Atlanticus Holdings Corp - Annual Report: 2017 (Form 10-K)
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
For the year ended December 31, 2017
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.
Atlanticus is not a well-known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933.
Atlanticus (1) is required to file reports pursuant to Section 13 of the Act, (2) has filed all reports required to be filed by Section 13 of the Act during the preceding 12 months and (3) has been subject to such filing requirements for the past 90 days.
Atlanticus has submitted electronically and posted on its corporate Web site every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months.
Atlanticus believes that its executive officers, directors and 10% beneficial owners subject to Section 16(a) of the Act complied with all applicable filing requirements during 2017.
Atlanticus is a smaller reporting company and is not a shell company or an emerging growth company.
The aggregate market value of Atlanticus’ common stock (based upon the closing sales price quoted on the NASDAQ Global Select Market) held by non-affiliates as of June 30, 2017 was $18.3 million. (For this purpose, directors, officers and 10% shareholders have been assumed to be affiliates, and we also have included 1,459,233 loaned shares at June 30, 2017.)
As of March 15, 2018, 15,360,058 shares of common stock, no par value, of Atlanticus were outstanding, including 1,459,233 loaned shares to be returned.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Atlanticus’ Proxy Statement for its 2018 Annual Meeting of Shareholders are incorporated by reference into Part III.
Table of Contents
Page | ||||
PART I | ||||
Item 1. | Business | |||
Item 1A. | Risk Factors | |||
Item 1B. | Unresolved Staff Comments | |||
Item 2. | Properties | |||
Item 3. | Legal Proceedings | |||
Item 4. | Mine Safety Disclosure | |||
PART II | ||||
Item 5. | Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities | |||
Item 6. | Selected Financial Data | |||
Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | |||
Item 7A. | Quantitative and Qualitative Disclosures About Market Risk | |||
Item 8. | Financial Statements and Supplementary Data | |||
Item 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure | |||
Item 9A. | Controls and Procedures | |||
Item 9B. | Other Information | |||
PART III | ||||
Item 10. | Directors, Executive Officers and Corporate Governance | |||
Item 11. | Executive Compensation | |||
Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters | |||
Item 13. | Certain Relationships and Related Transactions, and Director Independence | |||
Item 14. | Principal Accountant Fees and Services | |||
PART IV | ||||
Item 15. | Exhibits and Financial Statement Schedules | |||
Item 16. | Form 10-K Summary | |||
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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. Atlanticus owns Aspire®, Emerge®, Fortiva®, Imagine®, Salute®, Tribute® and other trademarks and service marks in the United States (“U.S.”) and the United Kingdom (“U.K.”).
Cautionary Notice Regarding Forward-Looking Statements
We make forward-looking statements in this Report and in other materials we file with the Securities and Exchange Commission (“SEC”) or otherwise make public. In this Report, both Item 1, “Business,” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contain forward-looking statements. In addition, our senior management might make forward-looking statements to analysts, investors, the media and others. Statements with respect to expected revenue; income; receivables; income ratios; net interest margins; long-term shareholder returns; acquisitions of financial assets and other growth opportunities; divestitures and discontinuations of businesses; loss exposure and loss provisions; delinquency and charge-off rates; the effects of account actions we may take or have taken; changes in collection programs and practices; changes in the credit quality and fair value of our credit card loans and fees receivable and the fair value of their underlying structured financing facilities; the impact of actions by the Federal Deposit Insurance Corporation (“FDIC”), Federal Reserve Board, Federal Trade Commission (“FTC”), Consumer Financial Protection Bureau (“CFPB”) and other regulators on both us, banks that issue credit cards and other credit products on our behalf, and merchants that participate in our point-of-sale finance operations; account growth; the performance of investments that we have made; operating expenses; the impact of bankruptcy law changes; marketing plans and expenses; the performance of our Auto Finance segment; our plans in the U.K.; the impact of our credit card receivables on our financial performance; the sufficiency of available capital; the prospect for improvements in the capital and finance markets; future interest costs; sources of funding operations and acquisitions; growth and profitability of our point-of-sale finance operations; our entry into international markets; our ability to raise funds or renew financing facilities; share repurchases or issuances; debt retirement; the results associated with our equity-method investee; our servicing income levels; gains and losses from investments in securities; experimentation with new products and other statements of our plans, beliefs or expectations are forward-looking statements. These and other statements using words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “project,” “target,” “can,” “could,” “may,” “should,” “will,” “would” and similar expressions also are forward-looking statements. Each forward-looking statement speaks only as of the date of the particular statement. The forward-looking statements we make are not guarantees of future performance, and we have based these statements on our assumptions and analyses in light of our experience and perception of historical trends, current conditions, expected future developments and other factors we believe are appropriate in the circumstances. Forward-looking statements by their nature involve substantial risks and uncertainties that could significantly affect expected results, and actual future results could differ materially from those described in such statements. Management cautions against putting undue reliance on forward-looking statements or projecting any future results based on such statements or present or historical earnings levels.
Although it is not possible to identify all factors, we continue to face many risks and uncertainties. Among the factors that could cause actual future results to differ materially from our expectations are the risks and uncertainties described under “Risk Factors” set forth in Part I, Item 1A, and the risk factors and other cautionary statements in other documents we file with the SEC, including the following:
• | the availability of adequate financing to support growth; |
• | the extent to which federal, state, local and foreign governmental regulation of our various business lines and the products we service for others limits or prohibits the operation of our businesses; |
• | current and future litigation and regulatory proceedings against us; |
• | the effect of adverse economic conditions on our revenues, loss rates and cash flows; |
• | competition from various sources providing similar financial products, or other alternative sources of credit, to consumers; |
• | the adequacy of our allowances for uncollectible loans and fees receivable and estimates of loan losses used within our risk management and analyses; |
• | the possible impairment of assets; |
• | our ability to manage costs in line with the expansion or contraction of our various business lines; |
• | our relationship with (i) the merchants that participate in point-of-sale finance operations and (ii) the banks that issue credit cards and provide certain other credit products utilizing our technology platform and related services; and |
• | theft and employee errors. |
Most of these factors are beyond our ability to predict or control. Any of these factors, or a combination of these factors, could materially affect our future financial condition or results of operations and the ultimate accuracy of our forward-
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looking statements. There also are other factors that we may not describe (because we currently do not perceive them to be material) that could cause actual results to differ materially from our expectations.
We expressly disclaim any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.
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PART I
ITEM 1. | BUSINESS |
General
A general discussion of our business follows. For additional information about our business, please visit our website at www.Atlanticus.com. Information contained on or available through our website is not incorporated by reference in this Report.
We are a Georgia corporation formed in 2009, as successor to an entity that commenced operations in 1996. We provide various credit and related financial services and products primarily to or associated with the financially underserved consumer credit market. 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. 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 21-year operating history to support lenders who originate a range of consumer loan products. These products include retail credit, personal loans, and credit cards marketed through multiple channels, including retail point-of-sale, direct mail solicitation, Internet-based marketing 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. 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. 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. Additionally, we support lenders who market general purpose personal loans and credit cards directly to consumers (our “direct-to-consumer” products) through additional channels, which enables them to reach consumers through a diverse origination platform that includes direct mail, Internet-based marketing and our retail partnerships. 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 credit. 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.
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.
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.
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.
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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.
Our overhead structure was built to accommodate higher managed receivables levels and a much greater volume of accounts serviced. Although we significantly reduced our overhead at the start of the Great Recession, we have maintained a sizable amount of our infrastructure in order to facilitate expansion in our point-of-sale and direct-to-consumer finance and credit solutions and new product offerings. Although this has resulted in increased overhead costs, we believe that we have the potential to grow into our existing infrastructure and provide long-term shareholder returns. In any event, we continue to closely monitor and manage our overhead costs.
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; (2) investments in other assets or businesses that are not necessarily financial services assets or businesses; and (3) the repurchase of our convertible senior notes and other debt or our outstanding common stock.
Credit and Other Investments Segment. Our Credit and Other Investments segment includes our point-of-sale and direct-to-consumer finance operations, investments in and servicing of our various credit card receivables portfolios and other product development and limited investment in consumer finance technology platforms that generally capitalize on our credit infrastructure.
As previously discussed, we support lenders who originate a range of consumer loan products over multiple channels. Through our point-of-sale operations, we leverage our flexible technology platform that allows retail partners and service providers to offer loan options to their customers who may have been declined by a primary lender. The same proprietary analytics and infrastructure also allows lenders to offer general purpose loan products directly to consumers with our direct-to-consumer products. We reach these consumers through a diverse origination platform that includes direct mail, Internet-based marketing and partnerships.
Our growing portfolio of receivables assets are generating, and we believe will continue to generate, attractive returns on assets, thereby allowing us to secure debt financing under terms and conditions (including advance rates and pricing) that will allow us to achieve our desired returns on equity, and we continue to pursue growth in this area.
We are currently expanding our acquisitions of new receivables associated with credit card accounts. With respect to the credit card accounts underlying our historical credit card receivables and portfolios, substantially all of the related credit card accounts have been closed to new cardholder purchases since 2009. We continue to service these credit card portfolios as they liquidate and they no longer constitute a meaningful part of our ongoing operations.
Our credit and other operations are heavily regulated, which may cause us to change how we conduct our operations either in response to regulation or in keeping with our goal of leading the industry in adherence to consumer-friendly practices. We have made several significant changes to our practices over the past several years, and because our account management practices are evolutionary and dynamic, it is possible that we may make further changes to these practices, some of which may produce positive, and others of which may produce adverse, effects on our operating results and financial position. Customers at the lower end of the credit score range intrinsically have higher loss rates than do customers at the higher end of the credit score range. As a result, we price our products to reflect this higher loss rate. As such, our products are subject to greater regulatory scrutiny than the products of prime only lenders who are able to price their credit products at much lower levels than we can. See “Consumer and Debtor Protection Laws and Regulations—Credit and Other Investments Segment” and Item 1A, “Risk Factors.”
Auto Finance Segment. The operations of our Auto Finance segment are conducted through our CAR platform, which we acquired in April 2005. CAR primarily purchases and/or services loans secured by automobiles from or for a pre-qualified network of independent automotive dealers and automotive finance companies in the buy-here, pay-here used car business. In 2010, we started offering floor-plan financing to this same group of dealers and finance companies. In 2013, we also started offering certain installment lending products in addition to our traditional loans secured by automobiles. While this product represented less than 15% of CAR’s net outstanding receivables as of December 31, 2017, we seek to modestly grow the volume of these loans in the coming quarters.
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Through our CAR operations, we generate revenues on purchased loans through interest earned on the face value of the installment agreements combined with the accretion of discounts on loans purchased. We generally earn discount income over the life of the applicable loan. Additionally, we generate revenues from servicing loans on behalf of dealers for a portion of actual collections and by providing back-up servicing for similar quality assets owned by unrelated third parties. We offer a number of other products to our network of buy-here, pay-here dealers (including our floor-plan financing offering), but the majority of our activities are represented by our purchases of auto loans at discounts and our servicing of auto loans for a fee. As of December 31, 2017, our CAR operations served more than 575 dealers in 33 states, the District of Columbia and two U.S. territories. These operations continue to perform well (achieving consistent profitability and generating positive cash flows with modest growth).
How Do We Manage the Receivables and Mitigate Our Risks?
Credit and Other Investments Segment. We manage our investments in receivables using credit behavioral scoring, credit file data and our proprietary risk evaluation systems. These strategies include the management of transaction authorizations, account renewals, over-limit accounts, credit line modifications and collection programs. We use an adaptive control system to translate our strategies into account management processes. The system enables us to develop and test multiple strategies simultaneously, which allows us to continually refine our account management activities. We have incorporated our proprietary risk scores into the control system, in addition to standard credit behavior scores used widely in the industry, in order to segment, evaluate and manage the receivables. We believe that by combining external credit file data along with historical and current customer activity, we are able to better predict the true risk associated with current and delinquent receivables.
For our point-of-sale and direct-to-consumer finance activities as well as the accounts that are open to purchases, we generally seek to manage credit lines to reward financially underserved customers who are performing well and to mitigate losses from delinquent customer segments. We also employ strategies to reduce otherwise open credit lines for customers demonstrating indicators of increased credit or bankruptcy risk. Data relating to account performance are captured and loaded into our proprietary database for ongoing analysis. We adjust account management strategies as necessary, based on the results of such analyses. Additionally, we use industry-standard fraud detection software to manage the portfolio. We route accounts to manual work queues and suspend charging privileges if the transaction-based fraud models indicate a probability of fraudulent use.
Auto Finance Segment. Our CAR operations manage credit quality and loss mitigation at the dealer portfolio level through the implementation of dealer-specific loss reserve accounts. In most instances, the reserve accounts are cross-collateralized across all accounts presented by any single dealer. CAR monitors performance at the dealer portfolio level (by product type) to adjust pricing or the reserve account or to determine whether to terminate future account purchases from such dealer.
CAR provides dealers with specific purchase guidelines based upon each product offering and delegates approval authority to assist in the monitoring of transactions during the loan acquisition process. Dealers are subject to specific approval criteria, and individual accounts typically are verified for accuracy before, during and after the acquisition process. Dealer portfolios across the business segment are monitored and compared against expected collections and peer dealer performance. Monitoring of dealer pool vintages, delinquencies and loss ratios helps determine past performance and expected future results, which are used to adjust pricing and reserve requirements. Our CAR operations also manage risk through diversifying their receivables among multiple dealers.
How Do We Collect?
Credit and Other Investments Segment. The goal of the collections process is to collect as much of the money that is owed to us in the most cost-effective and customer-friendly manner possible. To this end, we employ the traditional cross-section of letters and telephone calls to encourage payment. We also sometimes offer flexibility with respect to the application of payments in order to encourage larger or prompter payments. For instance, in certain cases we may vary from our general payment application priority (i.e., of applying payments first to finance charges, then to fees, and then to principal) by agreeing to apply payments first to principal and then to finance charges and fees or by agreeing to provide payments or credits of finance charges and principal to induce or in exchange for an appropriate payment. Application of payments in this manner also permits our collectors to assess real time the degree to which payments over the life of an account have covered the principal credit extensions on that account. This allows our collectors to readily identify our potential economic loss associated with the charge off of a particular receivable (i.e., the excess of principal loaned over payments received throughout the life of the account). Our selection of collection techniques, including, for example, the order in which we apply payments or the provision of payments or credits to induce or in exchange for a payment, impacts the statistical performance of the portfolios that we
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present under “Credit and Other Investments Segment” within Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Our collectors employ various and evolving tools when collecting receivables, and they routinely test and evaluate new tools in their effort toward improving our collections with a greater degree of efficiency and service. These tools include programs under which we may reduce or eliminate the annual percentage rate (“APR”) associated with a receivable or waive a certain amount of accrued fees, provided a minimum number or amount of payments have been made. In some instances, we may agree to match the payment on a receivable, for example, with commensurate payments or reductions of finance charges or waivers of fees. In other situations, we may actually settle and adjust finance charges and fees on a receivable, for example, based on a commitment and follow through on a commitment to pay certain portions of the balances owed. Our collectors may also decrease minimum payments owed under certain collection programs. Additionally, we employ re-aging techniques as discussed below. We also may occasionally use our marketing group to assist in determining various programs to assist in the collection process. Moreover, we voluntarily participate in the Consumer Credit Counseling Service (“CCCS”) program by waiving a certain percentage of a receivable that is considered our “fair share” under the CCCS program. All of our programs are utilized based on the degree of economic success and customer service they achieve.
We regularly monitor and adapt our collection strategies, techniques, technology and training to optimize our efforts to reduce delinquencies and charge offs. We use our operations systems to develop these proprietary collection strategies and techniques, and we analyze the output from these systems to identify the strategies and techniques that we believe are most likely to result in curing a delinquent account in the most cost-effective manner, rather than treating all accounts the same based on the mere passage of time.
As in all aspects of our risk management strategies, we compare the results of each of the above strategies with other collection strategies and devote resources to those strategies that yield the best results. Results are measured based on, among other things, delinquency rates, expected losses and costs to collect. Existing strategies are then adjusted based on these results. We believe that routinely testing, measuring and adjusting collection strategies results in lower bad debt losses and operating expenses.
We discontinue charging interest and fees for most of our credit products when loans and fees receivable become contractually 90 or more days past due and we charge off loans and fees receivable when they become contractually more than 180 days past due or 120 days past due for the direct-to-consumer personal loan product. However, if a payment is made that is greater than or equal to two minimum payments within a month of the charge-off date, we may reconsider whether charge-off status remains appropriate. For all of our products, we charge off receivables within 30 days of notification and confirmation of bankruptcy or death of the obligor. However, in some cases of death, we do not charge off receivables if there is a surviving, contractually liable individual or an estate large enough to pay the debt in full.
Our determination of whether an account is contractually past due is relevant to our delinquency and charge-off data provided under the “Credit and Other Investments Segment” caption within Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Various factors are relevant in analyzing whether an account is contractually past due (e.g., whether an account has not satisfied its minimum payment due requirement), which for us is the trigger for moving receivables through our various delinquency stages and ultimately to charge-off status. For our point-of-sale and direct-to-consumer finance accounts, we consider an account to be delinquent if the customer has not made any required payment as of the payment due date. For credit card accounts, we consider a cardholder’s receivable to be delinquent if the cardholder has failed to pay a minimum amount, computed as the greater of a stated minimum payment or a fixed percentage of the statement balance (for example 3% to 10% of the outstanding balance in some cases or in other cases 1% of the outstanding balance plus any finance charges and late fees billed in the current cycle).
Additionally, we may re-age customer accounts that meet our qualifications for re-aging. Re-aging involves changing the delinquency status of an account. It is our policy to work cooperatively with customers demonstrating a willingness and ability to repay their indebtedness and who satisfy other criteria, but are unable to pay the entire past due amount. Generally, to qualify for re-aging, an account must have been opened for at least nine months and may not be re-aged more than once in a twelve-month period or twice in a five-year period. In addition, an account on a workout program may qualify for one additional re-age in a five-year period. The customer also must have made three consecutive minimum monthly payments or the equivalent cumulative amount in the last three billing cycles. If a re-aged account subsequently experiences payment defaults, it will again become contractually delinquent and will be charged off according to our regular charge-off policy. The practice of re-aging an account may affect delinquencies and charge offs, potentially delaying or reducing such delinquencies and charge offs; however, this impact generally changes such delinquencies and charge offs by less than 10% and 5%, respectively.
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As discussed above, typically, once an account 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 elimination of the annual percentage rate (“APR”) charged to an account and a cessation of fee billing. Following this adjustment, if a customer demonstrates a willingness and ability to resume making monthly payments and meets the additional criteria discussed above, 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. Thus we do not recognize an impairment or write-down solely due to the re-aging process. Once an account is placed on a non-accrual status, it is closed for further purchases. We believe that re-ages help our customers to manage difficult repayment periods, return to good standing and avoid further deterioration to their credit scores. Accounts that are placed on a non-accrual status and thereafter make at least one payment qualify as troubled debt restructurings (“TDRs”). See Note 2, “Significant Accounting Policies and Consolidated Financial Statement Components-Loans and Fees Receivable-Troubled Debt Restructurings” to our consolidated financial statements included herein for further discussion of TDRs.
Auto Finance Segment. Accounts that CAR purchases from approved dealers initially are collected by the originating branch or service center location using a combination of traditional collection practices. The collection process includes contacting the customer by phone or mail, skip tracing and using starter interrupt devices to minimize delinquencies. Uncollectible accounts in our CAR operation generally are returned to the dealer under an agreement with the dealer to charge the balance on the account against the dealer’s reserve account. We generally do not repossess autos in our CAR operation as a result of the agreements that we have with the dealers unless there are insufficient dealer reserves to offset the loss or if a dealer instructs us to do so.
Consumer and Debtor Protection Laws and Regulations
Credit and Other Investments Segment. Our U.S. business is regulated directly and indirectly under various federal and state consumer protection, collection and other laws, rules and regulations, including the federal Credit Card Accountability Responsibility and Disclosure Act of 2009 (the “CARD Act”), the federal Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), the federal Truth In Lending Act (“TILA”), the federal Equal Credit Opportunity Act, the federal Fair Credit Reporting Act, the federal Fair Debt Collection Practices Act, the Federal Trade Commission (“FTC”) Act, the federal Gramm-Leach-Bliley Act and the federal Telemarketing and Consumer Fraud and Abuse Prevention Act. These laws, rules and regulations, among other things, impose disclosure requirements when consumer products are advertised, when an account is opened, when monthly billing statements are sent and when consumer obligations are collected. In addition, various statutes limit the liability of consumers for unauthorized use, prohibit discriminatory practices in consumer transactions, impose limitations on the types of charges that may be assessed and restrict the use of consumer credit reports and other account-related information. Many of our products are designed for customers of our lending partners at the lower end of the credit score range. We price our products to reflect the higher credit risk of these customers. Because of the inherently greater credit risks of these customers and the resulting higher interest and fees, we and our finance partners are subject to significant regulatory scrutiny. If regulators, including the FDIC (which regulates bank lenders), the CFPB and the FTC, object to the terms of these products, or to our marketing or collection practices, we could be required to modify or discontinue certain products or practices.
In the U.K., our operations are subject to U.K. regulations that provide similar consumer protections to those provided under the U.S. regulatory framework. We are licensed and regulated by the Financial Conduct Authority (“FCA”), and we are governed by an extensive legislative and regulatory framework that includes the Consumer Credit Act, the Data Protection Act, Privacy and Electronic Communications Regulations, Consumer Protection and Unfair Trading regulations, Financial Services (Distance Marketing) Regulations, the Enterprise Act, Money Laundering Regulations, Financial Ombudsman Service and Advertising Standards Authority adjudications. The aforementioned legislation and regulations impose strict rules on the form and content of consumer contracts, the calculation and presentation of annual percentage rates (“APRs”), advertising in all forms, parties who can be contacted and disclosures to consumers, among others. The regulators, such as the FCA, provide guidance on consumer credit practices including collections. The FCA requires a comprehensive licensing process.
Auto Finance Segment. This segment is regulated directly and indirectly under various federal and state consumer protection and other laws, rules and regulations, including the federal TILA, the federal Equal Credit Opportunity Act, the federal Fair Credit Reporting Act, the federal Fair Debt Collection Practices Act, Dodd-Frank, the federal Gramm-Leach-Bliley Act and the federal Telemarketing and Consumer Fraud and Abuse Prevention Act. In addition, various state statutes limit the interest rates and fees that may be charged, limit the types of interest computations (e.g., interest bearing or pre-computed) and refunding processes, prohibit discriminatory practices in extending credit, impose limitations on fees and other ancillary products and restrict the use of consumer credit reports and other account-related information. Many of the states in which this segment operates have various licensing requirements and impose certain financial or other conditions in connection with these licensing requirements.
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Privacy and Data Security Laws and Regulations. We are required to manage, use, and store large amounts of personally identifiable information, principally the confidential personal and financial data of our lending partners’ customers, in the course of our business. We depend on our IT networks and systems, and those of third parties, to process, store, and transmit that information. In the past, financial service companies have been targeted for sophisticated cyber attacks. A security breach involving our files and infrastructure could lead to unauthorized disclosure of confidential information. We take numerous measures to ensure the security of our hardware and software systems as well as customer information.
We are subject to various U.S. federal and state laws and regulations designed to protect confidential personal and financial data. For example, we must comply with guidelines under the Gramm-Leach-Bliley Act that require each financial institution to develop, implement and maintain a written, comprehensive information security program containing safeguards that are appropriate to the financial institution’s size and complexity, the nature and scope of the financial institution’s activities and the sensitivity of any customer information at issue. Additionally, various federal banking regulatory agencies, and at least 48 states, the District of Columbia, Puerto Rico and the Virgin Islands, have enacted data security regulations and laws requiring customer notification in the event of a security breach.
Competition
Credit and Other Investments Segment. We face substantial competition from financial service companies, the intensity of which varies depending upon economic and liquidity cycles. Our point-of-sale and direct-to-consumer finance activities compete with national, regional and local bankcard and consumer credit issuers, other general-purpose credit card issuers and retail credit card and merchant credit issuers. Many of these competitors are substantially larger than we are, have significantly greater financial resources than we do and have significantly lower costs of funds than we have.
Auto Finance Segment. Competition within the auto finance sector is widespread and fragmented. Our auto finance operations target automobile dealers that oftentimes are not capable of accessing indirect lending from major financial institutions or captive finance companies. We compete mainly with a handful of national and regional companies focused on this credit segment (e.g., Credit Acceptance Corporation, Westlake Financial, Mid-Atlantic Finance, Santander Consumer USA, Western Funding Inc., U.S. Auto Credit, and United Acceptance) and a large number of smaller, regional private companies with a narrow geographic focus. Individual dealers with access to capital may also compete in this segment through the purchase of receivables from peer dealers in their markets.
Employees
As of December 31, 2017, we had 297 employees, including 7 part-time employees, most of whom are principally employed within the U.S. We consider our relations with our employees to be good. None of our employees are covered by a collective-bargaining agreement, and we have never experienced any organized work stoppage, strike or labor dispute.
Trademarks, Trade Names and Service Marks
We have registered and continue to register, when appropriate, various trademarks, trade names and service marks used in connection with our businesses and for private-label marketing of certain of our products. We consider these trademarks, trade names and service marks to be readily identifiable with, and valuable to, our business. This Annual Report on Form 10-K also contains trade names and trademarks of other companies that are the property of their respective owners.
Additional Information
We are headquartered in Atlanta, Georgia, and our principal executive offices are located at Five Concourse Parkway, Suite 300, Atlanta, Georgia 30328. Our headquarters telephone number is (770) 828-2000, and our website is www.Atlanticus.com. We make available free of charge on our website certain of our recent SEC filings, including our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and amendments to those filings as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.
Certain corporate governance materials, including our Board of Directors committee charters and our Code of Business Conduct and Ethics, are posted on our website under the heading “For Investors.” From time to time, the corporate governance materials on our website may be updated as necessary to comply with rules issued by the SEC or NASDAQ, or as desirable to further the continued effective and efficient governance of our company.
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ITEM 1A. | RISK FACTORS |
An investment in our common stock or other securities involves a number of risks. You should carefully consider each of the risks described below before deciding to invest in our common stock or other securities. If any of the following risks develops into actual events, our business, financial condition or results of operations could be negatively affected, the market price of our common stock or other securities could decline and you may lose all or part of your investment.
Investors should be particularly cautious regarding investments in our common stock or other securities at the present time in light of uncertainties as to the profitability of our business model going forward and our inability to achieve consistent earnings from our operations in recent years.
Our Cash Flows and Net Income Are Dependent Upon Payments from Our Investments in Receivables
The collectibility of our investments in receivables is a function of many factors including the criteria used to select who is issued credit, the pricing of the credit products, the lengths of the relationships, general economic conditions, the rate at which consumers repay their accounts or become delinquent, and the rate at which consumers borrow funds. Deterioration in these factors would adversely impact our business. In addition, to the extent we have over-estimated collectibility, in all likelihood we have over-estimated our financial performance. Some of these concerns are discussed more fully below.
Our portfolio of receivables is not diversified and primarily originates from consumers whose creditworthiness is considered sub-prime. Historically, we have invested in receivables in one of two ways—we have either (i) invested in receivables originated by lenders who utilize our services or (ii) invested in or purchased pools of receivables from other issuers. In either case, substantially all of our receivables are from financially underserved borrowers—borrowers represented by credit risks that regulators classify as “sub-prime.” Our reliance on sub-prime receivables has negatively impacted and may in the future negatively impact, our performance. Our various past and current losses might have been mitigated had our portfolios consisted of higher-grade receivables in addition to our sub-prime receivables.
Economic slowdowns increase our credit losses. During periods of economic slowdown or recession, we experience an increase in rates of delinquencies and frequency and severity of credit losses. Our actual rates of delinquencies and frequency and severity of credit losses may be comparatively higher during periods of economic slowdown or recession than those experienced by more traditional providers of consumer credit because of our focus on the financially underserved consumer market, which may be disproportionately impacted.
We are subject to foreign economic and exchange risks. Because of our operations in the U.K., we have exposure to fluctuations in the U.K. economy. We also have exposure to fluctuations in the relative values of the U.S. dollar and the British pound. Because the British pound has experienced a net decline in value relative to the U.S. dollar since we commenced our most significant operations in the U.K., we have experienced significant transaction and translation losses within our financial statements.
Because a significant portion of our reported income is based on management’s estimates of the future performance of receivables, differences between actual and expected performance of the receivables may cause fluctuations in net income. Significant portions of our reported income (or losses) are based on management’s estimates of cash flows we expect to receive on receivables, particularly for such assets that we report based on fair value. The expected cash flows are based on management’s estimates of interest rates, default rates, payment rates, cardholder purchases, servicing costs, and discount rates. These estimates are based on a variety of factors, many of which are not within our control. Substantial differences between actual and expected performance of the receivables will occur and cause fluctuations in our net income. For instance, higher than expected rates of delinquencies and losses could cause our net income to be lower than expected. Similarly, levels of loss and delinquency can result in our being required to repay lenders earlier than expected, thereby reducing funds available to us for future growth. Because all of the credit card receivables structured financing facilities are now in amortization status—which for us generally means that the only meaningful cash flows that we are receiving with respect to the credit card receivables that are encumbered by such structured financing facilities are those associated with our contractually specified fee for servicing the receivables—recent payment and default trends have substantially reduced the cash flows that we receive from these receivables.
Due to our relative lack of historical experience with Internet consumers, we may not be able to evaluate their creditworthiness. We have less historical experience with respect to the credit risk and performance of receivables owed by consumers acquired over the Internet. As a result, we may not be able to target and evaluate successfully the creditworthiness of
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these potential consumers. Therefore, we may encounter difficulties managing the expected delinquencies and losses and appropriately pricing products.
We Are Substantially Dependent Upon Borrowed Funds to Fund Receivables We Purchase
We finance receivables that we acquire in large part through financing facilities. All of our financing facilities are of finite duration (and ultimately will need to be extended or replaced) and contain financial covenants and other conditions that must be fulfilled in order for funding to be available. Moreover, some of our facilities currently are in amortization stages (and are not allowing for the funding of any new loans) based on their original terms. The cost and availability of equity and borrowed funds is dependent upon our financial performance, the performance of our industry generally and general economic and market conditions, and at times equity and borrowed funds have been both expensive and difficult to obtain.
If additional financing facilities are not available in the future on terms we consider acceptable—an issue that has been made even more acute in the U.S. given regulatory changes that reduced asset-level returns on credit card lending—we will not be able to purchase additional receivables and those receivables may contract in size.
Our Financial Performance Is, in Part, a Function of the Aggregate Amount of Receivables That Are Outstanding
The aggregate amount of outstanding receivables is a function of many factors including purchase rates, payment rates, interest rates, seasonality, general economic conditions, competition from credit card issuers and other sources of consumer financing, access to funding, and the timing and extent of our receivable purchases.
Despite our recent purchases of credit card receivables, our aggregate credit card receivables contracted over the last several years. The amount of our credit card receivables is a product of a combination of factors, many of which are not in our control. Factors include:
• | the availability of funding on favorable terms; |
• | our relationships with the banks that issue credit cards; |
• | the degree to which we lose business to competitors; |
• | the level of usage of our credit card products by consumers; |
• | the availability of portfolios for purchase on attractive terms; |
• | levels of delinquencies and charge offs; |
• | the level of costs of acquiring new receivables; |
• | our ability to employ and train new personnel; |
• | our ability to maintain adequate management systems, collection procedures, internal controls and automated systems; and |
• | general economic and other factors beyond our control. |
Reliance upon relationships with a few large retailers in the point-of-sale finance operations may adversely affect our revenues and operating results from these operations. Our five largest retail partners accounted for over 50% of our outstanding point-of-sale receivables as of December 31, 2017. Although we are adding new retail partners on a regular basis, it is likely that we will continue to derive a significant portion of this operations’ receivables base and corresponding revenue from a relatively small number of partners in the future. If a significant partner reduces or terminates its relationship with us, these operations’ revenue could decline significantly and our operating results and financial condition could be harmed.
We Operate in a Heavily Regulated Industry
Changes in bankruptcy, privacy or other consumer protection laws, or to the prevailing interpretation thereof, may expose us to litigation, adversely affect our ability to collect receivables, or otherwise adversely affect our operations. Similarly, regulatory changes could adversely affect the ability or willingness of lenders who utilize our technology platform and related services to market credit products and services to consumers. While the new Presidential Administration and the congressional majorities in the U.S. Senate and House of Representatives support reducing regulatory burdens, the prospects for significant modifications are uncertain. Also, the accounting rules that apply to our business are exceedingly complex, difficult to apply and in a state of flux. As a result, how we value our receivables and otherwise account for our business is subject to change depending upon the changes in, and, interpretation of, those rules. Some of these issues are discussed more fully below.
Reviews and enforcement actions by regulatory authorities under banking and consumer protection laws and regulations may result in changes to our business practices, may make collection of receivables more difficult or may expose
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us to the risk of fines, restitution and litigation. Our operations and the operations of the issuing banks through which the credit products we service are originated are subject to the jurisdiction of federal, state and local government authorities, including the CFPB, the SEC, the FDIC, the Office of the Comptroller of the Currency, the FTC, U.K. banking and licensing authorities, state regulators having jurisdiction over financial institutions and debt origination and collection and state attorneys general. Our business practices and the practices of issuing banks, including the terms of products, servicing and collection practices, are subject to both periodic and special reviews by these regulatory and enforcement authorities. These reviews can range from investigations of specific consumer complaints or concerns to broader inquiries. If as part of these reviews the regulatory authorities conclude that we or issuing banks are not complying with applicable law, they could request or impose a wide range of remedies including requiring changes in advertising and collection practices, changes in the terms of products (such as decreases in interest rates or fees), the imposition of fines or penalties, or the paying of restitution or the taking of other remedial action with respect to affected consumers. They also could require us or issuing banks to stop offering some credit products or obtain licenses to do so, either nationally or in selected states. To the extent that these remedies are imposed on the issuing banks that originate credit products using our platform, under certain circumstances we are responsible for the remedies as a result of our indemnification obligations with those banks. We also may elect to change practices that we believe are compliant with law in order to respond to regulatory concerns. Furthermore, negative publicity relating to any specific inquiry or investigation could hurt our ability to conduct business with various industry participants or to generate new receivables and could negatively affect our stock price, which would adversely affect our ability to raise additional capital and would raise our costs of doing business.
If any deficiencies or violations of law or regulations are identified by us or asserted by any regulator, or if the CFPB, the FDIC, the FTC or any other regulator requires us or issuing banks to change any practices, the correction of such deficiencies or violations, or the making of such changes, could have a material adverse effect on our financial condition, results of operations or business. In addition, whether or not these practices are modified when a regulatory or enforcement authority requests or requires, there is a risk that we or other industry participants may be named as defendants in litigation involving alleged violations of federal and state laws and regulations, including consumer protection laws. Any failure to comply with legal requirements by us or the banks that originate credit products utilizing our platform in connection with the issuance of those products, or by us or our agents as the servicer of our accounts, could significantly impair our ability to collect the full amount of the account balances. The institution of any litigation of this nature, or any judgment against us or any other industry participant in any litigation of this nature, could adversely affect our business and financial condition in a variety of ways.
We are dependent upon banks to issue credit cards and provide certain other credit products utilizing our technology platform and related services. We acquire receivables generated by banks from credit cards that they have issued and other products, and their regulators could at any time limit their ability to issue some or all of these products that we service, or to modify those products significantly. Any significant interruption of those relationships would result in our being unable to acquire new receivables or help develop other credit products. It is possible that a regulatory position or action taken with respect to any of the issuing banks might result in the bank’s inability or unwillingness to originate future credit products in collaboration with us. In the current state, such a disruption of our issuing bank relationships principally would adversely affect our ability to grow our investments in the point-of-sale and direct-to-consumer receivables.
Changes to consumer protection laws or changes in their interpretation may impede collection efforts or otherwise adversely impact our business practices. Federal and state consumer protection laws regulate the creation and enforcement of consumer credit card receivables and other loans. Many of these laws (and the related regulations) are focused on sub-prime lenders and are intended to prohibit or curtail industry-standard practices as well as non-standard practices. For instance, Congress enacted legislation that regulates loans to military personnel through imposing interest rate and other limitations and requiring new disclosures, all as regulated by the Department of Defense. Similarly, in 2009 Congress enacted legislation that required changes to a variety of marketing, billing and collection practices, and the Federal Reserve adopted significant changes to a number of practices through its issuance of regulations. While our practices are in compliance with these changes, some of the changes (e.g., limitations on the ability to assess up-front fees) have significantly affected the viability of certain credit products within the U.S. Changes in the consumer protection laws could result in the following:
• | receivables not originated in compliance with law (or revised interpretations) could become unenforceable and uncollectible under their terms against the obligors; |
• | we may be required to credit or refund previously collected amounts; |
• | certain fees and finance charges could be limited, prohibited or restricted, which would reduce the profitability of certain investments in receivables; |
• | certain collection methods could be prohibited, forcing us to revise our practices or adopt more costly or less effective practices; |
• | limitations on our ability to recover on charged-off receivables regardless of any act or omission on our part; |
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• | some credit products and services could be banned in certain states or at the federal level; |
• | federal or state bankruptcy or debtor relief laws could offer additional protections to consumers seeking bankruptcy protection, providing a court greater leeway to reduce or discharge amounts owed to us; and |
• | a reduction in our ability or willingness to invest in receivables arising under loans to certain consumers, such as military personnel. |
Material regulatory developments may adversely impact our business and results from operations.
Our Automobile Lending Activities Involve Risks in Addition to Others Described Herein
Automobile lending exposes us not only to most of the risks described above but also to additional risks, including the regulatory scheme that governs installment loans and those attendant to relying upon automobiles and their repossession and liquidation value as collateral. In addition, our Auto Finance segment operation acquires loans on a wholesale basis from used car dealers, for which we rely upon the legal compliance and credit determinations by those dealers.
Funding for automobile lending may become difficult to obtain and expensive. In the event we are unable to renew or replace any Auto Finance segment facilities that bear refunding or refinancing risks when they become due, our Auto Finance segment could experience significant constraints and diminution in reported asset values as lenders retain significant cash flows within underlying structured financings or otherwise under security arrangements for repayment of their loans. If we cannot renew or replace future facilities or otherwise are unduly constrained from a liquidity perspective, we may choose to sell part or all of our auto loan portfolios, possibly at less than favorable prices.
Our automobile lending business is dependent upon referrals from dealers. Currently we provide substantially all of our automobile loans only to or through used car dealers. Providers of automobile financing have traditionally competed based on the interest rate charged, the quality of credit accepted and the flexibility of loan terms offered. In order to be successful, we not only need to be competitive in these areas, but also need to establish and maintain good relations with dealers and provide them with a level of service greater than what they can obtain from our competitors.
The financial performance of our automobile loan portfolio is in part dependent upon the liquidation of repossessed automobiles. In the event of certain defaults, we may repossess automobiles and sell repossessed automobiles at wholesale auction markets located throughout the U.S. Auction proceeds from these types of sales and other recoveries rarely are sufficient to cover the outstanding balances of the contracts; where we experience these shortfalls, we will experience credit losses. Decreased auction proceeds resulting from depressed prices at which used automobiles may be sold would result in higher credit losses for us.
Repossession of automobiles entails the risk of litigation and other claims. Although we have contracted with reputable repossession firms to repossess automobiles on defaulted loans, it is not uncommon for consumers to assert that we were not entitled to repossess an automobile or that the repossession was not conducted in accordance with applicable law. These claims increase the cost of our collection efforts and, if correct, can result in awards against us.
We Routinely Explore Various Opportunities to Grow Our Business, to Make Investments and to Purchase and Sell Assets
We routinely consider acquisitions of, or investments in, portfolios and other assets as well as the sale of portfolios and portions of our business. There are a number of risks attendant to any acquisition, including the possibility that we will overvalue the assets to be purchased and that we will not be able to produce the expected level of profitability from the acquired business or assets. Similarly, there are a number of risks attendant to sales, including the possibility that we will undervalue the assets to be sold. As a result, the impact of any acquisition or sale on our future performance may not be as favorable as expected and actually may be adverse.
Portfolio purchases may cause fluctuations in our reported Credit and Other Investments segment’s managed receivables data, which may reduce the usefulness of this data in evaluating our business. Our reported Credit and Other Investments segment managed receivables data may fluctuate substantially from quarter to quarter as a result of recent and future credit card portfolio acquisitions.
Receivables included in purchased portfolios are likely to have been originated using credit criteria different from the criteria of issuing bank partners that have originated accounts utilizing our technology platform. Receivables included in any particular purchased portfolio may have significantly different delinquency rates and charge-off rates than the receivables previously originated and purchased by us. These receivables also may earn different interest rates and fees as compared to
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other similar receivables in our receivables portfolio. These variables could cause our reported managed receivables data to fluctuate substantially in future periods making the evaluation of our business more difficult.
Any acquisition or investment that we make will involve risks different from and in addition to the risks to which our business is currently exposed. These include the risks that we will not be able to integrate and operate successfully new businesses, that we will have to incur substantial indebtedness and increase our leverage in order to pay for the acquisitions, that we will be exposed to, and have to comply with, different regulatory regimes and that we will not be able to apply our traditional analytical framework (which is what we expect to be able to do) in a successful and value-enhancing manner.
Other Risks of Our Business
We are a holding company with no operations of our own. As a result, our cash flow and ability to service our debt is dependent upon distributions from our subsidiaries. The distribution of subsidiary earnings, or advances or other distributions of funds by subsidiaries to us, all of which are subject to statutory and could be subject to contractual restrictions, are contingent upon the subsidiaries’ cash flows and earnings and are subject to various business and debt covenant considerations.
Unless we obtain a bank charter, we cannot issue credit cards other than through agreements with banks. Because we do not have a bank charter, we currently cannot issue credit cards ourselves. Unless we obtain a bank or credit card bank charter, we will continue to rely upon banking relationships to provide for the issuance of credit cards to consumers. Even if we obtain a bank charter, there may be restrictions on the types of credit that the bank may extend. Our various issuing bank agreements have scheduled expiration dates. If we are unable to extend or execute new agreements with our issuing banks at the expirations of our current agreements with them, or if our existing or new agreements with our issuing banks were terminated or otherwise disrupted, there is a risk that we would not be able to enter into agreements with an alternate issuer on terms that we consider favorable or in a timely manner without disruption of our business.
We are party to litigation. We are defendants in certain legal proceedings which include litigation customary for a business of our nature. In each case we believe that we have meritorious defenses or that the positions we are asserting otherwise are correct. However, adverse outcomes are possible in these matters, and we could decide to settle one or more of our litigation matters in order to avoid the ongoing cost of litigation or to obtain certainty of outcome. Adverse outcomes or settlements of these matters could require us to pay damages, make restitution, change our business practices or take other actions at a level, or in a manner, that would adversely impact our business.
We face heightened levels of economic risk associated with new investment activities. We have made a number of investments in businesses that are not directly related to our traditional servicing and receivables financing activities to, or associated with, the underserved consumer credit market. In addition, some of these investments that we have made and may make in the future are or will be in debt or equity securities of businesses over which we exert little or no control, which likely exposes us to greater risks of loss than investments in activities and operations that we control. We make only those investments we believe have the potential to provide a favorable return. However, because some of the investments are outside of our core areas of expertise, they entail risks beyond those described elsewhere in this Report. As occurred with respect to certain such investments in 2012 and 2011, these risks could result in the loss of part or all of our investments.
Because we outsource account-processing functions that are integral to our business, any disruption or termination of that outsourcing relationship could harm our business. We generally outsource account and payment processing, and in 2017, we paid Total System Services, Inc. $4.7 million for these services. If these agreements were not renewed or were terminated or the services provided to us were otherwise disrupted, we would have to obtain these services from an alternative provider. There is a risk that we would not be able to enter into a similar agreement with an alternate provider on terms that we consider favorable or in a timely manner without disruption of our business.
If we are unable to protect our information systems against service interruption, our operations could be disrupted and our reputation may be damaged. We rely heavily on networks and information systems and other technology, that are largely hosted by third-parties to support our business processes and activities, including processes integral to the origination and collection of loans and other financial products, and information systems to process financial information and results of operations for internal reporting purposes and to comply with regulatory financial reporting and legal and tax requirements. Because information systems are critical to many of our operating activities, our business may be impacted by hosted system shutdowns, service disruptions or security breaches. These incidents may be caused by failures during routine operations such as system upgrades or user errors, as well as network or hardware failures, malicious or disruptive software, computer hackers, rogue employees or contractors, cyber-attacks by criminal groups, geopolitical events, natural disasters, failures or impairments of telecommunications networks, or other catastrophic events. If our information systems suffer severe damage, disruption or
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shutdown and our business continuity plans do not effectively resolve the issues in a timely manner, we could experience delays in reporting our financial results, and we may lose revenue and profits as a result of our inability to collect payments in a timely manner. We also could be required to spend significant financial and other resources to repair or replace networks and information systems.
Unauthorized or unintentional disclosure of sensitive or confidential customer data could expose us to protracted and costly litigation, and civil and criminal penalties. To conduct our business, we are required to manage, use, and store large amounts of personally identifiable information, consisting primarily of confidential personal and financial data regarding consumers across all operations areas. We also depend on our IT networks and systems, and those of third parties, to process, store, and transmit this information. As a result, we are subject to numerous U.S. federal and state laws designed to protect this information. Security breaches involving our files and infrastructure could lead to unauthorized disclosure of confidential information.
We take a number of measures to ensure the security of our hardware and software systems and customer information. Advances in computer capabilities, new discoveries in the field of cryptography or other developments may result in the technology used by us to protect data being breached or compromised. In the past, banks and other financial service providers have been the subject of sophisticated and highly targeted attacks on their information technology. An increasing number of websites have reported breaches of their security.
If any person, including our employees or those of third-party vendors, negligently disregards or intentionally breaches our established controls with respect to such data or otherwise mismanages or misappropriates that data, we could be subject to costly litigation, monetary damages, fines, and/or criminal prosecution. Any unauthorized disclosure of personally identifiable information could subject us to liability under data privacy laws. Further, under credit card rules and our contracts with our card processors, if there is a breach of credit card information that we store, we could be liable to the credit card issuing banks for their cost of issuing new cards and related expenses. In addition, if we fail to follow credit card industry security standards, even if there is no compromise of customer information, we could incur significant fines. Security breaches also could harm our reputation, which could potentially cause decreased revenues, the loss of existing merchant credit partners, or difficulty in adding new merchant credit partners.
Internet and data security breaches also could impede our bank partners from originating loans over the Internet, cause us to lose consumers or otherwise damage our reputation or business. Consumers generally are concerned with security and privacy, particularly on the Internet. As part of our growth strategy, we have enabled lenders to originate loans over the Internet. The secure transmission of confidential information over the Internet is essential to maintaining customer confidence in such products and services offered online.
Advances in computer capabilities, new discoveries or other developments could result in a compromise or breach of the technology used by us to protect our client or consumer application and transaction data transmitted over the Internet. In addition to the potential for litigation and civil penalties described above, security breaches could damage our reputation and cause consumers to become unwilling to do business with our clients or us, particularly over the Internet. Any publicized security problems could inhibit the growth of the Internet as a means of conducting commercial transactions. Our ability to service our clients’ needs over the Internet would be severely impeded if consumers become unwilling to transmit confidential information online.
Also, a party that is able to circumvent our security measures could misappropriate proprietary information, cause interruption in our operations, damage our computers or those of our users, or otherwise damage our reputation and business.
Regulation in the areas of privacy and data security could increase our costs. We are subject to various regulations related to privacy and data security/breach, and we could be negatively impacted by these regulations. For example, we are subject to the safeguards guidelines under the Gramm-Leach-Bliley Act. The safeguards guidelines require that each financial institution develop, implement and maintain a written, comprehensive information security program containing safeguards that are appropriate to the financial institution’s size and complexity, the nature and scope of the financial institution’s activities and the sensitivity of any customer information at issue. Broad-ranging data security laws that affect our business also have been adopted by various states. Compliance with these laws regarding the protection of consumer and employee data could result in higher compliance and technology costs for us, as well as potentially significant fines and penalties for non-compliance. Further, there are various other statutes and regulations relevant to the direct email marketing, debt collection and text-messaging industries including the Telephone Consumer Protection Act. The interpretation of many of these statutes and regulations is evolving in the courts and administrative agencies and an inability to comply with them may have an adverse impact on our business.
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In addition to the foregoing enhanced data security requirements, various federal banking regulatory agencies, and at least 48 states, the District of Columbia, Puerto Rico and the Virgin Islands, have enacted data security regulations and laws requiring varying levels of consumer notification in the event of a security breach.
Also, federal legislators and regulators are increasingly pursuing new guidelines, laws and regulations that, if adopted, could further restrict how we collect, use, share and secure consumer information, which could impact some of our current or planned business initiatives.
Unplanned system interruptions or system failures could harm our business and reputation. Any interruption in the availability of our transactional processing services due to hardware and operating system failures will reduce our revenues and profits. Any unscheduled interruption in our services results in an immediate, and possibly substantial, loss of revenues. Frequent or persistent interruptions in our services could cause current or potential consumers to believe that our systems are unreliable, leading them to switch to our competitors or to avoid our websites or services, and could permanently harm our reputation.
Although our systems have been designed around industry-standard architectures to reduce downtime in the event of outages or catastrophic occurrences, they remain vulnerable to damage or interruption from earthquakes, floods, fires, power loss, telecommunication failures, computer viruses, computer denial-of-service attacks, and similar events or disruptions. Some of our systems are not fully redundant, and our disaster recovery planning may not be sufficient for all eventualities. Our systems also are subject to break-ins, sabotage, and intentional acts of vandalism. Despite any precautions we may take, the occurrence of a natural disaster, a decision by any of our third-party hosting providers to close a facility we use without adequate notice for financial or other reasons, or other unanticipated problems at our hosting facilities could cause system interruptions, delays, and loss of critical data, and result in lengthy interruptions in our services. Our business interruption insurance may not be sufficient to compensate us for losses that may result from interruptions in our service as a result of system failures.
Climate change and related regulatory responses may impact our business. Climate change as a result of emissions of greenhouse gases is a significant topic of discussion and may generate federal and other regulatory responses. It is impracticable to predict with any certainty the impact on our business of climate change or the regulatory responses to it, although we recognize that they could be significant. The most direct impact is likely to be an increase in energy costs, which would adversely impact consumers and their ability to incur and repay indebtedness. However, we are uncertain of the ultimate impact, either directionally or quantitatively, of climate change and related regulatory responses on our business.
Risks Relating to an Investment in Our Securities
The price of our common stock may fluctuate significantly, and this may make it difficult for you to resell your shares of our common stock when you want or at prices you find attractive. The price of our common stock on the NASDAQ Global Select Market constantly changes. We expect that the market price of our common stock will continue to fluctuate. The market price of our common stock may fluctuate in response to numerous factors, many of which are beyond our control. These factors include the following:
• | actual or anticipated fluctuations in our operating results; |
• | changes in expectations as to our future financial performance, including financial estimates by securities analysts and investors; |
• | the overall financing environment, which is critical to our value; |
• | the operating and stock performance of our competitors; |
• | announcements by us or our competitors of new products or services or significant contracts, acquisitions, strategic partnerships, joint ventures or capital commitments; |
• | changes in interest rates; |
• | the announcement of enforcement actions or investigations against us or our competitors or other negative publicity relating to us or our industry; |
• | changes in GAAP, laws, regulations or the interpretations thereof that affect our various business activities and segments; |
• | general domestic or international economic, market and political conditions; |
• | changes in ownership by executive officers, directors and parties related to them who control a majority of our common stock; |
• | additions or departures of key personnel; and |
• | future sales of our common stock and the transfer or cancellation of shares of common stock pursuant to a share lending agreement. |
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In addition, the stock markets from time to time experience extreme price and volume fluctuations that may be unrelated or disproportionate to the operating performance of companies. These broad fluctuations may adversely affect the trading price of our common stock, regardless of our actual operating performance.
We are not currently in compliance with the minimum public float requirement of the NASDAQ Global Select Market. If our common stock is delisted from NASDAQ, the market price and liquidity of our common stock and our ability to raise additional capital would be adversely impacted. Our common stock is currently listed on the NASDAQ Global Select Market (“NASDAQ”). Continued listing of a security on NASDAQ is conditioned upon compliance with various continued listing standards. On February 20, 2018, we received a letter from NASDAQ notifying us that, for the last 30 consecutive business days, we had not met the $15 million minimum market value of publicly held shares continued listing standard. As provided in the NASDAQ rules, NASDAQ provided 180 calendar days, or until August 20, 2018, to regain compliance. In order to do so, the market value of our publicly held shares must be $15 million or more for a minimum of ten consecutive business days at any time prior to August 20, 2018. During this period, our common stock will continue to trade uninterrupted on NASDAQ.
If we do not regain compliance with the minimum public float requirement by August 20, 2018, we may transfer our common stock listing to The NASDAQ Capital Market, provided we meet the continued listing requirements for that market. If we fail to regain compliance with the minimum public float requirement and are not eligible for listing on The NASDAQ Capital Market, we will receive notice of delisting from NASDAQ, which notice may be appealed at that time. If our common stock is delisted, the liquidity of our common stock would be adversely affected and the market price of our common stock could decrease. The delisting of our common stock from NASDAQ also would make it more difficult for us to raise additional capital.
Future sales of our common stock or equity-related securities in the public market, including sales of our common stock pursuant to share lending agreements or short sale transactions by purchasers of convertible senior notes, could adversely affect the trading price of our common stock and our ability to raise funds in new stock offerings. Sales of significant amounts of our common stock or equity-related securities in the public market, including sales pursuant to share lending agreements, or the perception that such sales will occur, could adversely affect prevailing trading prices of our common stock and could impair our ability to raise capital through future offerings of equity or equity-related securities. Future sales of shares of common stock or the availability of shares of common stock for future sale, including sales of our common stock in short sale transactions by purchasers of our convertible senior notes, may have a material adverse effect on the trading price of our common stock.
We have the ability to issue preferred stock, warrants, convertible debt and other securities without shareholder approval. Our common stock may be subordinate to classes of preferred stock issued in the future in the payment of dividends and other distributions made with respect to common stock, including distributions upon liquidation or dissolution. Our articles of incorporation permit our Board of Directors to issue preferred stock without first obtaining shareholder approval. If we issue preferred stock, these additional securities may have dividend or liquidation preferences senior to the common stock. If we issue convertible preferred stock, a subsequent conversion may dilute the current common shareholders’ interest. We have similar abilities to issue convertible debt, warrants and other equity securities.
Our executive officers, directors and parties related to them, in the aggregate, control a majority of our common stock and may have the ability to control matters requiring shareholder approval. Our executive officers, directors and parties related to them own a large enough share of our common stock to have an influence on, if not control of, the matters presented to shareholders. As a result, these shareholders may have the ability to control matters requiring shareholder approval, including the election and removal of directors, the approval of significant corporate transactions, such as any reclassification, reorganization, merger, consolidation or sale of all or substantially all of our assets and the control of our management and affairs. Accordingly, this concentration of ownership may have the effect of delaying, deferring or preventing a change of control of us, impede a merger, consolidation, takeover or other business combination involving us or discourage a potential acquirer from making a tender offer or otherwise attempting to obtain control of us, which in turn could have an adverse effect on the market price of our common stock.
The right to receive payments on our convertible senior notes is subordinate to the rights of our existing and future secured creditors. Our convertible senior notes are unsecured and are subordinate to existing and future secured obligations to the extent of the value of the assets securing such obligations. As a result, in the event of a bankruptcy, liquidation, dissolution, reorganization or similar proceeding of our company, our assets generally would be available to satisfy obligations of our secured debt before any payment may be made on the convertible senior notes. To the extent that such assets cannot satisfy in
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full our secured debt, the holders of such debt would have a claim for any shortfall that would rank equally in right of payment (or effectively senior if the debt were issued by a subsidiary) with the convertible senior notes. In such an event, we may not have sufficient assets remaining to pay amounts on any or all of the convertible senior notes.
As of December 31, 2017, Atlanticus Holdings Corporation had outstanding: $244.0 million of secured indebtedness, which would rank senior in right of payment to the convertible senior notes; $118.4 million of senior unsecured indebtedness in addition to the convertible senior notes that would rank equal in right of payment to the convertible senior notes; and no subordinated indebtedness. Included in senior secured indebtedness are certain guarantees we have executed in favor of our subsidiaries. For more information on our outstanding indebtedness, See Note 9, “Notes Payable,” to our consolidated financial statements included herein.
Our convertible senior notes are junior to the indebtedness of our subsidiaries. Our convertible senior notes are structurally subordinated to the existing and future claims of our subsidiaries’ creditors. Holders of the convertible senior notes are not creditors of our subsidiaries. Any claims of holders of the convertible senior notes to the assets of our subsidiaries derive from our own equity interests in those subsidiaries. Claims of our subsidiaries’ creditors will generally have priority as to the assets of our subsidiaries over our own equity interest claims and will therefore have priority over the holders of the convertible senior notes. Consequently, the convertible senior notes are effectively subordinate to all liabilities, whether or not secured, of any of our subsidiaries and any subsidiaries that we may in the future acquire or establish. Our subsidiaries’ creditors also may include general creditors and taxing authorities. As of December 31, 2017, our subsidiaries had total liabilities of approximately $323.5 million (including the $244.0 million of senior secured indebtedness mentioned above), excluding intercompany indebtedness. In addition, in the future, we may decide to increase the portion of our activities that we conduct through subsidiaries.
Note Regarding Risk Factors
The risk factors presented above are all of the ones that we currently consider material. However, they are not the only ones facing our company. Additional risks not presently known to us, or which we currently consider immaterial, also may adversely affect us. There may be risks that a particular investor views differently from us, and our analysis might be wrong. If any of the risks that we face actually occurs, our business, financial condition and operating results could be materially adversely affected and could differ materially from any possible results suggested by any forward-looking statements that we have made or might make. In such case, the trading price of our common stock or other securities could decline, and you could lose part or all of your investment. We expressly disclaim any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.
ITEM 1B. | UNRESOLVED STAFF COMMENTS |
None.
ITEM 2. | PROPERTIES |
We lease 335,372 square feet of office space in Atlanta, Georgia for our executive offices and the primary operations of our Credit and Other Investments segment. We have sub-leased 255,110 square feet of this office space. Our Auto Finance segment principally operates from 12,807 square feet of leased office space in Lake Mary, Florida, with additional offices and branch locations in various states and territories. Our operations in the U.K., which are within our Credit and Other Investments segment, include leased space in Crawley. We believe that our facilities are suitable to our business and that we will be able to lease or purchase additional facilities as our needs, if any, require.
ITEM 3. | LEGAL PROCEEDINGS |
On April 4, 2007, we purchased a portfolio of credit card accounts from Barclays Bank PLC (“Barclays”) pursuant to a Sale and Purchase Agreement (the “SPA”). A portion of the accounts had an optional feature known as a “payment break plan” (“PBP”) that, in broad terms, enabled a customer to freeze his/her account for a period of time in certain circumstances, during which period, in general, the customer was not required to make minimum payments. This feature was mis-sold by Barclays, and, consistent with U.K. practice and Barclays’ own procedures and instructions to us, we established a claims process and provided remediation. Since 2011, we have claimed substantial sums from Barclays on the basis that (i) such sums have been paid, or otherwise credited, by us to customers in respect of PBP mis-selling complaints, and (ii) Barclays is liable to
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reimburse us pursuant to a contractual indemnity provision contained in the SPA. Until recently, Barclays paid invoices issued by us for reimbursement of amounts paid, or otherwise credited, to customers for alleged PBP mis-selling.
In late 2016 we also concluded that Barclays, in connection with the SPA, fraudulently misrepresented the portfolio, resulting in our overpayment for the portfolio and incurrence of substantial losses that we otherwise would not have incurred.
On May 4, 2017, we sued Barclays in the High Court of Justice Business and Property Courts of England and Wales, Claim No. FL-2017-000003. The claims include, among others, claims relating to Barclays’ obligation to reimburse us for remediation of the PBP claims and the other damages incurred as a result of the SPA and Barclays’ actions and inactions. We are seeking monetary damages for these claims.
In conjunction with the lawsuit, Barclays asserted a counterclaim alleging that past reimbursement claims paid to us were not in accordance with its policies. We have been processing claims from consumers since 2010 and historically payments on these claims and associated processing costs were reimbursed by Barclays based upon our invoices to Barclays. We believe that the counterclaim is simply a part of Barclays litigation strategy and is without merit.
We intend to pursue our suit against Barclays and to recover the amounts due to us.
We are involved in various other legal proceedings that are incidental to the conduct of our business. There are currently no other pending legal proceedings that are expected to be material to us.
ITEM 4. | MINE SAFETY DISCLOSURES |
None.
PART II
ITEM 5. | MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |
Our common stock is traded on the NASDAQ Global Select Market under the symbol “ATLC.” The following table sets forth, for the periods indicated, the high and low sales prices per share of our common stock as reported on the NASDAQ Global Select Market. As of March 15, 2018, there were 46 record holders of our common stock, which does not include persons whose stock is held in nominee or “street name” accounts through brokers, banks and intermediaries.
2016 | High | Low |
1st Quarter 2016 | $3.48 | $2.90 |
2nd Quarter 2016 | $3.23 | $2.64 |
3rd Quarter 2016 | $3.15 | $2.72 |
4th Quarter 2016 | $3.50 | $2.71 |
2017 | High | Low |
1st Quarter 2017 | $3.07 | $2.42 |
2nd Quarter 2017 | $3.19 | $2.30 |
3rd Quarter 2017 | $2.70 | $2.14 |
4th Quarter 2017 | $2.45 | $2.15 |
The closing price of our common stock on the NASDAQ Global Select Market on March 15, 2018 was $2.15.
ISSUER PURCHASES OF EQUITY SECURITIES
The following table sets forth information with respect to our repurchases of common stock during the three months ended December 31, 2017.
Total Number of Shares Purchased | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Maximum Number of Shares that May Yet Be Purchased under the Plans or Programs (1)(2) | |||||||||
October 1- October 31 | 7,054 | $ | 2.38 | 7,054 | 4,864,131 | |||||||
November 1 - November 30 | 11,188 | $ | 2.38 | 11,188 | 4,852,943 | |||||||
December 1 - December 31 | 25,342 | $ | 2.36 | 25,342 | 4,827,601 | |||||||
Total | 43,584 | $ | 2.37 | 43,584 | 4,827,601 | |||||||
(1) | Because withholding tax-related stock repurchases are permitted outside the scope of our 5,000,000 share Board-authorized repurchase plan, these amounts exclude shares of stock returned to us by employees in satisfaction of withholding tax requirements on vested stock grants. There were no such shares returned to us during the three months ended December 31, 2017. |
(2) | Pursuant to a share repurchase plan authorized by our Board of Directors on May 12, 2016, we are authorized to repurchase 5,000,000 shares of our common stock through June 30, 2018. |
We will continue to evaluate our stock price relative to other investment opportunities and, to the extent we believe that the repurchase of our stock represents an appropriate return of capital, we will repurchase shares of our stock.
ITEM 6. | SELECTED FINANCIAL DATA |
As a “smaller reporting company,” as defined by Item 10 of Regulation S-K, we are not required to provide this information.
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ITEM 7. | 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, 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 Item 1A and elsewhere in this Report, that our actual experience will differ materially from these expectations. For more information, see “Cautionary Notice Regarding Forward-Looking Statements” at the beginning of this Report.
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.
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. 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 21-year operating history to support lenders who originate a range of consumer loan products. These products include retail credit, personal loans, and credit cards marketed through multiple channels, including retail point-of-sale, direct mail solicitation, Internet-based marketing 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. 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. 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. Additionally, we support lenders who market general purpose personal loans and credit cards directly to consumers through additional channels, which enables them to reach consumers through a diverse origination platform that includes direct mail, Internet-based marketing and our retail partnerships. 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 credit. 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.
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.
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.
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.
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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 (and in recent years have significantly reduced our overhead infrastructure which was built to accommodate higher managed receivables levels and a much greater number of accounts serviced). As such, 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.
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; (2) investments in other assets or businesses that are not necessarily financial services assets or businesses; and (3) the repurchase of our convertible senior notes and other debt or our outstanding common stock.
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CONSOLIDATED RESULTS OF OPERATIONS
Income | |||||||||||
For the Year Ended December 31, | Increases (Decreases) | ||||||||||
(In Thousands) | 2017 | 2016 | from 2016 to 2017 | ||||||||
Total interest income | $ | 114,707 | $ | 88,622 | $ | 26,085 | |||||
Interest expense | (27,700 | ) | (20,207 | ) | (7,493 | ) | |||||
Fees and related income on earning assets: | |||||||||||
Fees on credit products | 10,427 | 3,526 | 6,901 | ||||||||
Changes in fair value of loans and fees receivable recorded at fair value | 3,456 | 1,587 | 1,869 | ||||||||
Changes in fair value of notes payable associated with structured financings recorded at fair value | 2,315 | 3,773 | (1,458 | ) | |||||||
Rental revenue | 148 | 8,235 | (8,087 | ) | |||||||
Other | (2,057 | ) | 195 | (2,252 | ) | ||||||
Other operating income: | |||||||||||
Servicing income | 3,854 | 4,087 | (233 | ) | |||||||
Other income | 1,419 | 320 | 1,099 | ||||||||
Gain on repurchase of convertible senior notes | — | 1,151 | (1,151 | ) | |||||||
Equity in income equity-method investee | 1,158 | 2,150 | (992 | ) | |||||||
Total | $ | 107,727 | $ | 93,439 | $ | 14,288 | |||||
Net recovery of losses upon charge off of loans and fees receivable recorded at fair value | (9,460 | ) | (22,096 | ) | (12,636 | ) | |||||
Provision for losses on loans and fees receivable recorded at net realizable value | 77,612 | 53,721 | (23,891 | ) | |||||||
Other operating expenses: | |||||||||||
Salaries and benefits | 22,751 | 24,026 | 1,275 | ||||||||
Card and loan servicing | 31,534 | 30,662 | (872 | ) | |||||||
Marketing and solicitation | 13,070 | 4,904 | (8,166 | ) | |||||||
Depreciation, primarily related to rental merchandise | 1,021 | 7,477 | 6,456 | ||||||||
Other | 18,449 | 7,101 | (11,348 | ) | |||||||
Net loss | (40,872 | ) | (6,341 | ) | (34,531 | ) | |||||
Net loss attributable to noncontrolling interests | 91 | 6 | 85 | ||||||||
Net loss attributable to controlling interests | (40,781 | ) | (6,335 | ) | (34,446 | ) | |||||
Year Ended December 31, 2017, Compared to Year Ended December 31, 2016
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 $214.3 million as of December 31, 2016 to $316.7 million as of December 31, 2017. These increases were partially offset, however, by continued net liquidations of our historical credit card receivable portfolios over the past year. 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 throughout 2018. 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. Despite anticipated increases in point-of-sale and direct-to-consumer receivables, continued net liquidations of our
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historical credit card receivables will continue to offset some of the expected increases but are not expected to result in overall net declines in interest income period-over-period.
Interest expense. Variations in interest expense are due to 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 offset by new borrowings associated with growth in point-of-sale and direct-to-consumer receivables and CAR operations as evidenced within Note 9, “Notes Payable,” to our consolidated financial statements. Outstanding notes payable associated with our point-of-sale and direct-to-consumer operations increased from $112.4 million as of December 31, 2016 to $204.0 million as of December 31, 2017. We anticipate additional debt financing over the next few quarters as we continue to grow, 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; |
• | declines in rental revenue as we significantly reduced rent-to-own operations in the fourth quarter of 2015 and for which we discontinued new acquisitions in 2016. We do not expect future revenues associated with this product offering as existing rent-to-own contracts have effectively concluded with no new acquisitions expected; 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 for 2018 as we continue to invest in new credit card receivables as part of our direct-to-consumer operations, offset somewhat by diminishing fee income associated with our existing portfolios of liquidating credit card receivables. 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 historical credit card receivables liquidations and associated debt amortizing repayments. Further, as discussed above, we do not expect meaningful levels of rental revenue as existing rent-to-own contracts have effectively concluded with no new acquisitions expected. This decline in rental revenues will serve to offset some of the aforementioned growth we expect in our credit card fee income.
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. Historically included within our other income category are ancillary and interchange revenues, which are now relatively insignificant for us due to previous credit card account closures and net credit card receivables portfolio liquidations. Given recent growth associated with new credit card offerings and related receivables, we expect ancillary and interchange revenues to grow modestly throughout the year. Also included within our other income category are gains or losses associated with investments previously made in consumer finance technology platforms carried at the lower of cost or market valuation. In the fourth quarter of 2017, we incurred a $2.1 million write-down of the carrying value associated with one of these investments.
Gain on repurchase of convertible senior notes. In 2016, we repurchased $5.0 million aggregate principal amount of outstanding 5.875% convertible senior notes for $2.3 million plus accrued interest from unrelated third parties. The purchase resulted in a gain of $1.2 million (net of the notes’ applicable share of deferred costs, which were written off in connection with the repurchase). Upon acquisition, the notes were retired. We did not repurchase any notes in 2017.
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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 recovery of losses upon charge off of loans 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. Additionally, net recovery in both periods reflects the effects of reimbursements received in respect of one of our portfolios which have declined year over year. In the years ended December 31, 2017 and 2016, these reimbursements exceeded the charge-offs experienced within the portfolio during the periods presented as the reimbursements are not directly associated with the timing of actual charge-offs. The timing of these reimbursements cannot be reliably determined and we currently do not expect that these reimbursements will result in a net recovery of losses upon charge-off in 2018.
Provision for losses on loans and fees receivable recorded at net realizable value. Our provision for losses on loans 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 the years ended December 31, 2017 and 2016 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 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 year ended December 31, 2017, relative to the year ended December 31, 2016, reflect the following:
• | decreases in salaries and benefits related to accruals made in 2016 associated with certain long-term incentive plans for employees at our CAR subsidiary that were not replicated in 2017; |
• | slight increases in card and loan servicing expenses in the year ended December 31, 2017 when compared to the year ended December 31, 2016 due to growth in receivables associated with our investments in point-of-sale and direct-to-consumer receivables which grew from $214.3 million outstanding to $316.7 million outstanding at December 31, 2016 and December 31, 2017, respectively, offset by the discontinuation of our rent-to-own products and the continued net liquidations in our historical credit card portfolios, the receivables of which declined from $32.1 million outstanding to $21.6 million outstanding at December 31, 2016 and December 31, 2017, respectively; |
• | increases in marketing and solicitation costs for the year ended December 31, 2017 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 2018 although the frequency and timing of marketing efforts could result in reductions in quarter-over-quarter marketing costs; |
• | decreases in depreciation expense that are primarily associated with the discontinuation of acquisitions under our rent-to-own program which had no meaningful depreciation in 2017 compared to $5.3 million in 2016; and |
• | increases in other expenses due to the reversal of a £3.4 million ($5.0 million) reserve in the year ended December 31, 2016. This reserve related to a review in the U.K. by HM Revenue and Customs (“HMRC”) associated with filings by one of our U.K. subsidiaries to reclaim value-added-tax. Additionally impacting the higher expenses noted during the year ended December 31, 2017 are increased occupancy costs, legal costs associated with new product offerings and our ongoing litigation efforts, and increased costs associated with translation impacts for U.K. liabilities. |
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 historical credit card receivables. This trend is gradually reversing as we continue to grow our earning assets (including loans 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
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better utilize our fixed costs to grow our asset base. We continue to perform extensive reviews of all areas of our businesses for cost savings opportunities to better align our costs with our portfolio of managed receivables.
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 personal loan and 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, depending upon the earnings generated from our Auto Finance segment and our liquidating credit card portfolios, 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.
Income Taxes. We experienced an effective income tax benefit rate of 13.5% and 48.7% for the years ended December 31, 2017, and 2016, respectively. Our effective income tax benefit rate for the year ended December 31, 2017, is below the statutory rate principally due to (1) interest and penalties that we accrued on unpaid federal tax liabilities and (2) our establishment of valuation allowances against our net federal deferred tax assets associated with our net loss incurred in this year. Our effective income tax benefit rate for the year ended December 31, 2016 is above the statutory rate principally due to income of our U.K. subsidiary (1) that is not subject to tax in the U.S., and (2) the U.K. tax on which was fully offset by a release of U.K. valuation allowances.
We net against our income tax benefit line item on our consolidated statements of operations interest and penalties associated with our tax liabilities (including our accrued liabilities for uncertain tax positions and our unpaid tax liabilities). We likewise report the reversal of such interest and penalties within the income tax benefit 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 years ended December 31, 2017 and 2016, $0.5 million and $0.4 million, respectively, of net income tax-related interest and penalties are netted against those years’ income tax benefit 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. Our net unpaid income tax assessment associated with that settlement was $7.4 million at December 31, 2017; this amount excludes unpaid interest and penalties on the tax assessment, the accruals for which aggregated $4.1 million at December 31, 2017. Prior to our filing amended return claims that would have eliminated the $7.4 million assessment (and corresponding interest and penalties) under a negotiated provision of the 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. During the fourth quarter of 2017, we attended an IRS Appeals conference related to the subject matter underlying our amended return claims and submitted supplemental information to address matters on which the IRS Appeals Officer needed additional support.
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.
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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, over-limit, 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 and fees receivable 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 losses upon charge off of loans 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.
Managed Receivables
We make various references within our discussion of the Credit and Other Investments segment to our managed receivables. Historically, our managed receivables data included the current period results for our ownership in receivables, regardless of the manner of accounting. This included those receivables that are shown as Loans and fees receivable, gross on our consolidated balance sheet, the liquidating credit card portfolios underlying our Loans and fees receivable, at fair value on our consolidated balance sheet and those liquidating credit card portfolios underlying non-consolidated equity-method investees. In order to provide data that are more reflective of our current operations, we have changed our methodology for calculating managed receivables data to include only the performance of those receivables underlying consolidated subsidiaries and exclude 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 now calculate average managed receivables based on the quarter ending balances. In this Report, we have calculated managed receivables and the related ratios for all periods presented in accordance with this new methodology.
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 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) 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 charge off of loans and fees receivable recorded at fair value line item on our consolidated statements of operations totaling approximately $0 for the three months ended December 31, 2017, $2.9 million for the three months ended September 30, 2017, $1.1 million for the three months ended June 30, 2017, $8.6 million for the three months ended March 31, 2017, $10.3 million for the three months ended December 31, 2016, $2.4 million for the three months ended September 30, 2016, $7.1 million for the three months ended June 30, 2016, and $5.9 million for the three months ended March 31, 2016. 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, it is difficult to determine the future effects of any such reimbursements that may be received.
A reconciliation of our Loans and fees receivable, at fair value to the assets underlying those receivables which are included in our managed receivables are as follows (in thousands):
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At or for the Three Months Ended | |||||||||||||||
2017 | 2016 | ||||||||||||||
Dec. 31 | Sept. 30 | Jun. 30 | Mar. 31 | Dec. 31 | Sept. 30 | Jun. 30 | Mar. 31 | ||||||||
Loans and fees receivable, gross | 16,601 | 18,180 | 20,102 | 21,922 | 24,229 | 28,313 | 28,514 | 32,271 | |||||||
Fair value adjustment | (5,492) | (6,161) | (7,332) | (8,331) | (8,581) | (9,868) | (7,994) | (8,535) | |||||||
Loans and fees receivable, at fair value | 11,109 | 12,019 | 12,770 | 13,591 | 15,648 | 18,445 | 20,520 | 23,736 | |||||||
Asset quality. Our delinquency and charge-off data at any point in time reflect the credit performance of our managed receivables. The average age of the accounts underlying our receivables, the timing of portfolio purchases, the success of our collection and recovery efforts and general economic conditions all affect our delinquency and charge-off rates. The average age of the accounts underlying our receivables portfolio also affects the stability of our delinquency and loss rates. We consider this delinquency and charge-off data in our allowance for uncollectible loans and fees receivable for our other credit product receivables that we report at net realizable value. Our strategy for managing delinquency and receivables losses consists of account management throughout the life of the receivable. This strategy includes credit line management and pricing based on the risks. See also our discussion of collection strategies under the “How Do We Collect?” in Item 1, “Business”.
The following table presents the delinquency trends of the receivables we manage within our Credit and Other Investments segment, as well as charge-off data and other managed receivables statistics (in thousands; percentages of total):
At or for the Three Months Ended | |||||||||||||||||||||||
2017 | 2016 | ||||||||||||||||||||||
Dec. 31 | Sept. 30 | Jun. 30 | Mar. 31 | Dec. 31 | Sept. 30 | Jun. 30 | Mar. 31 | ||||||||||||||||
Period-end managed receivables | $333,286 | $303,080 | $267,637 | $247,569 | $238,493 | $219,016 | $193,253 | $145,753 | |||||||||||||||
Percent 30 or more days past due | 13.7 | % | 12.1 | % | 11.5 | % | 11.5 | % | 12.7 | % | 11.7 | % | 8.9 | % | 11.4 | % | |||||||
Percent 60 or more days past due | 9.8 | % | 8.3 | % | 7.8 | % | 8.3 | % | 8.8 | % | 7.8 | % | 5.8 | % | 8.4 | % | |||||||
Percent 90 or more days past due | 6.5 | % | 5.5 | % | 4.9 | % | 5.5 | % | 5.5 | % | 4.9 | % | 3.7 | % | 6.0 | % | |||||||
Average managed receivables | $318,183 | $285,359 | $257,603 | $243,031 | $228,755 | $206,135 | $169,503 | $143,874 | |||||||||||||||
Total yield ratio | 39.5 | % | 36.5 | % | 35.1 | % | 34.8 | % | 33.4 | % | 35.6 | % | 35.8 | % | 36.1 | % | |||||||
Combined gross charge-off ratio | 20.1 | % | 18.2 | % | 21.1 | % | 22.4 | % | 20.1 | % | 12.6 | % | 13.9 | % | 16.1 | % | |||||||
The following table presents additional trends and data with respect to our current point-of-sale (“Retail”) and direct-to-consumer operations (“Direct”) (dollars in thousands). Results of our historical credit card receivables portfolios are excluded:
At or for the Three Months Ended | ||||||||
2017 | ||||||||
Dec. 31 | Sept. 30 | Jun. 30 | Mar. 31 | |||||
Retail | Direct | Retail | Direct | Retail | Direct | Retail | Direct | |
Period-end managed receivables | $206,877 | $109,808 | 193,403 | $91,497 | 180,830 | $66,705 | 161,876 | $63,771 |
Percent 30 or more days past due | 14.0% | 12.9% | 14.0% | 8.3% | 12.3% | 9.3% | 11.8% | 10.8% |
Percent 60 or more days past due | 10.1% | 9.1% | 9.9% | 5.0% | 8.4% | 6.2% | 8.6% | 7.4% |
Percent 90 or more days past due | 7.2% | 5.3% | 6.9% | 2.7% | 5.6% | 3.4% | 6.1% | 3.8% |
Average APR | 24.2% | 31.0% | 26.7% | 30.0% | 26.7% | 30.0% | 26.5% | 30.3% |
Receivables purchased during period | $64,036 | $38,338 | $59,293 | $38,005 | $65,786 | $15,051 | $64,617 | $5,782 |
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At or for the Three Months Ended | ||||||||
2016 | ||||||||
Dec. 31 | Sept. 30 | Jun. 30 | Mar. 31 | |||||
Retail | Direct | Retail | Direct | Retail | Direct | Retail | Direct | |
Period-end managed receivables | $141,261 | $73,003 | $110,542 | $80,161 | $89,836 | $74,903 | $76,844 | $36,638 |
Percent 30 or more days past due | 13.4% | 10.8% | 13.8% | 7.9% | 12.6% | 3.5% | 13.1% | 5.5% |
Percent 60 or more days past due | 9.6% | 6.9% | 9.5% | 4.9% | 8.3% | 2.0% | 9.8% | 3.5% |
Percent 90 or more days past due | 6.4% | 3.6% | 6.5% | 2.3% | 5.4% | 1.1% | 7.3% | 1.8% |
Average APR | 26.3% | 30.5% | 25.5% | 30.6% | 25.0% | 30.8% | 24.9% | 30.0% |
Receivables purchased during period | $60,118 | $5,602 | $44,871 | $15,852 | $35,478 | $45,562 | $27,233 | $12,830 |
The following discussion relates to the tables above.
Managed receivables levels. We experienced overall quarterly growth throughout 2017 and 2016 related to our current product offerings with over $102.4 million in net receivables growth associated with our point-of-sale and direct-to-consumer products during 2017. The addition of large point‑of‑sale retail partners and ongoing purchases of receivables from existing retail partners helped grow our point-of-sale receivables by $65.6 million and $65.4 million in the years ended December 31, 2017 and 2016, respectively. Our direct-to-consumer acquisitions grew by over $36.8 million and $43.0 million, net during the years ended December 31, 2017 and 2016, respectively. Towards the end of 2016, we changed the product mix of direct-to-consumer receivables we purchased such that new receivable acquisitions in this business line decreased for the last two quarters of 2016 and the first quarter of 2017. As such, we experienced net declines in our direct-to-consumer receivables growth levels as we completed our shift in receivable acquisitions for these quarters. While we expect continued quarterly growth in our managed receivables balances for all of our products throughout 2018, this growth in future periods largely is dependent on the addition of new retail partners to the point-of-sale operations as well as the timing of solicitations within the direct-to-consumer operations. Further, the loss of existing retail partner relationships could adversely affect new loan acquisition levels.
Delinquencies. Delinquencies have the potential to impact net income in the form of net credit losses. Delinquencies also are costly in terms of the personnel and resources dedicated to resolving them. We intend for the receivables management strategies we use on our portfolios to manage and, to the extent possible, reduce the higher delinquency rates that can be expected with the younger average age of the newer originations in our managed portfolio. These account management strategies include conservative credit line management, purging of inactive accounts and collection strategies intended to optimize the effective account-to-collector ratio across delinquency categories. We measure the success of these efforts by reviewing delinquency rates. These rates exclude receivables that have been charged off.
As we continue to invest in our newer point-of-sale and direct-to-consumer receivables, our delinquency rates have increased. This is largely a result of the risk profiles (and corresponding expected returns) for these receivables. Our delinquency rates have continued to be somewhat lower than what we ultimately expect for our new point-of-sale and direct-to-consumer receivables given the continued growth and age of the related accounts. This trend can be seen in periods of large growth in the charts above which result in artificially low delinquency rates. If and when growth for these product lines moderates, we expect increased overall delinquency rates as the existing receivables mature through their peak charge-off periods. Additionally, we expect to continue to see seasonal payment patterns on these receivables which impact our delinquencies. For example, delinquency rates historically are lower in the first quarter of each year due to the benefits of seasonally strong payment patterns associated with year-end tax refunds for most consumers.
Total yield ratio. Currently, we are experiencing growth in our newer, higher yielding receivables, including point-of-sale receivables and direct-to-consumer loans. While this growth has contributed to increases in our total yield ratio, we expect this growth also will continue to result in higher charge-off rates than those experienced historically. The second quarter 2016 total yield ratio excludes the impact of gain associated with our repurchase of $4.5 million aggregate principal amount of outstanding 5.875% convertible senior notes which resulted in a net gain of $1.0 million. Additionally, our fourth quarter 2017 total yield ratio excludes the impact of our $2.1 million write-down of the carrying value associated with a previous investment in a consumer finance technology platform.
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We expect total yield ratios to continue to fluctuate somewhat based on the relative mix of growth in point-of-sale receivables and our higher yielding direct-to-consumer credit card receivables. This growth will be offset somewhat by the continued liquidation and thus reduced impacts of our historical loans and fees receivable, at fair value.
Combined gross charge-off ratio. We charge off our Credit and Other Investments segment receivables when they become contractually more than 180 days past due or 120 days past due for the direct-to-consumer personal loan receivables. However, if a payment is made greater than or equal to two minimum payments within a month of the charge-off date, we may reconsider whether charge-off status remains appropriate. Typically, we charge off receivables within 30 days of notification and confirmation of a consumer’s bankruptcy or death. However, in some cases of death, we do not charge off receivables if there is a surviving, contractually liable individual or an estate large enough to pay the debt in full.
Growth within point-of-sale finance and direct-to-consumer receivables has resulted in increases in our charge-off rates over time. Our recent combined gross charge-off ratios benefited in the first few quarters of 2016 from growth we experienced in our point-of-sale operations and more directly from growth in our direct-to-consumer receivables. Many of these receivables reached peak charge off periods in the fourth quarter of 2016 but continued to negatively impact the first and second quarters of 2017. Additionally, we made substantial investments in our personal loan offerings in the second quarter of 2016 which did not reach their peak-charge off period until the fourth quarter of 2016, thus positively impacting our second and third quarter combined gross charge-off ratios and negatively impacting the same ratios in the fourth quarter of 2016 and the first and second quarters of 2017. Our fourth quarter 2017 combined gross charge-off ratio reflects further significant investments during the second and third quarters in 2017 in direct-to-consumer receivables, which reached their peak charge off periods during the fourth quarter of 2017.
The growth in the point-of-sale and direct-to-consumer receivables continues to result in higher charge-offs than those experienced historically. In the next few quarters, we expect increasing charge off rates when compared to historical results, given the following: (1) higher expected charge off rates on the point-of-sale and direct-to-consumer receivables, (2) continued testing of receivables with higher risk profiles, which could lead to periodic increases in combined gross charge-offs, (3) the low charge-off ratios experienced in the second and third quarters of 2016 as discussed above and (4) recent vintages reaching peak charge-off periods. Offsetting these increases will be growth in the underlying receivables base which will serve to mute to a varying degree some of the aforementioned impacts as has been seen in recent quarters.
Average APR. Our average annual percentage rate (“APR”) charged to customers varies by receivable type, credit history and other factors. The average APR for receivables in our point-of-sale operations range from 9.99% to 36.0%. For our direct-to-consumer receivables, average APR ranges from 19.99% to 36.0%. We have experienced minor fluctuations in our average APR based on the relative product mix of receivables purchased during a period. We currently expect our average APRs in 2018 to remain consistent with the average APRs we have experienced over the past several quarters; however, the timing and relative mix of receivables acquired could cause some minor fluctuations.
Receivables purchased during period. Receivables purchased during the period reflect the gross amount of investments we have made, net of any credits issued to consumers during that same period. Our point-of-sale receivable purchases experienced overall growth throughout the periods presented largely based on the addition of new point-of-sale retail partners, as previously discussed. We may experience periodic declines in these acquisitions due to the loss of one or more retail partners or due to seasonal purchase activity by consumers but we currently expect to continue to see slight increases in receivable acquisitions when compared to the same period in prior years. Our direct-to-consumer receivable acquisitions tend to have more volatility based on the issuance of new credit card accounts by our banking partner and the availability of capital to fund new purchases. Nonetheless, we expect continued growth in the acquisition of these receivables throughout 2018.
Auto Finance Segment
Our Auto Finance segment historically included a variety of auto sales and lending activities. Similar to changes in the managed calculation above, the average managed receivables used in the ratios below is now calculated based on the quarter ending balances of consolidated receivables. In this Report, we have calculated managed receivables and the related ratios for all periods presented in accordance with this new methodology.
CAR, our auto finance platform acquired in April 2005, principally purchases and/or services loans secured by automobiles from or for, and also provides 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 have expanded these operations to also
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include certain installment lending products in addition to our traditional loans secured by automobiles both in the U.S. and U.S. territories.
Collectively, as of December 31, 2017, we served more than 575 dealers through our Auto Finance segment in 33 states, the District of Columbia and two U.S. territories.
Managed Receivables Background
For reasons set forth above within our Credit and Other Investments segment discussion, we also provide managed receivables-based financial, operating and statistical data for our Auto Finance segment. Reconciliation of the auto finance managed receivables data to our GAAP financial statements requires an understanding that 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 and fees receivable.
Analysis of Statistical Data
Financial, operating and statistical metrics for our Auto Finance segment are detailed (in thousands; percentages of total) in the following table:
At or for the Three Months Ended | |||||||||||||||||||||||||||||||
2017 | 2016 | ||||||||||||||||||||||||||||||
Dec. 31 | Sept. 30 | Jun. 30 | Mar. 31 | Dec. 31 | Sept. 30 | Jun. 30 | Mar. 31 | ||||||||||||||||||||||||
Period-end managed receivables | $ | 77,213 | $ | 74,923 | $ | 76,387 | $ | 72,121 | $ | 76,433 | $ | 73,624 | $ | 78,010 | $ | 75,747 | |||||||||||||||
Percent 30 or more days past due | 12.8 | % | 13.0 | % | 11.7 | % | 10.0 | % | 14.2 | % | 12.7 | % | 12.3 | % | 10.2 | % | |||||||||||||||
Percent 60 or more days past due | 5.0 | % | 5.0 | % | 4.0 | % | 4.2 | % | 5.4 | % | 4.5 | % | 3.9 | % | 4.2 | % | |||||||||||||||
Percent 90 or more days past due | 2.4 | % | 2.2 | % | 1.4 | % | 2.1 | % | 2.4 | % | 1.8 | % | 1.5 | % | 2.2 | % | |||||||||||||||
Average managed receivables | $ | 76,068 | $ | 75,655 | $ | 74,254 | $ | 74,278 | $ | 75,029 | $ | 75,817 | $ | 76,878 | $ | 75,513 | |||||||||||||||
Total yield ratio | 37.9 | % | 38.8 | % | 39.2 | % | 39.3 | % | 39.5 | % | 40.3 | % | 39.6 | % | 38.5 | % | |||||||||||||||
Combined gross charge-off ratio | 3.0 | % | 1.1 | % | 2.5 | % | 2.5 | % | 2.8 | % | 2.9 | % | 3.2 | % | 2.8 | % | |||||||||||||||
Recovery ratio | 1.5 | % | 1.7 | % | 2.0 | % | 1.6 | % | 1.6 | % | 1.1 | % | 1.6 | % | 1.4 | % | |||||||||||||||
Managed receivables. We expect modest growth in the level of our managed receivables when compared to the same periods in prior years in both the U.S. and U.S. territories. Although we are expanding our CAR operations, the Auto Finance segment faces strong competition from other specialty finance lenders, as well as the indirect effects on us of our buy-here, pay-here dealership customers’ competition with more traditional franchise dealerships for consumers interested in purchasing automobiles.
Delinquencies. Current delinquency levels are consistent with our expectations for levels in the near term with some marginal increases noted within the overall buy-here pay-here market. Delinquency rates tend to fluctuate based on seasonal trends and historically are lower in the first quarter of each year as seen above due to the benefits of strong payment patterns associated with year-end tax refunds for most consumers. We are not concerned with modest fluctuations in delinquency rates and do not believe they will have a significantly positive or adverse impact on our results of operations; even at slightly elevated rates, we earn significant yields on CAR’s receivables and have significant dealer reserves (i.e., retainages or holdbacks on the amount of funding CAR provides to its dealer customers) to protect against meaningful credit losses.
Total yield ratio. We have experienced modest fluctuations in our total yield ratio largely impacted by the relative mix of receivables in various products offered by CAR as some shorter term product offerings tend to have higher yields. Yields on our CAR products over the last few quarters are consistent with our expectations and we expect our total yield ratio to remain in line with current experience with moderate fluctuations based on relative growth or declines in average managed receivables for a given quarter as noted above. Additionally, our product offerings in the U.S. territories tend to have slightly lower yields
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than those offered in the U.S. As such, continued growth in that region will also serve to slightly depress our overall total yield ratio, yet will continue to generate attractive returns on assets.
Combined gross charge-off ratio and recovery ratio. We charge off auto finance receivables when they are between 120 and 180 days past due, unless the collateral is repossessed and sold before that point, in which case we will record a charge off when the proceeds are received. Combined gross charge-off ratios in 2016 and 2017 reflect the lower delinquency rates we have recently experienced. While we anticipate our charge-offs to be incurred ratably across our portfolio of dealers, specific dealer-related losses are difficult to predict and can negatively influence our combined gross charge-off ratio. We continually re-assess our dealers and will take appropriate action if we believe a particular dealer’s risk characteristics adversely change. While we have appropriate dealer reserves to mitigate losses across the majority of our pool of receivables, the timing of recognition of these reserves as an offset to charge offs is largely dependent on various factors specific to each of our dealer partners including ongoing purchase volumes, outstanding balances of receivables and current performance of outstanding loans. As such, the timing of charge off offsets is difficult to predict; however, we believe that these reserves are adequate to offset any loss exposure we may incur. Additionally, the products we issue in the U.S. territories do not have dealer reserves with which we can offset losses. As our investments in these loans grow, we expect that gross charge-off rates will climb slightly over existing rates. We also expect our recovery rate to fluctuate modestly from quarter to quarter due to the timing of the sale of repossessed autos.
Definitions of Financial, Operating and Statistical Measures
Total yield ratio. Represents an annualized fraction, the numerator of which includes (as appropriate for each applicable disclosed segment) the: 1) finance charge and late fee income billed on all consolidated outstanding receivables and the amortization of the accretable yield component of our acquisition discounts for portfolio purchases, collectively included in the consumer loans, including past due fees category on our consolidated statements of income; plus 2) credit card fees (including over-limit fees, cash advance fees, returned check fees and interchange income), earned, amortized amounts of annual membership fees and activation fees with respect to certain credit card receivables, collectively included in our fees and related income on earning assets category on our consolidated statements of income; plus 3) servicing, other income and gains (or less losses) on debt repurchases and other activities collectively included in our other operating income category on our consolidated statements of income. The denominator used represents our average managed receivables.
Combined gross charge-off ratio. Represents an annualized fraction, the numerator of which is the aggregate amounts of finance charge, fee and principal losses from consumers unwilling or unable to pay their receivables balances, as well as from bankrupt and deceased consumers, less current-period recoveries (including recoveries from dealer reserve offsets for our CAR operations) as reflected in Note 2 “Significant Accounting Policies and Consolidated Financial Statement Components-Loans and Fees Receivable”, and the denominator of which is average managed receivables. Recoveries on managed receivables represent all amounts received related to managed receivables that previously have been charged off, including payments received directly from consumers and proceeds received from the sale of those charged-off receivables. Recoveries typically have represented less than 2% of average managed receivables.
LIQUIDITY, FUNDING AND CAPITAL RESOURCES
As discussed elsewhere in this Report, we incur a significant level of costs associated with a fixed infrastructure that had been designed to support our significant legacy credit card operations. Our infrastructure costs are still somewhat elevated, and while we had in the past focused on cost reduction, our primary focus now is growing the point-of-sale and direct-to-consumer personal loan and credit card receivables so that our revenues from these investments can cover our infrastructure costs and return us to consistent profitability. Increases in new and existing retail partnerships and the expansion of our investments in direct-to-consumer finance products have resulted in quarterly growth of total managed receivables levels, and we expect this growth to continue in the coming quarters.
Accordingly, we will continue to focus in the coming quarters on (i) containing costs (as opposed to our previous focus on reducing expenses) (ii) obtaining new retail partners to continue growth of the point-of-sale receivables (iii) continuing growth in direct-to-consumer credit card receivables and (iv) obtaining the funding necessary to meet capital needs required by the growth of our receivables and to cover our infrastructure costs until our receivables investments generate enough revenues and cash flows to cover such costs.
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All of our Credit and Other Investments segment’s structured financing facilities are expected to amortize down with collections on the receivables within their underlying trusts and should not represent significant refunding or refinancing risks to our consolidated balance sheet. Additionally, we do not expect any imminent refunding or financing needs associated with our 5.875% convertible senior notes given their maturity in 2035. As such, the only facilities that could represent near-term significant refunding or refinancing needs as of December 31, 2017 are those associated with the following notes payable in the amounts indicated (in millions):
Revolving credit facility (expiring October 30, 2019) that is secured by certain receivables and restricted cash | $ | 49.4 | |
Revolving credit facility (expiring November 1, 2018) that is secured by the financial and operating assets of our CAR operations | 24.8 | ||
Revolving credit facility (expiring December 31, 2019) that is secured by certain receivables and restricted cash | 19.8 | ||
Revolving credit facility (expiring December 21, 2019) that is secured by certain receivables and restricted cash | 3.8 | ||
Senior secured term loan from related parties (expiring November 21, 2018) that is secured by certain assets of the Company with an annual interest rate equal to 9.0% | 40.0 | ||
Total | $ | 137.8 | |
Further details concerning the above debt facilities are provided in Note 9, “Notes Payable,” and Note 10, “Convertible Senior Notes,” to our consolidated financial statements included herein. Based on the state of the debt capital markets, the performance of our assets that serve as security for the above facilities, and our relationships with lenders, we view imminent refunding or refinancing risks with respect to the above facilities as low in the current environment, and we believe that the quality of our new receivables should allow us to raise more capital through increasing the size of our facilities with our existing lenders and attracting new lending relationships.
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 $65.0 million was outstanding as of December 31, 2017) to an unaffiliated third party pursuant to a facility that can be drawn upon to the extent of outstanding eligible receivables.
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 fee.
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. Our net unpaid income tax assessment associated with that settlement was $7.4 million at December 31, 2017; this amount excludes unpaid interest and penalties on the tax assessment, the accruals for which aggregated $4.1 million at December 31, 2017. Prior to our filing amended return claims that would have eliminated the $7.4 million assessment (and corresponding interest and penalties) under a negotiated provision of the 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. During the fourth quarter of 2017, we attended an IRS Appeals conference related to the subject matter underlying our amended return claims and submitted supplemental information to address matters on which the IRS Appeals Officer needed additional support. If our amended return claims are ultimately denied in whole or in part by the IRS, our liquidity position would be reduced by the amount of tax, interest and penalties owed.
The Tax Cuts and Jobs Act of 2017 enacted on December 22, 2017 reduced future U.S. federal corporate tax rates from 35% to 21%, effective for us as of January 1, 2018. Given that we have significant net deferred tax assets (including net operating losses) that can be used to offset future years' income, we do not expect our liquidity position to be enhanced by the tax rate reduction, for the foreseeable future.
At December 31, 2017, we had $41.5 million in unrestricted cash held by our various business subsidiaries. Because the characteristics of our assets and liabilities change, liquidity management has been a dynamic process for us, driven by the pricing and maturity of our assets and liabilities. We historically have financed our business through cash flows from operations, asset-backed structured financings and the issuance of debt and equity. Details concerning our cash flows for the years ended December 31, 2017 and 2016 are as follows:
30
• | During the year ended December 31, 2017, we used $25.5 million of cash flows from operations compared to the generation of $39.0 million of cash flows from operations during the year ended December 31, 2016. The decrease in cash provided by operating activities was principally related to decreases in 1) collections associated with rental payments in the year ended December 31, 2017 relative to the same period in 2016, given the cessation of our rent-to-own program of approximately $8.1 million; 2) increased billed but uncollected amounts associated with growth in acquired receivables; and 3) increases in billed but uncollected amounts in respect of one of our portfolios. |
• | During the year ended December 31, 2017, we used $92.9 million of cash from our investing activities, compared to use of $75.8 million of cash from investing activities during the year ended December 31, 2016. This increase is primarily due to: 1) the shrinking size of our historical credit card receivables, resulting in lower corresponding payments from consumers; 2) increasing levels of investments for 2017 in the point-of-sale and direct-to-consumer receivables relative to the same period in 2016 and which we expect to continue to make throughout 2018; and 3) increased levels of restricted cash required to be maintained due to increasing levels of collections on loans and fees receivable, the cash balances of which are required to be distributed to noteholders under our debt facilities and minimum cash balances held in accounts at the request of certain of our business partners. Slightly offsetting this increase in cash used by investing activities are returns on our aforementioned investments in point-of-sale and direct-to-consumer receivables which contributed positively to our cash generated from investing activities. |
• | During the year ended December 31, 2017, we generated $84.6 million of cash in financing activities, compared to our generating $63.5 million of cash in financing activities during the year ended December 31, 2016. In both periods, the data reflect borrowings associated with point-of-sale and direct-to-consumer receivables offset by net repayments of amortizing debt facilities as payments are made on the underlying receivables that serve as collateral. |
Beyond our immediate financing efforts discussed throughout this Report, we will continue to evaluate debt and equity issuances as a means to fund our investment opportunities. We expect to take advantage of any opportunities to raise additional capital if terms and pricing are attractive to us. Any proceeds raised under these efforts or additional liquidity available to us could be used to fund (1) the acquisition of additional financial assets associated with the point-of-sale and direct-to-consumer finance operations as well as the acquisition of credit card receivables portfolios, (2) further repurchases of our 5.875% convertible senior notes and common stock, and (3) investments in certain financial and non-financial assets or businesses. Pursuant to a share repurchase plan authorized by our Board of Directors on May 12, 2016, we are authorized as of December 31, 2017 to repurchase an additional 4,827,601 shares of our common stock through June 30, 2018.
CONTRACTUAL OBLIGATIONS, COMMITMENTS AND OFF-BALANCE-SHEET ARRANGEMENTS
Commitments and Contingencies
We do not currently have any off-balance-sheet arrangements; however, we do have certain contractual arrangements that would require us to make payments or provide funding if certain circumstances occur, which we refer to as contingent commitments. We do not currently expect that these contingent commitments will result in any material amounts being paid by us. See Note 11, “Commitments and Contingencies,” to our consolidated financial statements included herein for further discussion of these matters.
RECENT ACCOUNTING PRONOUNCEMENTS
See Note 2, “Significant Accounting Policies and Consolidated Financial Statement Components,” to our consolidated financial statements included herein for a discussion of recent accounting pronouncements.
CRITICAL ACCOUNTING ESTIMATES
We have prepared our financial statements in accordance with GAAP. These principles are numerous and complex. We have summarized our significant accounting policies in the notes to our consolidated financial statements. In many instances, the application of GAAP requires management to make estimates or to apply subjective principles to particular facts and circumstances. A variance in the estimates used or a variance in the application or interpretation of GAAP could yield a materially different accounting result. It is impracticable for us to summarize every accounting principle that requires us to use judgment or estimates in our application. Nevertheless, we describe below the areas for which we believe that the estimations, judgments or interpretations that we have made, if different, would have yielded the most significant differences in our consolidated financial statements.
On a quarterly basis, we review our significant accounting policies and the related assumptions, in particular, those mentioned below, with the audit committee of the Board of Directors.
31
Measurements for Loans and Fees Receivable at Fair Value and Notes Payable Associated with Structured Financings at Fair Value
Our valuation of loans and fees receivable, at fair value 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. Similarly, our valuation of notes payable associated with structured financings, at fair value 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.
The estimates for credit losses, payment rates, servicing costs, contractual servicing fees, costs of funds, discount rates and yields earned on credit card receivables significantly affect the reported amount of our loans and fees receivable, at fair value and our notes payable associated with structured financings, at fair value on our consolidated balance sheet, and they likewise affect our changes in fair value of loans and fees receivable recorded at fair value and changes in fair value of notes payable associated with structured financings recorded at fair value categories within our fees and related income on earning assets line item on our consolidated statement of operations.
Allowance for Uncollectible Loans and Fees
Through our analysis of loan performance, delinquency data, charge-off data, economic trends and the potential effects of those economic trends on consumers, we establish an allowance for uncollectible loans and fees receivable as an estimate of the probable losses inherent within those loans and fees receivable that we do not report at fair value. Our loans and fees receivable consist of smaller-balance, homogeneous loans, divided into two portfolio segments: Credit and Other Investments; and Auto Finance. Each of these portfolio segments is further divided into pools based on common characteristics such as contract or acquisition channel. For each pool, we determine the necessary allowance for uncollectible loans and fees receivable by analyzing some or all of the following unique to each type of receivable pool: historical loss rates; current delinquency and roll-rate trends; vintage analyses based on the number of months an account has been in existence; the effects of changes in the economy on our customers; changes in underwriting criteria; and estimated recoveries. To the extent that actual results differ from our estimates of uncollectible loans and fees receivable, our results of operations and liquidity could be materially affected.
32
ITEM 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
As a “smaller reporting company,” as defined by Item 10 of Regulation S-K, we are not required to provide this information.
ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA |
See the Index to Financial Statements in Item 15, “Exhibits and Financial Statement Schedules.”
ITEM 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE |
None.
ITEM 9A. | CONTROLS AND PROCEDURES |
Evaluation of Disclosure Controls and Procedures
As of December 31, 2017, an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Act) was carried out on behalf of Atlanticus Holdings Corporation and our subsidiaries by our management and with the participation of our Chief Executive Officer (principal executive officer) and Chief Financial Officer (principal financial officer). Based upon the evaluation, our principal executive officer and principal financial officer concluded that these disclosure controls and procedures were effective as of December 31, 2017.
Management’s Report on Internal Control over Financial Reporting
Management of Atlanticus Holdings Corporation is responsible for establishing and maintaining adequate internal control over financial reporting (as such term is defined in Rule 13a-15(f) under the Act) for Atlanticus Holdings Corporation and our subsidiaries. Our management conducted an evaluation of the effectiveness of internal control over financial reporting as of December 31, 2017, based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) Internal Control-Integrated Framework (2013 framework).
Based on our evaluation under the COSO 2013 framework, management has concluded that internal control over financial reporting was effective as of December 31, 2017.
This Annual Report does not include an attestation report of our independent public accounting firm regarding internal control over financial reporting. Management’s report is not subject to attestation by our independent public accounting firm pursuant to SEC rules that permit us to provide only management’s report in this Annual Report.
Changes in Internal Control Over Financial Reporting
During the quarter ended December 31, 2017, no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Act) occurred that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Limitations on Controls
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
33
ITEM 9B. | OTHER INFORMATION |
None.
PART III
ITEM 10. | DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE |
The information required by this Item will be set forth in our Proxy Statement for the 2018 Annual Meeting of Shareholders in the sections entitled “Proposal One: Election of Directors,” “Executive Officers of Atlanticus,” “Section 16(a) Beneficial Ownership Reporting Compliance” and “Corporate Governance” and is incorporated by reference.
ITEM 11. | EXECUTIVE COMPENSATION |
The information required by this Item will be set forth in our Proxy Statement for the 2018 Annual Meeting of Shareholders in the section entitled “Executive and Director Compensation” and is incorporated by reference.
ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS |
The information required by this Item will be set forth in our Proxy Statement for the 2018 Annual Meeting of Shareholders in the sections entitled “Security Ownership of Certain Beneficial Owners and Management” and “Equity Compensation Plan Information” and is incorporated by reference.
ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE |
The information required by this Item will be set forth in our Proxy Statement for the 2018 Annual Meeting of Shareholders in the sections entitled “Related Party Transactions” and “Corporate Governance” and is incorporated by reference.
ITEM 14. | PRINCIPAL ACCOUNTANT FEES AND SERVICES |
The information required by this Item will be set forth in our Proxy Statement for the 2018 Annual Meeting of Shareholders in the section entitled “Auditor Fees” and is incorporated by reference.
34
PART IV
ITEM 15. | EXHIBITS AND FINANCIAL STATEMENT SCHEDULES |
The following documents are filed as part of this Report:
1. Financial Statements
INDEX TO FINANCIAL STATEMENTS
Page | |
Report of Independent Public Accounting Firm | |
Consolidated Balance Sheets as of December 31, 2017 and 2016 | |
Consolidated Statements of Operations for the Years Ended December 31, 2017 and 2016 | |
Consolidated Statements of Comprehensive Loss for the Years Ended December 31, 2017 and 2016 | |
Consolidated Statements of Shareholders’ Deficit for the Years Ended December 31, 2017 and 2016 | |
Consolidated Statements of Cash Flows for the Years Ended December 31, 2017 and 2016 | |
Notes to Consolidated Financial Statements as of December 31, 2017 and 2016 | |
2. Financial Statement Schedules
None.
35
3. Exhibits
Exhibit Number | Description of Exhibit | Incorporated by Reference from Atlanticus’ SEC Filings Unless Otherwise Indicated(1) | ||
3.1 | Articles of Incorporation, as amended | |||
3.2 | Amended and Restated Bylaws (as amended through May 12, 2017) | |||
4.1 | Form of common stock certificate | |||
4.2 | Indenture dated November 23, 2005 with U.S. Bank National Association, as successor to Wachovia Bank, National Association | |||
4.3 | Supplemental Indenture dated June 30, 2009 with U.S. Bank National Association, as successor to Wachovia Bank, National Association | |||
10.1 | Stockholders Agreement dated as of April 28, 1999 | |||
10.2† | Second Amended and Restated 2014 Equity Incentive Plan | |||
10.2(a)† | Form of Restricted Stock Agreement–Directors | |||
10.2(b)† | Form of Restricted Stock Agreement–Employees | |||
10.2(c)† | Form of Stock Option Agreement–Directors | |||
10.2(d)† | Form of Stock Option Agreement–Employees | |||
10.2(e)† | Form of Restricted Stock Unit Agreement–Directors | |||
10.2(f)† | Form of Restricted Stock Unit Agreement–Employees | |||
10.3† | Amended and Restated Employee Stock Purchase Plan | |||
10.4† | Amended and Restated Employment Agreement for David G. Hanna | |||
10.5† | Amended and Restated Employment Agreement for Richard W. Gilbert | |||
10.6† | Employment Agreement for Jeffrey A. Howard | |||
10.7† | Employment Agreement for William R. McCamey | |||
10.8† | Outside Director Compensation Package | |||
10.9 | Amended and Restated Note Purchase Agreement, dated March 1, 2010, among Merrill Lynch Mortgage Capital Inc., CCFC Corp. (formerly CompuCredit Funding Corp.), Atlanticus Services Corporation (formerly CompuCredit Corporation), and CompuCredit Credit Card Master Note Business Trust | |||
10.10 | Share Lending Agreement | |||
10.10(a) | Amendment to Share Lending Agreement | |||
36
Exhibit Number | Description of Exhibit | Incorporated by Reference from Atlanticus’ SEC Filings Unless Otherwise Indicated(1) | ||
10.11 | Agreement relating to the Sale and Purchase of Monument Business, dated April 4, 2007 | |||
10.11(a) | Account Ownership Agreement for Partridge Acquired Portfolio Business Trust, dated April 4, 2007, with R Raphael & Sons PLC | |||
10.11(b) | Receivables Purchase Agreement for Partridge Acquired Portfolio Business Trust, dated April 4, 2007, with R Raphael & Sons PLC | |||
10.11(c) | Receivables Purchase Agreement for Partridge Acquired Portfolio Business Trust, dated April 4, 2007, with Partridge Funding Corporation | |||
10.11(d) | Master Indenture for Partridge Acquired Portfolio Business Trust, dated April 4, 2007, among Partridge Acquired Portfolio Business Trust, Deutsche Bank Trust Company Americas, Deutsche Bank AG, London Branch and CIAC Corporation (formerly CompuCredit International Acquisition Corporation) | |||
10.11(e) | Series 2007-One Indenture Supplement for Partridge Acquired Portfolio Business Trust, dated April 4, 2007 | |||
10.11(f) | Transfer and Servicing Agreement for Partridge Acquired Portfolio Business Trust, dated April 4, 2007, among Partridge Funding Corporation, CIAC Corporation (formerly CompuCredit International Acquisition Corporation), Partridge Acquired Portfolio Business Trust and Deutsche Bank Trust Company Americas | |||
10.12 | Assumption Agreement dated June 30, 2009 between Atlanticus Holdings Corporation (formerly CompuCredit Holdings Corporation) and Atlanticus Services Corporation (formerly CompuCredit Corporation) | |||
10.13 | Master Indenture for Perimeter Master Note Business Trust, dated February 8, 2017, among Perimeter Master Note Business Trust, U.S. Bank National Association and Atlanticus Services Corporation | |||
10.13(a)* | Series 2017-One Indenture Supplement for Perimeter Master Note Business Trust, dated February 8, 2017 | |||
10.13(b)* | Purchase Agreement, dated February 8, 2017, among TSO-Fortiva Notes Holdco LP, TSO-Fortiva Certificate Holdco LP, Perimeter Funding Corporation, Atlanticus Services Corporation and Perimeter Master Note Business Trust | |||
10.13(c) | Trust Agreement, dated February 8, 2017, between Perimeter Funding Corporation and Wilmington Trust, National Association | |||
10.14 | Loan and Security Agreement, dated November 26, 2014, by and among Atlanticus Holdings Corporation, Certain Subsidiaries Named Therein, and Dove Ventures, LLC | |||
10.14(a) | First Amendment to Loan and Security Agreement, dated November 23, 2015 | |||
10.14(b) | Second Amendment to Loan and Security Agreement, dated November 22, 2016 | |||
10.14(c) | Third Amendment to Loan and Security Agreement, dated November 22, 2017 | |||
21.1 | Subsidiaries of the Registrant | |||
23.1 | Consent of BDO USA, LLP | |||
31.1 | Certification of Principal Executive Officer pursuant to Rule 13a-14(a) | |||
31.2 | Certification of Principal Financial Officer pursuant to Rule 13a-14(a) | |||
37
Exhibit Number | Description of Exhibit | Incorporated by Reference from Atlanticus’ SEC Filings Unless Otherwise Indicated(1) | ||
32.1 | Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350 | |||
101.INS | XBRL Instance Document | Filed herewith | ||
101.SCH | XBRL Taxonomy Extension Schema Document | Filed herewith | ||
101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document | Filed herewith | ||
101.LAB | XBRL Taxonomy Extension Label Linkbase Document | Filed herewith | ||
101.PRE | XBRL Taxonomy Presentation Linkbase Document | Filed herewith | ||
101.DEF | XBRL Taxonomy Extension Definition Linkbase Document | Filed herewith | ||
† | Management contract, compensatory plan or arrangement. |
(1) | Documents incorporated by reference from SEC filings made prior to June 2009 were filed under CompuCredit Corporation (now Atlanticus Services Corporation) (File No. 000-25751), our predecessor issuer. |
* | Portions of this document were omitted and filed separately with the SEC pursuant to a request for confidential treatment in accordance with Rule 24b-2 of the Securities Exchange Act of 1934, as amended. |
ITEM 16. | FORM 10-K SUMMARY |
None.
38
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Atlanta, State of Georgia, on April 2, 2018.
Atlanticus Holdings Corporation | |
By: | /s/ David G. Hanna |
David G. Hanna Chief Executive Officer and Chairman of the Board | |
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this Report has been signed below by the following persons in the capacities and on the dates indicated.
Signature | Title | Date |
/s/David G. Hanna David G. Hanna | Chief Executive Officer and Chairman of the Board (Principal Executive Officer) | April 2, 2018 |
/s/ William R. McCamey William R. McCamey | Chief Financial Officer (Principal Financial Officer) | April 2, 2018 |
/s/ Mitchell C. Saunders Mitchell C. Saunders | Chief Accounting Officer (Principal Accounting Officer) | April 2, 2018 |
/s/ Jeffrey A. Howard Jeffrey A. Howard | Director | April 2, 2018 |
/s/ Deal W. Hudson Deal W. Hudson | Director | April 2, 2018 |
/s/ Mack F. Mattingly Mack F. Mattingly | Director | April 2, 2018 |
/s/ Thomas G. Rosencrants Thomas G. Rosencrants | Director | April 2, 2018 |
39
Report of Independent Registered Public Accounting Firm
Shareholders and Board of Directors
Atlanticus Holdings Corporation
Atlanta, Georgia
Opinion on the consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Atlanticus Holdings Corporation (the “Company”) and subsidiaries as of December 31, 2017 and 2016, the related consolidated statements of operations and comprehensive loss, shareholders’ deficit, and cash flows for each of the two years in the period ended December 31, 2017, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company and subsidiaries at December 31, 2017 and 2016, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ BDO USA, LLP
We have served as the Company's auditor since 2002.
Atlanta, Georgia
April 2, 2018
F-1
Atlanticus Holdings Corporation and Subsidiaries
Consolidated Balance Sheets
(Dollars in thousands)
December 31, 2017 | December 31, 2016 | ||||||
Assets | |||||||
Unrestricted cash and cash equivalents | $ | 41,484 | $ | 76,052 | |||
Restricted cash and cash equivalents | 29,174 | 16,589 | |||||
Loans and fees receivable: | |||||||
Loans and fees receivable, at fair value | 11,109 | 15,648 | |||||
Loans and fees receivable, gross | 393,898 | 290,697 | |||||
Allowances for uncollectible loans and fees receivable | (62,970 | ) | (43,275 | ) | |||
Deferred revenue | (36,956 | ) | (23,639 | ) | |||
Net loans and fees receivable | 305,081 | 239,431 | |||||
Property at cost, net of depreciation | 3,229 | 3,829 | |||||
Investment in equity-method investee | 4,244 | 6,725 | |||||
Deposits | 252 | 505 | |||||
Prepaid expenses and other assets | 42,149 | 19,416 | |||||
Total assets | $ | 425,613 | $ | 362,547 | |||
Liabilities | |||||||
Accounts payable and accrued expenses | $ | 115,737 | $ | 86,768 | |||
Notes payable, at face value, net | 226,238 | 141,166 | |||||
Notes payable to related parties | 40,000 | 40,000 | |||||
Notes payable associated with structured financings, at fair value | 9,240 | 12,276 | |||||
Convertible senior notes | 61,393 | 60,791 | |||||
Income tax liability | 9,132 | 15,769 | |||||
Total liabilities | 461,740 | 356,770 | |||||
Commitments and contingencies (Note 11) | |||||||
Equity | |||||||
Common stock, no par value, 150,000,000 shares authorized: 15,291,884 shares issued and outstanding (including 1,459,233 loaned shares to be returned) at December 31, 2017; and 15,348,086 shares issued and outstanding (including 1,459,233 loaned shares to be returned) at December 31, 2016 | — | — | |||||
Additional paid-in capital | 212,785 | 211,646 | |||||
Accumulated other comprehensive loss | (2,178 | ) | — | ||||
Retained deficit | (246,640 | ) | (205,859 | ) | |||
Total shareholders’ equity | (36,033 | ) | 5,787 | ||||
Noncontrolling interests | (94 | ) | (10 | ) | |||
Total equity | (36,127 | ) | 5,777 | ||||
Total liabilities and equity | $ | 425,613 | $ | 362,547 | |||
See accompanying notes.
F-2
Atlanticus Holdings Corporation and Subsidiaries
Consolidated Statements of Operations
(Dollars in thousands, except per share data)
For the Year Ended December 31, | ||||||||
2017 | 2016 | |||||||
Interest income: | ||||||||
Consumer loans, including past due fees | $ | 114,488 | $ | 88,389 | ||||
Other | 219 | 233 | ||||||
Total interest income | 114,707 | 88,622 | ||||||
Interest expense | (27,700 | ) | (20,207 | ) | ||||
Net interest income before fees and related income on earning assets and provision for losses on loans and fees receivable | 87,007 | 68,415 | ||||||
Fees and related income on earning assets | 14,289 | 17,316 | ||||||
Net recovery of charge off of loans and fees receivable recorded at fair value | 9,460 | 22,096 | ||||||
Provision for losses on loans and fees receivable recorded at net realizable value | (77,612 | ) | (53,721 | ) | ||||
Net interest income, fees and related income on earning assets | 33,144 | 54,106 | ||||||
Other operating income: | ||||||||
Servicing income | 3,854 | 4,087 | ||||||
Other income | 1,419 | 320 | ||||||
Gain on repurchase of convertible senior notes | — | 1,151 | ||||||
Equity in income of equity-method investee | 1,158 | 2,150 | ||||||
Total other operating income | 6,431 | 7,708 | ||||||
Other operating expense: | ||||||||
Salaries and benefits | 22,751 | 24,026 | ||||||
Card and loan servicing | 31,534 | 30,662 | ||||||
Marketing and solicitation | 13,070 | 4,904 | ||||||
Depreciation | 1,021 | 7,477 | ||||||
Other | 18,449 | 7,101 | ||||||
Total other operating expense | 86,825 | 74,170 | ||||||
Loss before income taxes | (47,250 | ) | (12,356 | ) | ||||
Income tax benefit | 6,378 | 6,015 | ||||||
Net loss | (40,872 | ) | (6,341 | ) | ||||
Net loss attributable to noncontrolling interests | 91 | 6 | ||||||
Net loss attributable to controlling interests | $ | (40,781 | ) | $ | (6,335 | ) | ||
Net loss attributable to controlling interests per common share—basic | $ | (2.93 | ) | $ | (0.46 | ) | ||
Net loss attributable to controlling interests per common share—diluted | $ | (2.93 | ) | $ | (0.46 | ) | ||
See accompanying notes.
F-3
Atlanticus Holdings Corporation and Subsidiaries
Consolidated Statements of Comprehensive Loss
(Dollars in thousands)
For the Year Ended December 31, | ||||||||
2017 | 2016 | |||||||
Net loss | $ | (40,872 | ) | $ | (6,341 | ) | ||
Other comprehensive income: | ||||||||
Foreign currency translation adjustment | (2,178 | ) | — | |||||
Reclassifications of foreign currency translation adjustment to Other operating expense on the consolidated statements of operations | — | 600 | ||||||
Income tax benefit related to other comprehensive loss | — | — | ||||||
Comprehensive loss | (43,050 | ) | (5,741 | ) | ||||
Comprehensive loss attributable to noncontrolling interests | 91 | 6 | ||||||
Comprehensive loss attributable to controlling interests | $ | (42,959 | ) | $ | (5,735 | ) | ||
See accompanying notes.
F-4
Atlanticus Holdings Corporation and Subsidiaries
Consolidated Statements of Shareholders’ Deficit
For the Years Ended December 31, 2017 and 2016
(Dollars in thousands)
Common Stock | ||||||||||||||||||||||||||
Shares Issued | Amount | Additional Paid-In Capital | Accumulated Other Comprehensive Loss | Retained Deficit | Noncontrolling Interests | Total Equity | ||||||||||||||||||||
Balance at December 31, 2015 | 15,332,041 | $ | — | $ | 211,083 | $ | (600 | ) | $ | (199,524 | ) | $ | (8 | ) | $ | 10,951 | ||||||||||
Stock options exercises and proceeds related thereto | 5,999 | 14 | — | — | — | 14 | ||||||||||||||||||||
Compensatory stock issuances, net of forfeitures | 321,068 | — | — | — | — | — | — | |||||||||||||||||||
Contributions from owners of noncontrolling interests | — | — | — | — | — | 4 | 4 | |||||||||||||||||||
Amortization of deferred stock-based compensation costs | — | — | 1,416 | — | — | — | 1,416 | |||||||||||||||||||
Redemption and retirement of shares | (311,022 | ) | — | (949 | ) | — | — | — | (949 | ) | ||||||||||||||||
Tax effects of stock-based compensation costs | — | — | 82 | — | — | — | 82 | |||||||||||||||||||
Other comprehensive income (loss) | — | — | — | 600 | (6,335 | ) | (6 | ) | (5,741 | ) | ||||||||||||||||
Balance at December 31, 2016 | 15,348,086 | $ | — | $ | 211,646 | $ | — | $ | (205,859 | ) | $ | (10 | ) | $ | 5,777 | |||||||||||
Compensatory stock issuances, net of forfeitures | 102,000 | — | — | — | — | — | — | |||||||||||||||||||
Contributions from owners of noncontrolling interests | — | — | — | — | — | 7 | 7 | |||||||||||||||||||
Amortization of deferred stock-based compensation costs | — | — | 1,528 | — | — | — | 1,528 | |||||||||||||||||||
Redemption and retirement of shares | (158,202 | ) | — | (389 | ) | — | — | — | (389 | ) | ||||||||||||||||
Other comprehensive loss | — | — | — | (2,178 | ) | (40,781 | ) | (91 | ) | (43,050 | ) | |||||||||||||||
Balance at December 31, 2017 | 15,291,884 | $ | — | $ | 212,785 | $ | (2,178 | ) | $ | (246,640 | ) | $ | (94 | ) | $ | (36,127 | ) | |||||||||
See accompanying notes.
F-5
Atlanticus Holdings Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(Dollars in thousands)
For the Year Ended December 31, | |||||||
2017 | 2016 | ||||||
Operating activities | |||||||
Net loss | $ | (40,872 | ) | $ | (6,341 | ) | |
Adjustments to reconcile net loss to net cash (used in) provided by operating activities: | |||||||
Depreciation of rental merchandise | 27 | 5,273 | |||||
Depreciation, amortization and accretion, net | 994 | 2,204 | |||||
Losses upon charge off of loans and fees receivable recorded at fair value | 3,624 | 6,110 | |||||
Provision for losses on loans and fees receivable | 77,612 | 53,721 | |||||
Interest expense from accretion of discount on convertible senior notes | 548 | 515 | |||||
Income from accretion of discount associated with receivables purchases | (59,119 | ) | (41,953 | ) | |||
Unrealized gain on loans and fees receivable and underlying notes payable held at fair value | (5,771 | ) | (5,360 | ) | |||
Income from equity-method investments | (1,158 | ) | (2,150 | ) | |||
Gain on repurchase of convertible senior notes | — | (1,151 | ) | ||||
Changes in assets and liabilities: | |||||||
Increase in uncollected fees on earning assets | (2,688 | ) | (4,687 | ) | |||
Decrease in income tax liability | (6,637 | ) | (6,452 | ) | |||
Decrease in deposits | 253 | 320 | |||||
Increase in accounts payable and accrued expenses | 23,341 | 41,436 | |||||
Additions to rental merchandise | — | (634 | ) | ||||
Other | (15,619 | ) | (1,836 | ) | |||
Net cash (used in) provided by operating activities | (25,465 | ) | 39,015 | ||||
Investing activities | |||||||
(Increase) decrease in restricted cash | (12,564 | ) | 3,869 | ||||
Proceeds from equity-method investee | 3,639 | 5,548 | |||||
Investments in earning assets | (466,740 | ) | (381,212 | ) | |||
Proceeds from earning assets | 383,179 | 296,304 | |||||
Purchases and development of property, net of disposals | (395 | ) | (349 | ) | |||
Net cash used in investing activities | (92,881 | ) | (75,840 | ) | |||
Financing activities | |||||||
Noncontrolling interests contributions, net | 7 | 4 | |||||
Purchase and retirement of outstanding stock | (389 | ) | (949 | ) | |||
Proceeds from borrowings | 324,997 | 242,388 | |||||
Repayment of borrowings | (239,976 | ) | (177,984 | ) | |||
Net cash provided by financing activities | 84,639 | 63,459 | |||||
Effect of exchange rate changes on cash | 144 | (1,615 | ) | ||||
Net (decrease) increase in unrestricted cash | (33,563 | ) | 25,019 | ||||
Unrestricted cash and cash equivalents at beginning of period | 76,052 | 51,033 | |||||
Unrestricted cash and cash equivalents at end of period | $ | 42,489 | $ | 76,052 | |||
Supplemental cash flow information | |||||||
Cash paid for interest | $ | 25,478 | $ | 19,481 | |||
Net cash income tax payments | $ | 258 | $ | 437 | |||
Supplemental non-cash information | |||||||
Issuance of stock options and restricted stock | $ | 1,364 | $ | 2,310 | |||
See accompanying notes.
F-6
Atlanticus Holdings Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
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. 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, on-line and partnerships. 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 personal loans and credit cards directly to consumers (collectively, the “direct-to-consumer” operations) through additional channels enabling them to reach consumers through a diverse origination platform which includes direct mail, Internet-based marketing and through partnerships. Using our infrastructure and technology platform, we also provide loan servicing activities, 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 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.
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.
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
F-7
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 and fees receivable, net, as shown on our consolidated balance sheets, as well as on the provision for losses on loans and fees receivable within our consolidated statements of operations.
We have eliminated all significant intercompany balances and transactions for financial reporting purposes.
Unrestricted Cash and Cash Equivalents
Unrestricted cash and cash equivalents consist of cash, money market investments and overnight deposits. We consider all highly liquid cash investments with low interest rate risk and original maturities of three months or less to be cash equivalents. Cash equivalents are carried at cost, which approximates market. We maintain unrestricted cash and cash equivalents for general operating purposes and to meet our longer term debt obligations. The majority of these cash balances are not insured.
Restricted Cash
Restricted cash as of December 31, 2017 and 2016 includes certain collections on loans and fees receivable, the cash balances of which are required to be distributed to noteholders under our debt facilities. Our restricted cash balances also include minimum cash balances held in accounts at the request of certain of our business partners.
Loans and Fees Receivable
Loans and Fees Receivable, at Fair Value. Loans and fees receivable held at fair value represent receivables underlying credit card securitization trusts that are consolidated onto our consolidated balance sheet, some portfolios of which are unencumbered and some of which are still encumbered under structured financing facilities. Further details concerning our loans and fees receivable held at fair value are presented within Note 6, “Fair Values of Assets and Liabilities.”
Loans and Fees Receivable. Our loans and fees receivable, gross, currently consist of receivables associated with (a) our U.S. point-of-sale and direct-to-consumer financing and other credit products currently being marketed within our Credit and Other Investments segment and (b) our Auto Finance segment’s operations. Our Credit and Other Investments segment loans and fees receivable generally are unsecured, while our Auto Finance segment loans and fees receivable generally are secured by the underlying automobiles in which we hold the vehicle title.
We show both an allowance for uncollectible loans and fees receivable and unearned fees (or “deferred revenue”) for our loans and fees receivable (i.e., as opposed to those carried at fair value). Our loans and fees receivable consist of smaller-balance, homogeneous loans, divided into two portfolio segments: Credit and Other Investments; and Auto Finance. Each of these portfolio segments is further divided into pools based on common characteristics such as contract or acquisition channel. For each pool, we determine the necessary allowance for uncollectible loans and fees receivable by analyzing some or all of the following unique to each type of receivable pool: historical loss rates; current delinquency and roll-rate trends; vintage analyses based on the number of months an account has been in existence; the effects of changes in the economy on our customers; changes in underwriting criteria; and estimated recoveries. A considerable amount of judgment is required to assess the ultimate amount of uncollectible loans and fees receivable, and we continuously evaluate and update our methodologies to determine the most appropriate allowance necessary. We may individually evaluate a receivable or pool of receivables for impairment (as indicated in the table below) if circumstances indicate that the receivable or pool of receivables may be at higher risk for non-performance than other receivables. This may occur if a particular retail or auto-finance partner has indications of non-performance (such as a bankruptcy) that could impact the underlying pool of receivables we purchased from the partner.
Certain of our loans and fees receivable also contain components of deferred revenue including discounts on the purchases of receivables for our point-of-sale receivables and annual fee billings for our direct-to-consumer credit card offerings. Our point-of-sale and auto finance loans and fees receivable include principal balances and associated fees and interest due from customers which are earned each period a loan is outstanding, net of the unearned portion of loan discounts. Additionally, many of our direct-to-consumer credit card offerings have an annual membership fee that is billed to the consumer on card activation and for each anniversary of that date thereafter. As of December 31, 2017 and December 31, 2016, the weighted average remaining accretion period for the $37.0 million and $23.6 million of deferred revenue reflected in the consolidated balance sheets was 11 months.
F-8
A roll-forward (in millions) of our allowance for uncollectible loans and fees receivable by class of receivable is as follows:
For the Year Ended December 31, 2017 | Credit Cards | Auto Finance | Other Unsecured Lending Products | Total | ||||||||||||
Allowance for uncollectible loans and fees receivable: | ||||||||||||||||
Balance at beginning of period | $ | (1.4 | ) | $ | (2.1 | ) | $ | (39.8 | ) | $ | (43.3 | ) | ||||
Provision for loan losses | (19.2 | ) | (1.9 | ) | (56.5 | ) | (77.6 | ) | ||||||||
Charge offs | 3.8 | 3.0 | 57.0 | 63.8 | ||||||||||||
Recoveries | (1.4 | ) | (1.3 | ) | (3.2 | ) | (5.9 | ) | ||||||||
Balance at end of period | $ | (18.2 | ) | $ | (2.3 | ) | $ | (42.5 | ) | $ | (63.0 | ) | ||||
As of December 31, 2017 | Credit Cards | Auto Finance | Other Unsecured Lending Products | Total | ||||||||||||
Allowance for uncollectible loans and fees receivable: | ||||||||||||||||
Balance at end of period individually evaluated for impairment | $ | — | $ | (0.2 | ) | $ | (0.2 | ) | $ | (0.4 | ) | |||||
Balance at end of period collectively evaluated for impairment | $ | (18.2 | ) | $ | (2.1 | ) | $ | (42.3 | ) | $ | (62.6 | ) | ||||
Loans and fees receivable: | ||||||||||||||||
Loans and fees receivable, gross | $ | 87.2 | $ | 77.8 | $ | 228.9 | $ | 393.9 | ||||||||
Loans and fees receivable individually evaluated for impairment | $ | — | $ | 0.4 | $ | 0.2 | $ | 0.6 | ||||||||
Loans and fees receivable collectively evaluated for impairment | $ | 87.2 | $ | 77.4 | $ | 228.7 | $ | 393.3 | ||||||||
For the Year Ended December 31, 2016 | Credit Cards | Auto Finance | Other Unsecured Lending Products | Total | ||||||||||||
Allowance for uncollectible loans and fees receivable: | ||||||||||||||||
Balance at beginning of period | $ | (1.2 | ) | $ | (1.7 | ) | $ | (18.6 | ) | $ | (21.5 | ) | ||||
Provision for loan losses | 0.7 | (2.6 | ) | (51.8 | ) | (53.7 | ) | |||||||||
Charge offs | 1.8 | 3.3 | 32.6 | 37.7 | ||||||||||||
Recoveries | (2.7 | ) | (1.1 | ) | (2.0 | ) | (5.8 | ) | ||||||||
Balance at end of period | $ | (1.4 | ) | $ | (2.1 | ) | $ | (39.8 | ) | $ | (43.3 | ) | ||||
F-9
As of December 31, 2016 | Credit Cards | Auto Finance | Other Unsecured Lending Products | Total | ||||||||||||
Allowance for uncollectible loans and fees receivable: | ||||||||||||||||
Balance at end of period individually evaluated for impairment | $ | — | $ | (0.3 | ) | $ | (0.3 | ) | $ | (0.6 | ) | |||||
Balance at end of period collectively evaluated for impairment | $ | (1.4 | ) | $ | (1.8 | ) | $ | (39.5 | ) | $ | (42.7 | ) | ||||
Loans and fees receivable: | ||||||||||||||||
Loans and fees receivable, gross | $ | 11.0 | $ | 77.1 | $ | 202.6 | $ | 290.7 | ||||||||
Loans and fees receivable individually evaluated for impairment | $ | — | $ | 0.7 | $ | 0.3 | $ | 1.0 | ||||||||
Loans and fees receivable collectively evaluated for impairment | $ | 11.0 | $ | 76.4 | $ | 202.3 | $ | 289.7 | ||||||||
Delinquent loans and fees receivable reflect the principal, fee and interest components of loans we did not collect on or prior to the contractual due date. Amounts we believe we will not ultimately collect are included as a component in our overall allowance for uncollectible loans and fees receivable. For most products other than our Auto Finance receivables, we discontinue charging interest and fees for most of our credit products when loans and fees receivable become contractually 90 or more days past due. We charge off our Credit and Other Investments and Auto Finance segment receivables when they become contractually more than 180 days past due or 120 days past due for the direct-to-consumer personal loan product. For all of our products, we charge off receivables within 30 days of notification and confirmation of a customer’s bankruptcy or death. However, in some cases of death, we do not charge off receivables if there is a surviving, contractually liable individual or an estate large enough to pay the debt in full.
Recoveries on accounts previously charged off are credited to the allowance for uncollectible loans and fees receivable and effectively offset our provision for losses on loans and fees receivable recorded at net realizable value on our consolidated statements of operations. (All of the above discussion relates only to our loans and fees receivable for which we use net realizable value i.e., as opposed to fair value accounting. For loans and fees receivable recorded at fair value, recoveries offset losses upon charge off of loans and fees receivable recorded at fair value, net of recoveries on our consolidated statements of operations.)
We consider loan delinquencies a key indicator of credit quality because this measure provides the best ongoing estimate of how a particular class of receivables is performing. An aging of our delinquent loans and fees receivable, gross (in millions) by class of receivable as of December 31, 2017 and December 31, 2016 is as follows:
Balance at December 31, 2017 | Credit Cards | Auto Finance | Other Unsecured Lending Products | Total | ||||||||||||
30-59 days past due | $ | 3.2 | $ | 6.4 | $ | 9.0 | $ | 18.6 | ||||||||
60-89 days past due | 3.3 | 2.1 | 7.1 | 12.5 | ||||||||||||
90 or more days past due | 4.9 | 1.9 | 15.7 | 22.5 | ||||||||||||
Delinquent loans and fees receivable, gross | 11.4 | 10.4 | 31.8 | 53.6 | ||||||||||||
Current loans and fees receivable, gross | 75.8 | 67.4 | 197.1 | 340.3 | ||||||||||||
Total loans and fees receivable, gross | $ | 87.2 | $ | 77.8 | $ | 228.9 | $ | 393.9 | ||||||||
Balance of loans 90 or more days past due and still accruing interest and fees | $ | — | $ | 1.6 | $ | — | $ | 1.6 | ||||||||
F-10
Balance at December 31, 2016 | Credit Cards | Auto Finance | Other Unsecured Lending Products | Total | |||||||||||
30-59 days past due | $ | 0.2 | $ | 7.0 | $ | 8.2 | $ | 15.4 | |||||||
60-89 days past due | 0.2 | 2.4 | 6.7 | 9.3 | |||||||||||
90 or more days past due | 0.4 | 1.9 | 11.4 | 13.7 | |||||||||||
Delinquent loans and fees receivable, gross | 0.8 | 11.3 | 26.3 | 38.4 | |||||||||||
Current loans and fees receivable, gross | 10.2 | 65.8 | 176.3 | 252.3 | |||||||||||
Total loans and fees receivable, gross | $ | 11.0 | $ | 77.1 | $ | 202.6 | $ | 290.7 | |||||||
Balance of loans 90 or more days past due and still accruing interest and fees | $ | — | $ | 1.5 | $ | — | $ | 1.5 | |||||||
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 elimination of the annual percentage rate (“APR”) charged to an account and a cessation of fee billing. 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 TDRs, including TDRs that have been re-aged, as of December 31, 2017 and December 31, 2016:
As of December 31, | ||||||||||||
2017 | 2016 | |||||||||||
Point-of-sale | Direct-to-consumer | Point-of-sale | Direct-to-consumer | |||||||||
Number of accounts on non-accrual status | 11,432 | 6,681 | 7,350 | 1,449 | ||||||||
Number of accounts on non-accrual status above that have been re-aged | 915 | 80 | 560 | 9 | ||||||||
Amount of receivables on non-accrual status (in thousands) | $ | 17,169 | $ | 7,067 | $10,346 | $4,728 | ||||||
Amount of receivables on non-accrual status above that have been re-aged (in thousands) | $ | 1,570 | $ | 86 | $865 | $10 | ||||||
Carrying value of receivables on non-accrual status (in thousands) | $ | 4,247 | $ | 1,173 | $2,432 | $474 | ||||||
TDRs - Performing (carrying value, in thousands)* | $ | 2,368 | $ | 508 | $1,279 | $279 | ||||||
TDRs - Nonperforming (carrying value, in thousands)* | $ | 1,879 | $ | 666 | $1,153 | $195 | ||||||
*“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 following table details by class of receivable, the number of accounts and carrying value of loans that completed a modification within the prior twelve months and subsequently charged off.
2017 | 2016 | |||||||||||
Point-of-Sale | Direct-to-Consumer | Point-of-Sale | Direct-to-Consumer | |||||||||
Number of accounts | 1,720 | 870 | 1,645 | 381 | ||||||||
Loan balance at time of charge off (in thousands) | $ | 2,675 | $ | 2,466 | $1,681 | $1,149 | ||||||
F-11
Property at Cost, Net of Depreciation
We capitalize costs related to internal development and implementation of software used in our operating activities in accordance with applicable accounting literature. These capitalized costs consist almost exclusively of fees paid to third-party consultants to develop code and install and test software specific to our needs and to customize purchased software to maximize its benefit to us.
We record our property at cost less accumulated depreciation or amortization. We compute depreciation expense using the straight-line method over the estimated useful lives of our assets, which are approximately 5 years for furniture, fixtures and equipment, and 3 years for computers and software. We amortize leasehold improvements over the shorter of their estimated useful lives or the terms of their respective underlying leases.
We periodically review our property to determine if it is impaired. We incurred no impairment costs in 2017 and $0.6 million of such impairment costs in 2016.
Investment in Equity-Method Investee
We account for an investment using the equity method of accounting if we have the ability to exercise significant influence, but not control, over the investee. Significant influence is generally deemed to exist based on ownership interest, although other factors, such as representation on an investee’s board of managers, specific voting and veto rights held by each investor and the effects of commercial arrangements, are considered in determining whether equity method accounting is appropriate. We record our interests in the income of our equity-method investee within the equity in income of equity-method investee category on our consolidated statements of operations.
We use the equity method for our 66.7% investment in a limited liability company formed in 2004 to acquire a portfolio of credit card receivables. We account for this investment using the equity method of accounting due to specific voting and veto rights held by each investor, which do not allow us to control this investee.
We evaluate our investments in the equity-method investee for impairment each quarter by comparing the carrying amount of the investment to its fair value. Because no active market exists for the investee’s limited liability company membership interest, we evaluate our investment for impairment based on our evaluation of the fair value of the equity-method investee’s net assets relative to its carrying value. If we ever were to determine that the carrying value of our investment in the equity-method investee was greater than its fair value, we would write the investment down to its fair value.
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) amounts due from a third party in respect of a servicing agreement totaling $30.4 million as of December 31, 2017, (3) ongoing deferred costs associated with service contracts and (4) investments in consumer finance technology platforms carried at the lower of cost or market valuation. In the fourth quarter of 2017, we incurred a $2.1 million write down of the carrying value associated with one of these investments.
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 owed in respect of one of our portfolios.
Revenue Recognition
Consumer Loans, Including Past Due Fees
Consumer loans, including past due fees reflect interest income, including finance charges, and late fees on loans in accordance with the terms of the related customer agreements. Premiums and discounts paid or received associated with a loan are generally deferred and amortized over the average life of the related loans using the effective interest method. Finance
F-12
charges and fees, net of amounts that we consider uncollectible, are included in loans and fees receivable and revenue when the fees are earned.
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 historical credit card receivables; (2) changes in the fair value of loans and fees receivable recorded at fair value; (3) changes in fair value of notes payable associated with structured financings recorded at fair value; (4) revenues associated with rent payments on rental merchandise; and (5) 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. 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 and fees receivable and revenue when the fees are earned.
In periods where applicable, we accrue periodic billed rental amounts (net of allowances for uncollectible billings) into revenues over the rental period to which the billed amounts relate, and we defer recognition in revenues of any advanced customer rental payments until the rental period in which they are properly recognizable under the terms of the contract.
The components (in thousands) of our fees and related income on earning assets are as follows:
Year ended December 31, | ||||||||
2017 | 2016 | |||||||
Fees on credit products | $ | 10,427 | $ | 3,526 | ||||
Changes in fair value of loans and fees receivable recorded at fair value | 3,456 | 1,587 | ||||||
Changes in fair value of notes payable associated with structured financings recorded at fair value | 2,315 | 3,773 | ||||||
Rental revenue | 148 | 8,235 | ||||||
Other | (2,057 | ) | 195 | |||||
Total fees and related income on earning assets | $ | 14,289 | $ | 17,316 | ||||
The above changes in the fair value of loans and fees receivable recorded at fair value category exclude the impact of charge offs associated with these receivables which are separately stated in Net recovery of charge off of loans 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.
Card and Loan Servicing Expenses
Card and loan servicing costs primarily include collections and customer service expenses. Within this category of expenses are personnel, service bureau, cardholder correspondence and other direct costs associated with our collections and customer service efforts. Card and loan servicing costs also include outsourced collections and customer service expenses. We expense card and loan servicing costs as we incur them, with the exception of prepaid costs, which we expense over respective service periods.
Marketing and Solicitation Expenses
We expense product solicitation costs, including printing, credit bureaus, list processing, telemarketing, postage and Internet marketing fees, as we incur these costs or expend resources.
Recent Accounting Pronouncements
In June 2016, the FASB issued Accounting Standards Update (“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
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(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 March 2016, the FASB issued ASU 2016-07, Simplifying the Transition to the Equity Method of Accounting. The ASU eliminates the requirement that when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations, and retained earnings retroactively, as if the equity method had been in effect during all previous periods that the investment had been held. The ASU requires that the cost of acquiring the additional interest in the investee should be combined with the current basis of the investor’s previously held interest and the equity method of accounting should be adopted as of the date the investment becomes qualified for equity method accounting. No retroactive adjustment of the investment is required. The ASU also requires that an entity that has an available-for-sale equity security that becomes qualified for the equity method of accounting recognize through earnings, the unrealized holding gain or loss in accumulated other comprehensive income at the date the investment becomes qualified for use of the equity method. The ASU was effective January 1, 2017. The impact of adoption of this authoritative guidance did not result in a material impact on our consolidated financial statements.
In February 2016, the FASB issued ASU No. 2016-02, Leases, which requires lessees to recognize assets and liabilities for most leases, changing certain aspects of current lessor accounting, among other things. ASU 2016-02 is effective for annual and interim periods beginning after December 15, 2018, with early adoption permitted. The adoption of ASU 2016-02 will result in the Company recognizing a right-of-use asset and lease liability on the consolidated balance sheet based on the present value of remaining operating lease payments. Net future minimum lease payments totaled $12.2 million as of December 31, 2017, as disclosed in Note 8 “ Leases”. We do not expect the adoption of ASU 2016-02 to have a material impact on our consolidated financial statements due to the limited lease activity we are involved in.
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 will now be effective for annual and interim periods beginning January 1, 2018 and early adoption is permitted. Most revenue associated with financial instruments, including interest income, loan origination fees and credit card fees, is outside the scope of the guidance. We adopted this standard in the first quarter of 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 December 31, 2017, 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.
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 December 31, 2017 and December 31, 2016, 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 year ended December 31, 2017 and 2016 were generated outside of the U.S.
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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:
Year ended December 31, 2017 | Credit and Other Investments | Auto Finance | Total | |||||||||
Interest income: | ||||||||||||
Consumer loans, including past due fees | $ | 86,395 | $ | 28,093 | $ | 114,488 | ||||||
Other | 219 | — | 219 | |||||||||
Total interest income | 86,614 | 28,093 | 114,707 | |||||||||
Interest expense | (26,702 | ) | (998 | ) | (27,700 | ) | ||||||
Net interest income before fees and related income on earning assets and provision for losses on loans and fees receivable | $ | 59,912 | $ | 27,095 | $ | 87,007 | ||||||
Fees and related income on earning assets | $ | 14,170 | $ | 119 | $ | 14,289 | ||||||
Servicing income | $ | 3,010 | $ | 844 | $ | 3,854 | ||||||
Depreciation of rental merchandise | $ | (27 | ) | $ | — | $ | (27 | ) | ||||
Equity in income of equity-method investee | $ | 1,158 | $ | — | $ | 1,158 | ||||||
(Loss) income before income taxes | $ | (54,387 | ) | $ | 7,137 | $ | (47,250 | ) | ||||
Income tax benefit (expense) | $ | 9,417 | $ | (3,039 | ) | $ | 6,378 | |||||
Total assets | $ | 359,563 | $ | 66,050 | $ | 425,613 | ||||||
Year ended December 31, 2016 | Credit and Other Investments | Auto Finance | Total | |||||||||
Interest income: | ||||||||||||
Consumer loans, including past due fees | $ | 59,614 | $ | 28,775 | $ | 88,389 | ||||||
Other | 233 | — | 233 | |||||||||
Total interest income | 59,847 | 28,775 | 88,622 | |||||||||
Interest expense | (19,011 | ) | (1,196 | ) | (20,207 | ) | ||||||
Net interest income before fees and related income on earning assets and provision for losses on loans and fees receivable | $ | 40,836 | $ | 27,579 | $ | 68,415 | ||||||
Fees and related income on earning assets | $ | 17,214 | $ | 102 | $ | 17,316 | ||||||
Servicing income | $ | 3,115 | $ | 972 | $ | 4,087 | ||||||
Gain on repurchase of convertible senior notes | $ | 1,151 | $ | — | $ | 1,151 | ||||||
Depreciation of rental merchandise | $ | (5,273 | ) | $ | — | $ | (5,273 | ) | ||||
Equity in income of equity-method investee | $ | 2,150 | $ | — | $ | 2,150 | ||||||
(Loss) income before income taxes | $ | (18,915 | ) | $ | 6,559 | $ | (12,356 | ) | ||||
Income tax benefit (expense) | $ | 8,390 | $ | (2,375 | ) | $ | 6,015 | |||||
Total assets | $ | 293,576 | $ | 68,971 | $ | 362,547 | ||||||
4. | Shareholders’ Equity |
During the years ended December 31, 2017 and 2016, we repurchased and contemporaneously retired 158,202 and 311,022 shares of our common stock at an aggregate cost of $389,000 and $949,000, respectively, pursuant to both open market and private purchases and the return of stock by holders of equity incentive awards to pay tax withholding obligations.
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We had 1,459,233 loaned shares outstanding at December 31, 2017 and December 31, 2016, 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 December 31, 2017 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 | |||||||
December 31, 2017 | December 31, 2016 | ||||||
Loans and fees receivable, at fair value | $ | 6,123 | $ | 9,650 | |||
Total assets | $ | 6,392 | $ | 10,291 | |||
Total liabilities | $ | 26 | $ | 204 | |||
Members’ capital | $ | 6,366 | $ | 10,087 | |||
Year ended December 31, | |||||||
2017 | 2016 | ||||||
Net interest income, fees and related income on earning assets | $ | 1,742 | $ | 3,249 | |||
Net income | $ | 1,370 | $ | 2,714 | |||
Net income attributable to our equity investment in investee | $ | 1,158 | $ | 2,150 | |||
6. | Fair Values of Assets and Liabilities |
We elected the fair value option with respect to our investments in equity securities as well as our credit card loans and fees receivable portfolios, the retained interests in which we historically recorded at fair value under securitization structures that were off balance sheet prior to accounting rules changes requiring their consolidation into our financial statements. With respect to our equity securities, we decided to carry these assets at fair value due to our intent to invest and redeem these investments with expected frequency. For our credit card loans and fees receivable portfolios underlying our formerly off-balance-sheet securitization structures, we elected the fair value option because, in contrast to substantially all of our other assets, we had significant experiences in determining the fair value of these assets in connection with our historical fair value accounting for our retained interests in their associated securitization structures. Because we elected to account for the credit card receivables underlying our formerly off-balance-sheet securitization structures at fair value, accounting rules require that we account for the notes payable issued by such securitization structures at fair value as well. For our other credit card receivables that have never been owned by our formerly off-balance-sheet securitization structures, we have not elected the fair value option, and we record such receivables at net realizable value within loans and fees receivable, net on our consolidated balance sheets.
For all of our other debt other than the notes payable underlying our formerly off-balance sheet credit card securitization structures, we have not elected the fair value option. Nevertheless, pursuant to applicable requirements, we include disclosures of the fair value of this other debt to the extent practicable within the disclosures below. Additionally, we have other liabilities that we are required to carry at fair value in our consolidated financial statements, and they also are addressed within the disclosures below.
Where applicable as noted above, we account for our financial assets and liabilities at fair value based upon a three-tiered valuation system. In general, fair values determined by Level 1 inputs use quoted prices (unadjusted) in active markets for identical assets or liabilities that we have the ability to access. Fair values determined by Level 2 inputs use inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset
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or liability. Where inputs used to measure fair value may fall into different levels of the fair value hierarchy, the level in the fair value hierarchy within which the fair value measurement in its entirety has been determined is based on the lowest level input that is significant to the fair value measurement in its entirety.
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 December 31, 2017 and December 31, 2016 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 December 31, 2017 (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 and fees receivable, net for which it is practicable to estimate fair value | $ | — | $ | — | $ | 324,945 | $ | 293,972 | ||||||||
Loans and fees receivable, at fair value | $ | — | $ | — | $ | 11,109 | $ | 11,109 | ||||||||
Assets – As of December 31, 2016 (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 and fees receivable, net for which it is practicable to estimate fair value | $ | — | $ | — | $ | 248,171 | $ | 223,783 | ||||||||
Loans and fees receivable, at fair value | $ | — | $ | — | $ | 15,648 | $ | 15,648 | ||||||||
(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 our loans and fees receivable included in the above tables, we assess the fair value of these assets based on our estimate of future cash flows net of servicing costs, and to the extent that such cash flow estimates change from period to period, any such changes are considered to be attributable to changes in instrument-specific credit risk.
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 year ended December 31, 2017 and 2016:
Loans and Fees Receivable, at Fair Value | |||||||
2017 | 2016 | ||||||
Balance at January 1, | $ | 15,648 | $ | 26,706 | |||
Total gains—realized/unrealized: | |||||||
Net revaluations of loans and fees receivable, at fair value | 3,456 | 1,587 | |||||
Settlements | (8,049 | ) | (12,335 | ) | |||
Impact of foreign currency translation | 54 | (310 | ) | ||||
Balance at December 31, | $ | 11,109 | $ | 15,648 | |||
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.
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Net Revaluation of Loans and Fees Receivable. We record the net revaluation of loans 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 and fees receivable recorded at fair value. The net revaluation of loans 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 December 31, 2017 and December 31, 2016:
Quantitative Information about Level 3 Fair Value Measurements | ||||||||||
Fair Value Measurements | Fair Value at December 31, 2017 | Valuation Technique | Unobservable Input | Range (Weighted Average) | ||||||
Loans and fees receivable, at fair value | $ | 11,109 | Discounted cash flows | Gross yield | 15.8% to 27.4% (24.5%) | |||||
Principal payment rate | 1.9% to 3.6% (2.6%) | |||||||||
Expected credit loss rate | 9.4% to 10.4% (9.7%) | |||||||||
Servicing rate | 10.2% to 12.3% (10.5%) | |||||||||
Discount rate | 6.0% to 14.2% (12.8%) | |||||||||
Quantitative Information about Level 3 Fair Value Measurements | ||||||||||
Fair Value Measurements | Fair Value at December 31, 2016 | Valuation Technique | Unobservable Input | Range (Weighted Average) | ||||||
Loans and fees receivable, at fair value | $ | 15,648 | Discounted cash flows | Gross yield | 24.2% to 35.8% (26.1%) | |||||
Principal payment rate | 2.2% to 3.5% (2.4%) | |||||||||
Expected credit loss rate | 11.8% to 18.0% (12.9%) | |||||||||
Servicing rate | 8.6% to 9.6% (8.8%) | |||||||||
Discount rate | 5.8% to 13.6% (12.5%) | |||||||||
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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 December 31, 2017 and December 31, 2016 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 December 31, 2017 | 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 | $ | — | $ | — | $ | 160,854 | $ | 160,854 | ||||||||
Amortizing debt facilities | $ | — | $ | — | $ | 65,384 | $ | 65,384 | ||||||||
Senior secured term loan | $ | — | $ | — | $ | 40,000 | $ | 40,000 | ||||||||
5.875% convertible senior notes | $ | — | $ | 43,588 | $ | — | $ | 61,393 | ||||||||
Liabilities carried at fair value | ||||||||||||||||
Notes payable associated with structured financings, at fair value | $ | — | $ | — | $ | 9,240 | $ | 9,240 | ||||||||
Liabilities - As of December 31, 2016 | 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 | $ | — | $ | — | $ | 83,184 | $ | 83,184 | ||||||||
Amortizing debt facilities | $ | — | $ | — | $ | 57,982 | $ | 57,982 | ||||||||
Senior secured term loan | $ | — | $ | — | $ | 40,000 | $ | 40,000 | ||||||||
5.875% convertible senior notes | $ | — | $ | 40,609 | $ | — | $ | 60,791 | ||||||||
Liabilities carried at fair value | ||||||||||||||||
Notes payable associated with structured financings, at fair value | $ | — | $ | — | $ | 12,276 | $ | 12,276 | ||||||||
For our material notes payable, we assess the fair value of these liabilities based on our estimate of future cash flows generated from their underlying credit card receivables collateral, net of servicing compensation required under the note facilities, and to the extent that such cash flow estimates change from period to period, any such changes are considered to be attributable to changes in instrument-specific credit risk. Gains and losses associated with fair value changes for our notes payable associated with structured financing liabilities that are carried at fair value are detailed on our fees and related income on earning assets table within Note 2, “Significant Accounting Policies and Consolidated Financial Statement Components.” For our 5.875% convertible senior notes due 2035 (“5.875% convertible senior notes”), we assess fair value based upon the most recent trade data available from third-party providers. We have seen no data that would suggest that the fair value of our other Credit and Other Investments segment debt is materially different from its carrying amount as evidenced in recent financing arrangements obtained with similar terms. See Note 9, “Notes Payable,” for further discussion on our other notes payable.
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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 year ended December 31, 2017 and 2016.
Notes Payable Associated with Structured Financings, at Fair Value | |||||||
2017 | 2016 | ||||||
Beginning balance, January 1 | $ | 12,276 | $ | 20,970 | |||
Total (gains) losses—realized/unrealized: | |||||||
Net revaluations of notes payable associated with structured financings, at fair value | (2,315 | ) | (3,773 | ) | |||
Repayments on outstanding notes payable, net | (721 | ) | (4,921 | ) | |||
Ending balance, December 31, | $ | 9,240 | $ | 12,276 | |||
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.
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 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 December 31, 2017 and December 31, 2016:
Quantitative Information about Level 3 Fair Value Measurements | |||||||||||
Fair Value Measurements | Fair Value at December 31, 2017 | Valuation Technique | Unobservable Input | Weighted Average | |||||||
Notes payable associated with structured financings, at fair value | $ | 9,240 | Discounted cash flows | Gross yield | 25.9 | % | |||||
Principal payment rate | 2.5 | % | |||||||||
Expected credit loss rate | 9.4 | % | |||||||||
Discount rate | 14.2 | % | |||||||||
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Quantitative Information about Level 3 Fair Value Measurements | |||||||||||
Fair Value Measurements | Fair Value at December 31, 2016 | Valuation Technique | Unobservable Input | Weighted Average | |||||||
Notes payable associated with structured financings, at fair value | $ | 12,276 | Discounted cash flows | Gross yield | 24.6 | % | |||||
Principal payment rate | 2.2 | % | |||||||||
Expected credit loss rate | 11.8 | % | |||||||||
Discount rate | 13.6 | % | |||||||||
Other Relevant Data
Other relevant data (in thousands) as of December 31, 2017 and December 31, 2016 concerning certain assets and liabilities we carry at fair value are as follows:
As of December 31, 2017 | Loans and Fees Receivable at Fair Value | Loans and Fees Receivable Pledged as Collateral under Structured Financings at Fair Value | ||||||
Aggregate unpaid principal balance within loans and fees receivable that are reported at fair value | $ | 4,416 | $ | 11,349 | ||||
Aggregate fair value of loans and fees receivable that are reported at fair value | $ | 1,869 | $ | 9,240 | ||||
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) | $ | 5 | $ | 17 | ||||
Aggregate excess of balance of unpaid principal receivables within loans 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 and fees receivable | $ | 107 | $ | 369 | ||||
As of December 31, 2016 | Loans and Fees Receivable at Fair Value | Loans and Fees Receivable Pledged as Collateral under Structured Financings at Fair Value | ||||||
Aggregate unpaid principal balance within loans and fees receivable that are reported at fair value | $ | 6,251 | $ | 16,614 | ||||
Aggregate fair value of loans and fees receivable that are reported at fair value | $ | 3,484 | $ | 12,164 | ||||
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) | $ | 6 | $ | 22 | ||||
Aggregate excess of balance of unpaid principal receivables within loans 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 and fees receivable | $ | 204 | $ | 562 | ||||
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Notes Payable | Notes Payable Associated with Structured Financings, at Fair Value as of December 31, 2017 | Notes Payable Associated with Structured Financings, at Fair Value as of December 31, 2016 | ||||||
Aggregate unpaid principal balance of notes payable | $ | 101,314 | $ | 102,035 | ||||
Aggregate fair value of notes payable | $ | 9,240 | $ | 12,276 | ||||
7. | Property |
Details (in thousands) of our property on our consolidated balance sheets are as follows:
As of December 31, | ||||||||
2017 | 2016 | |||||||
Software | $ | 5,542 | $ | 5,194 | ||||
Furniture and fixtures | 6,252 | 6,191 | ||||||
Data processing and telephone equipment | 11,196 | 11,008 | ||||||
Leasehold improvements | 10,651 | 10,638 | ||||||
Total cost | 33,641 | 33,031 | ||||||
Less accumulated depreciation | (30,412 | ) | (29,202 | ) | ||||
Property, net | $ | 3,229 | $ | 3,829 | ||||
Depreciation expense totaled $1.0 million and $2.2 million for the years ended December 31, 2017 and 2016, respectively.
8. | Leases |
We lease premises and certain equipment under cancelable and non-cancelable leases, some of which contain renewal options under various terms. Total rental expense for continuing operations associated with these operating leases was $1.7 million in 2017 and $1.5 million in 2016. During the fourth quarter of 2006, we entered into a 15-year lease in Atlanta, Georgia for 335,372 square feet (net of space which was surrendered to the landlord through our exercise of a termination option), 255,110 square feet of which we have subleased, and the remainder of which houses our corporate offices. In connection with this lease, we received a $21.2 million construction allowance for the build-out of our new corporate offices. We are amortizing the construction allowance as a reduction of rent expense over the term of the lease. As of December 31, 2017, the future minimum rental commitments (in thousands) for all non-cancelable operating leases with initial or remaining terms of more than one year (both gross and net of any sublease income) are as follows:
Gross | Sublease Income | Net | ||||||||||
2018 | $ | 9,865 | $ | (6,741 | ) | $ | 3,124 | |||||
2019 | 9,783 | (6,930 | ) | 2,853 | ||||||||
2020 | 9,808 | (7,126 | ) | 2,682 | ||||||||
2021 | 9,832 | (7,327 | ) | 2,505 | ||||||||
2022 | 4,157 | (3,117 | ) | 1,040 | ||||||||
Thereafter | — | — | — | |||||||||
Total | $ | 43,445 | $ | (31,241 | ) | $ | 12,204 | |||||
In addition, we occasionally lease certain equipment under cancelable and non-cancelable leases, which are accounted for as capital leases in our consolidated financial statements. As of December 31, 2017, we had no material non-cancelable capital leases with initial or remaining terms of more than one year.
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9. | Notes Payable |
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 December 31, 2017 and December 31, 2016, (2) the outstanding face amount of our structured financing note secured by certain credit card receivables and reported at fair value as of December 31, 2017 and December 31, 2016, 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 December 31, 2017 and December 31, 2016.
Carrying Amounts at Fair Value as of | |||||||
December 31, 2017 | December 31, 2016 | ||||||
Amortizing securitization facility (stated maturity of December 2021), outstanding face amount of $101.3 million as of December 31, 2017 ($102.0 million as of December 31, 2016) bearing interest at a weighted average 6.7% interest rate at December 31, 2017 (6.1% at December 31, 2016), which is secured by credit card receivables and restricted cash aggregating $9.2 million as of December 31, 2017 ($12.3 million as of December 31, 2016) in carrying amount | $ | 9.2 | $ | 12.3 | |||
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 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 $9.2 million in fair value of the structured financing note in the above table is $9.2 million, which means that we have no aggregate exposure to pre-tax equity loss associated with the above structured financing arrangement at December 31, 2017.
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.
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Notes Payable, at Face Value and Notes Payable to Related Parties
Other notes payable outstanding as of December 31, 2017 and December 31, 2016 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 | |||||||
December 31, 2017 | December 31, 2016 | ||||||
Revolving credit facilities at a weighted average interest rate equal to 7.8% at December 31, 2017 (4.8% at December 31, 2016) secured by the financial and operating assets of CAR and/or certain receivables and restricted cash with a combined aggregate carrying amount of $216.0 million as of December 31, 2017 ($127.9 million at December 31, 2016) | |||||||
Revolving credit facility, not to exceed $40.0 million (expiring November 1, 2019) (1) | 24.8 | 29.2 | |||||
Revolving credit facility, not to exceed $50.0 million (expiring October 30, 2019) (2) (3) | 49.4 | 34.7 | |||||
Revolving credit facility, not to exceed $12.0 million (expiring December 21, 2019) (2) (3) | 3.8 | — | |||||
Revolving credit facility, not to exceed $20.0 million (expiring December 31, 2019) (2) (3) | 19.8 | 19.5 | |||||
Revolving credit facility, not to exceed $90.0 million (expiring February 8, 2022) (2) (4) | 65.0 | — | |||||
Amortizing facilities at a weighted average interest rate equal to 6.0% at December 31, 2017 (5.4% at December 31, 2016) secured by certain receivables and restricted cash with a combined aggregate carrying amount of $77.9 million as of December 31, 2017 ($69.9 million as of December 31, 2016) | |||||||
Amortizing debt facility (repaid in June 2017) (2) (3) (5) | — | 20.4 | |||||
Amortizing debt facility (repaid in September 2017) (2) (3) | — | 9.7 | |||||
Amortizing debt facility (expiring March 31, 2018) (2) (3) (5) | 3.7 | 14.6 | |||||
Amortizing debt facility (expiring June 30, 2018) (2) (3) (5) | 18.3 | — | |||||
Amortizing debt facility (expiring December 12, 2018) (2) (3) | 6.0 | 6.0 | |||||
Amortizing debt facility (expiring September 14, 2018) (2) (3) | 7.5 | 7.5 | |||||
Amortizing debt facility (expiring November 30, 2018) (2) (3) (5) | 20.5 | — | |||||
Amortizing debt facility (expiring April 22, 2019) (2) (3) (5) | 10.0 | — | |||||
Other facilities | |||||||
Senior secured term loan from related parties (expiring November 21, 2018) that is secured by certain assets of the Company with an annual interest rate equal to 9.0% (4) | 40.0 | 40.0 | |||||
Total notes payable before unamortized debt issuance costs and discounts | 268.8 | 181.6 | |||||
Unamortized debt issuance costs and discounts | 2.6 | 0.4 | |||||
Total notes payable outstanding, net | $ | 266.2 | $ | 181.2 | |||
(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) | 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. |
(3) | These notes reflect modifications to either extend the maturity date, increase the loaned amount or both. |
(4) | See below for additional information. |
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(5) | Loans are comprised of four tranches with the same lenders. Terms and conditions are substantially identical with the exception of maturity date as indicated in the table above. |
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 December 31, 2017. In November 2017, the agreement was amended to extend the maturity date of the term loan to November 21, 2018. 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, 2018 (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 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 $65.0 million was outstanding as of December 31, 2017) 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 range from 8.0% 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 fee.
10. | Convertible Senior Notes |
In November 2005, we issued $300.0 million aggregate principal amount of 5.875% convertible senior notes due November 30, 2035 (“5.875% convertible senior notes”). The 5.875% 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 5.875% convertible senior notes.
In 2016 we repurchased $5.0 million aggregate principal amount of outstanding 5.875% convertible senior notes for $2.3 million plus accrued interest from unrelated third parties. The purchase resulted in a gain of $1.2 million (net of the notes’ applicable share of deferred costs, which were written off in connection with the repurchases). Upon acquisition, the notes were retired.
The following summarizes (in thousands) components of our consolidated balance sheets associated with our convertible senior notes:
As of | |||||||
December 31, 2017 | December 31, 2016 | ||||||
Face amount of 5.875% convertible senior notes | $ | 88,280 | $ | 88,280 | |||
Discount | (26,887 | ) | (27,489 | ) | |||
Net carrying value | $ | 61,393 | $ | 60,791 | |||
Carrying amount of equity component included in additional paid-in capital | $ | 108,714 | $ | 108,714 | |||
Excess of instruments’ if-converted values over face principal amounts | $ | — | $ | — | |||
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During certain periods and subject to certain conditions, the remaining $88.3 million of outstanding 5.875% convertible senior notes as of December 31, 2017 (as referenced in the table above) are convertible by holders into cash and, if applicable, shares of our common stock at an adjusted effective conversion rate of 40.63 shares of common stock per $1,000 principal amount of notes, subject to further adjustment; the conversion rate is based on an adjusted conversion price of $24.61 per share of common stock. Upon any conversion of the notes, we will deliver to holders of the notes cash of up to $1,000 per $1,000 aggregate principal amount of notes and, at our option, either cash or shares of our common stock in respect of the remainder of the conversion obligation, if any. The maximum number of shares of common stock that any note holder may receive upon conversion is fixed at 40.63 shares per $1,000 aggregate principal amount of notes, and we have a sufficient number of authorized shares of our common stock to satisfy this conversion obligation. We are required to pay contingent interest on the notes during a 6-month period if the average trading price of the notes is above a specified level. Thus far we have not paid any contingent interest on these notes. In addition, holders of the notes may require us to repurchase the notes upon certain specified events.
In conjunction with the offering of the 5.875% convertible senior notes, we entered into a 30-year share lending agreement with Bear, Stearns International Limited (“BSIL”) and Bear, Stearns & Co. Inc, as agent for BSIL, pursuant to which we lent BSIL 5,677,950 shares of our common stock in exchange for a fee of $0.001 per loaned share upon consummation of the agreement. We exclude the loaned shares from earnings per share computations. The obligations of Bear Stearns were assumed by JP Morgan in 2008. JP Morgan (as the guarantor of the obligation) is required to return the loaned shares to us at the end of the 30-year term of the share lending agreement or earlier upon the occurrence of specified events. Such events include the bankruptcy of JP Morgan, its failure to make payments when due, its failure to post collateral when required or return loaned shares when due, notice of its inability to perform obligations, or its untrue representations. If an event of default occurs, then the borrower (JP Morgan) may settle the obligation in cash. Further, in the event that JP Morgan’s credit rating drops below A/A2, it would be required to post collateral for the market value of the lent shares ($3.5 million based on the 1,459,233 shares remaining outstanding under the share lending arrangement as of December 31, 2017). JP Morgan has agreed to use the loaned shares for the purpose of directly or indirectly facilitating the hedging of our convertible senior notes by the holders thereof or for such other purpose as reasonably determined by us. We deem it highly remote that any event of default will occur and therefore cash settlement, while an option, is an unlikely scenario.
We analogize the share lending agreement to a prepaid forward contract, which we have evaluated under applicable accounting guidance. We determined that the instrument was not a derivative in its entirety and that the embedded derivative would not require separate accounting. The net effect on shareholders’ equity of the shares lent pursuant to the share lending agreement, which includes our requirement to lend the shares and the counterparties’ requirement to return the shares, is the fee received upon our lending of the shares.
Accounting for Convertible Senior Notes
Under applicable accounting literature, the accounting for the issuance of the notes includes (1) allocation of the issuance proceeds between the notes and additional paid-in capital, (2) establishment of a discount to the face amount of the notes equal to the portion of the issuance proceeds that are allocable to additional paid-in capital, (3) creation of a deferred tax liability related to the discount on the notes, and (4) an allocation of issuance costs between the portion of such costs considered to be associated with the notes and the portion of such costs considered to be associated with the equity component of the notes’ issuances (i.e., additional paid-in capital). We are amortizing the discount to the remaining face amount of the notes into interest expense over the expected life of the notes, which results in a corresponding release of associated deferred tax liability. Amortization for the years ended December 31, 2017 and 2016 totaled $0.5 million and $0.5 million, respectively. Actual incurred interest (based on the contractual interest rates within the two convertible senior notes series) totaled $5.2 million and $5.3 million for the years ended December 31, 2017 and 2016, respectively. We will amortize the discount remaining at December 31, 2017 into interest expense over the expected term of the 5.875% convertible senior notes (currently expected to be October 2035). The weighted average effective interest rate for the 5.875% convertible senior notes was 9.2% for all periods presented.
11. | 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 $375.1 million at December 31, 2017. 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,
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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 December 31, 2017, CAR had unfunded outstanding floor-plan financing commitments totaling $8.4 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 $10.8 million remains pledged as of December 31, 2017 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 December 31, 2017, 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 8, “Leases” .
Litigation
On April 4, 2007, we purchased a portfolio of credit card accounts from Barclays Bank PLC (“Barclays”) pursuant to a Sale and Purchase Agreement (the “SPA”). A portion of the accounts had an optional feature known as a “payment break plan” (“PBP”) that, in broad terms, enabled a customer to freeze his/her account for a period of time in certain circumstances, during which period, in general, the customer was not required to make minimum payments. Consistent with U.K. practice and Barclays’ own procedures and instructions to us, we established a claims process and provided remediation. Since 2011, we have claimed substantial sums from Barclays on the basis that (i) such sums have been paid, or otherwise credited, by us to customers in respect of PBP mis-selling complaints, and (ii) Barclays is liable to reimburse us pursuant to a contractual indemnity provision contained in the SPA. Until recently, Barclays paid invoices issued by us for reimbursement of amounts paid, or otherwise credited, to customers for alleged PBP mis-selling.
In late 2016 we also concluded that Barclays, in connection with the SPA, fraudulently misrepresented the portfolio, resulting in our overpayment for the portfolio and incurrence of substantial losses that we otherwise would not have incurred.
On May 4, 2017, we sued Barclays in the High Court of Justice Business and Property Courts of England and Wales, Claim No. FL-2017-000003. The claims relate to Barclays’ obligation to reimburse us for remediation of the PBP claims discussed above and other damages incurred as a result of the SPA and Barclays’ actions and inactions. We are seeking monetary damages for these claims.
In conjunction with the lawsuit, Barclays asserted a counterclaim alleging that past reimbursement claims paid to us were not in accordance with its policies. We have been processing claims from consumers since 2010 and historically payments on these claims and associated processing costs were reimbursed by Barclays based upon our invoices to Barclays. We believe the counterclaim is part of Barclays’ litigation strategy and is without merit. We have made no accruals for potential liability in this matter.
We intend to pursue our suit against Barclays and to recover the amounts due to us.
We are involved in various other legal proceedings that are incidental to the conduct of our business, none of which are expected to be material to us.
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12. | Income Taxes |
Deferred tax assets and liabilities reflect the effects of tax losses, credits, and the future income tax effects of temporary differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases and are measured using enacted tax rates that apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.
The current and deferred portions (in thousands) of federal, foreign and state income tax benefit or expense are as follows:
For the Year Ended December 31, | ||||||||
2017 | 2016 | |||||||
Federal income tax benefit: | ||||||||
Current tax (expense) benefit | $ | (113 | ) | $ | 59 | |||
Deferred tax benefit | 6,187 | 5,884 | ||||||
Total federal income tax benefit | $ | 6,074 | $ | 5,943 | ||||
Foreign income tax expense: | ||||||||
Current tax expense | $ | (94 | ) | $ | (41 | ) | ||
Deferred tax benefit | 8 | 3 | ||||||
Total foreign income tax expense | $ | (86 | ) | $ | (38 | ) | ||
State and other income tax benefit: | ||||||||
Current tax benefit (expense) | $ | 16 | $ | (116 | ) | |||
Deferred tax benefit | 374 | 226 | ||||||
Total state and other income tax benefit | $ | 390 | $ | 110 | ||||
Total income tax benefit | $ | 6,378 | $ | 6,015 | ||||
We experienced effective income tax benefit rates of 13.5% and 48.7% for the years ended December 31, 2017, and 2016, respectively. Our effective income tax benefit rate for the year ended December 31, 2017 is below the statutory rate principally due to (1) interest and penalties that we accrued on unpaid federal tax liabilities and (2) our establishment of valuation allowances against our net federal deferred tax assets associated with our net loss incurred in this year. Our effective income tax benefit rate for the year ended December 31, 2016 is above the statutory rate principally due to income of our U.K. subsidiary (1) that is not subject to tax in the U.S., and (2) the U.K. tax on which was fully offset by a release of U.K. valuation allowances.
We net against our income tax benefit line item on our consolidated statements of operations interest and penalties associated with our tax liabilities (including our accrued liabilities for uncertain tax positions and our unpaid tax liabilities). We likewise report the reversal of such interest and penalties within the income tax benefit 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 years ended December 31, 2017 and 2016, $0.5 million and $0.4 million, respectively, of net income tax-related interest and penalties are netted against those years’ income tax benefit 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. Our net unpaid income tax assessment associated with that settlement was $7.4 million at December 31, 2017; this amount excludes unpaid interest and penalties on the tax assessment, the accruals for which aggregated $4.1 million at December 31, 2017. Prior to our filing amended return claims that would have eliminated the $7.4 million assessment (and corresponding interest and penalties) under a negotiated provision of the 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. During the fourth quarter of 2017, we attended an IRS Appeals conference related to the subject matter underlying our amended return claims and submitted supplemental information to address matters on which the IRS Appeals Officer needed additional support.
The following table reconciles our effective income tax benefit rates for 2017 and 2016:
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For the Year Ended December 31, | ||||||
2017 | 2016 | |||||
Statutory benefit rate | 35.0 | % | 35.0 | % | ||
Increase (decrease) in statutory tax benefit rate resulting from: | ||||||
Changes in valuation allowances | (12.7 | ) | 6.2 | |||
Interest and penalties related to uncertain tax positions | (0.9 | ) | (0.1 | ) | ||
Foreign income taxes | 0.6 | 7.5 | ||||
Permanent and other prior year true ups | (0.4 | ) | (0.5 | ) | ||
Impact of change in federal tax rate | (8.7 | ) | — | |||
State and other income taxes, net | 0.6 | 0.6 | ||||
Effective benefit rate | 13.5 | % | 48.7 | % | ||
As of December 31, 2017 and December 31, 2016, the respective significant components (in thousands) of our deferred tax assets and liabilities were:
As of December 31, | ||||||||
2017 | 2016 | |||||||
Deferred tax assets: | ||||||||
Software development costs/fixed assets | $ | 83 | $ | — | ||||
Goodwill and intangible assets | 1,801 | 3,798 | ||||||
Provision for loan loss | 16,320 | 18,353 | ||||||
Equity-based compensation | 604 | 670 | ||||||
Accrued expenses | 113 | 1,678 | ||||||
Accruals for state taxes and interest associated with unrecognized tax benefits | 78 | 286 | ||||||
Federal net operating loss carry-forward | 49,098 | 70,778 | ||||||
Alternative minimum tax credit carry-forward | 2,005 | 2,145 | ||||||
Foreign net operating loss carry-forward | 362 | 374 | ||||||
State tax benefits | 44,643 | 35,409 | ||||||
Deferred tax assets, gross | $ | 115,107 | $ | 133,491 | ||||
Valuation allowances | (48,242 | ) | (33,924 | ) | ||||
Deferred tax assets net of valuation allowance | $ | 66,865 | $ | 99,567 | ||||
Deferred tax liabilities: | ||||||||
Prepaid expenses and other | $ | (194 | ) | $ | (184 | ) | ||
Software development costs/fixed assets | — | (157 | ) | |||||
Equity in income of equity-method investee | (1,054 | ) | (1,455 | ) | ||||
Other | (511 | ) | (58 | ) | ||||
Credit card fair value election differences | (32,464 | ) | (42,939 | ) | ||||
Deferred costs | (466 | ) | (696 | ) | ||||
Convertible senior notes | (20,098 | ) | (28,921 | ) | ||||
Cancellation of indebtedness income | (9,841 | ) | (29,491 | ) | ||||
Deferred tax liabilities, gross | $ | (64,628 | ) | $ | (103,901 | ) | ||
Deferred tax assets (liabilities), net | $ | 2,237 | $ | (4,334 | ) | |||
We undertook a detailed review of our deferred taxes and determined that a valuation allowance was required for certain deferred tax assets in the U.S. and various foreign jurisdictions (including U.S. territories). We reduce our deferred tax assets by a valuation allowance if it is more likely than not that some portion or all of a deferred tax asset will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which temporary differences are deductible. In making our valuation allowance determinations, we consider all available
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positive and negative evidence affecting specific deferred tax assets, including our past and anticipated future performance, the reversal of deferred tax liabilities, the length of carry-back and carry-forward periods, and the implementation of tax planning strategies. Because this evaluation requires consideration of future events, significant judgment is required in making the evaluation, and our conclusion could be materially different should certain of our expectations not be met. Our valuation allowance was $48.2 million and $33.9 million at December 31, 2017, and December 31, 2016, respectively. The significant components of the change in our valuation allowance include an $11.8 million increase due to losses incurred in our 2017 operations for which future benefits are not expected to be utilized, an $8.3 million increase against state tax deferred assets we believe will expire unused, offset by a $5.8 million decrease resulting from the corporate tax rate change enacted on December 22, 2017, in the Tax Cuts and Jobs Act of 2017. We note that we have not established a valuation allowance against approximately $2.0 million of federal minimum tax credits which are now fully refundable in the future without regard to our future results of operations.
Certain of our deferred tax assets relate to federal, foreign and state net operating losses, capital losses, and credits as noted in the above table, and we have no other net operating losses, capital losses, or credit carry-forwards other than those noted herein. We have recorded a deferred tax asset of $49.1 million reflecting the tax benefit of federal net operating loss and capital loss carryforwards, which expire in varying amounts between 2029 and 2033.
Beyond allowing for the refundability of federal minimum tax credits, the Tax Cuts and Jobs Act of 2017 made other significant changes to the Internal Revenue Code. Because of the significance of these changes, the SEC staff issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (“SAB 118”), which allows us to record provisional amounts during a measurement period not to extend beyond one year of the enactment date. Accordingly, we have recorded provisional amounts in our consolidated financial statements. Although we do not anticipate remeasurements of our recorded amounts, such remeasurements could occur given the passage of these significant tax law changes so late in the 2017 year, coupled with ongoing guidance and accounting interpretations that are expected over the next 12 months. We expect to complete our analysis within the measurement period in accordance with SAB 118.
One significant provision within the new tax legislation is the decrease in the U.S. corporate income tax rate from 35% to 21%, which resulted in the re-measurement of our net deferred tax asset balance and related valuation allowance to reflect the future tax benefit at the newly enacted rate. Our net U.S. deferred tax asset was reduced by $4.3 million, as was our valuation allowance against this asset. Because of these offsetting remeasurements, the change in the U.S. corporate income tax rate had no effect on our 2017 effective tax rate. The Tax Cuts and Jobs Act of 2017 also requires the payment of a transition tax on the mandatory deemed repatriation of cumulative, unremitted foreign earnings. Based upon all available evidence and our analysis, we have no transition tax liability because we have a net earnings and profits deficit in our controlled foreign corporations; accordingly, this particular provision did not affect our 2017 effective tax rate.
Although the Tax Cuts and Jobs Act of 2017 provides for a modified territorial tax system beginning in 2018, it includes two new U.S. tax base anti-erosion provisions, the global intangible low-taxed income (“GILTI”) provisions and the base-erosion and anti-abuse tax (“BEAT”) provisions. The GILTI provisions would require us to include foreign subsidiary earnings that exceed an allowable return on the foreign subsidiary’s tangible assets in our U.S. income tax return. We do not expect that the GILTI inclusions will result in any significant U.S. tax for us, and, if applicable, we intend to account for the GILTI tax in the period in which it is incurred. Therefore, we have not included any deferred tax impacts of GILTI in our 2017 consolidated financial statements. The BEAT provisions eliminate the deduction of certain base-eroding payments made to related foreign corporations and impose a minimum tax if it is greater than the regular tax. Based upon all available evidence and our analysis, we do not expect that the BEAT provisions will apply to us.
We conduct business globally, and as a result, our subsidiaries file federal, state and/or foreign income tax returns. In the normal course of our business, we are subject to examination by taxing authorities throughout the world, including such major jurisdictions as the U.S., the U.K., and various U.S. states and territories. With a few exceptions of a non-material nature, and with the exception of our 2008 tax-settlement-related claims discussed previously, we are no longer subject to federal, state, local, or foreign income tax examinations for years prior to 2013.
Reconciliations (in thousands) of our unrecognized tax benefits from the beginning to the end of 2017 and 2016, respectively, are as follows:
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2017 | 2016 | |||||||
Balance at January 1, | $ | (818 | ) | $ | (1,798 | ) | ||
Reductions based on tax positions related to prior years | 583 | 1,167 | ||||||
Additions based on tax positions related to the current year | (87 | ) | (82 | ) | ||||
Interest and penalties accrued | (51 | ) | (105 | ) | ||||
Balance at December 31, | $ | (373 | ) | $ | (818 | ) | ||
Further, our unrecognized tax benefits that, if recognized, would affect the effective tax rate are not material at only $0.4 million and $0.8 million at December 31, 2017, and 2016, respectively.
13. | Net Loss Attributable to Controlling Interests Per Common Share |
We compute net income attributable to controlling interests per common share by dividing net income attributable to controlling interests by the weighted-average common shares (including participating securities) outstanding during the period, as discussed below. Diluted computations applicable in financial reporting periods in which we report income reflect the potential dilution to the basic income per common share computations that could occur if securities or other contracts to issue common stock were exercised, were converted into common stock or were to result in the issuance of common stock that would share in our results of operations. In performing our net income attributable to controlling interests per common share computations, we apply accounting rules that require us to include all unvested stock awards that contain non-forfeitable rights to dividends or dividend equivalents, whether paid or unpaid, in the number of shares outstanding in our basic and diluted calculations. Common stock and certain unvested share-based payment awards earn dividends equally, and we have included all outstanding restricted stock awards in our basic and diluted calculations for current and prior periods.
The following table sets forth the computations of net loss per common share (in thousands, except per share data):
For the Year Ended December 31, | ||||||||
2017 | 2016 | |||||||
Numerator: | ||||||||
Net loss attributable to controlling interests | $ | (40,781 | ) | $ | (6,335 | ) | ||
Denominator: | ||||||||
Basic (including unvested share-based payment awards) (1) | 13,925 | 13,867 | ||||||
Effect of dilutive stock compensation arrangements (2) | 15 | 70 | ||||||
Diluted (including unvested share-based payment awards) (1) | 13,940 | 13,937 | ||||||
Net loss attributable to controlling interests per common share—basic | $ | (2.93 | ) | $ | (0.46 | ) | ||
Net loss attributable to controlling interests per common share—diluted | $ | (2.93 | ) | $ | (0.46 | ) | ||
(1) | Shares related to unvested share-based payment awards included in our basic and diluted share counts were 281,282 for the year ended December 31, 2017, compared to 300,478 for the year ended December 31, 2016. |
(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 years ended December 31, 2017 and 2016, 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 5.875% convertible senior notes. However, in future reporting periods during which our closing stock price is above the $24.61 conversion price for the 5.875% 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 10, “Convertible Senior Notes,” for a further discussion of these convertible securities.
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14. | Stock-Based Compensation |
We currently have two stock-based compensation plans, the Amended and Restated Employee Stock Purchase Plan (the “ESPP”) and the Second Amended and Restated 2014 Equity Incentive Plan (the “2014 Plan”). As of December 31, 2017, 9,092 shares remained available for issuance under the ESPP and 1,082,668 shares remained available for issuance under the 2014 Plan.
Exercises and vestings under our stock-based compensation plans resulted in $0 in income tax-related charges to additional paid-in capital during the year ended December 31, 2017, with $(82,000) in such charges for the year ended December 31, 2016.
Restricted Stock and Restricted Stock Unit Awards
During the year ended December 31, 2017 and 2016, we granted 102,000 and 321,068 shares of restricted stock (net of any forfeitures), respectively, with aggregate grant date fair values of $0.3 million and $1.0 million, respectively. We incurred expenses of $0.6 million and $0.6 million during the year ended December 31, 2017 and 2016, respectively, related to restricted stock and restricted stock unit awards. When we grant restricted stock, we defer the grant date value of the restricted stock and amortize that value (net of the value of anticipated forfeitures) as compensation expense with an offsetting entry to the additional 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 December 31, 2017, our unamortized deferred compensation costs associated with non-vested restricted stock awards were $0.1 million with a weighted-average remaining amortization period of 0.4 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 may be less than, equal to, or greater than the market price on the date the option is granted. The option period may not exceed 5 years from the date of grant. The vesting requirements for options could range from 0 to 5 years. We had expense of $0.9 million and $0.8 million related to stock option-related compensation costs during the years ended December 31, 2017 and 2016, 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. Information related to options outstanding is as follows:
December 31, 2017 | ||||||||||||
Number of Shares | Weighted- Average Exercise Price | Weighted- Average of Remaining Contractual Life (in years) | Aggregate Intrinsic Value | |||||||||
Outstanding at December 31, 2016 | 1,411,667 | $ | 3.09 | |||||||||
Issued | 1,215,000 | $ | 2.98 | |||||||||
Exercised | — | $ | — | |||||||||
Cancelled/Forfeited | (7,333 | ) | $ | 3.04 | ||||||||
Outstanding at December 31, 2017 | 2,619,334 | $ | 3.04 | 3.3 | $ | 17,312 | ||||||
Exercisable at December 31, 2017 | 794,871 | $ | 2.92 | 2.1 | $ | 17,312 | ||||||
We had $0.9 million and $0.7 million of unamortized deferred compensation costs associated with non-vested stock options as of December 31, 2017 and 2016, respectively.
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15. | Employee Benefit Plans |
We maintain a defined contribution retirement plan (“401(k) plan”) for our U.S. employees that provides for a matching contribution by us. All full time U.S. employees are eligible to participate in the 401(k) plan. Our U.K. credit card subsidiary offers eligible employees membership in a Group Personal Pension Plan which is set up with Friends Provident. This plan is a defined contribution plan in which all permanent employees who have completed 3 months of continuous service are eligible to join the plan. Company matching contributions are available to U.K. employees who contribute a minimum of 3% of their salaries under our Group Personal Pension Plan and to U.S. employees who participate in our 401(k) plan. We made matching contributions under our U.S. and U.K. plans of $272,005 and $307,361 in 2017 and 2016, respectively.
Also, all employees, excluding executive officers, are eligible to participate in the ESPP. Under the ESPP, employees can elect to have up to 10% of their annual wages withheld to purchase our common stock up to a fair market value of $10,000. The amounts deducted and accumulated by each participant are used to purchase shares of common stock on or as promptly as practicable after the last business day of each month. The price of stock purchased under the ESPP is approximately 85% of the fair market value per share of our common stock on the purchase date. Employees contributed $35,593 to purchase 16,954 shares of common stock in 2017 and $28,541 to purchase 11,053 shares of common stock in 2016 under the ESPP. The ESPP covers up to 150,000 shares of common stock. Our charge to expense associated with the ESPP was $22,590 and $16,930 in 2017 and 2016, respectively.
16. | Related Party Transactions |
Under a shareholders’ agreement into which we entered with David G. Hanna, Frank J. Hanna, III, Richard R. House, Jr., Richard W. Gilbert and certain trusts that were Hanna affiliates, following our initial public offering (1) if one or more of the shareholders accepts a bona fide offer from a third party to purchase more than 50% of the outstanding common stock, each of the other shareholders that is a party to the agreement may elect to sell his shares to the purchaser on the same terms and conditions, and (2) if shareholders that are a party to the agreement owning more than 50% of the common stock propose to transfer all of their shares to a third party, then such transferring shareholders may require the other shareholders that are a party to the agreement to sell all of the shares owned by them to the proposed transferee on the same terms and conditions.
In June 2007, we entered into a sublease for 1,000 square feet of excess office space at our Atlanta headquarters with HBR Capital, Ltd. (“HBR”), a company co-owned by David G. Hanna and his brother Frank J. Hanna, III. The sublease rate per square foot is the same as the rate that we pay under the prime lease. Under the sublease, HBR paid us $26,629 and $26,103 for 2017 and 2016, respectively. The aggregate amount of payments required under the sublease from January 1, 2018 to the expiration of the sublease in May 2022 is $124,087.
In January 2013, HBR began leasing four employees from us. HBR reimburses us for the full cost of the employees, based on the amount of time devoted to HBR. In the years ended December 31, 2017 and 2016, we received $263,453 and $260,586, respectively, of reimbursed costs from HBR associated with these leased employees.
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 December 31, 2017. In November 2017, the agreement was amended to extend the maturity date of the term loan to November 21, 2018. 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, 2018 (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.
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