Atlanticus Holdings Corporation — Q2 2013 Form 10-Q
Reporting period: Three and six months ended June 30, 2013; filed August 13, 2013. Atlanticus provides financial products and servicing to primarily subprime consumers. Its continuing reportable segments are Credit Cards and Other Investments and Auto Finance. Most legacy U.S. credit card accounts are closed and their receivables are liquidating; growth initiatives include U.K. cards and private-label merchant credit. The 2012 comparison includes discontinued operations from businesses sold in August 2012, so continuing-operations results are the more comparable measure.
Financial performance and position
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Interest income | $16.8 million | $23.1 million | $36.7 million | $48.4 million |
| Fees and related income on earning assets | $10.2 million | $14.4 million | $17.0 million | $64.3 million |
| Net interest, fees and related income after credit losses/provision | $10.1 million | $6.9 million | $22.0 million | $13.2 million |
| Continuing-operations loss | $(9.8) million | $(9.4) million | $(12.8) million | $(17.7) million |
| Net loss attributable to controlling interests | $(9.8) million | $(5.7) million | $(12.9) million | $(10.2) million |
| Basic loss per share from continuing operations | $(0.71) | $(0.42) | $(0.93) | $(0.79) |
Amounts are rounded. Q2 2012 and first-half 2012 net loss benefited from discontinued-operations income of $3.4 million and $7.2 million, respectively. Q2 2013 results included a $2.4 million write-off of a note received from buyers of the former JRAS auto dealership business. First-half 2013 also included approximately $0.9 million of interest and penalties associated with uncertain tax positions.
- Cash flow: For the six months, operating activities used $14.2 million, investing activities provided $34.6 million, and financing activities used $26.5 million. Unrestricted cash declined $7.0 million to $61.0 million; restricted cash was $15.0 million at June 30.
- Balance sheet: Total assets were $351.4 million versus $380.4 million at year-end 2012. Total liabilities were $347.0 million and total equity was $4.4 million, down from $19.2 million.
- Debt and tax exposure: Notes payable at face value were $42.0 million; structured-financing notes carried at fair value were $113.6 million; convertible senior notes had a $95.6 million carrying value and $139.9 million face amount. Income tax liability was $61.0 million, substantially related to uncertain tax positions.
- Receivables: Net receivables carried at net realizable value were $76.4 million; receivables at fair value were $15.7 million, and receivables pledged under structured financings at fair value were $107.3 million. The allowance for uncollectible loans and fees was $13.6 million.
Material changes versus prior periods
- Interest income fell year over year as credit card and auto receivables continued to liquidate. Management said, absent portfolio acquisitions, it expects interest income to decline for the next several quarters, with only limited offset from growth in merchant credit and U.K. cards.
- Q2 continuing-operations loss widened modestly year over year; first-half continuing-operations loss narrowed. The comparison is affected by large prior-year fair-value income and charge-offs, as well as the 2012 discontinued operations.
- Credit losses on fair-value receivables fell substantially year over year: charge-offs were $4.4 million in Q2 and $10.1 million in the first half, compared with $17.3 million and $72.9 million, respectively. Management attributed the trend largely to portfolio liquidations and lower charge-offs, while noting fair-value results remain assumption-sensitive.
- Servicing income rose to $2.6 million in Q2 and $5.2 million in the first half, reflecting new third-party servicing relationships. Marketing and solicitation expense increased to $2.6 million in Q2 and $4.5 million in the first half as new products were pursued.
- Notes payable at face value increased from $26.7 million at year-end to $42.0 million, while fair-value structured-financing notes declined from $140.1 million to $113.6 million. Total assets and equity contracted.
- In June, Atlanticus increased its ownership in a credit-card receivables investee from 50.0% to 66.7%, but retained equity-method accounting because investor voting and veto rights prevent control.
Outlook, risks and unusual items
- Management expects legacy receivables to keep contracting and says new merchant-credit and U.K. card growth is not expected to offset that contraction in the near term. It expects lower interest expense in future 2013 quarters versus comparable prior-year periods and a relatively stable net interest margin in the low-to-mid teens.
- Management expects higher provisions on net-realizable-value receivables as new products grow, primarily reflecting volume rather than deteriorating credit quality. It anticipates generally stable legacy-portfolio charge-off performance, with possible increases as newer products season.
- Management cautioned that fixed overhead is not declining as quickly as receivables. Credit Cards and Other Investments cash inflows cover direct variable costs and only part of overhead; failure to reduce costs or expand revenue may pressure liquidity and profitability.
- Liquidity and funding remain important risks. The company reported $40.0 million of facilities that could present near-term refinancing needs, though management assessed imminent refinancing risk as low. It also cited constrained subprime funding markets and dependence on bank and servicing relationships.
- Fair-value assets and liabilities rely on Level 3 discounted-cash-flow estimates, including projected yields, payment rates, credit losses and discount rates; changes in assumptions or actual performance could materially affect reported earnings.
- Uncertain tax positions could result in significant future payments. Management said resolution, including IRS matters involving 2007 and 2008, may be several years away.
- On August 5, 2013, after quarter-end, the company received $10.0 million of escrowed proceeds from its 2012 sale of the Investments in Previously Charged-Off Receivables segment. The filing reported no other subsequent events requiring adjustment.
- Other commitments included $39.0 million of unfunded merchant-credit lines, $5.8 million of floor-plan financing commitments, and a $9.1 million potential early-termination penalty under a processing-services contract. The company said it did not expect contingent commitments to result in material payments; it reported no material pending legal proceedings.
Important facts for investors to verify
- Whether merchant-credit and U.K. card growth can generate sustainable earnings and cash flow sufficient to offset shrinking legacy portfolios.
- Whether unrestricted cash held across subsidiaries is available to meet parent-company needs, and how operating cash use and upcoming facility maturities evolve.
- The assumptions supporting fair-value receivables and structured-financing liabilities, and the sensitivity of earnings to actual collections, credit losses and discount rates.
- The outcome and potential cash cost of uncertain tax positions underlying the $61.0 million tax liability.
- The effect of the JRAS note write-off and other unusual reimbursements or fair-value changes on recurring results.
- Whether overhead reductions and credit performance keep pace with portfolio contraction and new-product expansion.