased
legal and professional fees offset in part by decreases in operating expenses,
resulting from managements successful cost cutting efforts.
See also the discussion above under Three Months Ended August 31, 2009,
Compared to Three Months Ended August 31, 2008 General and
Administrative Expenses.
Total
Other Income
. Our total other income for the
nine months ended August 31, 2009 was $10,000, compared to $331,000 for
the same period in 2008. Virtually all of our other income is interest earned
on our cash balance, and the decrease is a result of lower interest rates due
to the current U.S. economic crisis and lower cash balances.
Income
taxes
. The
Company recorded a tax expense of $17,000 for the nine months ended August 31,
2009 compared to a benefit of $5,000 for 2008, which includes the impact of
continuing and discontinued operations.
Discontinued
Operations
. We
had no income from discontinued operations for the nine months ended August 31,
2009 and $10,000, net of taxes, in 2008. As discussed in Note 2 to the
Consolidated Financial Statements and Item 2. Managements Discussion and Analysis of Financial Condition and Results
of Operations Overview,
we sold our operations in the U.S., Miami, Mexico and Chile
.
CLST
Asset I
For
the nine months ended August 31, 2009, collections for Trust I were $9.0
million, representing $5.0 million of principal payments and $4.0 million of
interest and payments and other charges.
As of August 31, 2009, the aggregate outstanding principal balance
of the notes receivables net of reserves was $33.9 million, which represents
82.7% of the original purchase price of $41.0 million. The ending balance consists of approximately
5,295 customer accounts, with an average outstanding principal balance per
account of approximately $6,787
and an average FICO score of 654. The average interest rate for these accounts
was 14.3%. Total assets of Trust I at August 31,
2009 net of reserves were $34.0 million, excluding certain accrued interest and
deferred cost.
Total
revenues for the period were approximately $4.1 million and primarily consisted
of interest income collected from the notes receivable. Operating expenses for the period were $3.8
million, which included $1.9 million provision for doubtful accounts, $1.4
million of interest expense to Fortress, our lender, and $0.5 million of
servicing expense to FCC.
As of August 31, 2009, Trust I owed $28.7
million to Fortress, representing 81.5% of the original loan amount.
29
Table of
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CLST
Asset II
Year to date collections
for Trust II were $2.5 million representing $1.9 million of principal payments
and $0.6 million of interest and other charges.
Revenues for Trust II were $0.8 million for the year to date. Allowance for doubtful accounts was $20,000
for past due accounts greater than 120 days.
Interest expense under the credit facility was $184,000 and loan
servicing fees were $122,000 year to date.
For the year, Trust II
has purchased $9.6 million of customer receivables at purchase discounts
averaging 8.7%. The highest discount has
been 14.5% and the lowest has been 6.0%.
The purchases have been financed with borrowings under the credit
facility of $6.4 million, purchase discounts of $0.8 million and the balance
from Company cash. The average interest
rate to date is 14.7% and the calculated leveraged yield when the purchase
discount is taken into effect is greater than 19.0%.
CLST
Asset III
For the nine months ended
August 31, 2009, collections for CLST Asset III were $1.6 million,
representing $1.4 million of principal and $0.3 million of interest and other
fees. Total revenue for the year was
$244,000. We incurred $19,000 of
interest expense related to the sellers notes delivered as part of the purchase
price. Defaults of $170,000 during the
year were applied to the notes payable to the seller per our purchase
agreement.
Liquidity
and Capital Resources
As of August 31,
2009, we had cash and cash equivalents of approximately $5.7 million, down from
$9.8 million at November 30, 2008. Historically, we have invested our cash
and cash equivalents in either money market accounts or short term Certificate
of Deposits. All of our cash deposits
are in accounts that are federally insured. To date, we have financed our
acquisitions of our receivables portfolios with cash, non-recourse debt, and the
issuance of shares of our Common Stock, and we expect that any future portfolio
acquisition would be financed with cash on hand and cash from operations,
non-recourse debt and additional issuance of our Common Stock.
Operating Activities
. The net cash used in
operating activities for the nine months ended August 31, 2009 was $1.2
million compared to cash received of $4.4 million for the same period in 2008.
The primary reason for this decrease was the collection of $4.7 million of
accounts receivable from Brightpoint (the purchaser of our U.S. and Miami
operations) in 2008 and increased operating expenses in 2009 related to the
cost incurred in connection with the actions of Red Oak for the Federal Court
Action and State Court Action offset slightly by the income (net of expenses)
generated by our portfolios.
Our legal and professional expenses for the
nine months ended August 31, 2009 were $3.3 million. Those fees relate primarily to defending
against claims brought by the Red Oak Group against us and our directors in the
State Court Action. We also incurred
substantial professional fees in the third quarter relating to the Federal
Court Action and to our arbitration claims against Wireless Solutions for
monies we believe are due us from the Mexico Sale. We have made a claim under our directors and
officers liability insurance policy for reimbursement of amounts we are
obligated under our certificate of incorporation and bylaws to advance to our
directors for their defense costs in the State Court Action. Our carrier has agreed to reimburse us for
those expenses in excess of our $1 million self retention under the policy,
subject to certain reservations of rights.
We expect to exceed our self retention amount in the fourth quarter,
after which point the carrier should begin to reimburse us for amounts advanced
to Messrs. Durham, Kaiser and Tornek in connection with their defense
against claims brought by the Red Oak Group.
The Company has expended a significant amount of management time and
resources in connection with Federal Court Action and the State Court Action.
The Company has had settlement discussions with certain of the plaintiffs
regarding the Federal Court Action and the State Court Action. The
Company may have further settlement discussions in the future. No assurance
can be given that any settlement agreement could be reached if the Company
undertakes further discussions or if a settlement agreement is entered into
that the terms of any such settlement would not have a material adverse effect
on the Company, its financial position or its results of operations.
Investing
Activities
.
The net cash
provided by investing activities for the nine months ended August 31, 2009
was $
4.0
million
compared to cash used in 2008 of $
10,000
. The increase from 2008 to
2009 is primarily a result of the collection of portfolio principal of $
8.1
million during the nine
months ended August 31, 2009 offset in part by (i) cash of $
4.0
million used to fund the
acquisitions of
CLST
Asset II and
CLST
Asset III portfolios and (ii) $
155,000
million in acquisition costs
during the nine months ended August 31, 2009
.
Financing
Activities
. The
net cash used in financing activities for the nine months ended August 31,
2009 was $6.8 million compared to zero for the same period in 2008. The cash used in financing activities in 2009
was used to reduce the outstanding debt principal balance under both the Trust
I Credit Agreement and Trust II Credit Agreement.
30
Table of
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Liquidity Sources
.
CLST Asset I
.
Our acquisition of Trust I was financed by approximately $6.1 million of
cash on hand and by a non-recourse, term loan of approximately $34.9 million to Trust I by an affiliate of the
seller of Trust I, pursuant to the terms and conditions set forth in the Trust
I Credit Agreement. As provided in the Trust I Credit Agreement, Fair may
become the servicer if and only if there occurs an event of default by the then
current servicer and only if Fair is not then in default either as a borrower
or as a servicer under any credit facility to which Fortress or any of its
affiliates is a party and no change of control of Fair has occurred. Also, we
have the right to require the seller to repurchase any accounts, for the
original purchase price applicable to such account, that do not satisfy certain
specified eligibility requirements set out in the Trust I Purchase Agreement as
of the October 31, 2008 cut-off date. If it is discovered by a party that
a receivable account was not an Eligible Receivable as of the cut-off date of
October 31, 2008, the seller is required to repurchase such receivable
account unless such breach is remedied within thirty business days of notice of
such breach. An account is not an Eligible Receivable if, as of October 31,
2008, such receivable account is, among other things, a defaulted receivable,
subject to litigation, dispute or rights of rescission, setoff or counterclaim,
or is not subject to a duly recorded and perfected lien, the seller must
repurchase the account. For the quarterly period ended August 31, 2009,
there had not been a determination that any receivables failed to meet the
eligibility requirements set out in the Trust I Purchase Agreement. The loan matures
on November 10, 2013 and bears interest at an annual rate of 5.0% over the
LIBOR Rate (as defined in the Trust I Credit Agreement). The obligations under
the Trust I Credit Agreement are secured by a first priority security interest
in substantially all of the assets of Trust I, including portfolio collections.
An
event of default occurs under the Trust I Credit Agreement if the three-month
rolling average delinquent accounts rate exceeds 10.0% or the three-month
rolling average annualized default rate exceeds 7.0%. For the third quarter of
2009, these default rates were 6.36% and 6.99%, respectively.
As
of August 31, 2009, the outstanding balance of our term loan was $28.7
million, representing 82.2% of our original balance. We have retired approximately
$6.2 million of our obligation to Fortress, and we have paid $1.5 million in
interest expense, all from customer collections.
Under
the terms of the Trust I Credit Agreement, the net cash proceeds in any
particular month are remitted to the Company on or about the 20
th
day of the following month.
CLST Asset II
.
The
Trust II
has become a
co-borrower under a $50 million credit
agreement that permits Trust II to use more than $15 million of the aggregate
availability under the revolving facility to purchase receivables. The Trust II
Credit Agreement is effective as of December 10, 2008, and was entered
into among the Trust II, FCC, the originator, SSPE Trust and SSPE, the
co-borrowers (who are the sellers under the Trust II Purchase Agreement),
Fortress Corp., the lender, FCC, the initial servicer, Lyons Financial Services, Inc.,
the backup servicer, Eric J. Gangloff, the guarantor, and U.S. Bank National
Association, the collateral custodian.
The non-recourse revolving
facility was initially established by Summit, an affiliate of the sellers under
the
Trust II Purchase
Agreement
.
The
revolver matures on September 28, 2010. The revolver bears interest at an
annual rate of 4.5% over the LIBOR Rate (as defined in the
Trust II Credit
Agreement
). The Trust
II pays an additional fee to the co-borrowers equal to an annual rate of 0.5%
for loans attributable to the Trust II equal to or below $10 million and an
annual rate of 1.5% for loans attributable to the Trust II in excess of $10
million. In addition, a commitment fee is due to the lender equal to an annual
rate of 0.25% of the unused portion of the maximum committed amount. The
obligations under the
Trust II Credit Agreement
are secured by a first priority security interest in
substantially all of the assets of the Trust II and the co-borrowers, including
portfolio collections.
An event of default occurs under the Trust II Credit Agreement if the
three-month rolling average delinquent accounts rate exceeds 15.0% for Class A
Receivables or 30.0% for Class B Receivables, or the three-month rolling
average annualized default rate exceeds 5.0% for Class A Receivables or
12.0% for Class B Receivables. As of August 31, 2009, there was a
provision of $20,000 for customer accounts greater than 120 days past due.
Also, pursuant to
the Trust II Credit Agreement, we have the right to require the sellers to
repurchase any accounts, for the original purchase price applicable to such
account plus interest accrued thereon, that do not satisfy certain specified
eligibility requirements set out in the Trust II Credit Agreement as of the
purchase date. If it is discovered by a party that a receivable account was not
an Eligible Receivable as of the purchase date, the seller is required to
repurchase such receivable account. An account is not an Eligible Receivable
if, as of the purchase date, such receivable account is, among other things, a
defaulted receivable, a delinquent receivable, subject to litigation, dispute
or rights of rescission, setoff or counterclaim, or is not subject to a duly
recorded and perfected lien, as the terms are defined in the Trust II Credit
Agreement, the seller must repurchase the account. For the quarterly period ended August 31,
2009, there had not been a determination that any receivables failed to meet
the eligibility requirements set out in the Trust II Credit Agreement.
31
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CLST Asset III
. The consideration paid by CLST Asset
III in return for assets acquired under the Trust III Purchase Agreement, was
financed in part by the issuance of common stock and promissory notes to the
sellers. We issued
2,496,077 shares of our common stock at a
price of $0.36 per share. In addition,
we issued the sellers six promissory notes with an aggregate original stated
principal amount of $898,588 (the
Notes
), of
which two promissory notes in an aggregate original principal amount of
$708,868 were issued to Fair, two promissory notes in an aggregate original
principal amount of $162,720 were issued to Mr. Durham and two promissory
notes in an aggregate original principal amount of $27,000 were issued to Mr. Cochran.
The Notes are full-recourse with respect
to CLST Asset III and are unsecured. The three Notes relating to
Portfolio A (the
Portfolio
A Notes
) are payable in
11 quarterly installments, each consisting of equal principal payments, plus
all interest accrued through such payment date at a rate of 4.0% plus the LIBOR
Rate (as defined in the Portfolio A Notes). The three Notes relating to
Portfolio B (the
Portfolio
B Notes
) are payable in 21 quarterly installments, each
consisting of equal principal payments, plus all interest accrued through such
payment date at a rate of 4.0% plus the LIBOR Rate (as defined in the Portfolio
B Notes).
Also, we have the
right to require the seller to repurchase any accounts, for the original
purchase price applicable to such account, that do not satisfy certain
specified eligibility requirements set out in the Trust III Purchase Agreement
as of February 13, 2009. If it is discovered by a party that a receivable
account was not an Eligible Receivable as of February 13, 2009, the
closing date of the acquisition, the seller is required to repurchase such
receivable account. An account is not an Eligible Receivable if, as of February 13,
2009, such receivable account is a delinquent receivable, a defaulted
receivable subject to litigation, dispute or rights of rescission, setoff or
counterclaim, or is not subject to a duly recorded and perfected lien, the
seller must repurchase the account. For
the quarterly period ended August 31, 2009, there had not been a
determination that any receivables failed to meet the eligibility requirements
set out in the Trust III Purchase Agreement.
Additionally, the
Trust III Purchase Agreement provides that each of the sellers jointly and
severally guarantee to CLST Asset III, up to the aggregate stated principal
amount of the Notes issued to such seller, that the outstanding receivable
balance of each receivable as of the closing date will be collectible in
full. For each receivable that becomes a
defaulted receivable following the closing date, the sellers are obligated to
pay to CLST Asset III an amount equal to the outstanding receivable balance of
such receivable and CLST Asset III has the right to offset such amount against
the amount due to the seller under the promissory notes issued to the sellers
on the closing date. The aggregate amount
of each sellers guarantee obligation is limited to the aggregate stated
principal amount of the promissory note issued to such seller representing
approximately 25% of the total purchase price of the portfolio of approximately
$3.6 million. Since the principal
balance of the notes declines over time as payments are made by the Company to
the sellers, future defaulted receivables can be offset only against the then
remaining balance of the notes issued to the sellers. Any future defaults of receivables will be
offset against any remaining amounts owed the sellers pursuant to these
notes. Defaults of $170,000 during the
nine months ended August 31, 2009 were applied to the notes payable to the
sellers.
The remaining
obligation to the sellers, as of August 31, 2009, was $676,000 after
interest was accrued and delinquent receivables were recorded.
32
Table of
Contents
Asset Quality
. Our delinquency rates reflect, among
other factors, the credit risk of our receivables, the average age of our
receivables, the success of our collection and recovery efforts, and general
economic conditions. The average age of
our receivables affects the stability of delinquency and loss rates of the
portfolio. The table below contains performance information for the receivables
as of and for the quarter ended August 31, 2009. The composition of the portfolios is expected
to change over time. The future
performance of the receivables in the portfolios may be different from the
historical performance set forth below.
The table below also sets forth our aging and the aggregate delinquency
and loss experience for the accounts in the portfolios as of and for the
quarter ended August 31, 2009. The
global and economic crisis has had and could continue to have an adverse effect
on the portfolio. The current deep
economic recession and rising unemployment have contributed to the significant
increases in delinquencies for 2009 compared to historical performance. Our net losses and delinquencies may continue
to correlate with declines in the general economy and increases in
unemployment. Increases in net losses and delinquencies could continue,
particularly if conditions in the general economy further deteriorate. We cannot assure you that the future
delinquency and loss experience for the receivables will be similar to the
historical experience set forth below.
|
|
CLST Asset I
|
|
CLST Asset II
|
|
CLST Asset III
|
|
|
|
Principal
Balance
|
|
% of
Total
|
|
Principal
Balance
|
|
% of
Total
|
|
Principal
Balance
|
|
% of
Total
|
|
Receivables Aging (Principal)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current 0-30 Days
|
|
$
|
31,683,282
|
|
94.7
|
%
|
$
|
7,616,190
|
|
108.3
|
%
|
$
|
1,961,055
|
|
93.3
|
%
|
31 - 60 Days
|
|
1,175,113
|
|
3.5
|
%
|
39,435
|
|
0.6
|
%
|
40,745
|
|
1.9
|
%
|
61 - 90 Days
|
|
642,203
|
|
1.9
|
%
|
18,957
|
|
0.3
|
%
|
73,741
|
|
3.5
|
%
|
91 + 120
|
|
356,116
|
|
1.1
|
%
|
|
|
0.0
|
%
|
42,518
|
|
2.0
|
%
|
120+
|
|
2,080,683
|
|
|
|
19,836
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unamortized Purchase Discounts
|
|
(583,714
|
)
|
-1.7
|
%
|
(665,312
|
)
|
-9.5
|
%
|
(65,759
|
)
|
-3.1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Acquisition Fees
|
|
183,057
|
|
0.5
|
%
|
26,203
|
|
0.4
|
%
|
48,492
|
|
2.3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for Doubtful Accounts
|
|
(2,080,683
|
)
|
|
|
(19,836
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
33,456,057
|
|
100.0
|
%
|
$
|
7,035,473
|
|
100.0
|
%
|
$
|
2,100,792
|
|
100.0
|
%
|
An account is contractually delinquent if we do not
receive the monthly payment by the specified due date. After accounts are
delinquent for 120 days, a provision (reserve) is made for the account balance.
As of
August 31,
2009, the allowance for doubtful accounts recorded for CLST Asset I and CLST
Asset II is $2.0 million and $20,000, respectively. The allowance for CLST Asset I and CLST Asset
II is expensed in provision for doubtful accounts. For CLST Asset III,
delinquent receivables are charged against the Companys debt incurred to
acquire CLST Asset III. Defaults of
$170,000 during the nine months ended August 31, 2009 were applied to the
notes payable to the sellers.
Contractual
Obligations
. Included in accounts payable at August 31,
2009, is approximately $14.2 million associated with liabilities which accrued
in periods 2002 and earlier, and which has been in dispute since 2001. The
Company now believes that the statute of limitations on this trade payable may
have expired. The Company is reviewing these liabilities, and considering
appropriate steps to resolve them. In addition, the Company has contacted the
vendor in question several times during the second quarter of 2009 regarding
this matter with no results. The Company expects that the liabilities may be
resolved at less than the book value thereof, but can not provide assurances as
to the amount or timing of any adjustments. In the event that the Company is
able to settle the dispute with no payment, the settlement would result in $14.2
million of income to the Company for federal income tax purposes, and therefore
the deferred income tax asset will be realized.
If the Company is able to settle the dispute for any amount between $1
and $14.2 million, the deferred tax asset will be adjusted accordingly.
New
Accounting Pronouncements
In December 2007, the
Financial Accounting
Standards Board (the
FASB
)
released Statement No. 141 R, Business
Combinations (
SFAS 141R
), which
establishes principles for how the acquirer shall recognize acquired assets,
assumed liabilities and any non-controlling interest in the acquiree, recognize
and measure the acquired goodwill in the business combination, or gain from a
bargain purchase, and determines disclosures associated with financial statements.
This statement replaces SFAS 141 but retains the fundamental requirements in
SFAS 141 that the acquisition method of accounting (which SFAS 141called the
purchase method) be used for all business combinations and for an acquirer to
be identified for each business combination. The requirements of
33
Table of Contents
SFAS 141R apply to business combinations for which the
acquisition date is on or after the beginning of the first annual reporting
period beginning on or after December 15, 2008. Early application is not
permitted.
In
February 2008, the FASB issued FASB Staff Position FSP 157-2,
Effective Date of FASB Statement No. 157
(
FSP 157-2
). FSP 157-2 delayed the
effective date of SFAS 157 for all nonfinancial assets and nonfinancial
liabilities, except for items recognized or disclosed at fair value in the
financial statements on a recurring basis (at least annually), until the
beginning of the first quarter 2009. Application of SFAS 157 did not have a
material impact on our results of operations and financial position upon
adoption on January 1, 2009.
In
April 2009, the FASB issued FASB Staff Position No. FAS 107-1 and APB
28-1,
Interim Disclosures about Fair Value
of Financial Instruments
(
FSP FAS 107-1
).
FSP FAS 107-1 requires disclosures about the fair value of financial
instruments whenever a public company issues financial information for interim
reporting periods. FSP FAS 107-1 is effective for interim reporting periods
ending after June 15, 2009.
In May 2009, the FASB issued SFAS No. 165, Subsequent
Events (
SFAS 165
), which establishes
general standards of accounting for, and requires disclosure of, events that
occur after the balance sheet date but before financial statements are issued
or are available to be issued. The Company adopted the provisions of SFAS 165
as of August 31, 2009. The adoption of these provisions did not have a
significant impact on the Companys consolidated financial statements.
In
June 2009, the FASB issued SFAS 168,
The
FASB Accounting Standards Codification and the Hierarchy of Generally Accepted
Accounting Principles.
SFAS 168 identifies the FASB Accounting
Standards Codification as the authoritative source of
GAAP in the United States. Rules and interpretive
releases of the SEC under federal securities laws are also sources of
authoritative GAAP for SEC registrants. SFAS 168 is
effective for financial statements issued for interim and
annual periods ending after September 15, 2009. We do not expect adoption
to
have a material impact on our
consolidated financial statements.
From time to time,
new accounting pronouncements are issued by the FASB or other standards setting
bodies which we adopt as of the specified effective date. Unless otherwise
discussed, our management believes the impact of recently issued standards
which are not yet effective will not have a material impact on our consolidated
financial statements upon adoption.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
This information
has been omitted as our Company qualifies as a smaller reporting company.
Item 4T. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Disclosure controls and procedures are controls and procedures designed
to ensure that information required to be disclosed in our reports filed or
submitted under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the SECs rules and forms
and include controls and procedures designed to ensure that information we are
required to disclose in such reports is accumulated and communicated to
management, including our Chief Executive Officer and Chief Financial Officer,
as appropriate to allow timely decisions regarding required disclosure. Our
management, under the supervision and with the participation of our Chief
Executive Officer and Chief Financial Officer, has evaluated the effectiveness
of our disclosure controls and procedures as defined in Rules 13a-15(e) and
15(d)-15(e) promulgated under the Exchange Act, as of the end of the
period covered by this Quarterly Report on Form 10-Q/A. Based on such
evaluation, our Chief Executive Officer and Chief Financial Officer has
concluded that, as of the end of the period covered by this Quarterly Report on
Form 10-Q/A, our disclosure controls and procedures are not effective
because we failed to include a clear conclusion with respect to the
effectiveness of the Companys internal control over financial reporting in the
Managements Report on Internal Control Over Financial Reporting in our
Original Form 10-Q. We remedied this failure in the effectiveness of our
disclosure controls and procedures by amending our Original Form 10-Q to
include a clear conclusion regarding the effectiveness of the Companys
internal control over financial reporting. We have implemented additional
controls and procedures designed to ensure that the disclosure provided by the
Company meets the then current requirements of the applicable filing made under
the Exchange Act.
Changes in Internal Control over Financial Reporting
We have implemented
additional controls and procedures designed to ensure that the disclosure
provided by the Company meets the then current requirements of the applicable
filing made under the Exchange Act. To
address the Companys lack of adequate segregation of duties around check
writing, the Company hired an accountant beginning in January 2009. The
new accountant participates in the duties around check writing and the review
of financial reports for reasonableness.
To address the
34
Table of
Contents
Companys lack of
sufficient accounting technical expertise, during 2009, the Company brought in
additional accounting technical expertise as needed. There have been no changes in our internal
control over financial reporting during the three months ended
August
31, 2009 that have materially affected,
or are reasonably likely to materially affect, our internal control over
financial reporting. The significant deficiencies reported in our Annual Report
on Form 10-K/A for the fiscal year ended November 30, 2008, continue
to exist. However, in September 2009 the Company decided to separate the
Chief Executive Officer role from the Chief Financial Officer role and began a
search for a Chief Financial Officer. On
January 8, 2010, the Board of Directors elected William E. Casper as Vice
President, Chief Financial Officer and Treasurer of the Company, subject to his
acceptance of those positions. On January 18,
2010, Mr. Casper accepted these positions and was appointed Vice
President, Chief Financial Officer and Treasurer of the Company. Mr. Casper replaces Robert A. Kaiser in
these positions. Mr. Kaiser
continues to serve as the Companys Chief Executive Officer.
PART II
OTHER INFORMATION
Item 1. Legal Proceedings
In December 2008,
the Red Oak Group, by a telephone call from David Sandberg to Robert Kaiser,
approached our Board about its interest in making a minority investment in the
Company and obtaining control of the Company. Our Board responded by suggesting
that the Red Oak Group and the Company discuss the Red Oak Groups desire to
make a minority investment and obtain control after the Company had filed its
annual report with the SEC and made its results of operations available to
stockholders. On January 15, 2009, the Red Oak Group acquired 5,000
shares of our common stock in secondary market and privately negotiated
transactions. On or about January 30, 2009, the Red Oak Group
requested that the Company provide a stockholder list and security position
listings which it said it would use to make a tender offer. On February 3,
2009, the Red Oak Group announced its plan to commence a tender offer to
acquire up to 70% of our outstanding shares of common stock at $0.25 per
share. On February 5, 2009, we adopted a stockholder rights plan
which became effective on February 16, 2009. Stating as its reason
the Companys Rights Plan, the Red Oak Group announced on February 9, 2009
that it had abandoned its intention to make a tender offer. Nevertheless,
the Red Oak Group continued through February 13, 2009 to acquire shares of
our common stock in the secondary market and privately negotiated transactions
resulting in its beneficial ownership of 4,561,554 shares of our common stock,
according to the Red Oak Groups Schedule 13D filed with the SEC, representing
approximately 19.05% of our outstanding common stock as of the record date. The
Red Oak Group made its purchases of our common stock in open-market and
privately negotiated transactions, and not by means of tender offer materials
filed with the SEC. The Company alleges in the Federal Court Action discussed
below that by doing so, the Red Oak Group unlawfully deprived our stockholders
of the benefits of federal law regulating tender offers and such accumulations
of common stock. Among the consequences of this course of action is that
the Company and third parties were unable to make competing, superior proposals
to stockholders, and stockholders were deprived of the information that
complying with federal tender offer rules requires they receive.
On February 13,
2009, we filed a lawsuit in the United States District Court for the Northern
District of Texas against Red Oak Fund, L.P., Red Oak Partners, LLC, and David
Sandberg (the
Federal
Court Action
). Our Original Complaint and Application for
Injunctive Relief alleges that Red Oak Fund, L.P., Red Oak Partners, LLC, and
David Sandberg have engaged in numerous violations of federal securities laws
in making purchases of our common stock and sought to enjoin any future
unlawful purchases of our stock by them, their agents, and persons or entities
acting in concert with them. We believe the Red Oak Group violated federal
securities laws as follows:
(i)
violating Rule 14(e)-5 of the
Exchange Act by not truly abandoning its tender offer and instead directly or
indirectly purchasing or arranging to purchase shares not in connection with
its tender offer and without complying with the procedural, disclosure and
anti-fraud requirements applicable to tender offers regulated under Section 14
of the Exchange Act;
(ii)
violating Exchange Act Rule 14d-5(f) by
failing to return the Companys stockholder list, which we provided to Red Oak
upon its request, and by using such list for a purpose other than in connection
with the dissemination of tender offer materials in connection with its tender
offer;
(iii)
violating Exchange Act Rule 14(d)-10 by
purchasing shares pursuant to its tender offer at varying prices rather than
paying consideration for securities tendered in the tender offer at the highest
consideration paid to any stockholder for securities tendered; and
(iv)
violating Section 13(d) of the
Exchange Act by not timely filing a Schedule 13D and disclosing the information
required therein.
35
Table of
Contents
On March 2, 2009,
certain members of the Red Oak Group and Jeffrey S. Jones (
Jones
) filed a
derivative lawsuit against Robert A. Kaiser, Timothy S. Durham, and David
Tornek in the 134th District Court of Dallas County, Texas (the
State Court Action
).
The petition alleges that Messrs. Kaiser, Durham, and Tornek entered into
self-dealing transactions at the expense of the Company and its stockholders
and violated their fiduciary duties of loyalty, independence, due care, good
faith, and fair dealing. The petition asks the Court to order, among other
things, a rescission of the alleged self-interested transactions by Messrs. Kaiser,
Durham, and Tornek; an award of compensatory and punitive damages; the removal
of Messrs. Kaiser, Durham, and Tornek from the Board; and that the Company
hold an Annual Meeting of stockholders, or that the Company appoint a
conservator to oversee and implement the dissolution plan approved by
stockholders in 2007.
On March 13, 2009,
we announced that we would hold our Annual Meeting of Stockholders on May 22,
2009 in Dallas, Texas, and that the close of business on April 2, 2009
would be the record date for the determination of stockholders entitled to
receive notice of, and to vote at, the Annual Meeting or any adjournments or
postponements thereof.
On March 18, 2009,
the Red Oak Group sent a letter to us demanding to inspect and copy certain of
our books and records. We have taken the position that the Red Oak Group
has not complied with state law requirements applicable to stockholders seeking
such information.
On March 19, 2009,
the Red Oak Group sent a letter to us stating its intention to put forth
several precatory proposals including stockholder votes for: approval to
proceed with the 2007 shareholder-approved plan of dissolution; approval of the
November 10, 2008 transaction whereby CLST Asset I, LLC, a wholly owned
subsidiary of Financo, entered into a purchase agreement to acquire all of the
outstanding equity interests of Trust I from a third party for approximately
$41.0 million; approval of the 2008 Long Term Incentive Plan pursuant to which
the Board approved the new issuance to themselves of up to 20 million shares of
common stock, or just over 97% of the common stock outstanding at the time this
plan was approved; approval of the December 12, 2008 transaction whereby
Trust II, a newly formed trust wholly owned by CLST Asset II, a wholly owned
subsidiary of Financo entered into a purchase agreement, effective as of December 10,
2008, to acquire (i) on or before February 28, 2009 receivables of at
least $2 million, subject to certain limitations and (ii) from time to
time certain other receivables, installment sales contracts and related assets;
and approval of the February 13, 2009 transaction whereby CLST Asset III,
a newly formed, wholly owned subsidiary of Financo, which is one of CLSTs
direct, wholly owned subsidiaries, purchased certain receivables, installment
sales contracts and related assets owned by Fair, which is partly owned by
Timothy S. Durham, an officer and director of CLST. On the same day, the Red
Oak Group sent a letter to us stating its intention to nominate a slate of
directors to our Board.
On April 6, 2009, we
notified the Red Oak Group that our Board rejected the Red Oak Groups
nominations for Class I and Class II seats, as the nominations were
not in accordance with our certificate of incorporation. In addition, we
also rejected the Red Oak Groups proposals because they were not proper in
form or substance under federal and state law to come before an Annual
Meeting. We offered to discuss the Red Oak Groups concerns, director
nominations, and stockholder proposals provided that (1) the Red Oak Group
and the Company enter into a confidentiality and standstill agreement, (2) the
Red Oak Group appropriately make publicly available disclosures regarding its
rapid accumulation of the Companys shares and its intentions to acquire
control of the Company that are required by the federal securities laws,
including in a Report on Schedule 13D, and (3) the Red Oak Group not vote
the shares that the Company believes it to have acquired in violation of
applicable law, including the tender offer rules and other rules regulating
such accumulation of shares under the federal securities laws, at the Annual
Meeting.
On April 6, 2009, we
filed our First Amended Complaint and Application for Injunctive Relief in the
Federal Court Action against defendants Red Oak Fund, L.P., Red Oak Partners,
LLC, David Sandberg, Pinnacle Partners, LLC, Pinnacle Fund LLLP, and Bear
Market Opportunity Fund, L.P. alleging the same and other violations of federal
securities laws, including:
(i)
filing a materially false and misleading
Schedule 13D and failing to amend the same after delivering to the Company a
Notice of Director Nominations and proposal for business at the Annual Meeting;
(ii)
violating Section 14(d) of the
Exchange Act by engaging in fraudulent, deceptive and manipulative acts in
connection with its tender offer by failing to abide by Section 14(d)s
timing requirements and by failing to make required filings with the SEC; and
(iii)
that any attempt to solicit proxies from our
stockholders with respect to director nominations or notice of business would
be misleading in light of the defendants illegal activities in accumulating
Company stock.
Through this lawsuit, we
seek to obtain various declaratory judgments that the defendants have failed to
comply with federal securities laws and to enjoin the defendants from, among
other things, further violating federal securities laws and from voting any and
all shares or proxies acquired in violation of such laws. Also on April 6,
2009, because, among other reasons, we do not expect the litigation, which
bears directly upon our Annual Meeting of stockholders, to be resolved for some
months, our Board postponed the
36
Table of
Contents
Annual Meeting of
stockholders previously scheduled for May 22, 2009 until September 25,
2009. On August 14, 2009, our Board again postponed the Annual Meeting of
stockholders from September 25, 2009 to October 27, 2009.
On April 15, 2009,
the Red Oak Group submitted another letter to the Company, providing additional
information regarding the stockholder proposals it intends to bring before the
Annual Meeting and revising those proposals to: request the Board to complete
the dissolution approved at the stockholder meeting held in 2007; advise the
Board that the stockholders do not approve of the transaction purportedly
entered into as of November 10, 2008 whereby CLST Asset I, a wholly owned
indirect subsidiary of the Company, entered into a purchase agreement to
acquire the outstanding equity interest in Trust I and request the directors to
take any available and appropriate actions; disapprove the 2008 long term
incentive plan adopted by the Board and request the Board not to issue any
additional share grants or option grants under such plan and request that the
directors rescind their approval of such plan; advise the Board that the
stockholders disapprove of the transaction purportedly entered into as of December 12,
2008 pursuant to which CLST Asset II, an indirect wholly owned subsidiary of
the Company, entered into a purchase agreement to acquire certain receivables
on or before February 28, 2009 and request the directors to take any
available and appropriate actions; and advise the Board that the stockholders
disapprove of the transaction purportedly entered into as of February 13,
2009 whereby CLST Asset III, an indirect wholly owned subsidiary of the Company
purchased certain receivables, installment contracts and related assets owned
by Fair and request the directors to take any available and appropriate
actions.
On April 30, 2009,
the Red Oak Group and Jones amended their petition in the State Court
Action. In addition to the relief already requested, the petition sought
to compel the Company to hold its 2008 and 2009 annual stockholders meetings
within sixty days; to enjoin Messrs. Kaiser, Durham, and Tornek from any
interference or hindrance of such meetings or the election of directors; to
enjoin Messrs. Kaiser, Durham, and Tornek from voting any shares of stock
acquired in the alleged self-interested transactions; and to appoint a special
master. On June 3, 2009 and again on June 12, 2009, pursuant to
court order, Red Oak Partners, LLC, Pinnacle Fund, LLLP, Red Oak Fund, LP, and
Jeffrey S. Jones amended their petition in the State Court Action to, among
other things, remove Bear Market Opportunity Fund, L.P. as a plaintiff and add
Red Oak Fund, L.P. as a plaintiff.
On May 5, 2009, the
Red Oak Group and Jones filed a motion in the State Court Action seeking to
compel the Company to hold its 2008 and 2009 stockholders meetings on June 30,
2009 and to appoint a special master and requested an expedited hearing on
both. Hearings were held on May 8, 2009 and May 29, 2009, but
no ruling was reached.
On July 24, 2009, we
filed our Brief in Support of Application for Preliminary Injunction in the
Federal Court Action. The Red Oak Group filed its Opposition on August 7,
2009, and we filed our Reply Brief in Support on August 14, 2009.
On August 24, 2009,
the Red Oak Group resubmitted its director nomination letter and its letter
stating its intention to put forth the stockholder proposals, as mentioned in
the March 19, 2009 and April 15, 2009 letters.
On August 25, 2009,
the Court in the State Court Action set an evidentiary hearing on the
plaintiffs Application for Temporary Injunction, which had yet to be filed,
for October 7 and 8, 2009. The plaintiffs request for injunctive relief
concerned Messrs. Kaiser, Durham, and Tornek voting any shares of stock
acquired in the alleged self-interested transactions.
On August 28, 2009,
the parties to the State Court Action executed a Stipulation Regarding the
Companys Annual Meeting of Stockholders (
Stipulation
). The Court approved the
Stipulation the same day and entered an Order identical to the Stipulations
terms. Pursuant to the Stipulation, absent a determination by the Court
of good cause shown, the Company must hold its annual stockholders meeting for
the election of one Class I director and one Class II director and
consideration of any properly submitted proposals that are proper subjects for
consideration at an annual meeting on October 27, 2009, with a record date
for that meeting of September 25, 2009. Good cause for delaying the
Annual Meeting beyond October 27, 2009, and correspondingly amending the September 25,
2009 record date, includes among other things, situations where reasonable
delay is necessary: (1) for the Board to avoid breaching any of their
fiduciary duties to the Company or the Companys stockholders; (2) to
assure compliance with the Companys certificate of incorporation and bylaws; (3) for
the Company or the Board to comply with state or federal law; or (4) to
assure compliance with any order of any court or regulatory authority having
jurisdiction over the Company or members of its Board.
We received a letter
dated September 22, 2009 from the Red Oak Group seeking, pursuant to Section 220
of the Delaware General Corporation Law, to inspect the books and records of
the Company, including among other things a stockholder list as of the record
date. The letter states that the purpose of such request is to enable the Red
Oak Group to solicit proxies to elect directors at the 2009 Annual Meeting and
to communicate with stockholders. Our counsel responded by letter dated September 30,
2009 that the Company was aware of its obligations under Section 220 of
the Delaware General Corporation Law but believed that the demand letter did
not comply with the inspection requirements under Section 220. We received
another letter dated September 29, 2009 from the Red Oak Group pursuant to
Section 220 of the Delaware General Corporation Law in which the Red Oak
Group requests to inspect the books and records of the Company pertaining to,
among other things, all analyses performed with respect to our net operating
losses and a list of all business ventures and dealings Messrs. Tornek and
Durham have evaluated or commenced in the past
37
Table of
Contents
ten years and a list of
all investments they currently share. Our counsel responded by letter dated October 6,
2009 that (i) the commencement of the Red Oak Groups derivative action
bars it from using a Section 220 demand as a substitute for discovery
permissible in litigation; (ii) the stated purposes of the demand letter
do not constitute proper purposes under Section 220; and (iii) the
scope of information requested in the demand letter is overly broad and not
limited to books and records that are essential and sufficient to accomplish
the Red Oak Groups stated purposes.
The evidentiary hearing
for the State Court Action was held October 7 and 8, 2009. On October 9,
2009, the Court denied Plaintiffs application for injunctive relief, which
sought to enjoin Messrs. Kaiser, Durham, and Tornek from voting certain
shares at the CLST annual shareholders meeting currently scheduled for October 27,
2009. Further, the Court granted Defendants plea to the
jurisdiction, granted Defendants motion to disqualify Plaintiffs, and
dismissed Plaintiffs derivative claims. Beyond that, the Court granted
Defendants amended motion to stay, thereby staying all remaining direct claims
asserted by Plaintiffs. Defendants motion to disqualify Plaintiffs
was based on Plaintiffs lack of adequacy to pursue derivative claims on the
following grounds: (1) that Red Oak improperly brought derivative claims
to advance its own personal interests; (2) that Red Oak had engaged in
illegal conduct by violating federal securities laws; and (3) that Jones
was only a tag-along plaintiff and therefore suffered the same adequacy
problems as Red Oak, the driving force behind the State Court Action. The
Court reached each of these rulings after the two-day evidentiary hearing.
On October 14, 2009,
the Court denied the Companys application for preliminary injunction in the
Federal Court Action. The Federal Court Action remains pending.
On October 15, 2009,
we applied to the Court, on an emergency basis, for an order to: (1) reopen
this case for the limited purpose of modifying the Courts Order Regarding
Annual Meeting of Stockholders entered on August 28, 2009 (the
Annual Meeting Order
); (2) modify
its Annual Meeting Order to prevent CLST from alternatively being in violation
of (a) federal securities law, Delaware statutory law, and its Bylaws or (b) the
Annual Meeting Order; (3) nullify the current September 25, 2009
record date; and (4) grant an emergency hearing as soon as possible.
A hearing was held on CLSTs emergency motion on October 16, 2009.
The Court continued the hearing until a time agreeable to the parties and the
Court on or before October 26, 2009.
The Company has expended
a significant amount of management time and resources in connection with
Federal Court Action and the State Court Action. The Company has had settlement
discussions with certain of the plaintiffs regarding the Federal Court Action
and the State Court Action. The Company may have further settlement
discussions in the future. No assurance can be given that any settlement
agreement could be reached if the Company undertakes further discussions or if
a settlement agreement is entered into that the terms of any such settlement
would not have a material adverse effect on the Company, its financial position
or its results of operations.
Item 1A. Risk Factors
We
are party to securities and derivative litigation that distracts our management,
is expensive to conduct and seeks damage awards against us.
On
February 13, 2009, we filed a lawsuit, the Federal Court Action, against
the Red Oak Group alleging that the defendants have engaged in numerous
violations of federal securities laws in making purchases of our common stock
and sought to enjoin any future unlawful purchases of our stock by them, their
agents, and persons or entities acting in concert with them.
On March 2, 2009, certain of our
stockholders, including the Red Oak Group, have filed a derivative action, the
State Court Action, alleging that
Messrs. Kaiser, Durham,
and Tornek entered into self-dealing transactions at the expense of the Company
and its stockholders and violated their fiduciary duties of loyalty, independence,
due care, good faith, and fair dealing.
While we have directors and officers liability
insurance, it is uncertain whether the insurance will be sufficient to cover
all damages, if any, that we may be required to pay under the State Court
Action. In addition, both lawsuits have distracted the attention of our
management and are expensive to conduct. Our Board and management have expended
a substantial amount of time in connection with these matters, diverting
resources and attention that would otherwise have been directed toward our
portfolios of receivables, our plan of dissolution and other important
matters. We have incurred substantial
legal and other professional service costs in connection with these lawsuits,
approximately $2.1 million as of August 31, 2009. We expect to continue to
spend additional time and incur additional professional fees, expenses and
other costs with respect to the Federal Court Action and State Court Action,
all of which could have a material adverse effect on our business, financial
condition and results of operations.
We
are subject to certain default provisions under our loan agreements related to
the acquisitions by CLST Asset I and CLST Asset II that may be triggered by
events over which we have no control, and the assets of CLST Asset I and CLST
Asset II may be foreclosed upon; furthermore, the credit facility that CLST
Asset II currently has access to has been reduced and will expire in September 2010.
38
Table of
Contents
CLST Asset I
The loan obligations of
Trust I under the Trust I Credit Agreement are secured by a first priority
security interest in substantially all of the assets of Trust I, including
portfolio collections. The loan is a non-recourse term loan. The Trust I Credit Agreement contains
customary covenants and events of default for facilities of its type, including
among other things, limitations on the delinquent accounts rate and default
rates of the notes receivable accounts, as more fully described in Footnote 4
of the notes to the consolidated financial statements. A copy of the Trust I Credit Agreement was
filed as an exhibit to the Companys Current Report on Form 8-K filed
November 17, 2008, as amended to date.
If an event of default
occurs under the Trust I Credit Agreement, whether or not the default is
material to the loan as a whole, the lender has various remedies, including
among other things, raising the interest rate payable on the loan and
accelerating all of the obligations of Trust I under the Trust I Credit
Agreement, which would cause the entire remaining outstanding principal balance
plus accrued and unpaid interest and fees to be declared immediately due and
payable.
In addition, the Company
has no control over the delinquency or default rates of the notes receivable
accounts now held by Trust I. An event of default occurs if the three-month
rolling average delinquent accounts rate exceeds 10.0% or the three-month
rolling average annualized default rate exceeds 7.0%. On October 16, 2009, we received a
notice of default from Fortress stating that an event of default has occurred
and is continuing under the Trust I Credit Agreement. The Fortress notice
states that the three-month rolling average annualized default rate of the
Trust I portfolio has exceeded 7.0%. As a result of the default, pursuant to
the Trust I Credit Agreement, the interest rate payable by Trust I has
increased by an additional 2% per annum, and Fortress is entitled to foreclose
on the assets of Trust I and sell them to satisfy amounts due it under the
Trust I Credit Agreement. Fortress has
not yet sought to foreclose on the assets of Trust I, however, if it does so,
the Company may lose some or all of its investment in Trust I.
CLST
Asset II
Trust
II is a party to a non-recourse, revolving loan agreement between Trust II,
Summit,
SSPE and SSPE
Trust, as co-borrowers, Summit and Eric J. Gangloff, as Guarantors, Fortress
Corp., as the lender, and Summit Alternative Investments, LLC, as the initial
servicer
, pursuant to which Trust II purchased
$9.6 million of receivables with an aggregate purchase
discount of $0.8 million during the six months ended May 31, 2009
. In conjunction with this loan agreement,
Trust II borrowed $3.7 million to purchase the consumer receivables and became
a co-borrower under the Trust II Credit Agreement that permits Trust II to use
more than $15 million of the aggregate availability under the revolving
facility. A copy of the Trust II Credit Agreement was filed as an Exhibit to
the Companys Current Report on Form 8-K filed December 19, 2008, as
amended to date.
Advances
under the revolver are limited to an amount equal to, net of certain
concentration limitations set forth in the Trust II Credit Agreement, (a) the
lesser of (1) the product of 85% and the purchase price being paid for
eligible receivables with a credit score greater than or equal to 650 (
Class A Receivables
) or
(2) the product of 80% and the then-current aggregate balance of principal
and accrued and unpaid interest outstanding for Class A Receivables plus (b) the
lesser of (1) the product of 75% and the purchase price being paid for
eligible receivables with a credit score less than 650 (
Class B Receivables
) or
(2) the product of 50% and the then-current aggregate balance of principal
and accrued and unpaid interest outstanding for Class B Receivables.
During the second quarter of 2009 we were informed by
Summit that the credit facility we entered into with Trust II, Summit and
various other parties had been reduced by $20 million to $30 million. Summit did not indicate the specific reasons
for the reduction in the credit facility other than it was part of a
negotiation with Fortress regarding a default on another Summit portfolio. This reduction has no impact on the Company
because during the third quarter of 2009, we ceased purchasing any new
receivables under the facility and are no longer originating new loans under
the credit agreement and, as a result, the Company is no longer drawing
additional funds under the credit agreement.
Because we are no longer originating new loans under this credit
agreement, FCC is no longer providing origination services to the Company. The
origination services performed by FCC included loan documentation, collateral
documentation where applicable, credit verification, and other required
activities to secure loan approval per the Companys standards. FCC was paid a one-time fee of 2% of the
original principal amount of loans originated for performing these
services. Once a loan was approved, FCC
would perform the monthly servicing activities, which would include
collections, reporting, lock box services, customer service, and other related
services. FCC was paid 1.5%, per annum, of the outstanding principal balance
for these services. As of August 31,
2009, Trust II had an outstanding balance of approximately $5.2 million.
The
Trust II Credit Agreement contains customary covenants and events of default
for facilities of its type, including among other things, limitations on the
delinquent accounts rate and default rates of the consumer receivable accounts,
as more fully described in Footnote 4 of the notes to the consolidated
financial statements. If an event of
default occurs, whether or not the default is material to the loan as a whole,
the lender has various remedies, including among other things, raising the
interest rate payable on the loan and accelerating all of Trust IIs
obligations under the Trust II Credit Agreement, which would cause the entire
remaining outstanding principal balance plus accrued and unpaid interest and
fees to be declared immediately due and payable.
39
Table of
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Furthermore,
the Company has no control over the delinquency or default rates of the
consumer receivable accounts that the Trust II acquires. An event of default occurs if the three-month
rolling average delinquent accounts rate exceeds 15.0% for Class A
Receivables or 30.0% for Class B Receivables, or the three-month rolling
average annualized default rate exceeds 5.0% for Class A Receivables or
12.0% for Class B Receivables. As of May 31, 2009, there were no
defaulted receivables. There can be no assurance that these delinquency or
default rates will not result in an event of default for Trust II, which would
allow the lender to, among other things, raise the interest rate payable on the
loan, accelerate all of Trust IIs obligations under the Trust II Credit
Agreement, and sell all the assets of Trust II to satisfy the amounts due.
On December 15,
2009, we received a notice of default from Fortress stating that a servicer
default has occurred and is continuing under the Trust II Credit Agreement, as
a result of a material adverse effect with respect to the servicer. The Fortress notice states that Fair, in its
capacity as a sub-servicer for assets held by the SSPE Trust, has failed to
perform its servicing duties with respect to that portion of the receivables
portfolio owned by SSPE Trust for which Fair has been retained as a
sub-servicer by the SSPE Trust. This
failure, the Fortress notice asserts, results from the ongoing federal investigation
of Fair and Timothy Durham, and constitutes a material adverse effect with
respect to the servicer and thus a breach of a covenant under the Trust II
Credit Agreement. Fair is not a
sub-servicer for receivables purchased by Trust II. However, Trust II is a co-borrower with SSPE
Trust under the Trust II Credit Agreement, and all of its assets are pledged to
secure obligations to Fortress under the Trust II Credit Agreement. If a default in the covenants has occurred
under the Trust II Credit Agreement, the interest rate payable by Trust II may
be increased by an additional 2% per annum, and Fortress will be entitled to
accelerate and declare immediately due all of Trust IIs obligations under the
Trust II Credit Agreement. In addition,
if a default under the Trust II Credit Agreement exists and is continuing,
Fortress is entitled to foreclose on the assets of Trust II and sell them to
satisfy amounts due it under the Trust II Credit Agreement. Fortress has not yet sought to foreclose on
the assets of Trust II, however, if it does so, the Company may lose some or
all of its investment in Trust II.
The Company
continues to evaluate the circumstances and applicable information and has not
formed an opinion as to whether a default under the Trust II Credit Agreement
has occurred and remains uncured. The
negotiations, to prevent the foreclosure on the assets in the trust, between
Fortress and the Company are ongoing. With regards to Trust I, the Company has
discovered that a number of receivables purchased were ineligible at the time
of purchase. The Company has notified Fortress that approximately $2.2 million
of the accounts purchased, were by definition not eligible receivables at the
time of their purchase. Of the ineligible receivables purchased, approximately
$680,000 have become defaulted receivables. The Company believes that if the
ineligible accounts are excluded from the calculations, no event of default is
likely to have occurred as of September 2009. The Companys discussions with Fortress are
ongoing and the Company cannot predict when or if these matters will be
resolved favorably or at all.
For other risk factors,
please refer to Item 1A, Risk Factors, of our Annual Report on Form 10-K/A
for the fiscal year ended November 30, 2008.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
We did
not submit any matters to a vote of security holders in the third quarter of
2009.
Item 5. Other Information
On
July 31, 2009, October 9, 2009 and November 20, 2009, the
Company received comment letters from the staff of the Division of Corporation
Finance of the SEC. The comments from the staff were issued with respect to its
review of our Annual Report on Form 10-K/A for the year ended November 30,
2008 and review of our Quarterly Report on Form 10-Q/A for the quarterly
period ended May 31, 2009. The Company has included its proposed
additional disclosures in this Form 10-Q/A in its response to the SECs
comment letters.
40
Table of Contents
Item 6. Exhibits
Exhibit
No.
|
|
Description
|
|
Previously filed as an Exhibit and
Incorporated by Reference From
|
3.1
|
|
Amended and Restated
Certificate of Incorporation of CellStar Corporation (the Certificate of
Incorporation).
|
|
Previously filed as an
exhibit to our companys Quarterly Report on Form 10-Q for the quarter
ended August 31, 1995, and incorporated herein by reference.
|
|
|
|
|
|
3.2
|
|
Certificate of
Amendment to Certificate of Incorporation.
|
|
Previously filed as an
exhibit to our companys Quarterly Report on Form 10-Q for the quarter
ended May 31, 1998, and incorporated herein by reference.
|
|
|
|
|
|
3.3
|
|
Certificate of
Amendment to Certificate of Incorporation dated as of February 20, 2002.
|
|
Previously filed as an
exhibit to our companys Annual Report Form on Form 10-K for the
fiscal year ended November 30, 2002 and incorporated herein by
reference.
|
|
|
|
|
|
3.4
|
|
Certificate of
Amendment to the Amended and Restated Certificate of Incorporation dated as
of March 30, 2007.
|
|
Previously filed as an
exhibit to our companys Quarterly Report on Form 10-Q for the quarter
ended May 31, 2007, and incorporated herein by reference.
|
|
|
|
|
|
3.5
|
|
Amended and Restated
Bylaws of CellStar Corporation, effective as of May 1, 2004.
|
|
Previously filed as an
exhibit to our Quarterly Report on Form 10-Q for the quarter ended
May 31, 2004, and incorporated herein by reference.
|
|
|
|
|
|
4.1
|
|
Rights
Agreement, dated as of February 13, 2009, by and between CLST
Holdings, Inc. and Mellon Investor Services LLC, as rights agent.
|
|
Previously filed as an
exhibit to a
Form 8-A filed with the Securities and
Exchange Commission on February 13, 2009
, and incorporated herein by reference.
|
|
|
|
|
|
4.2
|
|
Certificate
of Designation of Series B Junior Preferred Stock of CLST
Holdings, Inc., dated as of February 5, 2009.
|
|
Previously filed as an
exhibit to a
Current Report on Form 8-K filed with the
Securities and Exchange Commission on February 6, 2009
, and incorporated herein by reference.
|
|
|
|
|
|
10.1
|
|
CLST
Holdings, Inc. Amended and Restated 2008 Long Term Incentive Plan.
|
|
Previously filed as
Annex B to our Preliminary Proxy Statement on Schedule 14A filed with the
Securities and Exchange Commission on September 11, 2009, as amended,
and incorporated herein by reference.
|
|
|
|
|
|
31.1
|
|
Certification of the
Chief Executive Officer pursuant to Rule 13a-14(a) promulgated
under the Securities Exchange Act of 1934, as amended.
|
|
Filed herewith.
|
|
|
|
|
|
31.2
|
|
Certification of the
Chief Financial Officer pursuant to Rule 13a-14(a) promulgated
under the Securities Exchange Act of 1934, as amended.
|
|
Filed herewith.
|
|
|
|
|
|
32.1
|
|
Certification of the
Chief Executive Officer and Chief Financial Officer pursuant to
Rule 13a-14(b) promulgated under the Securities Exchange Act of
1934, as amended, and 18 U.S.C. Section 1350.
|
|
Filed herewith.
|
Management
contract, compensatory plan or arrangement.
41
Table of
Contents
Signatures
Pursuant to the
requirements of the Securities Exchange Act of 1934, as amended, the Registrant
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
CLST HOLDINGS, INC.
By:
|
/s/
Robert
A. Kaiser
|
|
Robert A. Kaiser
|
|
Chief Executive
Officer and President
|
|
|
|
|
|
By:
|
/s/
William
E. Casper
|
|
William E.
Casper
|
|
Chief Financial
Officer
|
|
January 29,
2010
42
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