Notes to Consolidated Financial Statements

March 31, 2017 and 2016

 

 

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 the income earned from an investment in an equity-method investee that holds credit card receivables for which we are the servicer.

Lastly, we report within our Credit and Other Investments segment gains 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 as of March 31, 2017 . Some of these investees have raised capital at valuations substantially in excess of our associated book value. However, none of these companies are publicly-traded, there are no material pending liquidity events, and ascribing value to these investments at this time would be speculative.

Within our Auto Finance segment, our CAR subsidiary operations principally purchase and 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.

 

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

 

Basis of Presentation and Use of Estimates

 

We prepare our consolidated financial statements in accordance with generally accepted accounting principles in the U.S. (“GAAP”). The preparation of financial statements in accordance with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of our consolidated financial statements, as well as the reported amounts of revenues and expenses during each reporting

period. We base these estimates on information available to us as of the date of the financial statements. Actual results could differ materially from these estimates. Certain estimates, such as credit losses, payment rates, costs of funds, discount rates and the yields earned on credit card receivables, significantly affect the reported amount of credit card receivables that we report at fair value and our notes payable associated with structured financings, at fair value; these estimates likewise affect the changes in these amounts reflected within our fees and related income on earning assets line item on our consolidated statements of operations. Additionally, estimates of future credit losses have a significant effect on loans 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.

Loans and Fees Receivable

 

Our loans and fees receivable include loans and fees receivable, at fair value and loans and fees receivable, gross.

As of March 31, 2017 and December 31, 2016 , the weighted average remaining accretion period for the $25.2 million and $23.6 million , respectively, of deferred revenue reflected in the consolidated balance sheets was 11 months and 11 months , respectively.

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

For the Three Months Ended March 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		(0.4		)		(0.4		)		(9.9		)		(10.7		)
Charge offs		0.4				0.8				14.6				15.8
Recoveries		(0.4		)		(0.3		)		(0.6		)		(1.3		)
Balance at end of period		$	(1.8	)		$	(2.0	)		$	(35.7	)		$	(39.5	)

    

An aging of our delinquent loans and fees receivable, gross (in millions) by class of receivable as of March 31, 2017 and December 31, 2016 is as follows:

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 ultimately owed to consumers associated with reimbursements in respect of one of our portfolios.

Income Taxes

W e experienced an effective income tax expense rate of 45.9% for the three months ended March 31, 2017 , compared to an effective income tax expense rate of 4.2% for the three months ended March 31, 2016 .  Our effective income tax expense rate for the three months ended March 31, 2017 is above the statutory rate principally due to interest that we accrued on unpaid federal tax liabilities.  Our effective income tax expense rate for the three months ended March 31, 2016 is below the statutory rate principally due to income during that period of our U.K. subsidiary that was not subject to tax in the U.S. and the U.K. tax on which was fully offset by the release of U.K. valuation allowances in that period.

 

                We report potential accrued interest and penalties related to both our accrued liabilities for uncertain tax positions and unpaid tax liabilities, as well as any net payments of income tax-related interest and penalties, within our income tax benefit or expense line item on our consolidated statements of operations. We likewise report the reversal of such accrued interest and penalties within the income tax benefit or expense 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 both the three months ended March 31, 2017 and 2016, we included $0.2 million of net income tax-related interest and penalties within those periods’ respective income tax expense line items.

 

               In December 2014, we reached a settlement with the IRS concerning the tax treatment of net operating losses that 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 $7.3 million at March 31, 2017 ; this amount excludes unpaid interest and penalties on the tax assessment, the accruals for which aggregated $3.6 million at March 31, 2017 .  An IRS examination team denied amended return claims we filed that would have eliminated the $7.3 million assessment (and corresponding interest and penalties), and we filed a protest with IRS Appeals. Pending the resolution of this matter, and as is customary in such cases, the IRS filed a lien in respect of the $7.3 million assessment described herein. To the extent we are unsuccessful in resolving this matter with IRS Appeals to our satisfaction, we plan to litigate this matter.

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.

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. 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. While we are continuing to evaluate the effect that ASU 2016-13 will have on our consolidated financial statements and related disclosures, 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 would require 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. 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. We do not plan to early adopt the guidance. The scope of ASU 2014-09 excludes interest and fee income on loans and as a result, the majority of our revenue will not be affected; however, our review is ongoing. We do not expect the adoption of this standard to have a material impact on our consolidated financial statements.

    

Subsequent Events

 

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

 

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

As of both March 31, 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 three months ended March 31, 2017 and 2016 were generated outside of the U.S.

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

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

Three months ended March 31, 2017		Credit and Other Investments				Auto Finance				Total
Interest income:
Consumer loans, including past due fees		$	18,830			$	7,029			$	25,859
Other		101				—				101
Total interest income		18,931				7,029				25,960
Interest expense		(5,594		)		(223		)		(5,817		)
Net interest income before fees and related income on earning assets and provision for losses on loans and fees receivable		$	13,337			$	6,806			$	20,143
Fees and related income on earning assets		$	2,779			$	22			$	2,801
Servicing income		$	857			$	232			$	1,089
Depreciation of rental merchandise		$	(27	)		$	—			$	(27	)
Equity in income of equity-method investee		$	334			$	—			$	334
(Loss) income before income taxes		$	(387	)		$	1,732			$	1,345
Income tax expense		$	(33	)		$	(585	)		$	(618	)
Total assets		$	306,721			$	64,402			$	371,123

During the three months ended March 31, 2017 and 2016 , we repurchased and contemporaneously retired 6,702 and 122,981 shares of our common stock at an aggregate cost of $18,000 and $371,000 , 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.

We had 1,459,233 loaned shares outstanding at March 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.

 

Our equity-method investment outstanding at March 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: