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Section 1: 10-Q (FORM 10-Q)

atlc20190319_10q.htm
 

 

Table of Contents

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

  

FORM 10-Q

 

For the quarterly period ended March 31, 2019

 

of

ATLANTICUS HOLDINGS CORPORATION

 

a Georgia Corporation

IRS Employer Identification No. 58-2336689

SEC File Number 0-53717

 

Five Concourse Parkway, Suite 300

Atlanta, Georgia 30328

(770) 828-2000

 

Atlanticus’ common stock, no par value per share, is registered pursuant to Section 12(b) of the Securities Exchange Act of 1934 (the “Act”) and is listed on the NASDAQ Global Select Market under the symbol “ATLC”.

 

Atlanticus (1) has filed all reports required to be filed by Section 13 of the Act during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days.

 

Atlanticus has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months.

 

Atlanticus is a smaller reporting company and is not a shell company or an emerging growth company.

 

As of April 30, 2019, 15,973,770 shares of common stock, no par value, of Atlanticus were outstanding, including 1,459,233 loaned shares to be returned.

 

 

Table of Contents
 

 

Table of Contents

 

Page

PART I. FINANCIAL INFORMATION

 

Item 1.

Financial Statements (Unaudited)

1

 

 

Consolidated Balance Sheets

1

 

 

Consolidated Statements of Operations

2

 

 

Consolidated Statements of Comprehensive Income (Loss)

3

 

 

Consolidated Statement of Shareholders’ Deficit

4

 

 

Consolidated Statements of Cash Flows

5

 

 

Notes to Consolidated Financial Statements

6

 

Item 2.

Management's Discussion and Analysis of Financial Condition and Results of Operations

24

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

41

 

Item 4.

Controls and Procedures

41

 

Part II. OTHER INFORMATION

 

Item 1.

Legal Proceedings

42

 

Item 1A.

Risk Factors

42

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

50

 

Item 3.

Defaults Upon Senior Securities

51

 

Item 4.

Mine Safety Disclosure

51

 

Item 5.

Other Information

52

 

Item 6.

Exhibits

52

 

 

Signatures

53

 

i

Table of Contents

 

PART I--FINANCIAL INFORMATION

ITEM 1.

FINANCIAL STATEMENTS

 

 

Atlanticus Holdings Corporation and Subsidiaries

Consolidated Balance Sheets (Unaudited)

(Dollars in thousands)

 

   

March 31,

   

December 31,

 
   

2019

   

2018

 
                 

Assets

               

Unrestricted cash and cash equivalents (including $41.1 million and $16.8 million associated with variable interest entities at March 31, 2019 and December 31, 2018, respectively)

  $ 101,049     $ 60,968  

Restricted cash and cash equivalents (including $45.7 million and $61.0 million associated with variable interest entities at March 31, 2019 and December 31, 2018, respectively)

    65,184       80,786  

Loans, interest and fees receivable:

               

Loans, interest and fees receivable, at fair value (including $4.8 million and $5.7 million associated with variable interest entities at March 31, 2019 and December 31, 2018, respectively

    5,394       6,306  

Loans, interest and fees receivable, gross (including $453.1 million and $403.4 million associated with variable interest entities at March 31, 2019 and December 31, 2018, respectively)

    562,472       541,344  

Allowances for uncollectible loans, interest and fees receivable (including $76.5 million and $57.4 million associated with variable interest entities at March 31, 2019 and December 31, 2018, respectively)

    (85,319 )     (79,211 )

Deferred revenue (including $16.9 million and $13.2 million associated with variable interest entities at March 31, 2019 and December 31, 2018, respectively)

    (47,251 )     (43,897 )

Net loans, interest and fees receivable

    435,296       424,542  

Property at cost, net of depreciation

    3,385       3,625  

Investments in equity-method investees

    2,260       2,476  

Deposits

    125       124  

Operating lease right-of-use assets

    17,013        

Prepaid expenses and other assets

    11,922       10,087  

Total assets

  $ 636,234     $ 582,608  

Liabilities

               

Accounts payable and accrued expenses

  $ 108,837     $ 105,765  

Operating lease liabilities

    27,742        

Notes payable, at face value (including $382.4 million and $366.7 million associated with variable interest entities at March 31, 2019 and December 31, 2018, respectively)

    408,242       390,927  

Notes payable to related parties

    40,000       40,000  

Notes payable associated with structured financings, at fair value (associated with variable interest entities)

    4,776       5,651  

Convertible senior notes

    62,313       62,142  

Income tax liability

    300       252  

Total liabilities

    652,210       604,737  
                 

Commitments and contingencies (Note 10)

               
                 

Equity

               

Common stock, no par value, 150,000,000 shares authorized: 15,977,130 shares issued and outstanding (including 1,459,233 loaned shares to be returned) at March 31, 2019; and 15,563,574 shares issued and outstanding (including 1,459,233 loaned shares to be returned) at December 31, 2018

           

Paid-in capital

    214,891       213,435  

Accumulated other comprehensive income

    2,045       3,558  

Retained deficit

    (232,516 )     (238,784 )

Total shareholders’ deficit

    (15,580 )     (21,791 )

Noncontrolling interests

    (396 )     (338 )

Total deficit

    (15,976 )     (22,129 )

Total liabilities and deficit

  $ 636,234     $ 582,608  


See accompanying notes.

 

1

Table of Contents

 

 

Atlanticus Holdings Corporation and Subsidiaries

Consolidated Statements of Operations (Unaudited)

(Dollars in thousands, except per share data)

 

   

For the Three Months Ended March 31,

 
   

2019

   

2018

 

Interest income:

               

Consumer loans, including past due fees

  $ 50,390     $ 35,681  

Other

    69       45  

Total interest income

    50,459       35,726  

Interest expense

    (11,146 )     (8,153 )

Net interest income before fees and related income on earning assets and provision for losses on loans, interest and fees receivable

    39,313       27,573  

Fees and related income on earning assets

    11,264       6,214  

Net losses upon impairment of loans, interest and fees receivable recorded at fair value

    (254 )     (1,791 )

Provision for losses on loans, interest and fees receivable recorded at net realizable value

    (34,598 )     (15,991 )

Net interest income, fees and related income on earning assets

    15,725       16,005  

Other operating income:

               

Servicing income

    686       632  

Other income

    16,844       516  

Equity in income of equity-method investees

    227       9  

Total other operating income

    17,757       1,157  

Other operating expense:

               

Salaries and benefits

    6,591       6,298  

Card and loan servicing

    10,444       9,164  

Marketing and solicitation

    6,387       2,346  

Depreciation

    289       229  

Other

    3,878       3,700  

Total other operating expense

    27,589       21,737  

Income (loss) before income taxes

    5,893       (4,575 )

Income tax expense

    (238 )     (144 )

Net income (loss)

    5,655       (4,719 )

Net loss attributable to noncontrolling interests

    58       49  

Net income (loss) attributable to controlling interests

  $ 5,713     $ (4,670 )

Net income (loss) attributable to controlling interests per common share—basic

  $ 0.40     $ (0.34 )

Net income (loss) attributable to controlling interests per common share—diluted

  $ 0.39     $ (0.34 )


See accompanying notes.

 

2

Table of Contents

 

 

Atlanticus Holdings Corporation and Subsidiaries

Consolidated Statements of Comprehensive Income (Loss) (Unaudited)

(Dollars in thousands)

 

   

For the Three Months Ended March 31,

 
   

2019

   

2018

 

Net income (loss)

  $ 5,655     $ (4,719 )

Other comprehensive loss:

               

Foreign currency translation adjustment

    (1,513 )     (2,345 )

Reclassifications of foreign currency translation adjustment to Other operating expense on the consolidated statements of operations

           

Income tax expense related to other comprehensive loss

           

Comprehensive income (loss) attributable to noncontrolling interests

    4,142       (7,064 )

Comprehensive loss attributable to noncontrolling interests

    58       49  

Comprehensive income (loss) attributable to controlling interests

  $ 4,200     $ (7,015 )


See accompanying notes.

 

3

Table of Contents

 

 

Atlanticus Holdings Corporation and Subsidiaries

Consolidated Statement of Shareholders’ Deficit

For the Three Months Ended March 31, 2019 (Unaudited)

(Dollars in thousands)

 

   

Common Stock

                                         
   

Shares Issued

   

Amount

   

Paid-In Capital

   

Accumulated Other Comprehensive Income (Loss)

   

Retained Deficit

   

Noncontrolling Interests

   

Total Deficit

 
                                                         

Balance at December 31, 2018

    15,563,574     $     $ 213,435     $ 3,558     $ (238,784 )   $ (338 )   $ (22,129 )

Cumulative effects from adoption of new lease standard (Note 2)

                            555             555  

Stock option exercises and proceeds related thereto

    419,500             1,065                         1,065  

Deferred stock-based compensation costs

                412                         412  

Redemption and retirement of shares

    (5,944 )           (21 )                       (21 )

Comprehensive income

                      (1,513 )     5,713       (58 )     4,142  

Balance at March 31, 2019

    15,977,130     $     $ 214,891     $ 2,045     $ (232,516 )   $ (396 )   $ (15,976 )


See accompanying notes.

 

4

Table of Contents

 

 

Atlanticus Holdings Corporation and Subsidiaries

Consolidated Statements of Cash Flows (Unaudited)

(Dollars in thousands)

 

   

For the Three Months Ended March 31,

 
   

2019

   

2018

 

Operating activities

               

Net income (loss)

  $ 5,655     $ (4,719 )

Adjustments to reconcile net income (loss) to net cash used in operating activities:

               

Depreciation, amortization and accretion, net

    1,769       229  

Losses upon impairment of loans, interest and fees receivable recorded at fair value

    254       1,791  

Provision for losses on loans, interest and fees receivable

    34,598       15,991  

Interest expense from accretion of discount on notes

    233       216  

Income from accretion of discount associated with receivables purchases

    (21,862 )     (18,020 )

Unrealized gain on loans, interest and fees receivable and underlying notes payable held at fair value

    (874 )     (1,313 )

Amortization of deferred loan costs

    696       390  

Income from equity-method investments

    (227 )     (9 )

Deferred stock-based compensation costs

    412       254  

Lease liability payments

    (2,492 )     (2,523 )

Changes in assets and liabilities:

               

Increase in uncollected fees on earning assets

    (165 )     (802 )

Increase in income tax liability

    48       333  

Increase in deposits

    (1 )     (20 )

Increase (decrease) in accounts payable and accrued expenses

    13,710       (1,800 )

Other

    (1,769 )     (235 )

Net cash provided by (used in) operating activities

    29,985       (10,237 )

Investing activities

               

Proceeds from equity-method investees

    443       692  

Investments in earning assets

    (164,935 )     (125,768 )

Proceeds from earning assets

    141,354       116,164  

Purchases and development of property, net of disposals

    (48 )     (21 )

Net cash used in investing activities

    (23,186 )     (8,933 )

Financing activities

               

Proceeds from exercise of stock options

    1,065        

Purchase and retirement of outstanding stock

    (21 )     (14 )

Proceeds from borrowings

    89,661       89,538  

Repayment of borrowings

    (73,105 )     (73,996 )

Net cash provided by financing activities

    17,600       15,528  

Effect of exchange rate changes on cash

    80       (362 )

Net increase (decrease) in cash and cash equivalents

    24,479       (4,004 )

Cash and cash equivalents and restricted cash at beginning of period

    141,754       70,658  

Cash and cash equivalents and restricted cash at end of period

  $ 166,233     $ 66,654  

Supplemental cash flow information

               

Cash paid for interest

  $ 3,894     $ 8,718  

Net cash income tax payments (refunds)

  $ 190     $ (189 )

 

See accompanying notes.

 

 

5

Table of Contents

 

 

Atlanticus Holdings Corporation and Subsidiaries

Notes to Consolidated Financial Statements

March 31, 2019 and 2018

 

1.

Description of Our Business

 

Our accompanying consolidated financial statements include the accounts of Atlanticus Holdings Corporation (the “Company”) and those entities we control. We are primarily focused on providing financial technology and related services. Through our subsidiaries, we provide technology and other support services to lenders who offer an array of financial products and services to consumers who may have been declined under traditional financing options.

 

In most cases, we invest in the receivables originated by lenders who utilize our technology platform and other related services. From time to time, we also purchase receivables portfolios from third parties.  References to "receivables" include receivables purchased from our lending partners and from third parties. As discussed further below, we reflect our business lines within two reportable segments: Credit and Other Investments; and Auto Finance. See also Note 3, “Segment Reporting,” for further details.

 

Within our Credit and Other Investments segment, we facilitate consumer finance programs offered by our bank partners to originate consumer loans through multiple channels, including retail point-of-sale, direct mail solicitation, digital marketing and through partner relationships. In the retail credit (the “point-of-sale” operations) channel, we partner with retailers and service providers in various industries across the United States (“U.S.”) to enable them to provide credit to their customers for the purchase of goods and services. These services of our lending partners are often extended to consumers who may have been declined under traditional financing options. We specialize in supporting this “second look” credit service in various industries across the U.S. Additionally, we support lenders who market general purpose credit cards directly to consumers (collectively, the “direct-to-consumer” operations) through additional channels enabling them to reach consumers through a diverse origination platform that includes retail point-of-sale, direct mail solicitation, digital marketing and partnerships with third parties. Using our infrastructure and technology platform, we also provide loan servicing, including risk management and customer service outsourcing, for third parties.

 

Beyond these activities within our Credit and Other Investments segment, we continue to service portfolios of legacy credit card receivables. One of our portfolios of legacy credit card receivables is encumbered by non-recourse structured financing, and for this portfolio our principal remaining economic interest is the servicing compensation we receive as an offset against our servicing costs given that the likely future collections on the portfolio are insufficient to allow for full repayment of the financing.

 

Additionally, we report within our Credit and Other Investments segment: 1) the income earned from an investment in an equity-method investee that holds credit card receivables for which we are the servicer; and 2) gains or losses associated with investments previously made in consumer finance technology platforms. These include investments in companies engaged in mobile technologies, marketplace lending and other financial technologies. These investments are carried at the lower of cost or market valuation. None of these companies are publicly-traded and there are no material pending liquidity events.

 

Within our Auto Finance segment, our CAR subsidiary operations principally purchase and/or service loans secured by automobiles from or for, and also provide floor plan financing for, a pre-qualified network of independent automotive dealers and automotive finance companies in the buy-here, pay-here, used car business. We purchase auto loans at a discount and with dealer retentions or holdbacks that provide risk protection. Also within our Auto Finance segment, we are providing certain installment lending products in addition to our traditional loans secured by automobiles.

 

6

 

 

2.

Significant Accounting Policies and Consolidated Financial Statement Components

 

The following is a summary of significant accounting policies we follow in preparing our consolidated financial statements, as well as a description of significant components of our consolidated financial statements.

 

Basis of Presentation and Use of Estimates

 

We prepare our consolidated financial statements in accordance with generally accepted accounting principles in the U.S. (“GAAP”). The preparation of financial statements in accordance with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of our consolidated financial statements, as well as the reported amounts of revenues and expenses during each reporting period. We base these estimates on information available to us as of the date of the financial statements. Actual results could differ materially from these estimates. Certain estimates, such as credit losses, payment rates, costs of funds, discount rates and the yields earned on credit card receivables, significantly affect the reported amount of credit card receivables that we report at fair value and our notes payable associated with structured financings, at fair value; these estimates likewise affect the changes in these amounts reflected within our fees and related income on earning assets line item on our consolidated statements of operations. Additionally, estimates of future credit losses have a significant effect on loans, interest and fees receivable, net, as shown on our consolidated balance sheets, as well as on the provision for losses on loans, interest and fees receivable within our consolidated statements of operations.

 

We have eliminated all significant intercompany balances and transactions for financial reporting purposes.

 

Loans, Interest and Fees Receivable

 

Our loans, interest and fees receivable include loans, interest and fees receivable, at fair value and loans, interest and fees receivable, gross.  Some of these receivables are held by entities which qualify as variable interest entities ("VIE"), that are consolidated onto our consolidated balance sheet.

 

As of March 31, 2019 and December 31, 2018, the weighted average remaining accretion period for the $47.3 million and $43.9 million of deferred revenue reflected in the consolidated balance sheets was 11 months. Included within deferred revenue, are discounts on purchased loans of $29.5 million and $30.0 million as of March 31, 2019 and December 31, 2018, respectively.

 

A roll-forward (in millions) of our allowance for uncollectible loans, interest and fees receivable by class of receivable is as follows: 

 

For the three months ended March 31, 2019

 

Credit Cards

   

Auto Finance

   

Other Unsecured Lending Products

   

Total

 

Allowance for uncollectible loans, interest and fees receivable:

                               

Balance at beginning of period

  $ (35.4 )   $ (1.3 )   $ (42.5 )   $ (79.2 )

Provision for loan losses

    (19.7 )     (0.9 )     (14.0 )     (34.6 )

Charge offs

    12.3       0.9       17.1       30.3  

Recoveries

    (0.3 )     (0.3 )     (1.2 )     (1.8 )

Balance at end of period

  $ (43.1 )   $ (1.6 )   $ (40.6 )   $ (85.3 )

 

As of March 31, 2019

 

Credit Cards

   

Auto Finance

   

Other Unsecured Lending Products

   

Total

 

Allowance for uncollectible loans, interest and fees receivable:

                               

Balance at end of period individually evaluated for impairment

  $     $ (0.3 )   $     $ (0.3 )

Balance at end of period collectively evaluated for impairment

  $ (43.1 )   $ (1.3 )   $ (40.6 )   $ (85.0 )

Loans, interest and fees receivable:

                               

Loans, interest and fees receivable, gross

  $ 211.4     $ 90.2     $ 260.9     $ 562.5  

Loans, interest and fees receivable individually evaluated for impairment

  $     $ 0.6     $ 0.1     $ 0.7  

Loans, interest and fees receivable collectively evaluated for impairment

  $ 211.4     $ 89.6     $ 260.8     $ 561.8  

 

For the three months ended March 31, 2018

 

Credit Cards

   

Auto Finance

   

Other Unsecured Lending Products

   

Total

 

Allowance for uncollectible loans, interest and fees receivable:

                               

Balance at beginning of period

  $ (18.2 )   $ (2.3 )   $ (42.5 )   $ (63.0 )

Provision for loan losses

    (9.0 )           (7.0 )     (16.0 )

Charge offs

    6.5       0.7       15.1       22.3  

Recoveries

    (0.1 )     (0.3 )     (1.2 )     (1.6 )

Balance at end of period

  $ (20.8 )   $ (1.9 )   $ (35.6 )   $ (58.3 )

7

 

As of December 31, 2018

 

Credit Cards

   

Auto Finance

   

Other Unsecured Lending Products

   

Total

 

Allowance for uncollectible loans, interest and fees receivable:

                               

Balance at end of period individually evaluated for impairment

  $     $ (0.2 )   $ (0.1 )   $ (0.3 )

Balance at end of period collectively evaluated for impairment

  $ (35.4 )   $ (1.1 )   $ (42.4 )   $ (78.9 )

Loans, interest and fees receivable:

                               

Loans, interest and fees receivable, gross

  $ 188.6     $ 88.1     $ 264.6     $ 541.3  

Loans, interest and fees receivable individually evaluated for impairment

  $     $ 0.4     $ 0.1     $ 0.5  

Loans, interest and fees receivable collectively evaluated for impairment

  $ 188.6     $ 87.7     $ 264.5     $ 540.8  

 

An aging of our delinquent loans, interest and fees receivable, gross (in millions) by class of receivable as of March 31, 2019 and December 31, 2018 is as follows:

 

As of March 31, 2019

 

Credit Cards

   

Auto Finance

   

Other Unsecured Lending Products

   

Total

 

30-59 days past due

  $ 8.3     $ 5.5     $ 7.8     $ 21.6  

60-89 days past due

    6.7       2.1       6.9       15.7  

90 or more days past due

    17.0       2.7       18.5       38.2  

Delinquent loans, interest and fees receivable, gross

    32.0       10.3       33.2       75.5  

Current loans, interest and fees receivable, gross

    179.4       79.9       227.7       487.0  

Total loans, interest and fees receivable, gross

  $ 211.4     $ 90.2     $ 260.9     $ 562.5  

Balance of loans greater than 90-days delinquent still accruing interest and fees

  $     $ 2.0     $     $ 2.0  


    

As of December 31, 2018

 

Credit Cards

   

Auto Finance

   

Other Unsecured Lending Products

   

Total

 

30-59 days past due

  $ 7.1     $ 7.9     $ 9.7     $ 24.7  

60-89 days past due

    5.3       2.8       7.6       15.7  

90 or more days past due

    12.3       2.2       18.5       33.0  

Delinquent loans, interest and fees receivable, gross

    24.7       12.9       35.8       73.4  

Current loans, interest and fees receivable, gross

    163.9       75.2       228.8       467.9  

Total loans, interest and fees receivable, gross

  $ 188.6     $ 88.1     $ 264.6     $ 541.3  

Balance of loans greater than 90-days delinquent still accruing interest and fees

  $     $ 1.5     $     $ 1.5  

8

 

Troubled Debt Restructurings. As part of ongoing collection efforts, once an account in our Credit and Other Investments segment is 90 days or more past due, the account is placed on a non-accrual status. Placement on a non-accrual status results in the use of programs under which the contractual interest associated with a receivable may be reduced or eliminated, or a certain amount of accrued fees is waived, provided a minimum number or amount of payments have been made. Following this adjustment, if a customer demonstrates a willingness and ability to resume making monthly payments and meets certain additional criteria, we will re-age the customer’s account. When we re-age an account, we adjust the status of the account to bring a delinquent account current, but generally do not make any further modifications to the payment terms or amount owed. Once an account is placed on a non-accrual status, it is closed for further purchases. Accounts that are placed on a non-accrual status and thereafter make at least one payment qualify as troubled debt restructurings (“TDRs”).

 

The following table details by class of receivable, the number and amount of loans that qualify as TDRs, as of March 31, 2019 and December 31, 2018:

 

   

As of

 
   

March 31, 2019

   

December 31, 2018

 
   

Point-of-sale

   

Direct-to-consumer

   

Point-of-sale

   

Direct-to-consumer

 

Number of TDRs

    8,604       6,515       8,722       3,003  

Number of TDRs that have been re-aged

    2,737       1,503       2,414       236  

Amount of TDRs on non-accrual status (in thousands)

  $ 11,712     $ 6,160     $ 12,178     $ 3,193  

Amount of TDRs on non-accrual status above that have been re-aged (in thousands)

  $ 4,779     $ 1,608     $ 3,876     $ 262  

Carrying value of TDRs (in thousands)

  $ 8,015     $ 4,033     $ 7,535     $ 1,524  

TDRs - Performing (carrying value, in thousands)*

  $ 6,426     $ 3,449     $ 5,788     $ 1,208  

TDRs - Nonperforming (carrying value, in thousands)*

  $ 1,589     $ 584     $ 1,747     $ 316  


*“TDRs - Performing” include accounts that are current on all amounts owed, while “TDRs - Nonperforming” include all accounts with past due amounts owed.

 

Given that the above TDRs have a high reserve rate prior to modification as TDRs, we do not separately reserve or impair these receivables outside of our general reserve process.

 

The Company modified 19,383 and 15,723 accounts in the amount of $29.2 million and $26.4 million during the twelve month periods ended March 31, 2019 and March 31, 2018, respectively, that qualified as TDRs. The following table details by class of receivable, the number of accounts and balance of TDRs that completed a modification within the prior twelve months and subsequently defaulted.

.

 

   

Twelve Months Ended

 
   

March 31, 2019

   

March 31, 2018

 
   

Point-of-sale

   

Direct-to-consumer

   

Point-of-sale

   

Direct-to-consumer

 

Number of accounts

    2,279       1,985       2,753       1,245  

Loan balance at time of charge off (in thousands)

  $ 3,607     $ 2,168     $ 4,322     $ 2,415  


Prepaid Expenses and Other Assets

 

Prepaid expenses and other assets include amounts paid to third parties for marketing and other services as well as amounts owed to us by third parties. Prepaid amounts are expensed as the underlying related services are performed.  Also included are (1) commissions paid associated with our various office leases which we amortize into expense over the lease terms, (2) ongoing deferred costs associated with service contracts and (3) investments in consumer finance technology platforms carried at the lower of cost or market valuation.

 

Accounts Payable and Accrued Expenses

    

Accounts payable and accrued expenses reflect both the billed and unbilled amounts owed at the end of a period for services rendered. Also included within accounts payable and accrued expenses are amounts which may be payable in respect of one of our portfolios.

 

9

 

Income Taxes

 

We experienced an effective income tax expense rate of 4.0% for the three months ended March 31, 2019, compared to a negative effective income tax expense rate of 3.1% for the three months ended March 31, 2018. Our effective income tax expense rate for the three months ended March 31, 2019, is below the statutory rate principally due to reductions in our valuation allowances against net federal deferred tax assets during such period—the effect of such reductions being partially offset by accruals of interest on unpaid federal tax liabilities and uncertain tax positions and state and foreign income taxes during such period. Conversely, our negative effective income tax expense rate for the three months ended March 31, 2018, was greater than the statutory rate principally due to accruals of interest on unpaid federal tax liabilities and uncertain tax positions and state and foreign income taxes during such period—the effect of such accruals being partially offset by additions to valuation allowances against our net federal deferred tax assets during such period.

 

We report income tax-related interest and penalties (including those associated with both our accrued liabilities for uncertain tax positions and unpaid tax liabilities) within our income tax line item on our consolidated statements of operations.  We likewise report the reversal of income tax-related interest and penalties within such line item to the extent that we resolve our liabilities for uncertain tax positions or unpaid tax liabilities in a manner favorable to our accruals therefor.  During the three months ended March 31, 2019, and 2018, we included $0.1 million and $0.2 million, respectively, of net income tax-related interest and penalties within those periods’ respective income tax expense line items.

 

In December 2014, we reached a settlement with the IRS concerning the tax treatment of net operating losses we incurred in 2007 and 2008 and carried back to obtain refunds of federal income taxes paid in earlier years dating back to 2003. In 2015, we filed an amended return claim that, if accepted, would have eliminated the $7.4 million assessment (and corresponding interest and penalties) under a negotiated provision of the December 2014 IRS settlement. The IRS filed a lien (as is customarily the case) associated with the assessment.  Subsequently, an IRS examination team denied our amended return claims, and we filed a protest with IRS Appeals. Following correspondence and conferences held with IRS Appeals, we received and accepted a settlement offer from IRS Appeals in June 2018 that reduced our $7.4 million net unpaid income tax assessment referenced above to $3.7 million. In July 2018, we paid $5.4 million to the IRS to cover the $3.7 million unpaid income tax assessment and most of the interest that had accrued thereon; during the three months ended September 30, 2018, the IRS refunded $0.5 million of the $5.4 million payment. Although we have paid all assessed income taxes related to this matter, we still have an outstanding accrued liability for some of the interest and for failure-to-pay penalties related to this matter. We paid another $0.2 million against accrued interest liabilities in March 2019, and we are continuing to pursue complete abatement of failure-to-pay penalties of $0.9 million. Once this matter is resolved and we pay any residual interest liability, we expect the IRS to remove the aforementioned lien in due course.

 

Revenue Recognition and Revenue from Contracts with Customers

 

Consumer Loans, Including Past Due Fees

 

Consumer loans, including past due fees, reflect interest income, including finance charges, and late fees on loans, which are recognized in accordance with the terms of the related customer agreements. Premiums and discounts paid or received associated with an installment or auto loan are generally deferred and amortized over the average life of the related loans using the effective interest method. Finance charges and fees, net of amounts that we consider uncollectible, are included in loans, interest and fees receivable and revenue when the fees are earned based upon the contractual terms of the loans.

 

Fees and Related Income on Earning Assets

 

Fees and related income on earning assets primarily include: (1) fees associated with our credit products, including the receivables underlying our U.S. point-of-sale finance and direct-to-consumer activities, and our legacy credit card receivables; (2) changes in the fair value of loans, interest and fees receivable recorded at fair value; (3) changes in fair value of notes payable associated with structured financings recorded at fair value; and (4) gains or losses associated with our investments in securities. 

 

We assess fees on credit card accounts underlying our credit card receivables according to the terms of the related cardholder agreements and, except for annual membership fees, we recognize these fees as income when they are charged to the customers’ accounts. We accrete annual membership fees associated with our credit card receivables into income on a straight-line basis over the cardholder privilege period which is generally 12 months. Similarly, fees on our other credit products are recognized when earned, which coincides with the time they are charged to the customer’s account. Fees and related income on earning assets, net of amounts that we consider uncollectible, are included in loans, interest and fees receivable and revenue when the fees are earned based upon the contractual terms of the loans.

 

The components (in thousands) of our fees and related income on earning assets are as follows:

 

   

For the three months ended March 31,

 
   

2019

   

2018

 

Fees on credit products

  $ 10,296     $ 4,905  

Changes in fair value of loans, interest and fees receivable recorded at fair value

    (1 )     (18 )

Changes in fair value of notes payable associated with structured financings recorded at fair value

    875       1,331  

Other

    94       (4 )

Total fees and related income on earning assets

  $ 11,264     $ 6,214  

 

The above changes in the fair value of loans, interest and fees receivable recorded at fair value category exclude the impact of current period charge offs associated with these receivables which are separately stated in Net (losses upon) recovery of charge off of loans, interest and fees receivable recorded at fair value on our consolidated statements of operations. See Note 6, “Fair Values of Assets and Liabilities,” for further discussion of these receivables and their effects on our consolidated statements of operations.

 

Other Income

 

Included in Other income for the three months ended March 31, 2019, is $15.5 million associated with reductions in accruals related to one of our portfolios.  The original accrual was based upon our estimate of the amount that could be claimed by customers and is based upon several factors including customer claims volume, average claim amount and a determination of the amount, if any, which may be offered to resolve such claims.  The assumptions used in the accrual estimate are subjective, mainly due to uncertainty associated with future claims volumes and the resolution costs, if any, per claim.  As of March 31, 2019, we had approximately $92 million accrued related to this liability within accounts payable and accrued expenses on the consolidated balance sheets, including the reclassification of approximately $26 million from unrestricted cash and cash equivalents on our consolidated balance sheets. Also included in other income, are revenues associated with ancillary product offerings and interchange revenues. We recognize these fees as income in the period earned. 

 

10

 

Revenue from Contracts with Customers

 

The majority of our revenue is earned from financial instruments and is not included within the scope of this standard. We have determined that revenue from contracts with customers would primarily consist of interchange revenues in our Credit and Other Investments segment and servicing revenue and other customer-related fees in both our Credit and Other Investments segment and our Auto Finance segment. Servicing revenue is generated by meeting contractual performance obligations related to the collection of amounts due on receivables, and is settled with the customer net of our fee. Revenue from these contracts with customers is included as a component of Other income on our consolidated statements of operations. Service charges and other customer related fees are earned from customers based on the occurrence of specific services that do not result in an ongoing obligation beyond what has already been rendered.  Components (in thousands) of our revenue from contracts with customers is as follows:

 

 

   

Credit and

                 

Three months ended March 31, 2019

 

Other Investments

   

Auto Finance

   

Total

 

Interchange revenues, net (1)

  $ 928     $     $ 928  

Servicing income

    419       267       686  

Service charges and other customer related fees

    429       17       446  

Total revenue from contracts with customers

  $ 1,776     $ 284     $ 2,060  


(1) Interchange revenue is presented net of customer reward expense.

 

   

Credit and

                 

Three months ended March 31, 2018

 

Other Investments

   

Auto Finance

   

Total

 

Interchange revenues, net (1)

  $ 444     $     $ 444  

Servicing income

    402       230       632  

Service charges and other customer related fees

    25       47       72  

Total revenue from contracts with customers

  $ 871     $ 277     $ 1,148  

 

(1) Interchange revenue is presented net of customer reward expense.

 

Recent Accounting Pronouncements

 

In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments. The guidance requires an assessment of credit losses based on expected rather than incurred losses (known as the current expected credit loss model). This generally will result in the recognition of allowances for losses earlier than under current accounting guidance for trade and other receivables, held to maturity debt securities and other instruments. The standard will be adopted on a prospective basis with a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. ASU 2016-13 is effective for annual and interim periods beginning after December 15, 2019, with early adoption permitted. We are currently in the process of reviewing accounting interpretations, expected data requirements and necessary changes to our loss estimation methods, processes and systems. This standard is expected to result in an increase to our allowance for loan losses given the change to expected losses for the estimated life of the financial asset. The extent of the increase will depend on the asset quality of the portfolio, and economic conditions and forecasts at adoption.

In February 2016, the FASB issued ASU No. 2016-02, Leases, along with subsequent guidance, which requires lessees to recognize assets and liabilities for most leases and changes certain aspects of current lessor accounting, among other things. We adopted these standards using a modified retrospective transition approach for leases existing at, or entered into after, January 1, 2019 and did not restate the comparative periods presented in the Consolidated Financial Statements upon adoption.

ASU 2016-02 provides a number of optional practical expedients and policy elections in transition. We elected the ‘package of practical expedients’ under which we did not reassess prior conclusions about lease identification, lease classification and initial direct costs. We did not elect the use-of-hindsight or the practical expedient pertaining to land easements, the latter not being applicable to us. We also elected the short-term lease recognition exemption for all leases that qualify, meaning we did not recognize right-of-use assets or lease liabilities for these short term leases. 

 

Upon adoption, we recognized additional lease liabilities of $30.2 million and a corresponding right-of-use asset of $18.6 million with a $0.6 million cumulative effect on our opening retained deficit. The impact of our status as a lessor in the sublease arrangements we maintain did not result in a material change upon adoption.  See Note 7, "Leases" for additional disclosure.

        

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers.” ASU 2014-09 establishes a principles-based model under which revenue from a contract is allocated to the distinct performance obligations within the contract and recognized in income as each performance obligation is satisfied. Additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract is also required. In August 2015, the FASB delayed the effective date by one year and the guidance was effective for annual and interim periods beginning January 1, 2018. Most revenue associated with financial instruments, including interest income, loan origination fees and credit card fees, is outside the scope of the guidance. This includes most of the revenue of the Company.  We adopted this standard as of January 1, 2018 using the modified retrospective method of adoption. Our adoption of this standard did not have a material impact on our consolidated financial statements.

    

Subsequent Events

 

We evaluate subsequent events that occur after our consolidated balance sheet date but before our consolidated financial statements are issued. There are two types of subsequent events:  (1) recognized, or those that provide additional evidence with respect to conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements; and (2) nonrecognized, or those that provide evidence with respect to conditions that did not exist at the date of the balance sheet but arose subsequent to that date.  We have evaluated subsequent events occurring after March 31, 2019, and based on our evaluation we did not identify any recognized or nonrecognized subsequent events that would have required further adjustments to our consolidated financial statements.

 

11

 

 

3.

Segment Reporting

 

We operate primarily within one industry consisting of two reportable segments by which we manage our business. Our two reportable segments are: Credit and Other Investments, and Auto Finance.

 

As of both March 31, 2019 and December 31, 2018, we did not have a material amount of long-lived assets located outside of the U.S., and only a negligible portion of our revenues for the three months ended March 31, 2019 and 2018 were generated outside of the U.S.

 

We measure the profitability of our reportable segments based on their income after allocation of specific costs and corporate overhead; however, our segment results do not reflect any charges for internal capital allocations among our segments. Overhead costs are allocated based on headcounts and other applicable measures to better align costs with the associated revenues.

 

Summary operating segment information (in thousands) is as follows:

 

Three months ended March 31, 2019

 

Credit and Other Investments

   

Auto Finance

   

Total

 

Interest income:

                       

Consumer loans, including past due fees

  $ 42,672     $ 7,718     $ 50,390  

Other

    69             69  

Total interest income

    42,741       7,718       50,459  

Interest expense

    (10,769 )     (377 )     (11,146 )

Net interest income before fees and related income on earning assets and provision for losses on loans, interest and fees receivable

  $ 31,972     $ 7,341     $ 39,313  

Fees and related income on earning assets

  $ 11,236     $ 28     $ 11,264  

Servicing income

  $ 419     $ 267     $ 686  

Equity in income of equity-method investees

  $ 227     $     $ 227  

Income before income taxes

  $ 4,207     $ 1,686     $ 5,893  

Income tax benefit (expense)

  $ 239     $ (477 )   $ (238 )

Total assets

  $ 557,281     $ 78,953     $ 636,234  

 

Three months ended March 31, 2018

 

Credit and Other Investments

   

Auto Finance

   

Total

 

Interest income:

                       

Consumer loans, including past due fees

  $ 28,562     $ 7,119     $ 35,681  

Other

    45             45  

Total interest income

    28,607       7,119       35,726  

Interest expense

    (7,892 )     (261 )     (8,153 )

Net interest income before fees and related income on earning assets and provision for losses on loans, interest and fees receivable

  $ 20,715     $ 6,858     $ 27,573  

Fees and related income on earning assets

  $ 6,197     $ 17     $ 6,214  

Servicing income

  $ 402     $ 230     $ 632  

Equity in income of equity-method investees

  $ 9     $     $ 9  

(Loss) income before income taxes

  $ (6,914 )   $ 2,339     $ (4,575 )

Income tax benefit (expense)

  $ 399     $ (543 )   $ (144 )

Total assets

  $ 365,882     $ 67,030     $ 432,912  

 

12

 

 

4.

Shareholders’ Equity

 

During the three months ended March 31, 2019 and 2018, we repurchased and contemporaneously retired 5,944 and 7,006 shares of our common stock at an aggregate cost of $21,000 and $14,000, respectively, pursuant to the return of stock by holders of equity incentive awards to pay tax withholding obligations.

 

We had 1,459,233 loaned shares outstanding at March 31, 2019 and December 31, 2018, which were originally lent in connection with our November 2005 issuance of convertible senior notes. We retire lent shares as they are returned to us.

 

 

5.

Investment in Equity-Method Investee

 

Our equity-method investment outstanding at March 31, 2019 consists of our 66.7% interest in a joint venture formed to purchase a credit card receivable portfolio.

 

In the following tables, we summarize (in thousands) balance sheet and results of operations data for our equity-method investee:

 

   

As of

 
   

March 31, 2019

   

December 31, 2018

 

Loans, interest and fees receivables, at fair value

  $ 3,232     $ 3,546  

Total assets

  $ 3,407     $ 3,732  

Total liabilities

  $ 17     $ 18  

Members’ capital

  $ 3,390     $ 3,714  
   

Three months ended March 31,

 
   

2019

   

2018

 

Net interest income, fees and related income on earning assets

  $ 342     $ 14  

Net income (loss)

  $ 289     $ (61 )

Net income attributable to our equity investment investee

  $ 227     $ 9  

 

         

 

13

 

 

6.

Fair Values of Assets and Liabilities

 

Valuations and Techniques for Assets

 

Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability. The table below summarizes (in thousands) by fair value hierarchy the March 31, 2019 and December 31, 2018 fair values and carrying amounts of (1) our assets that are required to be carried at fair value in our consolidated financial statements and (2) our assets not carried at fair value, but for which fair value disclosures are required:

 

Assets – As of March 31, 2019 (1)

 

Quoted Prices in Active Markets for Identical Assets (Level 1)

   

Significant Other Observable Inputs (Level 2)

   

Significant Unobservable Inputs (Level 3)

   

Carrying Amount of Assets

 

Loans, interest and fees receivable, net for which it is practicable to estimate fair value

  $     $     $ 476,959     $ 429,902  

Loans, interest and fees receivable, at fair value

  $     $     $ 5,394     $ 5,394  

Assets – As of December 31, 2018 (1)

 

Quoted Prices in Active Markets for Identical Assets (Level 1)

   

Significant Other Observable Inputs (Level 2)

   

Significant Unobservable Inputs (Level 3)

   

Carrying Amount of Assets

 

Loans, interest and fees receivable, net for which it is practicable to estimate fair value

  $     $     $ 470,496     $ 418,236  

Loans, interest and fees receivable, at fair value

  $     $     $ 6,306     $ 6,306  

 

 

(1)

For cash, deposits and other short-term investments, the carrying amount is a reasonable estimate of fair value.

For those asset classes above that are required to be carried at fair value in our consolidated financial statements, gains and losses associated with fair value changes are detailed on our fees and related income on earning assets table within Note 2, “Significant Accounting Policies and Consolidated Financial Statement Components.”

 

For Level 3 assets carried at fair value measured on a recurring basis using significant unobservable inputs, the following table presents (in thousands) a reconciliation of the beginning and ending balances for the three months ended March 31, 2019 and 2018:

 

   

Loans, Interest and Fees Receivables, at Fair Value

 
   

2019

   

2018

 

Balance at January 1,

  $ 6,306     $ 11,109  

Total gains—realized/unrealized:

               

Net revaluations of loans, interest and fees receivable, at fair value

    (1 )     (18 )

Settlements

    (911 )     (1,691 )

Impact of foreign currency translation

          13  

Balance at March 31,

  $ 5,394     $ 9,413  

 

The unrealized gains and losses for assets within the Level 3 category presented in the tables above include changes in fair value that are attributable to both observable and unobservable inputs. Impacts related to foreign currency translation are included as a component of other operating expense on the consolidated statements of operations. 

 

 

14

 

Net Revaluation of Loans, Interest and Fees Receivable. We record the net revaluation of loans, interest and fees receivable (including those pledged as collateral) in the fees and related income on earning assets category in our consolidated statements of operations, specifically as changes in fair value of loans, interest and fees receivable recorded at fair value. The net revaluation of loans, interest and fees receivable is based on the present value of future cash flows using a valuation model of expected cash flows and the estimated cost to service and collect those cash flows. We estimate the present value of these future cash flows using a valuation model consisting of internally developed estimates of assumptions third-party market participants would use in determining fair value, including estimates of net collected yield, principal payment rates, expected principal credit loss rates, costs of funds, discount rates and servicing costs. Accrued interest income on receivables underlying our asset classes that are carried at fair value in our consolidated financial statements is recorded in Interest income - Consumer loans, including past due fees in our Consolidated Statements of Operations.

 

For Level 3 assets carried at fair value measured on a recurring basis using significant unobservable inputs, the following table presents (in thousands) quantitative information about the valuation techniques and the inputs used in the fair value measurement as of March 31, 2019 and December 31, 2018:

 

Quantitative Information about Level 3 Fair Value Measurements

 

Fair Value Measurements

 

Fair Value at March 31, 2019 (in thousands)

 

Valuation Technique

 

Unobservable Input

 

Range (Weighted Average)

 

Loans, interest and fees receivable, at fair value

  $ 5,394  

Discounted cash flows

 

Gross yield

    25.2% to 33.5% (26.3%)  
             

Principal payment rate

    2.1% to 3.1% (2.2%)  
             

Expected credit loss rate

    10.6% to 11.2% (10.7%)  
             

Servicing rate

    15.6% to 20.9% (16.3%)  
             

Discount rate

    14.9% to 14.9% (14.9%)  

 

Quantitative Information about Level 3 Fair Value Measurements

 

Fair Value Measurements

 

Fair Value at December 31, 2018 (in thousands)

 

Valuation Technique

 

Unobservable Input

 

Range (Weighted Average)

 

Loans, interest and fees receivable, at fair value

  $ 6,306  

Discounted cash flows

 

Gross yield

    25.8% to 30.8% (26.4%)  
             

Principal payment rate

    2.2% to 3.0% (2.3%)  
             

Expected credit loss rate

    8.7% to 11.3% (9.0%)  
             

Servicing rate

    14.9% to 19.5% (15.5%)  
             

Discount rate

    14.9% to 14.9% (14.9%)  

 

15

 

Valuations and Techniques for Liabilities

 

Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the liability. The table below summarizes (in thousands) by fair value hierarchy the March 31, 2019 and December 31, 2018 fair values and carrying amounts of (1) our liabilities that are required to be carried at fair value in our consolidated financial statements and (2) our liabilities not carried at fair value, but for which fair value disclosures are required:

 

Liabilities – As of March 31, 2019

 

Quoted Prices in Active Markets for Identical Assets (Level 1)

   

Significant Other Observable Inputs (Level 2)

   

Significant Unobservable Inputs (Level 3)

   

Carrying Amount of Liabilities

 

Liabilities not carried at fair value

                               

Revolving credit facilities

  $     $     $ 407,022     $ 407,022  

Amortizing debt facilities

  $     $     $ 1,220     $ 1,220  

Notes payable to related parties

  $     $     $ 40,000     $ 40,000  

Convertible senior notes

  $     $ 47,230     $     $ 62,313  

Liabilities carried at fair value

                               

Notes payable associated with structured financings, at fair value

  $     $     $ 4,776     $ 4,776  

Liabilities - As of December 31, 2018

 

Quoted Prices in Active Markets for Identical Assets (Level 1)

   

Significant Other Observable Inputs (Level 2)

   

Significant Unobservable Inputs (Level 3)

   

Carrying Amount of Liabilities

 

Liabilities not carried at fair value

                               

Revolving credit facilities

  $     $     $ 389,707     $ 389,707  

Amortizing debt facilities

  $     $     $ 1,220     $ 1,220  

Notes payable to related parties

  $     $     $ 40,000     $ 40,000  

Convertible senior notes

  $     $ 47,230     $     $ 62,142  

Liabilities carried at fair value

                               

Notes payable associated with structured financings, at fair value

  $     $     $ 5,651     $ 5,651  

 

 

For our material Level 3 liabilities carried at fair value measured on a recurring basis using significant unobservable inputs, the following table presents (in thousands) a reconciliation of the beginning and ending balances for the three months ended March 31, 2019 and 2018.

 

   

Notes Payable Associated with Structured Financings, at Fair Value

 
   

2019

   

2018

 

Beginning balance, January 1,

  $ 5,651     $ 9,240  

Total (gains) losses—realized/unrealized:

               

Net revaluations of notes payable associated with structured financings, at fair value

    (875 )     (1,331 )

Repayments on outstanding notes payable, net

           

Ending balance, March 31,

  $ 4,776     $ 7,909  

 

The unrealized gains and losses for liabilities within the Level 3 category presented in the table above include changes in fair value that are attributable to both observable and unobservable inputs. We provide below a brief description of the valuation techniques used for Level 3 liabilities.

 

16

 

Net Revaluation of Notes Payable Associated with Structured Financings, at Fair Value. We record the net revaluations of notes payable associated with structured financings, at fair value, in the changes in fair value of notes payable associated with structured financings line item within the fees and related income on earning assets category of our consolidated statements of operations. The legal entity associated with the securitization transaction is consolidated as a VIE as the Company is deemed the primary beneficiary of the entity.  The Company is not liable for the full face value of the liability in the VIE so it is carried at fair value based upon amounts the borrower will receive from the legal entity. The net revaluation of these notes is based on the present value of future cash flows utilized in repayment of the outstanding principal and interest under the facilities using a valuation model of expected cash flows net of the contractual service expenses within the facilities. We estimate the present value of these future cash flows using a valuation model consisting of internally developed estimates of assumptions third-party market participants would use in determining fair value, including: estimates of net collected yield, principal payment rates and expected principal credit loss rates on the credit card receivables that secure the non-recourse notes payable; costs of funds; discount rates; and contractual servicing fees. Accrued interest expense on notes payable underlying our notes payable associated with structured financings, at fair value is recorded in Interest expense in our consolidated statements of operations.

 

For material Level 3 liabilities carried at fair value measured on a recurring basis using significant unobservable inputs, the following table presents (in thousands) quantitative information about the valuation techniques and the inputs used in the fair value measurement as of March 31, 2019 and December 31, 2018:

 

Quantitative information about Level 3 Fair Value Measurements

 

Fair Value Measurements

 

Fair Value at March 31, 2019 (in thousands)

   

Valuation Technique

 

Unobservable Input

 

Weighted Average

 

Notes payable associated with structured financings, at fair value

  $ 4,776    

 

Discounted cash flows  

Gross yield

    25.2 %
                 

Principal payment rate

    2.1 %
                 

Expected credit loss rate

    10.6 %
                 

Discount rate

    14.9 %

 

 

Quantitative Information about Level 3 Fair Value Measurements

 

Fair Value Measurements

 

Fair Value at December 31, 2018 (in thousands)

   

Valuation Technique

 

Unobservable Input

 

Weighted Average

 

Notes payable associated with structured financings, at fair value

  $ 5,651    

 

Discounted cash flows  

Gross yield

    25.8 %
                 

Principal payment rate

    2.2 %
                 

Expected credit loss rate

    8.7 %
                 

Discount rate

    14.9 %

 

17

 

Other Relevant Data

 

Other relevant data (in thousands) as of March 31, 2019 and December 31, 2018 concerning certain assets and liabilities we carry at fair value are as follows:

 

As of March 31, 2019

 

Loans, Interest and Fees Receivable at Fair Value

   

Loans, Interest and Fees Receivable Pledged as Collateral under Structured Financings at Fair Value

 

Aggregate unpaid principal balance within loans, interest and fees receivable that are reported at fair value

  $ 1,016     $ 7,009  

Aggregate fair value of loans, interest and fees receivable that are reported at fair value

  $ 618     $ 4,776  

Aggregate fair value of receivables carried at fair value that are 90 days or more past due (which also coincides with finance charge and fee non-accrual policies)

  $ 4     $ 8  

Unpaid principal balance of receivables within loans, interest and fees receivable that are reported at fair value and are 90 days or more past due (which also coincides with finance charge and fee non-accrual policies) over the fair value of such loans, interest and fees receivable

  $ 28     $ 252  

 

As of December 31, 2018

 

Loans, Interest and Fees Receivable at Fair Value

   

Loans, Interest and Fees Receivable Pledged as Collateral under Structured Financings at Fair Value

 

Aggregate unpaid principal balance within loans, interest and fees receivable that are reported at fair value

  $ 1,160     $ 7,708  

Aggregate fair value of loans, interest and fees receivable that are reported at fair value

  $ 655     $ 5,651  

Aggregate fair value of receivables carried at fair value that are 90 days or more past due (which also coincides with finance charge and fee non-accrual policies)

  $ 3     $ 7  

Unpaid principal balance of receivables within loans, interest and fees receivable that are reported at fair value and are 90 days or more past due (which also coincides with finance charge and fee non-accrual policies) over the fair value of such loans, interest and fees receivable

  $ 35     $ 224  

 

Notes Payable

 

Notes Payable Associated with Structured Financings, at Fair Value as of March 31, 2019

   

Notes Payable Associated with Structured Financings, at Fair Value as of December 31, 2018

 

Aggregate unpaid principal balance of notes payable

  $ 101,314     $ 101,314  

Aggregate fair value of notes payable

  $ 4,776     $ 5,651  


 

18

 

 

7.

Leases

 

We have operating leases primarily associated with our corporate offices and regional service centers as well as for certain equipment.  Our leases have remaining lease terms of 1 to 5 years, some of which include options, at our discretion, to extend the leases for additional periods generally on one-year revolving periods.  Other leases allow for us to terminate the lease based on appropriate notification periods. For certain of our leased offices, we sublease a portion of the unoccupied space.  The terms of the sublease arrangement generally coincide with the underlying lease. The components of lease expense associated with our lease liabilities and supplemental cash flow information related to those leases were as follows:

 

   

For the three months ended March 31,

 
   

2019

   

2018

 

Operating lease cost, gross

  $ 1,709     $ 1,696  

Sublease income

    (1,283 )     (1,270 )

Net Operating lease cost

  $ 426     $ 426  

Cash paid under operating leases, gross

  $ 2,492     $ 2,523  
                 

Weighted average remaining lease term - months

    38          

Weighted average discount rate

    6.9 %        

 

Maturities of lease liabilities were as follows:

 

   

Gross Lease Payment

   

Payments received from Sublease

   

Net Lease Payment

 

2019 (excluding the three months ended March 31, 2019

  $ 7,460     $ (5,201 )   $ 2,259  

2020

    9,999       (7,115 )     2,884  

2021

    10,011       (7,315 )     2,696  

2022

    4,254       (3,112 )     1,142  

2023

    73             73  

Thereafter

    13             13  

Total lease payments

    31,810     $ (22,743 )   $ 9,067  

Less imputed interest

    (4,068 )                
Total   $ 27,742                  

 

 

 

8.

Notes Payable

 

The Company contributes certain receivables to VIEs.  These entities are established to facilitate a more efficient means of obtaining third party financing. When assets are contributed to the VIE, they serve as collateral for the debt securities issued by the VIE. The evaluation of whether the entity qualifies as a VIE is based upon the sufficiency of the equity at risk in the legal entity. This evaluation is generally a function of the level of excess collateral in the legal entity. We consolidate VIEs when we hold a variable interest and are the primary beneficiary. We are the primary beneficiary when we have the power to direct activities that most significantly affect the economic performance and have the obligation to absorb the majority of the losses or benefits. In certain circumstances we guarantee the performance of the underlying debt or agree to contribute additional collateral when necessary.  When collateral is pledged it is not available for the general use of the Company and can only be used to satisfy the related debt obligation. The results of operations and financial position of consolidated VIEs are included in our consolidated financial statements.

 

The following table presents a summary of VIEs in which we had continuing involvement or held a variable interest (in millions):

   

As of

 
   

March 31, 2019

   

December 31, 2018

 
Unrestricted cash and cash equivalents   $ 41.1     $ 16.8  

Restricted cash and cash equivalents

  $ 45.7     $ 61.0  

Loans, interest and fees receivable, at fair value

  $ 4.8     $ 5.7  

Loans, interest and fees receivable, gross

  $ 453.1     $ 403.4  

Allowances for uncollectible loans, interest and fees receivable

  $ (76.5 )   $ (57.4 )

Deferred revenue

  $ (16.9 )   $ (13.2 )

Total Assets held by VIEs

  $ 451.3     $ 416.3  

Notes Payable, at face value held by VIEs

  $ 382.4     $ 366.7  

Notes Payable, at fair value held by VIEs

  $ 4.8     $ 5.7  

Maximum exposure to loss due to involvement with VIEs

  $ 454.5     $ 438.5  

 

 

Notes Payable Associated with Structured Financings, at Fair Value

 

Scheduled (in millions) in the table below are (1) the carrying amount of our structured financing note secured by certain credit card receivables and reported at fair value as of March 31, 2019 and December 31, 2018, (2) the outstanding face amount of our structured financing note secured by certain credit card receivables and reported at fair value as of March 31, 2019 and December 31, 2018, and (3) the carrying amount of the credit card receivables and restricted cash that provide the exclusive means of repayment for the note (i.e., lenders have recourse only to the specific credit card receivables and restricted cash underlying each respective facility and cannot look to our general credit for repayment) as of March 31, 2019 and December 31, 2018.

 

   

Carrying Amounts at Fair Value as of

 
   

March 31, 2019

   

December 31, 2018

 

Securitization facility (stated maturity of December 2021), outstanding face amount of $101.3 million as of March 31, 2019 ($101.3 million as of December 31, 2018) bearing interest at a weighted average 7.5% interest rate, based upon LIBOR, at March 31, 2019 (7.5% at December 31, 2018), which is secured by credit card receivables and restricted cash aggregating $4.8 million as of March 31, 2019 ($5.7 million as of December 31, 2018) in carrying amount

  $ 4.8     $ 5.7  

 

Contractual payment allocations within this credit card receivables structured financing provide for a priority distribution of cash flows to us to service the credit card receivables, a distribution of cash flows to pay interest and principal due on the notes, and a distribution of all excess cash flows (if any) to us. The structured financing facility included in the above table is amortizing down along with collections of the underlying receivables and there are no provisions within the debt agreement that allow for acceleration or bullet repayment of the facility prior to its scheduled expiration date. The aggregate carrying amount of the credit card receivables and restricted cash that provide security for the $4.8 million in fair value of the structured financing facility included in the above table is $4.8 million, which means that we have no aggregate exposure to pre-tax equity loss associated with the above structured financing arrangement at March 31, 2019.

 

As discussed elsewhere, the legal entity holding the securitization facility discussed in the table above, is a VIE.  Beyond our role as servicer of the underlying assets within the credit cards receivables structured financing, we have provided no other financial or other support to the structure, and we have no explicit or implicit arrangements that could require us to provide financial support to the structure.

 

19

 

Notes Payable, at Face Value and Notes Payable to Related Parties

 

Other notes payable outstanding as of March 31, 2019 and December 31, 2018 that are secured by the financial and operating assets of either the borrower, another of our subsidiaries or both, include the following, scheduled (in millions); except as otherwise noted, the assets of our holding company (Atlanticus Holdings Corporation) are subject to creditor claims under these scheduled facilities:

 

   

As of

 
   

March 31, 2019

   

December 31, 2018

 

Revolving credit facilities at a weighted average interest rate equal to 7.7% at March 31, 2019 (7.6% at December 31, 2018) secured by the financial and operating assets of CAR and/or certain receivables and restricted cash with a combined aggregate carrying amount of $484.0 million as of March 31, 2019 ($468.8 million at December 31, 2018)

               

Revolving credit facility, not to exceed $40.0 million (expiring November 1, 2020) (1) (2)

    31.2       30.0  

Revolving credit facility, not to exceed $50.0 million (expiring October 30, 2019) (2) (3) (4)

    49.6       49.9  

Revolving credit facility, not to exceed $90.0 million (expiring February 8, 2022) (3) (4) (5) (6)

    69.0       61.0  

Revolving credit facility, not to exceed $100.0 million (expiring June 11, 2020) (3) (4) (5) (6)

    80.5       80.5  

Revolving credit facility, not to exceed $100.0 million (expiring November 16, 2020) (3) (4) (5) (6)

    16.0       8.0  

Revolving credit facility, not to exceed $167.3 million (expiring November 15, 2023) (3) (4) (5) (6)

    167.3       167.3  

Other facilities

               

Other secured debt (expiring September 8, 2023) that is secured by certain assets of the Company with an annual rate equal to 5.5%

    1.2       1.2  

Senior secured term loan to related parties (expiring November 21, 2019) that is secured by certain assets of the Company with an annual rate equal to 9.0% (4)

    40.0       40.0  

Total notes payable before unamortized debt issuance costs and discounts

    454.8       437.9  

Unamortized debt issuance costs and discounts

    (6.6 )     (7.0 )

Total notes payable outstanding

  $ 448.2     $ 430.9  


 

(1)

Loan is subject to certain affirmative covenants, including a coverage ratio, a leverage ratio and a collateral performance test, the failure of which could result in required early repayment of all or a portion of the outstanding balance by our CAR Auto Finance operations.

(2)

These notes reflect modifications to either extend the maturity date, increase the loan amount or both, and are treated as accounting modifications.

(3)

Loans are subject to certain affirmative covenants tied to default rates and other performance metrics the failure of which could result in required early repayment of the remaining unamortized balances of the notes. 

(4)

Loans are associated with variable interest entities.

(5)

See below for additional information.

(6)

Creditors do not have recourse against the general assets of the Company but only to the collateral within the VIEs.

 

20

 

Not included in the table above are certain bank commitments to lend additional capital upon assignment of available collateral.  The remaining terms on these agreements range from 9-30 months at interest rates based on LIBOR plus a spread of 4.5%-6.5%.  The total committed but undrawn capacity of these additional bank commitments as of March 31, 2019 was $97.0 million.

 

On November 26, 2014, we and certain of our subsidiaries entered into a Loan and Security Agreement with Dove Ventures, LLC, a Nevada limited liability company (“Dove”). The agreement provides for a senior secured term loan facility in an amount of up to $40.0 million at any time outstanding. The Loan and Security Agreement was fully drawn with $40.0 million outstanding as of March 31, 2019. In November 2018, the agreement was amended to extend the maturity date of the term loan to November 21, 2019. All other terms remain unchanged.

 

Our obligations under the agreement are guaranteed by certain subsidiary guarantors and secured by a pledge of certain assets of ours and the subsidiary guarantors. The loans bear interest at the rate of 9.0% per annum, payable monthly in arrears. The principal amount of these loans is payable in a single installment on November 21, 2019 (as amended). The agreement includes customary affirmative and negative covenants, as well as customary representations, warranties and events of default. Subject to certain conditions, we can prepay the principal amounts of these loans without premium or penalty.

 

Dove is a limited liability company owned by three trusts. David G. Hanna is the sole shareholder and the President of the corporation that serves as the sole trustee of one of the trusts, and David G. Hanna and members of his immediate family are the beneficiaries of this trust. Frank J. Hanna, III is the sole shareholder and the President of the corporation that serves as the sole trustee of the other two trusts, and Frank J. Hanna, III and members of his immediate family are the beneficiaries of these other two trusts.

 

In October 2015, we (through a wholly owned subsidiary) entered a revolving credit facility with a (as subsequently amended) $50.0 million revolving borrowing limit that can be drawn to the extent of outstanding eligible principal receivables (of which $49.6 million was drawn as of March 31, 2019).  This facility is secured by the loans, interest and fees receivable and related restricted cash and accrues interest at an annual rate equal to LIBOR plus 5.0%. The loan is subject to certain affirmative covenants, including a liquidity test and an eligibility test, the failure of which could result in required early repayment of all or a portion of the outstanding balance. The note is guaranteed by Atlanticus who is required to maintain certain minimum liquidity levels.

 

In October 2016, we (through a wholly owned subsidiary) entered a revolving credit facility with a $40.0 million borrowing limit that can be drawn to the extent of outstanding eligible principal receivables of our CAR subsidiary (of which $31.2 million was drawn as of March 31, 2019). This facility is secured by the financial and operating assets of CAR and accrues interest at an annual rate equal to LIBOR plus a range between 2.4% and 3.0% based on certain ratios.  The loan is subject to certain affirmative covenants, including a coverage ratio, a leverage ratio and a collateral performance test, the failure of which could result in required early repayment of all or a portion of the outstanding balance. In February 2019, we extended the maturity date of this revolving credit facility to November 1, 2020.  There were no other material changes to the existing terms or conditions and the new maturity date is reflected in the table above.

 

In February 2017, we (through a wholly owned subsidiary) established a program under which we sell certain receivables to a consolidated trust in exchange for notes issued by the trust. The notes are secured by the receivables and other assets of the trust. Simultaneously with the establishment of the program, the trust issued a series of variable funding notes and sold an aggregate amount of up to $90.0 million (of which $69.0 million was outstanding as of March 31, 2019) to an unaffiliated third party pursuant to a facility that can be drawn upon to the extent of outstanding eligible receivables. Interest rates on the notes are fixed and range from 12.0% to 14.0%. The facility matures on February 8, 2022 and is subject to certain affirmative covenants and collateral performance tests, the failure of which could result in required early repayment of all or a portion of the outstanding balance of notes. The facility also may be prepaid subject to payment of a prepayment or other fee.

 

In 2018, we (through a wholly owned subsidiary) entered into two separate facilities associated with the above mentioned program to sell up to an aggregate $200.0 million of notes which are secured by the receivables and other assets of the trust (of which $96.5 million was outstanding as of March 31, 2019) to separate unaffiliated third parties pursuant to facilities that can be drawn upon to the extent of outstanding eligible receivables. Interest rates on the notes are based on commercial paper rates plus 4.25% and LIBOR plus 4.5%, respectively. The facilities mature on June 11, 2020 and November 16, 2020, respectively, and are subject to certain affirmative covenants and collateral performance tests, the failure of which could result in required early repayment of all or a portion of the outstanding balance of notes. The facilities also may be prepaid subject to payment of a prepayment or other fee.

 

In November 2018, we sold $167.3 million of asset backed securities (“ABS”) secured by certain retail point-of-sale receivables. A portion of the proceeds from the sale were used to pay-down our existing term and revolving facilities associated with our point-of-sale receivables, noted in the table above, and the remaining proceeds are available to fund the acquisition of future receivables. The terms of the ABS allow for a two-year revolving structure with a subsequent 18-month amortization period. The weighted average interest rate on the securities is fixed at 5.76%.

 

We are in compliance with the covenants underlying our various notes payable.

 

 

9.

Convertible Senior Notes

 

In November 2005, we issued $300.0 million aggregate principal amount of 5.875% convertible senior notes due November 30, 2035. The convertible senior notes are unsecured, subordinate to existing and future secured obligations and structurally subordinate to existing and future claims of our subsidiaries’ creditors. These notes (net of repurchases since the issuance dates) are reflected within convertible senior notes on our consolidated balance sheets.   No put rights exist under our convertible senior notes.  

    

The following summarizes (in thousands) components of our consolidated balance sheets associated with our convertible senior notes:

 

   

As of

 
   

March 31, 2019

   

December 31, 2018

 

Face amount of convertible senior notes

  $ 88,280     $ 88,280  

Discount

    (25,967 )     (26,138 )

Net carrying value

  $ 62,313     $ 62,142  

Carrying amount of equity component included in paid-in capital

  $ 108,714     $ 108,714  

Excess of instruments’ if-converted values over face principal amounts

  $     $  

 

 


21

 

 

10.

Commitments and Contingencies

 

General

 

Under finance products available in the point-of-sale and direct-to-consumer channels, consumers have the ability to borrow up to the maximum credit limit assigned to each individual’s account.  Unfunded commitments under these products aggregated $717.0 million at March 31, 2019. We have never experienced a situation in which all borrowers have exercised their entire available lines of credit at any given point in time, nor do we anticipate this will ever occur in the future.  Moreover, there would be a concurrent increase in assets should there be any exercise of these lines of credit.  We also have the effective right to reduce or cancel these available lines of credit at any time.

 

Additionally our CAR operations provide floor-plan financing for a pre-qualified network of independent automotive dealers and automotive finance companies in the buy-here, pay-here used car business.  The financings allow dealers and finance companies to borrow up to the maximum pre-approved credit limit allowed in order to finance ongoing inventory needs.  These loans are secured by the underlying auto inventory and, in certain cases where we have other lending products outstanding with the dealer, are secured by the collateral under those lending arrangements as well, including any outstanding dealer reserves. As of March 31, 2019, CAR had unfunded outstanding floor-plan financing commitments totaling $8.0 million.  Each draw against unused commitments is reviewed for conformity to pre-established guidelines.

 

Under agreements with third-party originating and other financial institutions, we have pledged security (collateral) related to their issuance of consumer credit and purchases thereunder, of which $11.4 million remains pledged as of March 31, 2019 to support various ongoing contractual obligations. 

 

Under agreements with third-party originating and other financial institutions, we have agreed to indemnify the financial institutions for certain liabilities associated with the services we provide on behalf of the financial institutions—such indemnification obligations generally being limited to instances in which we either (a) have been afforded the opportunity to defend against any potentially indemnifiable claims or (b) have reached agreement with the financial institutions regarding settlement of potentially indemnifiable claims. As of March 31, 2019, we have assessed the likelihood of any potential payments related to the aforementioned contingencies as remote. We will accrue liabilities related to these contingencies in any future period if and in which we assess the likelihood of an estimable payment as probable.

 

We also are subject to certain minimum payments under cancelable and non-cancelable lease arrangements. For further information regarding these commitments, see Note 7, “Leases”.

 

Litigation

 

We are involved in various legal proceedings that are incidental to the conduct of our business, none of which are expected to be material to us.

 

22

 

 

11.

Net Income (Loss) Attributable to Controlling Interests Per Common Share

 

The following table sets forth the computations of net income (loss) per common share (in thousands, except per share data): 

 

   

For the Three Months Ended March 31,

 
   

2019

   

2018

 

Numerator:

               

Net income (loss) attributable to controlling interests

  $ 5,713     $ (4,670 )

Denominator:

               

Basic (including unvested share-based payment awards) (1)

    14,355       13,899  

Effect of dilutive stock compensation arrangements (2)

    362        

Diluted (including unvested share-based payment awards) (1)

    14,717       13,899  

Net income (loss) attributable to controlling interests per common share—basic

  $ 0.40     $ (0.34 )

Net income (loss) attributable to controlling interests per common share—diluted

  $ 0.39     $ (0.34 )

 

 

(1)

Shares related to unvested share-based payment awards included in our basic and diluted share counts were 397,566 for the three months ended March 31, 2019, compared to 184,196 for the three months ended March 31, 2018.

 

(2)

The effect of dilutive stock compensation arrangements is shown only for informational purposes where we are in a net loss position.  In such situations, the effect of including outstanding options and restricted stock would be anti-dilutive, and they are thus excluded from all loss period calculations.

 

For the three months ended March 31, 2019 and 2018, there were no shares potentially issuable and thus includible in the diluted net income attributable to controlling interests per common share calculations pursuant to our convertible senior notes. However, in future reporting periods during which our closing stock price is above the $24.61 conversion price for the convertible senior notes, and depending on the closing stock price at conversion, the maximum potential dilution under the conversion provisions of such notes is 3.6 million shares, which could be included in diluted share counts in net income per common share calculations. See Note 9, “Convertible Senior Notes,” for a further discussion of these convertible securities.

 

23

 

 

12.

Stock-Based Compensation

 

As of March 31, 2019, we had two stock-based compensation plans, the Second Amended and Restated Employee Stock Purchase Plan (the “ESPP”) and the Second Amended and Restated 2014 Equity Incentive Plan (the “2014 Plan”).  On May 9, 2019, our shareholders approved the Fourth Amended and Restated 2014 Equity Incentive Plan (the "Fourth Amended 2014 Plan").  Among other things, the Fourth Amended 2014 Plan (i) increased the number of shares of Common Stock available for issuance under the Fourth Amended 2014 Plan by 2,000,000 shares and (ii) extended the term of the Fourth Amended 2014 Plan by approximately two years. As of March 31, 2019, 78,169 shares remained available for issuance under the ESPP and 1,796,770 shares remained available for issuance under the 2014 Plan (including the additional shares authorized by the Fourth Amended 2014 Plan).

 

Exercises and vestings under our stock-based compensation plans resulted in no income tax-related charges to additional paid-in capital during the three months ended March 31, 2019 and 2018.

 

Restricted Stock and Restricted Stock Units

 

During the three months ended March 31, 2019 and 2018, we granted 205,000 and 69,000 cumulative shares of restricted stock and restricted stock units (net of any forfeitures), respectively, with aggregate grant date fair values of $0.7 million and $0.2 million, respectively. We incurred expenses of $0.2 million and $0.1 million during the three months ended March 31, 2019 and 2018, respectively, related to restricted stock awards. When we grant restricted stock and restricted stock units, we defer the grant date value of the restricted stock and restricted stock unit and amortize that value (net of the value of anticipated forfeitures) as compensation expense with an offsetting entry to the paid-in capital component of our consolidated shareholders’ equity. Our restricted stock awards typically vest over a range of 12 to 60 months (or other term as specified in the grant) and are amortized to salaries and benefits expense ratably over applicable vesting periods. As of March 31, 2019, our unamortized deferred compensation costs associated with non-vested restricted stock awards were $1.3 million with a weighted-average remaining amortization period of 2.0 years.

 

Stock Options

 

Our 2014 Plan provides that we may grant options on or shares of our common stock (and other types of equity awards) to members of our Board of Directors, employees, consultants and advisors. The exercise price per share of the options must be equal to or greater than the market price on the date the option is granted. The option period may not exceed 10 years from the date of grant.   The vesting requirements for options are determined by the Compensation Committee of the Board of Directors. We had expense of $0.2 million and $0.2 million related to stock option-related compensation costs during the three months ended March 31, 2019 and 2018, respectively. When applicable, we recognize stock option-related compensation expense for any awards with graded vesting on a straight-line basis over the vesting period for the entire award. The table below includes additional information about outstanding options:

 

 

   

Number of Shares

   

Weighted-Average Exercise Price

   

Weighted-Average of Remaining Contractual Life (in years)

   

Aggregate Intrinsic Value

 

Outstanding at December 31, 2018

    3,121,200     $ 3.50                  

Issued

    50,000     $ 3.13                  

Exercised

    (419,500 )   $ 2.54                  

Cancelled/Forfeited

        $                  

Outstanding at March 31, 2019

    2,751,700     $ 3.64       2.9     $ 934,117  

Exercisable at March 31, 2019

    959,868     $ 3.34       2.1     $ 239,953  

 

We had $1.0 million and $1.2 million of unamortized deferred compensation costs associated with non-vested stock options as of March 31, 2019 and December 31, 2018, respectively.

 

 

24

 

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

    

The following discussion should be read in conjunction with our consolidated financial statements and the related notes included therein and our Annual Report on Form 10-K for the year ended December 31, 2018, where certain terms have been defined.

 

This Management’s Discussion and Analysis of Financial Condition and Results of Operations includes forward-looking statements. We base these forward-looking statements on our current plans, expectations and beliefs about future events. There are risks, including the factors discussed in “Risk Factors” in Part II, Item 1A and elsewhere in this report, that our actual experience will differ materially from these expectations.  For more information, see “Forward-Looking Information” below.

 

In this report, except as the context suggests otherwise, the words “Company,” “Atlanticus Holdings Corporation,” “Atlanticus,” “we,” “our,” “ours,” and “us” refer to Atlanticus Holdings Corporation and its subsidiaries and predecessors.

 

This report contains information that we obtained from industry and general publications and research, surveys and studies conducted by third parties.  This information involves many assumptions and limitations, and you are cautioned not to give undue weight to any of this data.  We have obtained this information from sources that we believe are reliable.  However, we have not independently verified market or industry data from third party sources.

 

OVERVIEW

 

We utilize proprietary analytics and a flexible technology platform to enable financial institutions to provide various credit and related financial services and products to or associated with the financially underserved consumer credit market. According to data published by FICO (NYSE: FICO), 41.7% of consumers had FICO® scores of 700 or less as of April 2018 which represents a population in excess of 90 million consumers.  The “Report on Economic Well-Being of U.S. Households in 2017” published by the Board of Governors of the Federal Reserve System further states that 40% of adults do not have ready access to $400 to cover an unexpected expense or would cover the expense by selling something or borrowing money, with CareerBuilder noting that 75% of Americans live “paycheck to paycheck”.  These consumers often have short-term, immediate credit needs that are often not effectively met by traditional financial institutions.  By facilitating fairly priced consumer credit alternatives with value added features and benefits specifically curated for the unique needs of this financially underserved consumer, we endeavor to empower consumers on a path to improved financial well-being.

 

Currently, within our Credit and Other Investments segment, we are applying the experiences gained and infrastructure built from servicing over $25 billion in consumer loans over our 22-year operating history to support lenders who originate a range of consumer loan products. These products include retail credit and credit cards marketed through multiple channels, including retail point-of-sale, direct mail solicitation, and partnerships with third parties. In the point-of-sale channel, we partner with retailers and service providers in various industries across the U.S. to allow them to provide credit to their customers for the purchase of a variety of goods and services including consumer electronics, furniture, elective medical procedures, healthcare, educational services and home-improvements. These services of our lending partners are often extended to consumers who may not have access to traditional financing options. We specialize in supporting this “second-look” credit service. Our flexible technology platform allows our lending partners to integrate our paperless process and instant decision-making platform with the technology infrastructure of participating retailers and service providers. Additionally, we support lenders who market general purpose credit cards directly to consumers through additional channels, which enables them to reach consumers through a diverse origination platform that includes retail point-of-sale, direct mail and digital marketing solicitation and partnerships with third parties. Our technology platform and proprietary analytics enable lenders to make instant credit decisions utilizing hundreds of inputs from multiple sources and thereby offer credit to consumers overlooked by traditional providers of financing. By offering a range of products through a multitude of channels, we enable lenders to provide the right type of credit, whenever and wherever the consumer has a need.

 

In most cases, we invest in the receivables originated by lenders who utilize our technology platform and other related services. From time to time, we also purchase receivables portfolios from third parties.  In this report, "receivables" refer to receivables we have purchased from our lending partners or from third parties.

 

Using our infrastructure and technology platform, we also provide loan servicing, including risk management and customer service outsourcing, for third parties. Also through our Credit and Other Investments segment, we engage in testing and limited investment in consumer finance technology platforms as we seek to capitalize on our expertise and infrastructure.

 

Additionally, we report within our Credit and Other Investments segment: (1) the income earned from an investment in an equity-method investee that holds credit card receivables for which we are the servicer; and (2) gains or losses associated with investments previously made in consumer finance technology platforms. These include investments in companies engaged in mobile technologies, marketplace lending and other financial technologies. These investments are carried at the lower of cost or market valuation. None of these companies are publicly-traded and there are no material pending liquidity events.

 

The recurring cash flows we receive within our Credit and Other Investments segment principally include those associated with (1) point-of-sale and direct-to-consumer receivables, (2) servicing compensation and (3) credit card receivables portfolios that are unencumbered or where we own a portion of the underlying structured financing facility.

 

We believe that our point-of-sale and direct-to-consumer receivables are generating, and will continue to generate, attractive returns on assets, thereby facilitating debt financing under terms and conditions (including advance rates and pricing) that will support attractive returns on equity, and we continue to pursue growth in this area.

 

Within our Auto Finance segment, our CAR subsidiary operations principally purchase and/or service loans secured by automobiles from or for, and also provide floor plan financing for, a pre-qualified network of independent automotive dealers and automotive finance companies in the buy-here, pay-here, used car business. We purchase auto loans at a discount and with dealer retentions or holdbacks that provide risk protection. Also within our Auto Finance segment, we are providing certain installment lending products in addition to our traditional loans secured by automobiles.

 

We closely monitor and manage our expenses based on current product offerings. At this time, we are maintaining our infrastructure and incurring increased overhead and other costs in order to expand point-of-sale and direct-to-consumer finance and credit solutions and new product offerings that we believe have the potential to grow into our existing infrastructure and allow for long-term shareholder returns.

 

Beyond these activities within our Credit and Other Investments segment, we invest in and service portfolios of credit card receivables. One of our portfolios of credit card receivables is encumbered by non-recourse structured financing, and for this portfolio our principal remaining economic interest is the servicing compensation we receive as an offset against our servicing costs given that the likely future collections on the portfolio are insufficient to allow for full repayment of the financing.

 

Subject to the availability of capital at attractive terms and pricing, we plan to continue to evaluate and pursue a variety of activities, including:  (1) investments in additional financial assets associated with point-of-sale and direct-to-consumer finance and credit activities as well as the acquisition of interests in receivables portfolios and (2) the repurchase of our convertible senior notes and other debt and our outstanding common stock.

 

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CONSOLIDATED RESULTS OF OPERATIONS

 

                   

Income

 
   

For the Three Months Ended March 31,

   

Increases (Decreases)

 

(In Thousands)

 

2019

   

2018

   

from 2018 to 2019

 

Total interest income

  $ 50,459     $ 35,726     $ 14,733  

Interest expense

    (11,146 )     (8,153 )     (2,993 )

Fees and related income on earning assets:

                       

Fees on credit products

    10,296       4,905       5,391  

Changes in fair value of loans, interest and fees receivable recorded at fair value

    (1 )     (18 )     17  

Changes in fair value of notes payable associated with structured financings recorded at fair value

    875       1,331       (456 )

Other

    94       (4 )     98  

Other operating income:

                       

Servicing income

    686       632       54  

Other income

    16,844       516       16,328  

Equity in income of equity-method investee

    227       9       218  

Total

  $ 68,334     $ 34,944     $ 33,390  

Net losses upon impairment of loans, interest and fees receivable recorded at fair value

    254       1,791       1,537  

Provision for losses on loans, interest and fees receivable recorded at net realizable value

    34,598       15,991       (18,607 )

Other operating expenses:

                       

Salaries and benefits

    6,591       6,298       (293 )

Card and loan servicing

    10,444       9,164       (1,280 )

Marketing and solicitation

    6,387       2,346       (4,041 )

Depreciation

    289       229       (60 )

Other

    3,878       3,700       (178 )

Net income (loss)

    5,655       (4,719 )     10,374  

Net loss attributable to noncontrolling interests

    58       49       9  

Net income (loss) attributable to controlling interests

    5,713       (4,670 )     10,383  


Three Months Ended March 31, 2019, Compared to Three Months Ended March 31, 2018

 

Total interest income. Total interest income consists primarily of finance charges and late fees earned on point-of-sale and direct-to-consumer receivables, credit card and auto finance receivables. Period-over-period results primarily relate to growth in point-of-sale finance and direct-to-consumer products, the receivables of which increased from $322.3 million as of March 31, 2018 to $472.3 million as of March 31, 2019. We are currently experiencing continued period-over-period growth in point-of-sale and direct-to-consumer receivables and to a lesser extent in our CAR receivables—growth which we expect to result in net period-over-period growth in our total interest income for these operations in 2019. Future periods’ growth is also dependent on the addition of new retail partners to expand the reach of point-of-sale operations as well as growth within existing partnerships and continued growth and marketing within the direct-to-consumer receivables. 

 

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Interest expense. Variations in interest expense are due to new borrowings associated with growth in point-of-sale and direct-to-consumer receivables and CAR operations as evidenced within Note 8, “Notes Payable,” to our consolidated financial statements offset by our debt facilities being repaid commensurate with net liquidations of the underlying credit card, auto finance and installment loan receivables that serve as collateral for the facilities. Outstanding notes payable associated with our point-of-sale and direct-to-consumer operations increased from $219.9 million as of March 31, 2018 to $382.4 million as of March 31, 2019. We anticipate additional debt financing over the next few quarters as we continue to acquire receivables, and as such, we expect our quarterly interest expense to be above that experienced in the prior periods for these operations.

 

Fees and related income on earning assets.  The significant factors affecting our differing levels of fees and related income on earning assets include:

 

 

increases in fees on credit products, primarily associated with growth in direct-to-consumer products and to a lesser degree by growth in point-of-sale finance products, offset somewhat by general net declines in historical credit card receivables; and

 

the effects of changes in the fair values of credit card receivables recorded at fair value and notes payable associated with structured financings recorded at fair value as described below.

 

We expect increasing levels of direct-to-consumer fee income throughout 2019 as we continue to invest in new credit card receivables as part of our direct-to-consumer operations. Additionally, for credit card accounts for which we use fair value accounting, we expect our change in fair value of credit card receivables recorded at fair value and our change in fair value of notes payable associated with structured financings recorded at fair value amounts to gradually diminish (absent significant changes in the assumptions used to determine these fair values) in the future. These amounts, however, are subject to potentially high levels of volatility if we experience changes in the quality of our credit card receivables or if there are significant changes in market valuation factors (e.g., interest rates and spreads) in the future. Such volatility will be muted somewhat, however, by the offsetting nature of the receivables and underlying debt being recorded at fair value and with the expected reductions in the face amounts of such outstanding receivables and debt as we experience further legacy credit card receivables liquidations and associated debt repayments.

 

Servicing income.  We earn servicing income by servicing loan portfolios for third parties (including our equity-method investee). Additionally, we will receive periodic compensation for processing reimbursements to consumers with respect to one of our portfolios. Unless and/or until we grow the number of contractual servicing relationships we have with third parties or our current relationships grow their loan portfolios, we will not experience significant growth and income within this category, and we currently expect to experience continued declines in this category of revenue relative to revenue earned in prior periods.

 

Other income.  Included within our Other income category are ancillary and interchange revenues. Given recent growth associated with new credit card offerings and related receivables, we expect ancillary and interchange revenues to grow throughout the year.   Also included in Other income for the three months ended March 31, 2019 is $15.5 million associated with reductions in accruals related to one of our portfolios.  The original accrual was based upon our estimate of the amount that could be claimed by customers and is based upon several factors including customer claims volume, average claim amount and a determination of the amount, if any, which may be offered to resolve such claims.  The assumptions used in the accrual estimate are subjective, mainly due to uncertainty associated with future claims volumes and the resolution costs, if any, per claim. As of March 31, 2019, we had approximately $92 million accrued related to this liability within accounts payable and accrued expenses on the consolidated balance sheets, including the reclassification of approximately $26 million from unrestricted cash and cash equivalents on our consolidated balance sheets.  We currently expect a significant majority of the remaining accrued amount to be either reduced or paid to customers by December 31, 2019.  Any further reduction in the amount accrued would result in future earnings within this income statement category.

 

Equity in income of equity-method investee. Because our equity-method investee uses the fair value option to account for its financial assets and liabilities, changes in fair value estimates can cause some volatility in the earnings of this investee. Because of continued liquidations in the credit card receivables portfolio of our equity-method investee, absent additional investments in our existing or in new equity-method investees in the future, we expect gradually declining effects from our equity-method investment on our operating results.

 

Net losses upon impairment of loans, interest and fees receivable recorded at fair value. This account reflects charge offs (net of recoveries) of the face amount of credit card receivables we record at fair value on our consolidated balance sheet. We have experienced a general trending decline in, and we expect future trending declines in, these charge-offs as we continue to liquidate our historical credit card receivables.  

 

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Provision for losses on loans, interest and fees receivable recorded at net realizable value.  Our provision for losses on loans, interest and fees receivable recorded at net realizable value covers, with respect to such receivables, changes in estimates regarding our aggregate loss exposures on (1) principal receivable balances, (2) finance charges and late fees receivable underlying income amounts included within our total interest income category, and (3) other fees receivable. We have experienced a period-over-period increase in this category between both the three months ended March 31, 2019 and 2018 and the years ended December 31, 2018 and 2017 primarily reflecting the effects of volume associated with point-of-sale and direct-to-consumer finance receivables (i.e., growth of new product receivables and their subsequent maturation), rather than specific credit quality changes or deterioration, which also impacted our provision for losses on loans, interest and fees receivable recorded at net realizable value to a lesser degree. See Note 2, “Significant Accounting Policies and Consolidated Financial Statement Components,” to our consolidated financial statements and the discussions of our Credit and Other Investments and Auto Finance segments for further credit quality statistics and analysis.

 

Total other operating expense. Total other operating expense variances for the three months ended March 31, 2019, relative to the three months ended March 31, 2018, reflect the following:

 

  increases in salaries reflecting marginal growth in both the number of employees and increases in related benefit costs.  We expect some marginal increase in this cost for 2019 when compared to 2018 as we expect our receivables to continue to grow;
 

increases in card and loan servicing expenses in the three months ended March 31, 2019 when compared to the three months ended March 31, 2018 due to growth in receivables associated with our investments in point-of-sale and direct-to-consumer receivables which grew from $322.3 million outstanding to $472.3 million outstanding at March 31, 2018 and March 31, 2019, respectively, offset by the continued net liquidations in our historical credit card portfolios, the receivables of which declined from $15.6 million outstanding to $8.7 million outstanding at March 31, 2018 and March 31, 2019, respectively;

 

increases in marketing and solicitation costs for the three months ended March 31, 2019 when compared to the three months ended March 31, 2018, primarily due to volume-related increases in costs attributable to the growth in our retail point-of-sale and direct-to-consumer portfolios. We expect that increased origination and brand marketing support will result in overall increases in year-over-year costs during 2019 although the frequency and timing of marketing efforts could result in reductions in quarter-over-quarter marketing costs; and

 

slight increases in other expenses primarily related to realized translation gains and losses recognized during both periods.

 

Certain operating costs are variable based on the levels of accounts and receivables we service (both for our own account and for others) and the pace and breadth of our growth in receivables. However, a number of our operating costs are fixed and until recently have comprised a larger percentage of our total costs based on the ongoing contraction of our legacy credit card receivables. This trend is reversing as we continue to grow our earning assets (including loans, interest and fees receivable) based principally on growth of point-of-sale and direct-to-consumer receivables and to a lesser extent, growth within our CAR operations. This is evidenced by the growth we experienced in our managed receivables levels with minimal growth in the fixed portion of our card and loan servicing expenses as well as our salaries and benefits costs as we were able to better utilize our fixed costs to grow our asset base. We continue to manage our costs effectively.

 

Notwithstanding our cost-control efforts and focus, we expect increased levels of expenditures associated with anticipated growth in point-of-sale and direct-to-consumer credit card-related operations. These expenses will primarily relate to the variable costs of marketing efforts and card and loan servicing expenses associated with new receivable acquisitions. While we have greater control over our variable expenses, it is difficult (as explained above) for us to appreciably reduce our fixed and other costs associated with an infrastructure (particularly within our Credit and Other Investments segment) that was built to support levels of managed receivables that are significantly higher than both our current levels and the levels that we expect to see in the near future. At this point, our Credit and Other Investments segment cash inflows are sufficient to cover its direct variable costs and a portion, but not all, of its share of overhead costs (including, for example, corporate-level executive and administrative costs and our convertible senior notes interest costs). As such, if we are unable to contain overhead costs or expand revenue-earning activities to levels commensurate with such costs, then we may experience continuing pressure on our ability to achieve consistent profitability.

 

Noncontrolling interests.  We reflect the ownership interests of noncontrolling holders of equity in our majority-owned subsidiaries as noncontrolling interests in our consolidated statements of operations. Unless we enter into significant new majority-owned subsidiary ventures with noncontrolling interest holders in the future, we expect to have negligible noncontrolling interests in our majority-owned subsidiaries and negligible allocations of income or loss to noncontrolling interest holders in future quarters.

 

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Income Taxes. We experienced an effective income tax expense rate of 4.0% for the three months ended March 31, 2019, compared to a negative effective income tax expense rate of 3.1% for the three months ended March 31, 2018. Our effective income tax expense rate for the three months ended March 31, 2019, is below the statutory rate principally due to reductions in our valuation allowances against net federal deferred tax assets during such period—the effect of such reductions being partially offset by accruals of interest on unpaid federal tax liabilities and uncertain tax positions and state and foreign income taxes during such period. Conversely, our negative effective income tax expense rate for the three months ended March 31, 2018, was greater than the statutory rate principally due to accruals of interest on unpaid federal tax liabilities and uncertain tax positions and state and foreign income taxes during such period—the effect of such accruals being partially offset by additions to valuation allowances against our net federal deferred tax assets during such period.

               

We report income tax-related interest and penalties (including those associated with both our accrued liabilities for uncertain tax positions and unpaid tax liabilities) within our income tax line item on our consolidated statements of operations.  We likewise report the reversal of income tax-related interest and penalties within such line item to the extent that we resolve our liabilities for uncertain tax positions or unpaid tax liabilities in a manner favorable to our accruals therefor.  During the three months ended March 31, 2019, and 2018, we included $0.1 million and $0.2 million, respectively, of net income tax-related interest and penalties within those periods’ respective income tax expense line items.

 

In December 2014, we reached a settlement with the IRS concerning the tax treatment of net operating losses we incurred in 2007 and 2008 and carried back to obtain refunds of federal income taxes paid in earlier years dating back to 2003. In 2015, we filed an amended return claim that, if accepted, would have eliminated the $7.4 million assessment (and corresponding interest and penalties) under a negotiated provision of the December 2014 IRS settlement. The IRS filed a lien (as is customarily the case) associated with the assessment.  Subsequently, an IRS examination team denied our amended return claims, and we filed a protest with IRS Appeals. Following correspondence and conferences held with IRS Appeals, we received and accepted a settlement offer from IRS Appeals in June 2018 that reduced our $7.4 million net unpaid income tax assessment referenced above to $3.7 million. In July 2018, we paid $5.4 million to the IRS to cover the $3.7 million unpaid income tax assessment and most of the interest that had accrued thereon; during the three months ended September 30, 2018, the IRS refunded $0.5 million of the $5.4 million payment. Although we have paid all assessed income taxes related to this matter, we still have an outstanding accrued liability for some of the interest and for failure-to-pay penalties related to this matter. We paid another $0.2 million against accrued interest liabilities in March 2019, and we are continuing to pursue complete abatement of failure-to-pay penalties of $0.9 million. Once this matter is resolved and we pay any residual interest liability, we expect the IRS to remove the aforementioned lien in due course.

 

Credit and Other Investments Segment

 

Our Credit and Other Investments segment includes our activities relating to our servicing of and our investments in the point-of-sale, direct-to-consumer personal finance and credit card operations, our various credit card receivables portfolios, as well as other product testing and investments that generally utilize much of the same infrastructure. The types of revenues we earn from our investments in receivables portfolios and services primarily include finance charges, fees and the accretion of discounts associated with the point-of-sale receivables or annual fees on our direct-to-consumer receivables.

 

We record (i) the finance charges, discount accretion and late fees assessed on our Credit and Other Investments segment receivables in the interest income - consumer loans, including past due fees category on our consolidated statements of operations, (ii) the rental revenue, annual, activation, monthly maintenance, returned-check, cash advance and other fees in the fees and related income on earning assets category on our consolidated statements of operations, and (iii) the charge offs (and recoveries thereof) within our provision for losses on loans, interest and fees receivable recorded at net realizable value on our consolidated statements of operations (for all credit product receivables other than those for which we have elected the fair value option) and within net losses upon impairment of loans, interest and fees receivable recorded at fair value on our consolidated statements of operations (for all of our other receivables for which we have elected the fair value option). Additionally, we show the effects of fair value changes for those credit card receivables for which we have elected the fair value option as a component of fees and related income on earning assets in our consolidated statements of operations.

 

We historically have invested in receivables portfolios through subsidiary entities. If we control through direct ownership or exert a controlling interest in the entity, we consolidate it and reflect its operations as noted above. If we exert significant influence but do not control the entity, we record our share of its net operating results in the equity in income of equity-method investee category on our consolidated statements of operations.

 

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Managed Receivables

 

We make various references within our discussion of the Credit and Other Investments segment to our managed receivables. Our managed receivables data includes only the performance of those receivables underlying consolidated subsidiaries and excludes from managed receivables data the performance of receivables held by our equity method investee. As the receivables underlying our equity method investee reflect a diminishing portion of our overall receivables base, we do not believe their inclusion or exclusion in the overall results is material. Additionally, we calculate average managed receivables based on the quarter ending balances. 

 

Financial, operating and statistical data based on aggregate managed receivables are important to any evaluation of the performance of our credit portfolios, including our risk management, servicing and collection activities and our valuing of purchased receivables. In allocating our resources and managing our business, management relies heavily upon financial data and results prepared on this “managed basis.” Analysts, investors and others also consider it important that we provide selected financial, operating and statistical data on a managed basis because this allows a comparison of us to others within the specialty finance industry. Moreover, our management, analysts, investors and others believe it is critical that they understand the credit performance of our managed receivables because it provides information concerning the quality of loan originations and the related credit risks inherent within the portfolios.

 

Reconciliation of the managed receivables data to our GAAP financial statements requires an understanding that: (1) our managed receivables data are based on billings and actual charge-offs as they occur, without regard to any changes in our allowance for uncollectible loans, interest and fees receivable; (2) our managed receivables data exclude non-consolidated receivables (3) the period-end and average managed receivables data include the face value of receivables which are accounted for under the fair value option; and (4) when applicable, we exclude from our managed receivables data certain reimbursements received in respect of one of our portfolios which resulted in pre-tax income benefits within our net recovery of impairment of loans, interest and fees receivable recorded at fair value line item on our consolidated statements of operations totaling approximately $0.4 million for the three months ended September 30, 2018, $1.7 million for the three months ended June 30, 2018, $2.9 million for the three months ended September 30, 2017, and $1.1 million for the three months ended June 30, 2017. This last category of reconciling items above is excluded because it does not bear on our performance in managing our credit card portfolios, including our risk management, servicing and collection activities and our valuing of purchased receivables; moreover, we do not expect to receive any further material reimbursements with respect to this portfolio.

 

A reconciliation of our Loans, interest and fees receivable, at fair value to the assets underlying those receivables which are included in our managed receivables are as follows (in thousands):

 

   

At or for the Three Months Ended

 
   

2019

   

2018

   

2017

 
   

Mar. 31

   

Dec. 31

   

Sept. 30

   

Jun. 30

   

Mar. 31

   

Dec. 31

   

Sept. 30

   

Jun. 30

 

Loans, interest and fees receivable, gross