Atlanticus Holdings Corporation — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. Dollar amounts below are in millions unless stated otherwise. Atlanticus provides financial technology and services to lenders serving financially underserved consumers, and invests in receivables. Its reportable segments are Credit and Other Investments and Auto Finance.
Key financial results
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Total interest income | $21.5 | $16.9 | $39.8 | $34.4 |
| Net interest income before fees and loan-loss provision | $16.7 | $12.4 | $30.3 | $25.3 |
| Net income attributable to controlling interests | $0.3 | $1.4 | $4.8 | $3.4 |
| Basic and diluted EPS | $0.02 | $0.10 | $0.35 | $0.24 |
| Operating cash flow | Not separately presented for the quarter | $12.7 | $(10.2) |
- Q2 net interest income, fees and related income on earning assets was $17.9 million, down from $29.1 million a year earlier. The six-month figure was $39.6 million, versus $62.5 million. The filing attributes the decline principally to runoff of rent-to-own and legacy credit-card portfolios, partially offset by growth in newer lending.
- Q2 pre-tax income was $0.9 million and income tax expense was $0.7 million. Six-month pre-tax income was $5.7 million and tax expense was $0.9 million. The Q2 effective tax rate was unusually high at 70.6%, largely because tax interest and penalties were significant relative to pre-tax income.
- Six-month operating cash flow improved to $12.7 million, while investing activities used $40.0 million and financing activities provided $7.6 million. Unrestricted cash fell to $30.4 million at June 30 from $51.0 million at year-end; restricted cash was $16.9 million.
- Total assets were $300.3 million and total equity was $16.1 million at June 30. Loans and fees receivable, net, were $198.2 million, up from $141.9 million at year-end. The allowance for uncollectible loans and fees receivable rose to $24.2 million from $21.5 million.
- At June 30, notes payable at face value were $103.6 million, related-party notes were $20.0 million, structured-financing notes at fair value were $15.6 million, and convertible senior notes had a $61.9 million carrying value. The filing reports weighted-average rates of 4.8% on revolving facilities and 5.1% on amortizing facilities; the related-party term loan bears 9.0% interest.
- Managed receivables in Credit and Other Investments were $201.4 million at quarter-end. The segment’s managed receivables delinquency rates were 8.2% at least 30 days past due and 3.4% at least 90 days past due; its total yield ratio was 36.8% and adjusted charge-off ratio 11.6%. Auto Finance managed receivables were $80.9 million, with 12.3% at least 30 days past due, 1.7% at least 90 days past due, and a 38.0% total yield ratio. These are management-defined portfolio measures, not GAAP margins.
Material changes versus prior comparable periods
- Q2 interest income increased 27% year over year, reflecting growth in point-of-sale and direct-to-consumer receivables and Auto Finance. Point-of-sale and direct-to-consumer receivables grew from $75.4 million at June 30, 2015 to $162.7 million at June 30, 2016.
- Despite higher interest income, Q2 net income attributable to controlling interests declined to $0.3 million from $1.4 million. Fees and related income on earning assets fell to $5.9 million from $12.8 million, primarily because rental revenue and credit-product fees declined.
- Six-month net income attributable to controlling interests rose to $4.8 million from $3.4 million. Results included a $5.0 million reversal of a U.K. VAT-related liability after HMRC ended its review and refunded the related claims, and a $1.0 million gain on repurchase of convertible notes.
- Six-month provision for losses on loans and fees receivable increased to $15.5 million from $9.1 million. Management attributed the increase mainly to larger newer-product receivables, rather than deterioration in credit quality.
- Rental revenue and related depreciation declined substantially as Atlanticus curtailed rent-to-own originations in late 2015 and discontinued new originations in 2016. Depreciation of rental merchandise was $6.3 million for the first half, versus $22.8 million a year earlier.
Outlook, risks and unusual items
- Management expected point-of-sale and direct-to-consumer receivables to continue growing and anticipated modest growth in managed receivables through 2016, subject to new retail partners, existing-partner expansion, funding availability and originations. It expected additional borrowing and higher quarterly interest expense as the business grew.
- Management expected legacy credit-card and rent-to-own income to continue declining. It also anticipated higher charge-off rates in newer Fortiva receivables as vintages mature, and stated that growth in these products would increase operating and marketing costs. The company cautioned that fixed infrastructure costs could pressure consistent profitability if revenue growth or cost containment proved insufficient.
- A $20.0 million related-party term loan was due in a single payment on November 22, 2016. On July 28, 2016, after quarter-end, Atlanticus borrowed an additional $20.0 million under the agreement, bringing the facility to its $40.0 million limit. The loan is secured and bears 9.0% interest. Management described near-term refinancing risk as low, but the maturity remains significant.
- The company had a $7.3 million unpaid IRS assessment and $3.1 million accrued interest and penalties at June 30. The IRS was reviewing amended-return claims that, if approved, could eliminate both amounts. Atlanticus also disclosed $128.6 million in unfunded consumer credit commitments and $9.4 million in unfunded auto floor-plan commitments.
- Fair-value measurements for certain receivables and structured-financing liabilities rely on Level 3 discounted-cash-flow estimates and unobservable assumptions, including yields, payment rates, credit losses and discount rates. Actual results could differ materially from those estimates. The company also disclosed dependence on subprime receivables, external funding, a limited number of major retail partners, issuing-bank relationships, and third-party processing systems, alongside consumer-protection, regulatory, cybersecurity and litigation risks.
- Management reported no pending legal proceedings expected to be material, no material change in internal control over financial reporting, and effective disclosure controls as of quarter-end. The filing states no material subsequent events requiring financial-statement adjustment.
Important facts for investors to verify
- Whether Fortiva originations and receivable growth can offset runoff in legacy portfolios and declining rent-to-own revenue, while supporting consistent profitability.
- Portfolio performance as newer receivables season: delinquency trends, charge-offs, allowance adequacy, and the assumptions underlying fair-value estimates.
- Funding capacity, covenant compliance and repayment or refinancing plans for the $40.0 million related-party term loan due November 2016, as well as other facilities maturing in 2017.
- The outcome of the IRS amended-return review and the potential effect on the $7.3 million assessment and $3.1 million accrued interest and penalties.
- Retail-partner concentration and dependence on issuing banks and third-party processors; management disclosed the three largest retail partners generated over 45% of point-of-sale finance revenue in 2015.
- The extent to which reported earnings and operating cash flow depend on unusual items, including the U.K. VAT reserve reversal, convertible-note repurchase gain, portfolio reimbursements and timing of accrued-liability payments.